Private Lending 103: Funding the Deal

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Arbitrage, Profiting from the Spread: Sunday Morning Thoughts 19 May 2013

Arbitrage The simultaneous purchase and sale of an asset in order to profit from a difference in the price. It is a trade that profits by exploiting price differences of identical or similar financial instruments, on different markets or in different forms. Arbitrage exists as a result of market inefficiencies; it provides a mechanism to ensure prices do not deviate substantially from fair value for long periods of time.  http://www.investopedia.com/video/play/arbitrage/

 

Understand when you look up the word arbitrage, you will find many varied references to the stock market, for this post the term will be applied to real estate investing.

In real estate as a private lender arbitrage will be the spread between the costs of monies.  If you borrow $100,000 at 3% interest then loan the same money at 6% interest then you would have 3% interest as a gain.  Many private lenders and real estate investors have taken advantage of arbitrage.

Flipping houses is also a form of arbitrage.  The method is slightly different today but it is still the buy low/ borrow low and loan/sell at a high rate and the difference will be the profit.

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Real Estate Retirement Investing Part 2: Sunday Morning Thoughts 09 September 2012

Retirement (Photo credit: Wikipedia)

Instead of wracking your brain over how long your retirement will last, why not give a lot of thought to understanding how you can use other non-conventional investments to make your money for retirement work for you.

Everyone either understands or pretends to understand how their 401k works. 401ks have been an investment vehicle for a long time, but there are many options for your 401k investment.

You can invest aggressively, moderately, or very cautiously, but will you still be able to have returns that will be viable when you retire?

Not necessarily.

You have to consider all of your fund options, and a diverse account is normally the best route.

What about if you are already in retirement, and your account is not going to last you for much longer and your greatest fear is out living your money?

No one should be afraid to live.

Precautions before your money runs out is best, whether you are safe guarding what you have, or you are trying to make what you have grow larger; sound investments are your key to living in a happier state of being, without the worry of your money running to low or out altogether.

Diversifying your portfolio to include real estate investments may prove to be a great option for growing and/or maintaining your retirement nest egg.

Being a private lender, also known as being the bank, is a way of earning interest without the risk of owning a property.

As a private lender you are investing in the vision of someone else, but only the vision is backed by real property, something tangible, sellable, and if calculations are done properly can also be profitable.

So even if a borrower defaults on the loan you have given them, you will still have an asset that you can resale or keep for yourself as an investment.  Of course, you will already know from the documentation given to you in the initial evaluation of the loan, if the property is worth equal or more than your initial investment.

Retirement does not have to be bleak future/present if prepared for and maintained properly.

Related articles

• Real Estate Retirement Investing Part 1: Sunday Morning Thoughts 02 September 2012 (backedbyrealestate.com)
• Real Estate Retirement Investing Part 2: Sunday Morning Thoughts 09 September 2012 (backedbyrealestate.com)
• What Is A 401k Retirement Plan? (answers.com)
• Residential and Comercial Real Estate Investing: Sunday Morning Thoughts 5 August 2012 (backedbyrealestate.com)

Private Lender Tips If a Loan Goes Bad: Sunday Morning Thoughts 05 June 2011

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The goal for many private lenders is to make a return on investment better than CD rates.  If you chose the real estate investment wisely, you could stand to make more than CD rates, which is currently 2.39% for a  5 year term offered by Ally Bank.  Also to note with the volatility of the stock market, if you continue to invest in the stock market, then you will need to have more resolve than in previous years.  But with growth comes a little pain, does it have to be that way?  Short answer, no.

A private lender, with an investment secured by realty, may realize a profitable and safe return on investment.  Safe can be accomplished by being the first lien holder or as close as you can be to being the first lien holder.

As a second or third lien holder, a default can wipe-out your investment if the first lien holder files foreclosure first.  This isn’t to say that the second and third lien holder cannot file foreclosure if they are defaulted on to protect their interest in the property.  Most defaults begin with the lesser liens than with the primary.

