Private Lending. Is this an option for you to consider?
Certainly more common in single family residential lending, private lenders are often considered lenders of last resort. High rates and high fees meant that their borrowers are poor credits, and these lenders are unscrupulously taking advantage of peoples misfortunes. They couldn’t possibly have a role to play in commercial mortgage financing, right? Not so fast!
Private lenders can be useful to those borrowers who do not qualify for traditional loans from conventional lenders, or for good and valid reasons, do not wish to deal with their local Banker.
When is private lending appropriate?
Private lending is appropriate in several circumstances. Possibly some or all of these factors come into play:
-the property type is a challenge for conventional lenders (e.g. rooming houses, self storage facilities, motels, trailer parks, marinas, raw land, are but a few that come to mind)
-the property may have been recently remediated, but has the unfortunate stigma associated with previous environmental problems
-the borrower may be self employed, and is declaring little or no income
-perhaps the borrower does not wish to disturb an existing low rate mortgage, and expose themselves to repayment penalties.
-the borrower may be experiencing temporary credit challenges of one type or another.
-there may be property tax arrears.
-the borrower may wish to take immediate advantage of a purchase opportunity, and cannot afford to wait for conventional lender approval.
-perhaps funds are temporarily tied up in another property financing transaction.
-the borrower requires immediate “mezzanine” funds to finance construction, tenant improvement work or undertake renovations to attract a new tenancy.
-the property is be re-positioned in some manner (e.g. re-purposing an industrial building into a funky new office)
Private money is typically short term money
Many of these above noted factors suggest a need for temporary funds, and for this reason private lender solutions are often short term. Rates and fees can be high, however terms are typically 3 to 12 months in length. Rarely are these loans amortizing. More typical loan structures include interest only, interest accruing, or registering the loan in an amount which builds into the principal balance, some or all of the rate and fee, all consequently due at maturity. Many lenders will “encourage” full repayment at maturity by building in a significant rate increase, should the maturity date be exceeded.
Private funds play an important role in early stage real estate development
Private lending is also prevalent at the inception of real estate project development. Costs to be borne prior to the sale of a condominium project is a good example. Costs would include development charges, architectural fees, marketing and promotional materials and other soft costs. The more sophisticated private lenders providing this type of financing also often structure a profit participation. Known in the industry as an “equity kicker”, this implies a return to the investor prior to the owner/developer receiving any profit. This recognizes the additional and very considerable risk associated with this type of private lending. This type of loan will need to postpone in priority to a construction lender’s facility once the shovel hits the ground. Again, additional lender risk, resulting in higher borrowing costs.
Private lending can be from an individual or single source. Alternatively, it can be from a group of lenders. Referred to as a “syndicate” of investors, they are often represented by a broker or fund manager.
Important to keep in mind, is the importance of having a well defined exit strategy for this, or any financing.
For additional information on private lending sources and investment opportunities, take a look at Private Matters Today, a publication serving private lenders in Ontario.