SPECIAL INTERVIEW CRE ATING HOUSING OPPORTUNITIES FOR VETER ANS
BUSINESS STRATEGY
Checklist for Reducing Credit Risk
LEGAL
Pros and Cons of RE Investment Strategies
The Official Magazine of AAPL November/December 2018
ALTERNATIVE ANGLE
Why You Shouldn't Fear a Recession
LENDER LIMELIGHT
Jeffrey Tesch Practicing the Golden Rule Leads to Success NOVEMBER/DECEMBER 2018
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CONTENTS
NOVEMBER/DECEMBER 2018
07 WHAT'S CURRENT
18
Tr ending I ndu s t r y Topic s and N ew s Fr om A r ound t he Wor ld o f Pr i v a te L ending
10 BUSINESS S TR ATEGY
10 Us ing Ba s eline Repor t s to L imi t Ri s k s by Steve Clar k
14 Your M on t hl y C hec k li s t f or Re duc ing C r e di t Ri s k by J ef f Levin
18 5 C r uc ial Q ue s t ion s to A s k B e f or e L ending to A ny I nve s tor by B re Ann Stephenson
26 Your G uide to I n s ur ance L ending Re quir emen t s by Shawn Woedl
30 8 T ip s f or B r oker ing L oan s — W i t hou t B ur ning Rela t ion s hip s by Kellan J ones
34
34 LENDER LIMELIGHT
Ac hiev ing Succe s s — W hile Tr ea t ing O t her s Fair l y wi th J ef f rey Tesch
40 SPECIAL INTERVIEW
I njur e d Ve t I s C ur ing H ou s ing Woe s wi th Ken L ac y
44 C A SE S TUDY
40
Vene t ian M a s ter piece
46 IR A APPROACH C on s ider an I R A f or Your Financ ial Ri s k M anagemen t Tool B el t by Clay Malcolm
50 MANAGE & LEAD
62
50 H umanizing Your C ompany B r and by Er ic a L aCentr a
54 M ak ing Your Team Wor k by James Har t
58 LEGAL Your G uide to Real E s t a te I nve s t ing by B r yan Reding ton
62 ALTERNATIVE ANGLE
Why the Housing Market Shouldn' t Fear a Recession by Rober t Greenberg
NOVEMBER/DECEMBER 2018
3
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www.RollinsConsultingGroupLLC.com or 386-562-3016 PRIVATE LENDER
FROM THE CORNER OFFICE
Now that we’re approaching the holiday
season, it is the perfect time to reflect on
the past year and make plans for the next. If you are like me, you wonder how this year
R. MICHAEL WRENN
Chairman, Affinity Worldwide
passed so quickly. It seems like yesterday that
EDDIE WILSON
I held a newly inked list of things I wanted to
CEO, Affinity Worldwide
accomplish this year. I achieved many of those
LINDA HYDE
goals, made progress on others, and refocused
Executive Director, AAPL
a couple to make way for better plans.
CHRISSEY BREAULT
Editor in Chief, Private Lender Director of Marketing & Member Services, AAPL
TIM DRAPE
Senior Account Manager, AAPL
KELLY SCANLON Copy Editor
SPRINGBOARD CREATIVE Design
CONTRIBUTORS
Laura Chalk, Steve Clark, Robert Greenberg, James Hart, Kellen Jones, Erica LaCentra, Jeff Levin, Clay Malcolm, Bryan Redington, BreAnn Stephenson, Shawn Woedl
COVER PHOTOGRAPHY Ken Dao
Private Lender is published bi-monthly by the American Association of Private Lenders (AAPL). AAPL is not responsible for opinions or information presented as fact by authors or advertisers.
The end of the year is also a good time to evaluate our business strategies and finances. Do our current practices bring the desired results, or should we seek additional knowledge and fine tune them for better outcomes? Do any of our practices expose us to loss?
In this edition of Private Lender, we learn the latest insights from industry experts on risk management and productivity. They show us how to keep our businesses on solid footing while expanding, so we can create our best future possible. We hope you find the information valuable.
As always, thank you for being an important part of our community.
We here at AAPL and Private Lender wish you and your family health, happiness and success this holiday season and throughout the coming year.
SUBSCRIPTIONS
Visit www.facebook.com/aaplonline or email PrivateLender@aaplonline.com.
BACK ISSUES
Visit www.issuu.com/aapl, email PrivateLender@aaplonline.com, or call 913-888-1250.
LINDA HYDE For article reprints or permission to use Private Lender content including text, photos, illustrations, logos, and video: E-mail PrivateLender@aaplonline.com or call 913-888-1250. Use of Private Lender content without the express permission of the American Association of Private Lenders is prohibited.
Executive Director, American Association of Private Lenders
www.aaplonline.com Copyright © 2018 American Association of Private Lenders. All rights reserved.
The American Association of Private Lenders is an Affinity Worldwide Company. NOVEMBER/DECEMBER 2018
5
6
PRIVATE LENDER
WHAT’S CURRENT TRENDING INDUSTRY TOPICS AND NEWS FROM AROUND THE WORLD OF PRIVATE LENDING
NEW DIRECTION IR A FORMS TRUST COMPANY New Direction IRA has announced
New Direction Trust Company has
“Over the last 15 years, Bill Humphrey
that effective Oct. 18, 2018, New
broadened their footprint in the retire-
and I have proudly cultivated an
Direction Trust Company has replaced
ment investment industry by offering
education and customer service-based
New Direction IRA Inc. and Mainstar
expanded services to individual clients
culture to provide the best self-directed
Trust as custodian of all accounts
and institutional investment providers.
retirement platform in the industry,”
currently under administration
Among other initiatives, they have begun
said Catherine Wynne, president and
by NDIRA. New Direction Trust
offering custodial services for taxable,
co-founder/owner of NDIRA.
Company is a Kansas-regulated trust
nonretirement investment accounts and
company based in Overland Park,
accepting in-kind incoming transfers
Kansas, with administrative offices
of publicly traded securities like stocks
in Louisville, Colorado.
and mutual funds.
The move was made so that New
Since 2003, NDIRA has serviced self-
clients have the freedom to manage their
Direction Trust Company can position
directed IRAs, 401(k)s, health savings
accounts with little to no action required
itself for a new era of self-directed
accounts (HSAs), and other such tax-
on their part in relation to this transition.
financial services. The new company
advantaged vehicles and enabled investors
We obtained this trust charter not to alter
retains the management, staff, office
to hold alternative assets like real estate,
how we do business, but to build upon
and industry-leading business practices
precious metals, private loans and private
our strong foundation and enhance
that have propelled New Direction IRA
equity. These primary services will con-
our custodial abilities for the near and
Inc. for over 15 years.
tinue under New Direction Trust Company
long-term benefit of our clients.”
“Our standards of excellence, along with the dedicated staff that upholds them, remain firmly in place as we take this exciting step forward. Our existing
NOVEMBER/DECEMBER 2018
7
WHAT’S CURRENT TRENDING INDUSTRY TOPICS AND NEWS FROM AROUND THE WORLD OF PRIVATE LENDING
PEERSTREET EXPANDS REAL ESTATE INVESTING OPTIONS, NAMED TO LIST OF FASTEST-GROWING STARTUPS PeerStreet Cash Offer Loans is a new investment option
PeerStreet’s commitment to innovation has earned the
shorter duration than typical bridge loans.
Fastest-Growing Fintech Startups. The recognition comes on
intended to increase liquidity for investors by offering a
company a spot on the 2018 CB Insights Fintech 250 List of
PeerStreet’s range of investment options are designed to help
the eve of PeerStreet’s three-year anniversary. Now in its second
of risk, return and liquidity preferences. Investors can find
companies working on groundbreaking financial technology.
risk profiles and terms, which run from 30 days to 36 months.
PeerStreet’s mission is to democratize access to real estate
investors achieve diversification to fit their individual profile
year, the CB Insights Fintech 250 list names emerging private
investments with differing yields based upon the investments’
PeerStreet has made the list both years.
“We’re very excited to offer this new loan investment to our
debt investments. The company’s technology-driven market-
investors,” said John Devereux, chief real estate officer at
PeerStreet. “We’re committed to progressing innovation in
real estate, and when we see innovations happening in other
areas—such as homebuying—we think about how to potentially
bring the benefits to our users, at the same time as contributing to the improvement of the industry as a whole.”
8
PRIVATE LENDER
place enables accredited investors to diversify their capital in
a fixed-income asset class that had previously been difficult for individuals to access.
ALPHAFLOW ADDS EXECUTIVES AND OPENS NYC OFFICE AlphaFlow has added two new fintech executives to its team and opened
a New York office.
The online investment platform connects institutional and accredited investors with high-yield real estate bridge loans by partnering with local hard money lenders around the country. Stephan Leccese, the former chief operating officer and co-founder of Fund
That Flip, has joined AlphaFlow as vice president of partnerships. His goal is to scale the acquisition of loans from lending partners and successfully manage » Stephan Leccese
the loan portfolio. John Woodruff, who has more than 12 years of financial service experience at
i80 Group and Peer Street, will be joining Leccese in New York, serving as vice president of investments. Woodruff will manage and expand the company’s data-driven underwriting and analytics. AlphaFlow CEO and co-founder Ray Sturm said the additions will propel AlphaFlow forward as the company expands nationally. “AlphaFlow is rapidly scaling—so much so that we require a new base for East Coast operations, and expert talent in Stephan and John to pair with that expansion.” In a press release, the company noted that AlphaFlow’s presence in New York City and its reputation as a fast-growing automated real estate investment » John Woodruff
management service will better position the company to be at the forefront of investment alternatives.
COREVEST ADDS BL ACK SQUARE CoreVest has entered into an agreement to buy substantially all
CEO. "We are at a pivotal time in the short term lending market
providing bridge and rehabilitation loans on nonowner-occupied
ferentiator for lending partners. Black Square has that expertise."
residential properties. As part of the transaction, the entire
CoreVest, founded in 2014 as Colony American Finance, is a spe-
of the loan assets of Black Square Real Estate, a finance company
Black Square team will join CoreVest, including professionals in short-term lending and construction management oversight. "We are very excited about the business and talent that is coming with this transaction," said Beth O'Brien, CoreVest founder and
where significant construction experience is a strong positive dif-
cialty finance company that provides a range of debt solutions to residential real estate investors. The company offers portfolio and single-property term loans for stabilized rental properties as well as short-term credit lines and bridge financing.
NOVEMBER/DECEMBER 2018
9
BUSINESS STR ATEGY
USING BASELINE REPORTS TO LIMIT RISKS Make sure your clients’ projects stay on track. by Steve Clark
Sometimes even the savviest lender can overlook the perils that lurk in the shadows of construction. Too often, projects go upside down when reasonable oversight, like having a baseline report conducted, would have saved the day. Even on deals that look completely safe, there are risks that private lenders should address. 10
PRIVATE LENDER
Baseline reports provide lenders with a full overview of existing interior and exterior conditions of a structure before any construction activities begin. In addition, the intent of a baseline report is to provide a review of the contractor’s proposed scope of work, identify potential items of work that may have been left off the budget and bring attention to items that may be of special concern and may impact the cost or schedule for the project—all before the close of escrow. Overall, a baseline report provides the lender and owner with the information needed to make budget corrections, minimize cost increases and save valuable time before the start of construction. The following are just some of the ways to minimize risk.
DOCUMENTS NEEDED In an ideal situation, before a lender agrees to fund a new construction project, all plans and budget documents should be reviewed and analyzed to verify completeness and quantify amounts. The items needed to get a baseline report started might include a full set of plans, any signed contracts or bids, complete project specifications, a schedule of materials and a
“With the construction climate’s dramatic changes, it is extremely important to use qualified professionals to help you through your construction lending projects.”
complete budget for the project. Of course, any additional items that can be provided for in the baseline report will only add to the thoroughness of the analysis. Some of the typical results of baseline reports include necessary line items not included in the budget, rate increases for products that were not factored at current levels (such as when the costs of copper or asphalt skyrocketed due to economic changes), or when labor costs are established by “friends donating time to help out” and not by utilizing market rates.
BUDGET REVIEW The borrower should submit a complete line-item budget and a set of approved plans. You, as the lender, can then hire an independent, third-party firm to verify and valuate line-item costs by consulting constructioncost databases and subcontractors. The budget review will
show you if quoted prices are in line with the norm for that area and whether they reflect the true cost of construction. A budget review will give you and your borrower an opportunity to identify missing costs before construction begins. Make sure that funds are set aside for unforeseen issues. A project can fail if there is no “cushion” for contingencies. Typically, contingencies account for 10 percent of the overall budget.
CONSTRUCTION SCHEDULE A clear scope of work defines the extent of work necessary to complete the project. Your borrower’s contracts with remodelers and other contractors should require a schedule that spells out when the project will be completed. Without this lan-
guage, delays can result for both the borrower and the lender. Get the details. When will the project start? Who pays when there is a delay? Is the timeline for construction in line with the loan time? Does the schedule account for weather and product availability? Get these questions answered before the project begins.
INSURANCE AND LICENSING All contractors and subcontractors on the job site should provide proof of insurance. Subcontractors who are severely underinsured represent a significant financial threat. Also, review all licenses for contractors and subcontractors.
PERMITS No work should be done without permits. If work is started without a permit, the project can be halted by city or county jurisdictions until a permit is pulled. And, if a permit is not issued, it could still be discovered and lead to the new owner receiving a red tag from the city, leaving the borrower responsible even after the close of escrow.
