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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   August 2003

Do’s and Don’ts for Working Effectively with Your Hard Money Lender

A Primer for Borrowers

Recent economic events internationally and on Wall Street have created a sudden shortage of capital to finance many worthwhile commercial real estate transactions. This has resulted in many borrowers seeking financing from lenders with privately raised and administered capital, sometimes called “hard-money lenders.” These lenders fund a wide range of transactions, from local to national; loans from under a million dollars to under $100 million; construction loans to refinancing loans; and more. Most have one major theme in common, we are very busy (particularly lately). We need to review prospective projects quickly; and then speedily but carefully price, quote, finalize and close transactions.  

The following are some do’s and don’ts to think about as you undertake a loan with a hard-money lender.

DON’T send the lender an enormous pile of disorganized papers. Prepare a short deal synopsis, not more than two pages, which addresses the project and the loan requirements. Back this up with brief financial analyses, a map, photos, information on the borrower, and other supporting documents. Imagine a neat 6 page submission as compared to a 40 page disorganized pile of papers. Which do you think will receive the most attention the quickest?

DO describe the transaction: type of real estate project; location of real estate; type of loan; loan amount; equity available and source; term of loan; exit strategy; amount and types of debt that exist on the property; payoff situation; description of the borrower. 

DON’T ignore or try to hide the “hair” on the deal. This will come out through the due diligence carried out by your lender, and will cast a negative shadow over the deal. If there is “hair” on the deal, a brief overview of the “story,” or the events leading up to the story should be included.

DON’T tell the story of your life and the project’s entire life at the outset of your submission. Rather, start with the conclusion, the “therefore,” (project, loan amount, purpose and term), and then support the “therefore” with the supplemental information you will provide. The details of the “story” will probably come out during a telephone conversation at a later date.

DON’T expect your lender to be willing to do your deal unless there is an exit strategy in place. You should identify the exit plan in your initial submission, and be prepared to defend the strategy. Two exit plans are better than one. Your lender is not likely to be interested in not being able to be repaid when your loan matures.

DO provide last year’s profit and loss statement showing net operating income (NOI), as well as this year’s year-to-date profit and loss statement. 

DON’T include mortgage interest and depreciation in the financial or P&L statements. NOI before depreciation and debt service is what the lender will want to see. Don’t make your lender do the arithmetic.  

DO show actual vacancy information clearly, as well as management fees, reserves for replacement, etc. in the budgets. Assuming there will be no requirement for a management fee since the project is self managed is not useful. In the event of a default, the lender will most likely call in a professional management firm, and the cash flow must allow for this contingency. 

DO provide a detailed rent roll, (and list each vacancy), list every tenant, lease term, rental rate, pass-throughs, etc. Be sure that the numbers are all totaled and added correctly. 

DO make certain that the total square feet of the rent roll is equal to the total square feet of the building; or the number of units and the number of tenants plus vacancies, are equal, etc.

DON’T send a complete appraisal report with the preliminary submission. Rather, copy and send the “Opinion of Value” or “Value Reconciliation” page, (be sure it includes the date) and perhaps the 2 or 3 pages of worksheets that explain how the value was determined. At this point in the deal evaluation, your lender has little interest in the neighborhood characteristics of the town or the largest employers where the property is situated.

DO include a page or two from the phase I environmental assessment (including the date), if available. The section showing “Conclusions” is sufficient, plus the cover page or letter of transmittal, showing the name of the firm that carried out the study and the date of the report.

DON’T hire an environmental assessment firm or an appraiser, if you don’t already have the reports on file. You will expect your lender to automatically accept your selected third party consultant. Routinely, the lender will prefer to engage one of their own selection, later, if they elect to pursue the deal.

DO send along a copy of the local town’s vote(s) on zoning, permits, and other approvals, only if a to-be-built or expansion project, as applicable. Don’t send the entire package of minutes; extract the vote and note clearly the purpose of the particular document. 

