Fairfield Financial Services, Inc. - Private Money Loans, Lending & Borrowing

The Private Money Investor

Rehab and construction loan FAQ

March 8th, 2010

Clay Sparkman

One of the most promising areas for at the moment for real estate investors, by all indications, is REO, rehab, and quick flip of properties.  The opportunity to buy distressed properties at a low price point is evident in many markets.  And yet it is difficult for most end-buyers (with a non-profit initiative) to take advantage of these opportunities, as they are not prepared to deal with the financing challenges or the rehab work involved when buying one of these properties.  Thus comes a wonderful opportunity for those real estate investors who can size up a market effectively, move to buy challenged properties at below value prices, rehab them quickly, and get them back onto  the market at a slightly below market price.

Another point in favor of this brand of real estate buying/investing:  Real estate investors who either (a) buy and sell quickly or (b) hold for the long haul are not as likely to get hurt by falling market values.  It is those who are planning to hold a property for 1-5 years that are in the most danger.

And as we know, what is good for the borrower in this business is generally good for the lender as well;  these types of loans may be some of the best that private money lenders can expect to see for the next year or two.

With these thoughts in mind, it seemed appropriate to duplicate here the Rehab and Construction loan FAQ that I publish on my company website.  Keep in mind that it is directed primarily toward brokers and borrowers, though much of the information will be of interest to lenders and potential lenders as well.  And also note that it is about private money mostly, but does discuss the topic from a Fairfield-centric point of view.

At any rate, I tend to receive an endless parade of questions from lenders, brokers and borrowers as to how to best structure these types of loans, so here is an example (representative I think) of how one organization goes about it.

REHAB AND CONSTRUCTION LOAN FAQ

What is your maximum LTV ratio for rehab and construction loans?

Well, it is important to talk about front-end and back-end LTV. Our maximum back-end LTV is 75% and our maximum front-end LTV is about the same (with a little more flexibility), though in the present market we try to keep that closer to 70%.

What do you mean by “back-end LTV”?

By back-end LTV, I mean the LTV at the completion of the project. For example: let’s say a borrower needs $100,000 for the acquisition of a property and $20,000 for construction funds and thus wishes to borrow $120,000. If the completion value of the property is conservatively figured at $185,000 based on comps provided by the borrower, the back-end LTV will be 120/185 or 65%.

Okay, so then what is “front-end” LTV?

Front-end LTV is the LTV immediately upon the closing of escrow but prior to any construction. In the example above, it is a little tricky to talk about the current value of the property since it is a fixer (and fixers are tough to comp directly), but if we determine that the AS IS value of the property is $135,000 then the front-end LTV is 100/135 or 74%. Generally with rehab projects, if the back-end LTV is in-line then the front-end LTV will be in-line also. This is because with rehab projects, the profit is made in the buy, not in the construction.

With construction loans, on the other hand, it is usually the other way around. The profit is made in the construction and generally not in the acquisition of the land. So with construction loans, we need to work a little harder to make sure that the front-end LTV is in order.

Do you require an appraisal?

For rehab projects, rarely ever do we ask for an appraisal. We know that professional investors must move quickly and that they are frequently the best source for data regarding the projected value of their project. If an investor tells me that he expects to sell a property for $200,000 upon completion, I say, “Show me how you have come to this conclusion.” A good set of comps is frequently enough.

With construction projects, it is a little tougher sometimes to get a handle on the completed project, so on occasions, we will ask for an appraisal.

Are you able to loan 100% of hard costs?

Yes, and sometimes we are able to finance the soft costs as well. Our very strong repeat borrowers are sometimes able to leverage 100% and are not required to bring any money into the project. It really depends on two factors: (1) How strong is the borrower? And (2) How well is he buying?

How does the construction money get disbursed?

From time to time, as a borrower completes the construction of a project, the borrower will submit a draw request to Fairfield Financial. Fairfield will review this request and, upon approval, release funds either directly to the subs/suppliers (if requested to do so) or to the borrower (if the borrower has already paid the subs/suppliers). Fairfield is responsible for ensuring that (a) the work is completed to an appropriate quality standard, (b) the project is on-budget (or if not on-budget, appropriate adjustments are made), and (c) that all subs and suppliers get paid for their work on the project. Borrowers are encouraged to make as many draw requests as they require, and if a request is complete and valid, we can generally disburse funds within 48 hours.

How much experience do you require from the borrower?

Well, it is nice to see a borrower come in with a little experience, but I have learned over the years that success in this business isn’t as much about experience as it is about common sense and the willingness and the ability to work tenaciously toward the completion of a project. So if you don’t have experience but you can show me that you have the drive, the discipline, and the common sense, I’ll give you a chance.

What sort of credit and financial stability do you require from the borrower?

We don’t have specific underwriting guidelines. As far as credit, I am not looking for a perfect credit score (though we do have quite a few borrowers with credit scores in the 700s). I am looking at a pattern of payment over time. If a person has had a few bumps in the road or even a BK, for example, along the way, this doesn’t bother me. What concerns me is the borrower who has consistently shown a disregard for debt obligations over a period of time. I probably won’t want to get into a project relationship with this person.

Regarding financial strength (net worth and income), my primary concern is seeing that the borrower has either enough income (stated) or enough cash or liquid assets (stated) to get through the project (even if setbacks occur). That means showing the capacity to (a) make payments for the duration of the project (if an interest reserve account has not been set up) and (b) weather a few bumps in the road if the project doesn’t go exactly as planned. Beyond that, we don’t expect our borrowers to have any great wealth. We know that they are in the process of attempting to build something, and sometimes that starts from practically nothing.

What is the term of your loan and how are the payments handled?

The term of the loan is generally one year, though if a project is expected to require longer, we can make a loan for two years or more. Payments are made monthly and are interest-only. If there is enough equity in a project, we can arrange to have some number of payments held in reserve and applied to the loan for the initial period of the project.

What are your rates?

For this sort of thing, rates generally range from 11-14%. The rate is determined by (a) the LTV, (b) the strength of the borrower, (c) the amount of leverage involved, (d) the merits of the overall project, and (e) the perceived volatility of the local market.

Does the borrower pay interest on the full amount of the loan or only on the funds that have been disbursed?

The borrower must pay interest on the full amount of the loan for the duration of the loan. The funds are being held in trust by Fairfield Financial on behalf of the borrower. As such, the funds are not available to the lender throughout the duration of the loan and thus the lender has committed these funds and cannot utilize them in any way or earn interest.

What fees are involved?

We charge a loan fee equal to 5% of the gross amount of the loan. We also charge a doc prep fee (generally $500) and a collection account setup fee which is based on the size of the loan and averages about $120. There are no hidden junk fees.

Can the fees be paid from the proceeds of the loan?

Yes, if there is enough equity in the project. This is frequently the case.

Is there a pre-payment penalty?

Typically there is no pre-payment penalty.

What happens if there is money left in the construction account upon completion of the project?

Once the borrower has demonstrated that the project is 100% complete, we will disburse any remaining funds in the construction account to the borrower. Otherwise, these funds will be credited to the borrower at the closing of escrow.

What is the approval process?

There are basically four steps.

  1. The borrower (or a representative for the borrower) runs the project concept by us. If we like the project concept and feel that the numbers are acceptable, we proceed to the next step.
  2. We review a complete loan packet. We ask that this be sent via overnight mail or delivered to the office (fax copy is not acceptable). The packet should include the following items:
    1. 1003 for each borrower/personal guarantor
    2. Credit (tri-merge) for each borrower/personal guarantor (or permission to pull credit)
    3. Company financials if the borrower is an entity (2 years)
    4. A privacy notice signed by the borrower
    5. A purchase agreement (when property acquisition is involved)
    6. A preliminary title report (if available)
    7. A detailed line-item budget for all construction work to be done on the project
    8. Plans (for all construction loans, and for rehab loans that involve changes in the basic floor plan)
    9. Borrower’s estimate of the completion value of the project, and comps (or other value analysis) to support this estimate
    10. Photos of the subject property
    11. Borrower credentials
    12. A copy of contractor license, bond, and insurance (for all construction loans)
  3. If all this checks out, we ask the borrower for a deposit (generally somewhere between $500 and $2000). This should be in the form of a cashier’s check or money order. We provide a conditional loan commitment letter at this time.
  4. If the property checks out, we draw up the documents and close the loan through escrow.

Is the deposit check refundable?

If we close the loan through escrow, the deposit is applied as a credit to the loan fees. If we don’t close the loan because (a) the borrower does not or cannot perform or (b) the project upon inspection is significantly different than as represented, we keep the deposit to reimburse us for our costs. Otherwise, if Fairfield fails to perform for any reason, we return the deposit to the borrower.

How long does it take to put the loan together?

We generally ask for a minimum of two weeks from the time we review a project packet until closing.

—

Up next:  An interview with Grover Sparkman, founder and President of Fairfield Financial, with over 40 years of experience brokering notes/trust deeds/contracts and making private money loans.

– Clay (clay@privatemoneysource.com)

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Private Money FAQ

February 28th, 2010

Clay Sparkman

I realized early on that one of my greatest challenges in the private money lending business was to educate brokers, borrowers, and ultimately lenders regarding private money lending–what it is and when and how and when it should be used.  So many people know so little about it, and those who think they know quite often embrace vastly inaccurate ideas and misunderstandings.

It is quite amusing to watch people’s eyes glaze over when they ask me what I do at a cocktail party.  Usually that conversation doesn’t last very long.    People who aren’t interest are very uninterested.  However, people who are interested–and they are certainly the minority, this is a niche area after all–are immensely interested and seem to be insatiable.  I often have to terminate conversations with potential borrowers, brokers, and investors after an hour or so and suggest that we get back to it and cover the material over a series of one or more future conversations.

Moving on, I decided that it was one of my missions in life to educate agents and potential users of private money.  16 years later, I don’t know how much progress I have made, but I keep on trying.  Certainly that is what this blog is about.

I thought it might be informative to duplicate here the FAQ that I publish on my company website.  Keep in mind that it is directed primarily toward brokers and borrowers, though much of the information will be of interest to investors and potential investors.  And also note that it is about private money mostly, but does discuss the topic from a Fairfield-centric point of view.

At any rate, I hope you get something out of it.

Private money FAQ

Private money is often misunderstood. Many industry professionals know very little about it, and fallacies and misconceptions tend to dominate the collective wisdom.

What is private money used for?

Private money is generally used as a bridge: a way to get from point A to point B. It is generally a short to medium term solution (1-6 years), and there is nearly always an exit strategy going in. It is used for all types of real estate secured financing: commercial retail, restaurants, hotels/motels, marinas, elder care facilities, industrial, agricultural, raw land, land development, construction, rehab, multi-family, single family homes, manufactured homes, and floating homes. For a list of our loan programs, click here.

What are the interest rates?

