Funding private loans

[calmloki]

Used the majority of the last loan payoff to do something a little different for us: a second mortgage/bridge loan on a row house. Charged a 2% fee upfront and 12% interest with a 3 month term. Borrower has the right to extend the term another 3 months at the same interest rate by paying another 2% fee. That's effective short term interest of 20%. A bit spooky, but we got a free night at the coast in a similar unit, checked the title insurance, and met the borrower builder. All these row houses differ from condos in that they own the dirt they sit on and their own roofs. We'll see how it goes.... We loaned on the unit second to the right of the owner's big place - 16x40, 3 story w/ garage at one end of the bottom story - about 1560' living space, ocean front.




The owner's unit is looking crazy opulent - major props to a 35 YO guy who is going for it hard - I'm satisfied with much less.

 

[P.S.]

my mom ( and dad goes along for the ride) on a small scale. I had a condo, sold to tenant of several yrs, attorney with steady pay who took the loan from my parents. Guy got a cheaper mortgage, and parents got assured rate better than CD. Most recently she did a loan to my cousin to build a pool, paid back over 5 mo at 7%.

 

[calmloki]

Latest is that we got our 2 points on the beach front 2nd loan mailed back to us from the title company - silly game loaning money and then having 2% of it mailed back to us, but i kinda like it.

Also sent a return receipt requested letter off to the lawyer for the second position loan handling the foreclosure on the property we have a first on. Just to point out that we do have the first and asking that we be kept apprised. I guess (with regard to our borrower taking out a second without our permission & in violation of our contract) one can do anything one wants as long as one doesn't get caught and makes payments as agreed. We wouldn't have found out had he not had the foreclosure filed against him. Lawyer we hired says we're in fine shape and need do nothing, but I wanted to be sure the foreclosing lawyer had been informed by us of our claim. Belt and suspenders.

 

[clifp]

Thanks for keeping us update a very interesting alternative investment.

A couple macro question what percentage of your assets are involved in total with real estate lending. I assume you treat as a fixed income when looking at AA.

Second and more importantly, roughly how much time do you put in on a monthly/quarterly/annual (what ever is easier) doing the investigation, handling the paperwork, talking to lawyers etc.

thanks

 

[calmloki]

Thanks for keeping us update a very interesting alternative investment.

A couple macro question what percentage of your assets are involved in total with real estate lending. I assume you treat as a fixed income when looking at AA.

Second and more importantly, roughly how much time do you put in on a monthly/quarterly/annual (what ever is easier) doing the investigation, handling the paperwork, talking to lawyers etc.

thanks

Bearing in mind that most of our nut is in rental property and it's kind of hard to ascribe a value to that before sale... Assuming what i am pretty certain we could get for negotiated prices on the places and subtracting about 25% for taxes i figure we have our home F&C, about 5.7% in stocks & bonds, about 21.5% in property loans (including $50k for a home sale we carry paper on @ 7%), about 57.4 % in rental property and the remainder in PenFed Cds and such. I haven't set myself any rigid percentages to hew to on fixed versus equity - just happy to make money, sad not too.

Time-wise: to date we have bought two hours of lawyer time. Others could buy lots more, but we're pretty trusting and have great faith in reading contracts and title companies. Loans are kind of like properties - if they are right it doesn't take us an hour or two to decide on them - the 4-plex we loaned on was that way - did a drive by to be sure they were what we thought, checked the terms, and made the loan. Maybe an hour or so getting the lowdown on a place. Sometimes I might have spent 10-12 hours on a loan opportunity - seems to be a sign the loan isn't worth doing.

We do look at maybe 6 or so loans before making one, but they are mostly local, so maybe an hour or two each if we do drive bys. Looked at a few loans up in the mountains and the latest over on the coast, but those were thinly disguised fun drives. Once the loans are made i just check whatever bank we have the payments deposited to to be sure the payments get made once per month. Spend much less time than looking at CNN or morningstar to see what our stocks did for the day.

Timewise they take up way less of my time than the rentals and return something comparable, though i still think property tracks inflation and cash doesn't.

