Real Life Example

The lender is not in the business of assuming all the development and construction risks, such as those of a quasi-joint venture partner. The borrower must have some 'skin in the game, a term that refers to the borrower's investment in the project, typically in the form of their own money or assets.

A lender will expect a borrower to have significant risk capital in the transaction to ensure against economic risks.

When a borrower has no personal investment at stake, they may choose to walk away if the project fails, leaving the lender to deal with the fallout of a failed investment. This lack of personal investment means they have no financial risk or emotional attachment to the outcome, which can lead to potential issues for the lender.

Article:

When a real estate owner has "no skin in the game," they have invested little or no money or assets in the property or transaction.

The loan request:

A mortgage broker says:

"My client has a partially completed home with an outstanding balance of $650,000. His construction lender stopped funding during construction because of various delays, and the borrower defaulted. He needs an additional $300,000 to complete the project. The borrower believes the finished value will be about $1,400,000, so your loan-to-value will be 68%."

The lender's response after reviewing the file:

After a thorough review of the file, the lender, drawing on their expertise and knowledge, responded:

The borrower's lack of personal capital and minimal risk in this transaction led the lender to inadvertently assume development partner risks, which ultimately did not work out. The only solution is a bailout loan, a loan provided to prevent a financial collapse, or foreclosing on a partially completed property and selling it at a discount. A foreclosing lender could potentially lose a significant amount of money, a sobering reminder of the risks involved in real estate financing.

The lender's decision to decline this transaction was a clear demonstration of their power to make informed and responsible decisions, providing a sense of security. The borrower's lack of capital at risk and potential to walk away at any time could have left the lender with a partially completed problematic property. This decision-making power is crucial to the lender's role, empowering them to mitigate potential risks and making them feel in control and capable.

In an accelerating market, fix-and-flip lenders may appear brilliant. However, they may seem somewhat foolish in a declining market. This contrast highlights the importance of being cautious and prepared for potential risks, instilling a sense of proactivity. This alertness is key to navigating the complexities of real estate financing, making the audience feel proactive and prepared.