We’ve been through nearly 3 ½ rough years in the real estate market—and projections seem to indicate that we will finally see clear up-turn in the second half of this year, but no one really knows for sure.  We have managed to survive this down-time (thus far) and continue doing loans even in the face of uncertainty to borrowers and investors.  Certainly our loan volume is down.  Less people are borrowing for projects at the moment (though we are starting to see some upturn there) and our investors are being more conservative given the level of uncertainty.  The key areas we look, I would say, even more carefully than we did before the crash are:  (1) LTV: we used to do a lot of stuff at 75%.  Now most of what we place is at 65% or less.  (2) Professionalism of the borrower: we want to see that the borrower is proceeding with caution, has done his/her homework, has backup strategies in place, and has a reasonable track record.  (3) Exit strategy: it is hard to be certain in this climate that an exit strategy will work, but we beat this to death to be as sure as we can that there is/are one or more ways to exit the loan.

Rigorously following these guidelines has served us well and has generally worked out well for our investors.  By way of example, here are four loans that we have closed (or are in the process of closing) recently.

Mini-condos for simple living on the Washington coast

1.     Loan Amount: $286,000

2.     Term: 1 year

3.     Interest Rate: 13%

4.     Monthly Payments: $1,895.83 Interest Only

5.     Construction Holdback Account: $265,000

6.     Security:  Deed of Trust in 1^st Position security interest in real property at xxxxxxxxxx

7.     Projected Value by Borrower Comps: $476,000

8.     As-is Value by Borrower Estimate $30,000

9.     As-Is Front End LTV Borrower Estimate:  70%

10.     Completion LTV by Borrower Comps:  62%

This loan is to provide funds to build four detached condos on the Washington Coast.  The borrowers, xxxxxxxxxx of xxxxx company requested a loan of $286,000 to provide funds for the construction and various loan costs and closing fees.  $265,000 of this was deposited into a construction holdback account.  The borrowers have $21,000 invested into the purchase and clearing of the lot so far, which is effectively being considered as their down payment or skin in the game.

This will be the 3^rd group of condos that the borrowers have built.  The first set of condos was built in the fall of 2009, and the borrowers report that they sold in approximately 2 months.  The 2^nd set was completed in the fall of 2010 (this is an existing construction loan with Fairfield), and at least one of those units has been sold for the full asking price.  The borrower reports that there has been a lot of activity and interest in the remaining units.

Partner xxxxx  is a realtor, and her husband is the contractor who will do the actual construction.  The borrower plans to exit this loan through the sale of these condos, and has requested that each condo be released with a principal reduction of $75,000.

The property is located on a cul-de-sac approximately 1,800 feet from the average high tide line, and two blocks from public beach access. These condos will be 480Sq/Ft with a full kitchen and bath, and made with eco-friendly materials.

Adult care facility in Washington

1.     Loan Amount: $270,000

2.     Term: 24 Months

3.     6 months minimum interest

4.     Interest Rate: 14%

5.     Monthly Payments: $3,150.00 Interest Only

6.     Security:  Deed of Trust in 1st Position security interest in real property at xxxxxxxxxx

7.     Value of Collateral by Appraisal:  $750,000

8.     LTV based on Appraisal:  36%

The borrower, xxxxx, inherited an adult care facility approximately 2 years ago.  She requested this loan to funds to pay the probate and costs incurred in the transferring of the estate.

The subject property is a 4402 SF 8 bedroom 3-bath home being used as an adult care facility.  There are several outbuildings being used as rentals to the borrower’s family.  Leases were provided.  The home sits on 5 acres, adjacent to a bare 5 acre parcel that is also being used as additional collateral.

Vacation rental in central Oregon

1.     Loan Amount: $120,000

2.     Term: 36 Months

3.     6 months minimum interest

4.     Interest Rate: 13%

5.     Monthly Payments: $1,300.00 Interest Only

6.     Security:  Deed of Trust in 1st Position security interest in real property at xxxxxxxxxx

7.     Value of Collateral by Borrower Comps:  $227,900

8.     LTV based on Collateral by Purchase Price:  53%

The borrower, xxxxx company had negotiated the purchase of this property for $150,000.  The seller was in financial distress and needed to sell quickly.  The borrower believed that this price was well under value (the list price was reduced to $199,500 on 12/8/10), and were requesting 10K for cosmetic improvements.  They put down 25k, and the seller is carried back another 25K to make the loan work.  The loan was personally guaranteed.

The subject property is a 1,618SF home that will be used as a vacation rental.  It is located in the xxxxx subdivision which has amenities such as a club house, swimming pool, excessive common grounds use, and paved bike paths.  The property has 3 bedrooms, 2 baths, fireplace, and wrap around deck.

