Join us for a discussion with Preston Howard, principal of Rose City Realty, as we discuss the basics of hard money/private money loans in the multifamily property market.

Topics covered include:

(1)   The unique aspects of private money lending, including its speed and reduced documentation requirements compared to traditional financing;

(2)   The criteria for private money loan approval; and

(3)   The types of properties and situations best suited for private money loans

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*Transcript edited for clarity

Kiran Dhillon, SIG Commercial:

Welcome to our series called Simply Multifamily. My name is Kiran Dhillon and I am a Broker-Associate at KW Commercial specializing in multifamily property sales. The purpose of this series is to highlight issues that affect owners of multifamily properties via market updates, investment insights, and interviews with trusted professionals. Today, we have the privilege of sitting down with Preston Howard, principal of Rose City Realty,where he originates, pre-underwrites, structures, defends and funds the financing of office, retail, industrial, and multifamily real estate assets.We'll be speaking with Preston about hard money loans in the multifamily market.

Welcome, Preston, it's great to have you.

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Preston Howard, Rose City Realty:

Well, it's always good to be with you Kiran. It's great to be with your audience here today. Ready to get into our discussion.

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Kiran Dhillon, SIG Commercial:

All right, since we're talking about hard money loans, I thought it would make sense to start with what makes hard money lending unique in the multifamily property market and how does it differ from the traditional lending options?

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Preston Howard, Rose City Realty:

That's a good question to start the discussion off right off the bat. So, I always look at it as two handfuls that you can have. There is either(1) "best of the best" or (2) a "need for speed." Usually with the "best of the best," there's more time [and] there is more desire to get the lowest rate. So people are willing to give up more documentation, more of their time, more due diligence, more underwriting. With hard money, there's usually a "need for speed" component and documentation isn't necessarily available or they want to hold it close to the vest or there may be something else that the borrower really doesn't want to disclose right now or ever.

So usually with traditional commercial finance, they want everything. If I might suffice it to say, they might even want your first born child's first pint of blood. That's just where underwriting and due diligence is at because banks, if you want to get the absolute best of the best financing, they want you to give up the most of the documentation. Hard money usually pulls back on that documentation requirement as much as possible and as much as is reasonable. But usually the tradeoff is they want a lower loan to value compared to the "best of the best" financing in the market.There's usually a 10 to 15 percentage leverage spread in between what hard money will give and how high traditional financing will push it.

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Kiran Dhillon, SIG Commercial:

Okay, that makes sense. So, what's the typical process for a multifamily property owner to go through when applying for a hard money loan?

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Preston Howard, Rose City Realty:

Some people would say just a heartbeat, but normally we still want to know about credit, even though underlying everything is good old fashioned underwriting: people, credit, and the real estate in spite of the desire that some people have to be a vulture. My clients and I do not. So we still want to work with good people. We still would like to work with people with good credit. In the end, we want to see that they have something to lose, but we also want to see that they have a good habit of paying their bills. And then the third thing is the real estate. Many in hard money would like to just focus on this one, which is just the real estate component. And that's why in hard money they usually limit the leverage level to about 60% - 65% because they want to have that buffer in case something does go wrong.

They want to have enough of a buffer for legal costs, maintenance costs, and disposition costs to make sure that there's still something leftover in case things go bad and they go sideways. So I would say that for hard money, the most important things are making sure that the people are good,their credit is good with regards to their history, and underneath the real estate is a desire to make sure that the borrower, I said it before and I'll keep saying it, the borrower has something to lose.

We might lend on homes five parcels from the Pacific Ocean, lend on a sixplex right around the corner from the Santa Monica Third Street Promenade. I mean, those are the best of the best. When I say something to lose, who wants to go 50% LTV on their apartments with all two bedroom units,that's foolhardy. So accordingly, you want to have that spread in there for the LTV. And if the real estate itself is well located or has a good purpose,usually a transaction can get done even in the toughest neighborhoods. If you've got low LTV and tenants who are paying rent compared to what the debt servicing would be, if there's a nice spread between the rents collected and the amount of operating expenses, including debt that needs to be paid, there is a transaction to be had somewhere, anywhere, everywhere within the state and across the country.

