Evaluating Complex Problems in Real Estate Loan Transactions Examples (5 and 6) as Part of a Series

In two prior articles, we discussed mutual conversations between the borrower’s mortgage broker and the lender/broker who will fund the loan with a private party lender/investor.

Below is a continuation of examining case studies while identifying the problems and solutions to complete loan transactions.  The funding lender/broker has relationships with individual investors who wish to invest their capital into trust deed investments.  They will become beneficiaries on the recorded deed of trust. Below examples 5 and 6:

5. The borrower’s mortgage broker informs the funding lender/broker:

“My client has 10 apartment units and wants to refinance and pull cash out for investments.”

The funding lender/broker responds:

“We have completed a preliminary review of this file. The building is 6-units with 4 boot-legged units made by separating the 2-bedroom units into one-bedroom units and adding small bathrooms and kitchenettes. They constructed non-conforming units without getting building permits.  We can only underwrite this as a 6-unit building and give no value to the increased cash flow because of the illegal boot-legged units. A few cities may allow an upgrade from illegal non-conforming to legal non-conforming by a procedure which requires applying to the city building and planning department. Grandfathering is a term that refers to the change from illegal non-conforming to legal non-conforming status as an exception to zoning ordinances and possible parking requirements. When the owner completes the application and approval process, then the additional cash flow may be included for the income and expense analyses and value conclusion.”
(See my article on “Conforming vs. Non-conforming” if you have questions regarding the two.)

6. The borrower’s mortgage broker says to the funding lender/broker:

“My client has a 12-unit retail neighborhood shopping center with all mom and pop tenants. We could not get a bank loan because institutional lenders considered the property legal non-conforming under current zoning regulation and sporadic tenancy. Can you help us get a loan?”

The funding lender/broker responds:

“Small neighborhood shopping centers are characterized by localized small entrepreneurs who may start with a lease, but often the lease turns into a month-to-month tenancy. Is there a consistent pattern of tenancy with a somewhat reliable rental income cash flow? Is the parking, which may include on-site and off-site spaces, adequate for rush hour periods?  Is there a substantial vacancy as a percentage of the total units?  Are there professional service providers if the lender were to take the property back in foreclosure? Also, is the location a stable commercial location, meaning that there is little risk of tenants being solicited away to newer, better located commercial sites. Most times we find that small centers can be upgraded and re-positioned by a few physical changes, including re-slurry sealing and striping the parking lot, repainting, and improving the monument signage. The borrower can get estimates for these improvements and include the cost in the loan.”

Mortgage brokers on both sides of the transaction are licensed professionals. The borrower’s broker works on behalf of the borrower to obtain the required information, verify facts, and overcome obstacles.  Full disclosure is assumed, not hidden and treated as an avoidance game.

Understanding complex underwriting issues can make or break a transaction. Make sure you work with knowledgeable mortgage brokers to assist you through the process. In most cases, you may need to engage the services of third-party specialists such as attorneys, accountants, appraisers, property inspectors, environmental engineers, escrows holders, and title insurers.  Real estate brokers active in the community in which the security property is located may be helpful.

The examples presented provide limited information for readability. Each transaction comes with a more complex set of facts that may alter the outcome of a transaction.

Dan Harkey
Business and Private Money Finance Consultant
Cell 949 533 8315
dan@danharkey.com

I intend this article for educational purposes only and is not a solicitation.

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