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Oct. 14, 2011
Glimpse into private lending
An ability to adapt to conditions can serve borrowers best.
MICHAEL GOODMAN
At Tri City Capital, we’ve had a wide range of experiences in the private lending business over the past 50 years. These are the top three most common questions that investors and borrowers have asked.
Q: How are major banks different than private lenders?
A: Private lenders tend to be groups that hold assets in the range of a few million to a few hundred million dollars, while larger banks tend to have assets that range in the billions of dollars. Large banks also have obligations to public shareholders that don’t allow them to be as adaptable as smaller private lenders, who are obligated to much smaller groups of direct, private investors. In the case of private lenders, they lend their own money and, of course, that makes them more cognizant of risk.
As well, at a private lender, an investor or borrower may deal directly with an underwriter or even a principal at the group – this would be unheard of in a large bank – making the private lender more nimble. This also impacts the overhead costs per loan at a private lender; they are far lower than those at a major bank, enabling private lenders to be far more profitable on a per-loan basis than major banks.
The downside to this is that private lenders cannot achieve transactional volumes that would be even close to what major banks are capable of reaching, simply because private lenders must play a more active role in the administration of the loans they fund. On the upside, private lenders are able to fund deals in a matter of days, whereas traditional banks may fund in a matter of weeks or months.
Because private lenders are more flexible than larger banks and fund quickly, they charge a premium in higher interest rates and fees, and are most interested in the value of the collateral. They are also more likely to take on second and third positions.
Private lenders are smaller in corporate structure and, as such, they can change their lending criteria quickly to adapt to changing conditions. For example, before the U.S. real estate bust of 2008-9, despite the fact that many banks were seeing declining performance in their mortgage portfolios due to non-paying loans in 2004 and 2005, up until 2007 they were still lending money using the same types of programs that invited the decline. These banks have now reacted, but only after the fact, and it is believed that this is mainly due to the bureaucracy involved at such large institutions.
Further, private lenders can change the lending criteria on a deal-by-deal basis. If they feel the market might be ready for a dip, they can quickly lower the loan-to-value requirement. Now that the major banks have reacted to the meltdown and made their criteria more conservative, they may be unable to fine tune their reaction to accommodate deals that make sense. For example, they may change their lending criteria within different pockets of a city or in the Lower Mainland; loans on properties near Georgia and Howe streets in Vancouver might have a slightly different set of criteria than loans on properties near Fraser and Kingsway, also in Vancouver. They may also take securities over other properties in order to proceed with a loan in a timely manner, whereas large banks may not be able to take such actions with the same agility.
In addition, private lenders commonly hold their loans for a one-year period, after which the loan is due, whereas banks may hold loans for years, or at least underwrite them over that period. While underwriters at major banks have to look at multi-year horizons, private lending underwriters only have to focus on what may happen in the economy over the 12 months following funding of the loan.
Q: What is the most interesting deal you’ve done?
A: In 2009, a group approached Tri City for financing to purchase an apartment building in Powell River. They needed an advance of $3 million within a two-day time frame, and the owners were putting up 35 percent of the purchase price. They had a commitment from a major bank to fund the loan, however, two days before their purchase-and-sale contract was to expire, the bank issuing the commitment added further conditions that would have extended the lending process beyond two days. This put the group’s deposit at risk.
In the private lending industry, this is quite common; a bank may indicate a willingness to proceed yet, far into the lending process, it may ask for information about a borrower that he or she may not be able to produce within the time frame at stake. Because private lenders are mainly concerned with the quality of the real estate as collateral, their documentation requirement on a borrower will not be as intensive. In this case, the borrowers were able to close their purchase on time and Tri City made $60,000 plus interest for advancing the funds for one week.
Q: Why are there different lending tiers in the private lending industry?
A: There are different tiers in real estate lending simply because principals, investors and founders at their respective institutions have different tolerances for risk, and that is largely a personality trait of the various funds.
There are four tiers of lenders in the marketplace. A tier-one lender is a major bank, like CIBC or RBC. Their rates and fees will be among the lowest within all of the tiers, their lending criteria are more or less fixed and they will almost always be in a first position on title. Tier-two lenders, such as Home Trust, are slightly more expensive and have slightly relaxed criteria.
Tri City Capital Corp. is a tier-three lender. Borrowers typically come to us because they know the banks will not accept their deal; we may sit in second position behind a tier-one or -two lender. What is important to the tier-three lender is equity in the underlying asset. Tier-three and tier-four lenders are commonly short-term lenders, with higher fees and may lend over a period of a few days to a year or two.
Investors should always consult with a financial professional before making any investment decision.
Michael Goodman is president of Tri City Capital Corp. For the past 50 years, he has been an active real estate developer and private lender in British Columbia and Alberta. For more information, visit Tri City Capital Corp. at tricitycapital.com or call 604-569-2015.
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