Let’s say a borrower is ready to build a 100-unit multifamily development on a 10-acre site near St. Petersburg, Florida. The first step is to buy the site where these units will be built. But the borrower — someone with a great credit score and no blemishes on the financial record — goes to the bank, just to be turned down. Why did it happen, and what is the borrower to do next?
For a developer, raw land is a blank canvas. To traditional lenders, though, it’s a massive risk. Where a developer sees potential, a traditional lender sees red flags. Unimproved land with no approvals and no entitlements in place offers little reassurance to lenders that their investment can be recouped in the event of default.
Despite their hesitation, the fact remains: buying property is a must for any commercial real estate project to, quite literally, get off the ground. When institutional lenders aren’t willing to fund the deal, borrowers may find themselves unsure of the next steps to take.
Private benefits
Thankfully, securing a loan for raw land is still possible. Borrowers and brokers just need to know what to look for in a lending partner. Traditional lenders are often not interested in raw land deals or require very large down payments and other conditions that make the loan too expensive. But borrowers do have several options to obtain funds from other sources.
The first is working with private lenders, who tend to be more flexible than traditional lenders and can work with borrowers who are dealing with complex transactions involving raw land.
Aside from private lenders, there are two other common choices: borrowers tapping into their own cash reserves or electing to work with an equity partner. Those options can also have issues.
Borrowers not wanting to use their own cash to buy property is completely understandable. Using cash at the very beginning of a land deal may jeopardize liquidity, putting the project in a more fragile position later down the road. They may also have other plans for cash, such as using it to fund initial construction costs. Spending all of it at the earliest stages of a project is a risky move and one that most borrowers work hard to avoid.
Equity partners can help borrowers avoid tapping into their liquid assets. This avenue, however, isn’t for everyone. Even if an equity partner is open to lending on deals that involve raw land, accepting those funds involves the borrower giving up a portion of future earnings on sales of those multifamily units. They are also potentially giving up a significant percentage of those earnings. Not every borrower wants to do that, nor is every borrower in a position to make that commitment.
Private lender approach
Before submitting a loan application, it’s important to understand the lender’s point of view on raw land. Just like traditional lenders, private lenders must consider how to recoup their losses in the event of a default. The difference is in the private lender’s approach.
Traditional lenders are most likely not going to be open to a raw land deal because it’s much more difficult to sell that property than it is to sell a building or similar tangible asset. Private lenders allay these concerns by providing funds at a lower loan-to-value (LTV) ratio.
This puts less of the lender’s money at risk and ensures that the lender can sell the example of the St. Petersburg multifamily housing property for its true cash value in the event of a default. Borrowers still receive the funds they need to proceed with building a multifamily property, and private lenders feel that their investment is secured.
What’s important to remember is that private lenders are not hindered by the layers of red tape and lengthy approval processes that often slow traditional lenders. This enables borrowers to move to closing more efficiently and stay on track to bring their projects to fruition.
Brush up on relationships
The lack of flexibility is one reason why so many institutional lenders won’t work with land loans in the first place.
The truth is, anything can happen when applying for a loan. Mortgage brokers know how quickly respected institutional lenders can change their parameters. A borrower can have an application under review with a bank, just for the bank to change its requirements or decide they don’t want to service the borrower’s industry sector anymore. In those cases, borrowers must be willing to consider other possibilities. With a deadline looming, a private lender can step in and keep a deal moving forward.
A relationship with a private lender is also incredibly valuable if borrowers finds themselves overleveraged with their current financial institution. Even developers with deep ties with a bank may find themselves unable to borrow in these cases. If the borrower, or the borrower’s broker, has ties to a private lender, they can get the funds they need to get that project off the ground.
Crucial documents
Borrowers and brokers need to understand the property they want to buy inside and out. To that end, most private lenders are going to require the following documents to ensure there are no surprises — for borrowers or lenders — after closing.
- A clean title: Lenders want to know that there are no liens, disputes or other issues that will raise any flags when it comes time to transfer ownership of the property.
- No environmental issues: Undiscovered contamination issues can cost hundreds of thousands of dollars, or even millions, to remediate. Those kinds of surprise costs are enough to derail a project before a groundbreaking date is set.
- An ALTA survey: The precise boundaries of the property in question need to be formally evaluated and documented in an American Land Title Association (ALTA) survey.
- An appraisal: The property’s value as raw land must be assessed and documented, essential information for the lender, borrower and any project stakeholders.
Time is money. The sooner that a borrower can acquire or build the development, the faster the project becomes profitable. And when it’s a known fact that traditional lenders aren’t often willing to fund the essential first step of buying raw land, brokers need to help their clients find alternative funding options. Going straight to sources that are willing to help solve this problem, such as a private lender, is what keeps the timeline progressing forward and success in sight.
