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When life gives you lemons …

July 18th, 2010

Clay Sparkman

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 2nd 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.

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Posted in Case studies, Commercial lending, Nevada, Rehab loans, REO properties | No Comments »

A brief unofficial analysis of the private money market for investors

July 13th, 2010

Clay Sparkman

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.

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Posted in Analysis, Construction loans, Private money lending - general, Real estate market general, Rehab loans, REO properties, Risk management | No Comments »

Why title Insurance

June 28th, 2010

Provided by Corinne Akerill, Escrow Officer at First American Title

When making a loan that is to be secured by an interest in real property, the following are a few questions that a title insurance company can answer.

  • Does the person who wants to borrow the money have an interest in the property being offered as collateral? Are they the vested owner or do they have a vendor’s interest in a contract of sale?
  • Are there taxes, city liens or judgments that would have priority over a new loan?
  • Are there existing loans secured by the property?
  • What is the legal description of the property?
  • Is there a pending foreclosure action against the property?
  • Is the person who wants to borrow the money involved in a bankruptcy?
  • What is the priority (or position) of the lender’s security for the loan?
  • These are the basics to know when lending money and taking real property as collateral. All of these facts are public records and any lender can research them at the courthouse. But why bother when a title insurance company not only gives you the answers, but insures them?

Title insurance is issued after a careful examination of copies of public records. In addition to matters shown by public records, other title problems may exist that cannot be disclosed in a search.

Some common hidden risks that can cause a loss of title or create an encumbrance on title are:

  • False impersonation of the true owner of the property
  • Forged deed, releases or wills
  • Undisclosed or missing heirs
  • Instruments executed under invalid or expired power of attorney
  • Mistakes in recording legal documents
  • Misinterpretations of wills
  • Deeds by persons of unsound mind
  • Deeds by minors
  • Liens for unpaid estate, inheritance, income or gifts taxes
  • Fraud

Always ask for a title insurance policy when loaning money secured by real property. Leave the research to the title insurance experts, backed up by a policy of title insurance to secure your position.

— Posted by Clay Sparkman (clay@privatemoneysource.com, 503-476-2909)

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Posted in Closing | No Comments »

Question: what will it take to get the banks to lend?

June 14th, 2010

Clay Sparkman

Back in January, in my post entitled, “Won’t somebody please call a plumber … the banks are clogged,” I addressed what I consider to be the essential question regarding what it will take to get the real estate economy on track and moving in the right direction assertively and with confidence again.

And now, nearly six months later, my final paragraph seems quite equally relevant.

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

There used to be a lot of talk about getting toxic assets off the books and getting banks to lend again, but I hardly ever come across serious discussions of this issue in the financial press these days.  It is as thought government officials and journalists and such have decided that this question is just too difficult to answer and thus should just be ignored.  Like a stray dog, maybe if we don’t make eye contact it will just go away.

I used to think that the banks would have to begin lending again as soon as they cleaned up their books a bit.  After all, if a bank doesn’t lend, what then does it do, and wouldn’t it go out of business?  Well it turns out that, “no” it is not necessarily so.  From what I can tell (and this is not a terribly informed position mind you), many of the banks and bank-like entities have taken to investing in various commodity style investments.  They have effectively become investment houses, and are doing quite well, thank you.

So I pose the question to my dear readers, as I honestly don’t have a clue: what will it take to get banks to start lending again—and I’m talking about loans across the spectrum (residential, commercial, development and construction)?  If you have a position on this matter, please share it with the group.  Or if you have access to an informed article that seems to reasonably address the question, won’t you please pass it along?

I’m sure we’d all like to know.

— Clay (clay@privatemoneysource.com)

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Posted in Real estate market general, Uncategorized | No Comments »

Those who shorted subprime

May 24th, 2010

Clay Sparkman

I just recently finished reading The Greatest Trade Ever, the 2009 book by Wall Street Journal reporter Gregory Zuckerman.  It is a terrific read.  I really enjoyed it.  It evolves primarily around John Paulson, and tells the story of how he managed to make billions of dollars for himself and his hedge fund investors by arranging a series of investment positions that bet against the rapidly expanding subprime positions in the market.  In particular it tells the story of how he worked with banks such as Goldman and Bear Sterns to construct and facilitate such trades.

