- On March 30, 2020
Are you looking for a loan to cover an interval between two transactions? Then bridge lending is the one for you. In this episode, Ira Zlotowitz gives a great overview of bridge lending, from what it means to where you can get it from. In this business, there are two common ways to go about your loan, either through banks or private lenders. Ira explains the difference and discusses the benefits of a lender versus the buyer and syndicating loans versus buying. Helping you paint a clearer picture, she lays down scenarios that compare the two options of a lender and a buyer. Get inside today’s show to see where you benefit from your real estate investments best!
Listen to the podcast here:
Chapter 9 – Bridge Lenders & Syndicating Bridge Loans
This chapter is about bridge lenders and syndicating bridge loans. As one small introduction to this chapter, when I came into the business, it was pretty clear and simple. There were banks and there were private lenders. A private lender would be an individual who said, “I don’t want to buy this piece of real estate or I didn’t win the bid for this real estate, but I lend the person.” How would that typically work? Someone buys a deal and they are building on the market for $10 million. You could have Larry, who is bidding up to $9.8 million. Along comes a guy, Brian, who bids for $10 million. Brian gets a great price of $10 million, but he has to close fast. Who knows the building well? It is Larry. He was ready to buy for $9.8 million. If for whatever reason, Brian had to close quickly to secure this purchase. If he didn’t have all the money, he could turn to Larry. Larry can say, “I was going to buy the building myself all cash, whatever the deal was. I’ll put together this money. I’ll pull my friends and family. I’ll put together $9.8 million, but I’m going to charge you 10%, 12% or 14%.”
When I came into the business, it was popular to charge 14% in 4, which means bridge loans went up to a 14% interest rate in four points because they were taking all the risk. It was a short-term loan. It was a cheap way of getting equity. You could buy the building with this bridge money, stabilize it a little bit, and then come to a bank and refinance it. In many years, it’s a blend with technology, streamlining of documents and processes, and people getting more comfortable with real estate. Loans started counting the blurred lines. Nowadays, you could have bridge loans that have interest rates slightly higher than a bank because what’s happening behind the scenes is that the same person that wanted 14%, they’re happy at 10% to 12%. They would go ahead and find a bank to partner up with them. Instead of them putting all the money together, let’s say this $10 million deal, they would lend $7 million.
Instead of all the $7 million coming from people that wanted a 10% to 12% return, they would maybe get $2 million from the higher interest rates and get $5 million from cheaper. It allowed us the ability to do all different types of leveraging that bridge lenders no longer have this negative connotation by being a shark hard money lender lends to own 12% money. That’s why you have to understand what changed. This is going to continue on and soon, there are not going to be necessarily banks with bridge loans. It is going to be funds, non-bank lenders that are called that behind the scenes they put everything together. Wall Street at one point did it, but they did it with a primary drive that overwhelming majority of the money came from cheap sources, so the end rate was lower.
Understand the bridge lending. That’s the background we have in 2020. It’s going to keep moving in this direction. The competition allowed people to go from 12% on their money for risky money being only willing to make 8%. That’s what it looks like to the surface, but the loans are no longer full of 12% money. They broke it down and said, “This part of the loan is safe. This part of the loan is risky. This part of the loan, you should pay this. When you blend it together, your rate is 7% or 6% or 8%.” On the Eastern Union App, there’s a calculator that calculates what the blended rate should be from the borrower’s side, how it works out, and from the lender side, the profitability.
Lending Versus Buying
What benefits does the lender have over the buyer? Why are there people who would rather lend than buy? The answer is first position. When you buy a piece of commercial real estate and something goes wrong, you buy for $10 million and the building is already at $9 million. You lost that $1 million. When it’s sold, the lender gets their money first. If you were the lender, you have a cushion. If you lend a 70% loan-to-value, you have a cushion to say, “The building I’m buying is at $10 million.” He’s putting in $3 million of equity. If he makes a mistake and it’s only worth $9 million, $8 million or $7 million, it gets nerve-wracking. If it goes down 20% and there was a 20% mistake, think about how big this mistake is. That means that the buyer, Brian, made a mistake.
