In December of 2007 we were faced with a decision.  After three years of successfully flipping properties to low and moderate income buyers, we awoke one day with no buyers and no plan to find new ones.  Our dilemma was very simple, do we dissolve the company or do we create a new viable model that will work in this new economy?  If we decided to create a new model, what would that look like?

We had just begun to hit our groove in the spring and summer of 2007.  We had successfully flipped around 100 properties in the first 2 ½ years of business and we were working at about a 4 to 5 house pace per month.  We were making money and had been in the black for quite some time.  We considered ourselves “real estate investors” and thought we were pretty darn good at it.  So when we found ourselves faced with a flight or fight decision only a few short months later, it seemed surreal.  My partner, Karen, and I spent days talking about what a viable model was for the new economy.  We had heard of other local groups “selling to out of state investors.”  We decided to attempt to replicate a similar model, but with a focus on local investors.

For three months Karen and I worked on a plan and developed systems and processes that involved Golden Key (GK) (www.gkhouses.com) selling properties to investors that wanted to invest passively in real estate.  Our vision was that everyone recognized the opportunity, but very few people had the skills to do something about it.  We thought we would approach professionals (executives, doctors, lawyers) and pitch them on the idea of owning 10 – 15 properties instead of investing all their money in the stock market.  Locally, based on our expected average sales price, this involved them investing $100K to 150K individually.  Our responsibility in this plan involved acquiring the properties, rehabilitating them, leasing them, and then finally selling them to these new found investors.  We felt this model would eliminate most of their risk and objections.  Questions like, “What would it rent for?” and “How much will the rehabilitation cost?” became commonplace in our initial pitches.  What we decided was that we really needed to mold two businesses–an acquisition business (to find the deals) and a management business (to process the houses and manage them on a go-forward).  Our office quickly became a “mission control” of spreadsheets and flow charts.

In 2008 we had only moderate success with pitching this business.  We had very little trouble getting people to agree that there was an opportunity, but a whole lot of trouble getting them to write a check.  We were able to identify some investors, but continuing changes in the lending environment made it harder and harder to close the deals and made it more difficult for one person to purchase multiple properties.  This resulted in a time intensive process of dealing with lenders during the close and constantly finding new investors.

Because we became very frustrated with how slowly the business was progressing, we decided if we could pool the investors versus dealing with them individually, this would allow us to really deal with one “client” and speed up the process.  Since we didn’t know how to put together a fund, we approached a local investment bank, Founder’s Investment Banking (FIB) (www.foundersib.com) in late 2008.  We thought FIB to be a good fit since they had a real estate practice that had previous experience putting together real estate focused funds.  At the time, they were disinterested, but we did plant the idea.  We continued to approach other similar groups, but with very little success.  So we continued to sell to both local and out of state investors, one house at a time.

In the spring of last year (2009), FIB came back to us and said they would be interested in putting together a fund.  The fund’s investment thesis was to purchase the homes, already renovated with a tenant already paying rent, and then to hold the properties in a portfolio renting them, and as the market recovered begin selling them to homeowners, preferably the tenants.  What they saw was that the current market was allowing for a unique opportunity, and they could purchase these homes at similar returns to what they could expect from an apartment community; however, apartment communities will always sell using the same criteria (cap rate, cash flow, etc.) that they used when purchasing it.  In comparison, single family homes can be sold to a homeowner who purchases for much different reasons and thus will pay a premium for that home.

FIB also saw this as an opportunity to enter the single family management business.  They asked if, that in addition to putting together the fund, they could invest as a partner in both the acquisition business and the management business.  This fund would give both businesses a tremendous amount of horsepower, so settling on a sales price was a challenge.  After a series of meetings, over about three months, we finally agreed on a sales price for a portion of our business.

January 1^st of this year the deal was completed and the fund was closed.  The fund has purchased around 35 properties to date.  It takes us about 75 days from the time we acquire the property until the time we are able to sell it to the fund.  The fund has provided us exactly what we expected.  We’ve been able to produce product with speed.  Our margins are about 70% of what they were in the past, but we expect to do significantly more deals under this new model.

Our story is one of reinventing ourselves for the new economy.  Our biggest challenge these days is finding something that is sustainable long past the opportunities the current economy is presenting.  We never want to find ourselves in the same position we were in three years ago.  Our management company has grown from 20 houses in 2007 to almost 300 today.  We believe that the challenging market will be an opportunity for quite some time; maybe not as BIG of an opportunity as it is today, but we believe the U.S. will feel this pain for the next four to five years.  Additionally, single family management will benefit from the slow recovery and continue to grow over that same time period.

We’ve learned quite a few lessons over the last three years which will probably be, as we look back, the greatest return on our adventure reinventing Golden Key.

Our first lesson is that very few people really understand real estate investing.  This is very dangerous in a business where we talk about leverage being able to multiply an investor’s returns and the same holds true for his losses.  Becoming intimate with the actual data is a very healthy process.  What are the real expenses?  What are the real revenues?  How might they change?

