Commercial real estate land loans are among the hardest deals to finance. Banks and many alternative lenders typically won’t do them. For mortgage brokers trying to finance a land purchase or a project on raw land, it may sometimes feel like you are jumping out of a plane without a safe spot to touch down, but it is possible to make a soft landing.
Direct private lenders are often viewed as a commercial mortgage broker’s last resort, but they offer the speed and flexibility needed to get raw-land projects moving forward. You should consider these lenders first.
Imagine you are looking to finance a promising, in-demand, revenue-generating commercial property on raw land. All the important paperwork checks out. The title is clean. The environmental report finds no irregularities. You have a thorough and up-to-date appraisal in hand.
Before a shovel can go into the ground, though, you’ll need to secure the necessary funds for your investor client to make the purchase. Chances are, you’ll first call a bank with all the needed paperwork at your fingertips, only to learn the bank will automatically turn you down because its policy is to categorically reject land loans. An alternative lender might also say “no” for the same reason.
These rejections are common. Borrowers often struggle to find a reputable lender willing to fund a land loan. That’s because traditional and alternative lenders are risk averse. Although your borrower may have impressive vision, impeccable credentials and the right plan to make the venture work, too many factors can go wrong on the road to get there. Anything from legal issues and permitting, to municipal zoning changes, to something as uncontrollable as the weather can throw off the construction timeline. This increases the lender’s risk.
Wary of risk
Some lending concerns stem from how difficult it can be to judge what the land is worth. Many methods used for calculating value are either skewed or don’t apply when evaluating raw land. Using an income approach doesn’t work because the land is not likely generating any income, unless it’s farmland or is used for hunting.
A cost approach is based on the value of the land combined with the cost of constructing an equivalent building on the land. This also doesn’t apply because there is no existing structure. And a sales-comparison approach only works if there are enough comparable properties in the area. This can lead to erroneous or inaccurate appraisals, and working with an inaccurate appraisal could sink the entire deal.
Many lenders also are concerned about land entitlements that could change a project’s direction or derail it altogether. Land entitlements determine the type of structure that can be built on that site, which influences the value of the land.
The reality is that what can be done with a tract of raw land is at the mercy of the local zoning board — a factor that’s not always in the borrower’s control. Not only can the approval process take months and have unpredictable outcomes, but borrowers also need to satisfy the needs of utilities, landscaping, traffic safety and several other municipal regulations. With so many cooks in the kitchen, even many alternative lenders are understandably hesitant to dive in, even when a borrower has approvals in hand.
Traditional and alternative lenders are concerned about the future value of the project. What sort of revenue will the project generate once construction is complete? What sort of value will it add to the community? Most importantly, will the project be successful enough for the borrower to pay back the loan? Unfortunately, lenders have few assurances that the plan for the land will come to fruition as detailed on the application. One missed permit or one change of heart, and the entire plan can fall apart, leaving the lender potentially holding the paper on a defaulted loan and a difficult-to-offload tract of land as collateral.
Private lender flexibility
Although lenders of all sizes and types are generally unwilling to lend on land, you do have some options. Direct private lenders will do these loans under two circumstances: To fund an outright land purchase or as a bridge loan.
Terms will vary, but direct lenders typically lend up to 60% loan to value on a land-purchase deal. This means, for example, the typical direct lender would provide up to $300,000 to purchase raw land with an appraised value of $500,000. Direct private lenders, however, typically have the flexibility to make exemptions to this loan-to-value ratio. Some lenders will fund the full purchase price of the property if the circumstances are right.
Numerous private lenders also do bridge loans, which tend to be shorter- term loans used to jump-start a project while the borrower is securing longer- term financing from a bank or other traditional source. A bridge loan also can indirectly help a borrower obtain permanent financing. The traditional lender will gain confidence when a bridge loan is in place, knowing that another institution believes that the project is worth funding. This makes bridge loans an attractive option for borrowers who need money quickly and who may need more capital at later points in the project.
No matter how a borrower plans to use the proceeds, a direct private lender is still the best bet to fund a land loan. They are more willing to take on risk and are more likely to spot opportunity in a land deal when traditional lenders shy away. Direct private lenders typically don’t have rigid guidelines, and can look at an entire project and examine its merits. This flexibility means that direct private lenders can share in and support a borrower’s vision for the raw land.
Most importantly, direct private lenders can act fast. Borrowers need to move quickly to capitalize on an opportunity. Even if a traditional or alternative lending institution is willing to fund a loan for a land purchase, they typically take months to approve a loan. The borrower could miss their chance altogether. Direct private lenders have significantly less red tape to navigate, which usually means that borrowers will get an answer in a fraction of the time. Once approved, the typical direct private lender can usually close on a loan within days.
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Many commercial mortgage brokers assume that direct private lending is a last resort, but when it comes to land loans and other atypical applications, these institutions should be your first stop. Direct private lenders have the freedom and the flexibility to examine an opportunity from all angles, taking all factors into account that traditional lenders do not consider. A direct private lender is not just a backup source of funding, but a true partner who will understand and support your vision from day one.