 

[Arif]

Calmloki,
Thanks for sharing your experiences with your RE notes. As a die hard real estate guy I am always looking to diversify from the typical rentals. When I slow down I think this would strategy would work very well.

 

[calmloki]

The beach condo loan is 2 weeks late on their first payment - the larger project loan they were counting on hasn't happened yet. Of more concern is an unsecured loan we made to a real estate company - the company has closed up shop and the primary is now hawking vitamins and wanting to rewrite the loan and borrow more money. His interest only payment is also several weeks late - not an auspicious sign. If the real estate company loan goes bad it will neatly wipe out a year's worth of our total lending interest income. Lesson (re)learned: fancy office and a table with five suits is trumped by an old farmer with bad teeth and good collateral. Always get security.

We'll see what my friendly call generates in the way of improved performance. Will be looking at another local loan to a farmer with 190 acres looking for a 30% LTV.

In other news, 8 scheduled vacancies this month, including one eviction. One is already re-filled, another has an ex-tenant ready to move in as soon as the current tenant vacates. Still more vacancies than the norm - going to be a busy time. One little ex-rental house still sitting on the market, though i'm getting lots of lookers. Lending still looks like it will take less time - but it has to be profitable...

 

[CybrMike]

How many properties do u own?

I have 6 properties consisting of 10 units and am thinking about trying to expand to about 20, maybe 25 properties.

Any advice?

 

[calmloki]

Nine places, 51 units counting the house we are trying to sell. To a great extent more is not that much more work - you're tied down anyway, so more places just makes it easier to spend the money on tools and supplies and easier to get a good relationship with painters & carpet layers & such. 40 units was probably a sweet spot for me - i was in better touch with my tenants and feel i gave better service - could be that i'm just getting older and crankier and have seen the same sad stories too often.

For me, multi-units were a revelation - much easier to care for with a tiny percentage of the roof & exterior wall/unit. A vacancy in an 8-unit is of little consequence vs. a single family home going empty. We felt that though multi-units had better cash flow that the single family homes would be easier to sell. So that theory is not working out so well right now....

Exit strategy is a big problem. Our stuff is paid off and pretty depreciated out, so a sale will be a major tax event, leaving us with maybe 3/4 of the property value to generate income with. The Siren call is to roll the properties into bigger and bigger places, riding the income and depreciation, then dying and leaving heirs with a stepped up basis. No kids here and screw the heirs - let 'em make their own!

That's why i've been doing property loans - the hope is that the interest income will replace the rental income and that loaning out money at higher rates on after tax value of the sold properties will be an emotion neutral replacement for landlording.

 

[CybrMike]

Thanks for the info. I'm in Indianapolis and we don't have many 4-unit buildings or 8-unit buildings. We have some doubles but they are mostly in bad areas. We also of course have 100+ unit apartment complexes but not much in between.

For now I've been buying up single family homes since I'm getting them for $20K and $30K and renting them for $700 - $800 per month. The return there is phenomenal and I've got very cheap labor to fix them up and deal with the maintenance headaches. I probably wouldn't want to deal with it otherwise since most of the houses I buy need $5 - $10K of work.

I'm getting ready to start branching out into properties that are going to rent for $1200 or $1300 a month. I just looked at one the other day listed for $87K and needs maybe $25K of work. This property sold for $154K 2 years ago. Hoping that I can have $100K in it when its ready to rent out. We'll see if they'll let it go that cheap (its bank owned).

 

[calmloki]

Thanks for the info. I'm in Indianapolis and we don't have many 4-unit buildings or 8-unit buildings. We have some doubles but they are mostly in bad areas. We also of course have 100+ unit apartment complexes but not much in between.

For now I've been buying up single family homes since I'm getting them for $20K and $30K and renting them for $700 - $800 per month. The return there is phenomenal and I've got very cheap labor to fix them up and deal with the maintenance headaches. I probably wouldn't want to deal with it otherwise since most of the houses I buy need $5 - $10K of work.