Larry, the lender, who agreed originally with Brian’s price, puts a buffer of 30% is wrong. It doesn’t even sell for $7 million. The first benefit is your first position mortgage. You get your money back first. The second benefit is that you get to pick the level of risk. If I’m buying a piece of real estate, the deals on the market for $10 million, you either buy it or don’t buy it. I can’t decide to become a partner based on a $9.5 million, which is the right price. However, by lending, I could pick my level. I could say, “I don’t care what you’re paying for it. You want me to lend you money, I’ll give you a low rate, a good rate but I’m only lending $7 million.” The borrower, Brian, could say, “I’d rather put up $3 million of my own money. Take your loan of $7 million because you gave me a good rate.” Ultimately, the bridge lender could decide what level of risk they want to take.Most real estate is done by a syndicator. Click To Tweet
To be a little bit even more conservative in their pricing, people could decide to do what’s called AB lending. This is what’s unique here. Somebody buys a piece of real estate for $10 million and they come to me and say, “We’d like you to invest with me.” Either I agree with a $10 million valuation and I’m prepared that if something goes wrong, I take a risk on my money or you don’t. It’s a yes or a no. AB lending allows on the flip side. If someone’s doing a loan, they could come to me and say, “I’m looking to put together $7 million.” I say, “I’m nervous. I would only lend max at $6 million.” I can go into a partnership with them and say, “It is fine, are you going to break it into two buckets?” We’ll do a $6 million loan and another loan for $1 million and we’ll blend it together. You will be in the $6 million bucket. If something goes wrong before you take a loss on your participation, we have to lose the first million. As long as we get back paid $6 million or more, I already made home.
It’s like pick the level of risk. It doesn’t exist anywhere. That’s the biggest beauty I find when it comes to bridge lending. As an Orthodox Jew, some laws are governing lending money with interest. It’s called lending with ESCO with interest. In the Arab world, they have the terminology they use. I’m not advocating when I talk about the benefits of lending that should offset this as a principal-based, that people who do not lend on loans at all because of that issue. Some people say, “If I go work out the proper documentation, I’m willing to do it.” My disclaimer is not as any rabbinical level at all, all the legal, everything applies, but I want to continue going on and talking about the benefits and why it’s safer. I want to move on and continue talking about the actual business side, not the religious side of it.
Syndicating Loans Versus Buying
What are the benefits of syndicating loans versus buying? We said previously that most real estate is done by a syndicator. That guy buys a building, he goes to contract, and he raises money from friends and family. Why do I think more people are moving over to syndicating loans? What’s the benefit of it than syndicating purchases? This whole chapter is focusing on the lending side, what the merits are, why people are moving here, so you know it’s safer. What’s another big perk? The perk when I’ve started lending, this syndicating versus lending, it’s the benefits of the actual loan. Number one is that you don’t have any money at risk before closing. When you go to buy real estate, you get a deal. You have to spend time. No one cares about time, but then you’re interested in the deal. You have to hire an attorney to go to contract and negotiate. You may have to go out there and hire an appraiser to evaluate the building. You spend a lot of money. If the deal doesn’t close, you’re out of pocket money. When it comes to lending, you don’t put any money at risk.
We go with the example that Larry is going to be the lender and Brian is the buyer. Larry tells Brian, “I’m willing to lend you $7 million at 12%.” He doesn’t spend a nickel. If Brian is interested in pursuing it, he puts up some money to start the process, so there’s no money at risk for Larry. That’s one benefit. Let’s say it’s my first deal, the other benefit is I’m lending and I’m nervous. I want to take it slow. In real estate, if you want to take it slow, don’t buy a $100 million deal. Buy a $1 million deal. Buy fix and flip for $100,000. Buy something small. Over here, I could go into any size deal I want. I can be conservative. I could decide to go lower down on the LTV and make a lower rate. The market can be lending people $7 million. I’m a little nervous because I want to win the loan. Everyone’s collecting 10% to 12% for that risk. I could walk in and say, “I only lend you $6.5 million, which is I think is safe.” Be extra cautious and conservative, and then wow the borrower and say, “Brian, I’m only going to charge your rate of 5%.” Brian has a choice to borrow $6.5 million at 5%. He has an option to go $7 million at 12%.
