When commercial real estate is partially vacant or undergoing lease-up, permanent lenders cannot fund full stabilized loan proceeds on Day 1. An Earn-Out Facility allows the borrower to close an initial loan advance today, with additional delayed-draw loan proceeds released upon hitting verified leasing and Net Operating Income hurdles.
Interest Accrual RuleInterest accrues only on funded proceeds; zero interest charged on unfunded earn-out commitment
Earn-Out Fee0.50% to 1.00% fee charged on delayed-draw proceeds upon funding
Earn-Out ExpirationIf leasing milestones are missed within earn-out window, the unfunded facility is cancelled
* Earn-out disbursements require updated rent rolls, tenant estoppel certificates, and title date-down endorsements.
Why Borrowers and Lenders Utilize Earn-Out Structures
In transitional value-add properties, a sponsor has made capital improvements but leases are still ramping up. Sizing a loan strictly on current in-place cash flow yields inadequate proceeds, while sizing on speculative future pro-forma exposes the lender to default risk.
An Earn-Out Facility solves this dilemma. The lender approves an aggregate commitment (e.g., $15,000,000), funds $12,000,000 on Day 1 based on in-place occupancy, and reserves $3,000,000 to be disbursed in earn-out draws as new tenant leases commence.
Earn-Out Release Hurdles: Debt Yield and Occupancy Tests
To unlock earn-out funds, the borrower must satisfy contractual credit tests defined in the loan agreement:
1. Net Operating Income (NOI) Hurdle: The property must achieve a verified trailing 3-month or 12-month NOI supported by executed tenant leases.
2. Debt Yield Test: The combined loan balance (Initial Advance + Earn-Out Draw) must satisfy the lender’s required minimum Debt Yield (e.g., 10.0% Debt Yield).
3. Tenant Verification: New tenants must be in physical occupancy, paying full unabated rent, with executed estoppel certificates confirming no landlord defaults.
Closing Title Date-Downs and Re-Amortization Mechanics
When an earn-out funds, the title company issues an ALTA Date-Down Endorsement confirming no intervening mechanic’s liens have attached to the property. Furthermore, the lender recalculates the monthly amortizing payment based on the increased principal balance, preserving the original amortization schedule.
Frequently Answered Questions
Common Questions About Commercial Loan Earn-Out Facilities & Future Funding Mechanics
Direct, transparent answers regarding underwriting standards, documentation, and process.
Earn-Out Basics
What is an earn-out in commercial real estate lending?
Direct Answer
An earn-out is a loan provision where a commercial lender holds back a portion of total approved loan proceeds at closing and releases the additional funds later once the property hits specific leasing, occupancy, or Net Operating Income milestones.
It allows borrowers to lock in future proceeds today without paying interest on unadvanced funds.
Interest Accrual
Do borrowers pay interest on unfunded earn-out money?
Direct Answer
No. In institutional commercial loans, interest accrues only on funds that have actually been disbursed to the borrower; zero interest is charged on the unfunded earn-out commitment until it is drawn.
Borrowers pay interest strictly on funded capital.
Missed Milestones
What happens if a property fails to achieve the earn-out leasing hurdles?
Direct Answer
If the borrower fails to achieve the required leasing hurdles before the earn-out availability window expires (typically 18 to 36 months), the unfunded facility is permanently cancelled, leaving the initial loan balance in place.
Failing to qualify for an earn-out is not a loan default; it simply forfeits the additional debt advance.
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