NOVEMBER/DECEMBER 2018
11
BUSINESS STR ATEGY
CHANGE ORDERS
LIEN-WAIVER DOCUMENTS
Change orders are typically handled at the site level between the owner and the contractor; however, a project’s change-order documents should be included with each draw-request submission to the lender. This will keep the lender informed of any changes to the original scope of work. Change orders should be monitored closely so there is not a significant increase in project costs.
For the property owner’s and the lender’s benefit, all appropriate lien-waiver releases should accompany each draw request. Some lenders pay off invoices immediately. Others pay when materials are on-site. And others pay only when the materials are installed. Lien waivers that are not traced and cleared can result in double payment by the owner, as well as delay or impede sales.
Put our Lender Services team to work for your business
PROGRESS PAYMENTS Progress payments should only be made at agreed-upon times. All receipts, deposits, copies of permit cards and other relevant documents should be included with requests for pay. Typically, borrowers submit their request to the lender, who then processes it and forwards it to the inspection company, which in turn gives the field inspector a complete checklist to review at the job site. The inspector’s duty is to verify the progress-to-date against the application submitted. Do not advance project funds before work is completed. Investing always has its risks, but applying comprehensive risk-management oversight, especially with help of an independent, third-party inspection company, can protect a lender and help ensure a successful, profitable investment.
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12
PRIVATE LENDER
IT’S ALL IN THE BUDGET In the current lending environment, lenders are being held to tighter underwriting requirements. Limiting risks of portfolios and taking a more thorough look at project costs and overall feasibility is necessary before handing builders
and developers hundreds of thousands or even millions of dollars. In many situations, these requirements should be mandatory for protection of investors and lenders. Because of time and cost constraints, many construction lenders have been opting for estimates produced from sketchy square foot historical data. They do this rather than bear the expense and time required for a more detailed analysis using developed takeoff information for verification of construction costs.
SQUARE FOOT ESTIMATE VS TAKEOFF ESTIMATE All budgets are created equal, right? In a perfect world, maybe. While there is some validity and wide range use of the square foot (SF) method of estimating, it does not serve the needs of construction lenders who are looking for higher levels of assurances for the cost required to construct a project. These two approaches are exactly what they claim to be. They are a dichotomy in their approach and their meaning. The square foot estimate method is a much faster and cheaper way to generate costs and will provide an approximate idea of feasibility, but it is not an accurate method to
inspectors offers another opportunity to analyze the project to keep each construction project on schedule and within budget. With the construction climate’s dramatic changes, it is extremely important to use qualified professionals to help you through your construction lending projects. ∞ generate actual project costs. It is generally used in conceptual budgets in the early stages of project development, but that is usually where it ends. It is a quick reference tool based on historical data; however, it does not consider items such as design details that slow down production, items such as vaulted or higher ceilings, specialty interior or exterior finishes, enhanced levels of quality, building geometry and design elements. In addition, construction that must be done under the pressures of a deadline or in adverse weather conditions, or even rebuilding after a fire or other major catastrophe, or in a challenged labor market, can temporarily inflate costs substantially. Because SF estimates do not take these important factors into consideration, SF budgets are ultimately unreliable in predicting actual construction costs in the real world. The cost per square foot should be considered as a general barometer used to get a ballpark
idea of cost. It is not an accurate estimate of cost.
time generating or defending inaccurate information?
The takeoff estimate method produces a much more accurate estimate. This method allows you to start the task with a thorough understanding of the building project and its specific elements, quantifying each component in a construction project before determining the cost to construct. This method utilizes local cost databases with verifications from suppliers, installers and tradesmen. It also considers quality of construction materials and finishes, building shape, floor area, material usage and special design elements specific to the project. The takeoff estimate will always cost more to produce than a SF estimate, because it requires additional time for accuracy and detail. When your business and profitability depend on accurate information, it is the approach that should be implemented. How do you justify spending valuable
Estimating is both an art and a science. The science comes from approaching the estimate in a methodical, meticulous, organized and orderly manner. The art comes from being able to imagine how the project will be built in the location, including the means and methods involved in starting from the ground and working to the top. The experienced and knowledgeable estimator will apply both art and science in generating reliable cost information to produce an accurate and reliable baseline report. The use of unbiased third-party inspectors has become increasingly vital to lenders nationwide. Third-party audits from independent companies provide an invaluable component—a check and balance for your risk management. Additionally, using qualified third-party
ABOUT THE AUTHOR
STEVE CLARK H. Steve Clark is the CEO and president of Construction
Inspection Specialists, which has provided third-party
risk management services to the commercial and private
lending industry for more than 20 years. The company also offers a free Lender’s Kit to
help Private Lenders better manage their risk.
// steve@cisinspects.com // www.cisinspects.com
NOVEMBER/DECEMBER 2018
13
BUSINESS STR ATEGY
Your Monthly Checklist for Reducing Credit Risk Do these four things each month to track and reduce risk.
for risk—and start monitoring regularly. The four steps that follow track risk at both the micro level (for a borrower and his or her local market) and the macro level (looking at markets and the economy).
MONITOR YOUR BORROWERS’ PROJECTS Mistakes are part of the
business. For borrowers in new construction, adaptive reuse of commercial real estate, house flips and so on, every mistake, delay or cost overrun nips at
the return they can expect to earn at completion.
Private lenders often know
by Jeff Levin
their borrowers well and feel
comfortable with the level of scrutiny in the initial under-
writing process. But, when a borrower runs into difficulty
F
and a project no longer stands or many non-
bank lenders, risk manage-
ment is an
activity they do before they get to the closing table.
Lenders regularly evaluate the loan to value (LTV) ratio of the project when determining the creditworthiness of the buyer. The expectation is that if the borrower cannot repay the loan, the lender can cover the loss by foreclosing and selling the collateral. Certainly, after closing, 14
PRIVATE LENDER
the lender will keep an eye on the borrower’s debt service coverage—perhaps checking each monthly cash flow statement— but from a practical standpoint, that doesn’t protect against unforeseen events that may impact the lender’s level of risk. The approach fails to consider events that impact that initial LTV assessment going forward. Those include rapid market drops like we saw 10 years ago and the opportunity costs of funding deals that default. The
latter ties up capital that otherwise would have generated a higher ROI. So, it’s important to think of risk management as a continuing activity worth the investment of a few hours each month over the life of each loan.
to yield a profit, a borrower’s
One effective strategy for mitigating risk is to create a monthly borrower scorecard for tracking empirical data that are measured and evaluated over the life of the loan. Decide on a number scale—banks often use a 1 to 5 rating system
default and help your borrower
mindset can shift without a
lender noticing. The risk of a default materially increases, no matter how reliable the
borrower has been in the past. To monitor the potential for
stay on track, ask for a project
schedule and budget updates. Then evaluate the mistakes,
cost overruns, delays and so
on, by assigning a score each month. You can develop your own algorithm to take into
account the different com-
contractors and other profes-
to keep it simple, and use a
ers who are in trouble.
ponents of the project. Try
sionals who can help borrow-
one to five or one to 10 scale.
will rank on the higher end, and months where there are delays or problems
will have lower scores that reflect the challenges.
If a borrower has one or two
months of low scores, that is
an opportunity for the lender to engage with the borrower and provide some support
for staying on track. Lenders may benefit from keeping a
Rolodex of expediters, trusted
If you’ve been dutifully
tracking point #1, you’ll
Months where the project is on schedule and on budget
self-interest to default and
drop everything in your lap?
have some insight into the
DEVELOP BORROWER PROFILES
borrower’s mindset. This, of course, varies by borrower.
The dispassionate numbers
As a lender, you can’t read
guy is likely to default faster
can estimate how you think
slapper who has pride, press
the project, market conditions
tied up in the project.
the worse. Is he or she likely to
process, develop a profile
your borrower’s mind, but you
than the egocentric back-
the borrower will behave if
clippings and bragging rights
or both should take a turn for
As part of your monthly review
dip into other sources of cash
for each borrower. Note what
flow to continue servicing the debt? On the other hand, is it in his or her economic
he or she does under stress,
and identify potential pitfalls. As you identify situations
that lead to default, you’ll be able to extrapolate to other borrowers with similar per-
sonalities or propensities. If
you make repeat loans to the
same borrowers, you’ll have a record of previous concerns and behavior to help you
make decisions and monitor the loans you make.
FORECAST BUYER’S CASH FLOW IN DIFFERENT SCENARIOS Most lenders get their
borrowers’ monthly statement of cash flows. While this is
NOVEMBER/DECEMBER 2018
15
BUSINESS STR ATEGY
“... the monthly scorecard approach is a great way to track and mitigate risks ...”
handy information, it is backward looking. Healthy cash
flow in June does not mean
the borrower can service the debt in December. Regularly
run some models to see how
if things do go bad, and you
them, and sellers are keep-
best to modify the note or go
they’re aware that inventory is
can determine whether it’s
down the foreclosure path.
limited. A Chicago borrower creating luxury homes has
while the collateral risk to the
UPDATE THE LTV APPRAISALS
lender if the property is
Too many loans rely on
Yes, appraisals can be expen-
ducted during the origination
defaults are worse. If you don’t
over time. Changes in the
a fresh appraisal, then get a
triggering mechanism for
market comps and do the
a much keener awareness
you to understand whether
conditions are worsening.
can indicate when it might be
foreclosed is going up.
appraisals that were con-
sive and time consuming. But
process. These get stale
want to spend the money on
market comps are a natural
comprehensive update on
default, but the borrower has
math yourself. This will allow
than the lender as to when
your exposure is growing and
Update the LTV by running
“what if ” scenarios, looking out 3-6 months or longer.
Be sure to closely examine
a good idea to keep a close
eye on a borrower’s project.
WELL WORTH THE TIME
local changes. Take, for
example, the highly localized
What if the project is delayed
Riverside/San Bernardino
rower’s project repeatedly
prices grew 11 percent in
general contractor goes on
data from Realtor.com. But
The purpose of this exercise
market, where luxury prices
before they happen. Then, as
same period. And consider
will have in various scenarios.
luxury housing market. In the
six months? What if the bor-
market, luxury real estate
fails inspection? What if the
June, the most recent market
a medical leave of absence?
contrast that with the Chicago
is to identify pain points well
are down 0.8 percent for the
a lender, you’ll be well prepared
that the volume of luxury sales
has slowed in 2018. Buyers are waiting on the sidelines to see how the tax changes affect
PRIVATE LENDER
ABOUT THE AUTHOR
less incentive to avoid default,
much liquidity the borrower
16
ing prices too high because
In summary, the monthly scorecard approach is a great way to track and mitigate risks that inherently lurk in our industry. It takes time and a little elbow grease, and tracking golf scores is more fun. But over the long run, monitoring the risk for current projects will more than pay back in terms of money, time and fewer headaches. ∞
JEFF LEVIN Jeffrey N. Levin is the founder and president of Specialty Lending Group (SLG) and
Pinewood Financial, which
together provide a full suite of boutique private real
estate lending services in the Greater Washington,
D.C., area. Before launching
SLG, between 1993 and 2007, Levin was a co-founder and
CEO of iWantaLowRate.com and a co-founder and
president of Monument Mortgage. Levin is a
recognized authority, lecturer and panelist. He is also a
member of the American Association of Private
Lender’s Education Advisory Committee. He earned a bachelor’s degree from
The American University in Washington, D.C.
e t a D e h t e v Sa
0 1 s ’ L AAP onference
th
C l a u n n A
ER K A E P S E T O N Y ECIAL KE P S G IN T N E S E PR
k n a r F y Barne REGISTER EARLY TO SAVE! Tickets & Sponsorships at AAPLConference.com November 7-9, 2019 Las Vegas
NOVEMBER/DECEMBER 2018
17
BUSINESS STR ATEGY
CRUCIAL QUESTIONS TO ASK BEFORE LENDING TO ANY INVESTOR Your prospective borrower’s creditworthiness is certainly important, but also be sure you have a good understanding of their commitment to risk management. by BreAnn Stephenson
18
PRIVATE LENDER
Everyone in the lending industry should be familiar with the “5 C’s of Credit”: character, capacity, capital, collateral and conditions. They are the foundational principles that a prospective borrower’s creditworthiness rest upon. In the real estate lending industry, in addition to evaluating the borrower’s background, experience and creditworthiness, you need to consider the asset itself and who your borrower will be allowing on the premises. If you lend in the wrong part of town or select a borrower who does not act with a loss prevention mindset, your investment can literally go up in smoke. As you select which properties to lend on and who to lend to, ask yourself these five important questions.
can leave a property open
DOES YOUR BORROWER HAVE A PROPERTY MANAGER AND, MORE IMPORTANTLY, IS IT A GOOD ONE? Many investors find it
challenging to hire a reliable property manager.
Good ones can increase the profitability of a rental, and
a bad one can lead to a host of problems. If the property manager neglects routine
maintenance, major systems like the HVAC, electrical or
HOW WELL DO YOU KNOW THE PROPERTY? You should be as familiar as possible with the asset on
How granular is the data on median income, crime and occupancy, for example?
Tools like RentFax can be very
management can eliminate nearly all these potential
issues and keep the asset on an upward swing in value.
Make sure you know and vet your borrower’s property
manager. Any reputable property manager should have: T he proper licensing and insurance.
A thorough screening process for tenants.