I’m sure if he’s able to raise $3 million already, he can raise another $500,000. He’ll probably figure out a way to take your loan. Meanwhile, you’re in a very safe position. Your money is safe as you want it to be and you chose to be conservative by lowering the rate. The other part of it is you don’t need any money in the deal. When you come out to syndicating and buying real estate, if someone came to me and said, “I am buying and I’m up for $10 million. I need to put up $3 million,” I’m going to ask the person, “How much money are you putting in? Do you have skin in the game? What if something goes wrong?” Why do I extra care for that question when I’m investing? If he has no skin in the game, there’s room for error. $10 million might be worth $9.5 million. If he has money in the game, even with me, I’m a little safer.
When it comes to a loan, I’m deciding my level of risk. I don’t care if he has money in the deal. I care that I’m protected as a first position. It’s a lot easier for a syndicator loan to put the money or put up a little bit of money to show you some skin in the game. It is not proportionate to the amount of money he’s raising. Someone’s raising $10 million for equity deal. I wouldn’t let someone have $100,000 in the deal. If someone is doing a $10 million loan, I could be fine in as low as $500,000 because I’m trusting the loan documents, the legal side of things. The other big push is that deals chase you. When I’m looking to buy real estate, I have to convince a seller to sell to me. I have to convince a broker that’s selling real estate I’ll close so you’ll make the same commission or I’ll pay you extra. I have to do something to go ahead and do it.
When it comes to lending money, it’s the opposite. If someone buys real estate, he needs to take a loan out. He’s going to look for a lender. If I have a reputation that I’m lending out cheaper rates, I’m getting higher proceeds, or I’m someone certainty of execution, people are going to start calling me because they need the service. I want to go back to before about the luxury to be conservative. When you buy your first real estate deal for $10 million price, why is the guy selling to you? He has a reason to sell to you probably because you’re overpaying a broker the commission that the broker should say, “I normally have my normal slew of buyers. I’m going to come to you because you’ll overpay me.” The seller would sell it for $9.8 million. “Do me a favor, sell it to me. I’ll pay you over. I will overpay you at $10 million.”
That’s usually the reason and that’s what I’m saying. The reason is that you’re chasing someone. You have to offer them extra. When it comes to lending, putting that together in the level of being conservative, “To get my first deal, I won’t make a 10%, 8%, 6% or 5% return. I’ll make 3%.” You can be conservative that way. The last reason is to learn the business from the borrower. Everyone wants to get an internship. I get calls all the time. “I have a kid coming into the business. I can’t get a job. I want to learn the business from you.” To give that kid an internship, forget about the legalities of having to pay people and all that. It is time. Is the person going to slow me down? What work am I going to give them? Who’s going to train them? What is my motivation to train them? It’s tough to break into real estate. Why should someone to train you? You can go on your own. Why should a real estate owner want to train you? It slows them down. When it comes to lending, you can have the borrower train you.
You have a borrower that comes here and going to want to show you everything that they’re doing. By showing you what they’re doing, they’ll go and impress you about how great and amazing they are in what they do so that on the next loan, you’re going to be there for them. Through the process, you’re going to learn a lot from the borrowers who are motivated to explain everything. You will be that ticket. They need a $10 million of that $10 million. You brought them $7 million of the $10 million at a rate that was cheap enough and beneficial enough for them to want to go forward. They would love that so the next time you get comfortable, you can lend them $8 million. Next time you get comfortable, you might say, “Repeat client, I’ll go with a lower rate.” I want to tell you one story, which I found to be fascinating, where it’s not my style doing business to show you if someone was able to learn something. People think that someone in real estate knows financing great and they’re amazing at it. It’s apropos for this type of lending, bridge lending.
It was a person that was a great builder. They went to a bank and he applied for a loan. They told the bank, “My total cost is $40 million.” The bank said, “Total cost is $40 million. I’ll loan you $30 million at 75%. You put up $10 million.” The bank said the rate at that time is 5%. This person ended up taking a loan from a bridge lender at 9%. He thought it was crazy. He never would’ve gone to a bridge lender. Why did he go to the bridge lender? The bridge lender and his broker explained to him, “Let me tell you a better deal because this is what started to happen. The banks thought to underwrite that $40 million cost.” I said, “You’re going to build it in a year? It takes two years. You have to carry this loan for longer. I need an underwriter that you need money for two years. Do you think you can be able to get it built at this price per square foot? It’s going to cost you more.”
