Working With Available Capital – Part 3 (Last)

In the first two entries related to working with available capital we look at the real estate market liquidity and borrowers motivations. Today in the third part of the serie we will look at the exit strategy. Clearly being able to get back the capital invested is going to be a very important aspect of our decision to invest. We are private investors, but we also work with conventional sources of funds either through correspondent relationships or partnerships. Having an understanding on how other sources and financial professionals look at properties, allows us to make better and more informed decisions.

Valid exit strategies are, pay down, refinance and sell of the property each one of them will or will not make sense based on the details. If we start with a pay down, most private loans are interest only, thus they don’t include monthly reduction in principal. Most borrowers will not include additional payment on a monthly basis to reduce principal if they don’t have to. An alternative would be for borrowers expecting an influx of capital and plan to do a partial pay down. If this is part of the exit strategy we would want to verify that it will happen. We will ask for documentation supporting borrower’s claims.

While principal reduction is a possible exit strategy, the most likely ones are refinance and / or the sale of the property. In general we underwrite loans at no more than 65%LTV, however in some case we need to be more or less conservative. To allow for future refinance we need to look at properties’ income and apply debt service criteria to our underwriting. When we receive a package with a current debt service of 1 either the property is under rented / performing and we approve it. Or since the exit strategy is refinance, and refinance requires anywhere from 1.2 to 1.3 DSCR we will decline. We would be approving this loan for a refinance if no matter the DSCR we felt the LTV was low enough, the potential for future income was real and we could either refinance them into another private loan if the property’s financials did not improved enough or potentially extend their current one. We look at it relatively the same way for residential properties, if we have to take them over would rent cover costs?

Selling a property is a valid exit strategy and depending on the property type and location we will allow for more or less time. For example, if borrowers come to us and say they need finance on a commercial piece of property on a short term basis prior to a sell. We will most likely allow for financing to be between 12 to 18 months. However, if a residential borrower comes to us we will allow for 6 to 12 months no more. If borrowers tell us that they cannot execute within these timelines we have concerns on the validity of their exit strategy. In the case of sell as an exit strategy, we will ask for listing agreement with agent, agent contact information, escrow information, why borrower is selling etc… if all lines up, we will move forward.

This is the last post related to working with available capital. As you can see because capital is limited and market conditions are challenging we go beyond just looking at values when we make an investment decision. We both try to be reasonable in our investment approach and at the same time accommodate borrowers. We look at multiple criteria when underwriting, from our understanding of the market, to the exit strategy. By being thorough this has allowed us to stay in business in these trying times and to provide positive returns to our investors.

Working With Available Capital - Part 2

In our previous post we reviewed the liquidity aspect of the market and how it will affect us and our decision to invest. While real estate is not considered a liquid investment until 2007, getting the capital lended paid back was relatively easy. Most importantly, we did not expect to lose any amount of capital. Since then we have experienced a complete 360 we moved from a relatively liquid market to a frozen one. As part of working with our available capital, today we are going to look at what motivate borrowers to ask for financing.

As a real estate lender / investors we are constantly asked to finance deals and making choices that can be difficult. Our approach to approving loans and making an investment is to understand why a borrower needs money. When we get the reason then we verify that this is true and makes sense and if it is and does, then we move forward with the underwriting process. By asking questions and being inquisitive you get a lot of good information, and with experience we are able to determine the validity of what borrowers are telling us.

There are a number of good reasons to approve financing. Borrowers are buying numerous properties and banks will only finance a limited number of them. It is quite easy to verify that a borrower own multiple properties. Borrower need short term commercial loan, most commercial loan come with prepayment penalties. Borrowers need cash-out, today it is quite difficult to get cash out. Borrower, need second position loan, no second position loan are available today. Here we only approve second positions on low LTVs. Etc…

As well there are a number of reasons why we do not approve loans. When borrowers need capital to finish development projects that went over budget, it will be difficult to approve. In most cases this does not work because the LTV does not make sense. We will decline a financing when the borrower cannot afford to make the payments on the loan. We really are not interested in foreclosing on properties even when the value is there. We know this is a risk that we are willing to take, but we try to avoid putting ourselves, knowingly in this situation. Now if the borrower is selling the property and we can build interest payment into the loan then this is a different story. We will decline a loan when there is no clear exist strategy that makes sense. Etc…

Once we understand a borrower’s motivation, we can better figure out if we want to move forward with lending them capital. In real estate more than with everything else I like to use Ronald Reagan approach “trust but verify”. Most borrowers are completely willing to work with the lender, as they realize that lenders, even private ones, make rational decisions. A big red flag for us is when borrowers do not work with us, or set their own agenda, in general this signal that either they are not in touch with the market or, most likely, we don’t have the whole picture.