Clay Sparkman
As I pointed out in a previous mailing, our private money lending programs tend to be fairly rigid with regard to LTV requirements, but quite forgiving with regard to other issues. One of the nice things about private money is that it allows for creative problems solving. I have put many transactions together that initially didn’t appear to be doable, simply by seeking out a creative way to bridge the gap.
Let me give you one example. Say that you have a client come to your office and they want to buy a commercial building in Seattle and they need financing. The borrower is strong and the property is prime but the construction on the building is only 90% completed and there are no tenants yet, and thus no income, and in addition to all that, there is no appraisal and the buyer doesn’t have the time to wait for a commercial appraiser as this is a distress sale situation. So I would say that this guy might have a tough time getting bank financing, right? After some consideration, you decide that this is a good fit for private money. You check with me and find out that we will loan up to 65% LTV against the value of the property given your particular scenario. Now let’s say that the buyer has negotiated a purchase price of $800,000 for the property and he has $80,000 (10%) for the down payment. At 65% it appears that he may need to bring $280,000 (plus loan fees and closing costs) to the table to make this loan work, and so you are thinking that you’ve reached a dead end.
Well, not so fast. That’s where the flexibility angle kicks in. There are at least four ways that you can meet the equity requirements without the buyer bringing additional cash to the table. Study these because if you are going to work with private money you should know them by heart.
Solution #1 – the borrower may borrow based on the current *true value* of the property (so long as the true value can be reasonably determined on a 90% completed project). If he can demonstrate that he is buying well, and that the true value is higher than the purchase price, then we will tend to base our LTV on the true value of the property. In this case, if it is sufficiently demonstrated to us that the current true value of the property is $1.3MM, then we would be willing to arrange to loan enough to cover the purchase price ($800k) plus the loan fees and closing costs (this would vary depending on what the broker is charging, but let’s say $50k), minus the $80k down. Our loan here would be $820,000. The front-end LTV here (LTV at the close of escrow) is only 63% but note that we would require the $80k down payment at any rate with a new borrower because aside from LTV calculations we like to see sufficient “skin in the game” until we have some experience on projects with a particular borrower. As we get to know a borrower and they build a track record with us, this requirement diminishes significantly. Also note that in order to make this scenario work, the borrower needs to demonstrate one or more of the following: (a) funds to complete the project, (b) that the remaining 10% is not critical to the security of the property or to the marketability, (c) that there is a buyer ready to go under contract to buy the property as is, or (d) some other clear path to completion of the property or early exit.
Solution #2 – the borrower may borrow based on the projected value of the property. (This is our preferred modus operandi.) Say that he needs an additional $100,000 to complete the construction on the building, but that the building will be valued at $1.4M upon completion, then we would consider arranging a loan of $900,000 to cover both the purchase price and the construction fund. We would hold the construction fund money in our client’s trust account and disburse it as the work is completed on the project. The borrower will only need to bring in enough in this scenario to cover closing costs.
Solution #3 – the borrower may be able to persuade his seller to carry back a portion of the sales price as short-term debt. Particularly if the seller is in a distress situation, he may be willing to negotiate on this point. So in our example, let’s say that the buyer is able to convince the seller to carry back $400,000 of the sales price in second position subordinate to a $450,000 loan arranged by Fairfield (to cover the balance of the purchase money plus the loan fees and closing costs plus the funds to complete the project minus the $80,000 down payment).
Solution #4 – it may be the case that the borrower has additional real estate assets that he is willing to pledge as collateral to make up for the shortfall in down payment money. We are always willing to consider additional collateral to make a transaction come together. Say the borrower has another commercial building, this one in Twin Falls, Idaho, and that it is worth 1.5M with $500k owed against it. We would most likely be willing to make the loan, with the borrower bringing in $80,000 cash and the Idaho building as additional security for the transaction. And if the borrower is concerned about tying the building up, because he has plans to sell it or refinance it in the future, than we negotiate and write into the loan a specific release clause provision stating that we are willing to release the Idaho property as security in exchange for a principal reduction.
Keep in mind that these solutions can be brought to bear in combination, so that all four may come into play in order to bridge the gap for any particular loan scenario. Private money is flexible and creative and for this reason often takes up where the other options leave off. (In these moments, it tends to tap dance away from the competition.) I have often said that if the banks ever acquire imaginations, I will be out of business, but in fact I’m not worried about it because it isn’t going to happen. The banks are not interested in creative problem solving because it requires too much special handling. The banks prefer to batch process the plain vanilla loans–the kinds of loans where the whole story can be fit into a series of boxes–and then leave the loans which must be hand crafted one by one to people like us. So come join us for some loan crafting and some creative problem solving. It is not only lucrative but it is fun!
– Clay (clay@privatemoneysource.com, 503-476-2909)
Clay is Vice President of Fairfield Financial, a primary source for private money since 1964. Fairfield is currently targeting loans in OR, WA, AK, CA, CO, ID, FL, GA, ID, MT, NV, NY, OK and TX. To submit a loan to Fairfield for consideration: http://www.privatemoneysource.com/loanproposal.php
Tags: commercial lenders, Commercial loans, construction loans, finding lenders, hard money borrowing, hard money brokering, hard money loans, private money borrowing, private money brokering, private money loans, Quick flip loans, real estate investing, real estate rental
