Sacha's Blog

What is Private (Hard) Money?

Sacha Ferrandi (Source Capital Funding, Inc.) — Fri, 14 Nov 2008 12:44:05 -0500

Private hard money lending is fast becoming a very viable option for many borrowers. With the sub prime meltdown and conventional lenders left standing tightening their lending standards, this avenue of finance still offers the liquidity many conventional lenders now lack.

Hard money is a collateral based lending platform. Although credit, ability to repay, financials and the borrower's overall package do play a part in the lending decision, the largest consideration is given to the equity of the property. Hard money lending offers the flexibility needed in today's market. Creative structuring of transactions is common. With hard money, you are able to encumber multiple properties, provide alternative forms of income and overcome even major credit issues.

One big advantage of using a hard money lender is the personal relationship involved. You are not dealing with a large institution, trying to fit into a pre-determined qualification box. You have the opportunity to be underwritten on a personal level. Because there is no minimum credit score required, hard money lenders will look at all credit situations, giving you the opportunity to explain past issues. A good hard money loan is one where the investor and borrower are both on board with a solid game plan that leads to the take out of the hard money loan, usually through a refinance or sale.

Working with a hard money specialist is ideal when trying to obtain a private money loan. Not only is it important to have the correct structure and complete package, but it is just as important to be sure the professional you choose has the resources to fund your transaction. With the recent shakeup in the mortgage industry, many brokers who used to do only conventional financing have started to look into hard money. While you can learn how to structure deals, it takes time to build the relationships needed to fund hard money loans.

Please feel free to contact me with any questions or to discuss this in greater detail.

Guide To Trust Deed Investing - Part Two

Sacha Ferrandi (Source Capital Funding, Inc.) — Tue, 12 Feb 2008 16:58:26 -0500

This is the second part of the blog to help educate both borrowers and investors regarding trust deed investing. As always, please feel free to contact me with any questions...

Licensing

Department of Corporations (DOC) - The Department of Corporations issues two licenses for the purposes of loan origination; a California Finance Lender License (CFL) and a Residential Mortgage Lender (RML) license. Without going into too much detail here, a CFL is a license to work with consumers and other CFLs and a RML is a license to work with institutions. Department of Real Estate (DRE) - This is how Source Capital Funding, Inc. is licensed. The DRE licenses individuals and corporations to originate and broker loans. They must pass an exam and keep up with continuing education to maintain their license. A DRE license is not required to apply for a CFL license. A DRE license is really geared toward the buying and selling of real estate, and less toward the financing and underwriting of real estate. It is important to look at the licensing credentials of the firm you are investigating. But as stated before, experience in underwriting and originating private money loans is paramount in your evaluation process. Source Capital Funding, Inc. Trust Deed Investing.pdf 4

Trust Deeds vs. Other Income Investment Options

The real estate market has enjoyed a spectacular rise in fortune over the last number of years. Overall, real estate prices have appreciated by 12.4% annually between 2001 and 2006, according to the S&P/Case/Shiller US home price index. In certain geographical areas returns have exceeded 20% per year for the last few years. In comparing these returns to stock prices, investments in real estate clearly outperformed stock price appreciation. Stocks gained only 4.3% per year as measured by the Standard & Poor's 500 over the same period of 2001 to 2006. The volatility in investments in stocks and commodities may show acceptable returns over the long term. However, this volatility forces investors to endure painful lows. Trust deed investments on the other hand remain stable investments with the one exception: at times, investors may receive their funds later than expected due to periodic loan defaults and as long as loan to value ratios are adequately determined, investors tend to receive increased payouts in the case of a default as a result of higher default interest rates and penalties.

Evaluating Trust Deed Investments

Value Considerations

The real estate value is of critical importance to private money lending as private money lending is essentially equity based lending. An independent appraisal is of value, however the appraisal will have to be reviewed very carefully to ensure that the value derived at is based upon current and, more importantly, future expected market value rather than historical value. The value allows for the calculation of two key ratios: the first being the loan to value ratio (LTV) which is the total loan including impounds divided by the property value. The lower this ratio the better for the investor, as it expresses the equity in the property. Another important ratio is the loan to cost ratio (LTC) which is the total loan including any impounds divided by the total cost of the project. This ratio may well be a lot higher than the loan to value ratio and indicates the amount of cash the borrower is contributing to the project or has invested in the real estate. Actual cash invested is always a strong motivator to protect the property.

Borrower Credit and Experience Considerations

The data on the borrower's credit status, which would include a credit report, financial statements, details of other assets and obligations will be collected and reviewed to ensure that proper knowledge is obtained on the credit worthiness of the borrower. The evaluation influences the final loan decision and provides a credit profile of the borrower, however, it's not the determining factor in approving the loan. In addition to the borrower's credit considerations lenders must assess clearly the experience of the borrower or their general contractor in completing the project on time and within the budget.

