Private lending is a big business in Canada. Private lenders play an integral role for both consumers and businesses. While the lines often get blurred among lenders in the financial marketplace, we know that clients often use A lenders, B lenders and private lenders at the same time, or transition from one to the other as their needs or circumstances change.
Much like banks do, private lenders develop appetites for particular risks. Most private lending is based on real estate as security. Traditionally, private lenders offer short-term interest-only loans at higher rates to help clients consolidate debt, pay taxes, clear up credit issues or take quick advantage of opportunities when cash is scarce. Once the client’s circumstances improve, usually within a year, they can secure new financing from more traditional long-term banking sources. Although not for the faint of heart, private lending is pretty straightforward.
The old saying ‘time is money’ is especially true in the private lending world. Acting quickly and efficiently is mandatory. Winning strategies are usually about getting things done now. Showing a client who might not obviously need private lending how the quick and efficient use of this funding source can be profitable is an important opportunity for every participant in the financial marketplace.
Brokers can play a key role in identifying these opportunities and can create a recurring revenue stream for their brokerage in certain circumstances. So how would a broker create that revenue stream? Here’s one example that is a textbook case in which all parties win.
The client, a contractor with excellent credit and a strong relationship with an A lender, is in the business of purchasing and tearing down or significantly renovating a residential or multi-use property. The property may be sold or retained for a portfolio. The client is typically busy with several projects and has equity tied up in these projects. But opportunity knocks, and the client wants to seize it.
We need to understand the critical elements of success for the client in this enterprise – namely, speed, quality workmanship, cost control, creation of value and a market for the finished product. As good as this all sounds, most A lenders will not lend either quickly or at all against a building that is being significantly renovated or demolished.
However, a private lender will, based on the strong covenants of the borrower, his track record, the plan for the property and the borrower’s relationship with the A lender. Usually within three to six months, the project is complete, and the A lender is willing and often anxious to put long-term financing in place. In this case, everyone wins: the client, the private lender, the A lender and the broker.
Here’s the beauty of the deal: The client has paid a premium for the private funds, but only for a few months. This becomes part of the cost of construction; during that time, the client has added significant value to the project – usually beyond the actual price tag of receiving private funding. With a new or updated appraisal in hand, the A lender will finance based on a significantly higher ‘as complete value.’ The A lender likes this because security is now established and a higher credit is written.
Remember, the covenants are also strong. The client likes this, as it will often allow him to recover a good portion of the original equity in the project at a higher take-out amount, positioning him to tackle his next deal.
The private lender is paid out, and the broker has been paid a nice fee by the private lender, and often the A lender as well. But for the broker, there’s an additional upside: a client who needs financing regularly, not once every three to five years. To make this scenario work, it is critical to pay attention to this client and build trust and loyalty in the relationship.
Even convincing just one or two clients of the value of this classic lending strategy can give rise to an ongoing source of income. What’s not to like about that?
David Dexter has a background in real estate, insurance and investment, and is currently president and CEO and an equity partner in Atlantic Signature Mortgage & Loan, a private lender based in Halifax.