California’s construction industry is one of the strongest and most diverse in the world. However, it’s often misperceived. From the outside, it often seems as though construction companies and real estate developers have everything necessary to move from project to project, with businesses and consumers smoothly falling into line and purchasing developed properties. However, that smooth, seamless process is deceiving. The truth is that there is a great deal of turmoil involved, as well as uncertainty. Much of that stems from a lack of access to viable funding options designed for construction industry organizations, such as property developers, general contractors, and construction companies. Conventional lenders are risk averse. In the drive to hedge their bets, they leave a major portion of the industry underserved, and some parts unserved at all. There is a solution, though. Private money construction loans offer the flexibility and funding that real estate industry organizations require, as well as other benefits. They also provide investors with a solution to their wealth-building needs.
The Rationale Behind Funding Private Money Construction Loans
The North Star Capital Fund represents an innovative vision coupled with a deep understanding of the real estate industry, its numerous drivers, and the underlying purpose of the industry – to serve the needs of California’s residents and business owners. However, the fund does not offer direct-to-consumer loans. Instead, it targets proven individuals and companies already established, residential and/or commercial real estate developers, contractors, or investors.
This segment of the industry has been underserved historically, and by providing access to capital, the fund will spur growth and accelerate rebuilding, while simultaneously preserving principle, providing current income, and achieving consistent returns for investors and the fund managers.
The Benefits of Private Money Construction Loans
Conventional lending too often falls short when it comes to meeting the volume of demand and the specific needs of many in the real estate industry. Private money construction loans offer a viable, flexible, scalable alternative that does not suffer from the same drawbacks. Some of the benefits to borrowers include the following:
- Speed: Private money construction loans are usually originated much more quickly than conventional loans. This allows construction companies, developers, and other organizations to take advantage of industry cycles and complete projects more quickly. The knock-on effect is that these loans also benefit the industry as a whole, providing more work for construction workers, and ultimately resulting in a completed project in less time.
- Flexibility: Private money construction loans offer significantly more flexibility than conventional loans. Private lending is innately more risk-tolerant than banks and traditional lenders, and origination decisions are usually made on a case-by-case basis, rather than arbitrary underwriting criteria.
- Short-Term: Conventional loans can carry very long terms. Private money construction loans, on the other hand, are short-lived. The benefits here extend to the borrower, but also to the lender and, in the case of private money loans, to the investors that back the loan in the first place.
- Low LTV: Most private money construction loans offer a low loan-to-value ratio. This helps ensure security for investors, as loans are not only backed by real estate but often by additional assets. Risk mitigation is an important part of making an informed investment decision, and the more safeguards are in place, the more secure an investment will be.
The Strategy: Building Wealth and Offering Value
While the North Star Capital Fund is designed to spur growth and development/redevelopment, it also serves as an investment vehicle. The underlying strategy ensures that investors have the opportunity to build their wealth through careful, strategic participation in the origination of private money construction loans.
Understanding the Strategy
The fund’s objective is simple: to preserve principal, provide current income, and achieve consistent returns. Those goals are achieved by primarily focusing on short-term, private money construction loans secured by senior deeds of trust or mortgages, supported by a smaller percentage of secured junior-lien deeds of trust or mortgages and/or preferred equity investment, on residential and commercial real estate. The transaction structures will vary in terms of size and return.
Initially, the fund will operate only in California, and only with real estate-based assets. However, this vehicle is designed to offer flexibility and the opportunity to evolve and grow as the situation demands. In addition to the aforementioned senior and junior-lien deeds, the fund can also make use of non-real estate-based assets, as well as other real estate assets to be used as collateral. For instance, business equipment, high-value watercraft, manufacturing equipment – these are all potential collateral options to be used to secure loans the fund originates or invests in.