Private money rates generally range from 10 to 15%. The rate is determined by looking at a combination of factors: (a) LTV ratio, (b) strength of borrower, (c) condition/desirability of property, (d) actual cash-in or real equity contributed by borrower. Typically our rates fall in the 12-13% range. A list of our loan guidelines may be found here.

What fees are involved?

We generally charge a loan fee equal to 5% of the gross amount of the loan. We also charge a doc prep fee ($500 or more, depending on the size of the loan), a property inspection fee ($650 or more, depending on the location of the property), and a collection account setup fee which is based on the size of the loan. There are no hidden junk fees.

Can the fees be paid from the proceeds of the loan?

Yes, if there is enough equity in the project. This is frequently the case.

Is there a pre-payment penalty?

We generally don’t have a pre-payment fee but occasionally we have a 3-6 month minimum interest clause minimum interest clause for our loans. For instance, it means that if a borrower repays a loan in 3 months or more, there is no penalty. If the borrower repays the loan, for example in 2 months, then the borrower will have to pay an extra month’s interest out of escrow at closing.

Why would anyone pay those kinds of rates and fees for a loan?

There are many reasons why a borrower would choose to use private money over a cheaper institutional option. For example, professional real estate investors like to use private money when buying because they are able to make offers which are not constrained by long time lines and numerous rigid conditions. Often times speed is a very significant factor in completing a profitable transaction and in those cases it often makes sense to pay for a short-term private money option rather than loose the deal. Frequently the condition of a property won’t allow for the initial financing with conventional money, and in those cases private money may be used. Often the type of property is a factor: banks don’t like lending on raw land and lots, but private money lenders are more inclined to do so. Cash leverage is another factor. Fairfield Financial, for example, loans based on the true value of a property, not the purchase price, so sometimes we lend 100% of the total acquisition cost for a property. The structure of the deal may be a factor. Most private money lenders allow the buyer to establish their equity through the mechanism of a seller carry back; banks won’t do this. The list goes on and on.

What is the most common use for private money?

Our most common loans are probably construction, rehab, and land development loans. We have an entire FAQ devoted to these loans: see the Rehab and Construction Loan FAQ.

We have been known to close loans in a matter of a week, but more typically, you should figure on 2-3 weeks. (Keep in mind that it is only possible for us to move quickly if the borrower, broker and other third parties are moving quickly as well.)

Is an appraisal required?

Some private money lenders require them. We don’t. Evidence of value is a critical part of the private money loan process. However, it is our opinion that a good set of comps is just as effective in establishing value as a good appraisal. Many of our borrowers are professional investors, and we feel that they are qualified to perform the value analysis. This allows us to streamline the process. However, it is important to note that putting together a god set of comps is hard work. See this article on our website for a detailed description of how to prepare a proper value analysis.

As a mainstream mortgage broker, I don’t see much of this type of thing. Why should I be interested in private money?

To be perfectly frank, it is my belief that mainstream mortgage brokers are being squeezed out of the industry. Lenders are ramping up their operations to better provide online loan sourcing directly to borrowers. We saw a similar thing in the travel industry over the past years. The travel agents that have survived, and even thrived, are the ones who effectively established niches within the industry. It is my belief that the same will be true for mortgage brokers. Plain vanilla loans can be easily processed in an assembly line fashion which easily translates to the world of the novice and a web browser. Niche lending, on the other hand, tends to be a hand-crafting of sorts, and cannot be easily automated. Look at private money. There are no absolute rules. Many factors must be considered in making a decision and frequently those factors are intangible. Ultimately a high degree of thought work and common sense is involved. Private money will always be a people process. So if you tell me, “I am not interested in private money because I don’t do unusual loans,” I say to you, “You might want to reconsider.”

As a mortgage broker bringing you this transaction, how do I get paid?

It is simple. You bring us a borrower. We price the loan to you. (Think of yourself as a wholesale buyer.) You price the loan to your client, adding your fees as appropriate. You stay involved in the loan (or not) as you choose, and prior to closing, you submit a fee demand to escrow and receive a check directly from the title company. For more information on this topic, Click Here.

Why do they call it “hard money”?

It is difficult to find an answer to this question. I’ve heard plenty of speculation. Some people say that it’s because the money is used for “hard to do” loans. Others say it is because the loans are “hard to get” or “hard to pay.” It is my belief that it is called hard money because traditionally it has been “real money” in the sense that it is not borrowed. Institutions loan borrowed money, and in this sense they loan “soft money.” However, I must point out that things have changed a bit over the years, and these days a good deal of hard money is in fact borrowed. (I would guess as much as 50%.)

How do I go about doing a private money loan with Fairfield Financial?

There are basically four steps.

  1. First, run the concept by us. You may call and discuss the loan with us, or you may e-mail a summary, or you may use our online loan submission engine, which will walk you through the process. If we like the project concept and feel that the numbers are acceptable, we proceed to the next step.
  2. We review a complete loan packet. We ask that this be sent via overnight mail or delivered to the office (fax copy is not acceptable).
  3. If all this checks out, we ask the borrower for a deposit (generally $1,000 to $3,000). This should be in the form of a cashier’s check or money order. If requested, we provide a conditional loan commitment letter at this time.
  4. If the property checks out, we draw up the documents and close the loan through escrow.

Is the deposit check refundable?

If we close the loan through escrow, the deposit is applied as a credit to the loan fees. If we don’t close the loan because (a) the borrower does not or cannot perform or (b) facts or parameters of the loan are significantly different than as represented, we keep the deposit to reimburse us for our costs. Otherwise, if Fairfield fails to perform for any reason, we return the deposit to the borrower.

How does the construction money get disbursed?

From time to time, as a borrower completes the construction of a project, the borrower will submit a draw request to Fairfield Financial. Fairfield will review this request and, upon approval, release funds either directly to the subs/suppliers (if requested to do so) or to the borrower (if the borrower has already paid the subs/suppliers). Fairfield is responsible for ensuring that (a) the work is completed to an appropriate quality standard (this may require an on-site inspection which will incur a fee specified in the Loan Agreement), (b) the project is on-budget (or if not on-budget, appropriate adjustments are made), and (c) that all subs and suppliers get paid for their work on the project.

What needs to be included in a private money loan package?

A private money loan packet is generally fairly straightforward. For a list of our packaging guidelines, please Click Here

– Clay (clay@privatemoneysource.com)

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Is Oregon next?

February 18th, 2010

Clay Sparkman

After many years of holding relatively firm, the real estate market in the Pacific Northwest may be in trouble.  The following informative piece was printed yesterday at Business Insider.  Make sure to follow the “Check out how bad Oregon has become” link and the 14 slides that accompany the article.

http://www.businessinsider.com/oregons-expanding-foreclosure-rate-could-make-it-the-next-california-2010-2

What does this mean for Oregon and Washington?  How bad is it going to get before it gets better?  And what does this mean for the rest of the nation?  Please take a minute to share your opinions by clicking on the comments link for this site.

Keep in mind that this analysis is looking at residential properties only.

– Clay (clay@privatemoneysource.com)

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Top ten clues that you should probably pass on a particular loan offering

February 14th, 2010

Clay Sparkman

I thought it would be nice to publish something just for fun today.  I rather enjoy doing these TOP TEN lists, but I try to avoid doing them very often for fear that it will look like this blog is purely for my own self-amusement.  And of course to a certain extent this is true—but I wouldn’t want to give you that impression.

Drum roll please…

Top ten clues that you should probably pass on a particular loan offering:

10. The borrower looks uncannily like the young Al Pacino.  (Think Scarface.)

9. The loan packet looks like it has been through a war–beat-up, dog-eared, and coffee stained, and you detect the faint smell of urine.

8. The borrower describes his take-out strategy as, “win lottery.”

7. Worse yet: the borrower describes his take-out strategy as, “bank loan.”

6. The property exists in a different dimension and therefore cannot actually be inspected without passing though a seam in the universe.  (Think of the title problems alone: survey, easements, etc.)

5. The property is located in the near-bankrupt third-world state of California.

4. The property is located on the tropical Island of Cuba, but it is located on US territory.  Uh, yes: there is a spectacular bay view.

3. The use of funds section reads, “…to complete the design and manufacture of an advanced metallic protective hat which will deflect all external thought transitions to my brain and at the same time keep all my thoughts from escaping.”

2.  The borrower is a self-proclaimed Solo Performance Art Specialist who cannot afford to make regular interest payments but commits to make “equivalent value payments” in live regular performances on your front lawn.

1. There is an exception on title which requires that a Chihuahua named Gertrude maintain a perpetual right to fully occupy and utilize the property for the duration of her existence.  (I guess this isn’t an automatic dis-qualifier.  You might want to meet Gertrude before finalizing your position.)

– Clay (clay@privatemoneysource.com)

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Ten crucial steps in reading an appraisal

February 3rd, 2010

Clay Sparkman

The crucial thing that you must understand about any appraisal (or other real estate valuation instrument) is that it is only as good as its logic.  So that—in other words—you must never accept an appraisal’s conclusion regarding value without looking beyond the surface to understand the logic that leads to the conclusion and without making some reasonable determination as to the quality of the logical argumentation.

With that in mind, I offer you ten critical steps to follow when reading/analyzing (and thus attempting to assess the “goodness” of) an appraisal.

(1)    The very first thing you must ask as you analyze an appraisal is to what degree is the appraisal transparent?  In other words, how much of the logic leading to the value conclusion is on display for you the reader?  If the answer is none, the appraisal is useless.  Throw it away.  If the answer is some (in other words there are gaps in the logic) then you must either (a) once again, decide to toss the appraisal, (b) decide to accept some degree of uncertainty, (c) attempt to fill the gaps on your own, or (d) contact the appraiser and see if she can provide the missing logic.  (Sometimes the appraiser will have the information you need on file, but they just didn’t include it in their final report.)  Ideally the answer is none or very little, and the appraisal can be said to be highly transparent.  At any rate, you will need to be asking this question throughout your analysis.

(2)    The next thing you need to do is get a handle on what is being appraised.  Is it a home, a commercial building, a parcel of land?  What are the basic specifications?  Where is it located?  Is it urban or rural?  How desirable is the surrounding area?  Are there functional inadequacies?  If it is land, what horizontal infrastructure is in place or lacking and what does the current zoning allow?

(3)    I have never heard anyone else say this, but I stand by it: one of the first things I do after getting a basic sense of the property is go straight to the photos.  (And by the way, make sure you have an original appraisal or color copies.  The photos can be quite useful, but not if they are blacked out by copying and faxing.)  I study the photos of the subject property and then I compare them to the photos of each of the various comps.  You will be surprised at how often you will begin to sniff some bad cheese at this point in the process (particularly when dealing with structures).  What you are looking for here is: (a) whether or not the comps in the same general condition as the subject property, and (b) whether or not the comps are in the same general “class” as the subject property.  By class I am referring to the level of quality and distinction of the property.  If the answer to one or both of these is no, it is not necessarily game over, but you will now be looking even more closely at the adjustment matrix later on to see if the apparent differences are effectively accounted for to your satisfaction.