Additional Forms of Collateral

In addition to the subject property, additional sources of collateral may be available such as other properties which could be cross-collateralized, personal guarantees and, interests in partnership or LLC's.

Lien Priority

It is of great importance to determine what priority the loan is going to have on the collateral based upon liens that have already been recorded against the property. The preference would be a first trust deed position, but there are instances when consideration could be given to a second trust deed as an investment.

In the case of second trust deed investments, details of the senior lien has to be obtained to determine the amount owed and the terms of the senior note including prepayment penalties, negative amortizations and Source Capital Funding, Inc. Trust Deed Investing.pdf 5

whether junior financing is permitted. The requirements to service the senior loan are important in the event of a default. In a second or junior trust deed investment, special attention needs to be placed on the LTV as viewed from the junior loan's perspective, i.e. all indebtedness and impounds divided by the value of the collateral.

Borrower's Exit Strategy

As most of the private money loans are relatively short-term, it is of critical importance to determine the viability of the borrower's exit strategy. At the time that the loan matures, the interest impounds or any other impounds end. Any extension fees, interest payments and additional capital would have to be funded by the borrower, who may or may not be in a position to do so.

Additional Due Diligence

Determination of title and title insurance has to be completed and obtained. Insurances for such items as fire, earthquake, flood, construction and liability need to be investigated, as well as any possible environmental assessments and requirements. There are a number of other items to be examined and include borrower financials, tax returns, property reports, etc. Each private money lender has their own set of guidelines.

Foreclosure

In the event that the borrower is unable to have the loan extended or make payments in accordance with the promissory note, a notice of default is registered and sent by the trustee to the borrower and all parties involved in the trust deed. A debt under the trust deed can be reinstated if payment of the overdue amount is made at any time after the notice of default is recorded, but no later than five business days prior to the date of sale in the subsequent recorded notice of sale. No less than three months after the notice of default is recorded, a notice of trustee's sale is given in the same manner as the notice of sale in a foreclosure. Reinstatement is possible up to five days before the sale date. At the sale itself, the beneficiary lender can credit-bid up to the amount of the debt owed. The more significant difference between a mortgage and a trust deed is that there is no right of redemption following the trustee's sale. The sale is absolutely final and the purchaser can take position immediately. Some borrowers may elect to file a petition for protection under bankruptcy code in order to forestall a foreclosure sale. Once the bankruptcy petition has been filed, an automatic stay prevents lenders from initiating any adverse proceedings. The cost of a foreclosure will be added to the loan and most private money loans will have additional interest and penalties that would become effective once the loan goes into default. It is important to recognize that as long as the loan to value, and therefore, the equity in the property was calculated correctly during the underwriting process, investors may be in a good position to not only collect their capital but all the interest and costs due to them, including the penalties and higher default interest.

Risks Associated with Trust Deed Investments

Investors should be fully aware that investments in trust deeds generally yield higher (12% to 16%) annual returns than most other debt instruments. As a result, you need to expect that these investments include higher risk than other debt instruments. In particular: • Trust deed investments are not insured by any government agency and there can be no guarantee that capital and/or interest will be recovered from the borrower. • The value of the property is subject to change and to market forces. • The borrower's ability to repay the loan will depend upon the borrower's financial conditions and the success or failure of the project. Source Capital Funding, Inc. Trust Deed Investing.pdf 6

• Default of the borrower could interrupt monthly payments, and foreclosure could be stalled by the borrower seeking protection under the insolvency codes. • Investing in trust deeds is an illiquid investment. There is a limited, if any secondary market to trust deeds and generally investors are by law required to hold the investment for at least one year, and thereafter the liquidity is dependent upon market forces and the current state of the project and the borrower.

Guide To Trust Deed Investing - Part One

Sacha Ferrandi (Source Capital Funding, Inc.) — Tue, 08 Jan 2008 12:09:50 -0500

My goal is to help educate those interested in not only investing in trust deeds, but those that might not be aware that there are other legitimate sources for financing than a bank. Sometimes referred to as "hard money", there are a number of good and bad sources for financing real estate. Please feel free to conatct me with any questions. Part Two to follow...

Definition of a Trust Deed Investment

Real estate lending is essentially the making of a loan to a borrower. The loan is comprised of two basic components: a promise to repay the debt, known as the promissory note and a recorded document that is evidence of the debt, known as the deed of trust, also referred to as a trust deed or a mortgage depending on the state in which the document is recorded. Once the trust deed or mortgage is recorded, the promise to repay the loan is secured by a "lien" placed on the property. In short, the promissory note promises to repay the loan and the trust deed is the security instrument recorded with a county recorder's office creating the lien on the borrower's real estate.

