Fractional Private Money Loan

12 Replies

Hi BP, my first post here. Thank you for all your comments in advance.

I have been a SFH buy and hold investor and am considering this private money lending opportunity. The plan is to acquire two adjoining parcels in a prime California neighborhood and build four homes for sale. Land acquisition escrow is estimated to close this month after delays from May, due to issues with the city. Return is at a per annum rate, and payout will only at exit, either at the end of land acquisition and entitlement phrase (Q1 2017) or after construction and sale (Q1 2018). First position loan is less than 70% LTV, the offer here is a second position fractional loan among approx. 10 investors lending different amount. The investment is secured by a notarized promissory note and deed of trust. No personal guarantee will be given. The borrower is structured within a LLC. Planning/permitting and escrow communication is well-documented. Estimates seem to be conservative and pro forma comprehensive. I realize that this will be a high-risk investment but the return is also appealing.

Is this structure and process a standard one?

I am in contact with one other investor of this deal, would it be necessary to be acquainted with most of them? In case of default, each singular note would be treated separately, and priority based on investment fund proportion, correct?

Is it a high concern that personal guarantee is not given?

Wiring transfer of fund will directly go to the borrower (LLC), would it be possible to transfer to escrow for the land purchase?

Any comments would be much appreciated.

http://www.dre.ca.gov/files/pdf/forms/re860.pdf

For fractionalized loan in CA this is the form that must be used...

this is as you may or may not be aware the most vulnerable position a lender can be in.

notary of the docs is standard NOT THE NOTE  just the Deed of trust and offers no special protection other than the person who signed it has been witnessed by a notary.

read the form VERY carefully that the state of CA provides.. suggest you talk with attorney on this.

I normally am not one to advocate attorneys on the west coast for vanilla deals.. but there is a significant amount of risk in this deal.

you will want an intercreditor agreement with the first lender.

See many BP post when these don't go well and they have no agreement up front with first lender.

Also MOST good HML in CA are experts at fractionalized loans.. and can help as well..

http://www.calbre.ca.gov/files/pdf/forms/re851a.pd...

 you want to review this disclosure as well... in detail.

can't stress enough how junior position in a development deal if it does not go correct can very often lead to a complete loss of capital from the junior lender  ( you)

Also if this is NOT really really large return... IE some equity as you need to be careful about usury as well.. these types of deals demand big returns for the risk your taking  

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If the 2nd loan defaults, all benes are treated the same and they are all technically in "2nd position" as a whole. I have never seen a higher proportionate interest in 2nd position take priority over a lower proportionate interest that also in 2nd position via the same Note. All bene's would have to take part in a foreclosure or release action together, as one conglomerate....at least in my 20 years experience.

Looks like an absolute non starter.

2nd position alone, with little to no equity is enough to walk away.

No personal guarantee offered.

As @Jay Hinrichs mentioned, a "notarized note" means absolutely nothing, and seems to be trying to offer some false sense of security.

And worse, as a participant in a fractionalized note you have absolutely no control when something goes wrong....you'll just be sitting back saying "let me know how it all works out".

@Shannon Peace  this is correct about the bene's  but also see the CA disclosure form some loan docs will let a bene with 50% or more owner ship control the foreclosure process.

its key in multi bene deals to have this agreed upon BEFORE making the loan... Been there done that with one investor that holds out and you can't promulgate the foreclosure lest you be wiped out by the senior.. LOL...

This is definitely a security, but has a securities exemption exclusive to California licensed real estate brokers, spelled out in section 10237-10239.3 of the CA business and professions code.There are a number of requirements ... your 10 investors will each have to be vetted for investment suitability, each will have to sign a statement that their interest does not exceed 10% of their net worth, there is a max LTV which appears to be 75% (you're already at 70% with the first), plus other requirements.

Jay has done this, he knows.  I haven't done one, pretty sure I don't want to heard 10 cats (TD investors).  In any case, you need to go through a broker, preferably one that has done this before, and you might want to run it by an experienced attorney ... I am not one.

Originally posted by @Jay Hinrichs :

@Shannon Peace  this is correct about the bene's  but also see the CA disclosure form some loan docs will let a bene with 50% or more owner ship control the foreclosure process.

its key in multi bene deals to have this agreed upon BEFORE making the loan... Been there done that with one investor that holds out and you can't promulgate the foreclosure lest you be wiped out by the senior.. LOL...

I have actually NEVER seen this form in loan docs before, but it is a good form to use!!

An ICA is always good with biz deals too, but very hard to get done.

@Shannon Peace  the reason you have not seen this form is its for the brokers to use and keep in their file.. if they get audited they better have it LOL.. its not requirement for escrow as you know..

Just like you don't generally get copies of the Homeowners disclosure form that relators use when selling houses.. same Idea

Thank you for all the comments. It certainly added more layers of complexity to this deal, especially the necessity of intercreditor agreement before making the loan.

I would also add that the per annum rate of return is 40% with minimium investment at $50K. 

Goretti   this is in line with the risk your taking.. in essence its an equity play.. Do check with attorney on usury laws though there in CA... it may not apply but good to know.. if the note your getting states a 40% interest rate you want that double checked..

Best of luck with it !!

when I see these deals and people are being offered 10 to 12% interest on these 2nd positions that's when the risk does not equal the reward when you can buy 10% interest first positions that have little to no risk.

Goretti: Other aspects of a second on a fractionalized note aside, the last paragraph held a key fact that would really break the deal for me "Wiring transfer of fund will directly go to the borrower (LLC), would it be possible to transfer to escrow for the land purchase?"  Never, never, never send funds directly to the Borrower - ALWAYS use an escrow company which has received your written instructions as to distributions.  Just my thoughts...

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