This is how guys are getting rich in real estate
So about 2 months ago I joined a group that does about $1 to 1.5 billion per year in commercial and commercial real estate loans. Our entire production and underwriting group is comprised of about 25 people. I've looked at a few dozen deals now that have made their way to my desk after extensive review and negotiation with upper management. While this is probably not universal (it's not even necessarily universal at my organization), there is a pattern I've begun to recognize.
A lot of guys who have become mega millionaires in real estate have done the following: they start out small and they work closely with a handful of local or regional financial institutions for their depository and borrowing needs. They rarely over leverage and they act responsibly. These borrowers also tend to involve their children in the projects and get their children hooked into the institution's relationships. Over 20-30 years with these same institutions doing deal after deal these FAMILIES can do practically anything they want at much higher leverage. I've seen guys with 650 credit scores get $10 million loans at 80% LTV on spec retail construction. On Friday, we extended a $2 million unsecured line of credit to small spec real estate developer with 660 credit and $300,000 in total cash and maybe $700,000 in net worth. Why do we do this? I'm still in the process of learning why, but it seems that their past performance with the institution is their credit. I came from institutions that securitize most of their debt and therefore are radically committed to extensive documentation and personal credit documentation, so I was blown away by how little paper verification we require and how liberal we are with our funds to these clients. But since we don't securitize we can do whatever we want.
I was extremely skeptical about this type of lending until I learned that our default rate is 1.13% compared to 1.25% among our peers. Not sure what the number is, but I'd guess default loss is close to 0.1%. Turns out that lending based on relationships is actually a pretty amazing way to lend. Turns out that basically ignoring traditional credit metrics and using past performance as one's credit is remarkably accurate.
The point in all of this is, apparently the way many people are getting rich is by developing deep and long lasting family relationships with a small handful of financial institutions and always, always, always making sure to make good on their debts. Over the decades they build up a phenomenal reputation inside and outside the bank, build a lot of real estate equity and then they become kings of the castle--they come to those institutions to get practically anything they want to turn themselves from simply rich to extremely rich at little risk to the lender. I had a $3 million deal come to my desk last week. After underwriting the entire deal, we asked the guy for verification of liquid assets. The borrower told us to pound sand. Management has said it will sign off on the deal next Thursday. It's pretty remarkable.
Doesn't practically anything get underwritten at the right rate?
I'd be interested in finding out how much better their terms are versus first-time investors with the same specs.
Definitely not. In this environment underwriting standards are extremely high. Just spent 2 years running my own bank branch where we did a lot of consumer, mortgage and small construction loans. You absolutely cannot just walk into a bank and get a loan with a 15% interest rate and go about your business.
These guys are getting fixed rates in the low 4s on $3 million, $6 million, $20 million deals. It's not out of the ordinary for these quality borrowers to get great deals like this, but they are great borrowers with lots of experience.
I'm a complete noob here, so bear with me...
Why would anyone give out an unsecured loan for fixed rates in the low 4s??? Makes zero sense to me.
Maybe I'm missing something here? If I take out a $3mm unsecured loan to pick up a sandlot, and default on the loan... I get to keep the lot?
If that's the case (which I highly doubt,) I have a better idea for getting rich quick: default.
I'm assuming that you need to declare bankruptcy, and sell the lot. In which case, there are still ways around this where you can get stinking rich selling to friends, no?
Because most of the guys are already rich. Their 20+ years of history with the financial institution is their credit, and it's ultimately their source of debt capital. If they purposely defaulted on something like that they would be out of business indefinitely, if not permanently. As I was trying to get across, none of these guys just walk in and demand a $2 million line of credit. The guy we approved for a $2 million line of credit has 25-30 years of experience as a real estate developer/home builder and he has done 80 home builds through our organization in the last 10 years with an additional 10 years of history as a depository client. He f*cks the bank then he is out of business forever since he can't just walk in to, say, SunTrust and get debt capital for a spec home build.
Right, that makes sense. It just seems pretty damn risky haha.
