In commercial real estate lending, an earnout clause lets you tap into extra loan proceeds once your transitional property hits predetermined performance goals.
Your lender will release additional funds through an existing loan structure after confirming that your property has achieved a defined benchmark.
The earnout will be built into your bridge loan, so you don’t have to take out a new loan or refinance an existing one.
This setup gives you a practical way to access more financing without triggering new closing costs or origination charges.
The basics
An earnout is a clause in a commercial real estate loan that lets the lender release more loan proceeds once your property hits a defined performance target.
The property must already be generating enough income at that point to support the additional debt.
For instance, a lender may release more money if your property completes renovations or raises its tenant income requirements.
The earnout only moves forward when the property meets certain DSCR or LTV metrics.
Note that an earnout is not a separate loan or a refinance. It’s simply an expansion of your original loan.
Because of this, you can access additional capital without the extra costs typically associated with securing a new commercial loan, such as closing charges or attorney fees.
When does an earnout become available in commercial real estate?
You can only get an earnout when your CRE property meets clear and measurable performance goals defined by your lender:
1. Debt service coverage ratio
Your lender may agree to release more capital when your property reaches a DSCR of 1.25x. To calculate this, they will refer to your most recent three months of stabilized income.
2. Loan-to-value
Another factor is how much equity the property now carries. If your loan closed at 65% LTV, for example, a lender might release additional proceeds after a new appraisal shows a stronger property value and reduces the LTV to about 60%.
3. Operating performance
Lenders will also test whether the property’s day-to-day performance has stabilized.
This can include hitting an occupancy level of 90% or higher or confirming updated rent rolls, as well as verifying that tenants meet stricter income requirements.
When will my lender release the earnout?
The extra funds won’t be available to you right away, even after your property already clearly meets the target metrics.
You still need to submit your updated financials, including rent rolls and operating statements. Sometimes, a lender may even request a new valuation.
This process may take 30 days or longer (especially when third-party underwriters or inspectors are involved).
Given the potential for delays, it pays to manage your cash flow and interest reserves carefully.
Consider your earnout as future liquidity instead of treating it as instant cash.
How do lenders handle interest reserve and accrual on earnouts?
In many bridge loans, the interest reserve only covers your original loan amount and won’t always account for the earnout.
If the earnout activates, your monthly payments may increase before the property reaches full stabilization.
Some lenders may also charge interest on the earnout holdback from the start of your loan, even if you haven’t drawn those funds yet, so be sure to factor this into your projections so that you’re not squeezed by tight NOI margins later in the deal.
How does an earnout affect your exit (sale or refinancing)?
When your lender releases the earnout funds near the end of the loan term, your principal balance increases.
This can lower your refinance DSCR or cut into what you take home in a sale.
Before you move forward with an earnout, verify that your exit strategy can support the larger balance, especially if your planned hold period is shorter than the amortization schedule.
Should you agree to an earnout in your commercial real estate loan?
You’ll want to weigh the timing and long-term impact before you decide.
An earnout gives you access to more capital once your property demonstrates stronger performance, avoiding the pressure of increasing the loan too early.
However, this approach works best only when your business plan is realistic and your timeline factors in review periods and documentation requirements.
It pays to add a cushion to your projections and revisit your DSCR assumptions, and remember that approvals and fund releases take time.
Get tailored advice for your commercial loan
Our team at Private Capital Investors can guide you through your commercial loan strategy, including how to structure and time an earnout.
Feel free to reach out at 972-865-6206 to connect with one of our specialists.
FAQs
How can I benefit from an earnout in commercial real estate?
An earnout allows you to access additional funds without paying new closing costs and attorney fees, or other charges tied to setting up a separate commercial loan. However, you can only access the added capital once your property meets the performance targets in your loan agreement, such as after renovations or when you have more occupants and stronger tenant income.
Do earnouts in commercial real estate come with risks?
Yes. There are a few potential risks in an earnout.
If your commercial property’s value drops, the increased loan amount could create an imbalance and place the loan at a disadvantage.
Your monthly payments may also rise sharply once an interest-only period ends and principal payments begin.
So before committing to an earnout structure, consult a qualified commercial real estate advisor to fully understand both the advantages and the potential downsides.
What are the different earnout types in commercial real estate loans?
Commercial real estate earnouts generally fall into three categories:
- DSCR earnouts activate when your property meets a specified debt service coverage ratio
- LTV earnouts are triggered when your property reaches a target loan-to-value ratio
- Operating performance earnouts are tied to metrics such as completed renovations or higher occupancy
Keep in mind that an earnout is not a separate loan or a refinance.
It is an increase to your existing loan, giving you access to more funding without incurring new loan setup expenses.
How can I negotiate an earnout in a commercial real estate loan?
To negotiate an effective earnout:
- Understand all the terms in your loan, especially the exact performance criteria required to activate the earnout.
- Keep track of the fees you avoid by using an earnout structure instead of initiating a new loan.
- Be ready to discuss terms with your lender so you can secure a structure that aligns with your business plan.
- Pay attention to the DSCR and LTV thresholds. They will determine when additional funds become available.
