Private Lending

What is private money lending?

Private money lending involves private individuals, or entities, lending their investment capital to borrowers, while securing their loan with a deed of trust, recorded against the borrowers’ real property.  Private money lending is a niche market for borrowers and/or properties that do not meet conventional institutional lending requirements.

Private money lending is based on lending against real property secured by deeds of trust, driven by the value of the underlying collateral.  If carefully underwritten with conservative loan-to-value ratios, private lending offers a built-in safety net of protective equity, should the borrower ever default.  That said, no investment is risk-free and private lending is no exception.  Generally speaking, private money loans are short-term in nature, and provide highly favorable returns to investors who participate.

Historically, private money lending has been a fragmented, “mom and pop” industry, and is known in some circles as “hard money” lending.  The industry has expanded in recent years, most notably as a result of traditional lenders  having tightened their lending requirements and forced credit-worthy borrowers to look elsewhere for their financing needs, in knee-jerk response to market corrections such as the subprime mortgage meltdown of 2008.   USI believes there exists enormous opportunity to mature the industry and bring to it an institutional level of sophistication while providing investors outsized risk-adjusted returns.

Isn’t what USI does kind of similar to what traditional banks do?

Yes, very much so, but with one key difference.  Banks typically take your money, pay you say 1% a year in interest if you’re lucky, and then loan that money out to borrowers, at much higher rates, and pocket the interest rate differential.  At United Security Investors, we take out the middleman and allow you, as the investor to make the spread.

We make disciplined, well-underwritten loans, as do traditional banks.  But instead of paying you back only 1%, we pass along 100% of the borrower’s actual interest payment, less a small management and/or servicing fee.

Why would a borrower need a private money loan?

Frequently the answer is timing.  Let’s assume a borrower has applied for a conventional commercial bank mortgage, the closing date is fast approaching, the bank is still completing its due diligence, yet the borrower must close in a timely fashion in order to avoid losing a his/her contract deposit.  The borrower might choose to finance with a private money lender for its speed to close, and then after this “bridge loan” closes, the borrower can take as long as necessary to arrange permanent commercial financing.

Property type:  Certain property classes, such as mixed use properties, have trouble qualifying for some conventional institutional loans.

There are many occasions where a borrower will not fit into institutional lending guidelines, such as poor credit, citizenship issues, employment status (e.g. self-employed)

Finally, macroeconomic conditions can play a part.  The availability of conventional financing has tightened recently, due to the retraction of available banking credit as a result of the recent events of the Global Financial Crisis.   As a result, loans that would have been approved pre- crisis are now having trouble getting approved due to tighter lending standards.

What are the potential risks in private lending?

Risk varies among different types of property classes, lien positions, loan-to-value ratios (LTVs), as well as geographic locations to name just a few.  No investment is entirely risk-free and in the case of private lending with deeds of trust, real estate values may fluctuate and borrowers may default for a number of reasons, which could potentially impair the timing of an investor’s cash flows or even compromise them altogether.   But diligent and thorough underwriters, like USI, can effectively manage those risks with our strong local knowledge of the market, rigorous underwriting policies and sound business judgment.

How does USI manage risk?

Risk can never be eliminated, but it can be managed.  A trust deed investment is only as secure as the underlying property securing the loan, and the security of the loan is a function of the strength of the underwriting process.  As the first line of defense, USI underwrites each loan, working to identify foreseeable and potential risks of the investment.  Our strict underwriting standards and understanding of the local market help manage some of the risk.

Additionally, our investors are always provided with access to all underwriting materials, which we strongly encourage all investors to review, as an important second line of defense, in furtherance of their conducting their own due diligence.

The following factors are the fundamental drivers in our due-diligence process.

  • Typically 65% maximum loan-to value ratio, depending on the property, which is typically more conservative than institutional lenders
  • Licensed and insured appraisers; and/or third-party, independent, licensed real estate brokers who have expertise in their geographic area and property type, providing broker price opinions (BPOs).
  • A stringent due-diligence review process for all loans.

Since our inception, our investors have not incurred any losses on any investment that we have underwritten.*  Additionally, every loan that USI makes has our principals’ capital co-invested, so USI’s interests are always aligned with our investors’.

Who services the loan and sees to it that the borrower makes timely payments to the lender / investor?

Loans are serviced by USI Servicing, Inc., (DRE #01910640) (“USIS”), an affiliate of United Security Investors.  Unlike a non-affiliated third-party loan servicer, USIS retains an institutional knowledge of each loan and its respective borrower, throughout the loan’s full life cycle: from loan origination all the way to payoff.  In the unlikely but very possible event of a borrower default, USIS is the investor’s one-stop shop for special servicing, working tirelessly and skillfully to resolve the default, all the way up through loan payoff.

Are there any outside resources that you can recommend?

Yes!  The California Department of Real Estate publishes a very informative paper on Trust Deeds, that we recommend all potential investors review:

Click here to read the DRE publication Trust Deed Investments – What You Should Know.

Additionally, we encourage you to visit our Latest News section, where we have highlighted some recent articles of interest from the financial press.