So, would you say that you have more developers receiving these types of unsecured loans versus just prospective land lords? Because that would seem counter intuitive.
What would you suggest the best way to go about fostering a relationship with a bank if you just want to buy homes/buildings(commercial or not) in order to rent the space out? Would the approach be any different?
If I'm holding down a decent job, have $100k in the bank, a 750 score (but less than 2 years income,) what are the odds I can get an unsecured loan for that purpose?
Developers/landlords are pretty much one in the same among these guys. Most of them aren't buying, building and flipping. They are buying, building and managing.
Odds are zero that you would get an unsecured line of credit for real estate development or purchases. What you would do is get a standard collateralized loan, possibly with recourse, possibly without, depending on the institution, LTV, etc.
I would start with small deals. Instead of buying a house and getting a mortgage from, say, a large mortgage bank, maybe it would benefit you to work with a local or regional bank. Move your deposits over to that institution. Refer some business. Get a credit card with them. Establish yourself as an "all-in" client. As you do more deals your reputation with them will improve. I'm dead freaking serious--establish some good history with an institution that's known for commercial lending and in a few years start doing some small retail or office builds. Go in with some family members or a partner. Do a few small ones successfully and establish good credit with them and you'll be on your way to the bigger deals with pretty liberal credit standards. It won't happen over night, but you don't need to start out with a $25 million office building. Start out with a $750,000 retail build. Might help if you met some general contractors who you could partner with.
Thanks.
Yeah, I actually have plenty of contractor connections that I intend to team with on any residential setups. Unfortunately, they don't work on commercial construction so that's why I'm leaning towards residential.
One thing I would be worried about in dealing exclusively with one bank (if I had a significant amount of property) is any liberty they may have in changing certain terms which would render me non-liquid - not something I'm worried about right now, just pointing out the risk.
So, if I can solicit some advice:
One thing I'm looking at is buying a store within a strip (not sure if deals like that are even done?,) while also partnering up with some friends to open up a liquor store. The plan would be to rent (going rate) to the store. Would that sort of circumstance help me to a significant degree in negotiating better terms - I know it depends on the institution, but I'm just trying to get a sense.
Also, say, I have $100k cash, but only want to put down $50k and scrape another $100k from partners for this property (the other $50k would probably go into the business.) A $750k (20%) loan is still a decent amount of leverage, so would this be seen as fairly risky?
Biggest problem, is location I think. It's also hard to find retail spaces at that price in the NY area. A lower middle-class home in LI runs around $300k...
What you pitched is certainly feasible. A deal that size at our institution wouldn't even go to loan committee--it could be approved by a senior credit officer with an analyst's recommendation. It would be underwritten by the commercial & industrial (C&I) group.
For a deal like that they would look at your personal credit score, your education, your job, the collateral (80% LTV as you pitched it), projected cash flow, your liquidity and your experience. In the early stages you may want to--or even need to--partner up with someone who has experience running or owning a store; even better, someone who has experience in running a liquor store...That may be what you need to get your file over the approval hump. You would probably also have to issue a full recourse guaranty.
A college graduate with 750 credit score, 20% down payment, good projected numbers, a personal guaranty and an experienced partner would have a decent shot at a loan like that. Although lenders wouldn't be falling over themselves to lend money to young people for liquor stores. Haha.
A lot of people don't realize this but banks are supposed to lend. They are required to lend. So banks are looking for reasons to lend. Your job is to give them the reasons. There are some banks that specialize in vanilla mortgage loans, while others are more commercial heavy. Find a commercial heavy bank and start developing that relationship.
In my limited experience in MM lending, yes you had a deep relationship with the lending institution but you also built the same relationship at a couple other institutions. That way one bank can't screw you over. It never seemed to make any of the banks you threw business to question your "loyalty" even as they were competing for your business.
Does your default rate take into account loans that are securitized or loans that have been removed from your balance sheet?