With that being said, the fund manager will primarily focus on specific types of loans. These will be secured loans and will be made on residential and commercial real estate. Loans will be made for the purpose of development, renovation, and new construction, and will be made to established companies offering those services (development, renovation, and construction) located within California and potentially in other states. Because of the flexibility within the fund’s structure and the vision of the managers, it may be possible to take advantage of opportunities outside the state of California in certain situations.
All private money construction loans are based on an in-depth analysis of the project, its impact, the value derived, and other factors. In addition, the fund will focus on issuing short-term loans closely tied to real estate cycles, rather than long-term loans. The average loan will be between six and 18 months in duration. By issuing multiple, short-term loans, the fund will generate a constant flow of income for investors and the fund managers, while still providing access to critical capital for borrowers. The short-term lending format also reduces risk to investors.
Investment Characteristics
While the fund will originate private money construction loans for a variety of different properties and project types, all investments will share similar characteristics. Identifying these characteristics within potential investments helps ensure that each opportunity offers stability, the opportunity to earn a return, carries a known, acceptable level of risk, and guaranteed recourse. These characteristics include the following:
- Collateral property will be primarily located in California
- Up to 75% loan to value (LTV) [based on the after repair value (ARV)]
- Up to 85% loan to cost (LTC)
- Full-recourse guarantees from a qualified guarantor
- Loan maturities will range from Six (6) months to eighteen (18) months and may occasionally have longer terms.
- Minimum loan amount is $150,000
- Prepayment penalties when applicable
- Contingency of 5% on new construction or 10% on renovation loans
- Value is determined via appraisal or BPO with adjustments approved by Investment Committee and/or Manager
- Construction draws are released only after a draw inspection is completed and reviewed by a construction management company approved by the Manager or Investment Committee
- Property protected by title policy and builder’s risk insurance
However, note that each individual investment may not share all of the characteristics listed above. Each situation will be evaluated based on its own merits and action will be taken where justified, so long as many of the preferred characteristics are present.
The Private Money Construction Loans Offered
Just as the North Star Capital Fund will focus on serving the needs of various types of borrowers, it will also originate a range of different loan types. These include the following:
- Acquisition: Acquisition loans are originated to purchase a specific asset, or for another reason listed within the loan documentation. In most cases, acquisition loans can only be used for the stated purpose within the agreement.
- Acquisition and Renovation: Acquisition and renovation loans are similar to acquisition loans, in that they are short in duration and can only be used for a specific, stated purpose, but they also provide for the need to renovate a property/asset, as well as for the purchase price.
- New Construction: New construction loans can be made for residential or commercial construction projects. They can also include only the structure, or land and the structure, depending on the needs of the borrower and the specifics of the purchase.
- Entitlement and Development: Entitlement and development loans are made for the purchase and legal entitlement of raw land and usually include all soft costs. Without entitlement, development on these projects cannot move forward, as it is essential for conveying legal rights from the local/state government to develop a property for a specific use.
- Refinance: Refinancing provides developers, construction companies, and others in the real estate industry the ability to borrow and pay off an existing loan, usually to move to a lower interest rate, or obtain better terms.
- Cash-Out: Cash-out loans provide more money than is owed on a property, allowing the borrower to tap into the additional cash and spend it on other needs, such as property improvements, paying down other debts, or handle other expenses.
Regardless of type, every situation is carefully analyzed to ensure it is a good fit for both the fund and the fund’s investors. Risk versus reward, duration, value versus cost, and numerous other factors are evaluated before a decision is made. The goal is always to provide needed capital and spur growth within the real estate industry, while simultaneously mitigating risk, and ensuring a consistent, measurable return for investors and the fund manager.
Immense Potential with the North Star Capital Fund
An investment in the North Star Capital Fund offers significant potential returns annually. However, all potential investors need to understand that an investment in the fund is inherently speculative. No specific return on invested capital, or even return of the invested capital, can be promised or guaranteed.