Written maintenance
procedures and a schedule
stress on your borrower’s
(drive-by and walkthrough).
replaced more often, putting
tenants too much to them-
need to make a wise decision?
subject to arson. Skilled
plumbing will need to be
ability to pay you. Leave
deliver all the data points you
to becoming a drug lab or
selves and they may move
in long-term guests who are
not on the lease, damage the property with their lack of
cleaning or culinary skills or just skip town in the middle of the night, door left wide
for routine inspections A secure and reliable
method for collecting rents.
A written plan for late fees and evictions. This may
include a Cash-for-Keys
program to help reduce losses in the event a
tenancy doesn’t work out.
which you are lending. This
helpful for gathering solid
ing if that asset is not in the
especially if you are lending
knowledgeable about the
states away. Whether you
methods for collecting
a clear picture of any factors
FOR MORE DETAILED INFORMATION ON CHOOSING A
Does the service you use
success of a real estate project.
5-CS-TO-CHOOSING-A-QUALIT Y-PROPERT Y-MANAGER.
can sometimes be challeng-
data on the potential asset,
same state. If you aren’t overly
on a property that is several
area, you will need reliable
are near or far, you will want
demographic information.
that influence the financial
open. If a vacant property is left unmonitored, break-ins are almost guaranteed and
A track record for successful management and a list
of enthusiastic testimonials.
QUALIT Y PROPERT Y MANAGER, VISIT AFFINIT YLPS.COM/
NOVEMBER/DECEMBER 2018
19
BUSINESS STR ATEGYÂ
IF YOUR BORROWER WILL BE SELF-MANAGING THE PROPERTY, HOW CAPABLE ARE THEY AT MANAGEMENT? It may or may not be of
benefit to have your borrower oversee everything about the
property. The borrow certainly has a greater vested interest in its profitability than a property manager who only collects 10 percent of the monthly
20
PRIVATE LENDER
rent for their fee. That stated, if your borrower has a large portfolio, they could overstretch themselves in their ability to adequately manage each asset. How do they schedule their time for all the activities that running a successful real estate investment business involves? For example, do they vet prospective tenants thoroughly, or do they rush the process so they can get a renter placed quickly? Examine your borrower’s
process for screening renters
and make sure it involves at least the following:
B ackground check C redit check E mployment history C urrent employment/
adequate income (typically 3x the monthly rent)
R eferences from
former landlords
A brief visit to their
current residence to
assess its condition and meet any pets
IF YOU ARE LENDING ON A REHAB PROJECT, ARE THE CONTRACTORS YOUR BORROWER HIRES SKILLED AND RESPONSIBLE? If the property on which you lend is going to be
renovated, do you know who is going to have full access
while the work is being done? Can you trust the contractors or subcontractors your
borrower has hired? Do they
D oes your borrower pay
H ow else the property will
want to incur the additional
you are protected from
an alarm? Will door and
do the work safely? You don’t risk of becoming tangled
in a mess of faulty workmanship or party to a lawsuit
contractors on time, so liens being placed on the properties?
with this particular
contractor or group of
subcontractors before? H ow long have the general
contractor or any subs been in business?
D o the contractors have a good reputation with other professionals in
their industry? A solid
body of professional and client references?
D o both the general
contractor and any subs
carry licenses and insurance appropriate to the type of work they are doing?
Were there any problems with prior projects? With the schedule? With the quality of the work?
H as anyone ever been
injured on the job site?
window reinforcements be used?
relationship with the
during the rehab.
H as your borrower worked
ABOUT THE AUTHOR
I f they have a good
because someone is injured Consider the following:
be secured. Will there be
neighbors, so they can
HOW WILL THE PROPERTY BE MONITORED AND SECURED DURING THE TIME IT IS VACANT? There is perhaps no more vulnerable time for a
property than when it is sitting vacant between
tenants, in the time before
renovations or even sitting
have additional sets of eyes on the property.
T he plan for keeping the property maintained so
it looks as lived in as possi-
ble. Will there be scheduled
lawn maintenance? How will
the mailbox be kept free of overflowing mail?
W hether they will they
on the market for sale.
be shutting off the water
must have a concrete plan
from a burst pipe, or
property while it is vacant.
gets broken into?
For this reason, your borrower
to prevent water damage
in place for securing the
worst-case, if the property
BREANN STEPHENSON BreAnn Stephenson is the
assistant vice president of Affinity Loss Prevention Services and a licensed
property/casualty insurance
agent. She has been working with remodelers and real estate investors for more
than 10 years. If you sense a
musicality in BreAnn’s writing, it’s because she holds a
bachelor’s degree in music
from the University of Kansas. // breann@affinitylps.com
They should be able to tell you:
W hether they plan to board it up if it will be vacant for a significant period. W hether they are
prepared to board it with the materials the city
requires if that’s different from a traditional
plywood board-up. H ow quickly locks are
changed after a tenant moves out.
Your prospective borrower’s creditworthiness is certainly important, but also be sure you have a good understanding of their commitment to risk management. Knowing what measures they will take to protect the property and being able to trust the people your borrower allows on the premises is crucially important. Don’t overlook the questions asked above. A solid borrower should not be frustrated or become nervous if you ask a few extra questions. ∞ NOVEMBER/DECEMBER 2018
21
A DV E R T I S E M E N T
HOW TO MINIMIZE LOAN PAINS NOW & IN THE NEXT CRISIS YES, THERE IS A NEW RESIDENTIAL LOAN PLAN, PATENTED AND COPYRIGHTED, THAT CAN MINIMIZE LOAN PAINS DURING STRONG MARKETS—AS WELL AS DURING ANY REAL ESTATE DOWNTURNS. As you know, even in strong housing markets, some borrowers cannot make their payments. There is also the awful mess of many failed loans with short sales and foreclosures during the crisis of a serious market downturn. Existing loan modification plans can help, usually only for primary residence loans, but they can still result in some losses for lenders and investors. These situations may not deter the large investors who finance private loans, but in a serious market downturn, securitization could become more difficult. Both large and smaller investors who work with private lenders could be very happy to find and work with private lenders who have a loan plan that prevents most losses from troubled loans, and even provides for possible profit. This is especially true regarding loans that are not agency insured. Also, private lending companies and servicers obviously would prefer to avoid the mess of short sales, foreclosures and loan modification plans that never prevent all losses or have any chance to provide profit, especially when market downturns are making way too much trouble.
22
PRIVATE LENDER
Then there are the home developers and flippers who need private lender loans. Having a loss of credit, associated with a loan in big trouble, could halt their ability to continue in their business for quite a while. Those borrowers would love to know there are private lender loans available that provide a new loan modification plan when needed, which is also available for any loan that gets in trouble, so that money losses can be avoided, there is no credit loss and the borrower’s business can go on. And, then there are the loan originating servicers who can offer this new plan to their existing and potential private lending clients. As we know all too well, about once every decade or so, there is a significant housing downturn with much higher levels
of pain for lenders, investors, LOS providers, servicers and borrowers. In fact, the whole economy can take quite a downturn. Sure, if you’re a private lender, some or all of your loans may be ultimately insured these days, but the downturn results in fewer loans and less investor enthusiasm, and new home construction and flipping volume go downhill.
A New Loan Plan All of this motivated me to patent a new loan plan called HELPPR™ (“helper”), which stands for Home Equity for Loan Principal & Payment Reductions. It’s a new kind of loan modification that not only prevents most of the losses seen with other loan mod plans, it actually provides a likelihood of profit for the lenders, the investors, and even the borrowers, in the end. And, unlike most loan mod plans, it's available for nonprincipal residence loans. HELPPR™ can be added to any new residential loan, for use later if the loan goes sour. It can be used for loan modification of any existing home loan that is in trouble. Best of
A DV E R T I S E M E N T
all, if HELPPR™ becomes widely used, future downturns are likely to be much milder and shorter. You and I know that if one or two homes are foreclosed upon on any residential block, all the other homes on that block are likely to fall in value. Homeowners lose. Home developers and flippers may do well buying some foreclosures, but if the downturn is severe enough, sales and revenues go down, not up. Private lender business suffers from real estate slumps, as do LOS providers. Borrowers who build and flip housing must often wait for their existing completed homes to be sold, generally at reduced prices. Many investors become more cautious. Loan servicers are strained with extra work. The whole economy suffers. It’s pretty much everyone losing versus everyone winning. With the HELPPR™ Plan, there is no charge for LOS providers and private lenders to be licensed to use the patented plan and copyrighted loan verbiage. There is a reasonable usage fee that the borrower pays for HELPPR™ protection. The cost is divided among lenders, LOS providers and Loans That Help (licensor of HELPPR™ and AAPL member). Everyone involved can win.
How It Works Here’s how HELPPR™ works: When the loan is in trouble, whether HELPPR™ was included in the original loan note or not, using this loan modification includes the transfer of a percentage of ownership of the securing real estate to the lender or current loan owner. The ownership transfer is in exchange for a reduction in loan principal owed (plus payoff of any default) as determined by the amount of the current value of that percentage of the property ownership being transferred. The monthly loan payment is reduced accordingly, without necessarily requir-
ing any reduction in interest rate. Then, in an average of one to three years (the parties can name the time frame) for homes not lived in by the borrower, the home must be sold or refinanced by the borrower. Besides paying off the modified loan, this can result in a profit if the real estate market has improved. This is even more true if the finished new housing or improved flipper add to the property’s value significantly— that profit goes both to the lender/loan owner and to the borrower, split according to the percentage of the property owned by each.
money to complete that job, after working six months on it. So, to save his credit, and to allow him to continue to finish the current flipper, he requests the HELPPR™ loan mod. The home is now valued at $850,000 due to the market downturn. His current monthly payment is $5,000 per month. To keep the math simple, we are assuming an interest-only monthly payment.
“”
ALL OF THIS MOTIVATED ME TO PATENT A NEW LOAN PLAN CALLED HELPPR™ (“HELPER”), WHICH STANDS FOR HOME EQUITY FOR LOAN PRINCIPAL & PAYMENT REDUCTIONS.
The lender or current loan owner can sell their owned percentage of the property, once the loan modification is completed, to any investor. Only the borrower is responsible for upkeep costs, utilities, property taxes and insurance for the entire property during the term of the modified loan.
A Real Example Let’s look at a case example to see in detail how the HELPPR™ loan mod works. Suppose the original home loan was for $750,000 on a residential property that appraised, and was purchased, by the borrower for $1,000,000. Due to a market slowdown, the home flipper/borrower has not been able to sell another completed flipper at a profit and is having trouble making his payments on the in-progress flipper’s $750,000 loan. Plus, he is unable to afford the
He can afford close to a $3,000 per month payment, which would allow him to afford to complete the work on his current flipper. He has missed one monthly payment, so there is a $5,000 default amount.
He agrees to transfer 40 percent of the ownership of the property to the current loan owner. Forty percent is worth $340,000. So, after subtracting the $5,000 default amount, so that the default is paid off, the borrower’s mortgage payment is reduced by $335,000 to $415,000, and his monthly payment is reduced accordingly to $2,767. No interest rate change was needed. The loan owner is receiving a $2,233 per month lower payment for an agreed-upon two years, the same maximum term if needed, as per his original private loan term. If there had been no loan problem, the loan owner would have received $53,592 more in payments during that remaining two years. Two years go by after the loan mod is done, and the real estate market has NOVEMBER/DECEMBER 2018
23
A DV E R T I S E M E N T
would also pay off the modified loan to lenders/current loan owners, for homes that are owner occupied. Owner occupied loan modifications can be for longer periods of time, such as five years, to give more time for property values to rise for homes not necessarily being improved for resale. A refinancing would have to pay off the balance of the modified loan to the lender or current loan owner, and the borrower would have to pay off the currently appraised value of the percentage of the property owned by the modified loan lender or current modified loan owner.
mainly rebounded. The now totally redone flipper is valued at $1,500,000. The borrower put in $100,000 to upgrade the flipper. The flipper has now been sold for $1.5 million. The profit Is $400,000, less paid loan interest of $30,000 in the first six months, plus $66,408 in interest paid in the final 24 months. The borrower is responsible for all holding costs such as utilities, property taxes and insurance, plus closing costs of the sale, for the purpose of calculating profits to the lender or current loan owner. So, the profit is $400,000 less $96,408, which equals $303,592. The borrower gets to keep 60 percent of that profit, as per the percentage the borrower owned of the property at the time it sold. The borrower’s profit is $182,155, prior to the borrower deducting holding and closing costs for tax purposes. The lender or current loan owner (or the investor who may have purchased
24
PRIVATE LENDER
the 40 percent of the property from the lender or current loan owner) receives 40 percent of the profit, which is $121,437. That profit is more than double what the lender or current loan owner would have received if the loan had not had a problem requiring a loan modification. And, the borrower would have made no profit and would have had a loss of credit. Had the lender or current loan owner sold the 40 percent of the property to an investor right after the loan mod was done the sale price would have likely been about $340,000, which would have prevented any loss for the lender/current loan owner. The investor purchaser of the 40 percent would have made a profit of $121,437 at the time of the sale of the home. Instead of being sold, a home that has the HELPPR™ Plan loan mod can be refinanced, for homes occupied by the borrower, which would not apply to most private lender loans. Refinancing
Lenders and current loan owners have the right to sell off the percentage of the property owned by them at any time, to any investor, during the term of the modified HELPPR™ loan. You can see how HELPPR™ can take everyone involved with troubled private lending loans, in good times or bad, from everyone losing to everyone winning, at least in a significant percentage of cases. When Henry Ford drove his first horseless carriage (aka car) down the streets, the horses were upset by the engine’s noise, and that upset the people riding their horse-drawn carriages. It’s tough adjusting to new things. People feared the small pox vaccinations, but now there are no more small pox epidemics killing millions. This HELPPR™ Plan may be the best loan/economic loss vaccine ever seen. Investors, borrowers, lenders and everyone else involved will feel, and will be, more secure. Gain is better than pain.
