This article was posted on Thursday, Jun 01, 2017

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Continued from Part 19:  It turned out that the zoning in most, but not all, of the area accommodated two or three units per 5,000 sq. ft. lot. He explained to her that while the zoning affected a general area, each lot had a specific “use code” revealing what was approved for that individual lot. For example, a Use Code of 100 might mean a SFR but Use Code 101 would indicate a SFR with a permitted pool. If Emily bought a lot with a SFR on it, she could apply to change the use code. She would need to do it while her plans were checked and permits issued. Emily hadn’t known any of that, but mentally filed the information away for the future.

She didn’t want to drive here again and wait in line if she didn’t have to. She asked, “Is there a way to call you if a question comes up later?” He immediately gave her his card with his name, position, and office phone number on the front. He wrote his private cell number on the back. Emily caught a look from him and wondered if maybe he was interested in her. She glanced at his left hand. No ring, not even a white circle. 

It had been ages since anybody had noticed her in that way and she became a little unsettled. She recognized the mating dance and was flustered because she knew she was rusty. It was totally unexpected and she didn’t want to blow it. Every girl needs to be loved by someone. Whether she loved him in return was nice, but her mother never thought it entirely necessary. As she took the elevator back to the first floor she started to name their future children.

Maybe she’d get her hair done early this month.

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Construction Loan                                        

Emily was satisfied there was at least the possibility that she really could do this. Of course, she’d have to find a willing seller of a suitable lot. She knew that. But improved properties (improved: meaning there’s already a house on it) come on the market all the time. And now she was confident that the City would allow a second house on the lot as long as their zoning and land use restrictions were honored. She was pleased. If she could put the pieces together, it would eventually happen for her.

The next concern was financing. Just as she didn’t expect the City to formally approve the new construction until she had the lot and the plans, Emily didn’t expect a lender to approve a loan until she had City approval. Her hope was that she could get some unofficial assurance that financing would be available if this project got to that point.

Emily called her mortgage broker. By this time she knew the number by heart. It turned out that there were several lenders offering construction loans, but interest rates, costs, and terms were all a little different. Construction financing was a niche business and lenders tended to answer specific needs. There was a lender for “this” need and another for “that” need. Certain lenders did only seven-figure projects; others would finance a bathroom remodel. At some lenders a borrower needed a lengthy resume just to get buzzed into the waiting room, but other lenders had been known to rely mostly on the resume of the contractor and favorable feasibility comments from the appraiser.

At least one institutional lender would fund rehab projects up to 85% of the purchase price and 90% of rehab costs. The lender required stringent borrower qualification because it was assuming greater perceived risks. On the face of it this was an attractive offering, but few people qualified.

From the viewpoint of a typical institutional construction lender, Emily didn’t have much to offer. She’d never developed from the ground up before, so she had no appropriate resume. With most (but not all) institutional lenders, that was a biggie. On the other hand, she had money in the bank from the sale of that day care center to Shortsy Cake, and the cash flows from her fourplex, each (now) with three bedrooms. She had an appropriate down payment, the necessary reserves, and perhaps a bit more. And her contractor Hiram Abiff, had a long and sound resume, so that was a help.

Overall, she had a history of making properties more valuable. She had good (over 700) credit. She had money in the bank. She had a small team (mortgage broker, contractor) on her side. Maybe one of the big institutional lenders wouldn’t look at her, but a private money lender might love to work with her.

The talk with her mortgage broker was lengthy. They went over the likely alternatives, discussed the positives and negatives, and decided on a two level financing scenario. The first level would involve a government insured first mortgage, with an amount built in for renovating the original home. She would have a low interest, 30 year amortized loan that would cover the original purchase price and likely rehab costs to the existing house. Once that was done, her loan broker would get her a private money loan to build the house at the rear. The fact that she could show 30% down on the original purchase price would prove to the private-money guy that she had equity in the project. He would like that.

The private money loan would be secured by a second TD on the entire parcel. As long as Emily had sufficient equity, non-institutional money could be found. It would be at a higher interest rate and more points than her conventional 1st TD, and for a shorter term, but it would make her plan possible.

She had to ask her mortgage broker to review what “points” were.  Points, she was told, was a term used in different ways when talking about mortgages. The appropriate definition is understood in context.

For example, sometimes a person will hear the phrase, “Prime plus 3 points”.  In the context of an adjustable rate loan (ARM), that means that the interest rate on the loan will be the index (in this case noted as the prime rate) plus a 3% margin. If the index (the prime rate) was 2.5%, “prime plus 3 points” would indicate a 5.5% interest rate on the proposed mortgage.

Sometimes the bank quotes an up-front origination fee for the mortgage. This happens occasionally in conventional lending, but is almost universal in private money. A hard-money lender may quote an interest rate of “Nine percent plus 6 points”.  That means that the lender requires an up-front origination fee of six percent and the annual interest rate will be 9%. While both the points and the rate are higher than conventional bank quotes, it’s important not to confuse the niches. Private lenders will do loans that banks won’t look at. That’s probably a good way to look at hard-money lenders: they make a deal possible.


By this time Emily was confident she could meet the City’s requirements when she added a second house at the rear of an already improved lot. And she was comfortable that the necessary financing would be available in the marketplace when she got to that point. The next hurdle was to estimate her maximum budget.

