Introduction

California’s Department of Corporations issued Regulation 260.204.1, allowing real estate and mortgage brokers to act as broker-dealers in certain securities transactions.  This authority is subject to strict obligations under Business & Professions Code § 10232.45, which require brokers to conduct comprehensive due diligence on both borrowers and private investors.  These measures aim to ensure suitability, transparency, and risk mitigation in hard money lending.

Core Due Diligence Requirements

• Investor Suitability: Verify financial capacity, risk tolerance, and investment objectives.
• Borrower Credit Assessment: Analyze ability to repay, review credit History, and confirm exit strategy.
• Independent Appraisal:
• 1–4 Residential Units:
• Other Income-Producing Properties or Vacant Land:
• Certified General Appraiser.
• Risk Disclosure: Provide written notice of all material risks to investors and borrowers.

Special Considerations

If due diligence reveals severe risks—such as insolvency or prior criminal charges (e.g., arson)—brokers must:

• Document findings.
• Advise investors in writing.
• Confirm informed consent before funding.

Real-World Case Studies

Case Study 1: Proper Due Diligence Saves Investors

A California broker arranged a $600,000 hard-money loan for a small apartment building.  Due diligence revealed the Borrower had high rental income and a clear refinance plan.  Independent appraisal confirmed a $1.2M value (LTV = 50%).  The loan was repaid early, and investors earned a 9% return.  Lesson: Conservative LTV and verified income reduce risk.

Case Study 2: Ignoring Red Flags Leads to Loss

A broker funded a $750,000 loan on a commercial property appraised at $900,000 (LTV = 83%).  Due diligence was rushed; the Borrower’s financials were weak, and the prior bankruptcy was overlooked.  The Borrower defaulted, and the property sold for $800,000 after legal costs—investors lost $50,000.  Lesson: High LTV and poor underwriting violate AB 1212 principles and increase investor exposure.

Case Study 3: Disclosure Protects Broker

A Borrower seeking $500,000 for land development had prior arson charges and minimal liquidity.  The broker disclosed all risks to investors who chose to proceed.  The project failed, but investors acknowledged the risk in writing, shielding the broker from liability.  Lesson: Full disclosure and documented consent are essential for maintaining trust and legal protection when risks are high.

Closing Statement

California’s regulatory framework emphasizes one principle: risk must be understood, disclosed, and documented.  Brokers are fiduciaries, not mere intermediaries.  By qualifying investors, underwriting borrowers, and obtaining independent appraisals, brokers protect all parties and comply with Regulation 260.204.1 and B&P § 10232.45.  Even in high-risk scenarios, informed consent and transparency are the broker’s strongest defenses.