(4)    Next, you will want to check the effective date of the value given.  How current is the appraisal?  In a steady up economy we used to be comfortable using appraisals that were as much as 1-2 years old.  We would adjust the value to be in-line with changes in the market.  With the chaos of the past 2+ years, this is much more difficult.  Generally speaking (though this would depend to a certain extent on regional are) you would want your appraisal to be less than 6 months old.

(5)    Check carefully to see if there are any “subject to” items associated with the value.  Generally this will initially be indicated by checking a box that indicates the appraised value is subject to certain additions, improvements, or modifications as indicated later in the appraisal.  This of course is a critical item, so make sure you have read through the entire body of the appraisal so as not to miss any such “subject to” items or conditions.

(6)    Look to see if any extraordinary assumptions are made by the appraiser.  Here again, you will be forced to read through the entire body of the appraisal to be sure.  On more than a few occasions I have seen what looked to be a perfectly reasonable appraisal completely neutralized (or actually undermined) at the discovery of one or more extraordinary assumptions.  The problem with most extraordinary assumptions is that they are indeed extraordinary.  If I am evaluating a parcel of bare land zoned rural agricultural, and an extraordinary assumption in my appraisal states that “The zoning will be changed to allow multi-unit residential at 8 units per acre.” … well chances are, the gig is up.  Even if some serious local zoning change is in the works, what is the chance that you can count on it to come through and turn this “straw property” into gold?

(7)    Take an accounting of the methods utilized for valuing the subject property.  In my opinion, a market sales comparison approach is ALWAYS essential and should be the primary method—and the one given most weight—in valuing a property.  The only true value anything has in a  market economy is the amount that others are willing to pay for it, and thus the attempt to estimate market value by looking at recent sales—though still at best a process of estimation—is the only method we have that goes to the heart of the matter.  Beyond that, it would be nice to have a cost approach and an income approach (where relevant) but these are, in my opinion, at best a good way to cross-check the market value derived by the appraiser.

(8)    Another thing you need to take a close look at is the aging of the comps.  If all the comps were sold quite recently, then you are good in this department.  But if one or more of the comps are more than 6 months old, this may be a problem.  The next step would be to look at the comp matrix to see how much the appraiser adjusts the target value to factor comp aging.  If one or more of the comps are listings … well then, these aren’t really comps at all.  I have seen comp workups using nothing but listings.  This is totally unacceptable. Anyone can list a property for any price they want.  It would perhaps be reasonable to have 1-2 listings along with at least as many “true” comps, but even this is getting into squishy territory.  So here again, you would have to look at how the appraiser adjusted the subject value based on the “listing” comps.

(9)    You should spend the majority of your effort fussing over the comp matrix.  This is the matrix which compares various characteristics of the subject property with various characteristics of the comps and makes specific adjustments for each of the comps to arrive at adjusted values for the comps (effectively attempting to monetarily “convert” each of the comps into the subject property).  If you have: (a) many adjustments, (b) large adjustments (relative to the price of the property), and/or many seemingly subjective adjustments, then you may want to seriously question the integrity of the appraisal.  You will want to walk through each and every adjustment, and here again, you must look for transparency.  Does the appraiser explain the logic behind his adjustment decisions?  If not, you have a transparency problem.  At the end of the day, you must be comfortable with the adjustments and you must feel that they are objective, transparent, well thought out, and seemingly reasonable.  If not, you must either (a) discard the appraisal, (b) contact the appraiser for further explanation, and/or (c) revise one or  more adjustments and revised the final subject value accordingly.

(10) And finally you will want to be sure and take a look at other methods of valuation utilized (generally income and cost on commercial appraisals).  And then you will want to determine how the appraiser has gone about reconciling the different values arrived at utilizing different methods.  Sometimes a weighted value approach is used.  If so, how much weight is being given to the comp value approach relative to other methods utilized.  As you may have guessed by now, I generally like to see all or at least the vast majority of weight given to the comp analysis.  If the appraisal doesn’t explain the reconciliation, you have a transparency problem.  If the comp value approach is not given enough weight, you may want to fall back on the value arrived at by the comp value approach as your own final value.

And there you have it.  There is a great deal more that can be said about reading an appraisal, and certainly this list of ten items is far from exhaustive, but it does give you a few things that you will not want to overlook.  If anyone has their own favorite “crucial” steps we would love to hear about them.  Please let us know and we wills share them with the group.

– Clay (clay@privatemoneysource.com)

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What exactly do you want me to do for you?

January 20th, 2010

Clay Sparkman

When evaluating loan requests, this is the fundamental question:  what exactly do you want me to do for you?  It is impossible to count the number of times that I have receive loan packets or proposals that didn’t include a loan summary or any clear description of the request.  The process of evaluating a loan must begin with a well prepared summary of the loan proposal.  (This item might be called a loan summary, an executive summary, or a cover sheet.  We call it a Prospectus.)   I don’t know why borrowers and brokers are so reluctant to provide such a fundamental item when attempting to secure private funding for real estate projects.  I suspect that it has to do with the way banks operate.  They don’t require a summary so why should we?  And beyond that, I think that many brokers and borrowers simply don’t know what to include in a summary.  One of the ways that we have gotten around the problem is by including a loan submission form on our website which walks the broker/borrower through a simple electronic form.  At least in the initial stages of the application process, this seems to provide much needed guidance.

Ultimately, however, we will not accept a loan packet or submission which is not accompanied by an adequate summary, and if the summary is quite good, we will probably tend to be much more receptive to at least considering the loan proposal at hand.  For today’s post, I am including a sample of a prospectus (redacted) that we prepared for submission to our private money investors.  We actually place our prospectus on top of all the relevant documentation, data, photos, etc., scan it into Adobe, and then e-mail a link and password to our interested investors, so that they may review the loan proposal in its entirety.  Here then is what we consider to be a well informed prospectus.  I recommend that all private money investors insist on adequate documentation and don’t settle for less.

Clay Sparkman

Fairfield Financial Services, Inc

2727 NE Hoyt St, Portland, OR 97232

Phone (503)476-2909, e-mail clay@privatemoneysource.com

REAL ESTATE PROSPECTUS

SECURED LOAN

Purchase and rehab on 4-plex in Las Vegas, Nevada

Loan Details

  1. Loan Amount: $130,000
  2. Term: 2 yr
  3. Interest Rate: 13%
  4. Monthly Payments: $1,408.33 Interest Only
  5. Construction Holdback Account: $54,750
  6. Security:  Deed of Trust in 1st Position security interest in real property at xxxx Bassler Street, North Las Vegas, NV 89030
  7. Completion Value by Borrower Estimate / Comps is $220,000
  8. Completion Value LTV by Borrower Estimate / Comps is 59%
  9. Conservative Completion Value is $195,000
  10. Conservative Completion Value LTV is 67%

Loan Overview

This is a purchase and rehab construction loan for a 4-plex in Las Vegas, NV.  The property will be purchased as a bank REO for $78,000.  The borrower (hereafter referred to Flip Guy for the purpose of this sample) is bringing $13,000 to escrow in order to demonstrate some cash investment on his part, and requesting $54,750 to complete the construction on the property.  Flip is experienced flipping homes in Las Vegas, and has rehabbed over 200 properties in this area.  He currently holds 62 properties in his inventory.  42 of these homes are free and clear and all but 5 of his properties are rented and producing income.  Flip reports that these 5 properties are for sale.

Flip Guy has successfully completed four loans with Fairfield over this past year and a half.  In each of these loans the construction was completed and the properties were listed in under a month.  Both houses were sold and the loans paid in full well before the loans matured and Flip has never been late with a payment.  Before and after photos of two of these properties are provided as an example of his work.  In addition, Flip has provided before and after photos of a similar 4-plex that was not financed through Fairfield.

In each of Flip’s previous loans, his exit strategy was to sell the properties.  For this loan, he intends to refinance the property and hold it as a rental.  To be safe, he has requested a 2 year term, although he anticipates that he will be able to exit this loan in approximately year.  He will pursue a take-out loan as soon as the rehab is completed, which should take 1-2 months.  Flip will hold title to this property under his company, xxx, LLC, and he will personally guarantee this loan.

Property

The subject property is 3040 SF and has 4 units, each with 2 bedrooms and 1 bath.  The 4-plex was built in 1963 and sits on a .21 acre lot.  The 4-plex is structurally sound, but is in need of cosmetic repairs.  Flip plans to update and modernize each unit of this house.  He will replace the flooring, paint, update the kitchen, and landscape the property to add curb appeal.

This property is approximately seven miles northeast of the Vegas strip and one block east of the Las Vegas Blvd.  It is located in a neighborhood that is primarily working class rentals.  There are three 4-plexes neighboring this property and they are all reported to be in good condition.

Valuation

Completion Value Comps by Borrower

To determine the completion Value, the borrower utilized 7 comps in a close proximity to the subject property that range from $209,900 to $249,900.  Three of these comps are sales, while the other four are current listings.  Three of these listings have sales pending, but those pending prices are unknown.  Based on these comps, Flip estimates that the property should be worth $220,000 once the repairs are made.

Analysis of Comps by Inspector

Based on the average price/unit of all comps and listings, the value of the subject property would be $224,408, which supports the borrower’s estimate of value.  However, when the average rent is broken down to a conservative price/SF, and multiplied by the average gross rent multiplier (see inspection report), a value of 194,803 is suggested.  In addition, if the average sale price/SF is multiplied by the size of the property, it yields a value of $193,982.  Based on these calculations, the inspector suggests that it would be reasonable to consider $195,000 as a conservative value for this property.

A field report is available for review.

Market Trends

Altosresearch.com is a website that provides real time market data for single family homes, and was used to evaluate the Las Vegas market trends.  Average home prices, time on the market, and the current home inventory are all considered in the evaluation of this property.

Average home prices have continued to fall over the past year, and the median home price as of Nov 29, 2009 is $119,928.  There appears to be a significant decrease in the rate of this fall over the past few months, and in the past 30 days prices appear to be relatively stable.  Seven day averages show a very slight increase.

The average time on the market in Las Vegas area has been steadily declining over the past 8 months, and has dropped from 175 days at the high point in April 2009 to a157 days as of Nov 29, 2009.

The current home inventory is one of the most important factors to consider.  A decreasing inventory is often a precursor to stabilizing market.  Since its high point in April 2009, the home inventory has decreased by approximately 20%.  There is a current downward trend in the home inventory which could potentially explain the decrease in the rate at which home prices have dropped over the past few months.

Market trend graphs are available for review.

Flip’s first loan, the Pinedale property, sold in just less than 5 months from the time of listing.  Flip’s second loan, The Ashbrook property, was sold in just less than 8 months from the time of listing.  His next two loans, the Bengal property and the Almondwood property, each sold in approximately 3 months after the property was listed.