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Kiran Dhillon, SIG Commercial:

And how long does that process usually take?

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Preston Howard, Rose City Realty:

If a borrower and my team are in sync, everybody's communicating effectively and we are literally talking, emailing, texting every day, a hard money transaction can get done in three weeks or less. I've done transactions for example where a client had a two bedroom condo on Ocean Boulevard in Santa Monica and only owed $250,000. The condo was worth $800,000. It's one block literally from the Pacific Ocean in Santa Monica. That is something to lose.And he was in foreclosure. The trustee sale was going to occur the next week.Once I presented the property, gave my investor the address and sent a couple photos, we were able to fund and still beat the clock at the courthouse steps.

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Kiran Dhillon, SIG Commercial:

Wow, impressive. So the ball is in the court of the borrower in terms of how on top of it they are to help move the process along?

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Preston Howard, Rose City Realty:

Absolutely, absolutely. And we're all human. We all have families of origin (our parents, brothers, cousins) and many of us have families of creation (our children, our spouses), and needless to say, they create roadblocks, distractions, and things that slow us down. I have been in the midst of a transaction and, lo and behold, the spouse died. That slowed things down. A child ran into trouble with the law, another child ran into trouble at school and it takes the borrower's eye off the transaction and those things can slow us down.

We hope that everybody stays well and healthy and can communicate effectively. But things do happen. Case in point, I had a transaction that was only going to be a one day financing case. They only needed my financing to borrow money to pay beneficiaries in the name of the trust. Money was borrowed against the property, an investment piece of multifamily, they bought against it. The mother, who is the original owner of the property, has passed away and the property is still in her trust. So we need to borrow against the asset to pay out the different trustees who are three different beneficiaries. Three brothers, they're the three beneficiaries. They're all on title as successor trustees. They've come to an agreement, nobody's fighting. And all we needed to do was put a loan of $1,400,000 against a $2.1 million property. So that's 66% LTV, give each brother $700,000 and everything should be fine. They only need to borrow the money for one day because one of the brothers is going to pay us off the next day to preserve the tax base because one of them actually wants to move into the property.

Lo and behold, two days before we're supposed to sign loan documents, one of my three trustees has a massive stroke. So that's incapacitation. And amazingly his other two brothers, because they're so tight,did not want to sign loan documents without him. They wanted to wait until that brother got back on his feet because they believed that he deserved the right to sign the loan documents, too. It was a whole family dynamic. This was mom's property and now our brother's going to move in and he's going to live there.It was just family dynamic, can definitely mess with a transaction. And this is one of those cases where they pulled out of the transaction and just preferred to sell the property because this particular brother that wanted to move in is also the same brother that had the stroke, and accordingly, he's going to need care. So as opposed to having him move in, they're going to sell the property and use the proceeds to pay for his care.

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Kiran Dhillon, SIG Commercial:

That makes sense. So what are the key factors or criteria you consider when you're evaluating a multifamily property for a loan approval?

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Preston Howard, Rose City Realty:

I said it before, I'm going to say it again. They have got to have something to lose no matter where it's located, no matter what the property type. If they don't have something worth losing, they'll take a whatever type attitude about making payments. I've had clients with tough properties and tough neighborhoods, and the county of Los Angeles, he owed $200,000. The property is worth $1 million and it's a cash cow. Even in the toughest areas that cash cow is something that he does not want to lose. The property that was five parcels from the ocean, they owed nothing. They only borrowed $100,000 and the property was worth $2 million. Definitely something to lose. So that's the first thing. Good payment history.

And I go back to the original thing: people, credit, and real estate. Are the people good? Do they have a credit history showing that they have a good history of making payments on time? And then is the real estate good? I mean, we can go through loan applications, we can collect proofs of rental payments, we can get rent rolls, operating statements, but in the end,do we actually believe that the person who's supposed to cut the check every month is going to cut it and send it?