Zuckerman doesn’t waste much time judging the ethical or legal aspect of such trades.  Rather, he tells a damned good story of how a few individuals predicted an event that others just couldn’t fathom, and then positioned themselves, against all prevailing notions, to ultimately reap enormous profits from their heart-felt predictions.

It is a story of the most profitable series of trades on Wall Street, and if one theme comes through loud and clear, it is that only an outsider (and somewhat of a misfit) such as Paulson (and a handful of others) could have managed to “think” so counter to the prevailing notions of the industry, and perhaps more importantly, would have dared to defy so many others in the industry to the point of personally and professionally marginalizing themselves in the process.

Paulson is not under indictment, but as we know, Goldman is being sued by the SEC in a high profile case specifically targeting the Paulson-backed synthetic CDOs.  I personally would have to say that I lean toward Warren Buffet’s position that overall Goldman is not really to blame here.  See the New York Times story, From Buffett, Thought-Out Support for Goldman, http://dealbook.blogs.nytimes.com/2010/05/04/from-buffett-thought-out-support-for-goldman/

According to Buffet, “I don’t care if John Paulson is shorting these bonds. I’m going to have no worries that he has superior knowledge,” he said, adding: “It’s our job to assess the credit.” The assets are the assets. The math either works or it doesn’t.”

His point being that it wasn’t important for Goldman to disclose to fat-cat institutional buyers that John Paulson was shorting the synthetic CDOs they were buying.  The buyers were professional investors, and should have looked deep inside the assets to see exactly what they were buying.  Paulson certainly did.

I am now nearly finished reading The Big Short by Michael Lewis, and I must say this book—like every Lewis book I have read–is fascinating and irresistible.  It deals with the same basic material as Zuckerman’s book but tells the story from various other points of view.  It is quite a bit more technical than Zuckerman’s book, and in this sense, is precisely what I was looking for.  Lewis has a talent for explaining complex things in simple ways, and this book goes a long way toward answering unanswered questions I had regarding “How did this all work?”

What I get out of Lewis that I didn’t get out of Zuckerman so much, is that it is the ratings agencies that are at ground-zero of the breakdown of the system.  It is hard to tell if they were really stupid or really crooked or both, but certainly there had to be a good dose of both at work here.  I don’t care how you package and re-package subprime loans into bonds.  It should have been clear that such bonds could never be packaged in such a way as to earn a triple-A rating (same as US Government debt), and yet this was happening (and so much more).  Yes, the sellers of bonds and CDOs were gaming the system, but nonetheless, the ratings agencies allowed themselves to be quite easily gamed.  You might say they were easy.

The real lesson of all this is that the sub-prime collapse could have been quite readily predicted—as it was so clearly by a small number of individuals—but that there was just too much money being made and perhaps more importantly, a deeply institutionalized thought process at work here that defied those involved to even consider notions counter to the norm.

And what is the lesson for the individual trust deed investor?  It is this I think: Don’t invest in trust deed style securities unless you know what you are doing.  You must be able to evaluate the quality of any given loan.  And most of all, never–I mean never ever–let anyone else tell you what is and is not an acceptable level of risk.  Ultimately that decision is yours and only yours to make.