Secondly, we’ve learned that investing for value over investing based on speculation is a whole lot less sexy, but it sure pays the bills.  In the past we purchased properties based on what we “thought” we could sell them for.  Today we purchase properties based on what we KNOW they will sell for.  Rental value is a much more accurate measure of intrinsic value than a sales price.

Lastly, it is hard to both manage and invest–so no matter how emotional the month is, you have to examine your business as both the operator AND the investor.  Make sure it makes sense for both.

We continue to grow and learn daily and I hope that our story will add some value to what you are doing.

Matthew Whitaker is Managing Member of Magnolia Partners, LLC and Golden Key, LLC (www.gkhouses.com) in Birmingham, Alabama.  He has been investing in single family houses since 2004.  He has acquired over 150 houses personally and has a team that has the collected wisdom of acquiring over 400 houses.

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.

Okay, I don’t know about you, but whenever I read news about some new development in the real estate market, my first instinct is to say, “What does this mean to me?”  Hey I’m not proud of it, but that’s just how I’m wired.

This past two weeks we read that:

(1)  GMAC and JPMorgan Chase are being challenged with regard to the legitimacy of their batch judicial foreclosures, and are in the process of reevaluating their foreclosures for possible irregularities.

(2)  Old Republic National Title said this week that it would not issue policies on GMAC foreclosures until further notice.

(3)  Bank of America, the country’s largest mortgage lender (by assets), went a step further, saying on Friday that they would freeze all their judicial foreclosure actions pending a review for irregularities.

(4)  Richard Blumenthal, the Connecticut attorney general, asked judges in his state to put a halt to all foreclosures for 60 days so the “situation” can be further evaluated.

(5)  California’s attorney general, Jerry Brown, said that Chase should stop any foreclosures in the state until it proved that it was following proper legal practice.

(6) Chase said that they have now frozen 56,000 foreclosure cases.

So as I scratch my head and try to make sense of all this, the question is floating in the ether: What does this mean to us?  And by us, I mean those of us who are involved, directly or indirectly, in investing in private money loans.

Here is what I have come up with thus far.

(1) We are very happy that we are not title companies.  They are in a tough spot.  If they insure polices for these properties, they may end up paying enormous amounts in claims at some point, and if they don’t insure these properties, they will be turning away a great deal of business, and revenues will take a serious hit.  (Fidelity National Financial shares fell more than 4% and FATCO shares fell on the order of 3%.)

(2)  I think this is primarily impacting judicial foreclosures, so those of us who lend more on the west coast and generally in non-judicial foreclosure states, may not have too much to worry about, as far as any direct impact may go.  (Though it is not clear to me what is up with Chase in California, California being a non-judicial foreclosure state.)

(3)  If you are a private money lender, you probably aren’t doing large batch foreclosures and so again the problem may have very little direct impact on you.  The issue with regard to the judicial foreclosures is primarily related to large batch foreclosure processes involving thousands of loans at a time.  Apparently the issue involved inappropriately filing for summary judgments across the board and “robo-signers” in which mid-level executives would sign thousands of affidavits per month attesting that they had personal knowledge of the facts of the case.

(4)  With regard to the economy, this may actually be a good thing.  I was talking to my dear friend and wise attorney Jeff Hill on Friday and he said that he felt that this may be a sign that, though it is going to be messy, things are beginning to come to a head.  I’ll take that idea one step further and suggest that this might actually serve as a sort of damper or shock absorber, slowing down the resolution process just enough to allow a more gentle transition to occur.  (Of course, you could see this either way.  Maybe it would be best to have it all come undone and be done with it—the sooner the better.  The corrections must eventually take place.)

(5)  I think this may open some real opportunities for those looking to buy short sale properties.  Banks are going to be screaming to get these properties off their books.  And of course that opens up opportunities for private money lenders looking for quality loans.

(6)  Certainly this is good for home owners who are in foreclosure or on the brink of foreclosure.  They may have gained 1-2 years in their homes.

(7)  And of course, as always, this will be good for the lawyers.  Any distressed homeowner who doesn’t go out and retain a defense lawyer immediately is probably missing the boat.

I guess I am being fairly optimistic here.  It is certainly going to be a messy situation and it is difficult to know how it is going to all play out.  It certainly won’t be good for the banks.  And yet do we really care anymore what is good for the banks?

I’d love to hear from some readers out there.  What unforeseen impacts do you anticipate or see coming about as a result of this fiasco?

– 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.

We are always looking for the sweet spot these days in the real estate market.  And by sweet spot, I mean that realm of  investments that are on balance less risky and more likely to turn a profit in what is otherwise a jaded real estate market.

I have gone on a bit in my blogs about REO properties, foreclosures, rehabs and quick flips–and I remain convinced that this is a sweet spot.  Investors are making some real money in this area in today’s market.

I haven’t talked much, however, about multifamily property, and it would be a shame not to, for that is another clear sweet spot in the current market.

See the following article at CoStar Group for plenty of evidence:

Investor Hunger for Apt. Properties Still Sharp in Second-Half 2010

As real estate lenders, of course, we look for the real estate investors who are working the sweet spots successfully.  We want to lend money to people who are making money and have figured out the market (or at least are figuring it out).  If the investors succeed then we succeed and it is as simple as that.

– 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.

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 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)