By the time it was said and done, the bank thought he probably cost himself between $15 million to $16 million. Even though we’re lending him 75%, instead of $10 million, he had to come up with $12 million to $15 million. That money is expensive as an equity. On the flip side of the coin, banks take time until they close. Every time you want to get your drawdowns, you have to do a site inspection to make sure the work was done. He wanted to move fast. Also, he could build it in under a year and hit the timeline. The way he wanted to do it, the bank probably wouldn’t let him. What was his story? His story was that he built this building that fast because he’s able to build into everything. He worked 24 hours a day.
How did they work 24 hours a day? You’re only able to work in New York City up until 7:00. There’s a fine, otherwise you go to that. That fine is $1,000 a day. I put into my budget a $365,000 worth of funds. Every day, I got a fine. I paid for it and I went on. No bank will let me stay with him. He says, “I was able to go and build this whole building, get it in the budget for $40 million, get it done within a year. I overpaid on my rate of $30 million by 2%. Big deal. For me, this is the best deal, the fastest deal. No bank would have tolerated it. They would have come down on me. They’re getting ended up with the press. At the time the press go after anybody, there was no real brand name to go after. We got the loan, we closed it, and move forward. This is an example, I’m telling you, “I want to learn these examples.” You’re only going to learn stories and what people do. When you’re that lender, they talk to you as a lender because they want to keep getting you comfortable to stay with them and keep lending them in the future.Money rests on the riskier side. Click To Tweet
I already started some of the storylines. We’re going to go through more it in detail. To recap it, it’s a $10 million purchase, $1 million in closing cost. I’m in for about $11 million. It’s an apartment building, multifamily. It’s not fully rented. It needs some work in some of the vacancies. That’s why it’s called a value-added deal. It’s not finished yet. A conventional bank wouldn’t want to lend me fully because it is not fully rented. I need a bridge loan to bridge me. The name bridge loan comes from exactly like it’s a bridge. I’m here with a piece of purchase I’m making. The sooner I’m here, there’s the island I’m going to be when my building is done. How do I get across? I build a bridge. I need a lender that’s going to focus on that comfortable. They’re going to make me the loan and not look at the fact that everything’s not perfect. In this case, we’re going to go with Larry being the lender and Barry being the buyer. There’s a letter of intent that was put out to do this loan for $7 million at 70% of the purchase price.
The interest rate was 12%. Two points means a 2% fee to the lender. If it’s $7 million, 2% is $140,000. That was the fee and it was a 41-year loan. That’s the storyline we’re going to go with. The $10 million purchase plus $1 million probably to an $11 million. It is called capitalization, total cost. $7 million loan from Larry at a 12% interest rate, two points for a year loan. Where does Larry get the money from? It’s not a conventional bank. It’s a person, similar to our syndicate against a firm. He has his own money or he has even partners. He syndicates the loan to friends and family or he breaks it down to an APs and BPs loan. The APs and BPs from banking is the game-changer by me. I opened up an entity called the IRA Group, which is going to participate in bridge loans by the APs and bridge loans.
I don’t tend to compete and make bridge loans, but I do want to find people to have safe money. I want to participate in the APs. I’m never competing with my clients on my hard money lenders and saying, “I’m in the same business as you.” This was an eyeopener how this works and it puts a lot of things in finance together for me. There’s the impetus for giving this detailed part on education regarding syndicating loans and how they make their money and seeing how people can participate at different levels of risk. Let’s go with Larry. Larry has a universe of 30 people. There’s a group of people that Larry knows directly. There’s a group of people that he could have got from the IRA Group. He could’ve gotten another group from John’s lenders. He could’ve gotten a group from a different group. Larry goes out into the universe because when he’s looking to raise money, he will send out an email to his group and say, “Are you looking to participate?” Depending on the deal they offer, a lot of different people say, “Yes, I’m interested in participating.” He’ll work out the details on the terms. Those are not his direct people. He will probably end up paying of commission to somebody. If it came to the Ira Group, in theory I brought him someone, he’s going to pay commission.
