PROFESSIONAL REAL ESTATE INVESTORS GUIDE TO OBTAINING PRIVATE MORTGAGE AND HARD MONEY MORTGAGE LOANS

BY

DON H KONIPOL

Investor Loans with

 

NO CREDIT CHECK

NO SEASONING

ASSET BASED

copyright 2001 by Don H Konipol

WHAT ARE PRIVATE MORTGAGE LOANS

Private mortgage loans are loans secured by real estate made by a private lender instead of a bank, lending institution or government agency. The private mortgage loans we are concerned with here are short-term (6 months - 3 years) hard money or asset based loans made to the professional real estate investor for the purchase, rehabilitation or equity cash out of real property. This means that the decision to lend is based on the equity and value of the property being put up as collateral, not on the borrowers credit. The security for the loan is enhanced because the loan represents a maximum of 65 - 70% of the appraised value of the income producing property. On non-income producing property (raw land, lots, construction money) a maximum of 55% loan to value is lent. Investors can expect to pay interest rates of 12 to 14% on 1st liens and 16 to 18% on 2nd liens in this current low interest rate environment. Historically 1st lien yield of 6 points over prime has been obtainable.

WHY ARE REAL ESTATE INVESTORS WILLING TO PAY HIGH RATES TO BORROW PRIVATE MONEY?

When interest rates of 14 to 18% are added to 4 to 8 points, the real estate investor/borrower is paying 20% plus annually for the money borrowed. Its obvious why this is a good deal for the private mortgage lender, but why should real estate investors be willing to pay these high rates when conventional mortgage money costs 7 to 10%? There are many reasons, but all fall into four categories.

1- Speed of closing the transaction. Mortgage money obtained from banking or institutional sources, called conventional mortgage money, usually takes between 45 and 90 days to fund. Institutional lenders need not only obtain appraisal of the value of the property, but also require detailed examination of the borrowers credit history and current financial status, as well as financial statements and tax returns, not only for the property collateralizing the loan but for all real property and business interests owned by the borrowing entity and the borrower himself. Private mortgage lenders on the other hand can usually complete a transaction within 7 to 10 days. Since the property itself is the main criteria to be used to determine loan eligibility, much less information on the borrower and the borrower's other properties are required, resulting in a much quicker approval process. The private mortgage lender is protected by lending at much lower loan to value ratio, 65% is typical for the private mortgage lender vs. 80% - 90% for the institutional lender. Further, the private mortgage lender can make a decision within 24 hours of receiving information; institutional mortgage money must be approved by a loan committee that may only meet twice a month, and that may send the loan request back to the loan officer for more information, necessitating a further two week delay until the committee meets again.

2- Borrowers may not want or be able to provide personal financial information or go through the hassles of the application process associated with obtaining an institutional mortgage loan. The borrower may be going through a divorce or business separation and may not want his wife, partner, government, lawyers, etc. to obtain his personal financial statement. Additionally the borrower may not have all financial information on all his real properties and businesses up to date or complete; he may have filed for an extension on his latest tax return; his accountant may be behind in preparing his financial statements. While all these would negate or at least delay his getting an institutional mortgage, it should have no effect on the borrower's ability to obtain a private mortgage loan.

3- The real estate investor/borrower and/or the real property does not qualify for an institutional mortgage loan. This can be anything from low borrower credit scores or too much borrower debt, to the borrower's properties not producing a sufficient enough income. Further, the property itself may not support the type of loan the borrower wants. Many institutional lenders will not loan amounts under $500,000; many will not lend second lien money even if there is significant equity in the property. If major repairs or rehabilitation is necessary, institutional lenders will not be interested unless the project is very large and the borrower has an extensive track record. In these cases the private mortgage lender may be the only resource available for the real estate investor/borrower. Institutional lenders are concerned with both the appraised value of the property and borrower and property credit. Private mortgage lenders are only concerned with the appraised value, as long as the appraised value represents a fair market price. Hence, if a property is producing or can produce sufficient income to pay the note and the value of the property will fully secure the note and provide sufficient equity, then the borrower's credit is not an issue for the private mortgage lender.

4- The real estate investor may be able to borrow more from the private or hard moneylender and therefore have less of his own capital invested in the property. Institutional mortgage lenders lend based on the lower of the cost of the property or appraised value of the property; private mortgage lenders lend based on the appraised value only. Hence the real estate investor utilizing a private or hard money loan is not penalized for purchasing the property at a significant discount to market value. Additionally, most private mortgage lenders do not have onerous seasoning requirements to make the loan.

