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-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
Single-family residence, owner-occupied
Single-family residence, not owner-occupied
Commercial properties and income-producing properties not described above
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
Land that produces income from crops, timber, or minerals
Land that is not income producing but has been zoned for (and if required,
approved for subdivision as) commercial or residential development
Other real property
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.
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.
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.
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.
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.
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:
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.
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
Not sure if your construction loan documents are SB 978 compliant? Contact
Melissa Martorella or
Nema Daghbandan. Geraci Law Firm is a law firm dedicated to the representation of lenders,
brokers, and other real estate professionals. The firm has fourteen attorneys
with experts in securities, lending compliance, document preparation,
litigation, and secured creditors rights.
Interested in this subject? Check out Geraci Law Firm's webinar on
Construction Lending under our events page,
www.geracilawfirm.com/events. Looking to innovate in the lending space? Sign up for Geraci Law Firm’s
inaugural Innovate Conference 2016, which will focus on the innovative
approach to the lending marketplace. This event will take place on September 25th-26th, and more info is available at: