Archive for the ‘Uncategorized’ Category

Last week I was telling you about a “Fictional” story of Real Estate Investor James and his Private Lender Terry. James bought a house and borrowed money privately from Terry to buy, renovate and sell this investment. Things quickly went wrong.

I put “Fictional” in quotes because this is based in fact. Actually I put together a couple of worse case scenarios from actual lenders and investors. Nothing can ruin a relationship faster than money. Fortunately, it can be prevented with a little forethought and communication.

If you missed last week’s newsletter you can read it below.

James could have prevented this situation by finding another lender. Terry needed her money in 9 months because of a previous commitment with the money. James did not take into account that he may need to have more than one exit strategy. He didn’t take into account that things may not always go just right. He should have put a safety factor into the timeline. Unfortunately, it seems that things never go the way we plan.

Remember the old saying; “Man plans and God Laughs.”

Unfortunately, like most investors, James would rather have gotten the money right away so that he did not lose the deal and the potential profit. He saw close to $95,000 gross profit and he wanted to get started. Nothing wrong with being anxious to make money but you need to think ahead at what could go wrong as well as what could go right.

When planning, I always have a contingency for both time and money. If something looks to take 6 months I will plan for 12. If I figure that I could sell retail I analyze what could happen if I need to discount or sell creatively.

In this story, James only planned on selling retail. He did not anticipate what would happen if he would need to sell on lease option or seller financing. If he had, he would never have promised to pay of the note in 9 months.

At month 9 he could not pay off the note. He was in default. What could he have done differently?

1. Talk to the lender, starting in month one. Give status reports and updates along the way. At least on a quarterly basis, preferably once per month.

2. At month four James should have been asking Terry if he could extend the loan term out because of the selling situation. Terry may say yes. Things could have changed in her life as well. If not James should start to look for another lender.

3. Once he finds a lender that will better match the loan he could then do a “refinance” closing, swapping out one loan for the other. I would be communicating with both lenders to ensure they understand what is going on.

That would have been the cleanest way out for both the lender and the investor. They would still have had a good relationship; James could have borrowed money from Terry in the future.

Due to these circumstances Terry was forced to foreclose on James. Terry was in second position and had to begin making payments on the first mortgage. Terry spent 150+ days foreclosing on the property and in the end had a property worth $325,000 but it cost her $245,000 + in legal costs. She ended up making about $80,000 because James couldn’t sell the property. She then had the option to sell it or to turn it into a rental.

At the end rather than have Terry foreclose, James could have given Terry the deed in lieu of foreclosure. James would have admitted his mistake and done everything he could have to mitigate the loss to Terry. Terry would have gotten the property, rather than go through the foreclosure process, and would have saved almost 5 months worth of hassles.

Either way, the foreclosure would have been prevented if James would have found a lender that was looking for a longer term investment rather than 6-9 months. There are plenty of people like that out there; you just need to find them. It would have been better for all involved.

By the way, James didn’t just mess up on the loan he ruined his real estate investing business. Terry would have spread the word and nobody would ever lend money to James again, and they shouldn’t.

This is why I advocate protecting your private lenders above all others. It can ruin you and your business. Whether intentional or not, you can really harm people and their lively hood. This is why there are tough securities laws. If this is done intentionally, it can be determined to be fraud and you can be prosecuted.

This can easily be prevented by being realistic going into your transactions and with continual communication.

There are so many issues with the real estate market in 2009. First there is the foreclosure mess and the resulting banks tightening their guidelines. There are seller’s that have unreasonable expectations about housing values. There are buyers with unreasonable expectations about housing prices. As an investor we are stuck in the middle.

Another thing that has been happening as a result are that real estate investors who have been utilizing private lenders have been making compromises in their policies and taking the first Lender with money that comes along. Franticly worrying about the money and not caring where the money comes from.

This is Bad Business! Bad for the lender because they are expecting an opportunity to be a specific type of transaction and they may receive what ever the investor had on hand. The Investor may be anticipating a particular exit strategy but may not find a buyer in time. This could be a conflict between the two.