So if you are the second or third lien holder then you can proceed with foreclosure per the contract you have with the borrower.  The loan servicing company can help with the process of foreclosure.  After filing foreclosure on the property, as the second or third lien holder you will have to begin making payments to the first lien holder or suffer foreclosure.  If the first loan has become delinquent then you will have to negotiate to bring the first loan current.

If you are the third lien holder on a property, you still can file foreclosure and you may be able to buy out the second lien holder’s position to make your interest in the property more stable, and if you can acquire the first lien holder’s note, then that would make you investment in the property even more stable.

Being the first lien holder not only yields you a better return on investment, but can also give your investment better stability.

Foreclosure on a bad loan is not the only option.  As a private lender you can allow the borrower to have another entity assume the loan. So instead filing foreclosure, if you or the borrower can find someone else to assume the loan, and use the down payment to bring all liens current, then that would be a win—win situation without the cost of court.  Being a private lender gives the flexibility to do more than just a standard few things as long as it is agreed upon by all involved parties.

Another option as a private lender is to allow the borrower to exercise a deed-in-lieu of foreclosure.  This can also avoid costly legal fees and you can either sell the defaulted note, or property.

Quick recap on what to do if the loan goes bad

1.    Be the first lien holder or as close to being the first lien holder
2.    Use a loan servicing company
3.    Have contracts in place for the what if’s
4.   Allow the loan to be assumable
5.   Use deed-in-lieu of foreclosure over a traditional foreclosure

Covering your downside can make all the difference in having an upside in passive income.

 

Level of Risk in Real Estate Investing: Sunday Morning Thoughts 22 May 2011

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As with all types of investments, there exists a level of risk.  Risk can range from low to high.  The range also has an impact which can be directly proportional to your return on investment.  Often times, the more the risk the better the profit.  But does that actually apply when considering real estate investing or private funding of real estate?

In a previous post we explored the amount of risk and the impact on return of investment.

Using the previous examples from part #1, the lower risk investment was the 60% occupied apartment.  The high risk and low yield was the strip mall.  The medium risk investment was the SFR.  But even then the determination of level of risk is based on what we already know about each project.  This isn’t to say we will jump into either investment of low or medium risk without knowing more information; now it is purely a judgment at first glance, to see if the potential investment warrants any more analysis time.

First we will examine the apartments with 60% occupancy and knowing the current management/owner is tired of owning rental property.  And for good reason, the tenants always seem to have some sort of an issue; maintenance always has to be performed from general maintenance keeping the grounds neat and tidy to fixing other issues such as plumbing, electrical, etc.

Now with the current owner letting things go, his rental income property has become his nightmare.  As long as the property can support itself, and generally 60% occupancy can do that, then the investment becomes a steal of a deal for another owner, one who will make sure the property has great people oriented management.  This one would definitely garner a request for the financials and a deeper analysis in order to make a reasonable offer.  This investment would be a medium with a superior yield even in its current state.

The other medium risk investment would be the SFR.  The SFR is in a middle class area without too many homes for sale.  The area is considered desirable for families to move into.  Once the house has been rehabbed and cosmetic touches have been applied then we would have either a passive investment property as a rental or sell it for at the fair market value.  This property could also become a lease with the option to purchase.  This one would also garner a further look to make sure the numbers are in order, and that the return on investment is worth all the hassle of the rehab, if rehab is necessary.

Not all houses are worth the rehab effort.  Some houses may only have a value due to the land which they have built on, versus the amount of work needed to fix the place.

As for the high risk and low yield investment, the highly vacant strip mall or office space, would be an investment that would not receive consideration if the typical strip mall/ office space in the area are almost empty or empty.  It would be a matter of evaluating employment statistics for the area, in addition to taking a look at the local demographics.  All of which is just a mouse click away.  Most of all the information can be found quickly on the internet.

But if the area is dense with vacant strip malls/ and or office space then it might be best to move to on to a more viable investment.

As a private lender, the investor presenting you the deal for funding should have already checked the numbers and made sure the deal is profitable.  But as a private lender you still need to look for profitable characteristics in all possible deals before funding.

