BiggerPockets

I'm new to the hard money lending business and have just done a few deals with a good friend. I know enough to be VERY dangerous, hence my outreach to my much more experienced peers.

A local builder in my area is looking for short term (12 month) financing to get a small housing project off the ground. They want to cash out 4-5 single family lots so they can use cash to build the first couple of homes and then keep their project going by their own cash after the first sale or two.

I don't feel comfortaable lending on just the dirt. It was mentioned that they could collateralize the loan with other real estate they own free and clear. This is way out of my league. Is this common and are there any traps I need to be aware of?

If it is a residential property that would be an easy re-sale, I'd be ok, but I could really use some guidance.

They are hoping for $200,000 and are willing to pay 10-12% and a few points, but I didn't go too far with it because I'd like to have a lot more information from other experienced people. The builder is well known and has completed many projects over the years, but did get caught up in the downturn and lost a lot of his capital. Apparently he has completed 4-5 hard money deals in the past 3 years and has a strong payment history.

Where do I start with this???

There are plenty of good builders out there, and I'm sure Karen M. is one of them, so Karen, please don't take my comments as relating to you.

@Tyler Byrnes, lending on land for the building of spec homes is one of the riskiest loans you can make. If you collateralize only the land, you are usually under collateralized, because if you had to foreclose, unless you are in a hot area, the land will sell at auction for far less than the retail value.

Cross collaterallizing with additional properties adds a great deal of extra security.What it means is when the mortgage or deed of trust is prepared, it links to not only the land in question, but other properties. Therefore, if you have to foreclose to get your money back, you are foreclosing on the land AND the other property(ies).

An important point: If the second property already has a mortgage on it, your position for that property would be second. Therefore, if you foreclosed, you would be subject to the first mortgage. Meaning you, or whoever bought it at foreclosure auction, would have to pay off the first.

If you cross collateralize a property where you go into second position, the advantage is that a borrower is likely to work harder to prevent foreclosure on two properties than on one. Of course, if his financial world is crashing, it won't help. So consider what you agree to collateralize.

Your attorney would draw up the mortgage (deed of trust) documents, and would do a title search on both (or all three if you use more) properties. The borrower pays for your loan docs and the extra title search and title insurance at closing.

Also strongly recommend that you find an inspection company and have them do the inspections and approval of draws based on the construction budget the builder submits to you. (budget should be submitted to you before you decide to lend) If you can't find an inspection company on your own, a bank that does construction lending will know the local inspection companies. Try googling "construction inspection yourcity" or something like that.

In general, if you are a new lender, I would not recommend starting with a deal like this. I make some bad decisions when I first started, because you don't know what you don't know. If you are very comfortable with the cross-collateralized property, it will probably be fine, I'm not trying to scare you, but it's a fairly complex deal for a new lender to manage if something goes wrong. Just my 2cents

Thanks for the replies. We have decided that this is too risky to start off with. However, the builder also approached us about loaning on a development site he owns free and clear with a rental home. The house is on few acres and brings in $1400 per month. The property is zoned for a 70 unit apartment complex with plans being developed. It sold 12 months ago for $220,000 and the market is very stable here. My question now is what LTV would you generally use for this?

My gut says I'd loan no more than $100,000 and that would be with 2-3 pts and at a 10-12% rate with a 2 year balloon. I figure a fire sale in our current market would easily net $160,000-$175,000. Seems fairly safe to me, but I would appreciate input on if you set your LTV to market value or get out quick value?

Thanks

Ann,

Thanks for the great information. I am much more comfortable with this property. I didn't think about making sure that insurance is maintained, which would be critical, so thanks for that tip!

I believe the builder would actually just take whatever amount we loan on thie house and use the money on building out the lots. Should that even matter if our loan is properly collateralized?

What is the best way to ensure that there would be no other loans against the property he wants to use? A title search would show anything recorded against the property, but not any non-recorded loans. Do we just make sure we record a first position to essentially make a first claim against the property if things go south? Would a non recorded lien holder have any rights?

Wow, lots of questions. Sorry.

Good stuff from Ann.

Tyler, I suggest you get with a title company, most do construction disbursements and have an inspector. The insdpection is not to compliance with codeds so much as X dollars worth of material being on site and advance based on completion. Best way to do it!