I'm getting ready to start branching out into properties that are going to rent for $1200 or $1300 a month. I just looked at one the other day listed for $87K and needs maybe $25K of work. This property sold for $154K 2 years ago. Hoping that I can have $100K in it when its ready to rent out. We'll see if they'll let it go that cheap (its bank owned).

In your case i'd be buying the heck out of the little places - home values here are still at about 100xmonthly rent at the very very best - think that when we were buying apartments cheap we were at .60 -.75x100 total complex monthly rent at the best - and some of those were awful old and beat up. The thought of renting at a .33 multiple sounds like gold rush time! You and TheFed man - if you can handle the tenants and keep the buildings standing for a while i forsee mucho dinero in your futures...

 

[Kroeran]

When doing such mortgages we always personally inspect the properties and make effort to meet with the borrowers. This gives us a good indication of value. That may be simplistic starting point but essential.

Often times we also request an appraisal of the property which is a cost to the borrower. Any costs to draw up legal papers are also a cost to the borrower and is indicated in writing prior to proceeding with the loan. Further, all discharge costs are also the responsibility of the borrower.

Any terms and conditions of the mortgage such as a 3 month pre penalty clause, charges for NSF cheques, attendance for insurance issues and many other clauses are laid out in the beginning. Cost for foreclosure proceedings are also indicated and added to the ultimate payout should the loan go bad.

Make sure you as the lender are named on insurance policies.

Just some things we do. Hopefully this is helpful and the kind of info u may be looking for.

If such legalese is dealt with in the beginning, should the property proceed to forecloser then the ending process is less stressful.

Bookeeping, on a simple spreadsheet is not hard either.

This is something I have done (in Ontario). I have been winding out of it, but I still have a couple of boring and productive firsts on a commercial condo and a gas station.

My general advice is that this is like rock climbing or flying. You have to be detail oriented and not get complacent.

I would say ALWAYS get an appraisal. My big one mistake was taking my brokers word on it, and I placed a second mortgage bridge loan on a large property, just at the moment the borrower went nuts.

Then it turns out the broker did it as an off books loan so I couldnt sue her company. I could have yanked her license and had her suicide on my conscience. I could have sued the borrower and pushed a nut case over the edge, wondering when he was going to show up at the back door with a weapon. I eventually slowly backed out and only took a 50% haircut.

So, strict security regarding borrowers knowing where you live, or being able to figure out where you live.

Another trick...ask to see any leases on the property or ensure any verbal agreements are disclosed. I had one situation where the property was compromised by an agreement between the owner and the renter that he could live at a reduced rent for life....this was a payoff to the renter to get him to waive an objection to condoizing a rental property...he was the last holdout.

When getting into lending, you are going to be pressured by brokers and borrowers to do things that you shouldn't. High pressure sales and promises of big fast payoffs. If you are not a skeptical cool customer who knows how to say no, you are going to get into trouble. I had one such guy, who I barely managed to say no to. Years after I still get calls from the police who are investigating this guy for fraud against seniors.

At first you are going to have a few easy deals, taking in 10% plus, and getting fees every time the borrower passes gas. You will feel giddy. This is the time to buckle down and stay conservative and wary. Simple rule is to not place more than 10% of your stake in one property or with one borrower, because shiatsu WILL happen.

what is the saying...there are old lenders, bold lenders, but no old bold lenders - or my version...find the courage to do that dangerous but rewarding thing, but be the most cautious scared person doing it.

Oh yeah, and there is nothing more expensive than a cheap lawyer. Find out who is the meanest litigating reptilian sob in your area and get established as his client. Otherwise, in a fight, you may find the other guy has the best guns on this side.

I don't think this the sort of thing for a softy. In my quirky way, I try to be Christian person of sorts. It is very hard to do this hand to hand combat stuff if you are also thinking about keeping your soul intact. This is one reason I am backing out of this. Another way to put it, when placing a loan, think about how you are going to feel about foreclosing if it goes sour. It is better if you don't like the borrower.

Other ideas.