His average turn time is compatible with the expectations based on current market trends.  The price point at which Flip purchases these homes, his ability to rehab them quickly, his realistic approach to time on market, and the decreasing home inventory, seem to support his business model.

Process

Las Vegas does not require any permits for the type of work that will be performed, nor do they require a contractor’s license.  The borrower will be ready to go as soon as the loan is funded and plans to have the house completed in approximately two weeks.

Income

We were provided with a signed 1003 for Flip Guy, which states a monthly income of $55,000, and a net worth of $5,245,000.  Flip states that his monthly income is a combination of the rental net income and proceeds from the properties that he flips.  A copy is provided here for your review

Credit

Flip Guy has a mid credit score 686.  This is typical for rehab developers who use bank cards for construction financing.

– Clay (clay@privatemoneysource.com)

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Won’t somebody please call a plumber … the banks are clogged

January 5th, 2010

Clay Sparkman

One of my dear good readers sent the following e-mail in response to my last post, Home strippers coming to a neighborhood near you.

“Good topic Clay.  Now forgetting about us private lenders, the conventional lenders continue to be their own worst enemies.  They persist in bringing the properties to the city hall steps at 40% over market.  When no one buys the property, they have it inspected and insured, pay the utilities, and pay a realtor to sell it for them at a discount.  On top of all that they may face the problem that your article addressed.

Pricing it to sell on the steps would solve their problems.

In early December, I looked at this piece of bank owned junk in St Helens, Oregon.  It was rough around the edges but the bones were good.  It was a typical Ranch style, 2-bath, 3-bed, 1400 sq ft, nice large lot, fenced, but no garage.  The bank had it listed for $198,000, but they had started out at $139,000 a couple of months earlier.  I called the agent and asked them if they had a misprint on the price (as there are nice, newer homes with garages going for $165k max).   The agent said no, it wasn’t a misprint; the lender had called him when it was at $139,000 and told him to boost the price to $198,000.  What is that about?

Until the banks get their head out, their balance sheets are going to continue to worsen.

Regards, Alan”

Well I can hardly say that it is the first time that I have heard of or seen this type of thing with the banks.  One does get the distinct feeling that these institutions are somehow unmotivated to remove the toxic assets from their books.

And it is even worse than all that.  As if they needed additional help at slowing down the corrective process:  The federal and state governments, with all of their efforts to keep owners in homes which they cannot afford, are seriously compounding the problem.  It could take an extra year or two to get many of these bad loans off the books due to the various federal and state requirements being imposed upon the banks.  (And that assumes the banks are motivated.)  The following NYT article does a nice job of discussing the matter.

http://www.nytimes.com/2010/01/02/business/economy/02modify.html

And so even though a lot of good things are happening with our economy as of late, real estate prices will not correct until lending institutions provide adequate funding once again to owners and buyers—and the economy as a whole will remain at least partially broken until this occurs.

And so I say:  “Won’t somebody please call a plumber … the banks are clogged.”

– Clay (clay@privatemoneysource.com)

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Home strippers coming to a neighborhood near you

December 29th, 2009

Clay Sparkman

Okay, so I was told that if I wanted to get more people to read my posts, I need to utilize attention grabbing headlines.  (How am I doing so far?)  Now I’d like to see a show of hands, and please be honest here, as this is purely for scientific purposes and the results will remain strictly private:  Was it the headline that caused you to click on the link to this blog-post (if so raise your hand) or was it merely your overwhelming and insatiable lust for all things private-money-lending related?  Uh huh … right okay … hey I believe you.

At any rate, I figured that this recent New York Times article would be of interest to any active private money and trust deed investors.

http://www.nytimes.com/2009/12/23/business/economy/23stripped.html

Fortunately, we haven’t seen too much of this sort of thing yet in our dealings at Fairfield.  But then we haven’t had to foreclose on loans in Arizona or Nevada and only have one in foreclosure in Florida and that particular loan is a land loan.  We’ve had a little trouble here and there, but nothing big.  Greg Brown—a favorite musician of mine—used to talk about how folk musicians were different from rock musicians.  He said that when folk musicians went on the road, there idea of trashing a hotel room was leaving the TV unplugged.  I am happy to say that most of our borrowers thus far have been more the folk-musician-type.  Let’s hope it stays that way.  We wouldn’t want home strippers coming to a neighborhood near you.

– Clay (clay@privatemoneysource.com)

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Trust deed lending – ten mistakes you should never make and ten mistakes you must never make

December 19th, 2009

Clay Sparkman

Okay, first the ten mistakes you should never make:

(1)    Never close a loan without title insurance.

(2)    Never close a loan on property that has valuable structures without a valid hazard insurance policy in effect listing you or your entity as loss payee.

(3)    Never close a loan leaving property taxes unpaid (unless you are fully aware of the amount of unpaid property taxes and have knowingly agreed to allow some amount to remain unpaid for a certain specified period of time).

(4)    Never lend on land which may have wetland issues without seeing a wetland study or speaking with a relevant government official, and understanding the potential impact of possible mitigation requirements.

(5)    Never lend on property for which labor and/or materials have been provided within 90 days prior to closing without either (a) having an extended ALTA policy of title insurance with no exception for labor and materials liens (difficult to get), or (b) having received a signed affidavit from the borrower which lists all providers used (along with contact info and the amount of any outstanding debt), and contacting all labor and materials providers on the list to make sure that none is preparing to file labor or materials liens.

(6)    Never close a loan secured by property which appears to show (by inspection, general observation, public record, or known history) a reasonable possibility of being contaminated by any form of hazardous waste, unless you have seen a current level I or level II environmental study showing the property to be clean.  And in any event, always require borrowers to sign a hazardous waste indemnity agreement.

(7)    On a construction, rehab, or development loan: never disburse funds for work that has not been completed (unless as a deposit to a company that has been carefully checked out and is considered to be highly credible) and never disburse funds directly to the borrower unless as reimbursement for work that has already been completed and paid for, and which is documented accordingly.

(8)    On a construction, rehab, or development loan: whenever advancing funds to a labor, service, or material provider, never advance such sums without first requiring the provider or entity to sign a form acknowledging that the money is an advance and that the advance was provided by the lender or otherwise a third party, and that any refund must go back to the lender or third party and never back to the borrower directly.

(9)     Never close a loan without reviewing every single exception allowed on title in positions superior to your own.

(10) Never close a raw land loan without first understanding precisely what is allowed by the applicable zoning and without speaking to appropriate government authorities to be sure that there are no known problems which may obstruct or deter any reasonable plans to develop the property.

Okay, now for the ten things that you really absolutely must never ever do:

(1)    You must never close a loan at a title company known as Joe’s First National Title located in a former burrito cart at the corner of 3rd and Main in Springfield.

(2)    You must never lend money on a property if you happen to catch your loan broker or borrower walking the property with a Geiger counter.

(3)    You must never lend money on a property in a country (or region) presided over by anyone named Hugo Chavez, Fidel (or Ramón) Castro, Kim Jong-Il, Jim Jones, Iddi Amin, Papa Doc, Baby Doc, or well … any Doc for that matter.

(4)    You must never make a loan secured by documents which are written in iambic pentameter verse.  Just back out the door, turn, and run as fast as you can.

(5)    You must never lend money to a non-human primate—except possibly a rhesus monkey (and then only if the monkey is a natural born US citizen).

(6)    You must never lend money on a property if when you ask about inspecting the property, the broker intones, “You can’t get there from here.”

(7)    You must never lend money on a property if the appraisal states that the property’s highest and best use is “ancient burial ground.”

(8)    Four words: tar pit never ever!

(9)    You must never make a loan where your trust deed will be in the thirty-seventh position.  Ah, ah, ah … don’t even think about it.  (I don’t care how good the CLTV is.)

(10) You must never lend on property which straddles the international dateline.  It is quite simply too confusing.

Okay, so hopefully it was clear to many of you that the first set of items was meant to be serious and that the second set was intended to make you laugh.  If not, don’t worry about it.  These are really all things that you shouldn’t do—funny or not.

Now, I am good at telling people what not to do, so if anyone asks, I’ll gladly crank out another ten not-to-do items (the serious ones that is) or if you would like for me to expand on any particular item on the first list, I will give that a shot as well.  Any comment would be good actually.  Hecklers are particularly welcome.  (So far, we have been a little light on conversation, so I still get excited about the daily spam that trickles in.  And yet not one to be easily discouraged, I take your silence as a kind of mesmerized reverence.  What else could it be?  Yes, that’s it.  Very good.  Now: at ease my good readers … at ease.)

– Clay (clay@privatemoneysource.com)

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Commercial real estate tsunami?

December 6th, 2009

Clay Sparkman

There has been quite a bit of talk in 2009 about the possibility of a meltdown in the market for commercial real estate.  I came across some statistics recently that were quite astounding in support of the idea that a wave of commercial defaults is coming.  It is estimated, apparently, that there is currently 3 trillion in commercial real estate debt outstanding in the US.  According to this particular source (which I’m sorry to say I don’t recall), 1.3 trillion of that debt will come due within the next four years.  As we all know, there doesn’t appear to be much in the way of new commercial funding available for those current loan holders (or their potential buyers), so the above statistics—on the face of it–would tend to be worrisome.

Still, 4 years is a long way out.  I personally suspect that we will get a much better feel for what is likely to occur over the long haul by looking at what happens in 2010.  But I am not a prognosticator.  You’d think that with a degree in economics, I might have the ability–or at least the inclination–to analyze and predict long-term economic trends.  But I am not that kind of guy.  I am more of a “sure it works in practice, but does in work in theory” kind of guy.  I like the type of economics where you look at what happened and then play with the numbers and try to figure out why it happened that way.  Those familiar with Freakonomics and SuperFreakonomics by Levitt and Dubner will know what I am talking about.

I recall my first day in a big lecture hall at University of Oregon attending Macroeconomics 101.  I was a fresh faced kid eager to learn and ready to believe just about anything.  When the professor said something like this:  “Okay the fundamental assumption that we will make as economists is that people are rational and that they will behave in a rational manner,” it sounded fine to me at the time—perfectly reasonable.  I hadn’t been around long enough to believe otherwise.  It was only with the passing of years, after graduating from the university and going to work in the real world, that I began to question that assumption.  And ultimately I concluded that it was downright ridiculous.  My entire economics education was based on one fundamental and ridiculous idea. It would be as though we had utilized a chicken bone as the foundation for building a skyscraper.  (Needless to say, I was not happy when considering the amount of money I had spent obtaining this degree.)

A very good read which speaks to the matter is Predictably Irrational, by Dan Ariely.  The bad news, if you wish to draw conclusions from this book, is indeed that individuals often engage in irrational behavior.  However, the good news and the saving grace–I should think–if you are trying to understand human behavior in the aggregate, is that we are as it turns out quite predictable in our irrational behavior.

