How to Match the Lender to the Loan So That It Will Work For Everyone?
There are so many issues with the real estate market in 2009. First there is the foreclosure mess and the resulting banks tightening their guidelines. There are seller’s that have unreasonable expectations about housing values. There are buyers with unreasonable expectations about housing prices. As an investor we are stuck in the middle.
Another thing that has been happening as a result are that real estate investors who have been utilizing private lenders have been making compromises in their policies and taking the first Lender with money that comes along. Franticly worrying about the money and not caring where the money comes from.
This is Bad Business! Bad for the lender because they are expecting an opportunity to be a specific type of transaction and they may receive what ever the investor had on hand. The Investor may be anticipating a particular exit strategy but may not find a buyer in time. This could be a conflict between the two.
I will use the following example, (this situation is hypothetical and is not based on any one investment.) Real Estate Investor James puts a property under contract to purchase for $200,000. His exit strategy was to rehab and resell quickly. He determined the after repaired value to be $325,000 after $20,000 in rehab.
He was buying the property Subject To the existing 1st mortgage of $180,000 and needed to give the seller $20,000 for their equity. James will then pay the monthly payments of $1500 per month on the first mortgage until he sells the property. He was planning on being in an out of the property in 6 months.
James finds Terry, who had some money in her home equity line of credit that she would like to earn a good return on investment. Terry borrows $75,000 from her HELOC, She puts $10,000 in her savings account to make the payments on the HELOC until is it paid off and then lends $65,000 to James on a 9 month promissory note secured by a second deed of trust.
Terry figured that she was safe because the ARV was $325,000 and the total loans would be $245,000 which is 75% of ARV. She figured that having $80,000 in equity would be good enough. The note was structured as a balloon payment of principal and interest when the house sold. This also gave James 1.5 times the length of time than he figured it would take to rehab and sell.
Terry told James that 9 months was the longest she could lend the money out because she was going to be doing some remodeling on her house next summer and would need the money then. James was comfortable with 9 months as he had completed a similar project and it only took 10 weeks from start to finish because the house was put under contract to sell before it was finished.
Things went down hill from there…
James had to find a new contractor because the one he had used on the last project moved away. The contracting bids came back much higher than anticipated. James had done carpentry in the past so he decided to rehab the property himself.
The rehab took twice as long. It was completed in 20 weeks instead of the 10 weeks he planned. It also cost $35,000 instead of the expected $20,000 and because he did the work himself it wasn’t the same quality of work that a contractor would have done.
The market had slowed dramatically and all properties were taking much longer to sell. James was between a rock and a hard place. The property wasn’t selling. The 9 month note was coming due in the next couple of weeks. What could he do?
Many things went wrong. Let’s address the point of this article: Matching the loan with the lender. James should have found another lender with a longer term. You should always build in multiple exit strategies into the equation. If he would have found a lender that would be willing to have their money working for 2 years James could have sold with seller financing or Lease option.
He could have gotten a tenant buyer in the property quickly that had a sizable down payment. Instead he was forced to sell for full retail in a declining market. Obviously this is not a good situation.
How does he get out of this situation? Or Does He? We will pick this up where we left off next week.
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