Robert Amter – Colorado Real Estate Journal – September 2014

There are two basic types of land loans: land acquisition loans and land refinance loans. Land acquisition loans are sometimes available from banks under specific circumstances. Land refinance loans, particularly if the owner wants to cash out, are much more difficult.

The typical borrower needing a land acquisition loan is a developer that would like to take title to the land prior to finishing their full presentation to a bank or life company to apply for a construction loan. There are three options for this type of loan.

The best option is an owner-carry loan, in which the seller is willing to carry back all or part of the purchase price for a relatively short time. This is the simplest and least expensive way to get the time needed to complete the construction loan request.

As a second option, some banks are willing to consider funding a relatively low loan-to-value land acquisition loan. These are normally limited to their best customers and will require personal guarantees from parties with significant, liquid net worth. Federal regulators are not enthusiastic about banks funding land loans though and, therefore, are quick to classify these loans as high risk at the slightest hint of trouble.

For the purchaser of land who is not able to convince the seller (or perhaps multiple sellers) to carry back an owner-carry loan and who is not able to provide a high-net-worth guarantor that meets bank requirements, the remaining option is to work with a private capital lender. Private money lenders are not subject to Federal regulations and lend their own funds or funds obtained from investors. Many private capital lenders are also reluctant to fund land loans, because of the lack of marketability of land when the commercial real estate market takes a nosedive. However, private lenders will typically consider each land acquisition loan request on a case-by-case basis and are potentially the easiest source of this type of loan. Although the interest rate charged by private capital lenders is always higher than banks, these lenders can close quickly and are more flexible in their requirements. This type of land acquisition loan is called a bridge loan because it is in place for a relatively short time—between 6 and 12 months—and normally will be paid off by the construction lender. A developer must balance their ability to take down and control the land versus paying higher, but short-term, interest rates.

The ability for a land owner who has an existing land loan that is maturing to find a lender to refinance their loan is even more limited. If they have a bank loan, the Federal regulators frown upon renewals. If the bank is willing to consider the renewal at all, it is probable that they will change their terms from an interest-only loan to a loan with a rapid amortization, which results in high monthly payments. Private capital lenders, who are not subject to Federal regulations, are more likely to provide the funds to refinance these loans. Since private lenders weight their underwriting more heavily towards creating a conservative loan-to-value ratio and less on the cash flow or credit of their borrowers, those owners who have significant equity in their land have a good chance of finding a source to refinance their loan. If their property has appreciated in value since their land loan was put in place, a private capital lender may be willing to consider not only refinancing the loan but also increasing the amount of the new loan to allow the owner/borrower to get cash out to use for any purpose they choose. Finding a bank that will refinance a loan and allow cash out as well is quite unusual.

One problem a borrower seeking a land loan must address up front is to create a credible explanation for their lender (regardless of whether the lender is traditional or private) as to where the funds to make the monthly loan payments are going to come from. Land obviously does not normally produce income. Unless the borrower is a large and substantive development company, most lenders will be uneasy about the source of funds for monthly payments. One way to deal with this concern is for the lender to reserve sufficient funds from the loan principal to cover all or part of the monthly interest during the term of the loan. Both banks and private capital lenders are able to do this. Banks are required to place more emphasis on their borrower’s cash flow than private lenders, and for this reason using a private capital bridge lender may prove to be the more realistic option. In either case, there must be a great deal of equity in the land for this solution to the monthly loan payment to work.