Where was I then?  Oh yes … my fundamental point is that I would rather not go too far down the road of attempting to predict the economic (or any other) future.  I will only go so far as to say that I’d rather it not happen.  But it is worth pointing out that a downturn such as that discussed may not be all bad for those who invest and traffic in private money loans.  If banks aren’t lending as 1.3 trillion in loans come due and with private money lenders as the primary option, the pickings would be quite impressive indeed for those who choose to keep investing.

So what do others have to say?  As per usual, there are a wide range of opinions.  And they tend to be somewhat polarized.  I myself tend to think that the doomsday people somewhat undermine themselves by being so certain and unrelenting, but at the same time, I am suspicious of anyone who says that things are looking good.  I figure the later must work the national association of realtors or some such thing.

I guess we’ll each have to decide for ourselves, and so here is a sampling of web content regarding the matter.

From the Dallas Morning News

http://www.dallasnews.com/sharedcontent/dws/bus/columnists/chall/stories/DN-Hallcolumn_09bus.ART.State.Edition1.3cf46e6.html

From the Business Insider

http://www.businessinsider.com/michael-panzner-commercial-real-estate-2009-11

From the National Real Estate Investor

http://nreionline.com/property/retail/foreclosure_in_doubt/

From the Real Estate Channel

http://www.realestatechannel.com/us-markets/commercial-real-estate-1/national-association-of-realtors-lawrence-yun-nar-commercial-real-estate-index-commercial-real-estate-trends-2009-office-space-lease-office-space-sale-investment-1273.php

From the Urban Land Institute

http://www.uli.org/ResearchAndPublications/EmergingTrends/Americas.aspx

Okay, there is plenty more where that came from, but I won’t burden you with it here; if you wish to read it, you’ll have no trouble finding it.  I would be very interested, however, in hearing the views of those who follow this site.  We are still quite small in number, but we have enough folks to fill a good sized classroom now, so by all means, raise your hand and be heard.  Please: prognosticate.

– Clay (clay@privatemoneysource.com)

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Private money through the looking glass

November 22nd, 2009

Clay Sparkman

First off, I’d like to point you to a list of 37 private money investment tips posted by Brad Evans of Brad Evans Real Estate Loans.  This list has been circulating on the net for quite a few years now.  It is one of the more thoughtful comprehensive items that I have come across and so I thought I would share it with you.  Though I agree with a lot of what Brad has to say, I don’t agree with all of it.  I will utilize a future post to give my own input/comments on each of the points given on Brad’s list.

http://www.bradevans.com/37pointchecklist.html

For today’s post, I spent some time looking at You-tube videos that came up under a search of “private money lending”.  To the negative, as with content in general regarding private money investing, I didn’t (yet) find a whole lot of substance in these videos for the most part.  However, to the plus side, I have to say that I really had a good time with this.  There is some very interesting and entertaining stuff out there.  And I find it quite useful to see what people are saying about private money: how it works and how to obtain it in particular.  When I have more time I’m going to go much deeper as I just really scratched the surface.

At any rate, here is a representative cross section of what I found out there in cyber-video-landia.

On making massive montly income

Our narrator is a representative of http://www.askaexpertwholesaler.com/.  I went to the homepage but didn’t actually enter because you have to enter your e-mail address (and I wasn’t so inclined), but the entry page compels with the question, “Who Else Wants to Discover the Astonishing Secrets of How to Make Massive Monthly Income with Real Estate in 2008 By Asking an Expert Wholesaler”

This is one in a series of “quick tips” to real estate investors on how to find private money lenders

http://www.youtube.com/watch?v=0-frYFdYJw4

My comment: It’s hard to argue with “run your mouth.”

The discovery of iced coffee

Patrick Riddle of http://www.privatemoneyblueprint.com on “How to Convert Wannabe REIs into Private Money Lenders.”

http://www.youtube.com/watch?v=B2VfCnCgibM

My comment: I love this guy.  He has a bunch of videos out there and I wanted to watch every one of them.  He definitely has a certain charisma that keeps you watching.  Will his plan work?  Maybe one time in ten thousand, I suspect.  Most of the people who attend those meetings haven’t made their fortune yet—and don’t really have cash to invest.  And hey, that is just a tough road to go down anyway.  I don’t try to sell anyone on trust deed investing, but if I did, it certainly wouldn’t be the inexperienced, uneducated, and uninitiated.  There is too much to know before you can be ready for this kind of investing.  At any rate, I’m glad Patrick discovered iced coffee.

How to avoid talking to investors about the things you need to talk to investors about

Here is another one from Patrick Riddle at http://www.privatemoneyblueprint.com called “How to explain the “Worst Case Scenario” to a Private Money Lending Prospect.”

http://www.youtube.com/watch?v=Ps0Cv6QSC18

My comment: Okay, this one somewhat disturbs me.  It might be more appropriately titled, “How to avoid talking to investors about the things you need to talk to investors about.”  I do like his description of the workout process.  Basically:  You are a lender and then you become an owner and we all live happily ever after.  I guess he didn’t want to muck up the conversation with tedious details like how to choose between a judicial foreclosure and a non-judicial foreclosure, what happens if the borrower contests a judicial foreclosure, the potential impact of a bankruptcy, taking back a property that is distressed or an unfinished project, the potential impact of market changes and/or a protracted foreclosure process on your equity position, how to go about marketing the property, and how to obtain and collect on a deficiency judgment, if need be in order to fully recover.

Would you like to vacation in paradise?

This is Cash Money Quick’s (http://www.CashMoneyQuick.com) video ad for a “New FREE Ebook – How to Find MILLIONS in Private Money.”

http://www.youtube.com/watch?v=Sua7AqOzgCA

My comment: Well I haven’t read the e-book, but the guy comes off nice enough and I like the palm tree in the background, suggestive of … long tropical vacations perhaps?

On drawing legal documents like a real attorney

Dmitry Mikhaylov (http://www.komelot.com) putting on a boot-camp, Attorney at Low, on how to prepare private money lenders documents.  “Find out from attorney what documents you will need to get Private money lenders money for your real estate needs.”

http://www.youtube.com/watch?v=MBFcGD7LSbI

My comment: I like the “Attorney at Low” part.  There might be just a little bit more to the document process, but you get the general idea.

On self-directed IRAs

Self-Directed IRA’s are explained by Trent Dalrymple, Director of Investor Relations at Metro Mortgage Investments LLC, a private mortgage lender in Huntington Woods, Michigan. More info at www.metro-mi.com

http://www.youtube.com/watch?v=jrdBlOU7nZA

My comment: This one I actually thought was quite good.  I have no wise-guy remarks.

Am I still in the real estate lending section?

This is an ad, for what I’m not sure but I enjoyed it.  The YouTube text states:  “Get private money, cash loans from lenders. Private individuals have money to give away today. Online. Instant cash now. Bad Credit ok. Lenders MUST give away cash now. Hurry. Money for real estat…”

http://www.youtube.com/watch?v=WIAUVgMRUnE

My comment: Va va voom!

Subliminal advertising

This is another ad:  “EASY LOAN TO BUY FORECLOSURES Hard Money can be a quick way to fund everything from residential property, to industrial facilities to new home construction.”

http://www.youtube.com/watch?v=rjsMc3ExY2M

My comment: Did you notice the subtly placed images of cash and money–almost subliminal.  You might want to play it back again in slow motion.

And thus concludes your private money through the looking glass tour for today.  I sincerely hope that I have not come off as too terribly condescending.  (In general, these videos can’t be easy to do.)  I only wish that I could find better resources out there—text, video, and otherwise—that could be helpful to all of us in this complex realm of trust deed and private money investing.  And so the search goes on.  Please do share whatever you may have, whatever you may know, and whatever you may find.

– Clay (clay@privatemoneysource.com)

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Two hicks from Oregon go to Malibu – a cautionary tale

November 11th, 2009

Clay Sparkman

The runway was drenched in sunlight as our plane touched down that morning at LAX.  It was a golden balmy day.  We grabbed our bags and headed for the rental car kiosks.  I don’t recall how it happened exactly, but the fellow at the counter said something like, “I can make you a real good deal on a sporty little convertible.  Do you want it?”  We looked at each other and shrugged, “Why not, let’s have some fun.”

It was a business trip, me traveling as a private money loan broker and accompanied by Alan, a stalwart friend and investor of many years.  Over the past two weeks we had been carefully picking our way through a loan file for a request to loan money on a bare land parcel in the Malibu hills.  This was not a normal loan for us.  At this point, we had not expanded our regional boundaries much beyond Oregon and Washington.  California would have seemed strange to us, but Malibu was like another planet.  Still, this was in the glory days of the California Empire, back when money ran free in the streets, and we were having a hard time finding good reasons not to like the loan, so we finally decided it was time to go have a look for ourselves.

We hopped into the little red convertible—top down, ready to go.  I don’t recall who navigated and who drove, but eventually we found ourselves cruising south along the coast and really enjoying the ride, the sunshine, and the beautiful sparking blue sea.  “I’m sure we must be quite a sight,” said Alan, “two pasty white Oregonians on the California coast riding high in a bright red convertible.”  Some SP 40 and a couple of old baseball hats would have been useful, but we were in a hurry to get to our meeting and couldn’t stop to shop.

Our designated meeting spot was just off highway 101 near a small Realtors office at a cross-road leading into the Malibu hills.  We pulled up a few minutes late and found two cars and three people waiting.  The loan broker who had been the point man on the project was there.  He was standing and talking to two other guys.  We were introduced to our borrower.  He was quite young (maybe mid-twenties), well dressed with a pony tail and friendly enough but a bit on the slick side (at least by Oregon hick standards, that is).  His sports car—an Audi TT—was a real sports car, unlike our little domestic model.  The other fellow (quite young himself) was introduced by the borrower.  The introduction was a bit vague and came out sort of mumbled; somewhere in there, we thought we heard the word “appraiser.”  We noticed quickly that he and the borrower appeared to be quite friendly with one other—a couple of old pals maybe.

After exchanging pleasantries, we all hopped into our respective vehicles and fell in line behind the TT.  The kid was working the peddle hard and seemed to be making a point as we wound our way around hairpin turns on this high windy gravel road; we struggled to keep up with the spray of gravel.  Somehow we eventually managed to arrive alive and intact at the subject property, and everyone got out and stomped around in the dirt for awhile.

The circumstances were pretty simple.  The kid’s father owned the property and was holding it as part of the kid’s inheritance.  The kid planned to use the free and clear property as collateral for a loan that he would utilize to pay for tuition (or some such thing).  There were no immediate plans for development, but we were told that the property was fully accredited, meaning it was fully qualified as a buildable parcel for one residence.  (Of course this is no small thing; in the hills of Malibu, CA the ecosystem of these hills has been seriously stressed due to over-building and becoming accredited for a new structure is no easy task.)