Getting Securities Law
This is where I want to stop. You have to make sure that all the people around the table, they get advice on securities law. This is not about real estate. There’s a lot of laws regarding lending, securities and participating. If this was a loan lender, the only exception is not a security. If it’s purely a loan that a lender and a lendee are coming together to make a loan. Two banks, they can lend money together and it’s not a security. If I’m making a loan and I’m taking money from someone else to invest in a vehicle that’s going to make a loan, depending on how it’s structured and what people’s typical business plans are, it could be an investment in an entity. It might be making loan, but it’s an investment to make a loan as opposed to borrowers coming together. I don’t want to focus on this topic. I don’t intend to talk about it much more. This is something we should have to get a securities law. It’s possible that when you speak to a security lawyer, he might tell you, you could do this and you could only take certain types of investors or certain types of borrowers.
In my illustration, you can see an X going through one person because of the way Larry is structuring this loan, this security might decide someone who could join and not join. This is more to open up your eyes to a possibility. However cautious you want to be, I’m a big fan of being extra cautious when it comes to this, but as a concept applies, don’t say, “Everyone does it.” In Family Feud, the top answer is on the board. The top answer is they didn’t know. The second part of the answer is, “I’ll take a risk because everyone does it. I’ll deal with it.” If that’s the way you run your life, run your life how you want to run. That’s not the way I run my life. That’s not why I was advised to go move forward on this topic. How a bridge lender is different than conventional banks? I’ll be able to move a lot faster because a lot of the things in the intro I went off tangent on, but the different reason they have from a conventional bank is they have no regulation or barely.
The reason why I say barely is that to lend to a one to four-family, primary residence or someone lives, there are all laws. There are banking laws about that, but otherwise for the most part, aside from maybe the interest rates of usury, there’s no regulation. It’s a business to business. Let’s say I was Larry. Larry can decide what he wants to do. Brian decides that he wants to pay. They work out a deal amongst each other and they’re good. The second thing is that most bridge lenders focus on the assets. They lend on assets and they don’t care about how much cashflow is there. They might want to put a reserve to make sure there’s money every month, but they focus on this building that’s being bought is worth $10 million. In a fire sale, I could sell it for even $9 million or $8 million. I’m covered at $7 million. That’s what they care about.
Number three is to be prepared to foreclose. People make a joke, “It is lend-to-own.” Someone tells somebody that when someone gets a compliment or a comment that they’re like a used car salesman, it’s a negative connotation that you’ll sell me any garbage. It’s also a compliment that you’re a great salesperson. There’s a little word in the lending business called lend-to-own. “He’s lending you money. Everyone is lending you $7 million. They’re only lending you $8 million because he knows you can’t make the payments.” He’s going to foreclose and own this building at $8 million. That’s not the case. I found that if you are dealing with a lender, other exceptions to every rule are the bad apples. At the end of the day, most lenders in the business of lending money and the reputation is, “I lend. I get paid back and we move on.”
They’re on the business of lending, foreclosing and owning, but they aren’t prepared. Their ultimate decision is they want to move forward. “I am prepared to own it. If I’m stuck, a bank has no interest in ever owning.” If they think there’s a chance they may own it. You can say, “What are you nervous about? It’s a great loan. If it doesn’t work out, you can own it at $7 million.” They don’t want to own it at all. The terms of a loan, they’ll only go up to 70% typically. They want to be more conservative. We’re finding loans on the flip side, and this is why I’m playing a wait and see approach on the Ira Group. I am being extra cautious because it used to be it went to 70% and you want to take an eight-piece on the safest part of it. What’s happening is that some riskier investors are out there that would do mezzanine loans, crazy risky loans. They’re going over to these bridge lenders and saying, “Do you want to stop at 70% and lend a 10% or 12%? I’m willing to give this person an extra million dollars, but I want 14%.” It’s a high risk, then loans are coming 80% but it’s not the typical bridge lender.
APs And BPs Hard Money Lending
If they find a mezzanine to come together, let’s go to keep it simple, but I have to give you and open your eyes because the market’s changing on us. We can only go to 70%. The rates are typically going to be 9% to 12%. If they get cheaper money for part of it, they’ll blend lower. The blends are hovering around 9%. I’m seeing some deals that are bridge loans at 8%, but let’s go the typical 9% to 12%. Typically, it’s a 1 to 3-year loan. Someone’s coming in because no one’s buying a building to pay 12% for life. They’re coming in a bridge. Within twelve months, I’ll fix it up. We give the example of a bridge before. There is a 2% fee that goes to the lender. Sometimes that money is split amongst a lot of different people, but the borrower ends up paying a 2% fee to go do these loans. Let me break it out to you and talk out the storyline before APs and BPs hard money lending. This is a simple case. Larry lends Brian $7 million, with 12% interest in two points. He ends up making in that deal at 66% return on his money, ROI, Return On Investment. How does he do it? In this case, Larry himself put up $500,000 of the $7 million. Larry takes $6.5 million from loan participants, friends and family. We discussed before, everyone does it.