— Clay (clay@privatemoneysource.com)

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Don’t put all your egg baskets in one egg truck

April 27th, 2010

Clay Sparkman

Colloquialisms are funny things.  We use them pretty much every day in our speech and in our writing and yet most of us, I suspect, though we know the meanings of the expressions, frequently don’t know why the individual words have come to mean what they mean.  Take for example: “Don’t look a gift horse in the mouth.”  I must have been in my forties before I looked up one day, scratching my head, and mumbled to myself, “What the heck does that really mean?”  I remember asking my Dad, and having grown up on a farm he was able to explain to me without hesitation that it was a little like what tire kicking is to automobiles.  So there you go.  It all makes sense–if you know something about farms and horses, that is.  And while we’re on that topic, does anybody really do that: kick tires I mean?  I have purchased maybe ten cars in my life, and I’m pretty sure I never actually kicked the tires on any of them out on the showroom floor.  And still, it is a great image.  I wish I were that kind of guy who could pull it off.

So with regard to investing, the egg analogies are kind of funny.  First of all, there is “the nest egg,” which seems to refer to ones entire savings or investments.  It is singular however you will note.  You don’t have nest eggs.  You have a nest egg.  But given the fate of Humpty Dumpty and the fragility of eggs as such, we almost can’t bear the thought of our entire fortune being so fragile.  (And yet, if we don’t invest intelligently, maybe it is.)

And so of course to that end, we attempt to diversify our investments—and pretty much everyone is familiar with the expression, “Don’t put all your eggs in one basket,” which immediately makes sense as an analogy—that is until you stop to think about it.  Follow me here: if each egg represents a single investment, then perhaps each egg basket in the analogy represents an investment type or sector, and if you think about it, you still don’t have a secure investment strategy here.  Say you have ten baskets, each with a handful of eggs in them.  Are you going to keep those baskets stored all in one place, and how are you going to transport them?  Surely you must never put them all in the same egg truck!  I would like to propose thus a revised version of the expression.  Can we all get on board with “Don’t put all your egg baskets in one egg truck?”

So what is your point, you ask?  Well I do have one, and it is about diversification as it relates to trust deed investing.  Most investors—dare I say—view trust deed investing as a single egg truck, and put many of their egg baskets (but certainly not all) in their “trust deed” egg truck.  And this is where we need to get really specific about this whole issue of egg security.  Almost all the investors I have worked with over the years have been quite certain that they didn’t want to put all of their trust deed money into one single trust deed investment.  That is practically a given.  Typically, an investor with say, one million to invest in trust deeds will look to put that into somewhere in the range of 5-10 separate trust deed investments.  So we are all agreed that a dedicated “trust deed” egg truck is needed.

However, I would go a step further and suggest that if you are seriously involved in trust deed investing, you may want to deploy a small fleet of egg trucks just for trust deed investing.  And how does one do this?  Well, I used to think that this could be accomplished nicely by putting some into subdivision projects, some into home construction projects, and some in standing homes and commercial buildings.  But now I’m not so sure: when the real estate market for residential property tanked, residential subdivisions, residential construction, and finished homes all began to merge into one big thing.  Yes, they were all at different stages of the production process, but ultimately they all became one thing: residential homes.  And those homes all had to be sold or refinanced ultimately at the level of the individual homes.  (The residential river flows in one direction, and always comes to the same point where the river meets the sea.)  And in retrospect, commercial vs. residential didn’t provide as much real diversification as I would have hoped.  Though residential property was the first to fall, commercial seems to have more or less followed along (lemming-like) on its heels, and really not so far behind.  So: perhaps this type of versification was more like putting different types of egg baskets in the same “trust deed” egg truck (as opposed to deploying multiple “trust deed” egg trucks).

I would suggest that perhaps the best way to obtain effective diversification in trust deed investments is to invest in multiple geographic locals.  And in particular, I am thinking on a state by state basis.  For many investors, this goes against their fundamental instincts because they feel safer investing close to home, where they know something about values and where they can deal more effectively (they feel) with the property if they have to take it back.  Those are valid issues and such instincts should not be ignored, but it is important to weigh against them the fact that the massive depreciation in home prices which continues to occur nationwide, happened at widely varying times and to vastly different magnitudes in varying states across this nation.

So not to pick on anyone in particular, but If you think about it: when sub-prime hit the fan in 2007, if your only “trust deed” egg truck was a sixteen wheeler with “SoCal” printed in large letters on the sides, you and your egg baskets were in for a long, rough, treacherous ride down the mountain-side.

