Private money investing

The industry is not well publicized and is largely centered in California, several Western states, and New York. Lenders are predominantly small, highly specialized mortgage brokers familiar with commercial real estate lending. The trend in California is towards mortgage funds or mortgage pools, which are structured and operate similar to commercial banks. Private Money Bankers or Real Estate Bankers, are groups, individuals, companies or funds, that pool private money, and then lend those pooled funds for profit.

Investors range from private individuals, trusts, and LLCs to pension funds. Individual investors generally have substantial knowledge and experience in real estate or trust deed investing. Individual investors are tending to pool their money with other sophisticated investors through pooling via Private Money Bankers, also known as Real Estate Bankers, or Private Real Estate Bankers.

The motivation for investing includes: the simplicity of the underlying investment and a desire for: 1) An investment secured by real estate 2) Regular income derived from monthly dividend distributions; 3) Higher yields than those available from investing in money market funds or bonds; 4) An Active involvement in real estate finance.

A borrower seeking funds approaches a mortgage broker or private money lender and describes his borrowing needs. These include: 1) The amount of money sought; 2) The value of the property that is being pledged as security, or collateral; 3) A description of the property; 4) The use of funds.

The mortgage broker or lender then assesses the proposed loan, focusing on the value of the property being proposed as collateral. The maximum amount that may be borrowed is determined by establishing the amount of “protective equity” existing in the property.

For the private mortgage investor, this equity provides the cushion for the risk taken in extending a loan. In the event that the borrower defaults on the loan, investors recoup their capital by assuming the borrower's equity in the property.

Protective equity is calculated by taking the liquidated value of the property (the price at which the property could be sold quickly, usually ninety days), and then subtracting any outstanding debt related to the property in the form of existing loans or tax liens on the property.

This amount is then compared to a Loan to Value (“LTV”) ratio. The ratio, established by the lender, represents the maximum amount that the lender will lend a borrower. It is expressed as a percentage of the total amount of protective equity, divided by a percentage.

This percentage varies primarily with the type of property that will form the basis of the collateral. Non-income producing or difficult-to-liquidate property carries the lowest ratio. So, raw, undeveloped land may carry a maximum LTV of 50%...if a lender will even consider using it as collateral. Rural income producing property, such as a small shopping center, may similarly carry a low LTV.

Example: Appraised land value = $1,200,000 Existing trust deed = $200,000 Equity = $1,200,000 - $200,000 = $1,000,000

LTV = 60% Maximum total Loan Amount available to borrower = 60% of $1,200,000, or $800,000. The lender may choose to place a $600,000 2nd Deed of Trust behind the $200,000 existing Deed of Trust or it may place a new single $800,000 First Trust Deed loan.

If the broker determines that the liquidated value of the property falls within acceptable limits, the broker prepares a loan package summarizing the underlying details. If a broker is not involved, the lender performs these functions in-house.

The borrower is advised as to an approximate amount of funds that may be borrowed, and is provided with a preliminary estimate of a range of interest rates and loan fees that may be anticipated. This advisement often comes in the form of a Letter of Intent or Letter of Interest prepared by the lender.

If the borrower agrees to these figures, the broker proceeds by doing one of two things: 1) He contacts individual Private Money Investors and solicits their direct investment in the loan. This is called FRACTIONAL INVESTMENT [described below]; 2) Alternatively, he brokers the loan by contacting Private Money Lenders known to be interested in making loans of the size, type and location sought by the borrower. These lenders in turn create fractional investments themselves or are MORTGAGE FUNDS [described below].

Following receipt and agreement of the Letter of Intent, the lender performs a rapid review of the property and underlying financing, title and credit issues. This due diligence process includes the preparation of a property appraisal by an independent professional appraiser and, frequently, personal meetings with the borrower and personal inspections of the property by the lenders.

Following the completion of the preparation and compilation of necessary documentation, the loan proceeds are transferred to the borrower. After a brief pause in financing activities, the borrower then turns his attention to arranging permanent financing to replace the higher cost bridge loan he is committed to.

Private Mortgage Investment takes three primary forms: Direct Mortgage Investment, Fractional Investment and Mortgage Fund Investment.

Minimum net worth requirements must be met by investors (in California) to be eligible to invest in Mortgage Funds operating subject to a Permit. These restrictions are intended to limit Mortgage Fund investment to more experienced investors. Additional restrictions limit the maximum percentage of an individual's self-directed IRA that can be invested.

Eligibility: Net worth requirements (California) Either: • Annual gross income of $65,000 plus net worth of $250,000 (exclusive of home, furnishings and automobiles) or • Net worth of $500,000 (exclusive of home, furnishings and automobiles).

Mortgage funds operating pursuant to a Plan (described below) limit investor eligibility to California residents or to International residents. Residents of other states may not participate.

Fractional investments [in California] fall under the jurisdiction of the Department of Real Estate. Regulations require, among other things, that a broker be licensed as a real estate broker by the Department.

Mortgage Funds are regulated [in California] by the Department of Corporations. They are established only after the Department reviews a Plan submitted by the managers of the proposed fund, which sets out, in detail, the specifics of the fund's operations, such as LTVs. Funds are limited as to the maximum number of investors they may take into themselves, the minimum initial amount an investor may invest, and the maximum total dollar amount that will be accepted into the fund.

Funds are required to submit annual audited financial statements to the Department and to investors. Funds are also subject to operation and investor regulation from the Department of Real Estate and the Department of Industrial Relations.

Fractional investments are generally originated and managed by mortgage brokers specializing in the field. [In California] these brokers operate under the auspices of the Department of Real Estate and are subject to its regulations.

Mortgage funds operate under the auspices and regulations of the Department of Corporations subject to Plans that are reviewed and renewed annually by the Department. Funds often are formed as LLCs, and may be referred to as Private Money Banks, or managed by Private Money Bankers.

Funds are managed by separate entities which are also subject to Department of Corporations regulations. These entities may be referred to as Private Money Banks, or managed by Private Money Bankers, and provide operational functions for the funds: They originate, underwrite and service the loans enabled by the fund's investors.

Fractional vs. Mortgage Fund • Need for liquidity vs. need for details on individual loans prior to making investment decision • Desire for diversification vs. need for details on individual loans prior to making investment decision

Which Fund? • Fund location and lending area • Property type fund specializes in • Fund operations: responsiveness to initial queries, follow-up • Personal impression of fund managers and support staff

Other, Personal • Amount of investmentGDVZV • Monthly cash distribution or reinvest all or some of dividends?

REITs (Real Estate Investment Trusts) are companies that own and manage commercial properties. Most REITs sell securities that are publicly traded. Investors buy stock in them, seeking to benefit by the stock dividends REITs pay, as well as the appreciation of the price of the stock itself.

Although the traditional fractional investment model will continue, the trend to mortgage funds is accelerating. Reasons:

1. Increasing property values continue to push prices – and loan amounts – higher. More investors are necessary for each transaction, a costly and time-consuming process to conduct for each loan. This time lag translates into slower funding for borrowers – and more time on the sidelines for investors.

2. The regulatory preference [in California] will likely continue. The structure, accountability and standards required for mortgage funds provides a better fit for government oversight.

3. The combination of diversification, liquidity and professional management enabled by mortgage funds will increasingly give them more of the appearance of banks, further adding to investor appeal.

• Hard money loan
• Asset-based loan A similar type of commercial loan based on real estate, indicating the loan will be based upon a percentage of the properties appraised value, as the key criteria.
• Bridge loan - A similar type of commercial loan based on real estate.
• Non-conforming loans - loans for non-conforming projects.
• Commercial loan - Standard, broad types of loans based on commercial property value.