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 completes the project and obtains 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 completing all planned improvements. 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 underscores the need for meticulous planning and presentation in the loan approval process.

As-is valuation:

The 'as-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 any assumptions or estimated 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 a sale.

As-completed valuation:

An as-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 know how much the property's value has increased. The seller usually looks for 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 before and after the improvements, considering various factors that could influence its value, such as the quality of artistry, materials used, and location. Their comprehensive report, submitted to the lender, ensures a thorough and reliable assessment. 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 $1,000,000 for this old dog.

The borrowers believe they could build a new single-family structure of about 3,000 square feet for about $300 per square foot or $900,000 and have an excellent investment for resale. Their proforma showed a $600,000 profit, all in. They paid 60% on the purchase, leaving a first loan of $400,000. They want to borrow about $1,500,000 to pay off the $400,000 and provide approximately $900,000 for the construction, plus expenses and 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 is whether the borrower has significant equity in the project (skin in the game). They made a down payment of $600,000 for a $1,500,000 loan request, so it appears they have about 40% equity. The answer is yes. This reassures the lender of the borrower's commitment. The lender's crucial role in reducing the risk and ensuring your security and protection is carefully evaluating the project and ensuring the loan is structured to minimize potential losses.

Also, does the property owner have a course of construction insurance policy, which provides coverage for damage to the property during the construction process, an umbrella liability policy, and riders to cover workers comp if the contractor or sub-contractors fail to cover 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 do 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 with subsequent 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 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 personal property because they are not attached to the real property. Money sitting in the trust account or the account of a construction fund control agent is 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 so that the Secretary of State can 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 construction lending industry's mechanics lien law risks are 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 for lack of 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 completion to file a mechanics lien. If a notice is filed on time, during the 90 days, general contractors have only 60 days to file a lien, and suppliers and subcontractors have 30 days.

Certificate Of Occupancy:

A Certificate Of Occupancy must be filed based on the California Building Code and 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. Just to let you know, the oversight does not end when the loan funds but when the loan is paid off. Constant vigilance is necessary.