Private lending (commonly referred to as “Hard Money” in the Industry) is often touted as a safe vehicle for individuals who are new to real estate investing for learning the basics of evaluating a deal, or by experienced investors seeking to generate passive income through a balanced portfolio of loans. We are often called upon to advise investors on evaluating their hard money loans, which is critical since most are using their hard earned savings or retirement, and so you want to make sure you are doing everything you can to make sure you are adequately protected. As a private lender, important details to ensure the security of your investment include the following:
- Make Sure Your Loan is Secured by the Property – For most real estate investors, this is common sense, but our office consistently receives calls from private lenders asking us about options when the borrower fails to pay, only to find out that, because they failed to secure their investment by the real estate, their only recourse is to sue their borrower and hope their borrower has assets to pursue. In most cases, the borrower (especially if it is an entity) does not have assets to pursue, and so the Lender in such situation has no other choice but to completely write off the loss. Making sure that your loan is secured by a mortgage or deed of trust on the property is absolutely critical to protecting your investment, but just having the lien is not enough. You must also understand whether you are in a judicial or non-judicial foreclosure state, and what the foreclosure process in that state entails since the timing and expense of foreclosures can vary greatly depending on the state. Moreover, you must make sure the transaction documents (usually a note and mortgage/deed of trust) are properly drafted to fully protect your interest. For example, do the transaction documents and does the title company involved confirm the priority of your interest (i.e. that you are the senior lienholder, 2nd position junior lienholder, etc.)? Do the transaction documents confirm that you will be protected in the event of certain adverse events (e.g. that are you covered by hazard insurance, title insurance, etc.). Not all legal documents are created equal so make sure your legal documents adequately protect your interests.
- Perform Due Diligence on the Property as if you are the Buyer – We often say if you are going to be the bank, “act like a bank.” As a private lender, when you are deciding the scope of your due diligence, you should be thinking to yourself “What would a bank do in this situation?” While the type of due diligence that is appropriate for any particular deal will vary depending on the deal, we always advise clients to evaluate a deal as if you were going to be owner of the property because, if anything goes wrong, you could very well become the owner of the property. That means performing adequate due diligence on issues such as title, the value of the property, the solvency and qualifications of the buyer, the likelihood that the deal (whether it is a fix & flip or a buy and hold) will be successful, Don’t rely on the bare assurances of your borrower that the deal will be profitable, but do your own independent due diligence as to the details of the investment.
- Consider Personal Guaranties – Most institutional lenders such as banks will not lend on residential real estate without qualifying the creditworthiness of the individual borrower and will not lend to entities such as corporations or LLCs. Obviously corporations and LLCs can and often do go defunct, and unless you have reserved your right to seek recourse from other “creditworthy individuals” through personal guarantees, you may be left with the only option of suing a defunct entity that has no assets which, in most cases, is just throwing “good money after bad.”
- You Call the Shots – Anyone who has ever tried to get a mortgage (especially recently) will know all of the various requirements lenders impose as a condition to approving your loan. As the one with usually the most “skin in the game,” there is no reason why, as a private lender, you should not also demand that your borrowers meet your own stringent requirements to approve the loan. This is not the time to be “shy” or make decisions based on emotions. Remember hard money lenders are in high demand in real estate investment circles and we always remind our clients who are contemplating deals that there will always be another deal. Don’t risk your hard earned savings or retirement on a deal that you have not received sufficient information, or on a borrower who is balking at providing full transparency about the deal.
There will certainly be more details than what could be covered in this article on how to evaluate your specific deal. The attorneys at KKOS Lawyers are here to assist you in answering your questions about your private money deal.