My own hard money shop, Blackburne & Sons, does NOT make private money construction loans. One more time: Blackburne & Sons does NOT make private money construction loans. Watch, I'll still get a bunch of applications for construction loans. Ha-ha!
Very few other hard money commercial lenders make ground-up commercial construction loans either. The problem is that construction loans have to be funded in a series of draws or invoice payments. Funded does not mean that the loan closed. Funded means that the loan proceeds are actually released to the borrower.
Billy "White Nose" Johnson is a developer, who also has a penchant for fast cars, pretty girls, and cocaine. Billy applied to Rookie Bank for a $2 million construction loan to build a small apartment building in Indianapolis. At the closing of the construction loan, Rookie Bank gave Billy a $1.8 million check to go build the apartment building. The bank held back $200,000 for the interest reserve.
One year later, when the interest reserve had run out, the bank called Billy to ask that he start making monthly payments. After the bank had left a dozen messages, many of them threatening, the bank sent an inspector out to look at the apartment building. There was no apartment building, just an empty field.
Six months later, a private investigator from the bank located Billy in a local homeless shelter, suffering horribly from withdrawal symptoms. Apparently Billy had gone on a partying binge with the loan proceeds. Almost $1.8 million had gone up Billy's nose.
By the way, while a commercial property is under construction, it's not generating any rental income. Therefore most construction lenders will hold back nine-months' or one-years' worth of monthly interest payments in an interest reserve, out of which the construction lender pays itself a monthly interest payment.
Obviously construction lenders must therefore never release the construction loan proceeds entirely to the developer. Instead, construction loan proceeds are released using either a five-draw system or the bank pays the invoices of the subcontractors directly, after the developer has signed off on their work and after a progress inspector from the bank has inspected the work.
The five-draw system of funding construction loans is an older, almost obsolete method of controlling the loan proceeds. The proposed work is divided up into five, roughly equal phases. At the closing, the construction lender funds the first draw, and the developer cannot get at draw number two until he has completed the first phase. The problem with the five-draw system is that the construction lender still has to release $400,000 to the developer and to pray that he doesn't have a drug problem.
Progress inspections are site visits by the commercial loan officer or by a progress inspector, hired by the construction lender, to verify that the work is being completed according to the plans and specifications. A progress inspector might charge $200 to $350 per inspection, and the the cost of these progress inspections is paid for by the developer.
It is now time to get to the point of today's training article:
Very few private money (hard money) lenders make ground-up construction loans. There are several reasons. First of all, private money loans are much more expensive than bank loans, so few good developers will pay their prices.
I am actually pro-Trump, but in the interests of equal opportunity humor...
The second problem is that construction loans need to be made by local lenders. Pay attention here. This is important: Construction loans are almost always made by local lenders because the bank needs to go out and drive by the project on a regular basis to make sure that work is progressing.
The smart developer or commercial loan broker will immediately see that in order to find a construction lender, he needs to find a bank located close to his project. How? Go to Google Maps and type in the address of the property. Then hit the "Nearby" icon and type in "Banks". In most areas, he will find scores of different banks.
It's the servicing income, guys!
The second reason is because private money lenders are usually one-office lenders. Few have offices located across a state or region. Therefore they are very limited geographically in their construction lending area.
A buddy of mine, Mike Cleaver of Emerald Creek Capital, makes construction loans and renovation loans of over $2 million in New York City. Brooklyn is hot right now. Even though he is limited to New York City (guys, I really mean NYC only), he still gets to make a fair number of these loans because of the population. You can reach Mike with your NYC construction loans and renovation loans of over $2 million at 212-239-6845. Did I mention New York City only?
The third reason why few private money lenders make construction loans is because many private money lenders raise their lending capital by syndicating private investors. A private money lender might have 50 private investors in a single deal. If the lender is using an invoice system of funding his construction loans, it is very awkward to fund a $2,000 invoice by asking for $400 from each of 50 private investors. My buddy, Mike Cleaver, solves this problem by using his mortgage fund.
So this is my appeal. Do you know of a private money lender who makes commercial construction loans? Won't you please-please share him with me by sending me his contact information at firstname.lastname@example.org? Thanks so much!.