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Kiran Dhillon, SIG Commercial:

So what types of properties are best suited for hard money loans,and are there any property types or conditions you typically avoid? So I understand if it's a very coveted piece of real estate that makes sense, but is there other criteria, like a lot of the listeners might just have the average class B or C multifamily property anywhere in the Greater LA area. Are there other criteria that make certain properties more well suited for hard money than others?

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Preston Howard, Rose City Realty:

First thing that I'll say, and as you my real estate professional friend who is a former attorney, you can appreciate this. Title's got to be clean. Litigation -- everybody knows that the minute you see litigation, you might as well press stop. Don't press go. If a property is in litigation, you pull that preliminary title report, you look, you see lis pendens, you know nothing's going to happen for at least a month. You already know that. So I'm avoiding litigation, eminent domain issues, and environmental issues.

There's nothing like getting all excited about a transaction only to find out that there's an environmental issue. Occupancy, in this state particularly. We're a very litigious state. And another form of litigation, not litigation that's already preexisting or that's on title, but litigation that could come is when people want to approach someone like myself to do hard money and either the owner or a beneficiary, someone of bloodline or of step-line like a stepson or stepdaughter, lives in the property but does not have the ability, cannot show the ability to repay. And ever since the Dodd-Frank Law of2010 came in to existence, one of the biggest things that it brought was ATR -ability to repay. The minute that you have a borrower who lives in a property that's a subject property to be borrowed against, you have to prove their ability to repay the loan and you have to structure it certain ways, at least a five year term, and prove that even under the worst circumstances, they can make the payment. Hard money lenders don't want to do that. They just want to do transactions and collect their interest payments. Having to do 60 page disclosures when all they normally have to do is 10 -- it doesn't make sense to do an owner occupied transaction when you could just do another transaction that's tenant occupied or vacant. Those are the type of things that you want to look for that make certain transactions easier than others.

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Kiran Dhillon, SIG Commercial:

So in your experience, what are some common challenges or misconceptions that multifamily owners might have about hard money lending? So the one that I can think of is the interest rate is higher, right? But is that essentially the only hurdle or are there other things that you think owners might be worried about that they don't necessarily need to be worried about?

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Preston Howard, Rose City Realty:

Sure, it's probably best to maybe give a story and give an example. Case in point, many times I work with the estates of individuals who have passed away or they've gone into some state of dementia. I have worked with a borrower through some trust and estate attorneys where there was a property near the Westside Pavilion, great location, all two bedrooms, property was worth about $4 million. On a bad day, they only owe $500,000. So $500,000divided by $4 million. That's only a 12.5% LTV. Like I said, all two bedrooms,$4 million of value, only owes $500,000. That's a no brainer, that is 87.5% equity. That is definitely something that they don't want to lose. So the first thing is checkout the real estate. But my borrower, my underlying borrower, has dementia. So she is forgetting that the stack of papers on her desk are bills of mortgage payments that need to be made. She's missed five. So they've already put her in a default and it takes a niece who's a real estate attorney to come in, look on the desk and say, "Auntie, what's going on?" And Auntie has no clue that she's in default.

I am brought in. There was potential litigation because a stepchild who thought he was the trustee and this rock star attorney niece who truly is the trustee, started to fight over who has the rights. And then they continued to fight and it was going to go into litigation until they realized you all are 121 days from foreclosure. They said, we'll hold off -- truce. They put their arms down and they said, "Preston, go ahead, get the loan in place."

Now, to answer your question directly, the structure. Once my investors had seen the property, walked through the property, had got a chance to get comfortable with the property, they loved the neighborhood, they knew it. Actually, their house of worship was right around the corner. So they knew that area well. They knew that there was something to lose, and they liked that. Since this woman was in dementia, she had to have a conservator, a professional conservator placed over her, and they actually knew the conservator, the licensed professional fiduciary who was going to be paying their bill. They knew this person personally. So at the time in the market when home mortgages were about 2.5%, hard money went down as well. That loan got done, I think at 6.75%, fixed for three years, and whether you pay six payments upfront or wait and just make your six payments every thirty days, you're free to go after the sixth payment.