NOVEMBER/DECEMBER 2018
25
BUSINESS STR ATEGY
Your Guide to Insurance Lending Requirements Require borrowers to carry adequate property and liability insurance to minimize your risk on an investment property. by Shawn Woedl
26
PRIVATE LENDER
I
f you’re lending money on an investment property, you should have a specific set of insurance lending requirements, or insurance coverages (both property and liability), that your borrowers must purchase and carry throughout the duration of the loan term. These requirements are
designed to protect your interest in the property, as well as the interest of your borrowers. Private lenders can be very lax when it comes to what they require of their borrowers. Some don’t require any coverages at all. Let’s look at some coverages you should consider requiring your borrowers to carry.
This coverage option allows your borrower to recover any applicable depreciation levied against them during the claims process, which can help minimize any additional financial hardship your borrower may incur.
SPECIAL FORM VS. BASIC FORM
Depending on the type of properties you are lending on, these required coverage packages can and should be very different. Our focus here is on single-family investment properties up to about four units at any one location. (Larger unit counts per location require additional property coverages.)
MINIMUM COVERAGES Always require that the insured building value your borrower secures meets or exceeds the outstanding loan value (with some lenders even going as far as to require borrowers to carry up to 125 percent of the loan value). Always require replacement cost coverage.
To minimize exclusions and unnecessary exposures, consider requiring your borrower to purchase special form property coverage. Think of special form as “all risk” coverage. It is the most comprehensive coverage form available to investors for their non-owner occupied, vacant and renovation properties. There are several standard exclusions from special form policies, but any peril not specifically excluded is automatically included. This leaves the burden of proof on the insurance company to prove to both the insured and their insurance agent that the loss that occurred was from an excluded peril. Standard exclusions on special form policies are mold and fungus, wear and tear, sewer and drain backup, earth movement (including earthquake), flood, poor workmanship and defective maintenance (also extending to faulty zoning and
materials), damage caused by vermin, intentional loss by tenants, power failure, war, neglect, nuclear hazard, governmental action, equipment breakdown and ordinance (or law). Some of these exclusions can be bought back by endorsement or on a stand-alone policy; others are considered uninsurable by insurance companies. As a point of reference, basic form is another coverage available to investors, but it is a “named peril” form that has additional exclusions that can harm an investor: theft; weight of ice, sleet or snow; water damage; collapse; and falling objects.
PROPERTY DEDUCTIBLE THRESHOLDS Many lenders require their borrowers to stay at or under a certain property deductible threshold. This is typically a percentage of the total insured value at the location in question and is usually no more than 2 percent. This deductible applies to the AOP (All Other Perils) property deductible, with exceptions allowed for the following exposures: wind and hail (including named windstorm), water damage as well as theft and vandalism. Exceptions are made for these exposures to control the
borrower’s property insurance costs, as the losses associated with these perils are often more severe. This prompts insurance companies to assign a higher deductible to them.
MORTGAGEE OR LOSS PAYEE? A common point of confusion for many lenders is how they should be listed on both the property and the liability policies their borrowers purchase. Should they be listed as mortgagee, loss payee or both? Simply put, a mortgagee is used when dealing with real estate, and loss payee is for chattel. So, when the rolling appliances (that have been rented) are on fire, the party from whom these appliances are rented should be listed as the loss payee on the borrower’s property policy. As the lender for the real estate investment property in question, being listed as mortgagee is correct. This notifies you before coverage is cancelled due to nonpayment or any other underwriting issue. It also guarantees you are listed on all claim payments for any property losses that occur on-site. As mortgagee, your interest is protected and prevents your borrower from cashing a claim check and leaving town.
NOVEMBER/DECEMBER 2018
27
BUSINESS STR ATEGY
LIABILITY COVERAGE AMOUNTS Require your borrower to obtain a commercial premises liability policy. The limits you require your borrower to carry is up to you, but consider at minimum a $1,000,000 per occurrence limit and a $2,000,000 annual aggregate limit. Defense costs should always be outside of these policy limits, so they do not take away from the amount available, if needed, to settle the loss. Defense costs inside the limits provided can leave your borrower potentially vulnerable to paying additional funds out of pocket to make an injured party whole again. If you are lending on a location taller than three stories, it is a good idea to require additional limits of liability (in the form of an umbrella or excess liability policy), as the means of egress change substantially at these locations. If you are working with a borrower who is renovating and/or flipping homes, it is important to know where
28
PRIVATE LENDER
“Requiring your borrower to carry adequate property and liability insurance is vital to minimizing your risk as the lender on an investment property.”
ABOUT THE AUTHOR
SHAWN WOEDL Shawn Woedl is the vice
their premises liability policy doesn’t help. It does not provide coverage to anyone hired to work on-site who is injured, nor does it extend to any products or completed operations at the location done by your borrower. (Think of this as coverage for betterments and improvements completed by your borrower that, post-sale, are uncovered to be faulty by the new owners and lawsuits are filed). The premises liability coverage available to your borrower extends coverage to slip and falls, personal injuries, etc., that occur on the location’s premises where your borrower is determined to be negligent. As a private lender, it is important to be listed as “additional insured” on your borrower’s liability coverage. This guarantees you are notified
before coverage is cancelled for nonpayment or for any other underwriting reason. Requiring your borrower to carry adequate property and liability insurance is vital to minimizing your risk as the lender on an investment property. These coverages should be specific to what your appetite for risk is and should be fully complied with ahead of funding any deal. Partner with an independent insurance agent who specializes in coverage for investment properties and who can assist in designing your insurance lending requirements. ∞
president of National Real
Estate Insurance Group (NREIG), an industry-recognized speaker and an educator with an
emphasis in commercial
property. Prior to committing to growing NREIG into the
largest and most profitable insurance program in the
country, Shawn spent seven years with CORE Insurance
Group, specializing in large
habitational risks nationwide. When Shawn is not selling
insurance, he can be found at the Warriors Academy
training Brazilian Jiu Jitsu or at home in Kansas City with
his wife, two children and Bane, his English Bulldog.
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Call Go Media today for a free consultation (470) 878-2000 or visit us online at www.TryGoMedia.com NOVEMBER/DECEMBER 2018
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BUSINESS STR ATEGY
8 TIPS FOR BROKERING LOANS — WITHOUT BURNING RELATIONSHIPS Brokers can add value to a deal by working collaboratively with lenders rather than at odds with them.
30
PRIVATE LENDER
by Kellan Jones
Private lenders rely on loan brokers for deal flow and assistance in stacking files. But, a broker’s benefits can often be eclipsed by the problems some brokers cause. On one hand, it’s important for a broker to be engaged and to add value to justify any fee; however, the broker must recognize the lender’s protocol and know when to step aside.
In order to be a boon to lenders without burning bridges, here are a few guidelines for private loan brokers:
01 Don’t claim you’re a
lender // It’s bad for the industry when loan brokers misrepresent themselves as a direct money source. Brokers get creative by titling themselves in a way that confuses borrowers. For instance, many say they “provide capital to borrowers seeking real estate financing.” It can take weeks for a borrower to realize that by “provide,” the broker meant they would make an introduction to the capital source (or, ironically, another broker). There aren’t many things as frustrating to private lenders than when a deal is sub-
mitted from a broker who has already taken an upfront fee. If the lender then contemplates a legitimate fee for real travel or legal costs, the borrower is less likely to pay a second fee. Borrowers and lenders alike respect brokers much more for being transparent. Establish yourself as an intermediary that lenders want to do business with and borrowers know they can rely on. Add value in exchange for a success fee.
02 Don’t overvalue
yourself // Regardless of how valuable a broker is to a transaction (and yes, we know the parties would have never met without you), understand that lenders who write checks are taking risks that outweigh the value of an introduction. Brokers who beg beyond industry standards for as much compensation
as the lender makes are simply delusional. When a lender makes a loan, that capital, whether it be funded by an institution or individual, represents hard work. Someone made that money and trusted a manager to make a loan with it. Most lenders don’t even make money until a loan closes, but there are brokers who try to justify their “time is worth more.” Time, even effort, pale in comparison to the weight of liability and fiduciary responsibility. Brokers should be reasonable in what they expect and charge, especially if there is a chain of multiple intermediaries expecting to be paid.
03 Pick a lane // The most
successful brokers know a select group of go-to sources, and they stick to what they know. “Feast or Famine Brokers” claim to do everything and spend their time peddling deals that have a low likelihood to close. It’s a poor practice for brokers to market services not only as a direct source, but one that does every type of deal, internationally, at the best terms possible. These brokers believe that if they claim to
do it all, they’ll capture and control all the deal flow. In reality, if deals sit on the wrong desk for too long, the market for that deal often dies while the broker tries to deliver on the promises that attracted the borrower in the first place.
04 L et the lender do his or
her thing // Get your NDA or fee agreement in place, and ask the lender how they wish to communicate with the borrower. Many lenders want to speak directly to the borrower from the beginning of the underwriting process, present their own terms and communicate with unlimited access to the borrower. If this is the case, have confidence in your agreements and require that you stay in the loop, but provide the space needed for the lender to make a decision. Other lenders prefer to filter information through the broker. Brokers should follow the lenders’ lead and convey things exactly as instructed. Too often, brokers are charged with a task of conveying information and requests but end
NOVEMBER/DECEMBER 2018
31
BUSINESS STR ATEGY
“Borrowers and lenders alike respect brokers much more for being transparent. Establish yourself as an intermediary that lenders want to do business with and borrowers know they can rely on.” up lacing the loan package with their own influence.
05 Don’t pilfer the credit //
Rather than giving credit to those who extend credit (lenders), brokers sometimes represent themselves as the funder out of fear that prospective borrowers will apply directly. It is OK for brokers to make public announcements about their services, but they cross the line when they use a lender’s performance as their own. Brokers providing more of an active role have every reason to use that experience to attract more business, but they should clearly define who did what in getting the deal closed.
06 Be tenacious, not rapa-
cious // Brokers should get into the habit of following up with the borrower every day or two to collect what the lender is requiring.
32
PRIVATE LENDER
That kind of tenacity is an asset to any deal. Brokers should refrain from badgering a lender for an update when a system is clearly outlined. There are always brokers who demand to be the lead on every phone call, which gets in the way of principal-to-principal interaction. Pre-empt what the lender may request, but never extend promises or commitments until instructed otherwise. Work with the lender to collect all the needed items quickly. Brokers who bombard each side with information and questions sometimes appear desperate. There must be a balance between not communicating enough and wasting everyone’s time.
07 Be loyal // Brokers should
make decisions that ensure future business from lenders and borrowers. Too often, brokers will take a side that isolates them from doing
business with either party in the future. If a deal dies or changes because the lender identifies risks that weren’t previously discovered, brokers should argue that decision. If a borrower finds a better lending solution than the one the broker is pursuing, the broker should show support rather than disdain. It should be evident to lenders and borrowers that the broker truly wants the best for his or her client. Constructive advice or counsel is one thing—but disagreeing with a lender’s terms, structure or decision shows immaturity and will likely end the relationship.
and stay the course have a better chance of building a reputation in the industry. Loan brokers are an important component of the private lending industry. Following the tips included here will ensure that relationships and value are mutually beneficial. ∞
ABOUT THE AUTHOR
08 B e wise with your
resources // As brokers taste success, it is prudent to set aside a portion of the income to build a business. Brokers have a hard time making the jump to a more credible business because when a deal closes, there is a tendency to “catch up” or buy a new car. And when brokers get a taste of success in private lending, their appetite grows. Not enough brokers determine ways to bring a consistency to their income by standardizing systems. Few brokers commit to a discipline they know can pay dividends. Brokers who define their business
KELLEN JONES Kellen Jones is CEO and
Founder of FundingDatabase, which has developed the
most comprehensive loan and
investor management platform according to its users (ideal-
SUITE). Jones is a fintech expert
with particular affinity to private lending technologies. Jones is
also President of Cache Private Capital, which makes direct loans to borrowers seeking
commercial financing under
loans ranging from $500,000 to $5,000,000 nationwide. Jones also serves on the
Ethics Committee for American Association of Private Lending.
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LENDER LIMELIGHTÂ WITH JEFFREY TESCH
34
PRIVATE LENDER
ACHIEVING SUCCESS — WHILE TREATING OTHERS FAIRLY Jeffrey Tesch of RCN Capital shares his
strategies for meeting market demands while practicing the Golden Rule. by Laura Chalk
NOVEMBER/DECEMBER 2018
35
LENDER LIMELIGHT WITH JEFFREY TESCH
Jeffrey Tesch, managing director and co-founder of RCN Capital, grew a small, local private lending company into one of the largest in the U.S. in just eight years. Tesch followed a specific recipe for building that success. By his own account, he is not one to keep that recipe a secret. Here, he shares insights with Private Lender on developing the best loan products to meet market demands, hiring stellar employees and cultivating clients’ trust.
Q
What were the strategies you followed for growing your private lending business, while managing risk?
