Any commercial mortgage originator who has worked on putting together a new project knows that land loans are not as easy to fund as most other types of commercial real estate. That doesn’t mean obtaining a land loan is impossible, but it can be difficult.
One reason for this is that there are few lenders who specialize in raw land loans. Lenders are traditionally wary of lending on this property type, and it is important for originators to understand the key components that give lenders confidence to fund a deal.
“Borrowers who are under pressure for a quick closing can greatly benefit from land loans and use their proceeds for various purposes, including the acquisition of other property.”
Since most traditional lenders avoid land loans completely, a borrower is faced with the challenge of finding that unique lender who understands the nuances of this kind of loan. This is especially daunting when time is of the essence to close the deal.
Risky business
One of the main reasons why it can be difficult to find a lender for undeveloped property is that it’s very hard to ascertain the present and future value of a specific site. What’s the market going to be like six months from now for a given site? What about five years from now?
Other concerns to keep in mind include zoning restrictions and the size of a project that the zoning regulations allow. There are setback requirements and code restrictions for all structures.
There are a variety of reasons why most lenders steer clear of land loans due to the risk that comes with land — particularly with undeveloped properties or “raw land.” The fact is there are too many variables that can go awry from the time of closing on a land loan to when construction on the land is complete.
If progress stalls on a development, this can affect the property’s value, and consequently, the borrower’s ability to repay. It’s also more difficult for borrowers to sell land than to sell a building, in the event the property is used as collateral. When assessing a potential lender, it’s a good idea to ask them about their experience and track their record on land deals.
Essential requirements
Despite the difficulties, there is demand for this type of loan. Borrowers who are under pressure for a quick closing can greatly benefit from land loans and use their proceeds for various purposes, including the acquisition of other property. It can also be used as cash to fund day-to-day operations and to start construction on a plot of land or resume construction on another property owned by the borrower. The money can be used as cash-out financing and fund a different commercial real estate acquisition.
Land loans have various requirements and assessments that may be essential to complete the lending process. Some lenders may require four vital assessments: a phase 1 environmental report, a recent appraisal, a title search and a land survey.
The phase 1 environmental site assessment (ESA) reviews property for contamination and other liabilities, such as whether there are underground tanks on-site, if an endangered species lives on the property or if the site is culturally or historically significant. The report also assesses the property for wetlands, potential earthquake hazards, air quality and ecological resources.
In many states, contamination issues become the responsibility of the buyer if inherited. Contaminants, including radon, asbestos, mold and lead can pose significant risks to public health, and they must be removed before any development begins. If the report finds evidence of contamination, costs skyrocket and cause developmental delays, making loan repayment a risky prospect for the lender. For this reason, lenders want to see a clean environmental report before approving any land loan.
An environmental report involves several key steps, including a site visit to assess the property, an assessment of nearby properties, and a review of historical records and public records for indicators of potential issues. There also should be interviews with site representatives, such as the buyer, seller and former owners. If the environmental report comes back clean, borrowers have passed the first hurdle to securing their land loan.
Land appraisal
The appraisal process uses an objective third party to evaluate the land and formulate an estimate of its value. This report is key for both borrowers and lenders. For borrowers, it ensures that they are paying true market value for the property.
For lenders, it’s an objective assessment of the value used to determine the loan-to-value (LTV) ratio and the final amount they are willing to lend. It also tells the lender how much they can expect to sell the land for, in the event the borrower defaults on the loan and the property is used as collateral. Borrowers and lenders alike want to work with an unbiased appraiser who has a reputation for honesty and integrity.
The appraiser should be a reputable nationally recognized firm (such as CBRE, Newmark or Colliers). Advanced appraisal methods may include computer-assisted mass appraisal (CAMA), a software system that pulls from multiple data sources for the purposes of assessing real estate value and a geographic information systems (GIS) map for gathering data on a parcel of land. These tools cut the amount of time needed for the appraisal process while improving accuracy.
The appraisal process itself involves several steps, including collecting relevant information and data. The value of the land is based on the collected data. Appraisals also include evaluating comparable properties in the area for comparison purposes. Once complete, the appraisal report is submitted to the borrower and the lender for review.
Title search
To make sure the land is clear of legal obstructions, lenders will conduct a title search to guarantee all is well before agreeing to fund the loan. This process involves digging deep into public records to ensure that there are no serious outstanding legal issues tied to the property. These problems can tie up a sale and put the borrower’s ability to repay the loan at risk.
A title company and a real estate attorney are the two main resources required for a title search. The former is responsible for conducting the title search, poring through legal documents, public records, tax documents, and other sources to confirm that there are no outstanding legal problems affecting the property. The real estate attorney assesses issues found by the title company and resolves them when possible. They’ll also verify the current owner’s legal claim to the property title.
Some of the key findings of a title search include whether a property has unpaid taxes, which chips away at property equity. It can also be an indicator of more serious issues. Plus, any unpaid tax balances will be due at closing, adding to the borrower’s closing costs. You also will need to know whether there are liens on the property. There are multiple types of liens that could apply to raw land, including tax-related liens from the internal revenue service or from the local government. Another type is a court order due to unpaid alimony or child support. If not addressed, depending on the state, the sale could be delayed or canceled altogether.
Easements will also be researched. Although easements don’t give another party ownership rights to the land, they could complicate a borrower’s plans for the land’s use, depending on the easement type. Knowing the precise nature of the easement, as well as which parts of the property are affected, is essential.
One of the most important title searches is for forgery and fraud. Illegal deeds and other types of title fraud can halt any loan application process. That’s because fraudulent deeds could allow another party to illegally access loan proceeds, with no easy way for the lender to recoup their losses. That’s too much liability for a lender to take on.
Detailed survey
Conducting a land survey before finalizing any property transaction is a critical step. This process, executed exclusively by a licensed land surveyor, provides a detailed survey map that delineates the exact property.
The survey will include an in-depth examination and mapping of the property to disclose the existence of easements or rights-of-way that grant others access to or use of your property for utilities. It also would identify the precise placement of structures on the property, such as buildings, fences, driveways, pathways and pools. Overreaching elements from neighboring lands — including fences or driveways — that might lead to boundary disputes would be identified. In addition to those features, a survey also verifies that the property’s legal description is accurate and comprehensive.
Understanding the precise limits of a property is paramount before making a purchase. A land survey highlights any potential issues, including encroachments or discrepancies, which could result in legal challenges down the line.
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Land loans may be a challenge to secure for borrowers and lenders alike, but they’re in no way out of reach. Borrowers can breathe a sigh of relief and avoid pressure, by seeking lenders who specialize in this type of loan. Such lenders will be able to review applications quickly, yet prudently. With the essential documentation in line — an environmental report, an appraisal, a title search and a land survey — the right lending partner has everything they need to make a decision. ●
