Summary:

Private money lenders play a unique and pivotal role in the real estate market.  Their ability to fund partially constructed buildings — a task that traditional banks might shy away from due to their risk-averse nature and stringent lending criteria — is a key aspect that real estate professionals, mortgage brokers, and potential borrowers interested in construction loans should be aware of.  This unique role of private money lenders is often overlooked but is crucial for a comprehensive understanding of the real estate market.

They often fund loans to complete partially constructed buildings that traditional banks might overlook due to their risk-averse nature and stringent lending criteria.

Their willingness to take on these opportunities that banks decline is a testament to their unique approach and a keen eye for potential..

These lenders provide the necessary funds to complete the structure, appurtenances, and interest reserve until the Borrower has completed the project and obtained a Certificate of Completion.

Article:

The ‘as-is’ and ‘as-completed’ appraisals are not just routine steps in underwriting construction completion loans.  They are thorough assessments that clearly understand the property’s current and potential value after all planned improvements are completed.  This level of thoroughness should reassure all parties involved in the appraisal process about the accuracy and fairness of the valuation.

• Here is a list of completed and paid items, including pictures, costs, and lien releases.
• A list of items that have been completed and not yet paid for, and expected loan proceeds to pay for these items.
• We will provide a list of items and a cost breakdown as we progress on the project’s cost.  The net proceeds of this loan are required for the project to be completed.
• In many cases, actual costs, contractor overhead and profits, interest carry, and contingencies must be considered.
• The better organized a Borrower and the mortgage broker’s presentation are, the quicker the response will be.  This level of organization is not just a formality but a critical factor in the lender’s decision-making process, providing reassurance about the Borrower's understanding and commitment to the project.  It highlights the importance of meticulous planning and presentation in the loan approval process.

As-is valuation:

The “s-is’ real estate appraisal is a straightforward tool in the property market.  It provides a clear understanding of the property’s current value, estimating its current condition without making any assumptions or estimating the prices of potential improvements or repairs.

An as-is appraisal is appropriate when the seller is unwilling or unable to make any repairs, improvements, or warranties regarding the property’s condition before the sale.

As-completed valuation:

A completed real estate appraisal evaluates a property’s value after it has been renovated, improved, upgraded, or modernized.  This type of appraisal is necessary when a property owner has made significant renovations or additions and wants to determine the property’s increased value.  The seller typically seeks a top retail price to sell on the open market.

In the ‘as-completed’ appraisal process, the appraiser’s role is pivotal.  They inspect the property both before and after the improvements, considering various factors that could influence its value, such as the quality of artistry, the materials used, and the location.  Their comprehensive report, submitted to the lender, ensures a thorough and reliable assessment of the property.  The lender then uses this report to determine the final loan amount, guaranteeing that the Borrower has enough funds to complete the project.

Real-life example:

My client purchased an ‘old dog of a property’ in a nice single-family residential neighborhood for total rehab or rebuilding.  The only reason to call it rehab is for property tax assessments and easier processing through the municipality’s building and safety department.  Otherwise, we would refer to it as scrap and rebuild a new home.  The client paid  1 million for this old dog.

The borrowers believe they could build a new single-family structure of approximately 3,000 square feet for around $300 per square foot, or $900,000, and have an excellent investment for resale.  Their pro forma showed a $600,000 profit, all in.  They paid off 80% of the purchase price, leaving a first loan of $400,000.  They want to borrow approximately $1,500,000 to pay off the $400,000 and provide around $900,000 for construction, plus expenses and an interest reserve.  The estimated value after completion is $2,700,000. They have some reserves and good credit.

The lender responds ..

Construction to completion is a vibrant and necessary business. However, there are multiple issues and hidden risks to consider.  The first consideration is whether the Borrower has significant equity in the project (i.e., “skin in the game”).  They made a down payment of $600,000 for a loan request of $ 1,500,000, indicating that they have approximately 40% equity in the property.  The answer is yes.  This reassures the lender of the Borrower's commitment to repay the loan.  The lender’s crucial role in reducing risk and ensuring your security and protection is to carefully evaluate the project and structure the loan to minimize potential losses.

Additionally, does the property owner have a course of construction insurance policy that provides coverage for damage to the property during the construction process, an umbrella liability policy, and riders to cover workers’ compensation if the contractor or subcontractors fail to provide coverage for the risks?

The next issue concerns funding the construction loan proceeds during the building process.  Most lenders prefer to use licensed construction fund control companies, which manage the entire bookkeeping, property inspections, and lien release process.  These companies ensure that the loan proceeds are used for their intended purpose and that the work is progressing as planned.  Can the lender anticipate that the fund control company will make their timely draws and inspections and obtain contractor lien releases?  Part of this question is whether the lender will distribute the loan proceeds in their entirety or fund them according to a draw schedule, where the Borrower only pays interest on the outstanding balance over time.  Some lender licenses allow split funding, meaning the lender can partially fund the original draw and subsequently fund additional draws over time.

Encumbering Real Property:

The next issue concerns the difference between the real and personal property liens encumbering the property.  Documents are drawn to cover the real and personal property permanently attached to the (fixed) real property.  The document encumbering the real property is a deed of trust or mortgage instrument that has been recorded at a municipal recorder’s office.  Recorded loan documents place a lien on the property but do not cover the construction draws.

The recorded deed of trust does not encumber the construction fund control holdbacks.  Cash proceeds are considered personal property because they are not attached to the real property.  Money sitting in a trust account or the account of a construction fund control agent is also considered personal property, not real property.

Encumbering the Personal Property:

The Uniform Commercial Code (UCC), first published in 1952, is a comprehensive set of laws governing all commercial transactions in the U.S.. The UCC laws also regulate personal property transactions and provide for a public notice mechanism, allowing the Secretary of State to identify liens.

A recorded UCC-1 statement filed with the Secretary of State’s office is part of the transaction’s closing.  The UCC-1 is an encumbrance and remains a matter of public record until a recorded UCC-3 occurs, reflecting the debt’s satisfaction.

The UCC-1 filing will cover all related personal property, including loan proceeds held by the construction fund control company, building materials delivered but not yet placed on the foundation, working drawings, third-party reports, entitlement approvals, and building permits.

Mechanics Lien Laws:

The mechanics lien laws in the construction lending industry are among the most draconian and punitive in real estate.  These laws require a lawyer to guide the property owner through the liability maze.

A mechanic’s lien is a cloud against the property title.

Any unpaid contractor, subcontractor, laborer, or material supplier can file a lien with the county recorder’s office due to non-payment.

The claimant is allowed a limited time to file a suit, begin a foreclosure action, and force the sale to pay off the lien.

The mechanic’s lien notification period begins at the point of the first drop of a surveyor’s markers, the first evidence of work in progress, the first supplies delivered to the property, or the first shovel in the ground.

Notice of Completion:

The contractor will file a California Notice of Completion upon completion, which will shorten the mechanics’ lien period for subcontractors and suppliers.  If a notice of completion is not filed, contractors and suppliers have 90 days from the date of completion to file a mechanics lien.  If a notice is filed on time, within the 90 days, general contractors have only 60 days to file a lien, while suppliers and subcontractors have 30 days.

Certificate Of Occupancy:

A Certificate of Occupancy must be filed in accordance with the California Building Code and the codes of most other states.  The building or structure cannot be occupied without filing a Certificate of Occupancy.

If all the above is professionally documented and analyzed, then this private money-lending business subset can be highly profitable for the loan broker and his private investors.  Please note thatw, the oversight does not end when the paid-off funds arexhaustedff, burather t when the loan ifully s paid off.  Constant vigilance is necessary.