California Senate Bill 978 (the “Bill”) became law on September 27, 2012. Despite more than three years since its enactment, many people we speak to fail to understand its far reaching implications especially as it pertains to changes in construction lending. The Bill created numerous new sections to California Business & Professions Code, including the creation of Section 10232.3 (“B&P 10232.3”). What used to be limitations which only applied to multi[1]beneficiary loans became a blanket rule for all loans arranged by licensed California brokers (“Brokers”).
B&P 10232.3 first lays out the maximum Loan-to-Value (“LTV”) limitations which must be adhered to for all loans arranged by Brokers, broken down by the type of collateral and type of occupancy as provided for in the table below:
| Type of Collateral | Maximum LTV |
| Single-family residence, owner-occupied | 80% |
| Single-family residence, not owner-occupied | 75% |
| Commercial properties and income-producing properties not described above | 65% |
| Single-family residentially zoned lot or parcel that has installed offsite improvements including drainage, curbs, gutters, sidewalks, paved roads, and utilities as mandated by the political subdivision having jurisdiction over the lot or parcel | 65% |
| Land that produces income from crops, timber, or minerals | 60% |
| Land that is not income producing but has been zoned for (and if required, approved for subdivision as) commercial or residential development | 50% |
| Other real property | 35% |
The LTV determination is based on the Current Market Value of the real property collateral, often referred to as the “as-is value.” However, as most construction lenders know, basing LTV off the as-is value often far exceeds the LTV limitations proscribed above. This is because the Borrower’s intended improvements should dramatically improve the LTV, and a higher loan amount is necessary to make those intended improvements. The property value calculated post improvements is often referred to as the “After Repaired Value” (“ARV”). To address this issue, SB 978 sought to provide a framework permitting Brokers to arrange loan transactions in which the LTV limitations used ARV versus the as-is value.
B&P 10232.2 specifically applies to loans in which the Lender is not disbursing all loan funds directly to Borrower at loan closing, and the Broker must rely on the ARV of the property in order to fall below the maximum LTV limitations above. The restrictions are broken down between loans in which there is a holdback in excess of $100,000 and loans which contain a holdback of $100,000 or less. The rules are described below.
Loans which include a construction holdback of $100,000 or less relying on ARV.
1. The loan must be fully funded, with the entire loan amount deposited into an escrow account before recording the deed of trust.
This means that any fees associated with the loan, including the construction holdback, cannot be net funded. The Lender must provide the full loan amount to escrow, and then any points or holdback amounts may be sent back to the Lender after recording.
2. A comprehensive, detailed draw schedule must be included to insure timely and proper disbursements to complete the project.
This is important because the draw schedule will outline for both Lender and Borrower how the disbursements will be made from the holdback amount. By providing a detailed draw schedule at closing, any disputes over the manner of disbursements will be addressed before the loan is funded. It will also provide both parties with the security of knowing that there will be sufficient funds to complete the project, and that there is a detailed plan in place to be successful.
3. A licensed appraiser must complete an appraisal.
Often considered one of the more cumbersome requirements, the Broker cannot rely on a BPO or other valuation. The investor must receive the valuation from a licensed appraiser in accordance with Uniform Standards of Professional Appraisal Practice (USPAP). Many clients find this requirement particular onerous in transactions that must close quickly, but unlike other sections of the code there is no exception made available here.
4. The loan documents must outline the actions that can be taken if the project is not completed, whether due to insufficiency of loan proceeds, default, or other causes.
Typically, the construction holdback language in the loan documents will describe what will happen if there is an event of default or another issue occurs that requires the lender to take action to protect the investment.
5. The loan amount may not exceed $2,500,000.00.
Clients are often surprised to hear that there is any limitation on the aggregate loan amount. A broker may create a first and second loan bifurcating the acquisition funds and constructions funds so long as the ARV LTV does not exceed maximum limitations provided above on the construction loan.
Loans which include a construction holdback of more than $100,000 and Broker is relying on ARV.
In addition to the five requirements enumerated above, if the construction project includes a holdback amount of more than $100,000.00, the broker may rely on ARV to determine the maximum LTV if two additional (and onerous) safeguards are met:
1. An independent, neutral, third-party escrow holder is used for all deposits and disbursements relating to the construction or rehabilitation of the secured property.
Often a highly contentious issue for investors who either want to retain control of the construction funds for obvious reasons, or alternatively would like to earn the added interest return on non-disbursed funds, B&P 10232.3 requires the funds to be disbursed by a neutral third party escrow holder as a funds control agent.
2. The disbursement draws from the escrow account are based on verification from an independent qualified person who certifies that the work completed to date meets the related codes and standards and that the draws were made in accordance with the construction contract and draw schedule.
An Independent Qualified Person is defined as “a person who is not an employee, agent, or affiliate of the broker and who is a licensed architect, general contractor, structural engineer, or active local government building inspector acting in his or her official capacity.”
Many of our clients retain the services of a construction management company who can satisfy both requirements above, because they are licensed as general contractors and as an escrow company.
Finally, B&P 10232.3 uniformly applies maximum investment limitations for investors by limiting investment in any one loan to no more than 10% of an investor’s net worth (exclusive of home, furnishings, and automobiles), or an investor’s adjusted gross income. This rule, similar to maximum LTV limitations, was strictly limited to multi-beneficiary loans prior to the enactment of SB 978, and now applies to all loans arranged by Brokers. Not sure if your construction loan documents are SB 978 compliant? Contact us below.
