Working With Available Capital - Part 2

In our previous post we reviewed the liquidity aspect of the market and how it will affect us and our decision to invest. While real estate is not considered a liquid investment until 2007, getting the capital lended paid back was relatively easy. Most importantly, we did not expect to lose any amount of capital. Since then we have experienced a complete 360 we moved from a relatively liquid market to a frozen one. As part of working with our available capital, today we are going to look at what motivate borrowers to ask for financing.

As a real estate lender / investors we are constantly asked to finance deals and making choices that can be difficult. Our approach to approving loans and making an investment is to understand why a borrower needs money. When we get the reason then we verify that this is true and makes sense and if it is and does, then we move forward with the underwriting process. By asking questions and being inquisitive you get a lot of good information, and with experience we are able to determine the validity of what borrowers are telling us.

There are a number of good reasons to approve financing. Borrowers are buying numerous properties and banks will only finance a limited number of them. It is quite easy to verify that a borrower own multiple properties. Borrower need short term commercial loan, most commercial loan come with prepayment penalties. Borrowers need cash-out, today it is quite difficult to get cash out. Borrower, need second position loan, no second position loan are available today. Here we only approve second positions on low LTVs. Etc…

As well there are a number of reasons why we do not approve loans. When borrowers need capital to finish development projects that went over budget, it will be difficult to approve. In most cases this does not work because the LTV does not make sense. We will decline a financing when the borrower cannot afford to make the payments on the loan. We really are not interested in foreclosing on properties even when the value is there. We know this is a risk that we are willing to take, but we try to avoid putting ourselves, knowingly in this situation. Now if the borrower is selling the property and we can build interest payment into the loan then this is a different story. We will decline a loan when there is no clear exist strategy that makes sense. Etc…

Once we understand a borrower’s motivation, we can better figure out if we want to move forward with lending them capital. In real estate more than with everything else I like to use Ronald Reagan approach “trust but verify”. Most borrowers are completely willing to work with the lender, as they realize that lenders, even private ones, make rational decisions. A big red flag for us is when borrowers do not work with us, or set their own agenda, in general this signal that either they are not in touch with the market or, most likely, we don’t have the whole picture.