As published in Scotsman Guide's Commercial Edition, March 2007.
When many people start a commercial mortgage business, they start as a mortgage broker, banker or correspondent. This is primarily because of their limited access to capital or limited experience in the business.
Over time, however, they acquire expertise, acumen and a track record. When that happens, they might gravitate toward an alternative business model that appears more lucrative -- one in which they originate their own deals, underwrite them and fund them with money from third-party private investors.
Unfortunately, as people in these companies soon realize, the economics are still somewhat limited. They end up on the proverbial treadmill of constantly having to replenish their deal flow with new transactions to provide a consistent revenue stream.
In many situations, these companies keep the origination fees and give the private investor the coupon on the underlying loan minus a small servicing spread. They can miss out on the opportunity to be a hard-money lender and earn the interest income spread they would get if they were to portfolio the loans within their company.
After establishing themselves as brokers -- developing the contacts, customers and referral network to sustain a business -- there is another step that mortgage companies could consider. That is to become a direct hard-money lender, moving from broker to banker to lender.
Evolving from a broker to lender requires a few salient items: investor capital, strong underwriting and servicing platforms, and a credit facility for financing the loan portfolio.
For many hard-money lenders, 100 percent of every loan is funded through third-party investors who provide the liquidity to fund the loans. Those third parties, however, may have other business priorities or may have timing constraints. They may not always be accessible or responsive to the timing and needs of your borrowers. Further, relying on a finite pool of investors creates inherent capital constraints that can limit the growth of your loan portfolio.
The solution is to create a strong business relationship with one or two individual private investors who can provide the equity "haircut" money you need to support your loan-portfolio financing.
By converting to a full lender, you will see a different capital structure that could be less expensive and potentially more user-friendly for your customers. You can create positive leverage because you can obtain cheaper capital costs by using a lower-priced loan-portfolio credit facility. You will therefore have more funds to support the growth of your loan portfolio.
When you are a commercial broker or banker, you do not need to use your resources on underwriting, due diligence and servicing. Frequently, your deals are shipped out to another lender's shop, where the actual underwriting takes place or a brief summary is prepared for your private investors.
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