— Clay (clay@privatemoneysource.com)

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Top ten clues that you should probably withdraw your loan request from a particular private money lender

April 6th, 2010

Clay Sparkman

I remember when I first came into this business 15 years ago, the general attitude toward private money–and private money lenders and brokers–was quite negative.  And to a certain extent, the reputation was not completely unearned.  It was an industry that seemed to harbor a small handful of crooks and a great many more just plain unprofessional “business people.”  And yet, what many people didn’t understand is that there were also honest, professional individuals and entities offering a legitimate, useful, and important product.

As time went by, the rap on private money lenders improved significantly, and it almost got to the point over the years where you might say that private money was a bit “sexy.”  Everyone wanted to have a piece of that market.  Most of the players these days are honest, in my opinion, and many are highly professional, but still I think I’d like to have a go at those still in the market who are either dishonest or unprofessional or both.  Some private money lenders quite simply don’t belong in the business.  If not dishonest, they are paranoid and distrustful of every borrower that comes to them, and as such, they tend to go too far in trying to protect their investment.  This TOP TEN LIST is dedicated to those folks.  (They know who they are.)

Drum roll please…

Top ten clues that you should probably withdraw your loan request from a particular private money lender:

10. One number and two words:  $25,000 non-refundable deposit.

9. The investor insists on moving in with you to “keep an eye on” his investment.

8. The investor insists on language in the loan agreement to the effect that: you will not eat junk food during the term of the loan, you will not engage in bar fights, you will certainly not smoke any sort of substance, and you will not jump out of airplanes or otherwise engage in so-called extreme sports.

7. The lender requires a lien against your pet corgi Noodles as additional collateral to secure the loan.

6. Lender keeps referring to your property as “my property.”

5. Rates are quoted by the day.

4. Lender keeps saying ka-ching at the end of every phone conversation.

3. The product on offer involves a one week term with a one week extension option.

2. The investor wants to become a co-signer on your checking account.

1. The investor requests a perpetual easement to ride his ATV on your property—and your lot is only 4,000 square feet.

— Clay (clay@privatemoneysource.com)

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The quest for a good set of comps

March 20th, 2010

Clay Sparkman

As I have mentioned in at least one previous posting (Ten Crucial Steps in Reading an Appraisal), I am not so concerned about the bottom line value on an appraisal or property valuation as I am about the particular logic that lead to the creation of that value.  If the instrument is transparent and the logic is clear and sensible, then chances are that the final valuation is an acceptable number that you can work with.

Most of the loans that we are involved with at Fairfield Financial are what I call “professional loans.”  That is: they are to developers, builders, rehabbers, or other types of real estate investors pursuing an asset or project for monetary gain.  When dealing with such professional borrowers it is not only reasonable to ask the borrowers how they came up with a particular value figure (or figures) for their particular property or project, but it would probably be quite unreasonable not to.  If anyone should have taken a hard and honest look at value and be in a position to demonstrate and defend that figure, it is the professional borrower.

And yet, when asking these folks–over the years—for a good comp based analysis of value, we have quite often found that we don’t initially get a presentation that we deem acceptable.  To that end we prepared a short article explaining our expectations with regard to the valuation process and presentation and posted that on our website.

I think this is one of the most read and most useful articles on our website, and so I thought it would be worthwhile to publish it here.  And so I give you, “The Quest for a Good Set of Comps:”

A professional appraisal can be a helpful tool, but appraisals are by no means foolproof, and a well-prepared set of comps is often superior and entirely sufficient for our purposes. Since appraisals are expensive and time-consuming, it is often well worth an investor’s time and effort to do their own value work. But although a good set of comps is often sufficient for our purposes, it is difficult for borrowers and brokers alike to understand exactly what we need from them in the process of determining the value of a subject property. This is unfortunate, since this evaluation is perhaps the most important part of the entire process of assembling a loan with Fairfield, and the borrower or broker often has an integral role to play in this evaluation. As an equity lender, our loans are only as secure as our determination of the value of the property against which we are lending, and consequently it is essential that we are confident of this determination. In point of fact, the confidence we require is nothing more than what any borrower should require and from himself or herself going into a project.

