Marketplace lending has created incredible new opportunities for private investors, but if you’re new to investing in real estate loans or crowdfunding in general, then you might need a primer on how to evaluate real estate loans. Here is a short checklist of criteria lenders use to evaluate whether a borrower is a solid risk for a requested loan and what investors need to know before you invest.
When it comes to real estate crowdfunding, every platform has its own criteria, so be sure to evaluate any platform’s lending and underwriting criteria before you invest. In general, however, most platforms focus on the following lending criteria:
- Property valuation – It’s essential to understand how a property is valued, especially with regard to a requested loan amount. This typically requires a property appraisal and could include comparables to other properties recently sold within the same geographical area. Banks and private lenders will review a subject property’s loan-to-value ratio (LTV) as an indication of the risk a particular loan presents to the lender.
- Business plan – Another criteria lenders use to judge whether a loan is a good investment is the borrower’s business plan. If it’s a rental property, lenders want to know the ongoing maintenance costs, how much rent is collected by each tenant, the number of units vacant for rent. On a rehabilitation project, the estimated cost of repairs is necessary. Also, how long will the property sit before it goes back on the market? On ground-up developments, all capital expenditures are evaluated, which include payroll expenses, equipment, cost of materials, licensing, regulatory expenses, and more.
- Borrower – A very important part of any loan evaluation is the character and experience of the borrower. Does the borrower have a good credit score? What other debt does the borrower have and will he or she be able to pay off the requested loan? What kind of real estate experience does the borrower have? More specifically, do they have experience in the kind of real estate deal for which they are requesting a loan? What is their track record? An investor with 10 failed deals is a much bigger risk than an investor with two successful deals and no failures.
The Importance of Underwriting in Real Estate Lending
Underwriting is one of the most important aspects of real estate lending. The underwriting and credit risk evaluation process determines so much in whether or not a loan is a successful investment. That’s why private investors interested in investing in a real estate deal should know they can trust the platform’s underwriting procedures. Sharestates uses a 34-point underwriting process that assesses the property as well as the borrower.
With regard to the property, the LTV ratio is one of the most important criteria. Different lenders have different expectations. Generally speaking, the lower the LTV, the less risky the investment. A 50% LTV is better than an 80% LTV, indicating that the borrower has a lot of room for unexpected expenses between the amount they are borrowing and the expected sales price of the property. Lien position, property location, occupancy rate, and development phase are also important criteria.
Evaluating the borrower is also important. Sharestates places a premium on the borrower experience, especially with regard to the type of project being funded. If the borrower includes a personal guaranty and is willing to back their project with their own money, that would also reduce the risk involved for the lender.
To learn more about Sharestates’ many loan programs and underwriting criteria for different types of real estate projects, click here.