He would typically pay them 10%. Larry ends up making 2% upfront plus 2% on the $6.5 million as a spread. He’s being paid 12%. They’re getting 10%. He’s keeping the spread at 2%. It works out that if $980,000 being paid between points and interest on a $7 million loan for a year, 2% plus 12%. $650,000 of that money has to be paid back to the loan participants. 10% of $650,000, there’s $330,000 profit. Divide it by $500,000, it brings you a 66% return. He has a safe loan and deal. The guy buying the deal is not making 66% of the money, but you could argue the guy who’s buying the deal, they have his money back and on this deal for life. That’s fine. Less risk, short-term and he moves on. The fact is at this point, using these numbers, he made a 66% return on his investment.
Let’s talk about APs, BPs lending. I’m going to focus on where truly a bank doing it, where he puts together money from friends and family that want expensive rates, 9% to 12% or higher. He goes out to a bank. The legal terminology here is a note on note financing. It’s going to appear in this discussion. In a case where there was $5 million from a bank, $2 million from Larry as the BP. The bank is A and Larry’s B is $2 million. In this scenario, you could look at it and say, “That’s the first and second mortgage behind the scenes.” That’s correct. Legally, it’s a structure that is $7 million loans being made by Larry and the bank is lending $5 million against the $7 million. It’s a technical legal term, but I’m going to flow with the layman’s way to explain it so you can relate to it.
The documentation, drafting, legal and closing documents, if you have a real estate attorney, he’ll explain the note to note, but let’s go through it here. In a typical case, the hard money lender in total, the bridge lender will lend $7 million at 70%. The bank would come in and say, “We’re willing to go around 70% to 75%, not to exceed 50% to 55% of the total loan-to-value.” To keep around, they would lend 70% of $7 million, which is for $4.9 million. It’s less than 50% of the whole value if you are buying a $10 million building. Let’s round it up for this conversation. $2 million is from Larry, $5 million from the bank, and together there’s a $7 million loan. In the event of a default is a problem, the money flows first to the bank. The bank gets back its $5 million. If there’s any extra, interest, and penalties that there was a problem, then from there, it flows up. Any extra money goes back to Larry and the BPs. In the flow of things, the bank is safe. I believe that any bank that can go into this space and participate in a bridge loan at a 50% loan-to-value, not to exceed 55% loan-to-value and not to exceed 70% to 75% of a bridge loan is the safest.At the end of the day, most lenders in the business of lending money lends to get paid back and then they move on. Click To Tweet
Everyone can make a mistake, but if someone who bought a building for $10 million, wrote a check for $2 million to $3 million. You have a BP person who wrote a check again for another $2 million above you. That means everyone had to be wrong. We, the bank, and the lender are wrong and that $10 million was off. It had to be wrong that everyone above them gets wiped out. I never heard of a bank take a loss on an APs. There’s another added perk for the A lender. Let’s say in an overall loan, the borrower stops paying and started the foreclosure process. It can take a long time. It can take a year or two. Who’s going to fight the whole process? If you’re doing an APs and BPs. It’s a note to note financing. It’s a loan to Larry. The A lender has a terminology in there. He has to be paid back within a year. Let’s say this thing goes into foreclosure or default. The bank could walk over and say, “Larry, I’m not staying around for the fight. I’m not making enough interest to stay on land with a fight. I want you to pay me my $5 million. If you don’t, I’m going to foreclose on you.”