The following rules and their explanations describe what we need from those investment professionals who choose to take advantage of this alternate approach to the valuation of their subject property. Let’s consider what we mean by “a good set of comps”:

Rule Number 1: Computer-generated listings are starting point, not an ending point

Very often we tell a borrower or a broker that we need an “objective measure of value” or a “good set of comps”, and in response are sent, for example, five or six comparable sales generated by the online search program of a public database containing sales histories. We have access to these programs also, and will most probably have already looked at these, or similar, listings. These sorts of listings are the beginning of the process, not the end, and by themselves they will almost never be sufficient. Don’t send these to us alone and expect that they will suffice.

Rule Number 2: Be skeptical

What we need from you is more involved than simply typing search criteria into a listing service, although this is indeed where the process usually starts. Once you have obtained a group of comparable sales listings with which to begin, take a hard look at them. From what you can see in the listings, are they really similar to your subject property in type, size, age, location and condition? If all of them aren’t similar in all these aspects, do some of them illustrate value factors that the others don’t? For example, all your comps are more than a mile away from your subject property, except for one, which although newer and larger than your subject property, is next door. The value of your location may be best indicated by this one property, although the building itself is not all that similar. It is important not to accept that a property is comparable just because a program or real estate agent tells you so.

Rule Number 3: There are more things in heaven and earth than are dreamt of in the MLS’s philosophy

Now, once you have selected your five or six most representative comps, grab a notebook and a camera and go find them. As you drive, ride or walk past each one, stop, look at the neighborhood, notice the condition. Are there differences between the listing you were given and the reality you are seeing? Are there things not included in the listing which are important factors in the value of the property? Is there a grist mill next door or a condemned meth lab across the street? Write it down in your notebook. Take a picture or two.

Rule 4: Think like an appraiser

Borrowers are often a bit daunted at the prospect of putting on the appraiser’s hat and analyzing the information they have gathered. “I’m not an appraiser,” they say, “I’m not trained for this.” We’re not asking you to be an appraiser; all we’re asking from you is to think through the information you’ve gathered, apply a little common sense, and to make your best case for value. When we look at your analysis, we may find corrections that need to be made, we may disagree with your logic in places, but if you’ve done your work, chances are your value is close.

Let’s take an example to illustrate what’s involved in this analysis: Our subject property is a 3000 sq. ft. SFR built in 2001. Let’s say it’s across the street from a nice park, with a school nearby. One of the comps we’ve looked at is a 2800 sq. ft. house built in 2000, about 1/4 mile from the subject property. It sold two months ago for $179,000. Our notes from when we looked at the house say that it is essentially in the same neighborhood as our subject, and is also a newer house with generally the same quality of construction. The two properties are quite comparable, even without any adjustments; but we can probably refine the value a bit more by taking the small differences into account. First, our subject property has a superior location, being across the street from the park. Depending on the neighborhood, we might determine that this location increases the value of the property by $5000. We add this figure to the sales price of the comparable property, to arrive at an adjusted value of $184,000. Next, we need to make a small adjustment for the size: dividing our adjusted value by the comparable property’s 2800 square feet, we arrive at a per square foot value of $65.71. Multiplying this value by our subject property’s 3000 square feet, we get a final adjusted value of $197,130.

Now, in your own case, your subject property might be a bowling alley, a piece of raw land, or an office building, and so your considerations might be very different. But in all these cases, the general process will still apply. There may be more research involved in finding out what individual differences are worth, but the overall approach described above can always be applied.

Rule Number 5: Presentation isn’t everything, but it helps

Now that you have gathered all the information you’ll need, and done all the necessary analysis, you are ready to assemble your “good set of comps.” This set should include:

  1. Your comparable sales analysis
  2. A map of the area indicating the location of the subject property and the comparable sales
  3. A photo and essential information for each comparable property, including the address, specs, sale date, sale price, and distance from the subject property.

