State law enforcement officials are investigating whether 70 retirees and other investors in Northern California were bilked when they put up $6.4 million for construction loans on Malibu land that may be undevelopable.
The investors have foreclosed on the land, which is worth just a fraction of its appraised value as prime home building property. But they're still trying to figure out where their money went.
"Nobody knows what happened to it," according to Fred I. Mann, 77, a retired advertising executive who said he invested more than $500,000 in the transaction and is facing a total loss.
The episode illustrates the perils of "hard-money" lending, a little known and largely unregulated corner of the real estate market.
Hard-money loans traditionally go to borrowers who can't qualify for conventional bank mortgages or construction loans. They are commonly funded by individual investors who buy fractional interests in the transactions, enticed by the promise of double-digit returns safeguarded by underlying property values.
Worries grow
Over the last year or two, hard-money portfolios have suffered the same problems afflicting conventional real estate lending -- questionable underwriting, rapidly deteriorating property values and, some investors believe, fraud. The fallout has begun to alarm state officials.
"We're getting a zillion of these types of cases with investors who have bought fractional notes," said Kathryn Holguin, an investigator for the state attorney general's office.
Responding to complaints by investors, Holguin said in an interview that she has opened an investigation into the Malibu transactions. She said it was not yet clear whether those deals involved criminal behavior, but "it's definitely worth looking into who put this together and what due diligence was done."
Hard-money loans are typically riskier than conventional mortgages. They are based on the value of the land being developed, rather than the income and creditworthiness of the borrowers.
Accordingly, they are subject to much lower loan-to-value ratios to provide larger cushions against loss and carry higher interest rates to compensate for the risk. The Malibu loans, for instance, were supposed to be limited to 50% of the appraised value of the properties and carried an above-market rate of 12%.