Self-storage facility in northern Washington

1.     Loan Amount: $375,000

2.     Term: 36 Months

3.     6 months minimum interest

4.     Interest Rate: 12%

5.     Monthly Payments: $3,750.00 Interest Only

6.     Security:  Deed of Trust in 1st Position security interest in real property at xxxxxxxxxx

7.     Value of Collateral by Purchase Price:  $565,000

8.     LTV based on Collateral by Purchase Price:  66%

The borrower, xxxxx, is an experienced owner and operator of self-storage facilities.  He had the subject property under contract for $565,000, and was seeking a loan of $375,000.  There was approximately $20,000 in credits that the seller agreed to provide, and the borrower stepped up with a down payment of approximately $200,000.

The borrower plans to live on site and manage the property which will greatly reduce his personal living expenses as well as eliminate the wages that are currently being paid to an on-site manager.  In addition, he plans to install a self-service Kiosk that would allow easier access for new tenants to sign up 24/7.  He also plans to improve the signage, making the property more visible.  Finally, he will offer a $1 first month move in special and change the name of the property from xxxxxxxxxx to yyyyyyyyyy.  He believes that this name change will improve the search engine rankings and ultimately increase occupancy.  Through these changes the borrower believes that he can increase his occupancy from the current 50% to 80% in the first year.

The borrower plans to exit this loan by refinancing with and SBA loan.  More info regarding the feasibility of this exit strategy is described below.

The subject property is consists of 2 lots with a combined 2 acres and 22,923SF of rentable space over 7 buildings.  In addition, there is a small 2br 1ba manufacture home on the property.  The property was reported to be in excellent condition, and located in a prime spot in northern Washington.  There are several self-storage facilities in this area, which are reported to have low vacancy rates.

The current occupancy rate is at 50%, which the borrower attributes to the current “absentee owner”.  As far as he can tell, there isn’t much for marketing activity and no incentive for the on-site manager to increase their workload by working to increase the occupancy.

– Clay (sparkman@lendicom.com, 503-476-2909 or 800-971-1858)

Clay is Vice President of Fairfield Financial, a primary source for private money loans since 1964.  Fairfield works with a broad range of private money investors, in a broker capacity, finding, underwriting, presenting, closing, servicing, and when necessary, assisting in the workout of difficult loans.

One of my long term objectives with this blog is to eventually walk with you through all of the private money loan processes and procedures, from the moment of conception until death (death of course not being a bad thing in my chosen metaphor, but simply meaning loan payoff, workout, or foreclosure).

This post deals specifically with the loan packet submission process (not quite conception, but in the early infancy stages you might say).  When working with either brokers or borrowers, it is very important to be specific regarding precisely what items are needed in order to properly review the loan in detail.  Presumably at this point, you will have reviewed the loan in concept, via a verbal interview or some form of written summary or submission and would like to take the next step and review a detailed paper (or electronic) packet.

It is also important at this point to very clear with brokers or borrowers regarding how and where and in what form to submit the packet, and if you require a deposit, as we generally do, this would be the time to ask for it.

And so, these are the guidelines used by my company, Fairfield Financial.  We have developed these over the years and they are pretty good, but keep in mind that these are only guidelines and that each situation is unique and may require additional underwriting items that are not mentioned here.   Also keep in mind that there is an element of style or expectation involved here, specific to the individual lender.  Our goal is to attempt to obtain all information that might have more than a negligible impact on the decision process.  You want to be thorough, but you don’t want (I think) to ask for every possible imaginable item.  (That would make you too much like a bank now, wouldn’t it?)

When submitting a loan proposal, please include:

• Residential loan application (1003) or equivalent (MUST BE SIGNED BY BORROWER)
• Signed and completed Fairfield Disclosure Forms
• Current tri-merge credit report (if loan is submitted by broker; if borrower submits directly, Fairfield will pull report)
• Trio of subject property (or other type of detailed spec summary)
• A good comp set, appraisal, or some other objective and transparent case for value
• Photo(s) (if not included in an appraisal)
• Cover sheet describing/summarizing parameters of loan
• Preliminary Title Report(s) for all properties
• Payment history on all loans encumbering the subject property (or properties)
• Payoff quote on present loan(s)

If borrowing entity is corporation

• Company financials (income statement and balance sheet)

If purchase

• Valid executed earnest money agreement (contract to purchase)

If credit history is rough

• Explanation of circumstances
• Supporting documentation to show status of resolved items

If present loan is in default

• Explanation of circumstances

If raw land or builder ready lots

• Supporting documentation (government correspondence/code) to address development plan and demonstrate likelihood of completing development according to plan
• Copy of zoning documentation and explanation of possible land uses
• Description and status of utilities and access to the lots
• May want signed affidavit from Borrower regarding completion status of lot(s)

If floating home

• Copy of registration
• Recent float survey
• Copy of lease (if slip is leased) or owners certificate (if slip is owned)

If leased land

• Copy of lease on land (or usage permit)

If 2nd or subordinate position loan

• Copies of notes and Deeds of Trust for all superior loans
• Payment histories and statements for all superior loans
• Payoff statements for all superior liens

If construction/rehab loan

• Summary of project
• Builder credentials
• Copy of contractor’s License, bond and insurance
• Detailed line item budget
• Supporting documentation to backup detailed line item bids/estimates
• Plans (if floor plan is new or changing)
• Copies of permits already obtained

If Income Property

• Copies of all leases and rental agreements pertaining to the property.

