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.
Qualifying Problems
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.
Privacy Concerns
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.
More Money
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.
Investment Parameters
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.
Don Konipol
Don H Konipol has a BS in Economics and an MBA in Finance from
the University of Michigan and is a licensed Texas Real Estate
Broker and Mortgage Broker. Mr. Konipol is General Partner of the
Managed Mortgage Investment Fund LP, a private limited partnership
that invests in short term, high yield private mortgage notes. He
can be reached at 832.577.8838 or by email at dkonipol@yahoo.com.
