Biggest lessons learned from making 1,800 real estate loans over 17 years (Part 1)
For those of us who specialize in one particular area over a long period of time, certain patterns emerge. I began making loans to real estate investors and developers 18 years ago and it was a turning point for me and my career. At the age of 41, I found the one thing that I really enjoyed and was good at. I'm very happy with the results of the more than 1,800 loans I have originated — and I hope to be able to originate another 1,800 or more in the years ahead!
And yet, there were some loans that did not go well. We learn the most important lessons from life's setbacks and mistakes. My goal now is to share what I have learned, and what red flags I missed or ignored when I made my worst lending investment decisions. I'm sharing part one of a two-part series on the lessons I learned in real estate loans. I hope you find this valuable.
Lessons Learned: Things To Do
If it's working, keep doing it. Finding a niche where one can generate good results is precious. While something better may be out there, don't overlook the low-hanging fruit right in front of you. In our case, the key to building a sizable business was just to keep doing more loans, and making sure our borrowers and investors were happy. The loan sizes and capital available to us grew naturally over time.
The corollary to this lesson, according to Will Rogers (for when something is not working): "When you find yourself in a hole, stop digging."
Private credit remains in demand. Ever since the Great Financial Crisis (GFC) of 2007-2008, the number of banks has been shrinking and the average size of the remaining banks has gotten bigger. Large parts of the economy that previously relied on banks and other highly regulated lenders for financing are now part of the non-bank economy. This is particularly true of loans that require skill to evaluate, originate and service.
Make sure your strategy aligns well with you and your whole life. I wanted a lower-risk strategy that would allow me to invest in the greater Los Angeles area, in part because I didn't enjoy extensive and regular long-distance travel for work. I also found that lending suited my strengths, while freeing me up from having to perform tasks where I had less skill, such as designing and developing real estate.
Repeat & direct relationships are the best. Mortgage brokers play an important role in the real estate investment and development world. On larger projects and developments, it is common for the owner to hire a broker to solicit proposals from many lenders to try to get the best pricing and terms. In our market, many borrowers work directly with one lender again and again, without using a mortgage broker. In our experience, we had a higher incidence of foreclosures and difficult borrowers among the loans that came in through mortgage brokers, vs. the loans that we sourced directly or through mutual professional contacts who made introductions without acting as a paid mortgage broker. More than half of our loans were to repeat borrowers, which reduces the risk of unexpected borrower behavior a great deal. Loans with mortgage brokers will usually be to borrowers who are new to the lender. It is worth asking the question, "Is there something difficult about this borrower that another lender knows, but I don't know yet?"
Margin of safety is your best friend. The biggest insurance against losing money or having foreclosures is to make sure the value of the property is significantly higher than the loan amount at all phases of the project. The margin of safety is measured by two ratios, the loan-to-cost (LTC) and the loan-to-value (LTV). This topic has a lot more detail, but suffice to say, a lower LTC and LTV will ensure that the borrower is highly incentivized to perform on the loan, because they would lose a lot of equity if they didn't.
In the next article, I will focus on things I learned to avoid as a lender, in hopes that our readers can side-step some of the mistakes we made over the past 17 years. Please subscribe to this newsletter if you’d like to be notified when the next article is published, and future articles related to investing in private credit.