Our Guidelines:

Region:

Alaska, California, Colorado, Florida, Idaho, Georgia, Montana, Nevada, New York, Oklahoma, Oregon, Texas, Washington, and Wyoming

Loan Amounts:

$50,000 minimum, no maximum

Interest Rates:

10 – 15% on firsts

Term of Loans:

1 – 5 years

Amortization:

Interest only

Broker Fee:

Typically 5%

Other Fees:

Document preparation: $675 to $2,900; Collection account set up: $470 plus $1 for each $1000 of the loan amount; Property inspection: generally $250 to $1000

Pre-pay Penalties:

None

– Clay (clay@privatemoneysource.com, 503-476-2909 or 800-971-1858)

Clay is Vice President of Fairfield Financial, a primary source for private money loans since 1964.  Fairfield works with a broad range of private money investors, in a broker capacity, finding, underwriting, presenting, closing, servicing, and when necessary, assisting in the workout of difficult loans.

The national economy is in a state of confusion and the local economy is in a state of confusion. So what does this mean for the market for investing in trust deed based loans?

Well of course nobody really knows–and this is just my take on it–but here goes:  First of all, let’s talk briefly about investment choices.  With so much uncertainty in alternative investment vehicles, maybe trust deed secured loans are a pretty good place to put your money.  After all, you will have real security backing up your value, and that can’t be said about most investments.  And you certainly have the opportunity to receive a nice double digit return on your investment, and that being so even if you opt for the best and most potentially safe such investments.

The key thing to keep in mind is that real estate markets are uncertain and potentially volatile.  And thus you need to be particularly rigorous in making loan selections.  I would say that the most important keys are: (1) Make sure you know as much as possible about the recent price history of the particular market you are considering.  This will most likely allow you to better gage the potential future volatility of the market.  (2) Keep the loans either short or long.  1-2 years for quick-turn projects, and maybe 5 years to those borrowers looking for and able to afford the long hold.  The danger zone in my opinion tends to be in between.  (3) Make sure that your borrower has a solid exit strategy (no exit strategy is foolproof given the seemingly scare nature of bank financing, but some strategies look a whole lot better than others).  And (4) Keep your LTV a little lower than usual so as to better absorb potential market depreciation during the life of your loan.  We still have clients who lend 75% LTV on very solid transactions, but these days most investors feel better at or around 65%.

With regard to demand, the following is relevant once again: Markets are uncertain and potentially volatile.  How does this apply to the market for borrowers of private money? To answer this question, we have to look at who borrows private money. I would say with complete confidence that easily 80% of all of the loans that we do (Fairfield Financial) are to those who buy, sell, renovate, and construct real property with the intention of earning a profit.

The relevant point here is that most real estate investors are likely to be avoiding the long-term hold and attempting to make the good buy and turn properties for a quick profit. This is a market where properties are going back to the banks at a frightening rate, and where this spells bad news for home owners who over-borrowed, this means opportunity for the quick-strike investor. The bottom line of all this is what? Again, it’s hard to say, but I think it would be fair to conclude that if you are a private money investor (like most of you on this list), you might want to look particularly for: (1) those borrowers looking to buy and sell property on a dime to make a profit (many times you can justify lending up to 100% of fix up money and repair money to these borrowers when they are buying well), or (2) borrowers that have a longer hold scenario (closer to 5 years) that fall between the cracks of the more conventional lenders, generally already own the property,  and might bear a 10-12% holding rate to bridge the gap for several years. The idea is that this type of borrower can afford private money sized payments over the longer haul and will utilize this option to get to from point A to point B.  And point B–I might add–is a place that we’d all like to believe is a better place, a place where life is predictable once again and property values are something we can hang our hat on.

– Clay (clay@privatemoneysource.com, 503-476-2909 or 800-971-1858)

Clay is Vice President of Fairfield Financial, a primary source for private money loans since 1964.  Fairfield works with a broad range of private money investors, in a broker capacity, finding, underwriting, presenting, closing, servicing, and when necessary, assisting in the workout of difficult loans.

One of the most promising areas 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.

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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)