Clear red flags to be avoided in private market, suggests executive
Amid a flurry of recent turmoil in the private lending space linked to high-leverage lending and risky borrowing, a top mortgage professional has urged lenders and brokers to focus on understanding and managing risk appropriately – and not blindly chase a prized double-digit return.
Dalia Barsoum (pictured), president and principal broker at Streetwise Mortgages, told Canadian Mortgage Professional that instances of money lent on multiple properties at 100% loan to value (LTV) with promissory notes should be clear red flags in the private space, particularly where no feasible exit strategy for the borrower has been defined.
“That is a scary picture, regardless of how good the renovation operational model is because if a business is high in debt load with no clear or validated exit, it’s just a matter of time before things unfortunately go sideways,” she said.
Managing the extent of the leverage should be a critical consideration for lender, borrower, and broker alike, according to Barsoum – particularly when it comes to so-called “creative financing” where properties are purchased through private borrowing with nothing down or a vendor takeback.
“I’m not saying creative strategies are bad, but you’ve got to really be conscious of how much creative money you take,” she said. “That’s on the borrower side. Running a business or an investment portfolio, [we’ve] got to be very conscious about how much leverage we take and also validating the exit ahead of time before getting into private money.”
For investors, that means steering clear of purchasing multiple properties with zero down and the intention of eventually refinancing – an instance of having a plan, rather than an exit. “Creative financing is an option for anybody, but it’s about how much of it we should take and what the things are we should do to make sure we pay that money back,” Barsoum said.
Recognizing and measuring risk crucial in private market
Private money is essentially temporary, she emphasized, rather than money that sits on a property for decades – meaning from the other side of the deal, identifying that exit strategy is of paramount importance.
“It’s managing that risk and validating the exit,” Barsoum said. “Lenders have got to really understand the type of risk they’re taking, and not chase the double-digit returns.”
Warnings from recent high-profile bankruptcy cases are multifold, she said, including the need for lenders to ask clear and detailed questions about borrower risk and ability to repay loans.
“I’m not saying don’t trust – but validate, ask questions, understand the risk,” she said. “On both sides of the equation, there are lessons and our responsibility as brokers is to inform all parties of the risks involved and help them understand what’s the worst case. What are the risks – and what’s the exit beyond just the numbers?”
Daniel Vyner, principal broker at DV Capital, anticipates a conservative approach from Canada's private lenders in 2024 due to economic uncertainties. https://t.co/00SaDUVUwo#mortgageindustry #lender #alternativelending #economicoutlook
— Canadian Mortgage Professional Magazine (@CMPmagazine) February 8, 2024
What are a broker’s responsibilities in private transactions?
The broker also has a clear role to play, with a strong responsibility to represent the best interests of all parties involved and keep the scale balanced between both ends of a transaction.
That means making sure things are neither weighed in favour of the borrower, having the lender assume all the risk, or moving things in the other direction and burdening the borrower with a multitude of fees and hidden costs, according to Barsoum.
It’s also important not to simply accept appraisal reports solely from the borrower, and make sure reported values are being validated by a third-party appraiser.
“That’s a big one, because at the end of the day everything is secured by the value of the property,” Barsoum said. “Secondly, for brokers – I know in the private space paperwork is lighter generally, and that’s a selling feature of private money.
“But the broker has to gather enough information from the borrower to gauge the risk of the deal so that when they’re presenting things to the lender, they’re presenting them with [enough information] so they can make an informed decision.”
That measured approach – ensuring risk is appropriately balanced between all parties involved in the transaction – is one that will prove a win-win for lender and borrower, Barsoum said, and help avert the prospect of a deal becoming embroiled in disaster.
“I’m not a big fan of calling the lender and saying, ‘Hey, I’ve got a great deal for you – you’re going to make 12%,’” she said. “That is not a good process. While it may be, in the broker’s opinion, a great deal, brokers should present facts to the lenders as to why they may think this was suitable for that lender, supported by the third-party appraisal report.
“So collect enough documents to validate value, to validate exit, to confirm who’s behind the deal beyond the property itself so that the lenders are protected, so that the borrower is getting decent pricing, and the broker at the end of the day is doing the right thing for both parties involved.”
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