A
Because I was from the non-banking world, it was all about not knowing what I did not know. I spent a great deal of time researching how other hard money lenders ran their process. I figured out how they secured their loans in such an effective manner. Many of these lenders were loan-to-own shops, meaning they would secure the property with such onerous terms that they would hope a customer would default, because then they would end up with a property that would be at a great LTV. This type of business practice was obviously not one I was interested in copying, but it did
36
PRIVATE LENDER
teach me how to become effective at being an asset-based lender. I would encourage folks just getting into the business to really spend a great deal of time making sure that all their energy and focus initially went into truly understanding the value of the asset their company is securing. Running credit and background and understanding your customers’ personal financial statements are nice; however, it is really only the asset itself that will truly protect you if the loan goes into foreclosure. From the beginning, I insisted on getting a full appraisal from a licensed appraisal management company. We eventually partnered with Appraisal Nation, which ended up becoming the leader in valuations in the private lending space. Aside from valuations, stick to your lending guidelines and do not chase deals. If the loan does not fit your program, walk away. There will always be someone else looking for money. You are on AAPL’s Ethics Committee. What work still needs to be done to further strengthen and legitimize private lending? Some of the opportunities that attracted me most to this business were the lack of branding and professionalism that existed in such a huge
industry. The industry has come so far since 2010, when we started RCN Capital. The private lending industry was largely made up of fragmented local hard money lenders, many of which took advantage of their customers. I believe the American Association of Private Lenders has helped standardize and elevate what private lending should be. The association helps set standards that must be adhered to for membership, and that is critical. The one area that still concerns me personally is brokers and small lenders who charge exorbitant loan application fees to generate income. Many of these so-called lenders have no chance of funding a loan and are just generating income by charging a fee to collect some documents. From the beginning, RCN insisted on only getting paid via origination fees if the loan closes; otherwise, we actually lose money. How can every private lending professional work to elevate the industry? By treating the customer the same way you would want to be treated if you were looking for a loan. This may sound simplistic; however, the Golden Rule works extremely well in our industry. Focus on basic items like not charging upfront fees, not charging outrageous
document fees and not quoting turn times that are completely unrealistic just to lock in a customer. Even doing simple things like returning phone calls goes a long way. Just do the right thing! What are your projections for the private lending industry? RCN is an asset-based lender securing nonowner-occupied residential properties across the U.S. For our business, the outlook is very bright. There continues to be a strong demand for renovation of properties that are close to urban centers. Many of these properties have not been
touched in 30 or 40 years. These rehabilitation loans are not loans that a traditional commercial bank makes. This type of financing has contributed to a great deal of growth in the private lending industry. A newer trend that seems to be really taking off across the country is the aggregation of single-family homes for rental. This has become a very large industry in a short period of time; however, it is easy for the new investor to enter as well. Until single-family new construction begins to meet the demand, I continue to expect robust growth.
Before co-founding RCN Capital and becoming a lender, you were in the trenches of residential and commercial real estate investing. How did your experiences as an investor help inform the way you operate your lending company? As a customer of lenders, I knew what I did not like about hard money lending. Some of these items included high rates, no commitment letters, commitment letters changed right before closing, closings canceled because the investor ran out of money and inability to get the “broker� to tell me what was going on. I knew that
if I combined my experiences and knowledge over the years as a restaurant franchisee with my years as an investor, I could put the customer first. We really made this part of our DNA at RCN Capital from the very beginning. Sometimes we run into situations where this mandate costs us money. For example, if rates change from our warehouse lines or an appraisal issue changes valuation, that will cost us. However, this mentality is worth it. We must protect the brand at all costs. Every team member at RCN Capital knows at the end of the day we must do right by the customer, no matter what it takes.
NOVEMBER/DECEMBER 2018
37
LENDER LIMELIGHT WITH JEFFREY TESCH
How do you determine what products to offer investors, and what is your advice for other lenders who are trying to decide what products to offer?
“... the Golden Rule works extremely well in our industry. Focus on basic items like not charging upfront fees, not charging outrageous document fees and not quoting turn times that are completely unrealistic just to lock in a customer. Even doing simple things like returning phone calls goes a long way. Just do the right thing!”
38
PRIVATE LENDER
Today the private lending space has become so competitive in the nonowner-occupied housing segment that research is critically important. RCN started off offering purchase money and no rehab dollars. The market quickly changed, and we began offering money to fund purchase plus renovations. As the years went by, more folks began holding homes as rentals, and we introduced a fully amortized 30-year loan. The key here is to stay in touch with what your customers are requesting as well as what your competitors are offering. Join the AAPL and other associations and interact with other lenders. Attend local REIA meetings and hear directly from other lenders and customers about the state of the marketplace. Constant research is required to stay on top in this business.
What is the one question every private lender should ask before developing a loan product? If I create this loan product and I have to foreclose and own this property, will it be at a value that my original loan amount will be covered? How do you keep a handle on industry and market shifts, and do these shifts continue to inform your product offerings? I attend as many industry conferences as possible. Nothing, and I mean nothing, replaces having a friendly conversation with your competitors in the industry. I always enjoy sharing what RCN is seeing in the marketplace as well as hearing what my competition is doing. I bring back ideas to my senior leadership team and we add loan products or change the ones we have based on that information. Do you foresee any big market shifts and, if so, how are you preparing for them? In the next 24 months, I believe we are in good shape in the single-family fix-and-flip space as well as in the single-
family rental space. I believe the supply of homes in the U.S. has a long way to go before the supply finally catches up with demand. If you look at some of the data, the number of permits filed for construction of singlefamily and multifamily homes in September are at the lowest they’ve been in almost three years. We would need to see an almost 15 percent increase in housing units to meet demand. Unless we return to the course of traditional commercial lenders financing large tracks of speculative single-family housing, we will continue to see solid demand for our customers’ renovated homes. What is your hiring philosophy? We hire on culture. We get all sorts of folks applying for careers here at RCN Capital. Some are experienced; some are just out of college. What we have figured out is that a fancy resume does not always equal a good, long-term employee. Each manager of their respective department knows what type of energy and culture fit is required for their team. To really boil it down, we are looking for the type of employee who can buy into the vision of creating the No. 1, nonowner-occupied residential lender, who is consistently
rated best in service. The theme always goes back to the brand that we have created. We need folks who will always put our company—and the customer—first. RCN always tried to hire from the conventional mortgage industry. What we figured out was that doing that did not always make the best hire. We started to recruit from industries that had hard-working individuals who were good on their feet. This includes the automotive sales business, restaurant managers, any sort of high-tech marketing, as well as recent college graduates. How do you spend your time away from work? My family takes up the majority of my time outside of work. I am married with three boys, two of which recently graduated from college and live out of state. I still have one boy living at home who runs his own successful property maintenance business. My wife and I enjoy traveling locally as well as longer trips on vacations. We both enjoy exploring destinations that we have never seen before. There is an excitement in discovering a cool place that
you have only heard about or seen in pictures.
What do you hope your legacy will be?
If you could travel anywhere, where would it be?
A family-man first, who truly appreciated those around him, and when rallied for a common goal, could take those individuals to a place they never imagined. ∞
Australia. My wife and I, as avid tennis fans, have always wanted to go to the Australian Open held every year in January in Melbourne. What is your favorite food? I have a lot of favorite entrees, but let’s get right to my biggest weakness: ice cream! I love a deep, dark chocolate, hot fudge sundae.
ABOUT THE AUTHOR
Do you have a philosophy by which you live? It really goes back to the way we started RCN: Treat others the way you would want to be treated. Over the years, I have learned how far a simple smile goes when you pass someone in the street or hold a door. Folks often tell me: “You always seem to be happy, Jeff.” Well not always, but I can assure you when you interact with others from a positive perspective, your own demeanor will greatly improve.
LAURA CHALK Laura Chalk is a freelance
writer, marketer and illustrator in the Kansas City area.
She contributes content to national magazines and
develops marketing campaigns for local businesses.
// FreelanceWriterPro.com
// LaurasCreativeCottage.com
NOVEMBER/DECEMBER 2018
39
SPECIAL INTERVIEW WITH KEN L ACY
Injured Vet Is Curing Housing Woes Real estate investor and veteran Ken Lacy created Veterans Path Up to put veterans on the path to home ownership. by Laura Chalk
Ken Lacy’s story is compelling. A veteran who overcame a severe injury, he started Veterans Path Up (VPU) in 2015. VPU is a 501(c)(3) that assists veterans who are experiencing housing instability and homelessness. The organization provides a path to homeownership for veterans in the Charlotte, North Carolina, area and connects them with complimentary agencies that teach financial literacy, budgeting and other life skills. Lacy’s vision is to expand and open affiliate locations across the country so that one day, no veteran is without stable housing.
40
PRIVATE LENDER
Q
You were a diver in the military and were injured during a job-related dive operation. You underwent years of physical rehabilitation and graduated from business school. What was that time like?
A
I was a Navy diver in the reserves and a civilian diver at the NNSY-Norfolk Naval Shipyard. I was on a civilian dive job with the Navy when I
got injured. At that point, I had to get rehabilitated because the ship yard said I wouldn’t have a job. I didn’t have a degree, so I wasn’t trained to do anything other than diving, which had always been my dream. Tasked with choosing a major, I settled on marine biology. I interviewed some professors, and they said that someone with a bachelor’s degree in marine biology doesn’t make much money. You have to be a Ph.D. and published to succeed at any high level. So, I went for a business degree instead. It seemed like the most marketable degree at the time. I graduated in December 2006, and during the three years in college and preceding one year, I became rehabilitated enough to accept an active duty deployment. I was mobilized and deployed to the Middle East— to Jabel Ali on the Persian Gulf, the closest town to Dubai. Our job was AT/FP dives (Anti-terrorism/Force Protection). We were looking for IEDs, or bombs underwater, attached to ships and other NATO vessels. When did you decide to get into real estate investing? When I returned from being deployed in the Middle East as a reservist, I was demobilized. Unless you have a job where you have return rights, you
“... we take the worst house, make it the best house and increase the property values of the neighborhood. Truly, it’s a win when we go into a neighborhood.”
need to find a job. I ultimately got an offer with a software company in Charlotte. After just over a year, I was asked to move to a telecommunications company underneath the same umbrella of the private equity firm that owned 65 other companies. After three years there, I learned that company was going to be absorbed by another one. The writing was on the wall, so I looked for another opportunity. I went to work for an IT company and didn’t love it. That’s when I became interested in real estate investing. This was in 2012. You were working with other organizations that helped veterans before starting VPU. What were the biggest challenges? I worked with other organiza-
tions that helped veterans who were at various stages: those
who were chronically homeless (which has different definitions, depending on who is interpreting); needed interview training, resume writing, skills training; help with finding a job, etc. I was educating landlords and property managers about the needs of veterans, but I had a high failure rate in the beginning: veterans who could not pay their rent as well as veterans who had a job and for a time were getting assistance from other organizations. Some organizations gave the veterans financial counseling services, but the counseling didn’t continue once they were in homes. The veterans didn’t have the tools to make the right financial decisions, so they would end up back on the street. I started doing research on how best to help them and came up with the criteria that
VPU now uses to determine which vets we help. First, the vet has to be honorably discharged, verified by their DD-214, which shows what kind of discharge the vet received and how long they served. Second, we require two years or more of military service. In 2012 and 2013, you developed an investment model that funded the acquisition and rehab of properties, then placed tenants in them under property management and sold the properties to turnkey investors. What was it about this investment model that made you think it could become a vehicle to help veterans? Right after we developed this model for real estate investing, I was at a veterans’ luncheon. The leader of the organization asked if I would use this model to house homeless veterans. That was the catalyst and the start of helping our veterans into homes. We got our 501(c)(3) Sept. 30, 2015. The very next week we had our first house donated to us by the city. Within a week, we had a 30-person party to help gut the property because it had been boarded up and vandalized for over four years. One of the workers found a loaded
NOVEMBER/DECEMBER 2018
41
SPECIAL INTERVIEW WITH KEN L ACY
handgun in the backyard. There were also used syringes in the property. That’s when we found out that the VPU house was next to the No. 1 drug house in Charlotte. People had been using the abandoned home as a drug house. We started to work on that first house in October 2015. The veteran moved in with his wife on Feb. 1, 2016. He had volunteered to work on the house and ended up receiving it. When he was helping with the renovation, he had no idea that he and his wife would be moving in. Before moving in, they had been couch-surfing. Shortly after they moved in, the veteran’s wife got a job at an assisted living facility. In addition to her main job, she volunteered to take over the chapel. A few months later, she became an ordained minister—I haven’t told that part of the story in a while—I get choked up. That veteran family now owns this house, and it’s the best home in the neighborhood. They also made a community garden in their backyard. They took flyers around the neighborhood to let people know they were making a community garden.
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PRIVATE LENDER
This was a win-win-win for the veteran’s family, the neighborhood and the city. It proves the VPU model works. There are other cities that would like to donate properties. The city of Charlotte doesn’t have any more properties, other than land, available to convey to us. They would like to because we take the worst house, make it the best house and increase the property values of the neighborhood. Truly, it’s a win when we go into a neighborhood. Local police agree that crime goes down. Incidentally, the police department has volunteered to work on every VPU house. How do VPU’s services differ from or compliment some of the other services you mentioned? Veterans coming to VPU are primarily looking for housing— a path to home ownership. If the veterans need additional services or are not yet ready for VPU, we connect them with Veterans Bridge Home, a nonprofit that helps veterans with many resources and bridges the gap between the military and civilian communities; Patriots Path, an organization that provides resume writing and interview skills; or a whole host of other veteran-focused government and nonprofit organizations.
