Bankers’ Hours column: Be careful when making a construction loan
We’ve covered various aspects of non-bank lending in this space before, and spoken of how private money is taking on an increased role financing just about everything.
Banks haven’t really paid a lot of attention to what has been developing over the past seven years, primarily because they’ve been myopically focused on staying afloat after the Great Meltdown, refitting the ship after the storm abated, and, finally, adjusting to a regulatory environment that’s bordered on nationalization of the banking business.
Also, bankers figured that eventually, things would get back to normal, with normal being what things were like around, say, 1999: now viewed as the Good Old Days of banking.
But nobody defined how long “eventually” might be, and everybody’s finding out that it’s not yet.
It used to be, before the Recession, that banks could handle the majority of deserving deals, and the borderline loans, just north of being bankable, had to migrate to hard money, at rates at least double institutional pricing. Too bad for those few, but the system seemed to work well enough.
But now the borrower population in the Great White North of non-bankable has exploded, and a lot of borrowers are facing hard money rates that are deal breakers, especially in the area of construction lending and commercial real estate loans.
At the same time just about everybody with any extra money is finding that the return on liquidity, i.e. cash, is minuscule, and may be approaching nonexistent. Increasingly, small investors in the stock market are frightened by the market’s volatility, and pervasive exposure to a crash.
People are looking for measurable yield and stability. Borrowers with good construction projects are seeking affordable capital. Banks are on the brink of a blossoming disintermediation. Sounds like a marriage made in heaven right?
But there are caveats. Anytime an investor puts a dollar with a private entity, be it individual, corporation, LLC, or whatever, there can be a risk to that investor. We’ve seen what can happen on a big scale with Bernie Madoff, right down to the small construction lending service companies that didn’t pay off their investors when the property sold and the loan should have been paid off, but rather simply took the money and reinvested it in another loan.
So, if someone comes along and says, “I’ve got these great projects and borrowers that need loans,” and you want to get, say, a 6 or 7 percent return on your money, what can you do?
Here are some tips:
• The best protection is to make the loan in your name, with the note payable to you, and you the beneficiary under the deed of trust. Then the money has to go to you when the loan is paid off.
• But, maybe you’ve got just $100,000, and the loan amount is, say, $500,000; another $400,000 is needed. One way is to form an investment group and create an LLC or corporation. Then that LLC makes the loan, and when it’s paid off, the proceeds are distributed in accordance with the corporate documents. Construction lending intermediaries often assist in bringing investors together, entity creation and documentation.
• If the loan is, for some reason, in the name of the originating entity, i.e. the construction service company, insist that the note be assigned to you, and that assignment be recorded. This should put the closing agent on notice that you have to confirm that the note is paid.
• If you invest in, say, construction lending with an intermediary company, make certain that the company has a blanket bond that covers fraud and malfeasance. Assess the limits of coverage. Determine that the premium has been paid and the coverage is in force.
• If you do lend your money along with others, and can’t control the loan, get a participation certificate from the originator that shows your ownership of a portion of that loan, and then record that certificate.
• If your brother-in-law comes to you touting a deal that’s “just too good to be true,” it, without question, is just that. This sounds like dumb, clichéd advice, and I guess it is. But it boggles the mind how many people put a lot of money in a deal that’s “unbelievable.”
Pat Dalrymple is a western Colorado native and has spent almost 50 years in mortgage lending and banking in the Roaring Fork Valley. He’ll be happy to answer your questions or hear your comments. His e-mail is firstname.lastname@example.org.
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