Private lending offers the promise of a great return on your funds – as well as the chance to learn about property development. However, private loans can be risky. This is particularly so when a construction lender has first mortgage security and you are lending money to a property developer.

In this article, we will explore the due diligence process in some detail. We will examine further elements of private lending in future articles

Due Diligence

There are many things that can go wrong with a property development. As a lender, you want to carefully review the proposed project to try to ensure that as many as possible have been adressed. Below is a list of some key issues – but there will be others in any situation:

  • Valuations – you should ensure that the land is valued “as-is” and “as-if complete” by an independent valuer. The cost of valuations should be paid by the borrower.
  • Budget – you should get and review the project budget. Key items, such as building costs and selling prices should be independently reviewed to make sure they are reasonable. Ensure that the budget includes a provision for contingencies. Property development is complex and unexpected delays and expenses are almost inevitable. Does the borrower have access to sufficient funds to complete the project?
  • Building Contract – is there a fixed price building contract? Is the builder experienced with this type of development?
  • Pre-Sales – are any of the developed lots pre-sold. This can reduce risk and provide certainty about selling prices.
  • Permits – are the required permits / approvals in place. If not, are the permits sought reasonably obtainable? If the permits are in place – what date do they expire?
  • Other Loans – Will the borrower be taking out other loans? If so, you need to ensure that these loans will ranking in priority (i.e. be repaid) after your loan. Has the construction finance been approved?
  • Documentation – You need to ensure that a properly prepared loan agreement is prepared and signed. If you are getting security – you need to ensure that the required paperwork is signed and the security is registered. Signing a loan agreement prepared by the borrower is rarely a good idea. The legal fees for the documentation should be paid by the borrower.
  • Security – What security are you getting? What percentage of the property value (LVR) are you lending to? You need to confirm that the borrower owns the property – or will own the property if you advance funds at settlement. This should include a personal guarantee from the directors of the borrower.
  • Credit History – You need to review the credit history of the borrower – and it’s directors.
  • Past Projects – Ask for details of similar projects that the borrower has completed in recent times. Ask to speak to investors in those projects and purchasers to satisfy yourself that the borrower has the ability to complete the proposed project.
  • Risk – Do you understand the level of risk in the proposed loan? What is the worst case scenario? (if the project stalls while the development is incomplete the value of the development is usually less than the funds expended). Are you comfortable with this level of risk?

The above is only a starting point. Other items will arise that are specific to the project you are looking at – or may be suggested by your initial inquiries. If the above sounds like a lot of work it is! However, this is necessary to maximise your chances of a trouble free investment.

Let’s be clear – reading the glossy brochure of someone recommended by a friend is barely scratching the surface of a proper due diligence.

Lewis O’Brien has extensive experience over 20 years with private loans – as an investor, advisor and as a member of the credit committee of a private mortgage fund.

Before you commit to a private loan CLICK HERE to arrange a time to discuss it with an expert in the field. Lewis’ expertise up front could save you thousands!