As a fund or private investors we need to continually balance the need we have to invest our capital, the quality of the deals, the yield we are looking for and our liquidity. Until the end of 2007 the liquidity factor was not a problem, however, since then it has become one of the most difficult challenges that we are facing. Getting an appropriate yield is easier than it was and since there is limited bank lending demand for our capital is quite high. A more difficult aspect of the investment process is to find an investment of quality.
Since liquidity is one of the most important factors that will influence our interest in an investment vs. another one then let explore it first. Until the end of 2007 and more so fall 2008, as investors we were assuming that we will be paid back, sometime rapidly as most borrowers would refinance their private loan as soon as possible. Who would want to keep a loan for 12 month or 18 months at 11% or 12% when you could get easy refinancing at lower rates. In addition, as the real estate values continue to increase the fear of losing our principal was quite low. However, since then the market conditions have changed significantly.
Today we are seeing a number of problems regarding current and future liquidity. The first problem is to get our principal back from previous investments. Even when the property has not lost significant amount of value or is not in foreclosure it can be difficult to get our money back. Only borrower with good to great credit can get financing, there are no stated income programs and numerous colleagues’ private investors / funds do not have capital to approve new loans. No refinance means no capital back which means no money to approve new loans etc…. In numerous cases the only exit strategy that we are seeing making sense and getting paid back is a sale of the property. This is both for commercial and residential investments.
Future liquidity is in question as well as there is no clarity regarding the future of real estate values and availability of capital. In part we are expecting property to rise once the market has stabilized, so capital loss may not be as much an issue in the next 12 to 24 months as availability and costs of capital. If there is no capital to finance transactions, to refinance properties, or if it is too difficult then to get financing approved through banking channels liquidity will not improve. In addition, an increase in interest rate could put some limit on the number of financing approved.
Our approach at this time is cautious optimism in relation to liquidity and the future of the market. Currently, I am working with buyers of performing and non performing notes and there is a demand for it, which is the good news. For investors who need to get liquidity today this is an option. Also, we have started to see more and more private capital being made available. Currently there is new private capital focused on the most distress deals, however, we are starting to see a shift toward performing high and good return assets. Markets bottoming out and new capital entering the market, even if in small quantities, will help unlock the market and make is more liquid.
Thursday, July 30, 2009
Wednesday, July 22, 2009
Due Diligence – Direct Lending
A successful direct investment or loan will be based on the quality of the due diligence being done. Based on our experience, one of the challenge for investors is to be able to evaluate the quality of the investment and then to assign it a risk. Due diligence is a process that combine research, verification of information, market valuation and a good understanding of possible exit strategies. Most investors that have experienced significant losses are telling us its because they moved too fast.
Each one of us will approach this process differently, however, here is the way we like to do it. We collect the initial documentation from potential borrowers. This will include but not limited to financial statement(s), credit reports, lease agreements if property is leased or last year plus year to date income and expenses on the business if owner user, pictures of the property, income and expenses on the property, title report. We will want to see a current bank asset statement. We ask the borrower for their current estimated property value, an old valuation (appraisal if possible), the loan amount there are looking for and the use of funds. Finally we will ask them to tell how they will be planning to pay us back. Since we are bankers and do conventional lending we have a good idea if their assumptions are true.
One of the main challenges is to make sense of these documents and to see how the information they contained compare to what is happening in the market. Borrower need hard money because they are not perfect and / or cannot qualify for bank financing. Thus when doing due diligence this is something to consider. If borrowers / loan officers are not providing the documentation, then you know that there is a problem somewhere. My rule of thumb, if people want money they can document what they say they can. As we know this is hard money thus there will be problems, but it is important to know what the problems will be from the get go.
Hard money is all about the property. Doing due diligence on the real estate is one of the more crucial aspect of this effort. If as an investor you cannot visit the property, make sure you send somebody you trust to see it. One time we saw a property and on the face of it, it looked good, once we visited the site the kitchen was missing. This was not noted in the appraisal not ordered by us. Make sure to understand what maintenance needs to be done if any.
Once the risks of both the borrower and the property have been evaluated terms can be confirmed. As experienced investors will tell you, they can get a general idea of the deal within few minutes of speaking with either the borrower or loan officer. However, in 98% of the cases, new issue or points of concern arise during the due diligence process that need to be addressed.
Each one of us will approach this process differently, however, here is the way we like to do it. We collect the initial documentation from potential borrowers. This will include but not limited to financial statement(s), credit reports, lease agreements if property is leased or last year plus year to date income and expenses on the business if owner user, pictures of the property, income and expenses on the property, title report. We will want to see a current bank asset statement. We ask the borrower for their current estimated property value, an old valuation (appraisal if possible), the loan amount there are looking for and the use of funds. Finally we will ask them to tell how they will be planning to pay us back. Since we are bankers and do conventional lending we have a good idea if their assumptions are true.
