You've spent the last 4 months trying to get your client a mortgage on his investment property. You gathered all his personal, business and real estate financial information, for not only the property you're trying to finance but for all his business and property interests. You've done projections, forecasts and read through 200 page appraisals. You've put together a loan package, sent it to numerous commercial mortgage lenders, only to find out each one needed the same information filled out on their particular unique forms. So you've spent dozens of hours more transferring the same information to tens of different applications. You've spent numerous hours obtaining “additional information” for each potential interested lender. And now you've exhausted all possible institutional mortgage sources and still no loan.
Sound familiar? Perhaps you're new to the commercial mortgage field. You have been successful originating residential loans, took the NAMB Commercial Mortgage course and decided to expand your practice to include commercial and investment property mortgages. Or maybe you're already a commercial mortgage broker, successful in obtaining financing for some clients, but feel you just spin your wheels trying to obtain financing for others. The key to spending your time more productively is to understand when institutional commercial mortgage money is NOT available for your client. The key to earning a commission from these same clients is to understand what type of financing may be available for this same client.
Private mortgage loans are loans secured by real estate made by a private lender instead of a bank, lending institution or government agency. Private mortgage loans are short-term (ranging from six months to three years) hard money or asset based loans made to the professional real estate investor for the purchase, rehabilitation or equity cash out of real property. This means that the decision to lend is based on the equity and value of the property being put up as collateral, not on the borrowers credit. The security for the loan is enhanced because the loan represents a maximum of 65% – 70% of the appraised value of the income producing property. On non-income producing property (raw land, lots, construction money) a maximum of 55% loan to value is lent. Investors can expect to pay interest rates of 12% to 14% on first liens and 16% to 18% on second liens in this current low interest rate environment. Historically first lien yield of six points over prime has been obtainable.
Why are real estate investors willing to pay high rates to borrow private money?
When interest rates of 14% to 18% are added to four-to-eight points, the real estate investor/borrower is paying 20% plus annually for the money borrowed. Its obvious why this is a good deal for the private mortgage lender, but why should real estate investors be willing to pay these high rates when conventional mortgage money costs 7% to 10%? There are many reasons, but all fall into four categories.
The real estate investor/borrower and/or the real property does not qualify for an institutional mortgage loan. This can be anything from low borrower credit scores or too much borrower debt, to the borrower's properties not producing a sufficient enough income. Further, the property itself may not support the type of loan the borrower wants. Many institutional lenders will not loan amounts under $500,000; many will not lend second lien money even if there is significant equity in the property. If major repairs or rehabilitation is necessary, institutional lenders will not be interested unless the project is very large and the borrower has an extensive track record. In these cases the private mortgage lender may be the only resource available for the real estate investor/borrower.
Institutional lenders are concerned with both the appraised value of the property and borrower and property credit. Private mortgage lenders are only concerned with the appraised value, as long as the appraised value represents a fair market price. Hence, if a property is producing or can produce sufficient income to pay the note and the value of the property will fully secure the note and provide sufficient equity, then the borrower's credit is not an issue for the private mortgage lender.
The Need For Speed
Speed of closing the transaction. Mortgage money obtained from banking or institutional sources, called conventional mortgage money, usually takes between 60 and 90 days to fund. Institutional lenders need not only obtain appraisal of the value of the property, but also require detailed examination of the borrowers credit history and current financial status, as well as financial statements and tax returns, not only for the property collateralizing the loan but for all real property and business interests owned by the borrowing entity and the borrower himself.
Private mortgage lenders on the other hand can usually complete a transaction within seven-to-10 days. Since the property itself is the main criteria to be used to determine loan eligibility, much less information on the borrower and the borrower's other properties are required, resulting in a much quicker approval process. The private mortgage lender can make a decision within 24 hours of receiving information; institutional mortgage money must be approved by a loan committee that may only meet twice a month, and that may send the loan request back to the loan officer for more information, necessitating a further two week delay until the committee meets again.
Borrowers may not want or be able to provide personal financial information or go through the hassles of the application process associated with obtaining an institutional mortgage loan. The borrower may be going through a divorce or business separation and may not want his wife, partner, government, lawyers, etc. to obtain his personal financial statement. Additionally the borrower may not have all financial information on all his real properties and businesses up to date or complete; he may have filed for an extension on his latest tax return; his accountant may be behind in preparing his financial statements. While all these would negate or at least delay his getting an institutional mortgage, it should have no effect on the borrower's ability to obtain a private mortgage loan.
The real estate investor may be able to borrow more from the private or hard moneylender and therefore have less of his own capital invested in the property. Institutional mortgage lenders lend based on the lower of the cost of the property or appraised value of the property; private mortgage lenders lend based on the appraised value only. Hence the real estate investor utilizing a private or hard money loan is not penalized for purchasing the property at a significant discount to market value. Additionally, most private mortgage lenders do not have onerous seasoning requirements to make the loan.
The investment parameters for private mortgage loans differ considerably from those of institutional mortgage loans, as we partially discussed in the previous section. The most important parameter to be considered when evaluating a private mortgage loan request is loan to value. This is the ratio of the amount lent expressed as a percentage of the properties value. For example if an office building is worth $100,000 and we lend $65,000 total secured by this office building, then our loan to value ratio, or LTV is 65%.
Private mortgage lenders will typically lend up to 50% on raw land or undeveloped property; 65% on commercial income producing property such as office buildings, shopping centers, warehouses, etc. and 70% on residential income property such as a duplex or apartment complex. The key words here are up to; the maximum amount will be lent if all additional criteria are met and if the lender feels good about the loan, lower amounts can be lent if the loan or borrower is considered less than ideal. This is a gut decision made by the lender with an in depth understanding of the criteria being used and the experience of looking at many lending proposals.
The second parameter is the type of properties to lend on. This is often determined by the comfort the lender has in disposing of this type of property in case of default. All other things being equal, single use property which would take a year to sell is obviously less desirable than a multi tenant office building which would not only sell quickly at 65%-80% of market value, but which would be producing income with tenants paying rents while the property is up for sale.
The third investment parameter the private or hard moneylender is concerned with is the cash flow or income potential of the property being put up as security for the note. Although many private mortgage lenders are liberal in this area, the monthly interest payments to keep the note current must come from somewhere. If the property is rented out and is producing a cash flow after all expenses of an amount at least equal to the note payment, the monthly payments can be covered by the property income alone without the borrower having to come out of pocket. This adds a great degree of safety to the note. Cash flow from other income properties or other sources can be substituted for cash flow from the property being placed as collateral; however, the income to pay the mortgage payments must be available from some source.
The fourth major investment parameter the lender must consider is exit strategy. Very simply, this is how the borrower plans to repay the loan. Since most private mortgage loans are short term the private mortgage lender has a keen interest in finding out the borrower's exit strategy and in analyzing whether this exit strategy is viable, and the risk of this particular exit strategy. The particular exit strategy must have a reasonable chance of success.
Typical exit strategies include property sale before the note is due, refinancing the property with a long term mortgage loan, packaging the property with other properties owned or to be acquired by the borrower and obtaining a blanket mortgage on all the properties, borrowing on equity in other property owned by the borrower and selling a partnership interest in the property to an equity investor. Each of these strategies has numerous variations. The lender must determine the viability of any particular exit strategy.