- try to impose the steepest amortization curve the borrower will accept, which builds owners equity (skin in the game) quickly
- if the brokers won't let you in, advertise directly in the paper, then shop for a junior broker to clerk the deal, if a broker is required (which is the case in Ontario)
- one of the best things I did was take a mortgage consultants certificate
- make sure the appraiser is arms length to the broker - pick your own guy

 

[Martha]

Nine places, 51 units counting the house we are trying to sell. To a great extent more is not that much more work - you're tied down anyway, so more places just makes it easier to spend the money on tools and supplies and easier to get a good relationship with painters & carpet layers & such. 40 units was probably a sweet spot for me - i was in better touch with my tenants and feel i gave better service - could be that i'm just getting older and crankier and have seen the same sad stories too often.

For me, multi-units were a revelation - much easier to care for with a tiny percentage of the roof & exterior wall/unit. A vacancy in an 8-unit is of little consequence vs. a single family home going empty. We felt that though multi-units had better cash flow that the single family homes would be easier to sell. So that theory is not working out so well right now....

Exit strategy is a big problem. Our stuff is paid off and pretty depreciated out, so a sale will be a major tax event, leaving us with maybe 3/4 of the property value to generate income with. The Siren call is to roll the properties into bigger and bigger places, riding the income and depreciation, then dying and leaving heirs with a stepped up basis. No kids here and screw the heirs - let 'em make their own!

That's why i've been doing property loans - the hope is that the interest income will replace the rental income and that loaning out money at higher rates on after tax value of the sold properties will be an emotion neutral replacement for landlording.

What we did was take money out of the individually owned properties and invest in big projects, like our latest, a 500 plus unit building in Phoenix. You have to put your trust in the diligence of others though. But the day to day work is nil.

Our other option, which we have some regrets at not following, was doing exchanges into bigger local projects. We missed out on two, where we could have exchanged into fairly significant properties that were large enough to have on site managers to take care of the day to day stuff. Unfortunately, deals were few and far between so we ended up on getting out, paying the taxes, and investing the money in other real estate deals and the market. We sold at the height of the market, but we also bought there, so who knows what would have been the best deal.

 

[calmloki]

Report regarding our private loans: things are getting sticky. The small loan office we have funded many of our loans through sent all investors/funders a letter saying they have run in the red the last four months and that borrowers aren't finding it possible to refinance. We have lent on the building they operate from, the borrower has gone bankrupt, and the holder of the second has filed (refiled since the bankruptcy filing) to foreclose. Result of that is that we should be repaid on our first position loan when the building sells. We continue to receive regular monthly interest payments.

The second position loan we made three months ago on the coast condo is not looking too good - the borrower's attempts to refinance his whole development are not going smoothly and we have received no monthly payments at all. Loan was to be repaid or extended on the 25th. Instead of payments we've had excuses and positive sounding emails. As old landlords we know that at some point one must stop meekly accepting blue sky and rainbows and show a little of the stick rather than the carrot. Have an appointment with a lawyer tomorrow to explore our options and maybe generate a letter. If the borrower does come into a bit of money I want him to remember us, if not we may end up buying out the first position loan and having a coast condo for sale. Don't really want an Oregon coast condo, but it looks better than our GM stock....

We had lent money to a real estate company up in Portland. Unsecured loan, but there were a bunch of suits and a nice office - that company has gone out of business. One of the owners of the business has continued to make the interest payments, albeit slowly, and has formed a new Llc to which he wants us to transfer the debt. That debt was due to be repaid on the 28th - figure we will discuss our options on that debt with the lawyer at the same meeting.

We've had the opportunity to invest in other loans lately but have not done so - if we do have to foreclose on the coast condo we need to have enough cash on hand to cash out the holders of the first. That need to have cash idling rather than earning is a strong argument against holding second position loans.

Other loans continue to pay as agreed, which is a good thing, and the rentals keep staying full - sure is good to have that regular income keep chugging along as the property loans are generating a little more concern than I had hoped to have.

 

[Kroeran]

after many adventures in this game my conclusion is that seconds are not worth the extra risk, unless you have a large pool with lots of diversification or you also have the first, and never ever do unsecured unless you are getting a loan shark level of return, but you have to ask yourself if you want to be in that sort of business.