So when you say hard money, people think: 15%, 10 points, five year prepayment penalty, stuck in the loan for five years no matter what you do-- it's not that. Competitive pressures in the marketplace have gotten hard money down to the point where it's longer term, less prepayment penalties, and more flexibility with regards to payment and obviously a lower rate. So there have been cases where I've done hard money at 5.75% fixed for 30 years. It had gotten to the point where even the Swiss banks were interested in investing in hard money loans right here in Los Angeles. So go figure, everybody wants in the game.

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Kiran Dhillon, SIG Commercial:

So for somebody who's potentially thinking about it, it really makes sense for them to not be sidelined by those misconceptions and actually reach out to you and go over their scenario.

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Preston Howard, Rose City Realty:

Sure, and something else I'll post with regards to apartments,like I said, best of the best, they want best of the best. In many cases, like Fannie, Freddie or maybe if you're doing a construction loan, FHA, they want occupancy of 90% or greater for 90 days. Some of them like to see two to three years of operating financials. They want to see two to three years of tax returns from the borrower, and some of them are even, depending on the institution, they want a personal guarantee from the borrower.

Once hard money identifies or structures it so that there's something to lose, personal guarantees go away. They're not worried about financials and occupancy, 90 for 90. They don't care. Give it to me. If it's vacant, I'll fill the building up myself.

So a lot of times people who do multifamily will use hard money when they want to add an ADU. When the property's in transition, maybe they have totally purged a building of all tenants. They want to redo the rent roll,do some tenant improvements, and occupancy is very low, if not zero, hard money makes perfect sense. You could pull some money out of the property, do your tenant improvements, granite countertops, recessed lighting, travertine, and tile to get the best rents. And then once the property is in perfect position,and you can lease it up 90 over 90, you got your ADUs done, you got your permits from the city and final sign-offs, at that point, best of the best is knocking at your door.

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Kiran Dhillon, SIG Commercial:

Yes and I see this myself in the market, the increased interest in adding ADUs to multifamily properties, and I just read an article about it too,because it makes sense. It's a great way to increase the income and the value of the property, and you already have tenants, so you're just adding more tenants to an already leased property.

You've talked a lot about some of your success stories, but I'm wondering if you have any other ones that stand out to you where it's like in this scenario, the hard money loan really came in and saved the day and how it worked out?

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Preston Howard, Rose City Realty:

Well, definitely there was that Santa Monica incident. It is usually with regards to the investment properties where the person doesn't live there. I will say that with regards to hard money, because hard money usually deals with investment properties only because they don't deal with having to verify income, it's easy to forget what's going on at a property if all you're doing is collecting the rent. I had a client who has multiple units, but he lives all the way out in the far edges of the Inland Empire, so he can't get into see his property. He didn't see that the city was posting REAP notices on his property, and he moved without updating his address with the city. So you as a multifamily expert know, REAP, you're not responding to notices. It's a nightmare. So needless to say, lots of people wouldn't touch his deal, but sometimes the people that could see the underlying value, they'll come in,especially when his LTV was only going to be 20%. So the risk, he had way more to lose than the investor that was putting up money, way more to lose because once we looked into what the REAP notice wanted to fix, it was totally doable.But for him, it was freaking him out because the city was really, they had posted multiple notices and his old address, when they finally got the mail, he was receiving multiple notices. And they were ready to apply maximum consequences to him. So he needed some money to fix the issues and we were able to come in before they came in and put down the hammer.

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Kiran Dhillon, SIG Commercial:

Okay, well good. That's a scary story. So what advice do you have for multifamily property owners who are considering getting a hard money loan?