Your comparable sales analysis should be a concise summary of all your reasoning in adjusting the values of the subject properties, with one paragraph or section for each property, stating what was different, how you adjusted for these differences, and why. At the end of each paragraph you will indicate an adjusted value; and at the end of the analysis you will summarize your conclusions, and give your final estimated value for your subject property. The documentation for each comparable sale (Number 3) gives us a frame of reference in which to read the analysis for that property.

When you haven’t done it before, this may seem like a lot of work. But again, anyone making an investment in a piece of real property should be at least this confident of the value of their investment, whether or not he or she is looking for a loan. And it is often well worth the work.

— Clay (clay@privatemoneysource.com)

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Posted in Valuation | No Comments »

An interview with Grover W. Sparkman

March 11th, 2010

S. Clay Sparkman

Grover W. Sparkman is the President of Fairfield Financial Services, a company that he founded with his wife, Louise Sparkman, and a business partner in 1964.  He has been involved in just about every imaginable aspect of private money lending and paper brokering for nearly half a century.  He also works as a licensed Realtor in Oregon and Washington, and previously worked for many years as a licensed appraiser (back when you still had to type appraisals).  As my mentor, he taught me how to be a private money professional.  And as my father, he taught me simply how to be.

Clay:  You started out as a Realtor and in fact you are still a Realtor.  When and how did you first get involved in trust deed investing?

Grover:  I had been working as a Real Estate salesman for Mayfair Realty, but since getting my Real Estate Broker’s License, I had always wanted to open an office of my own.  When an old time Real Estate broker named Henry English died in 1964, a partner and I, Milt Dalby, purchased the Real Estate business in Southeast Portland from the Henry English Estate.  In those days there were not many banks loaning money on real estate …

Clay:  That sounds like today.  Have we gone full circle do you suppose?

Grover:  Good point.  Perhaps we have.  At that time, the solution for sellers was to sell property on private land sales contracts …

Clay:  So maybe that is part of the answer.  Maybe we’ll see more of that once again.

Grover:  Indeed, we might.    The attitude then was one of, “why wait for the banks, let’s get going.”  Henry English had set up a collection department to collect the monthly payments on the contracts.  One day I received a call from an attorney saying one of the owners of a contract had died and he wondered if we could sell the contract to raise money to close the estate and pay the expenses.  He also explained that the 4 children that were heirs did not want to split the $400.00 per month coming in on the Contract; they all wanted the money immediately.

I started asking questions and discovered a new business–selling real estate contracts.  Back then we were called paper brokers.  Those were the days before computers and printing calculators, and I had to learn how to calculate interest yields on the unpaid balance on the contracts.  There were a set factor tables called the Elwood Tables that would give us the time value of the money and rate of yield so we could figure out what an investor could pay for a contract to get the interest he or she was looking for.  Interest rates being paid by the banks and savings and loans were very low and there were few safe places for investors to put their money to get a good monthly return.

Clay:  How has the private money business changed since you your early days in the business?

Grover:  The government began to get more involved with the residential mortgage business through programs like the Veteran’s loan program, HUD’s FHA programs, and private insurance programs protecting the banks against foreclosures.  This coupled with a growing economy caused more banks and Savings and Loan Companies to make more real estate secured loans, and in turn this caused private land sales contracts to dry up.

We still had the investors looking for a good return on relatively safe loans, so I started looking for ways I could meet their need and discovered Trust Deed financing of Real Estate loans.   Working with builders, people wanting to buy rental properties and business buildings, and developers creating subdivisions–I found people wanting to borrow, that could use their real estate as collateral for the loan, giving the lender a reason to support the borrower’s business plan and in turn receive a good return on their money.  If things didn’t work out, the property could be foreclosed and sold to recover the investment.