"Coming from institutions that securitize most of their debt and therefore are radically committed to extensive documentation and personal credit documentation, I was blown away how little paper verification we require and how liberal we are with our funds to these clients."
Or maybe they are more cavalier with the due diligence because the loans are securitized out to others and not held onto the lender's own balance sheet anyway so it is others who take up losses if something goes ugly. The lender is further incentiviced to bundle up as much CMBS as possible to make more fees off originating these. This sounds like what happened during the RE bubble.
No, I CAME from places that securitize into CMBS. The place I'm at currently does NOT securitize. It's got a $5 billion loan portfolio right now, of which $5 million (as in $5,000,000) are held for sale. When you securitize loans, they have to meet specific underwriting standards. When you don't securitize loans you can do anything that you want with regard to paperwork, loan terms, etc. I cut my teeth in Freddie Mac's multifamily underwriting group. It could take 3 months to underwrite a deal with the ridiculous amount of paperwork. When I put my head down I can do an entire deal in about 40 business hours here.
Also, I'm assuming that many of these banks have established relationships with agents? When you were running a bank, were you ever approached directly for information on properties in pre-foreclosure - or is that completely illegal?
Just trying to figure out how best to take advantage of a bank's network.
For banks that have a heavy focus on mortgages and that also have a large portfolio of loans underwritten to MBS standards that they are currently holding on their loan portfolio then yes, they definitely have relationships with real estate agents. The largest banks are the most likely to have those relationships, such as Wells Fargo, BOA, Chase, etc. Smaller banks will mostly sell their mortgage holdings to professional servicers. My current bank actually provides a few hundred million dollars in warehouse lending lines for mortgage banks, so while we don't do many single-family mortgages we do provide temporary funding to smaller institutions before they sell these loans to investors.
Since I was with one of the smaller banking institutions before I was not approached seeking information on foreclosures.
What is your firms default rate in a really bad year like late 08?
I have no idea, but I do know that the 1.13% would be closer to 0.2% if not for acquisitions of other institutions. When one bank acquires another it, unfortunately, must take on the acquired institution's debts. Bank of America is a classic example--not a particularly poorly run lending group until it acquired Countrywide, at which point BOA became the mortgage slum lord as it took on all of Countrywide's garbage loans. Sort of similar with us--our internal loan portfolio is extraordinarily sound, but other acquisitions increase substantially the default rate.
Most RE investors have shit credit.
I build credit risk model's for commercial lenders, and while your current observed PD may be low, with loans like that, you've got another thing coming in a downturn. I've talked with plenty of bankers who love to spin yarns about how developer years of experience is a relevant factor, but of the portfolios I've analyzed, it is not at all a significant factor.
The reason being is that if a guy with 20 years experience is sitting on a construction project and the economy blows up, he's no better off than the guy with 2 years. Both are sitting on a property that doesn't generate any income. That's the thing with credit risk, it's all theoretical when the economy is strong, but when a downturn hits,
I think to DCs point and based on my experience (I've had some developer IB clients) - these guys will sell off personal assets and basically do anything to not default. So yea maybe a deal hits the fan but these guys have the wealth/assets to make sure they don't default so they aren't ruined forever. Clearly so guys do bite the dust though.
This is exactly right. Guys with a lot of experience tend to understand that their 10-, 20-, 30- and even 90-year (yep, we have a family client of 90 years) history of strong reputation and excellent creditworthiness is not worth giving up by defaulting--in accounting terms, these guys are "going concerns". Also, guys who have a lot of experience are also taken at face value when they are drawing up budgets for new construction, estimating lease rates, and determining reserves for tenant improvements, leasing commissions and replacements.
I think real estate guys tend to have bad credit because they have "credit lifestyles" that contradict the algorithms--in other words, they have excessive usage. The credit score algorithms are incredibly opaque--in fact, the formulas are proprietary; the only reason we have any clue about how they work is through 30 years of observation. Generally, a lot of credit inquiries ding a person's credit. Generally, having a lot of available credit can ding credit. Often times these guys carry high revolving balances in relation to their credit limits. Having 1 revolving account with a ratio over 30% can ding credit by 20-30 points. While there is diminishing marginal negative impact on high balances, simply having a half dozen high balances can cost the person 70-80 points. To sum, it's the credit lifestyle of these guys that contradicts the algorithm.