So after some walking and pointing and a series of questions and explanations, I lead into my most pressing concern.  It had occurred to me on the flight down that there was a potentially serious error with the appraisal.  This error (assuming it was an error in this case) is a surprisingly frequent error in appraisals; I have seen it many times over the years.  Let’s call it the Fallacy of Infinite Scalability.  In order to demonstrate the Fallacy of Infinite Scalability, I’ll use an example.  Let’s say that our subject property is a five acre parcel and that we are looking at a comp which is a one acre parcel.  Assuming that the one acre parcel qualifies as a buildable parcel by virtue of size (say it was grandfathered in when the zoning was changed to 5 acre minimum size per site) and that the five acre parcel cannot be subdivided further (due to the change in zoning), then we cannot compare these properties acre for acre.  If the one acre comp parcel sold for $800,000, then we would not be correct to say that the five acre parcel, all other things being equal, is worth $4,000,000.  That would be the Fallacy of Infinite Scalability.  Instead we must determine the base price of one home site–in this case the first acre–and then determine the incremental value of each additional (incremental) acre.  So for example, we might determine that the one acre parcel is worth $800,000 and that each incremental acre is worth $50,000, giving us a total of $1,000,000.

However, by my interpretation of the appraisal and in the absence of further information, the appraiser had committed this error in determining the value of our subject property.  So I asked of the third fellow, “Are you the appraiser?”  “Uh … well no, I’m not the appraiser,” he muttered, “I’m his assistant.”  This seemed odd.  I couldn’t recall a time that an appraiser’s assistant had ever been sent to a site review.  At any rate, I went ahead and asked him about the appraisal and in particular whether or not the Fallacy of Infinite Scalability was at work here.  He scratched his head a bit, looked kind of confused, rocked back and forth with his hands in his pockets, and indicated that he really didn’t know the answer to my question.  “Okay, I’m going to have to speak to the appraiser,” I said.  At which point the assistant most adamantly explained that the actual appraiser did not like to talk to clients and could not be talked to (or something to that effect).

I countered that without a reasonable explanation for the apparent Fallacy of Infinite Scalability error I could not proceed and that I really needed to speak to the appraiser.  There was much commotion and back and forth between the kid and the assistant, until finally the assistant said that he would call the appraiser and see if he would speak to me.  Eventually he managed to get a signal and contacted the appraiser who apparently agreed to have me put on the line.  I took the phone and proceeded to ask about the appraisal and to what extent the Fallacy of Infinite Scalability applied.  The appraiser sounded frail and confused and was barely audible.  I walked him as carefully as I could back through the question a second time, much as I did for you the reader above, but he still didn’t answer.  It became clear that he simply could not respond to my question.

Well … at this point I glanced at my watch and I looked over at Alan. He looked back and said, “You know what?  We’ve got a flight to make.  We’ve gotta get back to Oregon.”  “That’s right,” I said.  “We’ll call you all once we’ve had a chance to talk this over,” and away we went.  And as we drove back up the coast the horror stories played out in our minds:  an appraiser held captive in his own home, tied to a chair, perhaps drugged into submission, or just a very old man gone senile and his son taking over his work, his license … and maybe his signature.  There were many possible interpretations, and we tended to favor the most hideous.

I learned a long time ago that a loan not done for the right reasons is a successful loan and so I put this one in the win column (and so did Alan, I believe).  On the flight back that evening we looked down at the sea and felt grateful for our pleasant journey, for the tragedy narrowly averted, and just to be on our way back to Portland in time for dinner, whole, intact, and more or less unscathed by the experience.  Of course, there was the small matter of our bright red sunburned heads which were—surprisingly–beginning to approximate the color of that cute little California sports car which we had just left behind.

– Clay (clay@privatemoneysource.com)

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Top ten ways you know it might be time to consider private money

November 1st, 2009

Clay Sparkman

I thought it would be nice to publish something just for fun today.  I originally wrote and published this TOP TEN list on our web site man years ago.  I think it is still relevant after all this time.

Again, keep in mind, this is done purely for the sake of laughter, so take it in the spirit in which it is intended.  It actually tends to reinforce some stereotypes that I have worked hard for many years to dispel regarding private money and the borrowers of private money so don’t take it too seriously.  Still – just this one time, I couldn’t resist. Drum roll please…

Top ten ways you know it might be time to consider private money:

10. The bank asks you to return the promotional pen which they gave you last month.

9. Your neighbor keeps throwing orange peels and egg shells on your house because they think it is a compost pile.

8. You are continually confusing your FICO score with your bowling score.

7. The Account Rep for your favorite lending institution laughs so hard that he suffers a hernia and is rushed off to the hospital before you can finish telling him about your loan request.

6. When figuring your net worth on a 1003, you include as assets: your karma, your winning smile, your exotic house cat Ms. Buttons, and your $5,000 instructional video course on how to make a million bucks investing in real estate.

5. The bank officer repeatedly refers to your floating home as a “boat”, and insists on using terms and expressions like “port” and “bow,” and “thar she blows.”

4. Meth lab shmeth lab! (A true real estate investor doesn’t let minor obstacles stand in her way.)

3. Your down-payment consists of twelve cases of Budweiser empties, an IBM 386 computer, and a Tim Duncan rookie card.

2. Your timeline is so short that you are working on a scheme which involves flying an escrow team westward to the international dateline and closing the deal at 12,000 feet.

1. The land which you hope to borrow against is so raw that it bleeds when you stick a fork in it.

– Clay (clay@privatemoneysource.com)

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The private money lending business: likes and gripes (part III)

October 19th, 2009

Clay Sparkman

I finished Part II with a brief mention of something I quite like about the trust deed system: that is, the option (generally available) to foreclose judicially.

Before moving on, I’d like to offer you a crude little decision tree which may guide investors in making the decision whether to foreclose a given trust deed judicially or non-judicially.

First, do you have an option to foreclose this particular trust deed non-judicially?  If the answer is no, then foreclose judicially.  If the answer is yes, continue.

Do you believe, with a high degree of confidence and having done sufficient research, that you are likely to fully recover by taking back the property at auction and then selling it?  If the answer is yes, then foreclose non-judicially. If the answer is no, then continue.

Do you believe, again with a relatively high degree of confidence and having done adequate research, that the borrower/personal guarantor has sufficient income and/or assets that you would stand a pretty fair chance of recovering on a deficiency judgment?  If the answer is yes, then foreclose judicially.  If the answer is no, then foreclose non-judicially.

Now moving on:  Today I will focus on a few website based tools that I have found to be useful in the business.

Let’s start locally (Portland, Oregon) and then expand out from there.  A really nice little site if you are doing business in the Portland area is:

www.Portlandmaps.com

The City of Portland provides PortlandMaps.com as a new way of easily accessing public data regarding properties and property areas.  A wide variety of data is available for the Portland Metropolitan Area, including the following:

  • Assessor/Tax Lot Information
  • Aerial Photography
  • Building Footprints
  • Building Permits
  • Census
  • Crime Data
  • Elevation
  • Parks
  • Mass Transit
  • Natural Hazard
  • Schools
  • Urban Growth Boundary
  • Underground Storage Tanks
  • Water/Sewer
  • Zip Code
  • Zoning Maps

Fortunately most states offer all kinds of helpful data on-line now.  For instance, this handy site offered by the state of Oregon gives you access to a wide range of licenses, permits, and registrations.

www.licenseinfo.oregon.gov/index.cfm

Of particular interest to me is this site which allows me to lookup a mortgage broker’s license:

www.licenseinfo.oregon.gov/?fuseaction=link_class&class_list=1732,14592,26398&class_name=Mortgage%20lenders&LinkType=P

It is also frequently useful to lookup the license status of a given contractor, which you may do in Oregon at:

www.licenseinfo.oregon.gov/?fuseaction=link_class&class_list=13833,13830,13831,1536,1551,1683,1537,1555,1556,1713,1677,1666,1665,13829,13828,1739,14724,26481,1674&class_name=Construction%20contractors&LinkType=P

I’m sure that just about everyone in this business already knows about Zillow:

www.zillow.com

Zillow is a great little comp tool, easy to use, with a vast national database, and free.  It does not offer the range of options available with most professional comp tools, but then they are expensive.  I can remember when we first signed up to MetroScan at Fairfield.  The price was very substantial and the software was localized to the machine, so that you could only use it at one workstation at one site without paying even more, and updates were given monthly via mailed CD-ROMs.  We also had very limited regional access and had to pay for access by county (that is if a particular county were available at all).  We’ve come a long way.

Also, I hear good things about the Zillow blog, though I haven’t had time to properly check it out for myself:

www.zillow.com/blog

I know I don’t need to tell anyone about Google Earth.  When I was first introduced to this site, I just about fell off my chair!  I still can’t quite believe that such a powerful far reaching tool exists, at my fingertips and for free.

http://earth.google.com

And it just keeps getting better.  The Street View layer of Google Earth is incredible.  It allows you to do drive by inspections from your home office or living room.  Of course it is not really as good a an actual drive by, but it certainly allows you to get a feel for a property and its neighborhood.

Now, if you want to look at real estate trend data for a given area—something I would think you would want to do these days before making just about any loan—this site is terrific:

www.altosresearch.com/altos/Home.page

The Scotsman Guide has long been regarded as the “bible” of the commercial and residential loan industry, offering detailed categorical listings of various active lenders and loan sources.  Their online site is here:

www.clender.com

And Lendicom may be of interest to you.  This site is geared toward commercial lending, and allows borrowers and brokers to sign up and submit specific loan proposals to lenders who have also signed up online.  If you are a hard money lender looking directly for commercial loans to fund, you may sign up as a lender and create an account that allows you to specify detailed criteria regarding the specific loans that you would be interested in.  In the interest of full disclosure, I am an officer and a part owner of the company that offers this site.  Maybe that’s why I like it so much.

www.lendicom.com

So that’s a lot to like, wouldn’t you agree?  It is hard to imagine that just ten years ago, none of this existed.  And there is so much more.  Please write in and tell us about other tools that you know of and websites of interest.

End of Part III

– Clay (clay@privatemoneysource.com)

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The private money lending business: likes and gripes (part II)

October 3rd, 2009

Clay Sparkman

In Part I, I began a discussion of my gripes and likes regarding the private money lending business and various industry related matters, items, and issues.  I allowed myself to amble a bit far afield and concluded by mentioning a book about the legal profession which I personally found to be informing and entertaining.  I’d like to indulge myself a bit more on this topic of books at least marginally related to private money investing.

An author who I particularly enjoyed this past year is Michael Lewis.  Moneyball: The Art of Winning an Unfair Game is one of the most interesting and influential books that I have read in a very long time.  This book on the face of it is about baseball, but in fact it is about so much more.  The book is really about exploiting pockets of inefficiency that inevitably exist in markets (for various curious reasons), and I frequently find myself applying lessons learned in this book to the way I think about other aspects of business and life in general.  There is most definitely an element of applicability to private money lending and trust deed based lending.  If you have read it, please comment and tell us if you don’t feel the same.  (A hat tip: to Charles Duck who gave this book to me and told me to read it some good three years ago;  I’m only sorry that I waited so long.)

