This section is from the book "Practical Real Estate Methods For Broker, Operator & Owner", by Thirty Experts. Also available from Amazon: Practical Real Estate Methods for Broker, Operator, Owner.
Taking again the same fifty-foot plot as typical, let us assume that instead of belonging to an operator, it belongs to the builder, who desires to improve it with a six-story tenement house. He has previously purchased the land for $30,000. He paid $5,000 cash and gave the seller a purchase money mortgage for $25,000. He goes to a building loan company and asks for $30,000 to assist him in constructing the house. The building loan company figures that the land is worth $30,000 and the building will cost $45,000, making a total cost of $75,000. If the company loans the builder $30,000, subject to a ground mortgage of $25,000, there will be a claim of $55,000 against the property, which will be more than 70 per cent of the cost. The company further figures that when the building is completed, the builder will not be able to borrow as a permanent loan over $55,000. It does not figure on what the builder will sell the property for, but what it will cost, and what permanent loan the builder can get. If the company is reasonably disposed, it offers the builder a loan of $25,000, subject to a ground mortgage of $25,000, making a total loan of $50,000, or two-thirds of the total value - the common first mortgage percentage. The fee for such loans is small compared with an operator's profit, and the amount of loan is figured on a different basis entirely.
When the builder makes application to the building loan man or company for a loan, the mortgage on the land is most essential in determining the amount to be advanced for building. If the builder had, instead of paying $5,000 cash, paid $10,000, his ground mortgage would be but $20,000, and a building loan of $30,000 would be equally as safe as a $25,000 building loan, subject to a ground mortgage of $25,000. If the builder had paid $1,000 on account of the land and had a mortgage of $29,000, the building loan man would not be justified in offering over $21,000, although this would be less than 50 per cent of the cost of the building.
These figures illustrate the first important deduction which brokers and lenders of building loans must consider. Loans where the land is owned by the builder, must be calculated as if they were first mortgage loans, and the building loan must include an amount sufficient to retire the land mortgage. It makes no difference how much mortgage is on the land, so far as the amount of loan goes; if there is no mortgage on it, the builder may obtain all of the loan to use toward his building, but if he has a mortgage on the land, he will have for building purposes only the difference between the amount of the loan and the mortgage on the land. Therefore, whether the loan is to be made as a first mortgage loan covering the land mortgage and cost of building, or second mortgage loan, covering the cost of building only, it must always be calculated on the basis of a first mortgage loan.
Another important requirement in figuring building loan applications, is to be able to judge as to the amount of permanent loan that may be obtained on the property when the building is completed. There is no rule to judge this by, other than that of experience and investigation as to mortgages on adjoining property similarly located and of like dimensions and character.
The amount of the mortgage on the land makes a material difference in the manner in which the building loan payments are made. If the land is originally mortgaged for all it is worth, it is obvious that the builder has no equity in his property until he has reached such a course in the construction of it as to create one. For instance, if this 50-foot plot of land had a mortgage of $30,000, or for all it was worth, it would not be until the building was enclosed that it could be said that a reasonable equity of, say, $20,000 was created. The property would then be worth $50,000, and one might reasonably loan two-thirds of the cost at that time.
This is the theory (two-thirds of the cost), on which some building loan payments are arranged and based. Another, and a more conservative theory, is to hold back enough money at all times to complete the building.
Another vital fact in our discussion, is the cost of putting up the building. Without these figures one cannot form any judgment as to whether a loan is good or not and how the payments should be made. There is no exact rule for figuring the cost of building. The only absolutely accurate method is to take the plans and specifications of each building, get in bids on each contract, add them together, add allowances for extras, interest, carrying charges, etc., and the total is what the building will cost. But while this may be necessary for a builder to know, it is hardly necessary for the loan man or broker, because he can arrive at it by less accurate and easier methods, which vary according to the character of the building proposed. If, for instance, it is such a building as a six-story tenement, covering two lots - he may roughly figure at so much per front foot or per cubic foot.
In figuring the cost of fireproof buildings, the usual way is to figure by cubic contents only.
Sometimes building loan operators do not want to make entire building loans themselves, and they arrange with a building loan man or company to advance as much of the loan as the building loan company deems proper. The building loan operator makes the additional loan, by taking a second mortgage behind the building loan company's mortgage, as security for his advance. This transaction is carried on in the same way as the one just outlined.