This is good stuff and I'm generally on board. I'm just confused as why these rich developers have such low credit scores. If they have 20+ years of experience and are wealthy why are their credit scores so low?
People whom have extremely high levels of debt have shit credit scores. It doesn't matter what your company or investment brings in at a certain point. You could have a DCR of 2.0 on a portfolio of investments with 100MM in loans your credit score is gonna be shit.
This is an informative thread, thanks for posting. I am curious about the same thing as @ke18sb is curious about. That is the missing piece of info for me.
There is a lot of crap of WSO, just now I had someone PM me asking me whether banks could catch a forged CV, and expecting me to reply to him due to my apparent experience in HR (I never worked in HR).
This post is B.R.I.L.L.I.A.N.T.I.S.M !!! Thank you so much for this. This is extremely informative.
I am involved quite heavily in the London market myself, very similar market to the US (credit score being hit everytime you get an enquiry, I got an Amex just to improve my score, and other ridiculous shi.t like that)
DCD, I'm gonna need to hit you up sometime. My family is in RE development and are looking at acquiring a multifamily project (120-units Class A) and possibly development for one project. I'd love to pick your brain on this. We have a good relationship with some lenders, but they freak out over anything above 70% LTV. Whats the max LTV for existing multifamily? And do you allow a mezz piece?
Everything is negotiable. Depends on the entire credit profile, which does include a borrower's history with the institution, although that is just one piece. Overall experience would be key to negotiating good terms or "above market" terms, as my boss likes to say.
Feel free to PM me to pick my brain, although I'm not going to respond to questions about jobs, interviewing, etc.
If you're lending 80% Loan to Value on spec residential construction, your credit committee is fucking nuts. If that's 80% Loan to Cost however, it's a different story.
Also, the example of a $700K 'personal' net worth is pretty standard for developers. Their personal net worth is negligible, but they usually have a portfolio of holding companies that when added up are worth in the tens to hundreds of millions. Lots of developers/real-estate investors don't like to claim personal assets to a bank because if they default, it can be used as recourse to cover the bank's credit losses.
We're well aware of their ownership interests, hence we collect tax returns (with K-1s required) and require disclosure of ownership interests and assets as terms of the loan agreement.
That's laughable. Trust me you do not know all of the information. They will only disclose what is needed to get the deal done.
Finally someone that seems to know what they're talking about...
OP sounding like he came to some sort of great epiphany after two months in lending...yes, banking relationships matter when your institution is willing to take on that high level of risk, especially if they have a proven track record with you in the past and have deposits with you. Why should this surprise you?
Just like heister mentioned, they'll only give you what's needed for the deal to work (and after building a relationship with your institution over several years or decades, they'll know exactly what's needed inside and out). If you think your disclosures cover you, you are mistaken, as they typically only cover the specific borrower seeking the loan (not their business debts, business partner debts, etc). Maybe you draft this into your disclosures, I don't know.
I have a feeling there's a lot more to these deals than you're seeing, as otherwise I don't see how you'll make it through the rough times.
Bring on the monkeyshit for being one of the few here that thinks this post is ridiculous
Whatever makes you feel like a big shot. I'm not going to re-hash my resume here to defend myself from a guy who thinks he knows everything. I'm not even sure what you're arguing--you as much as said you agree with me that long-term banking relationships matter. What have I said that is incorrect? I'll get the popcorn and wait with bated breath. Or did you just chime in to make yourself feel like a big man?
I'd argue with your points, but let me sum up my response by simply quoting you: "Maybe you draft this into your disclosures, I don't know." Why is this so hard to believe?