How could the readers of Private Lender get involved with VPU? Private lenders can partner with investors to flip a VPU home, make a tax-deductible cash donation, or even donate a house if they have any inventory they’d like to use as a tax-deductible donation. Or, they can sponsor a house. We are going to be breaking ground on our first new build project in a transitioning neighborhood. Be creative—as long as it supports our mission and vision, is legal and helps our veterans, we will entertain it! How many veterans in Charlotte struggle financially? Charlotte isn’t a military town, but we have a high number of veterans who live here. Charlotte alone has more 50,000 veterans. There are approximately 135,000 veterans in the greater metro area. Of those 135,000, two-thirds are in some sort of financiallychallenged situation, ranging from homelessness to working multiple jobs and simply trying to make ends meet. What are your plans for the program’s expansion? My goal is for VPU to eventually be self-funded and have
enough money to expand to every state. But, we’re not there yet. We’d need a couple of million dollars to be self-funded. Right now, we have the ability to buy or rehab here in Charlotte, but not both.
Projected affiliate locations are in Houston, Orlando, Maine, Ohio and Jacksonville. That’s our next step—generating affiliates that will share our vision and tap into their local markets to help get veterans into homes.
Our national entity, Veterans Path Up USA Inc., will be officially formed in a month. By January, we should have our national level 501(c)(3). Then we will start creating our affiliates. Our goal and vision is to end veteran instability in homes across the country. We already have an affiliate in Richmond, Virginia. The next affiliate will be in Gary, Indiana, and then in Mississippi, Atlanta and Dallas.
What is the one thing you want people to know about veterans who are experiencing instability in housing or homelessness? The veterans we help are honorably discharged and can be active or reserve. I believe that even if they’re homeless, you at least know you are supporting a vet who fought for our country.
We focus on veterans who,
through life changes and situations, find themselves in tough times. All they are looking for is a chance. When we give them hope, they can see a light at the end of the tunnel and they are more likely to take advantage of the hand up. We look for the veterans who ultimately desire to be self-sufficient. There are thousands of them out there, sometimes sleeping on a relative’s couch or somewhere else. ∞
ABOUT THE AUTHOR
LAURA CHALK Laura Chalk is a freelance
writer, marketer and illustrator in the Kansas City area.
She contributes content to national magazines and
develops marketing campaigns for local businesses.
// FreelanceWriterPro.com
// LaurasCreativeCottage.com
NOVEMBER/DECEMBER 2018
43
CASE STUDYÂ VENETIAN MASTERPIECE
VENETIAN MA S TE RPIECE
Contemporary Venice, CA, fix-and-flip yields greater return than expected.
44
PRIVATE LENDER
T
his contemporary
home, built by ARI Design Group, is an architectural masterpiece. It features
two swimming pools, more than
2,000 square feet of outdoor space, complete smart home functionality, a rooftop deck, a fireplace, fire pits and custom designer finishes.
Energy-efficient with “smart” features throughout, the home is within walking distance to local trendy shops on Lincoln and Abbott Kinney. It was listed for sale during the final stages of construction. The borrower contacted Sunset Equity for a purchase loan that included rehab to complete the project.
SUMMARY OF OPPORTUNITY Sunset Equity funded a purchase with rehab for an unfinished development. The fix-and-flip sold for $3,456,000, higher than the anticipated After Repair Value (ARV) amount and 59.2 percent higher than the original purchase amount. ∞
Lender // Sunset Equity Client/Borrower // ETSD Venture Capital Location // Venice, California Architecture Style // Contemporary Originally Built // 1927 Square Feet // 3,150 Loan Amount // $2.025 million LTV // 75% LTC // 60% Credit Score // Repeat borrower with high credit score Client/Borrower Experience // Experienced, repeat borrower Interest Rate // 7.99% Length of Loan // 12 months, with two 6-month extensions Rehab Costs // $750,000
NOVEMBER/DECEMBER 2018
45
IR A APPROACH
CONSIDER AN IRA FOR YOUR FINANCIAL RISK MANAGEMENT TOOL BELT Originating loans from a self-directed retirement plan can earn tax-advantaged income for your golden years. by Clay Malcolm
I
ncorporating
familiar private
lending practices
into an individual
retirement account (IRA),
401(k) or other tax-advan-
taged savings vehicles can give you true control over
your retirement, while
limiting your exposure to undue dangers.
The same origination practices you use for your day-to-day income or personal savings can be adopted by your retirement plan. For example, on behalf of your individual retirement account, you may qualify potential borrowers, make
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PRIVATE LENDER
final decisions on terms such as interest rates or loan durations, and oversee the generation of final paperwork in virtually the same way you normally would. The beauty of lending your individual retirement account money lies in your ability to adopt your tried-and-true lending model and maintain the tax benefits of your retirement account, all without incurring additional risk for the privilege. With pretax accounts like traditional IRAs, SEP IRAs or 401(k)s (in some cases), plan holders can defer contributions from income for tax purposes and, hopefully, pay lower taxes on distributions down the road.
Post-tax accounts such as Roth IRAs task holders with paying full income taxes on their contributions, but qualified distributions at retirement time can be 100 percent tax-free. In the meantime, year-to-year earnings within either account type would be completely tax-deferred.
as compared to lending your non-retirement money. Your individual retirement account can enjoy tax-deferred or taxfree earnings by originating private loans, produce a model for your long-term financial well-being, and do it all without carrying additional risk.
Exploring a new edge in your investment approach would seemingly open you up to other challenges or threats, especially when navigating IRS regulations in pursuit of tax benefits. Reward tends to come at the expense of risk, but that’s generally not the case when lending your retirement money
COLLATERAL TREATMENT The risks involved with a “private lending IRA” are consistent with those inherent to note investing in general. Securing a loan with collateral is a common security mechanism available to individual retirement
account and non-IRA investors alike, though doing so with an individual retirement account would involve a few nuances: A ny collected collateral
would belong to your individual retirement account. // If your borrower defaults on a loan issued by your IRA, any collateral involved in the transaction becomes the property of the individual retirement account (as the individual retirement account would be the “lender” and wronged party in this instance) and not of you personally. In addition to private notes, self-directed retirement plans
can hold real estate, equity positions (public or private) and any other such property. They can even hold physical precious metals if they meet purity requirements set by the IRS. Gold must be at least 99.5 percent pure (except for American Eagle coins, which are IRA-eligible but don’t meet the minimum), silver must be at least 99.9 percent pure, and platinum or palladium must be at least 99.95 percent pure. Any such assets may be requested as collateral, and if received, would be titled in the name of your account in the same manner as the original note.
I RAs cannot hold
collectibles. // Artwork, non-precious metals items (in this context, “precious” applies only to the four metals listed previously), older precious metals items that don’t meet their respective purity minimums, old or rare bottles of alcohol, sports or celebrity memorabilia and other such commodities whose values are determined strictly within a collector’s market are among the limited holdings that a self-directed retirement plan cannot accept. This would not, however, bar you from securing an IRA-owned note
with a collectible asset. If you choose to accept prohibited property as collateral on behalf of your account, you would need to arrange for its liquidation so that your individual retirement account could receive the cash balance in its place. The use of collateral in an IRAowned transaction demonstrates the key benefit of directing your own retirement—you can tailor the lending relationship to suit your risk tolerance and due diligence requirements. If your primary retirement account is sponsored by your employer or otherwise managed by a third-party financial entity,
NOVEMBER/DECEMBER 2018
47
IR A APPROACH
you’re hoping they have the expertise to assess your needs and mitigate risk on your behalf. Without a personal or direct relationship with your broker or plan manager, this can be difficult to achieve. Some plan managers may be more inclined to disregard risk considerations altogether if they collect commissions, regardless of how your account performs.
SECURITY ADVANTAGES Even if you can self-direct a retirement account that holds
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PRIVATE LENDER
stocks, mutual funds or other publicly traded equities, you may not have access to the same security options as you would with private lending. You may be able to hedge against a downturn in your stock positions with put options or with ETFs that short-sell a particular index or the market in general—both of which provide opportunities to profit when equity prices fall—but these holdings can be just as susceptible to the volatility that occasionally impacts stocks overall. With a private lending individual retirement account, you
may exercise more control over your hedge strategy in the same way you can over the process in general. If you originate a loan and your borrower offers a piece of property as collateral, you can decide to accept it or request something else. If you’re invested in the Standard & Poor’s 500 index during a market correction but would rather not bet against a turnaround, your choices could be somewhat limited (again, assuming you can self-direct your stock-based retirement plan in the first place). Selfdirected retirement not only
provides the flexibility to buy, sell or exchange the alternative assets that meet your needs, it also provides the flexibility to dictate the specific composition of those assets. As a private lender, a potential way you could take advantage of this flexibility and mitigate a loss from default is by reducing your interest rates, encouraging borrowers to pay off lower balances, and offsetting your “losses” with individual retirement account tax benefits. You may not be inclined to leave profits on the table by offering lower interest rates,
but you may also conclude that a borrower will be more likely to repay a loan in full if their payments are lower. By favoring the tax advantages of your individual retirement account income over the immediate benefit of additional earnings, you may be able to tread more safely without sacrificing your bottom line. For example, let’s say your borrower needs $5,000, but you’re not entirely confident that he or she will be able to repay a loan at your typical interest rate of 10 percent. Let’s also assume you pay 25 percent in income taxes and have a traditional individual retirement account that allows you to deduct contributions from your annual income. I f you loan $5,000 of your
non-IRA money, you could charge your usual 10 percent. This would net you $500, but only if your borrower follows through.
I f you contribute the
$5,000 to your individual retirement account, you’ll save 25 percent ($1,250) in taxes before ever lending a dime. This would allow you to tailor the transaction to your
borrower, diminish the likelihood of a default and still enjoy a positive margin. By cutting your interest rate to 5 percent, the individual retirement account strategy would net you $1,500 ($1,250 in tax savings plus $250/5% of $5,000 in earnings) in near-term tax savings and retirement income. Another IRA-specific tool for managing risk is that you won’t owe taxes (assuming qualified distributions) on pretax contributions, and you won’t have to pay the IRS for an uncollectible asset in the event of a default. Despite your best efforts to prevent such an occurrence, you may be out of luck if you find yourself unable to collect some or all of a loan you issue with non-IRA money. On the other hand, if you lend your individual retirement account money and experience an unfortunate default, the tax deductibility of your retirement contributions would not be affected. This would apply for traditional IRAs and other such pretax accounts. Let’s look at the previous example using the $5,000 contribution. A loss of that principle would have no bearing on your $1,250 tax deduction. As such, lending money from a self-directed retirement plan can at least
help soften the blow of a failed lending relationship. You also wouldn’t have to worry about any tax ramifications from distributing the worthless note from your account. Withdrawals from pretax accounts are taxed as income under normal circumstances, but that wouldn’t apply if you undergo the proper process for zerovaluing the asset. Individual retirement account custodians may have slightly different zero-value requirements, but they all will likely require your written notification of the defunct loan and supporting documentation from a thirdparty evaluator. You may not be able to eliminate risk from your business model, but it can pay to evaluate new ways of implementing your proven investment method. This is especially true when you don’t have to worry about taking on added risk for the privilege of doing so. By originating loans from a self-directed retirement plan, you maintain control of your familiar process and earn tax-advantaged income for your golden years—all while minimizing your potential liabilities as much as possible. ∞
ABOUT THE AUTHOR
CLAY MALCOLM Clay Malcolm is the chief business development
officer at New Direction Trust Company. He oversees most
avenues of marketing, teaches continuing professional
education and informal classes and webinars, and facilitates the training of business
development and client
relations teams. New Direction
Trust Company is a self-directed
IRA custodian that assists more than 17,500 clients nationally. Mr. Malcolm, who has more
than 20 years’ management experience in various roles, draws upon his teaching
background to develop the
educational aspects of New Direction Trust Company
and impart knowledge about
self-directed IRAs to its clients and prospective clients.
Mr. Malcolm received his bachelor's degree in
communications from
Northwestern University. www.ndtco.com
NOVEMBER/DECEMBER 2018
49
MANAGE & LEAD
Humanizing Your Company Brand y Erica b LaCentra
Using social media “socially” can make your company more relatable to customers.
50
PRIVATE LENDER
What makes a company social media post effective? From a corporate perspective, it’s often any post that actively promotes the company’s products or services to potential customers. Many believe that visibility alone will eventually translate into business. That is very rarely the case.
One of the most common mistakes companies make when trying to reach customers via social media is to bombard them with gratuitous selfpromotion. The social media posts focus heavily on pushing products or services. Little thought is given to what customers want to see on their feeds. You wouldn’t have a one-sided conversation with a customer, telling them what you can offer but never asking what they do or what they are interested in, would you? So, on social media, why do so many companies talk at their customers instead of engaging with them? Because many companies approach social media marketing the same way they approach other marketing channels. Simply put, they neglect the most important aspect of this social media—that it’s social.
media marketing efforts. But here are five basic steps you can incorporate into your social media strategy to set it up for long-term success.
DEFINE AND STRENGTHEN YOUR COMPANY’S VOICE Regardless of the medium, your brand has a unique
voice. That voice should carry through any marketing effort your company executes.
