So about 2 months ago I joined a group that does about $1 to 1.5 billion per year in commercial and commercial real estate loans. Our entire production and underwriting group is comprised of about 25 people. I’ve looked at a few dozen deals now that have made their way to my desk after extensive review and negotiation with upper management. While this is probably not universal (it’s not even necessarily universal at my organization), there is a pattern I’ve begun to recognize.
A lot of guys who have become mega millionaires in real estate have done the following: they start out small and they work closely with a handful of local or regional financial institutions for their depository and borrowing needs. They rarely over leverage and they act responsibly. These borrowers also tend to involve their children in the projects and get their children hooked into the institution’s relationships. Over 20-30 years with these same institutions doing deal after deal these FAMILIES can do practically anything they want at much higher leverage. I’ve seen guys with 650 credit scores get $10 million loans at 80% LTV on spec retail construction. On Friday, we extended a $2 million unsecured line of credit to small spec real estate developer with 660 credit and $300,000 in total cash and maybe $700,000 in net worth. Why do we do this? I’m still in the process of learning why, but it seems that their past performance with the institution is their credit. I came from institutions that securitize most of their debt and therefore are radically committed to extensive documentation and personal credit documentation, so I was blown away by how little paper verification we require and how liberal we are with our funds to these clients. But since we don’t securitize we can do whatever we want.
I was extremely skeptical about this type of lending until I learned that our default rate is 1.13% compared to 1.25% among our peers. Not sure what the number is, but I’d guess default loss is close to 0.1%. Turns out that lending based on relationships is actually a pretty amazing way to lend. Turns out that basically ignoring traditional credit metrics and using past performance as one’s credit is remarkably accurate.
The point in all of this is, apparently the way many people are getting rich is by developing deep and long lasting family relationships with a small handful of financial institutions and always, always, always making sure to make good on their debts. Over the decades they build up a phenomenal reputation inside and outside the bank, build a lot of real estate equity and then they become kings of the castle–they come to those institutions to get practically anything they want to turn themselves from simply rich to extremely rich at little risk to the lender. I had a $3 million deal come to my desk last week. After underwriting the entire deal, we asked the guy for verification of liquid assets. The borrower told us to pound sand. Management has said it will sign off on the deal next Thursday. It’s pretty remarkable