Risk Management Covering the Downside

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When investing in real estate risk comes with the territory, but minimizing risk to a manageable tolerance is crucial.  Some investors can tolerate huge losses while others would find a small loss difficult to handle.  It is a matter of considering all your options and then proceeding from there.  You do not need to have a vast knowledge as a private lender for a possible deal but you will have to make a consideration of many aspects of the deal.

Aspects to consider is the structure of the deal, what is the percent collateral to debt, which position are you 1st or 2nd, etc., and when will you receive your profit.

With the four aforementioned considerations you may be able to limit high risk and maximize profit. Remember the four points are when you initially look at a deal, if these things are not answered the way you want, then you can let the deal go or improve upon the deal to make it profitable for you.

The structure of the deal, how will the property be obtained?  Will it be seller financing and at what percent and length of time?  Will it be bank financing along with private funding, if so then how much bank financing is needed?

With seller and bank financing are you the second lien holder or even further away from the collateral?   Are you the rehab money?  The first lien holder is the best position especially if the borrower goes into default.

These are just a few things to consider when minimizing risk.

The downside would be being the 3^rd or even lesser lien holder on a collateralized note, a property having no to low occupancy (occupancy under 55%), a property with major rehab needed, and a property with poor management.  This is not the end of the list but only a few of the normal problems which can be encountered on a real estate deal.

Of course each one can be covered to help benefit in profitability.

Lien holder position, find out what it will take to make you number one or number two.  Funds necessary may only be the difference in $5000 or possibly less.

Having no to low occupancy; many profitable deals have started that way.  The upside is having new one year leases in a multi family property, or a buyer or a lease option for a single family residence.  In a no occupancy situation, finding the best management company for the area is a great start to a profitable finish.

Major rehab projects may be a time factor downside.  Time of year for weather concerns for certain areas, and or time of investment return.

A property with poor management, the remedy is to find the best management company in the area or build a team for the property.  Hiring people with people skills is the biggest key.  Many companies with less than stellar products may have high sales due to the people skills of the sales staff.  People have a tendency to stay when they have been treated fairly and respectfully.

So remember, covering the downside by taking proactive steps to maximize profitability can result in less risk of investment.

If Warren Buffett is looking for Deals Shouldn’t you be?: Sunday Morning Thoughts 27 Feb 2011

Well if you have been keeping up with all the latest news, you will notice that Warren Buffet’s letter to his investors is choc full of information not only for his businesses but for all Americans.

Warren Buffet is looking for companies to purchase and he’s paying cash.  Berkshire Hathaway is worth 52Billion dollars, with 38Billion dollars in cash reserves.

“Money will always flow toward opportunity, and there is an abundance of that in America.”  Warren Buffett

Warren also made a bold claim that the housing industry would bounce back in a year or so, although the bounce back is more or so than a year, if Warren is taking time to mention it, it can only mean take time to invest in it.

People do not realize that investing in real estate is still a safe bet, and waiting for the rock bottom you may miss it and be involved with the buying frenzy.

America is on the cusp of the recovery, it has been a long and hard road.

Take time to evaluate what, how, and when you want to invest.  Make sure the risk does not out weigh the return.  We have seen many people sitting on the sidelines waiting, but think, if Warren Buffet is no longer waiting and is actively seeking investments,-his elephant gun is loaded and his trigger finger is itching.

Neutral Arbitrage and the Effect on ROR: Sunday Morning Thoughts 19 December 2010

Quick recap, positive arbitrage is when your investment return increases with financing.  Negative arbitrage, your investment return decreases with financing.  Neutral arbitrage, your return on investment does not change with financing.

So how can an investor have positive or neutral arbitrage, picking the right loan is key to having a better rate of return.  When considering commercial property, such as multi-unit apartments, a low to no interest loan is best.

Interest only loans were only meant to have a life of no more than five years, after five years the loan could become upside down.  In today’s credit climate having a no interest loan would be difficult.  Lenders were admonished by the government for offering what is known as an investor’s loan to the average American.  This offering to the average person caused many to be in over their head at the time of the loan reset, contributing to our current foreclosure crisis.

All three arbitrage can be present when private lending, of course not at the same time; it just depends on the deal.

