There are private money lenders and private party investors who fund a particular subset of real estate loans referred to as bridge loans. These loans are made for a shorter or interim period such a 1 to 10 years. Some of these loans are made and arranged by real estate and mortgage brokers.
In most states, the private money real estate lending industry is subject to both state and federal real estate licensing and regulations for single Family 1 to 4 units, both owner and non-owner occupied. For all other property types regulations will differ depending on the type of real estate, type of loan, real estate laws, agency laws, purpose of loan, and operative industry standards for underwriting, funding, and loan servicing management.
This article is meant to be a general educational overview of the private party lending industry throughout the U.S.A. and is not intended as a solicitation for loans within a particular state.
Real estate borrowers will probably always choose the lowest interest rates and most favorable terms for their purpose. But institutional lenders who have the lowest interest rates will also have more ridged underwriting and approval requirements that limit, delay, or possibly kill many loan approvals.
Investors who make the decision to invest and the documentation required in this type of real estate loan transaction are referred to as a trust deed investment. This is also defined as a security under the Securities Act of 1933 because the documentation represents an evidence of indebtedness. Various federal securities exemptions from registration are commonly used to comply with federal securities laws. Federal exemptions are usually found in Regulation D, Regulation A, and Rule 147 and 147A. These can be found on www.sec.gov website.
The California Corporations Commissioner’s rules cover trust deed investments with several exemptions from registration. These include the private offering exemption 25102, specifically safe harbor rules contained in 25102(e) (f) (n), 25113, and 25102.5. The fractional note exemption for multiple investors is found in 25102.5. Fractional note exemption rules are defined in the Business & Professions Code 10237-10238, and 10232., and Civil Code 2941.9. Interested parties should consult a lawyer specialist. A maximum of 10 private investors can co-invest into a single trust deed as tenants-in-common. Their beneficial interest will represent the percentage that they own of the entire trust deed.
California has specific transactional regulations affecting private money loans, including a required license by the state for individuals engaged in the business of making or arranging loan transactions with the expectation of compensation. Additional regulations apply for trust accounting, agency relationships, and both borrower and investor required disclosures by the arranging broker. The reason for pointing this out is that for those who do not understand the business of privately funded real estate loans, which is highly regulated. Some states may fewer regulations, and some states have no regulations.
Usually private underwriting guidelines and standards for analyzing the borrower, credit, income, and value of the collateral property is a less ridged process than institutional or bank lenders. Whether dictated by government regulations, strict bank underwriting, the borrowers’ special circumstances, or COVID related disruptions private money provides a flexible option.
Here are just a few reasons that private lending industry participants have suggested as to why private loan transactions could benefit borrowers.
- Fast loan approval with possible 4-day funding for bank declines and fallouts. Some private lenders may fund faster, particularly when they have a mortgage pool with capital immediately available to fund.
- Debt consolidation of businesses, consumers, or a combination of both. In some cases, the loan may be used for debt consolidation that will lower the borrower’s total monthly payment obligations. This will give the borrower some breathing room to improve his/her credit to then obtain a long-term bank loan.
- Refinance and payoff existing first, second, and third lien position loans which may be coming due. This is available for both owner and non-owner occupied residential and commercial properties.
- Cash out refinance based upon the protective equity of existing real estate. The cash out can be used for most business and consumer purposes. Some states such as California require a special license for the consumer purpose loans that exceed 50% of the loan amount.
- Second lien position or junior lien loans on both owner and non-owner-occupied dwelling for business purpose.
- Construction completion, rebuild or upgrade a property in that is in poor or marginal condition. The loan is usually necessary because the collateral property and/or the borrower does not meet bank underwriting guidelines in its distressed or partially completed condition. Consideration by the lender will be given for the as-is-value and the as-completed-value.
- Marginal credit worthiness where a borrower is not bankable, and approval of a loan request is primarily property equity driven.
- Post COVID payment consolidation is possible. Borrower may need to catch up and give themselves breathing room for accrued payments.
- Borrower owns and operates a cash based small business and shows limited financial strength on paper. The borrower will still be required to prove that they or he/she can make required payments.
- Leveraging accrued equity of existing real estate owned by borrower to raise funds to purchase additional investment properties.
- Purchase a property with a combination of some cash down payment, sweat equity, and/ or seller’s agreement to carry a subordinated junior lien.
- Inherited property where successor trustees or beneficiaries need funds for distribution to the beneficiaries, pay legal costs of the estate, or to fix up of the property for future rental. Another option is to fix up and be sold on the open market.