Very good thread. I have 3 years real estate lending experience as a credit analyst. While I don't do that anymore, I am looking to get into real estate investing in the next year. SB coming your way DCD
As a fun data point to all this, a neighbor of my parents is a real estate developer who blew up in 2008-2010. I'm not sure if he defaulted, but he did everything but that. Oddly enough, he started building an absolute gargantuan of a house during all this. I'm talking 20k square feet, that probably ran him close to $10mm. The reason being that he had stopped paying all his contractors and was getting sued. The state I'm from has unlimited homestead protection so creditors cannot access the value in your house. Because of this, he had a net worth of literally zero, so no one even bothered to waste money on suing him.
It was hilarious to watch, for weeks there would be no progress going on at the house and then I'd read a story in the paper about how he landed a deal. Next day, the property was bustling with workers. It's been like that for four years and I think he just moved in. He's definitely a scummy guy but the house is pretty nice.
DCD what's your company's source of capital? Is it private/public?
95% time and demand deposits, probably 5% wealth management funds.
very informative thread.. :thumbsup:
Just to clarify, the majority of borrowers don't get "sweetheart" deals--I've noticed several comments here saying that no bank can sustain through those types of deals. You're right, that's why sweetheart financing is limited to the best and most active clients, hence why I wrote this post originally--to comment on the importance of long-term relationships with financial institutions.
We've issued a 90% LTC rolling credit line to a small homebuilder but are limiting houses to those that cost no more than $1.5 million. Still, it's a phenomenal situation for a builder to be able to obtain such great terms at the drop of a hat. I know--I'm from a family of home builders. Having that kind of financing is business altering. How can we justify these terms? We've done nearly 100 home builds with this guy since 1994. That's how. So that was my clarification--these terms aren't available to the general public--they are earned through decades of good performance.
I thought it was helpful DCD, thanks.
I've got a story for the "how people are getting rich in real estate" category (numbers changed, but only slightly):
A small REPE had the inside track on a commercial building in a downtown area of Boston/Dallas/LA, below-market rent, wealthy family just looking to get out. 5% of equity was, say, $500K, but this basis was immediately reduced by an acquisition fee (paid by the limited partners) of $200K. Three years later, the Property has doubled in value. Due to a 50/50 split of IRR over 20%, they will walk away with $5M+ on the sale. [Breaks keyboard on wall]
[Plugs in new keyboard] The lesson here, everyone, is to go vacation in St. Bart's more often. You have to spend money to make money.
This isn't really all that shocking. There was a kid in the Dallas Fort Worth area, while in college he started buying up houses around his college and a few years after graduation bought a high rise office building in downtown. These large deals are there you just have to find them.
FML.
DCDepository, how big is the bank you work for? I'm curious because I was always under the impression that a lot of the large banks (BofA, JPM, etc.) don't do a whole lot of these CRE loans.
I used to work in the multifamily capital group of one of the large banks doing asset management and working with some of the originators here and there--I can attest that the bank at large didn't do much commercial lending outside of some very strict lending groups (for example, the parent bank acquired our multifamily capital group and we did a few billion dollars per year in originations, which was a rounding error compared to their total lending). The large banks simply can't develop the deep, long-term relationships the way some of the regional players can. The large banks focus on consumer credit and mortgage lending, which definitely makes sense.
Our bank has something like $8.4 or $8.5 billion in deposits, something like $10 billion when a recent merger is complete.
@DCDepository (or others knowledgeable in the area) - For those seeking to identify these regional players who are willing to extend favorable credit terms/develop long term relationships with RE developers, among others - what primary factors would be most relevant in identifying a lending organization of this disposition? For example, are there any general guidelines re: assets held which might be useful in identifying potential flexibility (e.g.
When I began my career, I used to manage $200+ million portfolio in construction and land loans to real estate developers. I witnessed the same pattern as you describe. My lending institution put people first, credit second, real estate third. And by 'people' the lender meant, character (i.e. doing whatever it took to make the bank whole; word=bond). The best borrowers were gritty, self made folks who never updated their financial statements on file with the bank, but whose word was gold with the credit committee.
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