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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   February 2010

Making Sense of Private Money's New Parameters

You must comprehend lenders' criteria to guide hard-money loans to closing

When traditional commercial lenders turn down their deals, many mortgage brokers and borrowers are increasingly turning to private-money -- aka, hard-money -- lenders for funding.

Although these lenders often have fewer restrictions than traditional funding sources, they also have changed their parameters in today's difficult lending environment.

It is therefore important for brokers to know what goes through private investors' minds before they agree to fund a loan.

By seeing deals from a private-money investor's perspective, you likely will have more success finding funding for your clients. Here's what to seek.

Look at equity

In many areas, property values have decreased 30 percent or more. Further, rents continue to decline, and vacancies are increasing. Capitalization rates are climbing because of the greater risk now associated with commercial real estate, as well as because of the influx of real estate owned properties.

These factors have contributed to lower loan-to-value ratios (LTVs) than investors previously required to make loans.

Mortgage brokers must be aware that equity is the key in today's market, and it often is the first thing that private-money investors look at to determine if they will fund a loan. Maximum LTVs vary by lender as well as by property type. Rough estimates in today's lending market are 55-percent LTV for commercial properties, 50 percent for industrial properties and 35 percent for vacant land.

Equity is the investor's ultimate protection in case of default. In fact, equity can make up for a lot of mistakes.

A private investor knows that there may be credit challenges, income-documentation difficulties and other situations that may arise in placing a loan with institutional sources. If the borrower has a lot of equity in the property and some ability to repay, a private investor likely will be interested in extending a loan to the borrower.

Tell the story

Once your borrower's deal passes the LTV test, a private investor will want to know the story behind the project. Why is the borrower is seeking a hard-money loan and willing to pay the higher rates and fees?

Granted, with few available sources of commercial money today, that question often has an easy answer. If this is not the case, there always is a story behind the loan.

Private investors want to know why they should fund this deal. Did an important tenant move out? Has the loan matured, and does the original lender want to be paid off? Does the borrower need cash to keep other real estate investments afloat? Is there another reason?

Be prepared to answer these questions. A hard-money loan may be the only solution to help some borrowers get back on their feet, but many private investors aren't willing to write checks purely based on the LTV, as many did in the past.

The loan scenario also should make sense. What are the monthly rents? Do they come close to servicing the monthly payment?

If there are vacancies, what is the prospect of getting tenants in the units? How fast? Are there any needed repairs? What is the borrower planning to do with the property?

Finally, the private investor wants to know borrowers' exit strategy. Do borrowers have a plan in mind, or are they just buying time? 

In many cases in today's tight lending environment, buying time might not necessarily be bad.

An investor approach

Ultimately, mortgage brokers should attempt to think like an investor and ask themselves whether they would fund the loan. If so, then you likely have a marketable private-money loan.

Taking an investor approach can be simple, but there also are some hairy situations that can arise. That's when you should consult a private-money expert.

Mortgage brokers can offer an important source of financing for borrowers to solve some of the difficult or unusual situations that may arise in a borrower's life. Working with private-money lenders presents an opportunity to help borrowers, earn a nice paycheck and in most cases, work with borrowers to refinance out of the hard-money loan once their situation has changed.


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