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ISCOVER
We don’t know about how you feel, but we get a little bored of newsletters with examples of successful applications for loans in the non-bank space. Given the number of absolute dollies that come back to us time and again, we wonder if these shining examples of success contribute to understanding of what a good loan looks like.
So, we thought we’d turn things upside down and take a somewhat tongue-in-cheek look at applications we declined:
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Caravan park with DA
- $250,000 second mortgage over a property with a DA to convert a rural caravan park to an eco-lodge.
- Valuation: as-is value at $4 million, as-if-complete in excess of $10 million.
- First mortgage of $1.5 million.
Sound okay to you? Well the first questions we asked were:
- How long has the client owned the property and what did they pay for it?
- What is the build cost, is there a feasibility and business plan and what is the GRV (gross realisation value)?
- Do the applicants have experience in development and/or operating an eco-lodge?
- What are they using the money for?
- What is the exit?
The answers were telling:
- Bought 18 months ago and the clients paid $2.5 million.
- Don’t know.
- No, but they will get a fixed-price development contract.
- To pay for a full application to an offshore funder.
- Refinance by the offshore funder.
So if you’ve been around the traps, you’ll say “I’d like a dollar for every time I’ve heard about offshore funds coming to finance a local project”. That’s what we said! There are a number of other tell-tale problems here such as the fact that the loan sum by the bank is exactly 60 per cent of the original sale price, which indicates that the as-is value is probably no more than the price they paid plus a margin for the DA, but not much more. And then there was the value – the less said the better, but in this case the methodology was flawed. It wouldn’t take a genius to work out that the property did not have a current value of $4 million nor a future value of $10 million. But perhaps the most damning feedback came when we asked for a breakdown of the loan sum. It was to cover the broker’s commission to submit the proposal to their offshore lender (plus interest and fees of course). Enough said!
Overvalued asset
- Rural property with a specific use valued at $1,500,000.
- Seeking first mortgage of $1 million to settle out a business partner and conclude renovations to secure a lease to a non-profit organisation on a five-plus five-year basis.
- Existing first mortgage to big four bank of $375,000.
On the face of it, this makes sense, particularly given the lease agreement showing a rental income of $120,000 per annum. But herein lies the trigger for the ‘sniffometer’ because the rental on the proposed lease was exactly eight per cent of the supposed valuation – a valuer’s standard upper-end calculation for valuing a property on a multiple of rental yield. So we asked:
- How long has the client owned the property and what did they pay for it?
- Is the lease to be signed prior to refinance and is it at arm's length?
- Is their existing loan up to date, and if so, why will their bank not help?
- Why does the partner want out of the property when it is about to be leased at an attractive rate of return?
- What is the exit?
Meanwhile, we put out an offer letter subject to valuation, with no fees upfront apart from the valuation fee of course. They paid for the valuation and we were advised that the applicant was notorious for pumping up values based on rental returns. Good to know.
The answers were as follows:
- Five years, paid $1,000,000.
- No, but it is arm's length and there is genuine interest.
- Yes, but they don’t like their bank and want to move but don’t have time to arrange finance.
- Because they have other opportunities and want their money out.
- Sale of the property with the lease in place.
So we started due diligence while we awaited the property valuation and found that the site had been acquired two years previous (fair enough), but for $625,000 and not $1 million. Wait a minute! That means their existing loan is 60 per cent of the original purchase price. So either they bought well (another euphemism for “I’m being less than truthful about the value”) or they’re overestimating the value and their bank agreed. The valuation came back as $640,000 with advice that, even with consideration for the lease at $120,000 per annum, they would struggle to increase the value by much. We were asked to reconsider the value in light of the unsigned lease, but we thoughtfully declined.
There’s no rocket science to lending, and we find that Occam’s razor can very much be relied upon. It is a very useful principle.