Social media is no exception. In fact, companies that use social media to define and
strengthen their brand voice tend to have some of the
most successful social media marketing campaigns. For example, Wendy’s
executed one of the most successful social media
campaigns of 2017. They
There isn’t a foolproof way for a company to manage its social NOVEMBER/DECEMBER 2018
51
MANAGE & LEAD
decided to create a unique voice for their Twitter plat-
form. The “voice” had a quick
TELL STORIES
and pop culture, engaged in
Next, engage with your
and poked fun at competitors.
don’t revolve solely around
seems relevant to fast food,
promotion. Use the power
wit, referenced recent events
spirited banter with followers,
customers in ways that
While none of that really
customer service or product
Wendy’s experienced an
of storytelling to connect
profit in 2017 versus 2016,
example, if you are a lender
with your followers can make
loans, instead of posting your
almost 50 percent growth in
with your customers. For
proving that how you engage
that specializes in fix-and-flip
a huge difference.
program criteria, post prog-
You can replicate what Wendy’s did with your business. First, develop the right
voice for your brand, one
that your customers can best identify with. Think about
the qualities of your company that your customers enjoy, and then breathe life into
them. For example, if your
company is well-known for
its personable salespeople,
make your social media voice more casual and warm, as if you’re conversing with old friends versus selling to
customers. From there, make sure that all your messaging is consistent and carries the same tone across all your social media platforms.
ress updates on projects your customers are working on
encourage other customers to
mistake and offer a solution,
You could highlight unex-
experiences with your com-
the situation and keep your
and, ultimately, complete.
share stories of their positive
pected issues customers had
pany, perpetuating content.
the easier it will be to diffuse company’s reputation intact.
during their renovation and how they overcame those
challenges to finally succeed in their project.
This type of content creates a connection between your
followers and your company.
They become invested in what you are posting, increasing
the likelihood they’ll visit your social media pages in the
future to see how the “story”
is progressing. The best part is that followers still learn
about what your company
does and how they can use your products, without you
overtly selling to them. Plus,
you can use posts like that to
DON’T NEGLECT CUSTOMER SERVICE Finally, although you should focus on posting engaging content, you can’t neglect customer service entirely.
Always be prepared to han-
dle, fast and effectively, any issues that pop up. Have a
plan in place for situations
that require damage control, such as customers who post
negative reviews or customers who are looking for a
response to a critical prob-
lem. The worst thing you can
do is ignore the customer. The faster you can own up to your
DEVELOP AWARENESS AND BUILD YOUR REPUTATION In addition to using social media to define and
strengthen your company’s
voice, social media is a great way for you to build and
reinforce a credible, positive
reputation for your company. This approach will go a long way toward keeping you
top of mind with prospects
and guiding them to a place that will ultimately translate into business. Much like
having a plan in place when negative situations arise,
you should also have plans
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PRIVATE LENDER
videos, to sharing articles
they are finally ready to pull
you have the ability to track
commentary on the topic, to
sale is complete, make sure
can adjust accordingly and,
about the industry with your customer testimonials and
success stories. Get creative with your content to figure out the best way to pique interest with prospects.
the trigger. Once the initial you also have content that
what is and isn’t working, you ultimately, get to the point
appeals to recurring custom-
where social media is pro-
and they come back time and
hoped it would. ∞
ers, so you stay top of mind
viding the return you always
time again.
A strategy to spread awareness is just the beginning. Make sure you also have a
plan beyond initial awareness to guide customers to that final sale. Think about the
entire journey your customers in place to engage with
are taking.
prospects and customers at
All your content should have
with your company.
both prospects and return
every point of their interaction Developing a social media marketing funnel is key to taking your social media
strategy to the next level.
That starts with having a clear end-goal in mind. You may say, “Well, my end-goal is generating business.” So, how do you get there?
For prospects that may have
a call to action that will entice customers to interact with
your company in additional
ways. If you start a story about a customer project, remind
prospects to follow your page
so they can get updates. Posting pictures from events your
company attends? Encourage followers to sign up for your company newsletter so they can get exclusive access to
never heard of your com-
discounts on future events
social media content spreads
Any time you are posting on
pany, it’s important that your
awareness of what you do and how you fit in your industry.
Rather than relying on blatant
promotion, a better approach is to develop interesting
educational content. These posts could be anything
from short industry update
your company is attending.
D ON’T GET DISCOURAGED Once you have refined your
ABOUT THE AUTHOR
brand voice and developed
your social media marketing strategy it’s important to
think long term. For many
companies, it can take signifi-
cantly more time and effort to see a return on social media
than for other marketing channels. If you don’t see a return within the first few months of implementing a new strat-
egy, don’t get discouraged.
Positive return takes time. If
you have laid the appropriate groundwork, are working to
develop a following, and have
engaging, consistent messaging for your audience, you are
ERICA LACENTRA Erica LaCentra is the marketing manager for RCN Capital. She is responsible for planning,
developing and implementing RCN Capital’s strategic
marketing plan. After joining the company in 2013, Erica’s rapidly expanded RCN’s
customer base and elevated the company to a national
brand. She handles the creation
on the right track.
of the company’s traditional
social media, you should not
Like any marketing plan, it
management of paid search
the post is relevant to cus-
amount of flexibility with
customer, where do I go from
that some posts and content
for customers to engage with
others. Some of your content
only be thinking about how
is important to have some
tomers, but also “If I were a
your strategy. You will notice
here?” Offer numerous ways
get better engagement than
your company on social until
may fall flat. But don’t fret. If
and digital media, the
advertising, social media
marketing and email marketing as well as the coordination of tradeshow sponsorships and
event involvement. Erica has a bachelor’s degree in advertising with a minor is advertising
design from Suffolk University.
NOVEMBER/DECEMBER 2018
53
MANAGE & LEAD
MAKING YOUR TEAM WORK Struggling with a disconnected, disengaged team? Get back on track with time-tested advice and the latest research. by James Hart
H
ave you ever been part of a “team” that was anything but?
Maybe it was a study group back in high school. The building committee at church. The board of your homeowner’s association. Or—and this is where it might get a little painful—perhaps you’ve suffered from lackluster teamwork in your own business. Each story is a little different, but when teams aren’t clicking, the trouble usually stems from a few root causes: N obody knew exactly what they were supposed to do,
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PRIVATE LENDER
or even what the team itself was trying to achieve. A few team members
dominated the discussion, so other viewpoints weren’t heard.
S ome people didn’t do their job, or they did it carelessly.
T he group couldn’t get along. They bottled up
disagreements, refused to communicate and simply didn’t trust each other.
So, what can you do about it? What are the trademarks of a healthy, productive team— and how can you put them to
work in your lending and real estate business?
and leading teams. Here’s what should happen at each stage:
THE LIFE CYCLE OF A TYPICAL TEAM
Forming // This is where it all begins, where your team outlines its goals and the timeline it’s working against. It’s also where individual team members start forming relationships and learning about each other’s skills and personalities. There’s not much conflict because everyone’s still feeling each other out and being polite.
As it turns out, most teams go through the exact same growing pains. In 1965, psychologist Bruce Tuckman introduced the ideal “life cycle” of a team—Tuckman’s theory of group development. It’s made up of five phases: forming, storming, norming, performing and adjourning. Over the years, Tuckman’s theory has become one of the bestknown models for developing
At this point, it’s important for the leader (i.e., you) to provide structure and direction. Explain the team’s goals, assign tasks, introduce rules and be an example of the kind of behavior
you want to see from the group. Experts also recommend getting more familiar with your team members’ skills and desires. What do they want to achieve? Storming // The second stage is what happens “after the honeymoon.” Team members now know each other better—and that includes their annoying habits and personality quirks. They’re also starting to voice their own opposing opinions. You might also see some jockeying for position and authority, even if it means challenging yours. See why they call it “storming”? It’s the most dangerous stage of a team’s development.
Your leadership is critical here. Hear your people out when they have frustrations or feedback for improving things, and be willing to adopt their ideas when it makes sense. You’ll also need to coach your team through conflicts and “lower the temperature” during disagreements. Norming // The group starts gaining momentum. Team members might not love everything about their co-workers, but they’re also more aware of the other person’s strengths, so they can respect and tolerate differences. Everyone starts focusing on the group’s goals.
You’re still an important part of the team, but you’re doing more coordination and delegation. Your individual team members are shouldering more responsibility. Performing // This is what every leader wants: the team is executing its mission at optimum efficiency, usually without the need for a lot of supervision. If there are conflicts, they’re usually resolved without a lot of fuss. One warning: Don’t get too comfortable. It’s important to keep an eye on team dynamics for any signs of slipping back into earlier stages. Backsliding
happens, especially if employees are leaving or joining the group. Adjourning // Everything ends, including highly effective teams. As your team finishes its work, celebrate their contributions, and look back at everything you learned along the way. What wisdom will you take with you to your next team?
LET ‘EM TALK: WHY COMMUNICATION IS CRUCIAL Encourage your team members to talk to each other, and you could end up boosting their job performance, according
NOVEMBER/DECEMBER 2018
55
MANAGE & LEAD
to a recent study from the University of California, Santa Barbara.
THE TRUTH ABOUT TEAM-BUILDING
As part of the study, teams of four were asked to complete a series of tasks in one hour. Researchers rated their performance and then looked at how well each team’s members communicated with each other.
Getting your team members familiar with each other can be a good thing—up to a point.
High-performing teams chatted with each other often and early. And it helped that individuals had the ability to communicate directly with each other, without going through an intermediary. Tools like Slack (slack.com) are one way employers can encourage this. One caveat: It’s not clear if good communication caused high performance, or if highperforming teams simply did a better job of staying in touch. “Figuring out the true causal relationship between collaboration dynamics and performance outcomes is probably the biggest [question in] future work,” said Victor Amelkin, the study’s lead author.
That’s the takeaway from research generated by the University of Connecticut. Professors studied team productivity at a supply chain company that operates in 10 different countries. Because so much business is done internationally, more companies are relying on “virtual teams” that live in different time zones and may never set foot in the same building. Virtual teams can often feel disconnected, and they don’t do as well with complex projects as teams that meet in person. The UConn team wanted to see if greater levels of familiarity could help virtual teams overcome that disadvantage. So, the researchers surveyed more than 360 employees from 68 teams about their co-workers. Questions covered their colleagues’ competencies, reputation, hobbies, family, attention to detail, likes and dislikes, and more. Then the research team looked at how productive each team
“Effective teams are also dependable— everyone’s pulling their weight. They have structure and clarity, so everyone knows what they’re supposed to be doing. Individual members also feel confident their work is making an impact on the team’s goals.”
was, using self-evaluations from the survey respondents and ratings from their managers. The most productive teams tended to know a lot about each other professionally. For example, they might know if one co-worker had special training or was especially skilled at a certain task. “We want teams that function well and are efficient,” said John Mathieu, a UConn professor. “We found that those that were professionally familiar did well.” But knowing a lot of personal information about your team? It didn’t really move the needle.
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PRIVATE LENDER
If anything, researchers warned, becoming overly familiar could be a drawback. Team members might fail to hold each other accountable for their work if they view each other as friends first.
THE 5 ESSENTIAL INGREDIENTS OF EFFECTIVE TEAMS A couple of years ago, Google decided to ask itself an important question: “What makes an effective team at Google?” What its researchers learned could benefit your team, too.
02 C an we count on
each other to deliver high-quality results on time?
03 A re our goals, roles and execution plans clear?
04 A re we working on
something that is personally meaningful to each of us?
05 Do we fundamentally
believe that the work that we’re doing matters?
If you get a “yes” to each of those questions—not just from yourself, but your team members, too—then you’re in great shape.
Project Aristotle—named for the philosopher’s belief in the “whole being greater than the sum of its parts”—studied more than 180 internal teams, completed hundreds of interviews and built 35 statistical models as part of the effort. The No. 1 simply-must-have ingredient for an effective team? Psychological safety. Or, as Google defined it, “a shared belief held by members of a team that the team is safe for interpersonal risk-taking.”
It means that mistakes won’t be held against a person. That it’s possible to ask team members for help. And that it’s OK to take risks or express opinions without being undermined or rejected for being different.
making an impact on the team’s goals. And they’re able to find personal meaning in their role, whether it’s as a vehicle for using their talents or simply making enough money to be self-sufficient.
Effective teams are also dependable—everyone’s pulling their weight. They have structure and clarity, so everyone knows what they’re supposed to be doing. Individual members also feel confident their work is
You can boil it down to five questions, Google’s team reported:
01 C an we, as a team,
take a risk without feeling insecure or embarrassed?
Most of us, though, have room for growth. Google has provided a list of recommendations as part of Project Aristotle, which you can find at www.bit.ly/2hIMC2y. Is it difficult to build an effective team? Frustrating? Absolutely! Just remember: As an entrepreneur—as a human being—you’ll accomplish so much more with the support and encouragement of other people. Keep learning, and keep trying. The energy you invest in teamwork will pay off. ∞
NOVEMBER/DECEMBER 2018
57
LEGAL
Your Guide to Real Estate Investing How to navigate the pros and cons of various real estate investment vehicles. by Bryan Redington
Real estate has been a reliable builder of wealth for generations. The first thing people consider when thinking about buying and owning real estate is their home. Buying physical property is not just about home ownership, however. It has become a popular investment for many people who want to diversify their portfolio. Various investment vehicles for real estate exist. Investors must carefully consider the opportunities and the pitfalls of each.