That’s a quick foreclosure for the bank to wipe out Larry. The bank is in a situation where not only are they safe, the odds are that Larry, who is going to have a problem to protect his money at the top, will come up with another $5 million to buy out the bank. If he doesn’t, he’s wiped out. Imagine from a bank, controlling a $7 million judgment and only caring about $5 million. They could go into the street and say, “I have a loan for $7 million. Does anyone want to take over my position?” You run the fight, they could afford to give it for $6 million or $5 million. A big discount that entices people to buy it. For many reasons, a lot of this can be over a lot of your heads, but as you get more involved in real estate and re-read this piece, there are many protective measures to A lender to go ahead and do it. When I spoke to many banks who originally weren’t doing it, they didn’t understand how it works.
As I started to explain it to them and I explained it to the board and they understood it, it became one of the best loans that banks are lending. This is where I plan to play in the Ira Group in this space. If someone wants to take money not from a bank, they don’t want to get a bank to give them the APs. They’d rather deal with another individual like themselves, that’s where my players come in. I could come out to the marketplace and say, “I’ll bring you the $5 million from friends and family and people that want to save money short-term. It is safe and we don’t need 9% to 10% returns. We are happy with a 5% return.”
We went through the storyline. In this case, the math changes from getting a 66% return to a 77% return, which works out to the borrower, Brian. To Larry, that’s syndicating a loan. Larry puts a $500,000. He takes $5 million from the bank and the bank charge 7% at one point. I did a high number to show you that if a bank is at 6%, which many banks are. You can be in a situation where there are returns even better. I want to show you a conservative guesstimate. This is the conversation that Larry went to his investors and said, “I was going to take from you thirteen people, fourteen in total, including myself. Each gives $500,000 and I was going to pay you a 10% return. If there was a loss, we are even. Here’s what’s going to change. I only owe money from three of you. I’m going to come in. Me plus three, I need $2 million. Four of us in total. Which of you want to stick around?”
Here’s the good and bad. The good is that instead of making a 10% return, I’m going to give you 12%. Instead of giving you no fee, I’m going to share with you 1% of my two points. What’s the negative? If there is a 10% or 20% loss, it’s only us that share that loss. In this building, if we sell it later for $6 million instead of $7 million, we lost $1 million. The bank is safe. The truth is if you believe that $7 million was a safe loan, remember you only got into this because you believe $7 million was safe. What are you nervous about? If there’s a loss, take a bigger chunk of the loss, make a higher return. In a case like this, everybody can go ahead and wins. Larry collects the same $980,000. $400,000 the bank gets. That’s 8%. They get the 7% interest rate and 1%, one point that they get on the $5 million. To pay 12% in one point is 13% equivalent as a one-year loan. They paid $195,000. There’s $385,000 leftover and a 77% ROI.
Larry also is taking bigger risks because money is on the riskier side. Just like his investigating money, he’s making more money. I showed you a conservative scenario. In reality, what’s been happening is that some of the savings get passed along to the borrower. It was happening is that Brian was lending borrowing money at 12% in two points. If Larry didn’t offer 12% at one point, he would have gone back to the borrower to his investment and said, “I’ll go from 10% to 12% but no one point.” We could walk over to Brian and say, “If you do this loan with me instead of paying 12% in two points, I can do it at 11% in two points. I could do it at 12% in one point.” Also, if he got the bank to go to 6% or overtime, Larry got his investors to still be happy, maybe had 11% a little premium, he could pass along those savings. It translates to a scenario where the borrower is paying 10% on the same loan in two points. At the end of the day, everyone along the line is making the equivalent money they would’ve made before because the AP is financing, they are making a little bit more on the interest rate risk. Everyone wins in those scenarios.
Lenders And Borrowers Of APs And BPs
Who are the typical lenders and borrowers of APs and BPs lending? To wrap it up is putting the two worlds together. A conventional bank is going to be the APs lender and the bridge lender is going to be the BPs. That’s why I started this chapter. I’m summing it up as you see all the pieces coming back together. How does Larry protect himself and the participants? Some go more technical. We spoke about it outside, but go more in technical terms. Larry protects himself in two ways. He hires a competent real estate attorney to make sure that the loan between himself and the borrower is enforceable. If there’s a problem, he could later on deal, foreclose, and take over the property deal and what he has to do with. Also, this attorney reviews the title and survey to make sure that he’s the first borrower.
