Due Diligence – Direct Lending

A successful direct investment or loan will be based on the quality of the due diligence being done. Based on our experience, one of the challenge for investors is to be able to evaluate the quality of the investment and then to assign it a risk. Due diligence is a process that combine research, verification of information, market valuation and a good understanding of possible exit strategies. Most investors that have experienced significant losses are telling us its because they moved too fast.

Each one of us will approach this process differently, however, here is the way we like to do it. We collect the initial documentation from potential borrowers. This will include but not limited to financial statement(s), credit reports, lease agreements if property is leased or last year plus year to date income and expenses on the business if owner user, pictures of the property, income and expenses on the property, title report. We will want to see a current bank asset statement. We ask the borrower for their current estimated property value, an old valuation (appraisal if possible), the loan amount there are looking for and the use of funds. Finally we will ask them to tell how they will be planning to pay us back. Since we are bankers and do conventional lending we have a good idea if their assumptions are true.

One of the main challenges is to make sense of these documents and to see how the information they contained compare to what is happening in the market. Borrower need hard money because they are not perfect and / or cannot qualify for bank financing. Thus when doing due diligence this is something to consider. If borrowers / loan officers are not providing the documentation, then you know that there is a problem somewhere. My rule of thumb, if people want money they can document what they say they can. As we know this is hard money thus there will be problems, but it is important to know what the problems will be from the get go.

Hard money is all about the property. Doing due diligence on the real estate is one of the more crucial aspect of this effort. If as an investor you cannot visit the property, make sure you send somebody you trust to see it. One time we saw a property and on the face of it, it looked good, once we visited the site the kitchen was missing. This was not noted in the appraisal not ordered by us. Make sure to understand what maintenance needs to be done if any.

Once the risks of both the borrower and the property have been evaluated terms can be confirmed. As experienced investors will tell you, they can get a general idea of the deal within few minutes of speaking with either the borrower or loan officer. However, in 98% of the cases, new issue or points of concern arise during the due diligence process that need to be addressed.