9 Tips About Financing Land Acquisition Loans
9 Tips About Financing Land Acquisition Loans
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Land acquisition loans are designed to assist borrowers in purchasing land. Unlike regular mortgage loans which are used for buying developed properties, land acquisition loans are specifically for buying undeveloped land. These loans are generally considered riskier by lenders, as undeveloped land can be harder to sell and do not provide immediate income.
For this reason land acquisition loans may require slightly higher interest rates compared to traditional mortgages. The terms of these loans, including the loan-to-value ratio, interest rate, and repayment terms, may vary significantly based on the location, intended use of the land, and the borrower’s creditworthiness. Typically, borrowers must demonstrate a clear plan for the piece of land to increase the likelihood of loan approval.
Fewer hard money lenders are willing to underwrite land acquisition loans.Below, we have listed nine tips that will make it easier for borrowers to acquire financing to purchase a plot of land for development purposes:
1. Choose land with entitlements
Land entitlement is the necessary process of gaining all the required approvals before land can be developed. Pre-entitlement deals are so unpredictable and risky that private lenders are rarely willing to finance them, though some may consider them on a case-by-case basis. Typically, your land deal will have a much greater chance of being approved if the land is already entitled (in addition to getting better terms and higher leverage).
2. Provide documentary support of the property’s value
Some financial institutions require full appraisals when buying land. Other private lenders work by consulting with experienced real estate brokers to obtain a Broker’s Opinion of Value (BOV). If the purchaser/prospective borrower has a copy of an existing appraisal it would be helpful to the lender even if it is out of date. It will contain the basic facts about the property which shortens the time for the lender to get an updated value. Most private lenders like to see valuations derived from the comparable sales method of research.
Borrowers should be aware that lenders are typically likely to use as-is market values rather than proposed or future market values. The more information you can provide to your lender that supports what you believe the land’s value to be, the less potential for disagreement during this crucial part of the negotiations.
3. Be prepared to contribute equity
Private money bridge lenders typically require borrowers to invest significant funds of their own for the purchase of the subject property. Some lenders may accept third-party investor equity or mezzanine financing but, regardless, borrowers should not expect a loan-to-value (LTV) of more than 50 to 55 percent on a land acquisition loan and should be prepared to make their own contribution to the purchase. The down payment amount is a critical factor for most hard money lenders in their underwriting of a land acquisition loan.
4. Don’t expect an interest reserve
Land lenders may consider creating interest reserves out of their loan proceeds for borrowers to use to make part or all of their monthly loan payments. Lenders need to clearly understand how their borrower is going to make the monthly payments on their loan since undeveloped land is a non-income producing investment. This is critical part of land acquisition lending.
5. Showcase your experience
While private bridge lenders focus their underwriting process on the value of the collateral, they do look more favorably on borrowers who either have a proven track record developing land or have a partner or team with that kind of experience. While experience is not a guarantee that a deal will succeed, especially in the land development sector, private lenders show a decided preference to lend to borrowers who can demonstrate to them that they know what they’re doing and are capable of executing their plan and repaying the loan in full and on time.
6. Location matters
Land with a good geographic location has a greater chance of being approved if it is located in a prime location with substantial population, stable or increasing property values, and low unemployment rates. When considering land loan requests, lenders are likely to focus on local market conditions rather than overall national conditions. This is often the case even when the land is in a major market location because the raw land sector of the market is much more volatile than other commercial markets.
Geographic location can also play an important role in choosing a lender as many lenders will only lend within certain geographic areas. At Montegra, we will only underwrite land acquisition loans for land located in a major metropolitan region.
7. Plan a repayment strategy
Hard money lenders are short-term lenders, therefore having a credible exit strategy is a key part of getting your land loan request approved. While there used to be a number of exit strategies available to investors in raw land or unimproved land (e.g., sell to another investor at a higher price, refinance with another lender, etc.), now there are usually three main repayment strategies: sell it to a developer, build it out yourself or pay it off using funds from another source.
9. Have your loan application materials ready before you contact your lender
Private hard money bridge lenders strive to respond quickly to loan requests and applications; therefore, you should be prepared with all necessary documentation and a summary of the deal and your plans for it. Your summary should do the following:
- Explain the deal
- Specify the loan request
- Detail how the funds will be used
- Provide support for the valuation of the property
- Supply information about the borrower
- Include a location map
- Mention the status of entitlements and zoning
- and summarize the repayment strategy.
Providing all of this documentation immediately to your lending team will allow for the most efficient loan process.
Montegra is one of the few Colorado hard money lenders willing to consider underwriting land acquisition loans. Contact Bob or Kim to find out more about our land acquisition loan program or apply online today.