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PRIVATE LENDER
OWNING RENTAL PROPERTY Rental properties have been around since the nation’s founding and have been used not only as a source of income but also as a wealth generation tool. With a rental property, the owner and landlord are responsible for paying the mortgage, taxes, insurance and maintenance costs for the property. Typically, a landlord buys a rental property with the hope that the amount of rent received will cover most, if not all, the costs associated with owning it. This strategy requires patience, as there may not be enough rental income to provide much profit until after the mortgage is paid off. Once the mortgage is paid off, however, most of the rent collected becomes profit and the property is considered a “cash-flowing” property. Appreciation is another benefit to owning rental property. As long as you own the property, you receive all the value that comes with the property's appreciation in value. On top of cash flow, it is the most significant benefit of owning a rental property. Based on the location of the property, appreciation rates may vary, but the value of the property can increase by double digits over a relatively short period.
Investors must take into account the location of the rental property they are considering— proximity to schools, work areas and transportation hubs—and the rent that can be demanded for the neighborhood. The neighborhood where the property is located will influence both the type of tenants you will attract and the vacancy rate. By choosing the right neighborhood, you reduce the risk associated with high tenant turnover rates. Choose the wrong area, and you may be saddled with bad tenants, lower rent and damage to your property. A rental property will often need exterior and interior work after it is purchased. The difference between being a landlord and participating in other types of real estate investments is the amount of time you must spend renovating and maintaining the property. You could hire a professional management company, but then, of course, you would have to deduct that expense from any potential profits from the property.
FIX-AND-FLIP PROPERTIES The “fix-and-flip” strategy is the opposite of buy and hold. It works like trading stocks, in that an investor identifies an asset that could potentially make a profit, purchases the asset and “flips” it for a profit.
property or a portfolio of rental properties; however, a RELP holds these properties for only a specific number of years. An experienced real estate property management company typically acts as the general partner. Individual investors are invited to provide financing for the venture in exchange for an ownership share of the limited partnership. Most investors who employ this technique buy homes with the intention of holding them for only a few months and then reselling. The strategy can be challenging because the investor needs to identify properties that are significantly undervalued for their neighborhood while ensuring that the cost of renovation will not eat up too much of the potential profit. Another challenge is that the improvements to the property must be appealing enough to compel prospective buyers to accept the market price; however, there is a risk. An investor who is unable to sell the property has to carry the expenses associated with the property, namely, the mortgage and maintenance. The costs associated with this type of investment are high. Many times, flippers need to take out a short-term loan, typically with a much higher interest rate than a traditional mortgage, to outbid competi-
tors. If the property doesn’t sell or they run into problems with the renovation, the investor may get stuck making those high mortgage payments for many months, or be forced to dump the property for a loss.
REAL ESTATE INVESTMENT GROUPS Real estate investment groups are a type of investment vehicle, similar to a mutual fund, that invest into rental properties in specific markets. This strategy is a good investment for those who like the idea of owning rental properties but don’t want the headache associated with collecting rents, maintaining the property and filling vacancies. Under this scenario, a management group builds or buys rental properties, typically apartment buildings and multifamily dwellings, and holds them in a rental portfolio. Individual investors are then asked to join the group with one or
more properties that they own, but the management company takes care of the duties related to operating all the properties in the group. In exchange for overseeing the group of properties, the management company receives a percentage of the total rents collected. Typically, the investor still holds the lease for his or her property, while contributing a portion of the rent into a fund each month to cover the management fees and other shared group expenses. There are several variants of this type of real estate investing group depending on the type of property you own, the area where the property is located and the kind of returns your property generates.
REAL ESTATE LIMITED PARTNERSHIPS Like an investment group, a real estate limited partnership (RELP) holds and maintains a rental
The partners in the venture typically receive periodic income distribution based on the rental income the group of properties generates. At a later date specified by the terms of the partnership, the properties are sold for a profit, the partners split the proceeds and the RELP is dissolved. This investment strategy allows investors to participate in the real estate market without having any previous real estate investing or management experience. The downside is that since the properties are held for a specific period, the money you invest may be tied up for quite some time.
REAL ESTATE INVESTMENT TRUSTS A real estate investment trust (REIT) is similar to a RELP, except the properties form a holding trust. The trust is converted to certificates, similar to
NOVEMBER/DECEMBER 2018
59
LEGAL
a stock, which are then sold off to individual investors.
of real estate investments than provided by REITs.
In a REIT, a corporation acquires a group of incomegenerating properties that it holds and manages. These properties may include medical buildings, office buildings, malls or other high-capacity rental properties. The money raised from the certificate sales is used to finance the purchase of additional revenue-producing properties to be held by the trust.
The advantage is that novice investors can get involved in real estate after making an educated and informed decision. Mutual funds have a wealth of analytics and other data that can provide investors with all the tools they need to diversify their investment into sectors of the industry that make the most sense for their investment goals.
The revenue generated from mortgages or rents on the REIT’s properties is distributed to the certificate holders on a regular basis. It is a good strategy for real estate investors who want a steady rental income without the hassles of being intimately involved in the buying and management of physical properties.
WHY REAL ESTATE IS A GREAT INVESTMENT
REAL ESTATE MUTUAL FUNDS Real estate mutual funds invest in REITs and other real estate-related companies. This strategy allows individual investors to dabble in real estate without risking much capital. Mutual funds invest in a diversified group of real estate assets, therefore reducing the investor’s risk and exposure. They allow individuals to participate in a broader range
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PRIVATE LENDER
Real estate has proven to be a great wealth-generating tool over the past several decades. Even after you factor in the housing crisis of 2008, private commercial real estate investing returned 8.4 percent annually over the decade of 2000–2010. Real estate investing is also a great way to diversify a portfolio of stocks and bonds. Historically, real estate has low volatility compared to the stock market. While stocks can lose nearly all their value, it is improbable the same will occur with physical real estate that you own.
DIVERSIFICATION OF YOUR ASSET PORTFOLIO With real estate, an investor can hedge against a market
downside by owning tangible assets, with low risk of severe devaluation. Real estate has a negative correlation to the stock market, meaning that when the stock market drops, real estaterelated investment products are usually up. Although the Great Recession was somewhat of an anomaly, residential real estate prices continued to rise after 14 of the last 15 recessions.
help investors hedge against wild stock market swings, provide appreciation and a steady income stream, and improve balance to an investment portfolio of securities and other physical assets. ∞
ABOUT THE AUTHOR
INFLATION HEDGE During expanding economic conditions like we are experiencing now, demand for housing rises. When demand rises, rents and values rise along with it. In this respect, the correlation between gross domestic product (GDP) growth and real estate passes some of the inflationary pressure onto tenants, while generally retaining the purchasing power of the investor's capital.
FINAL VERDICT Real estate investing makes good sense to balance out an investor’s portfolio of stocks and bonds, mutual funds and physical commodities. Although real estate investing is generally accepted as an “alternative investment,” it can
BRYAN REDINGTON Bryan Redington is a
transactional associate in the banking and finance
section of Geraci Law Firm. He obtained his bachelor’s degree in American law
history from the University of California, Berkeley in 2010 with cum laude honors. He graduated from University
of Oregon School of Law in
2016. His experience includes representing lenders and brokers, preparing loan
documents, as well as drafting assignments, extensions,
modifications and agreements.
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ALTERNATIVE ANGLEÂ
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PRIVATE LENDER
WHY THE HOUSING MARKET SHOULDN’T FEAR A RECESSION Even in a downturn, opportunities exist for private lenders. by Robert Greenberg
T
he nation’s longest economic expansion in history is still underway, but eventually all good things must come to an end. When exactly the expansion will turn into a contraction is still anyone’s guess, but the housing and private lending markets are sure to be impacted when the next correction does occur.
While economic experts point to low imminent risk of recession over the next year,
surveys have predicted it could arrive between 2020 and 2022. Any number of issues could potentially push the country into recession: an asset bubble, geopolitical issues, a trade war, energy price spikes, or a variety of unforeseen shocks to the U.S. economy or to an interconnected market abroad. As a subset of the real estate market, a more appropriate question for private lenders might be “what?” not “when?”— as in “What will the private lending market do about the recession when it arrives?”
LESSONS LEARNED FROM THE LAST HOUSING CRISIS The mortgage market gained significant knowledge during the Great Recession, which should help inform it when the current real estate cycle wanes. The 2007 popping of the housing bubble—and the mortgage securities that backed questionable loans—got much of the blame for the 2008 financial crisis that dipped the country into a deep recession.
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While the recession officially ended in June 2009, it took far more time, into 2012, before housing hit a price floor and began to rebound. Mortgage credit tightened significantly during that time, as mortgage lenders and banks sought to shore up their finances and deal with the aftermath of delinquencies, defaults and foreclosures. The financial system is less leveraged today than it was when MBS secured subprime mortgages of questionable value. Loan quality is far better, and borrowers’ ability to repay their mortgages is stronger. The Office of the Comptroller of the Currency’s quarterly report on mortgages reports that 95.6 percent of mortgages were current and performing at the end of second quarter 2018, compared to 95.4 percent a year earlier. At the height of the foreclosure crisis, that number was between 86 and 87 percent. If and when the market does correct, mortgage lenders likely won’t be so quick to foreclose. Using experience gained during the last recession, they’ll make a concerted effort to work with borrowers who are delinquent via modifications
“The mortgage market gained significant knowledge during the Great Recession, which should help inform it when the current real estate cycle wanes.” and other assistance that will keep their loans active and their borrowers in their homes. Homeowners and real estate investors also have more equity in their residential properties today than they did when the Great Recession hit. That should provide a buffer if home valuations decline. A CoreLogic analysis shows that 2.2 million homes, or 4.3 percent of mortgaged homes, were in negative equity in the second quarter of 2018. In comparison, negative equity peaked at 26 percent of mortgaged residential properties in the fourth quarter of 2009. The figure is based on CoreLogic equity analysis the firm initiated beginning in the third quarter of 2009.
PRIVATE LENDER OPPORTUNITIES AMID A RECESSION While private lenders aren’t in a position to prevent a recession, they can and should adhere to sound financial business practices to lessen potential negative impacts. While loan volume will likely drop if the economy contracts, lenders will also have the opportunity to lend in a contracting market. One of the biggest opportunities will be to grow their client base of opportunistic real estate investors, who are increasingly using financing to buy and flip (or hold) homes. Among home flips completed in the second quarter of 2018, 38.6 percent were purchased by the home flipper with financing, according to ATTOM Data Solutions. In some states—Rhode Island, Colorado, New Hampshire, Minnesota and Washington— more than 50 percent of flips were being purchased with financing, according to second quarter numbers. Of homes flipped in the second quarter, 32.3 percent were distressed sales, down from 38.7 percent a year ago and down from a peak of 68.2 percent in the first quarter of 2010, which was in the middle of the housing crisis.
HOW TO SURVIVE AND GROW IN A DOWNTURN Savvy real estate investors have had a strong ride for about 10 years now as distressed housing provided ample opportunities to build their residential portfolios at discounted prices. Combine that with six years of rising home prices, strong homebuyer demand and increased single-family rental demand, these investors have toiled in a favorable market. Still, it certainly has become more challenging in recent years as home prices have risen and inventory has been in short supply. The housing market continues to experience inventory shortages nationwide, and an economic slowdown may contribute to a more balanced housing market. A balanced housing market where supply more adequately meets demand can be viewed as a healthy development, which should temper concerns about affordability and asset bubbles. It will also provide the opportunity for millennials to become first-time homebuyers— or even purchase investment properties, especially in areas of the country where
millennials are earning high wages and prefer to remain a renter but like the option of owning investment property. If the market does contract, real estate investors likely will once again see an opportunity to buy real estate at more reasonable prices. Additionally, they will be able to make their cash go further by using leverage that can be achieved via a partnership with a private lender. While certain players may view housing acquisitions during a recession as capitalizing on someone else’s misery, especially if the deal involved a foreclosure, real estate investors were credited with lifting housing off the floor and turning it around in 2012. Investors—and financing from private lenders—can come into distressed neighborhoods and turn them into the thriving communities. Private lenders could play a large part in a future turnaround once a market correction does hit. The lenders who will benefit the most, however, are those who begin preparing now to take advantage of that opportunity. ∞
ABOUT THE AUTHOR
ROBERT GREENBERG Robert Greenberg is chief
marketing officer for Patch of
Land. His professional experience includes over 25 years in marketing, working with
familiar consumer brands such
as Pepsi-Cola, Anheuser-Busch and Sara Lee as well as B2B
experience in retail, technology, finance and real estate.
Recently, he led the marketing efforts for B2R Finance, where
he helped originate more than
$1 billion of real estate investor loans that led to the industry’s first-ever multi-borrower sin-
gle-family rental securitization. At B2R, he was responsible for branding, corporate commu-
nications, lead generation and integrated marketing efforts.
He was responsible for leading the development and implementation of the marketing
automation and CRM platform that helped to deliver sales
management and operational efficiencies to enhance the
customer experience for real estate investors nationwide.
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We’re Geraci. And we’re here for you. Our main goal? Providing you peace of mind. As a full service real estate finance and banking law firm, Geraci’s team of passionate experts work tirelessly to provide you and your company peace of mind. From drafting documents to creation of mortgage funds, litigation to reviews, we have your needs completely covered. We also believe time is money, and we bet you do, too. That’s why we promise dedicated constant communication, accountability, and insist on going the extra mile—all at no extra fee. Whether you’re a small private lender or a national full-service bank, contact us today to discover how our team can best serve you. Visit www.geracilawfirm.com or call (949) 379-2600 for more information.
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