Trust Deeds vs. Mortgages

The advantage of a trust deed over a mortgage is a shorter foreclosure. With the judicial foreclosure proceedings required with a mortgage, it may take as long as a year to acquire clear title to a defaulted property. This is due to the filings, court delays and redemption periods. Under the non-judicial foreclosure trust deed's power of sale clause, this effort is reduced to as few as 120 days. Although the borrowers (trustors) still own their property, they have agreed to pass claim against this ownership over to the lenders or their nominees (trustees) to hold during the term of the loan. The trustee is often a title company, attorney, or an independent corporation that is set up to act as trustee. When the loan is fully repaid, this trust ownership is reconveyed (released) to the borrower, clearing the records of this encumbrance. If there is a default, this trust ownership will be perfected by the trustees through the foreclosure process and to full ownership of the real estate. Thus, under a deed of trust, borrowers retained an equitable title to the collateral while the lenders secure a form of legal title. Although only the borrowers sign the note, both borrowers and the trustees sign the deed of trust. Trust deeds are held by the trustees for the benefit of the lenders, also known as the beneficiaries. The most significant difference between a mortgage and a trust deed (or mortgage with out of sale) is that there is no right of redemption following the trustee's sale. The trustee's sale is absolutely final and the purchaser can take possession immediately.

Senior vs. Junior Positions

Trust deeds can also be in the form of senior and junior loans. Junior liens are behind senior liens in priority when the security is realized and debts paid. Because the second trust deed is in a subordinate position to the first trust deed, the junior lien holder is in a relatively higher risk position than the first trust deed holder. In the event of a default, a senior lender would usually give the junior lender a chance to step in and make the delinquent payments. The junior lender will then be in a position to foreclose against the collateral property and protect their interest.

Purchase Money Trust Deeds

Purchase money trust deeds are used to finance the purchase of real estate (as opposed to loans against property already owned by the borrower). It is important to note the distinction between purchase money trust deeds and other trust deeds, as California Law has separate rules for such trust deeds which materially affect investors' rights.

Why Borrowers Choose Private Money Loans

The question often arises as to why borrowers would borrow private money on real estate transactions at the high rates that private money demands. The immediate assumption is that these are high-risk ventures and the borrowers do not have the credit-worthiness that would allow them to borrow from regular and conventional sources. There are in fact a wide variety of factors that determine whether or not a borrower would be a candidate for a private money loan. Let's look at several more common reasons below:

• Quick Funding of a Time Sensitive Loan

Banks and conventional financial institutions normally take much longer than private money lenders to close a loan due to strict regulatory oversight over conventional banks and lending institutions.

• Reduction of Red Tape and Paperwork Hassles

Traditional lenders require substantially more documentation than private money lenders and have more stringent loan committee processes. When time is of the essence, traditional lenders typically cannot meet the time demands of the borrower.

• Flexibility and Creative Problem Solving

Private money lenders are more creative with complex loan situations. They can offer options like cross-collateralization of other properties, or offer more flexible terms than traditional lenders. The property may also have issues that make it difficult for conventional lenders to finance such as the need for improvements to increase the occupancy of a building, or partially completed construction, etc. Additionally, traditional lenders will not lend on raw or un-entitled land due to their strict underwriting guidelines.

• Nature of the Loan and Market Conditions

The constant change in market conditions in the real estate market forces conventional financial institutions into taking even more time and thus have become even more conservative in approving loans. Private money lenders on the other hand have the ability to assess the property or project's risk and charge an appropriate fee for the perceived risk. In essence, private money lenders are equity based and the most important component of the loan funding is the evaluation of the real estate. A borrower's past history and level of commitment plays a part in determining the viability of the loan but is not as paramount to the decision making process.

• Reduction of Equity Participation

Borrowers may also consider private money for a portion of the traditional equity component of a project. Equity investors require a preferred rate of interest, normally around 9%, plus a share of profit of up to 60%. This makes private loans a cheap alternative for a portion of the equity component.

• Borrower Circumstances

Again, these are not just limited to credit problems or a past or current bankruptcy as is most often assumed. There may be tax liens or other liens that need to be paid, or the property may be entering into foreclosure for a variety of reasons. The property may be held up in probate, or involved in a divorce or other family situation. There may be unemployment or a medical emergency, the list is endless but the principle is basically the same; private money lenders lend on the value of the asset first, and the strength of the borrower second. Ultimately, the decision resides with an experienced underwriter to evaluate the "whole story" when evaluating a potential borrower.

Private money is used by a wide variety of borrowers ranging from very high net worth individuals to sophisticated real estate investors and developers, all of whom prefer the speed and the simplicity of completing the loan process to credit-challenged borrowers who have limited choices for financing.