I would also follow the schiller real estate index closely and pull back when markets are overvalued or things are crazy...like now.

oh yeah, and don't permit the borrower to stack any seconds or thirds on top of your first or second, to keep skin in the game.

I think I would as well have a divorce escape clause - if the borrower has a change in marital status, loan is immediately due.

and ask for a very steep amortization

 

[calmloki]

Progress report: the coast condo loan has still not made any payments. Have spent about $1500 with a lawyer who did a demand letter, ordered a "foreclosure guarantee" (like a title report), and has set up the courthouse steps sale to come in February 2010. We have spoken with the holder of the first, who would much rather let this loan drag out - he has his eyes on the default rate interest and little dollar signs are dancing - OK for him, but the property would only have to sell for $120k for him to get paid in full - in the second position we need it to sell for $250k or so to cover our loan, interest, and legal expenses. We had held off on starting the foreclosure process for a month after the date the loan was due, hoping not to have to go through the process and trying to avoid waste of money - unfortunate. Still feel that the property is plenty adequate security for our loan, so this is serving as a learning experience for us.

 

[CybrMike]

Yikes. Will you bid @ $120K and get the property? What if the property sells for somewhere between $120K and $250K, do you just eat it?

Progress report: the coast condo loan has still not made any payments. Have spent about $1500 with a lawyer who did a demand letter, ordered a "foreclosure guarantee" (like a title report), and has set up the courthouse steps sale to come in February 2010. We have spoken with the holder of the first, who would much rather let this loan drag out - he has his eyes on the default rate interest and little dollar signs are dancing - OK for him, but the property would only have to sell for $120k for him to get paid in full - in the second position we need it to sell for $250k or so to cover our loan, interest, and legal expenses. We had held off on starting the foreclosure process for a month after the date the loan was due, hoping not to have to go through the process and trying to avoid waste of money - unfortunate. Still feel that the property is plenty adequate security for our loan, so this is serving as a learning experience for us.

 

[calmloki]

Yikes. Will you bid @ $120K and get the property? What if the property sells for somewhere between $120K and $250K, do you just eat it?

If the bid was for 120 to 250 we would take a loss. The assumption is that it will be worth more, so our bid will be for the amount to pay off the loan (including penalty interest ) on the first + our loan + interest + legal expenses. Hopefully someone will bid more, which excess would go to the borrower. If no one bids more we just bought a beach condo - after we pay off the first loan in full. Which means dipping into the pocket to save the value of our loan. Of course if beach front condos are going for 120 in February and we don't think property values will rise again we may just kiss that initial loan money goodbye. Think that's how it works.

 

[jdw_fire]

If the bid was for 120 to 250 we would take a loss.

dont think you necessarilly take a loss, only if you are unwilling to take back the property. you should be allowed to bid up to the full value of your mortgage plus expenses plus back interest plus the 1st mortgage without adding any more of your own money, provided the 1st is still in good standing

 

[calmloki]

dont think you necessarilly take a loss, only if you are unwilling to take back the property. you should be allowed to bid up to the full value of your mortgage plus expenses plus back interest plus the 1st mortgage without adding any more of your own money, provided the 1st is still in good standing

Loss in the sense that if it is only worth $120-150 and we are into it $$250 or so. The first was due, is in default (no payments either), and would have to be paid off, so we would need to do so to have the property in our name free and clear.

 

[jdw_fire]

Loss in the sense that if it is only worth $120-150 and we are into it $$250 or so. The first was due, is in default (no payments either), and would have to be paid off, so we would need to do so to have the property in our name free and clear.

well then i hope you have the cash to payoff the 1st (or that you can get a new 1st) but, getting back to the forclosure sale, i dont think you can accurately judge the FMV of a property by its selling price at the forclosure sale since the buyers there are looking to buy at a discount.

 

[tryan]

In MA condo fees and taxes come before the first position .... yup, condo fees!

I sure your counsel knows local law; these things really add up fast.

If they're not paying you; who else are they not paying??

 

[calmloki]

End of the year - for those with any interest in how my heathen flouting of "neither a borrower nor a lender be" is going the following is offered.