Clay:  Share with us, if you would, an experience as a private money broker/investor that you particularly enjoyed.

Grover:  Over the years many of my clients became personal friends and referred me to their family and friends.  I watched many of them become Snow Birds going to Arizona or California for the winter and coming back to Oregon in the spring.  There were a couple of investors that got involved in the Peace Corps and people to people programs and traveled around the world.

Clay:  And on the flip side, share with us an experience that you didn’t so much enjoy.

Grover:  On the flip side I found a lot of fraud creeping into the business.  People vastly overstating their ability to repay the loan and I found Appraisers that would give grossly inflated value to a property if they were being paid by a borrower or broker.  I found investors that were making loans to launder money from illegal activities.  There were also the investors that were only looking for loans they felt they would be able to foreclose and get property to resell at a profit.

Clay:  What is one of the funniest/strangest things that ever happened to you in the business?

Grover:  We received a proposal from another loan broker with an appraisal and pictures; they wanted a loan on two houses on one large lot.  When I went to inspect the property I couldn’t find the houses.  There had been a fire about three months before and the houses had been completely demolished and hauled away.   Another time a restaurant submitted a proposal for a remodeling loan, when I went to inspect the property they didn’t want me to go into the basement where the dining room had been.  There had been a flood that had filled the basement with muddy water.

Clay:  Would you dare to conjecture as to where the industry is going during the next few years?

Grover:  I was born just after the crash of 1929 and have seen several booms and busts in the real estate market.  I feel that there will always be a market where borrowers need money for their business plans and investors are looking to get a better than average return on their money on a relatively safe loan.  Real estate will always be good security for the loan, so long as both the borrower and the investor use good judgment and ensure that there is a proper plan for paying the loan off and that the values for the security are as accurate as possible.

Clay:  These are hard times for hard money lenders and hard money brokers.  Do you have any advice for those who are currently involved in private money investing?

Grover:  You have to like the business.  I like the real estate business because I like helping people solve their problems.  On the residential side I was helping people buy a house with the idea that they were going to make it a home and a place to raise a family.  On the commercial side of the business I always got a thrill out of watching a building grow into a business that became a part of the community.  As a loan broker, I was also helping people solve their problems of getting money to buy, develop and build while at the same time I was able to help investors get a good return on their money.

Being a broker is very much a people business; we sell one loan at a time, for a borrower with specific needs, to an investor with a desire to earn a better than average yield on the investment.  We don’t have anything to sell but our service.  I feel that it is our obligation to be as transparent and open with our clients–lenders, brokers, and borrowers–as possible.

Clay:  Would you agree with the supposition that (a) banks just aren’t lending and (b) our industry niche is being hurt by that since we are essentially a bridge and there must be a way to get on and off that bridge or people and businesses cannot cross it?

Grover:  Right now we are going through a cycle where the bigger banks are hurting the economy because they are loaning very little money on real estate.  Most of the loans we broker are for specific purposes that are generally short term, such as completing a remodel or putting up a building or developing a subdivision.  The exit strategy is to get a long term bank loan after the project is completed or sold.  If there is no money coming back into the pipeline, nothing happens and the economy suffers.

Clay:  I’ve noticed that through your many years in the business—in both good times and bad—you never seem to become bitter or discouraged.  What is your secret?

Grover:  Over the years I have seen a lot of changes:  computers and calculators and the internet, new rules and regulations, roller-coaster markets, and more frightened or suspicious people–but I remind myself that I love the business and its challenges.  I have found that most people are honest and well meaning.  My goal is to try to treat other people the way that I want to be treated in a business transaction.  Over 40 years ago I came up with our slogan:  “The Right Investment is Equal to a Lifetime of Toil.”  I believe that it is still true today.

— Clay (clay@privatemoneysource.com)

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Rehab and construction loan FAQ

March 8th, 2010

Clay Sparkman

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.

—

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

— Clay (clay@privatemoneysource.com)

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Posted in Construction loans, Rehab loans, REO properties | 2 Comments »

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