The thresholds in a burn-down are the part everyone negotiates. The NOI definition and the consecutive-quarter rule are what set the release date.
A recourse burn-down reduces a sponsor's payment guarantee in steps as the property passes performance tests written into the loan agreement. On an illustrative $40.0M loan with a 25 per cent guarantee, $10.0M falling to $4.0M at an 8.0 per cent debt yield and to nothing at 9.5 per cent, both tested on trailing twelve-month NOI for two consecutive quarters, the first step arrives in quarter 7 and the last in quarter 10, although the run-rate NOI passes 8.0 per cent in quarter 4. The definition of NOI, not the threshold, decides how long the sponsor is on the hook.
Worked in full in How to Read a Real Estate Loan Agreement by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Bridge and value-add loans are often non-recourse except for bad-boy carve-outs plus a partial payment guarantee covering the risk the lender cares about most: that the business plan stalls. The burn-down releases that guarantee once the plan has demonstrably worked. Three drafting points set the date: the metric (debt yield, DSCR or occupancy), the NOI it is measured on (trailing, in-place or annualised), and how many consecutive test dates must pass.
| Input | Value |
|---|---|
| Loan | $40,000,000 |
| Guarantee until the first test is met | 25% ($10,000,000) |
| Guarantee after debt yield ≥ 8.0% (NOI ≥ $3,200,000) | 10% ($4,000,000) |
| Guarantee after debt yield ≥ 9.5% (NOI ≥ $3,800,000) | Released |
| Test basis | Trailing 12-month NOI, 2 consecutive quarters |
| Annualised NOI at closing | $2,400,000 |
| Lease-up | +$200,000 a quarter to $4,000,000 |
Each quarter's NOI is a quarter of the run-rate. The trailing twelve-month figure adds the last four quarters, so on a steady lease-up it sits $300,000 below the current run-rate: it still carries the three weaker quarters behind it.
| Quarter | Run-rate NOI, $ | Run-rate DY | Trailing NOI, $ | Trailing DY | Guarantee, $ |
|---|---|---|---|---|---|
| 1 | 2,600,000 | 6.50% | 2,450,000 | 6.12% | 10,000,000 |
| 2 | 2,800,000 | 7.00% | 2,550,000 | 6.38% | 10,000,000 |
| 3 | 3,000,000 | 7.50% | 2,700,000 | 6.75% | 10,000,000 |
| 4 | 3,200,000 | 8.00% | 2,900,000 | 7.25% | 10,000,000 |
| 5 | 3,400,000 | 8.50% | 3,100,000 | 7.75% | 10,000,000 |
| 6 | 3,600,000 | 9.00% | 3,300,000 | 8.25% | 10,000,000 |
| 7 | 3,800,000 | 9.50% | 3,500,000 | 8.75% | 4,000,000 |
| 8 | 4,000,000 | 10.00% | 3,700,000 | 9.25% | 4,000,000 |
| 9 | 4,000,000 | 10.00% | 3,850,000 | 9.62% | 4,000,000 |
| 10 | 4,000,000 | 10.00% | 3,950,000 | 9.88% | 0 |
Trailing debt yield = sum of the last four quarters' NOI ÷ loan balance
Quarter 6: ($3,000,000 + $3,200,000 + $3,400,000 + $3,600,000) ÷ 4 = $3,300,000, and $3,300,000 ÷ $40,000,000 = 8.25%. With quarterly NOI in column C and the loan in F1, the test in row 10 is =AND(SUM(C7:C10)/$F$1>=8%,SUM(C6:C9)/$F$1>=8%), two consecutive passes.
The run-rate reaches 8.0 per cent in quarter 4. The trailing figure first passes in quarter 6, and the second consecutive pass needed to burn down comes in quarter 7, twenty-one months after closing. The full release follows the same pattern: run-rate 9.5 per cent in quarter 7, trailing 9.62 per cent in quarter 9, release in quarter 10, at thirty months. On a run-rate test with the same two-quarter rule, the steps would come in quarters 5 and 8, at fifteen and twenty-four months.
A payment guarantee pays the lender's loss up to the cap in force at the time of the claim. Suppose a default leaves the property worth $36,000,000. The lender is owed $41,500,000, the loan plus six months' interest at 7.5 per cent, and recovers $33,840,000 after enforcement costs of 6 per cent of value: a loss of $7,660,000.
| Default in | Cap in force, $ | Guarantor pays, $ | Lender bears, $ |
|---|---|---|---|
| Quarters 1 to 6 | 10,000,000 | 7,660,000 | 0 |
| Quarters 7 to 9 | 4,000,000 | 4,000,000 | 3,660,000 |
| Quarter 10 onwards | 0 | 0 | 7,660,000 |
The cap is not the exposure: before the first step the guarantor pays the whole loss because it is below $10.0M. On a trailing test the sponsor carries that full exposure for six quarters; on a run-rate test, for four.
| NOI added a quarter, $ | First step, trailing | Release, trailing | First step, run-rate | Release, run-rate |
|---|---|---|---|---|
| 150,000 | 8 | 12 | 7 | 11 |
| 200,000 | 7 | 10 | 5 | 8 |
| 300,000 | 6 | 8 | 4 | 6 |
The trailing figure lags the run-rate by one and a half quarters of NOI growth, so the gap between the two tests is one quarter on a slow lease-up and two on a faster one. A sponsor with a fast plan gains most from negotiating the NOI definition; a lender with a fast plan in front of it should insist on the trailing figure, since run-rate NOI is the easiest number to dress up with rent-free leases signed just before a test date.
Modelling the burn-down from the business plan's run-rate. A sponsor who expects the guarantee to fall to $4.0M at month twelve, when the run-rate first hits 8.0 per cent, will carry $10.0M for another nine months on this drafting, and may have committed that balance-sheet capacity elsewhere. Read the NOI definition, the consecutive-quarter requirement and any additional conditions, such as no event of default or a minimum occupancy, before putting a date on the release. And check what survives: the bad-boy carve-outs normally stay in place after the payment guarantee is gone.
Terms vary widely by lender and market; the loan, NOI path and loss are illustrative and not a description of any market standard.
The recourse provisions, from carve-outs to the workout, are set out with the free working documents for this book. The exposure under the carve-outs that remain after the burn-down is worked in how a bad-boy guarantee turns into full recourse.
A partial payment guarantee, often a quarter to a half of the loan, that steps down when the property meets debt yield, DSCR or occupancy tests. In the illustrative case a $10.0M guarantee on a $40.0M loan falls to $4.0M once trailing NOI reaches $3,200,000, an 8.0 per cent debt yield, and is released at $3,800,000, 9.5 per cent, each for two consecutive quarters.
Up to the cap in force when the claim is made. A default that leaves a $7,660,000 loss is paid in full by the guarantor while the cap is $10,000,000; after the first step the guarantor pays $4,000,000 and the lender bears $3,660,000; after the release the lender bears all of it.
Because trailing NOI still contains the weaker quarters of the lease-up. Adding $200,000 of annual NOI a quarter, trailing NOI sits $300,000 below the run-rate, so an 8.0 per cent debt yield is passed in quarter 6 instead of quarter 4, and the burn-down comes six months later.
This article is one calculation from How to Read a Real Estate Loan Agreement. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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