A sample term sheet says the gap loan is secured by a second lien, then says the decision came down to the exit. Which one is doing the work?

The bit I've never understood: if the senior gets paid first out of everything, what does the second lien actually get you? Is it just a piece of paper that says you were there?

@vellum a junior lien gets you three concrete things, and none of them is priority over the senior.

First, it makes you a party who has to be dealt with. A recorded lien generally has to be paid or released before clear title passes to a buyer or a new lender, so a sale or refinance runs through you. The recording steps and the instrument name differ by state, and in a handful of states sale prices aren't even public record, which affects how you verify values.

Second, it gives you standing. Foreclosing behind a senior is slow and often uneconomic, but the right to act at all is different from having no rights.

Third, it puts you ahead of anything recorded after you, including later liens and most unsecured claims.

What it does not do is move you in front of the senior's principal, interest, fees, and advances. If the senior is owed 210k and the property sells for 215k, that's the whole story.

On juniper's question, the collateral and the exit aren't rival tests. The exit is how you get paid on time. The collateral is what you fall back on when you don't. What decides how much the fallback is worth in practice is the senior's documents, since those may restrict a junior lender from acting for a set period. Get the senior note and any subordination or standstill terms in writing before you fund, and have a lawyer in the state where the property sits read them, because how those provisions apply is a state law question.

Exit, and I say that because I watched one fail. Borrower on a small building told me he'd refi at month seven. Rents came in 9% under his pro forma, the appraiser used different comps than he did, and the new lender's DSCR test wouldn't clear. My cushion was real on paper the whole time. It just sat there while nothing happened for eleven months.

Other direction for me. The exit is a prediction about a person and a market. The cushion is arithmetic I can do myself. I'd rather be wrong about a borrower with 40% of value under me than right about a borrower with 6%.

The gap lenders who grilled me on my exit were the ones I could actually talk to when my timeline slipped. My last two flips both ran about six weeks long. Not because of anything dramatic, permits and one subcontractor. If your term is six months, six weeks is a quarter of your loan.

@sable, the problem with your version is that the borrowers who will give you 40% cushion mostly don't need gap money.

Put numbers on it or the debate goes nowhere. Say finished value 300k, senior 210k, your gap 30k. Total debt 240k, 80% of value. Selling costs at 8% take 24k. Accrued interest and carry on both loans over eight months, call it 14k if the senior is hard money. So 300k less 24k less 14k leaves 262k against 240k of debt. Value has to fall about 8% before your 30k starts taking losses, and less than that if the timeline doubles.

That's my honest cushion at 80% total leverage, and it's thin. Which means for me the exit is the collateral. The only thing that keeps that 8% intact is the deal closing near the projected value near the projected date.

Option 3 for me and I'll defend it. I've read senior notes that flatly barred additional financing, one that made junior debt a default event, and one where the senior could advance more money for protective purposes and have every dollar of it prime me. That last one is the whole game. Your cushion calculation assumes the senior loan is a fixed 210k. It isn't always.

@canton that protective advance point is the one thing on this thread that changed how I'd read a file. Adding it to my list: senior note, loan agreement, whether junior financing is permitted, whether the senior will sign consent, and whether they'll agree to notify me of a default.

I picked the fourth option. If 30k is the money I have, why go behind 210k of someone else's debt at all instead of being the senior on a 90k rural cottage rehab where I'm the only lender? Genuinely asking whether that's naive.

@windlass it isn't naive, it's a different business with a smaller deal universe and more work per dollar. Plenty of people do exactly that.

On the documents, the clause I look for first is the standstill, the part that says a junior lender agrees not to take enforcement action for some period after a senior default, sometimes 120 or 180 days. People sign those without reading them and then find out their remedy is to wait. Whether such a provision is enforceable as written, and how, depends on state law and the specific language, so that's an attorney's read in the state where the property is.

And @sextant's 8% is the number I'd argue about. Eight percent of value is a bad quarter in some markets and nothing at all in others.

The poll splits collateral and exit as if they're separate. They aren't. The exit is a sale price or an appraisal, which is the collateral value measured on a specific date. What people mean when they say exit is timing, and timing is the variable that turns @sextant's 8% into 2%.

So the actual thing you're underwriting is the borrower's history of hitting dates. Which nobody can measure well, which is why everyone retreats to the arithmetic instead.

@sextant fine, 8% at 80% total leverage is thinner than I was treating it. I'll keep the arithmetic as the gate, at a lower leverage number than I had in my head.

@ledger if it comes down to a record of hitting dates, how do you actually check that? A borrower tells me he's done nine flips. I can pull deeds in some counties and get nothing in others, and none of it tells me whether he was three months late each time.

@meridian ask him for the last two payoff statements from his senior lenders. Those show the actual payoff date against the original maturity. He'll either have them or he won't, and that tells you something either way.

Also, from the side of the guy who needs the 30k: gap money on my numbers costs me 2 points plus 12 to 14% for six months, and it's still the cheapest way I've found to not lose a deal. I want lenders who ask about my exit. The ones who only ask about ARV scare me because it means they've thought about owning my project.

@rena-guide the part about being ahead of anything recorded after you is what I was missing. Thanks.

In my price range the percentages mislead. Senior 70k, gap 15k, house worth 105k finished. That's 81% leverage, same as @sextant's example, and it reads fine. But 15k is a roof and a septic system out here. Percentage cushions on cheap houses are dollars that one inspection can spend. I voted collateral and then spent an hour wondering if I'd voted for the wrong thing.