One of the main challenges is to make sense of these documents and to see how the information they contained compare to what is happening in the market. Borrower need hard money because they are not perfect and / or cannot qualify for bank financing. Thus when doing due diligence this is something to consider. If borrowers / loan officers are not providing the documentation, then you know that there is a problem somewhere. My rule of thumb, if people want money they can document what they say they can. As we know this is hard money thus there will be problems, but it is important to know what the problems will be from the get go.
Hard money is all about the property. Doing due diligence on the real estate is one of the more crucial aspect of this effort. If as an investor you cannot visit the property, make sure you send somebody you trust to see it. One time we saw a property and on the face of it, it looked good, once we visited the site the kitchen was missing. This was not noted in the appraisal not ordered by us. Make sure to understand what maintenance needs to be done if any.
Once the risks of both the borrower and the property have been evaluated terms can be confirmed. As experienced investors will tell you, they can get a general idea of the deal within few minutes of speaking with either the borrower or loan officer. However, in 98% of the cases, new issue or points of concern arise during the due diligence process that need to be addressed.
Wednesday, July 15, 2009
Direct Lending Vs. Investing into a Fund
Directly making a loan vs. investing through funds have both there pros and cons. Here are some of the issues that investors should consider and then make sure that the returns match their needs. Direct lending requires a greater involvement especially when there is a problem in getting paid. Investing through a fund will mitigate this involvement. However, even if investing though funds investors should from time to time speak with the fund manager and ask question regarding the fund investment.
Liquidity is also important. Investing through funds investors will have easier access to their capital, even if contractually they have to let their capital in the fund for a minimum period of time. Direct lending will not allow investors to get access to their capital unless the note is being paid off. Another way to get access to the capital when lending directly would be by selling the note to another investor. However it may require some capital losses.
Spreading the risks vs. concentrating the capital on few investments is also something to be evaluated. Investing through a fund investors will be able to spread the risk through multiple properties / loans. Thus if any one properties default then it will not affect significantly the fund returns. However, direct lending will be affected if there is a default situation. Returns will be suspended until either the property is sold and the note with arrears paid off, or the property is refinanced or the borrower is catching up with late payments.
We will continue to explore pros and cons of each option in other posts. Now let take a brief look at returns in general a fund can be anticipated to generate for the investors between 7% and 9.5% annual yield. Direct lending can generate anywhere from 10% to 12% annual yield. The spread is due to the type of investments that both a fund and a loan will target.
Liquidity is also important. Investing through funds investors will have easier access to their capital, even if contractually they have to let their capital in the fund for a minimum period of time. Direct lending will not allow investors to get access to their capital unless the note is being paid off. Another way to get access to the capital when lending directly would be by selling the note to another investor. However it may require some capital losses.
Spreading the risks vs. concentrating the capital on few investments is also something to be evaluated. Investing through a fund investors will be able to spread the risk through multiple properties / loans. Thus if any one properties default then it will not affect significantly the fund returns. However, direct lending will be affected if there is a default situation. Returns will be suspended until either the property is sold and the note with arrears paid off, or the property is refinanced or the borrower is catching up with late payments.
We will continue to explore pros and cons of each option in other posts. Now let take a brief look at returns in general a fund can be anticipated to generate for the investors between 7% and 9.5% annual yield. Direct lending can generate anywhere from 10% to 12% annual yield. The spread is due to the type of investments that both a fund and a loan will target.
Monday, July 13, 2009
Keeping It Simple
Today here is how most investors and funds that we are in contact with look at properties, they evaluate properties based on the income generate. If properties produce enough income tu support the loan amount requested then a discussion can start otherwise it becomes more complicated. It does not matter what the property type is.
If for example we are asked to finance a single family residence we will look at its potential income. When looking at financing a commercial property that is owned and used by the same person, we will look at what will it generate if leased out. In addition, we will take a look if the business being opperated can afford making the monthly payments.
Recently while speaking with a broker about a property value, we discussed multiple ways to get a valuation. However, from my perspective I mentioned to him, the only one that make sense is the one based on income. Current income is the best, future income could be considered.
If for example we are asked to finance a single family residence we will look at its potential income. When looking at financing a commercial property that is owned and used by the same person, we will look at what will it generate if leased out. In addition, we will take a look if the business being opperated can afford making the monthly payments.
Recently while speaking with a broker about a property value, we discussed multiple ways to get a valuation. However, from my perspective I mentioned to him, the only one that make sense is the one based on income. Current income is the best, future income could be considered.
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