I had a crazy story. It’s almost impossible for somebody to borrow money. Why is there title insurance? If there wasn’t title insurance, someone could go to three banks at the same time, agreed to close. He comes to a bank and his existing loan is $5 million, borrowed $6 million from each bank. Each bank goes to the title from the day before and they say, “There’s a balance of $5 million.” The title company would take the $6 million, hold $5 million in their account, give the borrower $1 million and get a pay off the $5 million. They know there’s a total amount of debt of $5 million. What happens if you went to three different banks and closes three loans? He walks out with $1 million cash on each one. Each title company calls back the bank and says, “Let me pay you off.” Only one of them gets a payoff. They will realize they’ve been scammed. He scammed them $1 million. This doesn’t happen because title insurance is protecting.
A crazy story I heard in the bridge world is that someone is doing this. He’s borrowing mezzanine money. He closed within a week with three different lenders mezzanine money and it came out. There’s over 100% financing. This happened. You take a crazy story and there’s no other way to prove it. No one knew when he took it, he had to sign it back and you’re trusting him. There’s no way to verify if it was true, but he did it in the same timeframe. Three different lenders, three different brokers, three different everybody. They never spoke to each other and they realized afterward, when they thought it to file their new loan as a mezzanine loan, they had the right to file it. They started realizing searches came up and they ran into a problem. Attorney’s going to protect you that you are the first position, that your title is clean and the documents. You want to hire a securities lawyer to work out the participation agreements. Larry and the people giving him money, they’re not structured as a security. As a loan, it’s so much easier. If it is a security, for whatever reason it has to be done in security, he’s following all of the security laws.
Final Steps To Get To The Closing Table
What are the final steps to get to the closing table? Throughout this due diligence that’s similar to a regular bank deal, he provides whatever information that Larry’s going to need. He does his due diligence. He issues a commitment. He’s ready to close. We’ll go to the same point. There’s a regular bank loan. At that point, they’re ready to close. There is a closing documents given to the borrower to him to sign simultaneously. Larry will take the money from all his participants, put it into an account. “I have all the money ready to fund the transaction.” Everybody signs and from there, the deal closes. I wish it would be as simple as that and reflected an old loan. This is where all the hell breaks loose is that things come up and they have to work it through. “I didn’t realize this. I didn’t realize that. What do we do with it?”
There was an asset-based lender because the bridge lender is charging a higher rate. The bridge lender is charging that rate because they know there’s an element of risk. It’s built into it so there’s more wiggle room. Ultimately, that thing could blow up. There was, “I’ve lied,” or something like that, but in a normal case. A bridge loan typically gets to the closing table. A bank runs into an issue, you run into problems, but I want to reflect here when you go to a bank. What happens if someone is buying a conventional building? Everything is great. He has to close in 90 days. Everything is moving forward to the closing. The 81 something comes up and the bank realized based on that,” I’m sorry, we’re regulated. We can’t close.”
That’s where a guy steps in and takes a bridge loan. We had many times where something happened that was found that no one knew about it. They couldn’t allow the deal to close, but the borrower had to close with a club of bridge lender and say, “Certainty of execution, I need a close. It’s the greatest deal for you.” In those scenarios, the lender made a killing. They were getting four beautiful buildings, the same as a bank would lend, for a short-term, 1 to 3-month loan. We get those high rates. It is not necessarily risky every single time, but it’s usually based on speed. Someone’s coming back to a bridge lender because they want to close fast and with certainty of execution that they’re going to have in close.
What lenders do for post-closing deals? What happens afterward? Banks and bridge lenders are the same thing that has to happen, but it’s much simplified with the bridge lender. It’s called servicing loan. You have to make sure that the payments come in every month or quarterly, whatever you agree on the money distributed. If there’s anything is supposed to take place, any updates he’s supposed to have. If you have escrow reserve for taxes, you pay the taxes. You confirmed that he’s maintaining his proper insurance. Whatever the borrower is doing in the covenant of the loan, he’s taking care of it. Hopefully it never happens, but unfortunately, it does in some case. If there’s an issue, Larry, the syndicator is the person taking responsibility to run the process. Is he taking responsibility for the money? No. Whatever you worked at upfront, but who was supposed to deal with this problem? If this loan has to go into foreclosure, who’s running point? Who’s the face of it? Who is the person that’s running the foreclosure process? Who’s the person negotiating on behalf of all the borrowers? That’s where Larry is the person post-closing who gets this thing done. I’d like to thank you for reading.