Another Michael Lewis book that became extremely relevant with the recent collapse of large financial firms on Wall Street (though written many years before and published in 1989) is Liar’s Poker: Rising through the Wreckage on Wall Street.  This book chronicles the author’s years as a bond trader for Salomon Brothers.  The inside look is riveting and terrifying at the same time, and may help explain how things could have gone so terribly wrong during the recent fall from grace.  And I must mention Home Game, Lewis’s book about the business of parenting.  As the father of a 4 year old boy, this book worked for me (though I warn you it is quite different from his other books, doesn’t have much to do with business and investing, and you may not enjoy it if you don’t have children of your own).

As one who brokers and services private money loans, a thing that I particularly like is quite simple:  I like it when the loan payments come in on time each month as per the contractual agreement and without any prodding from my office.  Fortunately this happens quite frequently and it makes my life and the life of those who work for me so much easier.  It also opens up the possibility for an extended ongoing relationship with the borrower.  Most of our borrowers tend to need private money loans on an ongoing basis; they use them to drive a series of ongoing professional projects.  And this is another thing I quite like in the business: ongoing, long-term professional relationships with borrowers, brokers, and investors.  Things get so much easier when you know who you are dealing with.

I do not like it so much when borrowers become “bad boys,” having to be prompted and prodded each month to send in their payments, and consistently push the envelope, going beyond the boundaries of their agreement.  This provides a certain level of strain, both physical and emotional within my organization and with certain of my investors.  I will say, though, that I have had cases where the borrower paid just a few days past the grace period each and every month, almost like clock-work, and certain lenders really liked it, as they knew that the payment was coming and that it would be accompanied by a substantial late fee and default interest payment as well.  This type of situation tends to push the yield up, so that a 13% loan may ultimately yield 15-16% to the investor over the life of the loan.

I do like it when borrowers who are having problems actively communicate and behave in a proactive and professional manner—seeking to work with the investors in an attempt to navigate through their financial problems and with the intention of ultimately making good on the overall commitment.  I have found that investors tend to be quite reasonable in working with borrowers who are reasonable–so that quite often a successful “work out” is possible.  In these situations there is ultimate satisfaction for all parties as everyone tends to benefit.

I don’t like it when borrowers who are struggling put their heads in the sand and go into hiding.  Once communication stops, there is no chance for a work out, and the only choice is to foreclose, go to auction, take back the property (if a higher bidder doesn’t take it at auction), and then go about the business of marketing the property.  This can still have a good ending and probably does as often as not, but the work involved is immense, and most loan servicers and investors would rather not go there.  Fortunately, though this certainly happens, it doesn’t happen frequently (though a bit more frequently than usual during the difficulties of the past two year period).

I do like the fact that investors generally have an option, in these situations to either foreclose judicially or non-judicially.  The non-judicial option is faster, easier, and more predictable, but the judicial option allows a the investor to obtain a deficiency judgment should the property fail to fully compensate the debt—and thus gives the investor an opportunity to recover any remaining obligation by chasing borrower income and assets.

In Part III, I will be highlighting some web based resources that I find to be particularly useful, enjoyable, and impressive.  If you have any sites that you feel enable you to make better moves and decisions as you invest in trust deeds, please send me a note, and I will most likely include your information in Part III of this post.

– Clay (clay@privatemoneysource.com)

End of part II

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The private money lending business: likes and gripes (part I)

September 24th, 2009

Clay Sparkman

I thought it would be kind of fun, and hopefully informative, to write a piece about my likes and gripes regarding the business of private money lending.  In other words, these are the things that tend to kick start my emotions and get me going.  There is a bit of free association going on here, as I allow one idea to lead to another and so on, allowing my emotions to carry the narrative–so these likes and gripes are in no particular order.  This is the first part in a multi-part series.

The trust deed system (particularly as it works in Oregon, Washington, and California) is a thing of great beauty!  It provides for order and procedure, eliminating subjectivity (except for in the event of a judicial foreclosure), nicely balancing the interests of the borrower/owner and those of all the lien holders involved with regard to a particular piece of real estate.  Most of the professional investors I know enjoy and appreciate the trust deed system and have a lot more good than bad to say about it.

Associated with this is another wonderful thing they call title insurance.  Title companies are the only businesses I know that provide insurance against the possibility of their own error.  Knowing title companies as I do, I’m betting against them.  I will take title insurance every time AND THUS I shall be able to sleep at night.

Which brings me to the escrow service role of the title company:  This is a very tough job, high stress, with many people simultaneously placing multiple demands, and the need to consistently walk a tightrope avoiding costly problems and errors.  I most certainly wouldn’t want to do it.  And apparently most title people don’t either.  Most title companies do a poor job of training and preparing their people and setting a high standard, and thus unfortunately, most escrow services offered by title companies stink.  Fortunately there are exceptions.  Unfortunately, we often don’t have any control over where a particular closing is going to take place.

Now don’t even get me started on loan brokers.  I have often heard that 10% of realtors do 90% of the sales—and I suspect that the numbers are even more extreme with regard to loan brokers.  A good loan broker is worth her weight in gold—and there are some good ones out there—but there are … oh so many sadly disappointing loan brokers.  Still, we need loan brokers so we soldier on.  I figure our loans at Fairfield are about 50%/50%, with half coming to us through loan brokers and the rest coming directly from the borrowers.  The problems in my experience are not so much with honesty (though this certainly can be a problem from time to time), but with matters of basic business professionalism in general and with the specific knowledge of the business in particular.  Of course, it is a big step for many loan brokers to move into the realm of private money and commercial lending, but my company works hard to provide assistance, education, and support; we spend extraordinary amounts of time working to educate brokers.  At the end of the day, only a few seem to stick.  I think the problem in this field is one of barriers to entry; just about anyone can take a little test (and I mean little) and become a loan broker and that is probably not a good thing.

Okay, now that you’ve got me going:  I am downright angry at banks for not lending money on real estate secured loans any more.  “Come on banks, lend money!  That’s what you do for a living isn’t it?”  We in the private money sector need banks.  We lend money to help generally strong borrowers get from point A to point B, and point B is frequently a bank loan (or a buyer who needs a bank loan in order to be a buyer).  This needs to change.  There are plenty of good safe loans for banks out there that don’t require the banks to disregard every rule of good lending (as they did with many sub-prime loans leading up the collapse in fall of 2007).  It reminds me of something Mark Twain said (and I’m paraphrasing).  He said that if a cat sits on a hot burner it will never sit on a hot burner again.  But then it won’t sit on a cold burner again either.

I love my attorney.  It took me years to find a guy like this.  Everything that you have ever heard that can be bad about attorneys: the opposite is true about my guy.  He is honest, pragmatic, honorable, and fair.  He knows his limitations—and will be the first to tell you when he comes up against them–but at the same time has a vast breadth of knowledge regarding real estate matters and business in general.  And he doesn’t start a clock every time he picks up the phone or answers an e-mail.  Believe it or not, he actually seems to charge for “real work:” research and document preparation and such.  (And on top of all that, he’s the kind of guy you’d want to have a beer with.)  If you want me to put you in contact with him, I will.

And speaking of lawyers, I have to say that I really enjoyed Happy Hour is for Amateurs, by Philadelphia Lawyer.  If you are offended by explicit talk of sex, drugs, and binge drinking, you may want to give it a miss.  But beyond the raucous tales, this book takes you right into the bowels of the enormous billing machine that is “the law firm in America.”  This book takes what we thought we already knew and knocks us right upside the head with it.  It turns out we knew nothing at all.

End of part I

– Clay (clay@privatemoneysource.com)

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Twenty-five questions you must ask

September 15th, 2009

Clay Sparkman

I’m going to make a list today of twenty-five important questions that I believe an investor must ask prior to funding any private money loan transaction.  I’m not going to elaborate much on each particular item here, but will drill down on each of the individual items in future posts.  For the sake of simplifying this discussion to a reasonable level, I’d like to start with several assumptions: (1) we are only talking about loans secured by real property, (2) we are only talking about first position loans, and (3) we are not talking about land development or raw land loans.  (Each of these exceptions, if removed, would be good for another whole list of special questions’ we’ll save those particular scenarios for future discussion.)

(1) What is the Loan to Value (LTV) ratio of the loan you are considering and how does that fit with your own risk limits regarding this particular loan and property type?

(2) If this is a value-added loan (construction, rehab, or development), what is the front-end LTV?  Font-end LTV refers to the LTV immediately after the close of escrow but prior to any construction/development or disbursement of construction holdback funds.  (I generally reference this as FLTV, and it is understood that LTV, for a project actually refers to the LTV upon completion of the construction/development and full disbursement of any/all hold-back funds.)

(3) How confident are you of the value?  The “L” part in LTV is easy.  It is the “V” part that can be quite difficult to accurately determine, and in fact it must be understood that any such determination (no matter how good) is only an estimate.

(4) What are the recent market trends for the area in which the property is located?  Given the real estate market of the past two years, this question is particularly relevant.

(5) How is the borrower’s credit?  What is the mid-score, what are the issues, if any, and what is the trend?

(6) If the loan is a refi: how is the borrower’s pay history on the existing loan?

(7) How much “skin” will the borrower have in the game at the close of escrow?  In other words, how much cash or additional collateral is the borrower bringing to the table?

(8) If this is a real estate development or investment loan or a loan to a business owner occupying his own property: what is the relevant experience and background of this borrower?

(9) What is the purpose of the loan and how will the funds be utilized?

(10) What is the term of the loan?

(11) Can the borrower afford to make payments OR does the loan scenario otherwise involve an adequate interest reserve?

(12) What is the borrower’s plan/exit strategy, and how likely is the borrower of success?

(13) What is the borrower’s net worth and how liquid are the borrower’s assets?

(14) If there are one or more structures on the property, will you be listed as loss payee on a hazard insurance policy at the close of escrow (or prior to the beginning of construction if new construction is being funded)?

(15) If there is a construction hold-back, who is administering this and do you trust them to do so effectively?

(16) Have you reviewed the operative preliminary title insurance policy and approved any liens that your title insurance policy will be listing as exceptions to your position?

(17) Is your loan compliant with all state and federal disclosure and usury laws?

(18) Will all taxes be paid current at closing?

(19) What is the likelihood that there are any serious hazardous waste issues associated with the property?

(20) What is the likelihood that there are any wetland issues associated with the property?

(21) If relevant: what is the status of all required permits, entitlements, or other government approvals?

(22) What is the likelihood of one or more construction labor/materials liens taking precedent over your lien position?

(23) Does the loan size/amount, location, type etc. allow you to obtain optimal diversification?

(24) What is your plan for servicing the loan?

