Traversing the Private-Money Path
Finding the right nonbank lender can be a complicated journey.
As the influence of private-money lenders has grown in the past decade, so have the types of lenders that fit the private-money definition. Borrowers need a roadmap through the private-lending landscape, and well-informed commercial mortgage brokers can provide one.
Even relative newcomers to any facet of the commercial real estate market have seen striking changes in the business. The same is true for those in the business of obtaining financing secured by commercial real estate — including those in the business of borrowing, brokering and lending private money.
To better understand private lending, it’s useful to define private money by its lending source. Generally, private money is a loan arranged through a source that is not a bank or a finance company that securitizes loans, or another traditional lender.
Rather, private money is arranged from other sources, including, wealthy individuals, private companies, investment funds and similar nontraditional sources. Although many loans from nontraditional sources may be considered private money, there are numerous types of financing that fall under the definition.
Although there are certain private-money players that lend into highly distressed situations at higher rates and fees with little due diligence — and with an eye toward “loaning to own” — many in the business, including commercial mortgage brokers and real estate agents, label all private-money lenders as hard money lenders. Further, with that label comes the expectation that no underwriting, analysis or due diligence should be conducted on the loan. Instead, commercial mortgage brokers and their clients ask, “Why do you care, if you’re hard money?” That is usually followed by the phrase, “I want maximum leverage at the lowest rate and fees, and the best terms.”
It is true that some private-money lenders, including certain crowdfunding and peer-to-peer lending platforms, use more relaxed underwriting standards and shift the majority of the credit risk to others to compete in a very liquid market. Even those lenders, however, do not fit into a one-size-fits-all category.
The new reality seems to be that private money has morphed into a sliding scale, with transactions that are not bankable on one end of the spectrum and hard money on the other, many variations in between. Although all hard money is nonbank financing, not all nonbank financing is hard money. Bridge loans in first-lien position on transactions that are not bankable, for example, will generally deliver more attractive rates and terms in exchange for additional underwriting, analysis and due diligence. Conversely, traditional hard money remains available on rougher transactions with perhaps a more streamlined process, albeit at a higher cost.
In addition to general loan types or loan programs, each lending platform has its nuances, which may be driven by a number of factors. Those factors may impact not only the underwriting parameters (for example, the loan program), but also the loan process.
Following are several of those factors:
• Discretionary versus nondiscretionary capital: Discretionary capital includes lending platforms where, although investors may be involved, it is the lender that has the authority to approve or decline the loan. Conversely, nondiscretionary capital requires that the lender obtain additional approvals (known as “investor approval” or “third-party approval”) before making the loan. Examples of lenders with discretionary capital include those using their own funds to make loans, and managers of blind pools and pooled mortgage funds. Examples of lenders with nondiscretionary capital include those that broker loans to high net worth individuals or other entities that approve and fund the loans.
• Balance-sheet versus nonbalance-sheet lending: Balance-sheet lending includes lending platforms where the lender retains and holds the loan in its own portfolio or in portfolios it manages. In non-balance-sheet lending, the loan is ultimately owned by a party other than the lender. Balance-sheet versus nonbalance-sheet lending is similar to the use of discretionary versus nondiscretionary capital, with the difference relating to the loan process and who makes lending decisions. Further, post-closing servicing and other related issues may be easier and more efficient to address with a balance-sheet lender. Examples of lenders using balance-sheet lending again include those using their own funds or managing discretionary pools of capital. Examples of nonbalance-sheet lenders include those brokering loans to individuals and entities. Hybrid-type lenders include those who may ultimately securitize their loans after holding them on their balance sheets for a period of time.
• Liquidity and concentration issues: Unlike governments, lenders do not print money and, therefore, ultimately have a finite amount of capital and need to manage liquidity. Further, lenders holding loans on their balance sheets may want to eliminate concentration issues — be it in a particular borrower or asset type — to achieve greater diversification. For lenders that are brokers or intermediaries, the challenge is finding capital for every loan request. Even those with large books of high net worth individuals may bump into situations where their go-to investors dislike the loan request, do not have sufficient capital to invest at the time of the request, may believe they have their own concentration issues, or have otherwise committed their capital elsewhere.
The result is that even in today’s very liquid market, it is wise for borrowers, brokers and other non lender intermediaries engaged in the financing process to work with several lenders that control the underwriting and funding process, and who have different lending styles and parameters.
When working and building a relationship with lenders, rather than asking whether they are a direct lender, it is better to ask whether they have discretionary capital and whether additional approvals are required. That is, where does their capital come from and how does it work? That is only one of a series of questions that should be asked to help you understand your potential lender, however, to assure that you and your client will not be unpleasantly surprised later in the underwriting process.
For instance, does your client meet the personal and financial standards of your lender? This is where knowing your deal and being transparent with the lender will go a long way. If your client has a troublesome legal or financial history, disclose the information early in the process, rather than having the lender discover it during the due-diligence process.
Has the lender done loans at the size requested, and do they have available liquidity to fund your loan? This is a legitimate question for some private institutions, as well as for lenders that intend to syndicate a loan. If that is the case for a loan you are brokering, understand the process and the timing of the syndication and find out whether additional approvals will be necessary after your primary lender makes a financing decision.
What information, documentation and reports will the lender require to underwrite the loan? In addition to the rent roll, leases and operating statements, for example, will the lender require tax returns and bank statements? Will an appraisal controlled by the lender be required? What about third-party reports?
It’s worth noting that although the discussion will ultimately turn to rates and costs, the most important consideration is usually the lender’s ability to execute on a particular deal — especially on deals that are not bankable. In that regard, brokers shopping a loan to 75 of their closest lender friends, double brokering loans, or starting conversations with lenders with a request for rates and fees as a means of “qualifying” the lender may not be employing the most effective approach. In other words, you will not improve your chances of securing a loan by pushing for a letter of intent or pressuring a lender for rates before sharing the details of a loan.
The value of transparency in this process among borrowers, brokers and lenders cannot be overstated. There’s an old axiom that says: “If you haven’t found any problems, you haven’t looked hard enough.” This is commercial real estate after all, and there are bound to be challenges in many transactions. This is especially true when, by choice or necessity, a borrower is seeking alternative financing.
Many lenders providing alternative financing secured by multifamily and commercial real estate are well-versed in identifying, considering and addressing risk. Lenders in the alternative-financing space make their living identifying risks they can quantify and address.
Brokers who really know their deal can narrow the field of potential lenders and quickly begin the work of finding solutions that mitigate risks to a level acceptable to the lender. Even if you ultimately take your current transaction elsewhere, a good private-money lender will remember your approach and may be more willing to work with you on the next deal.