What Does Earn Out Mean in Commercial Real Estate?

What Does Earn Out Mean in Commercial Real Estate?

In commercial real estate, an earn-out refers to a financial arrangement where a portion of the purchase price or a loan disbursement is contingent upon the property achieving certain performance milestones after the initial transaction. This is typically used in cases where the property's future income or value is uncertain at the time of sale or financing.

For example, a property buyer might agree to pay a base price upfront, with additional payments (the "earn-out") being made if the property reaches specified occupancy rates, income levels, or other performance targets. In a loan context, a lender might withhold part of the loan amount and only release it once the property demonstrates improved financial performance, such as achieving a higher net operating income (NOI).

Earn-outs help mitigate risk for both buyers and lenders by ensuring that additional payments are tied to the property's actual performance rather than speculative projections.

Earn Out Example

In a hypothetical commercial real estate deal, a buyer agrees to purchase a retail center for $10 million upfront, with an additional $2 million "earn-out" contingent on the property reaching 90% occupancy within the next two years. If the occupancy hits that target, the buyer pays the seller the extra $2 million. If it doesn't, the buyer only pays the initial $10 million, reducing the overall cost. This allows the buyer to hedge against the risk of underperformance while offering the seller potential upside.