Member Returns
The fund’s goal is to provide each investor member with an annual return on their investment of 10% to 12%. However, returns are paid quarterly, not annually. The breakdown is subject to performance, but will follow this format:
- Each quarter, investor members will receive a preferred return of 8%.
- Each quarter, members will divide any excess distributable cash (EDC) with the fund manager on a 50/50 basis.
So long as the fund meets its objectives, the payout schedule discussed above is expected to be within the 10% to 12% range annually. Note that the preferred return discussed above is non-cumulative and quarterly shortfalls will not carry forward into subsequent quarters.
Who Can Back Private Money Construction Loans?
The North Star Capital Fund is designed to spur industry growth through the provision of private money construction loans while providing measurable, consistent returns to investors. However, not all investors will qualify to participate in the fund. The fund uses the definition of “eligible investors” as defined by the SEC for Accredited Investors. Those requirements include meeting one or more of the following:
- An annual income of at least $200,000 for an individual, or $300,000 for joint income for at least the previous two years, with the expectation of higher earnings in the current tax year
- A net worth exceeding $1 million, either singly or jointly with their spouse
- Act as the general partner, director, or executive officer of the issuing company
- A private business development company or organization with over $5 million in assets
- Knowledgeable employees of an investment fund
Individuals or organizations failing to meet these requirements cannot be considered Accredited Investors and are not eligible to participate in the North Star Capital Fund.
Minimum Investment
In addition to meeting stringent eligibility requirements, all members are required to make a minimum investment of at least $100,000. This investment is per unique investor. Additionally, the fund manager reserves the right to adjust the minimum investment requirement as necessary based on their discretion alone.
Fees
The only fee assessed will be an annual management fee. It will consist of up to 3% of the total assets under management (AUM) within the fund and is designed to cover the costs incurred through administering the fund, handling construction financing and the underwriting process.
What Is EDC?
EDC, or excess distributable cash, will be split between investor members and the fund manager each quarter. What is EDC, though? Under the fund’s rules, EDC is “any remaining cash in the fund after having paid out fund expenses, the 3% (annualized) management fee, and the preferred return, and reserving sufficient capital for future activities of the fund as determined in the sole judgment of the manager”.
Any excess distributable cash remaining in the fund will be divided 50/50 between investor members and the manager. This division occurs quarterly and accompanies the disbursement of the preferred return. Note that EDC typically does not carry from quarter to quarter, and the manager determines the exact amount of EDC in the fund at any given time based on their discretion.
Distribution of Returns
Understanding how returns are distributed within a fund is a critical part of making an informed financial decision. Within the North Star Capital Fund, returns are distributed quarterly, and investors have options in terms of how they receive those returns. They can have all returns paid to them at that time, or choose to reinvest their returns in additional membership units at the current unit price. Members choose their distribution method on entry into the fund but can change their selection with notice no less than 30 days before the end of the quarter. Note that changes can only be made once per year.
The Distribution of Funds “Waterfall”
Within the North Star Capital Fund, the distribution of funds follows a specific order, called a “waterfall”. This order is as follows:
- Fund expenses are paid.
- The manager receives the stated 3% annual management fee.
- Members receive their preferred return (paid quarterly).
- Any EDC remaining in the fund is divided 50/50 between investors and the manager (divided quarterly).
Is the North Star Capital Fund Right for You?
Private money construction loans offer a wide range of benefits. They promise to spur growth within the real estate industry, alleviate the damage caused by the most disastrous year of wildfires in California, provide residents and businesses with the facilities they require and generate predictable, consistent returns for investors.
However, these investments are not right for everyone. Before investing, it is important to have a full understanding of your risk tolerance, the inherent risk involved with private money construction loans, and how the investment will operate. It is always a wise decision to retain an investment professional for advice and guidance before making any type of investment.
With that being said, private money construction loans can reduce risk, provide reliable returns on your investment, and help you build your wealth. The North Star Capital Fund offers an innovative solution to both real estate rebuilding and wealth generation. Contact us for more information about the fund.