INVESTMENT PARAMETERS PRIVATE MORTGAGE LENDERS USE WHEN MAKING A PRIVATE MORTGAGE LOAN

The investment parameters for private mortgage loans differ considerably from those of institutional mortgage loans, as we partially discussed in the previous section. The most important parameter to be considered when evaluating a private mortgage loan request is loan to value. This is the ratio of the amount lent expressed as a percentage of the properties value. For example if an office building is worth $100,000 and we lend $65000 total secured by this office building, then our loan to value ratio, or LTV is 65%. Private mortgage lenders will typically lend up to 50% on raw land or undeveloped property; 65% on commercial income producing property such as office buildings, shopping centers, warehouses, etc. and 70% on residential income property such as a duplex or apartment complex. The key words here are up to ; the maximum amount will be lent if all additional criteria are met and if the lender feels good about the loan, lower amounts can be lent if the loan or borrower is considered less than ideal. This is a gut decision made by the lender with an in depth understanding of the criteria being used and the experience of looking at many lending proposals.

The second parameter is the type of properties to lend on. This is often determined by the comfort the lender has in disposing of this type of property in case of default. All other things being equal, single use property which would take a year to sell is obviously less desirable than a multi tenant office building which would not only sell quickly at 65-80% of market value, but which would be producing income with tenants paying rents while the property is up for sale. Different categories of real estate are residential, multi-family residential, office building, office warehouse, warehouse, shopping center, industrial and single use facility. All these categories can be divided further. Residential can include single family residences, duplexes, or fourplexes. Multi-family residential can include small (5-20 unit) apartment buildings, medium (20-100unit) apartment buildings, and large (100 + unit) apartment complexes. Each of these categories can be further classified as A, B, C, or D property, based on age, condition, amenities, location, rental rates and area. Office warehouse can be classified by size and condition as well. Shopping centers are usually classified as strip centers, neighborhood centers, area center, town center or regional mall. A single use facility is a facility that can only be used for one type of business, such as a drive thru restaurant, and typically would have only one tenant.

The third investment parameter the private or hard moneylender is concerned with is the cash flow or income potential of the property being put up as security for the note. Although many private mortgage lenders are liberal in this area, the monthly interest payments to keep the note current must come from somewhere. If the property is rented out and is producing a cash flow after all expenses of an amount at least equal to the note payment, the monthly payments can be covered by the property income alone without the borrower having to come out of pocket. This adds a great degree of safety to the note. Cash flow from other income properties or other sources can be substituted for cash flow from the property being placed as collateral; however, the income to pay the mortgage payments must be available from some source.

The fourth major investment parameter the lender must consider is exit strategy. Very simply, this is how the borrower plans to repay the loan. Since most private mortgage loans are short term the private mortgage lender has a keen interest in finding out the borrower's exit strategy and in analyzing whether this exit strategy is viable, and the risk of this particular exit strategy. The particular exit strategy must have a reasonable chance of success. Typical exit strategies include property sale before the note is due, refinancing the property with a long term mortgage loan, packaging the property with other properties owned or to be acquired by the borrower and obtaining a blanket mortgage on all the properties, borrowing on equity in other property owned by the borrower and selling a partnership interest in the property to an equity investor. Each of these strategies has numerous variations. The lender must determine the viability of any particular exit strategy. For example, if the exit strategy is to refinance the property, the lender must determine if the credit score of the borrower is high enough to qualify for a long term mortgage; if the property cash flow is sufficient to cover the debt payments on a long term mortgage and if the property will meet the general criteria set up by the mortgage lenders most likely to refinance the property. This analysis becomes very quick and easy with experience and as knowledge of the mortgage and investment real estate market is increased over time.

At Capital Advantage, we lend our money and our investors money on income producing property. Additionally we will only lend if the property is improved property. This eliminates raw land, owner user facilities, and most single tenant properties. We want the properties we lend on to have rental income or at least rental income potential. This way there is cash flow for the borrower to pay our note payments. Additionally if we have to foreclose and take over the property we will have rental income coming in while the property is up for sale.

At Capital Advantage we usually lend to a maximum of 65% of appraised value. In rare cases in which the real estate is residential, we have a good relationship with the borrower, and we feel confident about the local economy, we may go as high as 70% LTV. Furthermore, we must be confident of the borrower's ability to make the loan payments when do. Positive cash flow being generated by the real estate being borrowed on is the best, though as previously discussed, not the only source of these funds for loan payments. Finally we assess whether the borrower has a realistic exit strategy. Of course any of these parameters can be eased under two conditions. First is a lower loan to value ratio. Second a desire or at least a mild interest in owning the property. Anytime these parameters are eased the chance of foreclosure is significantly increased.

DUE DILIGENCE - HOW LENDERS VERIFYING INFORMATION

Due diligence is concerned with the investigation of the property being used for collateral and the assessment and verification of the investment parameters being used to decide whether to make the loan.

The first item considered by the private mortgage lender when performing due diligence is the appraisal report. We have the appraisal done by an appraiser we know and whose work we are comfortable with. The appraisal is a full appraisal, encompassing market, cost and income approaches to determine value. Although we are most concerned with the market approach, if the other approaches result in a lower figure we will use the lowest figure to determine the maximum loan amount. We insist that at least four comparable properties be used to determine market appraisal, as well as a different four (as rental comps) to determine value by the income approach.