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Preston Howard, Rose City Realty:

We're working on rebranding first thing, and what I mean by that is this. You'll hear less hard money and now you're hearing more private money.You're hearing that, I know people are hearing that-- private lending -- even though we all know what that means, hard money. That moniker just looks like Guido, who's ready to break your legs if you don't pay up by Friday at 5:00 PM.It just seems harsh. It sounds harsh. So that's one of the things. Hard money is not as hard as it seems as long as you do what you're supposed to do. The underlying investors, the investors who I work with, the debt funds, who I work with, the majority of the people are pensioners who just want to get a good return on their investment. My average in investor is about 68, put in a 30 -40 year career, and they just want some autopilot income. They're not vultures.The majority of hard money investors, private money investors are grandmas and grandpas who had some extra cash lying around that don't want to just let its it there and they want to make some extra coupon.

They don't want trouble, you don't want trouble if you pay your mortgage on time. They don't want to get notices that property taxes haven't been paid. They don't want to get notices that the insurance bill hasn't been paid, or that the property insurance is being canceled because you've been found to be non-renewable. As long as borrowers aren't having their investors get notices like that in the mail, they work with them. They love doing transactions where they can make 9% - 12% and they don't want to make half a percent from a CD. I know CDs are higher now, but you get the point. You can make twice as much money investing on some vacant property in Pacific Palisades at 10%. Why not?

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Kiran Dhillon, SIG Commercial:

I always hear you talk about when to think of you, and it's death,divorce, dementia . . .

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Preston Howard, Rose City Realty:

Distress.

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Kiran Dhillon, SIG Commercial:

Distress. Okay. So just to recap for the listeners, these are instances where they might not typically be thinking that private lending is an option. These are the scenarios. So just say them again one time.

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Preston Howard, Rose City Realty:

(1) Deceased: This is most likely to happen when matriarchs or patriarchs of families pass away and the relatives left behind want to continue to own the property. And there is an opportunity to preserve grandma, grandpa,mom or dad's 1940s, 1950s, 1960s tax basis. A hard money loan is an option because we don't transfer the property out of the state of the decedent when the loan is made.

(2) Dementia: As I've mentioned, there are cases where owners of property have lost their cognitive ability to know what's going on. So we make loans like that because lots of times people don't want to deal with the potential for litigation due to incapacity, an elder being taken advantage of while they're in an incapacitated state.

(3) Distress: Things happen that put people in precarious positions and you just want to have an option to get them out of that distress.That allows them to restructure things, and probably the most important thing,allows them to breathe. We can structure a transaction where they make six months worth of payments upfront. So going through a distressed situation where you might lose your property, it's hair raising. Sometimes after they come out of that, they're really beat up. So we can structure a transaction where they can breathe for a while. Or if it's deceased and distress, where you've lost a relative and it's like a reverse mortgage, once the relative passes away, there verse mortgage now becomes due. That's stressful. And if the executor is the beloved son who loved his mother and they're still mourning the loss of their parent and they got to take care of this reverse mortgage, which is a ticking time bomb, sometimes private money comes in, pays off that reverse mortgage.The reverse mortgage lender is now out of the way and then they can breathe.

If it's structured right, they can grieve and then they can get back to taking care of administrative business once they've had a chance to just really get their heads back together.

(4) Divorce: And sometimes, it's divorce. It's interesting how divorce can wreck someone's credit because if they're really fighting and they want to be vindictive, they'll charge up credit cards, not pay credit cards.And then the innocent spouse is left with horrible credit and they've got the property they can't refinance through the normal way because their credit is so messed up. But they still need to pay off that spouse that may have done some nefarious activities. So those are definitely quick scenarios of what the four Ds: deceased, dementia, distress, and many times divorce.

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Kiran Dhillon, SIG Commercial:

Excellent. Well, Preston, thank you so much for sharing your knowledge about private money. What's the best way for someone to reach out to you if they're interested in learning more about this and maybe talking to you about getting a loan?

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Preston Howard, Rose City Realty:

Well, there's the old school way, telephone: (626) 644-6813. There is the digital experience, howardpr@rosecityrealtyinc.com. And then also I can be found on the worldwide web or company information can be found at www.rosecityrealtyinc.com.

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Kiran Dhillon, SIG Commercial:

Excellent. Thank you so much, Preston.

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Preston Howard, Rose City Realty:

No, thank you Kiran, it's a pleasure to be with you.

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