There is a growing real property lending industry problem whereby mortgage brokers licensed by the Bureau of Real Estate, and non-Bureau of Real Estate licensees, use private offering securities exemptions to circumvent regulatory requirements. Some brokers, and non-brokers, use a California exempt offering to create a pool-type limited liability company. They raise capital from private investors and institutional investors, using an entity, to grow the size of their pooled funds in order to make real estate loans. These LLC entities advertise to both the real estate broker community and to the public. They refer to themselves as “direct lenders” using lending standards that are unlawful according to current real estate law. This creates an environment where a licensed real estate broker, who makes every effort to be regulatorily compliant, cannot compete in the open market.
Solicitations from these lending sources, include catch-phrases like: “Loans Available”; “Direct Lender”; “No Appraisal”; “No Documentation”; “No Credit Report”; “No FICOs;” “Stated Income”; … in effect, no standards at all are required to get a loan. The only requirement they put forward is the equity in the real property. Many solicitations state: “One Investor, One Decision Maker,” or “No income, No assets, No reserves.”
On the other hand, the real estate broker who makes or arranges real property loans with the expectation of earning compensation has different and much more onerous requirements. The real estate broker, acting under the course and scope of his/her license, has a series of regulatory requirements that render its services uncompetitive. Regulators seem to have overlooked these circumvention strategies employed by some market participants.
For example, a licensed real estate broker is required to obtain information consistent with Business and Professions Code 10232.5 in a loan transaction. I am extremely familiar with these requirements since I co-sponsored Senate Bill 1554 in 1998, and wrote a portion of the language of the code. Guy Puccio & Associates acted as my legislative advocate.
The fundamental purpose of Senate Bill 1554 was intended to insure that if a mortgage broker solicits investors to purchase a loan as an investment, they should submit a package to the prospective investor providing the material facts relating to the loan transaction. With the disclosures submitted to the prospective investor, the investor can then make an informed decision whether the investment is suitable given the facts, risks, and economic reward.
Some requirements of Business and Professions Code 10232.5 are as follows:
- An address or other means of identification of the real property to be used as security for the borrower’s obligation
- Estimated fair market value of the securing property as determined by an appraisal, a copy of which shall be provided to the lender. However, a lender may waive the requirement of an independent appraisal in writing, on a case-by-case basis, in which case, the real estate broker shall provide the broker’s written estimated fair market value of the securing property, which shall include the objective data upon which the broker’s estimate is based.
- Age, size, type of construction and a description of improvements to the property if contained in the appraisal or as represented to the broker by the prospective borrower.
- Identity, occupation, employment, income, and credit data about the prospective borrower or borrowers as represented to the broker by the prospective borrower or borrowers.
- The terms of the promissory note to be given to the lender.
- Pertinent information concerning all encumbrances which constitute liens against the securing property and, to the extent of actual knowledge with respect to any anticipated or expected loan, means knowledge gained by the broker through arranging that other loan or receipt of written notification of that other loan. In this regard, the broker shall also provide to the prospective lender the option to apply to purchase a title insurance policy or an endorsement to an existing title insurance policy covering the securing property, and copy of a written loan application, and a credit report.
- Provisions for servicing the loan, if any, including disposition of the late charge and prepayment penalty fees paid by the borrower.
- Detailed information concerning any proposed arrangement under which the prospective lender, along with persons not otherwise associated with him or her, will be joint beneficiaries or obligees.
- If the solicitation is subject to the provisions of Section 10231.2, a detailed statement of the intended use and disposition of the funds being solicited including an explanation of the nature and extent of the benefits to be directly or indirectly derived by the broker.
Best industry practices may expand the disclosures somewhat. Here are my recommended guidelines:
- Identify the borrower, or borrowing entity. The borrower may be one or more individuals or an entity—such as a family trust, limited liability company or corporation. The procuring loan broker should be able to articulate who the borrow is and provide a brief background.
- Collateral property: A description of the property and its uses along with an address. Downloading a title profile from your favorite title company will accomplish much of this. If the property is income driven, a description of the tenancy, income stream and vacancy should be provided as well as a description of the condition of the property and its strengths and weaknesses. Will the property be improved as a result of this loan?
- Purpose of loan: Why is the borrower taking out a loan? What will be paid off as part of the loan? How much net proceeds will the borrower receive? What will the net proceeds be used for? The first question is obviously consumer vs. business purpose. Some lenders make consumer loans, but others do not. I am addressing business purpose loans in this correspondence, because consumer purpose would take an entirely different direction with state, and federal regulation and oversight.
- Acceptable reasons for real property loans include:
- Rehabilitate an existing structure for property which is substandard, or original ground-up construction
- Invest in another piece of real estate or business enterprise
- Refinance business property to lower interest and payment structure
- Refinance to obtain cash out to be used for business purposes
- Consolidate business debts, tax liens, other liens, property taxes, judgments
- Dissolve partnerships, or create new partnerships with new partners
- Borrower has been declined by the bank or institutional lender
- Borrower elects to avoid the arduous and time consuming process created by the bureaucracy of institutional lenders
- Borrower has a pending or an old bankruptcy, or poor FICO scores
- Complex financing structures such as seller carry-back subordinated junior financing, or partnership subordinated interest, which require an inter creditor agreement
Some lenders operate under a California Finance Lenders license with pooled limited liability company format. Others operate under a Bureau of Real Estate broker’s license with a pooled limited liability company format. And still others operate without a California license. Some are from out of state! All strategies are used to create a non-level playing field.
What, if anything, can be done to level the playing field?
Business and Private Money Finance Consultant
Bus. 949 521 7115
Cell 949 533 8315
This article is intended for educational purposes only and is not a solicitation.