Print Friendly

Private Money Lending: the Scene From the East

By Richard H. Zahm

On a recent trip to the East Coast, I met with a number of our counterparts in New York, New Jersey and Connecticut. Who are they? How do they do business? Is there an opportunity to work with them? Or do they pose a competitive threat? What can we learn from them?

On a recent trip to the East Coast, I met with a number of our counterparts in New York, New Jersey and Connecticut. Who are they? How do they do business? Is there an opportunity to work with them? Or do they pose a competitive threat? What can we learn from them?

PARALLEL WORLD

The striking element is the similarities in what we are doing. The young loan officers fielding inbound loan scenarios from brokers look and sound the same as those in California, save for a quicker conversation speed and stronger accents. Loan parameters are virtually identical to our own, with similar (or identical) LTVs and response times.

There is the same jumble of small brokers and larger direct lenders, the same need to differentiate between who is a lender and who is actually wishing to be one. Prestigious addresses mask cramped office spaces: desks are often arranged in rows, with employees and principals sitting side-by-side and face-to-face in rows. At $60/sq ft for office rent, this makes sense…

They’re less computerized, less regulated and often come from law and investment backgrounds.

Each firm has its own particular sweet spot for loans and its own minor variations on how it does business. As is often the case here, there is a strong preference for doing deals close – VERY close – to home. Overseeing property just down the street has definite advantages.

At the same time, there is a greater awareness and openness to extending loans at a distance. Given the smaller size of the states on the East Coast, crossing into another jurisdiction is more of a necessity than it is for California lenders. This in turn creates a need for a wider awareness of the vicissitudes of cross-border lending. And this extends beyond the US border: East Coast lenders are active and comfortable lending throughout Mexico and Central America and their presence there is increasing.

Bring in the Lawyers
Lending across state lines creates a need for a level of documentation and legal support that we’re not exposed to. EVERY deal involves at least one attorney, and, quite often, two or three. Their work spans from documenting loan agreements to title and escrow to providing letters of opinion that the loan transaction is not usurious.

This additional link in the lending chain doesn’t necessarily add considerable amounts of time to funding. Many Private Lenders have attorneys on staff who occasionally double as loan officers. But what it does create is expense, hard out-of-pocket costs that attach to every loan.

Get the Money Up Front
Lenders are thus put in the position of having to obtain due diligence funds from prospective borrowers early in the due diligence process. The representation is that this is a deposit, that it will be credited back to the borrower in some form at closing, that it is part of a screening process to determine if the borrower is actually serious about doing business. These fees typically range from $10,000 to $15,000.

This approach creates lender/borrower tension from the outset that we are seldom exposed to. From the borrower’s standpoint, they are being asked to front money to lenders for a deal that might not occur. For lenders, there is the element of walking the fine line between assuring the prospective borrower that the chances of the loan being made are good…while not promising too much.

Complicating the mix further, a large lender has developed a strong reputation for demanding – and getting – very large upfront deposits and then returning little or any of the amount received when their underwriting fails to qualify the loan. Other Private Lenders shake their heads at what they see as one aggressive player, who advertised heavily in print and online, poisoning the market for the others. There is little for them to do about this: they lack an industry association.

Mortgage pools are not used on the East Coast. Loans are fractionalized, just as they’ve always been. We’re familiar with the limitations an only-fractional approach can have: less diversification, slower response time, smaller deal size. But lenders there seem to have surmounted at least two of these issues.

A focus on deal generation and flow of investor funds counters some of the speed issues. Each office has one or more people pitching deals to investors fulltime. And deal size does not seem to be an issue, either. In fact, a handful of East Coast lenders regularly lend amounts that rival or exceed those originated by the largest funds in California.

Spread it Around
Their secret: participations. Lenders are close-knit, know one another and work closely together. Pari passu deals are commonplace. In contrast to the thinking in the West, “I’ve got first position, you can have second position,” East Coast lenders commonly split loan opportunities amongst themselves. Their rationale: this increases the size of loan that can be made – with commensurate increases in origination and servicing fees – while maintaining the speed advantage that is as vital to them as it is to us.

“Don’t tell ‘em a thing!” I was exhorted at the CMA Conference in San Francisco before my trip east. “They’ll be all over us!” But I don’t think so.

In the big scheme of things, there’s more than enough opportunity for everyone in our industry to make great loans. The constraint doesn’t come from competitors – it comes from the amount of time and resources each of us has to review, underwrite and fund loans that by definition are covered with problems.

East Coast lenders are doing their thing well – in some ways, better than we are. But from an industry awareness standpoint, from the standpoint of the nuances of operating a fund, of actually being in the securities business, they’re years behind.

Nowhere else is the importance of CMA made more clear. It’s easy to take for granted the phenomenal information that we exchange four times a year. Outside of our association, this just doesn’t exist.

Lawyers have long recognized the value of referrals. When caseloads exceed capabilities, prospective clients are referred to other attorneys. The same is true when a client appears with a case requiring another specialty: attorneys refer it out. There is no dickering with referral fees, no claims of deserving “points” for this service. It’s done as a matter of professional courtesy.

And lawyers do very, very well in the process. Not in the one case referred out: It’s in the next case referred in. Private Lenders can learn from this model.

Learn from the leaders in our own association as well. California lenders are expanding their own operations, lending on properties and obtaining investor funds.  Watch for the building of critical mass as California and West Coast fund structures marry cross-state lending operations. The benefits to borrowers, investors – and lenders – promise to be enormous.