DO include a few select color photographs. Obviously, a picture is worth many words, as well as a locator map, and 81/2 x 11 site plan.

DON’T send a full set of architectural and working drawings with your preliminary submission. What do you think your lender will do with another 5 pounds of paper?

DON’T send the lender originals. A busy, successful lender, (your preferred source of capital), probably receives dozens of deals every week. Keeping track of them is challenge enough, without being concerned about protecting your valuable originals. Also, returning them, if required, is time consuming and an unnecessary expense to your lender. Finally, you should be aware that it is your risk to send originals with your first submission. 

DON’T package up a number of different properties into one deal analysis. Each property must be evaluated and stand alone. A consolidated financial analysis and spread sheet will not help the lender to identify and study each property separately. Even if the properties must be consolidated so that the “losing” property is supported by a “winner,” each will require its own underwriting.

DON’T, at the outset, demand that the lender make a site visit. The lender’s time is of prime importance, and a site visit will not influence the lender to make a loan that is of little interest based on the documents. If the numbers and documents are a fit, the site visit will likely cement the deal, but not until then.

DON’T rely solely on your mortgage broker to make the deal. Shortly into the evaluation of the deal, the lender will probably want a direct conversation with the borrower. Offer a 3-way conference call including the lender, borrower and broker fairly early in the transaction based on your lender’s preference, to permit the lender and borrower to evaluate each other’s interest, style and objectives. 

DON’T permit the mortgage broker to reply to questions directed by the lender to the borrower during telephone conference calls. The lender usually has a specific purpose in inquiring of the borrower, and is expecting the borrower to respond. Failure, or inability, to respond, is as powerful a reply as a timely and detailed response. The broker’s input is valuable when he/she is called upon during such a telephone call, and also to follow-up when appropriate, perhaps later, as the deal develops.

DON’T arrange to do a deal with a selected lender until you have completed your initial due diligence on the lender, including the lender’s interests, experience, qualifications, and references. If, after a week or two of negotiations, you then suddenly determine that you are uncomfortable with the selected hard money lender, you have wasted a great deal of time for each of you as well as your borrower, and the lender will not be pleased with this sudden revelation. If the lender resists providing evidence of their ability to make the loan being contemplated fairly early, move on to another who is more cooperative.

DON’T expect anyone to provide 100% financing.

DO expect to invest between 15% and 25% in cash (or legitimate equity in the property’s value if the property has already been acquired.) You have heard, often enough, that there are no more no-cash deals. DO rely on this rule, particularly in the recent economic climate.

DON’T expect the lender to accept the difference between the price you actually paid for a recent acquisition and the appraised value if higher, as your share of equity. From the lender’s perspective, the price you paid in an arms length transaction is the market value, You may believe that you “stole” the property for substantially less than the appraised value. Your lender will probably congratulate you for your accomplishment, but the purchase price will nevertheless be the demonstrated market value.

DO expect the lender to recognize an appraised value that is significantly higher than the price you have recently paid for a property, if, and only if, you have successfully completed a significant number of bureaucratic accomplishments since the purchase date (such as obtaining full entitlement), have newly negotiated signed leases, or have physically improved the property, and you can prove it.

DON’T expect your lender to lend you operating capital. One of the best ways to demonstrate your capabilities as a developer/operator is to invest your own capital into the project to underwrite start-up expenses. And what is the collateral for a business start-up? Unless your lender is also your business partner, why should you be loaned the start-up money for your own business? 

DON’T expect your lender to rely solely on your enthusiasm for your deal as the only reason why your project will be a success. 

DO generate pre-leasing, pre-sales, or other demonstration of marketability. Market studies alone are seldom sufficient. Real prospects will ensure that your lender has serious interest in your project. 

As lenders, we often hear, “When you visit the property and see the market, the project will sell itself.”  No it won’t. First the numbers have to work, then the due diligence has to confirm the numbers and the reports, and finally the chemistry between the lender and the borrower has to coincide. The site visit puts the entire project into perspective. Only then, has the loan a high probability of closing.


 


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