I have always believed—and history seems to bear this out—that when the status quo becomes problematic, new opportunities present themselves.   Certainly the real estate economy of the past three years has proved problematic, and so as private money investors we are called upon to seek out those borrowers/investors who have encountered and successfully engaged those new hidden opportunities to create wealth in difficult times.

I would like to present here, by way of example, one real estate investor in particular who has done precisely that.   Mr. X saw opportunity in a Las Vegas real estate market turned upside down.   He assembled a crack team and began buying REO properties at heavily discounted prices from banks.   He used private money, along with his own funds, to buy, rehab, and either quick-flip or hold (depending on the particular circumstances) single family residences and multi-unit properties in the city.

He came to us to help fund his projects, and we have been thrilled to see him perform impeccably on loan after loan, grow his wealth position, and persistently decrease his leverage position (at a time when many real estate investors are doing just the opposite).

Our private money lenders are coming to us and asking for the chance to do more loans for Mr. X.   We just finished closing another 4-plex rehab loan for him and are now in the process of placing a very attractive 10-plex acquisition and rehab opportunity.   By way of illustration, I have provided the prospectus below.

Kristopher Gillmore

Fairfield Financial Services, Inc

3327 SE 50th St, Portland, OR 9706

Phone (503) 319-7294 / Fax (503) 419-4219 / E-mail: gillmore@privatemoneysource.com

REAL ESTATE PROSPECTUS

SECURED LOAN

Purchase and Rehab of 10-plex in Las Vegas, Nevada

Loan Details

1. Loan Amount: $210,000
2. Term: 2 yr
3. Interest Rate: 13%
4. Monthly Payments: $2,275.33 Interest Only
5. Security:  Deed of Trust in 1st Position security interest in real property in Las Vegas, NV 89102
6. Value by Borrower Estimate / Comps is $350,000
7. LTV by Borrower Estimate / Comps is 60%

Loan Overview

A loan for the purchase and rehab of this property has been requested by Mr. X’s company, xxx, LLC.   Mr. X is requesting $98,200 for the rehab of this property, and will be making a down payment of approximately $16,000.   Mr. X will personally guarantee this loan.

Mr. X is experienced flipping homes and multi-family homes in Las Vegas, and has rehabbed well over 200 properties in this area.   He currently holds 65 properties in his inventory.  38 of these homes are free and clear and all but 2 of his properties are rented and producing income.  Mr. X reports that these properties are for sale or pending renters.

Mr. X has successfully completed four loans with Fairfield over this past two years.  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 Mr. X has never been late with a payment.  In addition, Mr. X currently has five active loans through Fairfield.  These five loans are on 4-plexes that he is holding as rentals, and like the first four loans.  Each of these rehabs was completed and rented in approximately one month.  Each property has a positive cash flow and Mr. X has never been late with a payment.  To exit this loan, Mr. X will seek conventional financing once renters are in place.  He anticipates that it will take around a year to get this financing in place.

Property

The subject property is 5,500 SF and has 10 units.  There are eight 1 bedroom and 1 bath units, and two 2 bedroom, 2 bath units.  The 10-plex was built in 1956 and sits on a .15 acre lot.

Based on other rental properties that Mr. X owns in this area, he anticipates that property will rent for $4,300 / month total ($400 / 1-bed and $550 / 2-bed).  Mr. X aggressively markets his rentals which are all newly renovated and priced lower than his competitors.

The building is structurally sound, but is in need of cosmetic repairs.  Mr. X has agreed to make all of the repairs to this property out of pocked ($98,200), and will submit one final draw for reimbursement once this property has been completed.

This property is in a prime location, within walking distance from the Las Vegas strip.  It is located approximately ½ mile from the Stratosphere hotel and casino, in close proximity to some high end developments like Allure Towers, Soho Lofts, and Newport Lofts.

Valuation

Comps by Borrower

To determine the completion Value, Mr. X’s partner and realtor, Mr. Y, has provided some recent comps for multi-unit properties.  Based on the price per unit of these comps, location, and expected rents, Mr. X estimates a conservative value of at least $350,000 for this property.

In July 2010, a property inspection was performed for a 4-plex in a similar neighborhood (829 Held Road).  It was suggested by our inspector that a conservative value for this property would be $180,000.  Because these are both multi-unit income properties, the approach used to calculate this value should be similar.  Based on the inspectors estimate of value for this 4-plex, Mr. X’s estimate of $350,000 for a 10-plex seems reasonable.

Income

We were provided with a signed 1003 for Mr. X, which states a monthly income of $30,000.  In addition, he states a net rental income (not including taxes and insurance) of $72,180, and a net worth of $7,258,000.   A copy is provided here for your review

Credit

Mr. X has a mid credit score 575.  His credit score has dropped substantially due to late payments on a Mercedes for which his ex-wife is responsible.  Mr. X said that his name should not be on that anymore and he will look into it.

Market Analysis

There is ample information available for residential market conditions.  By utilizing sites like zillow.com and altosresearch.com, we can see that the residential market has been in decline for the past 2 years.  Altos research.com provides graphs of the average price, price/SF, days on market, and the number of homes on the market.  These graphs are provided for your review.

Most notably, the graph showing the number of homes on the market (and recent reports of a 2^nd wave of foreclosures) suggests that increased foreclosures continue to force people out of their homes.  The number of homes on the market has increased by approximately 10% over the past 6 months.

Mr. X states that this downturn in the residential real estate market has been one of the keys to his success.  Mr. X stopped flipping houses approximately one year ago, and started buying rentals.  In this market he’s able to purchase these properties below market value and rehab them quickly, so that they cash flow with hard money rates with minimal vacancy.  The fact that these rentals are newly renovated and competitively priced in a market where more people are renting, has allowed Mr. X to make a lot of money over this past year.

Now that’s some kind of lemonade!

– 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 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.

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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)