Private Development Loans

Many investors are unfamiliar with development loans, but they're a crucial tool in the real estate game and can represent a lucrative investment vehicle. Development loans are short-term loans that allow a developer to prepare a site for future construction. Funds are used for site work such as grading, utility installation, and basic infrastructure such as streets and lighting. Development loans are generally paid off quickly from the sale of lots to new property owners or builders.

In order to properly underwrite a development loan and control risk, a number of important factors have to be addressed:
                           

Borrower's Equity: Through initial investment of cash or the pledge of other unencumbered real estate, the borrower partially funds the project so that the Loan-to-Value (LTV) of the property being developed is within a prudent range. Most commercial banks require 30%–35% down. This equity protects the lender and investor as a cushion if the borrower fails to perform, allowing for full repayment of the loan with a discounted sale of the property.
Management Track Record: A review of the borrower's prior track record is important to determine their level of experience and success in identifying attractive development projects, and managing them to a profitable conclusion. Prior experience, while not indicative of future performance, certainly provides a level of confidence that the project will succeed and the loan repaid as agreed.
Market Dynamics: Lenders need to pay close attention to trends in the marketplace. It's important to understand the demand for the type of site being developed, and also what competing properties are, or likely will be developed during the life cycle of the project being considered.
Takeout Timing: The loan structure must include a reasonable pay down schedule based on the likely sales timing and price of the developed lots to be sold. Most developers want to keep their profit up front, therefore it's crucial that the lender negotiates for the proceeds of each lot sale to be applied to a repayment schedule that is in every party’s best interests. For example, an accelerated repayment structure ensures that the LTV stays in the lender's and investor's favor as lots are sold, leaving most of the developer’s profit to the end of the project.

Commercial banks are a typical source for development financing, but there are numerous important private alternatives. These can be valuable for developers and can also provide an excellent investment vehicle for private investors. Since the financial crisis of 2008, many banks have either exited the development lending space altogether or significantly tightened credit standards. This fact has left many developers with limited financing options, and a very slow and laborious process for obtaining financing. Private development loans from experienced non-bank private lenders are an increasingly attractive alternative. These firms are specialists, and can bring their narrow focus and expertise to the table to provide quick and efficient loan approval, streamlined loan documentation, and prompt closing to the developer.

Private lenders create investor opportunities as well. Private lending firms often fund their loans by working directly with individual investors and share a large portion of the loan's interest revenue with them. Compared to the anemic interest paid to depositors by banks, the returns can be highly attractive. Development loans in particular can be extremely lucrative with an elevated Return on Investment (ROI) and quick payback due to the short-term nature of the underlying loans.

Both developers and investors should conduct their own due diligence as they consider alternatives to meet their financial goals. While traditional commercial banks remain one alternative, savvy developers and investors should research private lending alternatives as another viable outlet.

William “Tripp” Nassour III is a Managing Director of United Security Investors (USI). Creating value amongst all stakeholders has been a hallmark of USI’s success within the private lending arena. As one of Beverly Hill’s prominent bridge lenders, providing liquidity for owners of both commercial and residential real estate assets, USI has developed a particularly strong track record by engineering value-added financial solutions for borrowers with whom the company has enjoyed a longstanding relationship. The USI team prides itself on repeat lending opportunities from its borrower clientele by providing the agility and responsiveness that its borrowers have become accustomed to. Additionally, USI’s investor base has enjoyed an unparalleled 58 consecutive months of positive returns since the company’s inception in 2011. This impressive track record can largely be attributable to USI’s vast local knowledge and experience of the areas in which it lends, paired with the impeccable financial acumen of its principals who boast more than 45 combined years of experience in the real estate industry

Bridge Loans as Business Investments

 While bridge loans constitute a non-conventional investment, the benefits of investing in them with a private lender can be significant:

• Collateralization: The funds are secured against a recently appraised commercial property without requiring the investor to manage or purchase an actual property. Generally, the maximum loan-to-value ratio is between 50% and 65% of the current or improved value of the commercial property.
• Diversification: Private lending in real estate gives an investor another option for diversification. The rate of return is hardly affected by global politics, stock market swings, or future real estate trends.
• Control: Unlike the mortgage products that led to the subprime meltdown, bridge loans are not sold, re-sold, or transformed into other investment products packaged to divert attention to deficiencies. These are straightforward, direct loans secured by commercial property structured to protect both the borrower and investor. Bridge loan borrowers are individually qualified and assessed, and investors are critical business partners that the lender wants to remain satisfied.
• Profitability: Investors can earn predictable, proven rates of return without committing their funds for years or decades in other investments. Generally, the lender will offer the investor a set rate of return with no fee structure, although terms can vary between lenders and specific deals.

Investing in bridge loans secured with commercial property has some potential disadvantages; however, with a little caution, the investor can reduce that risk substantially:

• Loan position: First position is obviously the better place to be, and it is best not to assume that a bridge loan is always first. Positions are directly tied to the amount of risk involved, and are inversely related to the returns.
• Research: While investing in certificates of deposit or even a fund that mirrors a certain index may be straightforward, bridge loans require a certain level of due diligence. While some investors work directly with borrowers, many reputable, proven companies pool investors and then lend to borrowers. They will find, analyze and structure the loans. These firms should have a verifiable track- record, references, and recommendations.
• Other factors to scrutinize include investor protection in case of default, the maximum LTV the company will lend, and whether the company lends to borrowers based on the current or anticipated value of an improved property.

With these factors in mind, becoming an investor in commercial real estate bridge loans can offer a relatively very rewarding rate of return.