Related Articles:

http://backedbyrealestate.com/2010/11/14/arbitrage-and-real-estate-sunday-morning-thoughts-14-november-2010/

Negative Arbitrage and the Effect on ROR:  Sunday Morning Thoughts 12 December 2010

Will the Real Estate Market continue to Decline?

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We are currently in the eye of the storm of impending foreclosures.  The foreclosure pace has seen a slowing in the past few weeks and will slow even more in the coming weeks.

For November the decline was caused by the robo-signing scandal which forced lenders to slow the roll of foreclosures until they made sure all of the blank spaces were filled and all sentences made sense.  The triple checking of paperwork caused a slow down in foreclosures.  Many people on the chopping block were given a temporary reprieve.

Starting on the 20^th of December banks will get into the holiday spirit, and halt foreclosures for the last two weeks of the year.  But then promptly restart foreclosures on the 3^rd of January.  These factors contribute to what will look like a slowing in foreclosures for the end of the year, then January will see a hard spike in foreclosures due to the catching up by the banks.

What impact will this have on property values?

Property values for the end of December will flat line then in January; there will be a decline due to a housing surplus from lenders proceeding with foreclosures.  The robo-signing scandal did have a positive impact on property values.  With lenders going at a slower pace, making it appear that the overall inventory was shrinking.

Once the banks begin to pick up the foreclosure pace again we will see another decline in property values.

This is great for buyers but sellers in areas where pre-foreclosures and foreclosures are on the rise, the value of the property may suffer.

How can this benefit a private lender??

Even with a decline in property values a private lender may still make a profit in a real estate venture.  Lending on commercial property– people who have been foreclosed on will need to rent a place- or lending on a single family residence then taking quarterly, monthly, or a one time payment depending on the situation of a particular property.  So even in a down market you can still realize a return.  Visit our website to learn and possibly earn more  http://www.BackedByRealEstate.com

Arbitrage and Real Estate: Sunday Morning Thoughts 14 November 2010

Arbitrage by definition: The practice of taking advantage of a price difference between two or more markets striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices.

And there you have it, a way of making money in real estate in a nutshell, now let’s crack it open and see what’s inside.

An example of simple arbitrage and real estate, making money on the difference as a private lender, would be if you did not have the funds but you have a wealthy Uncle with the funds.  The Uncle loans you the money at 2% simple interest then you loan the money to an investor with the collateral being real estate at 8% simple interest.  Not a bad investment.  Your Uncle loaned you the money as a personal loan then you in turn loan the money on a collateralized investment.  The difference of 6% simple interest is your profit.  This is how easy arbitrage works.

Now let’s look at arbitrage with your own credit abilities if the rich Uncle does not pan out.

There are many types of credit you can utilize to perform arbitrage.

Line of Credit from a property you currently own. You use the line of credit which has a low-interest rate then invest in a property as a private lender gaining a profit from the difference in interest.  You can pay a line of credit with the line of credit (read the fine print from your lender to make sure).  You may also have tax benefits, consult an accountant for the specific in’s and out’s.

Credit Offers in the mail, the best ones are the interest free for 12 months or longer.  But be careful to read the fine print, make sure the creditor is not charging a fee for using the credit.  Also make sure the investment you are lending on can be liquidated before the interest begins from the credit offer.  With the use of this type of credit, payments would have to be made, so make sure you can cover the monthly payments with either payments from the loan or from your own source of funds.

Credit Cards you currently have.  Credit card companies send convenience checks to some of their customers from time to time.  Occasionally the use of the check may or may not be interest free for a period of time.  But beware some of the check offers charge a fee, which may be a percentage of the value of the check.

Obtaining a regular personal loan, this may not give you the best arbitrage but as long as there is a difference in interest in your favor then you still have arbitrage.  A personal loan normally will have a specific limit with a payment schedule, so monthly payments are something to be considered.

Which ever way fits your situation arbitrage is a way a private lender can make money in real estate with minimal use of your own liquid funds.  You can make a profit on lending the funds and make a profit on the use of the funds.  So even if you are just thinking about becoming a private lender.