The second position loan we made on the spiffy beach front place is done - borrower never made a single payment so we got to have far more conversations with a lawyer than I ever wanted (funny how $175/hour affects my friendly chatty nature). Found out there was no flood insurance on the low bank beach front place - couldn't get any without the borrower's signature, and the insurance company was only interested in writing for the whole building, since the borrower was the putative owner. Fire insurance on the unit expired, which we paid to re-up. Found out that if one puts money into a fire insurance policy held in another's name, even if you are a lien holder, the insurance company won't give you the money you paid back. Paying the lawyer was worthwhile: after racking up thousands of dollars in charges, which we paid each month, the borrower's note was purchased pre-foreclosure by another daring investor. We were paid for all expenses and interest and penalties. The note we signed happened to have a default interest clause of 22% in it. Which we got. and the trouble was worth every nickle of same.

A small loan we have carried for the last 5 years matured - we didn't have any default interest provision, so when the loan got to the end of term it took the borrower several months to pay it off - she just paid the agreed upon modest interest rate till she paid in full. Not what we had in mind, but the idea that someone wouldn't pay their obligations when due didn't spring to mind 5 years ago - back then we thought a foreclosure happened pretty much instantly. We need to have a penalty in place in loan documents to encourage people to pay off loans at maturity.

The loan that we had on our lenders building was foreclosed by the holder of the second. They still have an obligation to us, and are paying the normal payments - when I suggested they pay me off they told me to go ahead and foreclose - no real point in my doing so unless I want to enrich the lawyers - the loan matures in late February next year and they are trying to sell the place currently - we would be paid out of the sale proceeds. If we don't get paid off at the due date we'll go ahead and start foreclosure, till then the interest payments are just fine.

The loan on the 5-plex paid off this month - we had a minimum one year term on that 11% loan and the borrower got conventional financing - good for him getting a lower interest loan and good for us putting a minimum term on the loan. It's not worth the trouble and the risk to make a really short term loan unless its at eyebrow curling rates.

Our neighbor didn't pay off their loan - OTOH, they are super punctual with their payments and we can keep real close tabs on their comings and goings. Happy with the interest they are paying, admire how they are conducting their lives - no stress, no problem.

The loan we made to a bunch of suits in Portland - unsecured - continues to be a thorn in my side - we did get a month of interest in December, but that was after about 5 skipped months. At some point I may turn loose the law dogs, but as an unsecured loan its real possible that we could be throwing another $3000 or so away and gaining nothing. Lesson, get security idgit!

We did take the payoff on the 5-plex and make a new loan today - first on a duplex in Portland and a second on a small house as co-security. 11% interest, 5 year term, 3% interest penalty for prepayment in the first year, 22% default interest. Failed to put in a penalty for failure to pay off in full when the loan matures, maybe next time.

All in all, pretty entertaining and except for the unsecured loan's non-performance fairly lucrative.

 

[haha]

All in all, pretty entertaining and except for the unsecured loan's non-performance fairly lucrative.

This is quite interesting. Can you tell us what the all-in project profit or loss is right now, making conservative assumptions about the non-performing loan?

Ha

 

[calmloki]

This is quite interesting. Can you tell us what the all-in project profit or loss is right now, making conservative assumptions about the non-performing loan?

Ha

It's an ongoing process right now and depends on how it's figured. For instance, should I include the $120k held in a MM account at 2% in case we needed to cash out the holder of the first on the coast property? Should the 7% contract we are carrying on our old house be included? How about the 22% default interest we just collected for a number of months on the non-performing coast loan? The loan we made to the suits in Portland managed to make 12 payments since 9/15/2007 and now owes $3000 more than we loaned them - but will we see our money back?

A middle of the road guesstimate - leaving out the uncommon 22% default interest and the old 7% contract and the poorly earning cash we hold in MM accounts, but pessimistically assuming we see no further payments on the loan to the suits we will make a weighted average 8.54% on the money we have loaned out at present. If the suits pay we should see 10%+. We are pretty staid - we hold a chunk in Penfed CDs and money markets, so the property loans juice up the 2-4% earnings in those accounts.