- Loaning on unimproved Land. Loaning on land can be a complex process. Is the land part of an existing subdivision referred to as an infill lot, a commercially or industrially zoned parcel within a subdivision, or a larger parcel held for future development?
- Retail strip and community centers or other properties which need upgrades or repositioning. Many centers are in distress due to the COVID shutdown where tenants have not had the ability to make their rent payments.
- High frequency real estate investors who need to finance fix and flips loans to turn a quick profit. Borrowers need both experience and some of their own capital at risk.
- Litigation settlements (e.g., a partition suit), buy a partner out or pay off a pesky family member.
- Pay off civil judgments and liens, including arrearage in property taxes, association dues, and federal and state tax liens.
- Sale of existing promissory notes and deeds of trust to 3rd party investors, usually at a discount, whether preforming or non-preforming.
- Hypothecation or pledge of a promissory note and deed of trust owned by a borrower (assigning note and deed of trust to an investor) as collateral for a new loan.
- Cross collateralization of more than one property to meet the equity requirements of the lender. Borrower would sign one promissory note but may have recorded liens that encumber 2 or more properties.
- Small mobile home parks where the property does not meet the underwriting standards of intuitional lenders.
- “Airbnb” rental income properties. Financials will be necessary to prove up the ability to make payments.
- Churches, synagogues, restaurants, bars, automotive repair shops, gas stations, and other current use single-purpose security properties.
- New ground up construction or construction completion for a partially completed project. Most request are a result of borrowers needing to fund more money into the project to complete the project when their own personal capital or existing construction loan proceeds have been depleted.
- Collateral is a combination of real and personal property such as a motel, restaurant, carwash, or gas stations with mini markets. Valuation and decision to make the loan must be on the real property only.
- Long-term lease on commercial property where the master tenant lease is expected to expire. This will cause disruption with other smaller in-line tenants because the master tenant is responsible for the primary draw to the center. Banks will usually not make this loan. This loan is usually made as a bridge loan until the owner obtains a long-term lease with a credit worthy tenant and manages the center into stabilization.
- Credit approval is subject to highly sophisticated lease analysis with multiple tenants having different terms of leases including length, lease rate, and lease provisions. Leases may include go dark provisions, or cancellation in the event of excess vacancy or loss an anchor tenant.
- Mutual property access easements for ingress/egress, or complex rights of usage such as reciprocal parking agreements.
- Foreign nationals with and without a social security number. The borrower must have a US bank account(s). The borrower must have a service of process agent which can be arranged.
- “Notice of a substandard condition” recorded on public records by a building department notifying the public that the property is out of conformance, or in disrepair for building and zoning codes. Institutional lenders will not make these loans. The bridge loan funded by private lenders will provide funds to make substantial improvements and modifications to bring the property up the acceptable building, safety, and zoning standards.
- Non-conforming property that does not comply with current zoning and building standards. As a result, there are strict limitations on the ability to repair or replacement of the structures in case of destructive acts such as fire, flood, windstorm, vandalism, earthquake. The property may not be able to be rebuilt to an acceptable level after the destructive event occurs.
- Earthquake seismic retrofit. Many older properties need to be upgraded with engineered reinforced steel frames bolted into the existing structure, and walls shored up with steel support fasteners to withstand earthquakes.
- Tenant improvements. Owners of commercial buildings need to provide funds to install interior and/or exterior improvements to satisfy the owner’s and the prospective tenants’ lease hold improvements.
- Cannabis related properties, both manufacturing and retail facilities. Some states have legalized lending in cannabis related operations and some states have not.
When property owners are unsuccessful in being approved or are declined for bank loans, they may discover that there is an alternative funding source that provides much greater flexibility in the underwriting, approval, and speed of funding. Interested parties should consult a highly qualified lending specialist to help in their circumstance.
Investors who are interested in investing in trust deeds with their capital will understand that they are securing their investment with their names placed on a recorded trust deed on the borrower’s collateral property. Additionally, their investment will usually provide for receiving monthly interest payments from the borrower, and a comparatively good, annualized yield. Interested parties should seek out loan broker professionals who understand required regulatory compliance and correct documentation. Lastly, interested parties should seek out someone with an experienced track record to act as their agent.
Business and Private Money Finance Consultant
Bus. 949 521 7115
I intend this article for educational purposes only and is not a solicitation.