I will use the following example, (this situation is hypothetical and is not based on any one investment.) Real Estate Investor James puts a property under contract to purchase for $200,000. His exit strategy was to rehab and resell quickly. He determined the after repaired value to be $325,000 after $20,000 in rehab.

He was buying the property Subject To the existing 1st mortgage of $180,000 and needed to give the seller $20,000 for their equity. James will then pay the monthly payments of $1500 per month on the first mortgage until he sells the property. He was planning on being in an out of the property in 6 months.

James finds Terry, who had some money in her home equity line of credit that she would like to earn a good return on investment. Terry borrows $75,000 from her HELOC, She puts $10,000 in her savings account to make the payments on the HELOC until is it paid off and then lends $65,000 to James on a 9 month promissory note secured by a second deed of trust.

Terry figured that she was safe because the ARV was $325,000 and the total loans would be $245,000 which is 75% of ARV. She figured that having $80,000 in equity would be good enough. The note was structured as a balloon payment of principal and interest when the house sold. This also gave James 1.5 times the length of time than he figured it would take to rehab and sell.

Terry told James that 9 months was the longest she could lend the money out because she was going to be doing some remodeling on her house next summer and would need the money then. James was comfortable with 9 months as he had completed a similar project and it only took 10 weeks from start to finish because the house was put under contract to sell before it was finished.

Things went down hill from there…

James had to find a new contractor because the one he had used on the last project moved away. The contracting bids came back much higher than anticipated. James had done carpentry in the past so he decided to rehab the property himself.

The rehab took twice as long. It was completed in 20 weeks instead of the 10 weeks he planned. It also cost $35,000 instead of the expected $20,000 and because he did the work himself it wasn’t the same quality of work that a contractor would have done.

The market had slowed dramatically and all properties were taking much longer to sell. James was between a rock and a hard place. The property wasn’t selling. The 9 month note was coming due in the next couple of weeks. What could he do?

Many things went wrong. Let’s address the point of this article: Matching the loan with the lender. James should have found another lender with a longer term. You should always build in multiple exit strategies into the equation. If he would have found a lender that would be willing to have their money working for 2 years James could have sold with seller financing or Lease option.

He could have gotten a tenant buyer in the property quickly that had a sizable down payment. Instead he was forced to sell for full retail in a declining market. Obviously this is not a good situation.

How does he get out of this situation? Or Does He? We will pick this up where we left off next week.

Co-a-li-tion [Koh-uh-lish-uh n]

According to Dictionary.com a Coalition is a temporary alliance between persons, factions or states into one body or mass.

A Private Lender Coalition is when you assemble a group of potential private lenders so that when you need to borrow money on a project you have a ready pool to tap into instead of running around searching for someone to lend on a property.

I advocate creating a coalition for several good reasons:

1. Having the money available when you need it.
2. Different Lenders have different criteria and you need to mix and match them to meet your criteria
3. According to the SEC you need to have a prior relationship with the private lender before you can offer them any securities.

There are a few more reasons than that but these are the most important ones.

Most people don’t understand that the main issue that gets people into trouble with the SEC is that they don’t have a prior business relationship to the lender. The State Department of Securities and the SEC have created most of the exemptions specifically around that one condition. They target and go after businesses that violate this in order to protect their constituents.

Matching the lender with the type of investment you are making. You would not want to place a private lender that wants monthly principal and interest payments on a house that you are going to Flip. Ideally you would want a lender that is looking for compound interest with no payments until the project is complete. Otherwise you may put yourself in a precarious situation that will not work for you or your business.

Many potential private lenders are looking to get and have their money working for them as quickly as they can. They also are looking for a good interest rate and having their money secured by either the government or real estate.

Because this is their goal they will not necessarily wait around for you to have an investment opportunity. They will balance the time they need to wait with their other opportunities. They may decide that the best thing for them to do is to put their money in another investment that they may not be able to liquidate to invest with you.

The moral of the story is that you need to get their money working quickly and keep it working so that it meets their goals. This is why you need to create a coalition of as many investors as you can. But keep in mind that some states place limits on how many lenders or investors you can have.

For more information watch the third video about “Keeping it Legal” on www.crackingthevault.com.