(25) If the loan involves a fractional interest, how comfortable are you joining with the other lenders involved in the loan?

So that’s my list for now.  There is nothing special about the number twenty-five, and I may well have left off some very important items, so please provide feedback as to which items you agree with, which ones you don’t, and what other items you might feel absolutely must be on a list of this sort.

– Clay (clay@privatemoneysource.com)

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Resources – where is all the good stuff?

August 30th, 2009

Clay Sparkman

As I continue my search for resources that might be useful to those who invest in real estate secured loans, I become increasingly convinced that our particular niche field is somewhat of an intellectual/informational wasteland.  Every time I stumble upon an article or site that looks like it might be of interest, it turns out to be a blatant plug for some specific product or company.  And the stuff that isn’t blatantly biased, quite often seems to be hack work, badly lacking in quality and perspective.  It would be as though I were searching for articles and blogs on gourmet food only to find that all of them had been written by employees of McDonald’s, Burger King, and Taco Bell.  (Hopefully I won’t get sued for this.  I did not mean to disparage the great corporate food powers in any way, shape, or form.)  My real point is: if I see one more article entitled “Hard Money Made EZ” or if I see “hard money” refereed to as “hard $$$” one more time, I’m outa here.

Moving on, I turned up a few items of interest in my lap around the internet this morning.  The following article is quite dated, but still might be of interest for those looking to expand geographically (and into a very large target market).

http://www.danwei.org/front_page_of_the_day/private_money_lending_business.php

I also stumbled onto this site/book by Paul Wells who claims to hold the secrets of private money.  I hope indeed he does, as we could use a good text book in this field.  I have asked him for a review copy, and if he is obliged to comply with my request, I will make a point to read/review it here.

http://www.paulwellsauthor.com/mortgageinvesting.html

I couldn’t help but be amused by this post by Leonard Rosen in August of 2007.

“America’s hard money expert shares his views on real estate investing. There are many different types of investing strategies that are available to the novice and sophisticated investor.

However, I do not know a safer investment strategy coupled with a higher rate of return than real estate. Unlike the equity markets, real estate has proven to be a safe haven for many investors. Over the past 40 years, real estate has risen in value in literally every major market in the United States.”

Oh well.  The full text is here:

http://www.americanchronicle.com/articles/view/35089

And here is another book on the topic, specific to California (but that is a pretty good starting point for talking about the basics of private money lending nationwide), and with five of five stars on five reviews.  I can’t figure out how to ask for a free review copy, so if anyone knows the book please weigh in here.

http://www.amazon.com/Smart-Trust-Deed-Investment-California/dp/0934581010

About.com defines private money pretty much the same way as most outsiders do:

http://www.answers.com/topic/hard-money-loan

At least they hedge the “last resort” part with the “short-term bridge” bit.  However, I am beside myself with how many people who should know better claim–I see this over and over again–that the borrower (credit/income/net worth and such) is irrelevant to the private money lending process.  Why would anyone make a private money loan and disregard readily available information about the financial status of the borrower?  It is beyond me.

Please oh please … if you know where the goodies are hiding out there, please share them with the rest of us.  That after all is what this blog is all about: sharing quality information and resources with like-minded folks who care about private money investing.  (Oh yes:  and promoting me and my company; but NOT BLATANTLY MIND YOU … good lord no … not blatantly.)

– Clay (clay@privatemoneysource.com)

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Private Money – The Rules of Physics May Not Apply

August 22nd, 2009

Clay Sparkman

I would like to make a proposal.  I would like to propose that the standard universal laws don’t necessarily apply to private money lending.  That is, the things which we most take for granted—or assume to be true–may not be true in the realm of private money lending.

Let’s talk about systems for a moment.  Let’s take physics as an example.  Physics is the scientific mechanism which man has devised for describing, conceptualizing and predicting the behavior of the physical world.  In the realm of physics, if one rule or one aspect of the system is called into question—even a small matter—then the entire system must be called into question.  This has happened on various occasions as the science of physics has evolved, and as you can well imagine, it has caused quite a fuss among those who study physics.

My goal here is to break your notion that the things which you “know to be true” in the realm of private money lending can be correctly assumed to be true.  Let’s start with something absolutely fundamental.  Everyone agrees that there is a direct relationship between the perceived risk of loss of investment capital associated with a particular investment and the rate of return from that investment.  And I think it would be fair to say that pretty much everyone in the field agrees (1) that private money loans are riskier than their institutional counterparts (hereinafter referred to as institutional loans, a category to include conventional loans, sub-prime loans, and everything not included in the category of private money) and thus carry higher interest rates, and (2) that within the private money realm, riskier loans carry higher interest rates than those which are perceived to be less risky.  I would be quite surprised if any of my readers take issue with either of these two basic notions.  Let me clarify one more time because this is important: when I speak of risk here, I am referring to the risk of direct monetary loss of investment capital.

So let me now proceed to turn these two basic notions upside down.  Fundamental notion #1 suggests that private money loans are riskier than institutional loans and that this is the reason why they carry higher interest rates.  This is quite simply wrong.  Institutional lenders don’t avoid risky loans per say.  In fact, the sub-prime realm tends to thrive on them.  Institutional lenders can (and do) factor known risk into their lending process.  What institutional lenders will not tolerate is this: they will not tolerate loans which cannot be analyzed or characterized within a specific manageable and objective framework.  Put another way, institutional lenders are only interested in commodity loans—as opposed, let’s say, to custom loans.

And why is this true?  It is true because institutional lenders choose to manage risk and this can only be done effectively within a commodity loan system.  Even though these lenders can accommodate almost any degree of risk, they cannot–and will not–accommodate unknown risk.  All risk must be measurable, and risk—to say it another way–is only measurable within a specific manageable and objective framework.  Using FICO scores and other specific measures, the typical institutional lender can predict to within a dime the value of their loan portfolios that will go bad.  So you see, by managing risk, in effect they eliminate risk.  Any given loan involves a certain amount of risk, but a portfolio of commodity loans is utterly predictable.

In case you’re not buying this particular line of logic, and you think that I’m just working with smoke and mirrors here, let me offer some (fairly) objective data.  At Fairfield Financial, we manage a portfolio of 200+ private money loans at any given time, a package that adds up to about $30 million dollars in face value.  Our average mid-score for that package is between 650 and 660.  That portfolio sees an average of 2 loans per year go to REO.  That is a 1% default rate.  Those are good figures: 650-660 mid scores and 1% default rate.  I suspect that many institutional lenders would rather enjoy such numbers.  And thus, it seems that our loans are not necessarily more risky—or even as risky—as their institutional counterpart.  Then of course then our rates must be on par with the institutional realm as well, yes?  No.  Our median interest rate is 13% (fixed).

Okay fine.  Certain irregularities occur in the risk-reward relationship when crossing from the institutional money realm to the realm of private money.  But surely we can say—with complete confidence–that within the realm of private money, riskier loans carry a higher rate of interest than those perceived to be less risky.  Here again, I would respectively suggest: it just aint so!

Private money lenders are averse to risk–as are all investors.  However, private money lenders on the whole are particularly averse to risk of default (as opposed to risk of loss).  Risk of default involves (a) temporary cash flow interruptions (something we affectionately refer to as “cashflowus interuptus”), (b) lying awake at nights and worrying about non-performing or sporadically-performing loans (which we call “bad boys”), and (c) lots of hassles and many hours of work (which tend to accompany the bad boys).

In fact, I would assert that on the whole private money lenders are less averse to risk of long-term potential loss then they are to risk of default, which we shall refer to hereafter as the “bad boy problems.”  I have spent the past 15 years of my life pricing private money loans and have a pretty good idea of how the market works.  Pricing private money loans is a little like pricing antiques but tougher; it is a highly subjective process.  But of course there are certain guidelines.  One takes a hard look at the long-term risk of the loan and at the potential for bad boy problems.  I would argue that the best indicator of long-term risk is LTV.  Bad boy problem indicators (such as credit, income, and pay history) may play into the risk equation, but as any private money lender will tell you, they are betting on the equity first and the borrower second—and in fact the borrower is a distant second.  Having established LTV as a risk indicator, let’s look for a bad boy indicator.  Let’s go with FICO mid-score.  I have found that FICO mid-score is indeed a very reliable indicator of the likelihood that you will have a bad boy on your hands.  When it comes to financial responsibility/performance, it seems that the past is a very good predictor of the future.

So now we have two objective scales to work with: LTV and FICO mid-score.  Here I’m going to take a giant leap (very unscientific, but also very interesting) and make the assumption that these two scales are basically linear.  The LTV scale for private money loans basically runs from 0% to 75%.  The FICO mid-score scale runs from 300 to 850.  So that now we have established a ratio of 7.33 between the two scales ([850-300]/75).  Thus we can say that a 10% change in LTV on the risk scale is roughly proportionate to a change of 73 in FICO mid-score on the bad boy scale.

If risk is the primary factor driving interest rate, then a 75% LTV loan to a borrower with a 700 mid-score would carry a higher interest rate than a 55% LTV loan to a borrower with a 554 mid-score.  Well, in fact just the opposite happens.  Equalizing for other factors, I would tend to price the first loan at 12-13% and the second loan at 14-15%.  So you see, long-term risk is a distant second to bad boy factors when pricing a private money loan.

Someone I respect immensely recently said that it is not what we don’t know that endangers us the most.  It is what we think we know but know incorrectly.

If you go away from this post knowing that the risk-reward relationship as applied to private money is a myth, then you have learned a little something.  If you lie awake tonight and wonder if things that go up in the private money universe really must come down—then that dare I say may qualify as an epiphany.

– Clay (clay@privatemoneysource.com)

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Learning How to Blog – Private Money Investing

August 16th, 2009

Clay Sparkman

Okay, here we go.  I’ve been fussing around with this software and reading books on blogging and thinking about how to do this just so so.  But I realize now that it’s kind of like running a class-5 rapid.  Ultimately you just have to do it.

Who am I?  My name is Clay Sparkman and I will be blogging to you on a regular basis about hard money investing.  I am the Vice President and part owner of Fairfield Financial.  I have been brokering and investing in private money loan transactions since 1992.  I hold an MBA degree from Portland State University and a BS in Economics and Computer Science from the University of Oregon.  If there is anything I have learned in my 17+ years in the private money investment field it is that there is a thirst out there for more high quality, well organized information regarding this type of investing.  Many people want to participate or get more involved, but don’t know where to go to learn about it.  To this day, I am personally astounded by the lack of quality resources on this topic.  So my goal with this blog is to help fill the void–to provide a quality forum in which interested parties can discuss and learn more about the many intricacies of private money or trust deed investing.

I’m not sure I even have a single chair filled yet in my forum, and so I may be listening to my own echo for awhile, but in case anyone is listening, I’d like to start by asking if anyone would be willing to share information regarding quality resources that already exist regarding private money investing.

– Clay (clay@privatemoneysource.com)

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