The appraisal report will be fully studied to obtain the appraiser's opinion of the neighborhood and area that the subject property is located in. Appraisals will also have sections pertaining to the growth potential of the property area as well as verification of property demand for rental purposes. All this information must be assimilated by the mortgage lender to help determine interest in making the mortgage loan.

A physical inspection of the property and neighborhood will be done to verify the appraiser's conclusions and to determine property condition. If property condition is a concern, or if renovations will be required to bring the property up to standard, then the services of a licensed property inspector will be obtained and a thorough property inspection by the inspector should be undertaken. The property inspector will issue an inspection report, which of course will be studied to determine any physical defects in the property. If the services of a property inspector are not used, the mortgage lender himself should plan on spending a sufficient amount of time inspecting the property to be satisfied that the property has no major physical defects.

On any commercial properties or multi family properties being considered for a mortgage loan, the lender will, as part of the due diligence process, examine all financial documentation relating to the property. While we as private mortgage lenders are not interested in the borrower's personal finances, we are most interested in the property's finances, as this will determine the property's ability to service the loan. At a minimum the private mortgage lender must see rent rolls, examine leases, be provided with current and past financial statements as well as pro forma income and expense projections. Verification of the information provided will be done by a combination of checking with the parties concerned and through the lenders ability to determine if the numbers “make sense” based on his knowledge and experience dealing in these properties. Due diligence is an on going process of evaluating and investigating each investment opportunity.

INSURANCE PROTECTION

A different kind of protection exists for the lender in the form of various insurances. Although the borrower is required to pay for this insurance protection, the beneficiary of this protection is actually the private mortgage investor/lender. Two types of insurance protection are a requirement for every mortgage loan finalized.

A Lenders Title Policy will protect the lender in the event that a claim is made against the clear title of the property. Title Insurance Companies underwrite these policies and guarantee that the owner of the property is indeed the rightful owner, that all liens and encumbrances have either been paid off or have been disclosed to the lender who has okayed the lien (as in the case of a 1st lien on the title report where the private mortgage lender is making a 2nd lien) and that all taxes owing on the property to any government taxing authority have been paid or the existence of which has been disclosed and approved by the lender. In addition, the title policy will list all exceptions to the policy (that which the title insurer will not insure against) and any right of ways or easements which may affect the value of the property.

Fire and hazard insurance will protect against the most common cause of real property destruction.

CONCLUSION

With offices in Texas and California and a base of $29,000,000, Capital Advantage specializes in providing short term private mortgage financing to the professional real estate investor. We provide these loans to be used for the acquisition, rehabilitation and equity cash out of residential and commercial income properties in Texas and California.

Capital Advantage private mortgage money offers unique advantages for the professional real estate investor. We are able to close most loans in 2 weeks or less whereas institutional lenders require 6 weeks or more to close and fund a commercial mortgage loan. Further, our loans are asset based; the real property itself is the basis of our lending decision. Hence, if a property is producing or can produce sufficient income to pay our note and the value of the property will fully secure the note and provide sufficient equity, then the borrower's credit is not an issue. Instead of concentrating on minute detail of the borrower's credit history as institutional lenders do, we concentrate our due diligence efforts on the real estate securing the loan. We provide the professional real estate investor with the ability to borrow on underwriting criteria not available through institutional lenders. No credit check or detailed application forms are required and we can usually render a decision in 24 hours.

We lend up to 65% of appraised value with no seasoning requirements and no minimum investment required on the part of the borrower, in other words financing of up to 100% of the purchase price is possible. Our loans are interest only, paid monthly and due in one year, renewable for a second year. We make both 1st and 2nd liens, with 1st lien interest rates at 14% and 2nd lien rates at 16-18%. No application fee or other costs are due upfront; our fee is 6 points at closing.

If you are interested in utilizing our private money mortgage for the purchase, rehabilitation or equity cash out of investment property, or would like more information, please do not hesitate to contact me a (832) 577-8838 or email me at CapitalAdvantage2000@yahoo.com

ABOUT THE AUTHOR

Don Konipol holds an MBA in Finance from the University of Michigan and a B.S. in Economics from the City University of New York and has been a licensed Texas Real Estate Broker and licensed Texas Mortgage Broker since 1978. He first came to Capital Advantage as a client interested in investing the proceeds of the sale of his automotive repair businesses. Mr. Konipol recently joined Capital Advantage as partner in charge of the Houston office.

Upon receiving his MBA in 1975, Mr. Konipol went to work for Societe General De Survalliance S.A., Geneva, Switzerland in investment banking. He left in 1978 to come back to the United States and went to work as a commercial realtor for First Equity Company in Houston, Texas. In 1984 Mr. Konipol formed the Investment Realty Group to purchase distressed real estate at auction.

Having been on all sides of the real estate and financing table, Mr. Konipol brings a unique set of skills to Capital Advantage, allowing him to successfully network and bring together all parties to insure a successful transaction.

Don Konipol can be reached at (832) 577-8838 or emailed at donhkonipol@yahoo.com or capitaladvantage2000@yahoo.com and will be happy to answer any questions or discuss any aspects of private mortgage loan investments.