The developer’s – and that’s what Emily was becoming – maximum loan is capped at whatever mortgage the Net Operating Income is projected to support.  Emily would have to pay for all other costs out of her reserves.

Experienced developers might have even tighter collars. They might say their construction budget was (a) the biggest loan they could get on the finished property minus (b) whatever cash they’d kicked in. In other words, an experienced developer would want to be able to refinance the property at the end of the construction period and pull out his entire financial contribution to the project. At the end he’d wind up owning the project with no direct investment from his own pocket.

Emily was not yet that confident. Her goal was simply to wind up with a nice little project that would pay for itself and kick out a little cash flow every month. But it would be extra nice if she could refinance it at the end and pull out at least some of her investment.


The reasonableness of Emily’s goal was dependent on the neighborhood rents. Theoretically, the material and labor (but not the city fees and surcharges that always pop up) necessary to complete a property costs the same whether the property is in Neighborhood A or Neighborhood B. So why would a developer select one location over the other? Because one area has higher forecast rents, and that means a bigger loan and that means greater developer profit. So Emily’s immediate objective was to estimate her future rents. To do this she had to find “comparable” rental properties.

Just any sale is not a “comparable”. A comparable is a sale that is enough similar to the subject property that a typical buyer would consider both the subject and the comparable to be “equally desirable substitutes”, one for the other, at a given price.

Some of the things affecting comparability that Emily considered were (a) location; (b) size, and (c) number of bedrooms.

Size was simple – all comps should be plus or minus 20% of the subject. If the subject was 1,500 sq. ft., then the comps would be from 1,200 sq. ft. to 1,800 sq. ft. There should be comps both below and above the subject’s 1,500 sq. ft. Comps should bracket the subject.

Bedrooms were simple as well: match ‘em up. If the subject was expected to have three bedrooms, then “an equally desirable substitute” would naturally have three.

Size is important; bedrooms are more important. But the most important item of comparability is probably Location.

Location:  No site is an exact duplicate of another. One might be closer to the bakery but farther from the beauty salon, or vice versa. What Emily was looking for were the borders within which most of the residential sites had reasonable access to the same (or similar) neighborhood amenities. A rough guide to estimating comparable locations was to realize neighborhoods are almost always defined by their surrounding major streets. That’s the process Emily started with: the area was identified by the major streets surrounding it. Then she printed out a map and highlighted the streets in an ugly fluorescent yellow. Voila, a neighborhood!

Two days later was Saturday, and it was time for a field trip. Emily got in her car and drove the area within the fluorescent border. She was looking for amenities, for the reasons people might want to live in that area. Were there neighborhood commercial blocks with the stores and services people needed on a regular basis? You know, things like grocery and drug stores, dry cleaners, gasoline stations, maybe hair or manicure salons. Was there a karate studio with “Little Dragon” classes for seven-year olds? Were the local properties reasonably well maintained, especially the landscaping? Was it a place Emily would want to live?

She wrote down the call-back numbers on the handful of For Rent signs she saw. Then she pulled into a Trader Joe’s and stood in the longest line she could find, holding a small plastic jar of peanut butter cups. Lots of good conversations start over peanut butter cups. All you have to do is to turn around, show the label to the woman behind you and ask, “Have you tried these?” That almost always gets the ball rolling. If it doesn’t, just give her a cold look so she knows you are nobody to trifle with, then go to another line and try again. Your goal is to first start a conversation of any sort then to move it towards finding out why her family moved to the area and how long she’s been there. Do this a dozen times and you’ll get a pretty good idea what the neighborhood attractions are. You don’t even have to buy 12 containers of peanut butter cups. Just put the jar down before you get to the cash register and go outside. Check your social media for a few minutes or so and go back in. If your peanut butter cups are still by the dark chocolate you can just snag them as you pass and again go to the back of the longest line: “Have you tried these?” A lot of these sorties can be done in a short time. The whole thing will take an hour or two, max.

Emily discovered that within her yellow borders were three elementary schools. They drew from different residential areas. The school rating guides ranked one school poorly and the other two schools much better. As you would expect, young families were eager to get their children into the better schools.

Emily believed that being serviced by a highly ranked public school would be something her tenants might be willing to pay for. She did a little research and then used another highlighter to run a pink border around the areas serviced by the two better schools.

Sure, Emily learned that people liked the local Saturday Farmer’s Market, but the biggest neighborhood draw was definitely the school system. Right then, she knew that (a) she must develop a property in one of the two higher rated schools, and (b) all of her comparables had to come from those school systems.

Now that Emily had almost a local’s grasp of the area and knew where she wanted to develop, it was simple enough to get MLS comps of recently (within the six months or so) sold two to 4 unit properties that were comparable to the property she hoped to develop. Those MLS comps gave her data on both (a) income and (b) market value. Both were important because Emily knew that a lender would consider both items when the time came to finance / refinance the property.


This article is for informational purposes only and is not intended as professional advice. For specific circumstances, please contact an appropriately licensed professional. Klarise Yahya is a Commercial Mortgage Broker,  BRE: 00957107 –  MLO: 249261. If you are thinking of refinancing or purchasing real estate, Klarise Yahya can probably help. Find out how much loan the building will support. For a complimentary mortgage analysis, please call her at (818) 414-7830 or email [email protected].