With lender guidelines continually tightening, investor financing has become more difficult than ever to obtain. Investors that I worked with even a year ago to acquire investment properties with conventional financing are having trouble getting approved for a loan in the current lending environment.

Whether it’s a borrowers borderline debt to income ratio, credit score, financial reserves or even number of properties currently owned – getting conventional financing on investment property can be tricky. It seems that in many cases, investors meet all of the guidelines except for one or two exceptions, which unfortunately may result in their loan being denied.

Having run into this situation many times, I’ve learned to ask the question, “Do you have any friends or family members that might want to partner with you?” Interestingly, most investors do. In many cases, we’ve been able to help the investor ultimately obtain financing by adding a partner to a loan or even swapping out the borrower for a partner who qualifies by him or herself.

Who Should You Turn to First?

For most of our investors, the first obvious choice is their spouse. Assuming the spouse has documentable income and good credit, getting qualified may be as simple as adding this income to the loan. (As an aside, when a couple can each qualify for a mortgage without the other, I recommend they do not go on a loan together. This way, they can maximize the number of properties that can be purchased between the two of them)

If a spouse cannot help with a loan approval, an investor may want to ask friends or family members to partner with them in the investment. Whether or not the partner gets the loan by himself or together with the investor doesn’t necessarily matter as long as both partners are comfortable with the arrangement. Most investors form a corporate entity and outline the terms of the partnership in an operating agreement of some sort. This involves detailing responsibilities that relate to time and financial requirements as well as the dividing of income. Once the property has been purchased, the partners may then decide to put the corporate entity on title to the property.

For somebody who is unable to finance an investment property, finding a partner may be the next best option. As with any business venture, I would highly recommend that in doing so, each party consult with an attorney and CPA to make sure all aspects of the investment are properly managed. With so many investment opportunities in this depressed real estate market, it would be a shame to miss out just because of a technicality in a particular lending guideline. If that’s you, find a partner and start investing!

Photo: counterculturecoffee

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

If You Can’t Find Real Estate Financing, Find a Partner.

If you’ve been investing in real estate for a while, chances are you have considered using private money lenders (investors) to grow your business. Most people fail when reaching out to potential investors because they don’t answer the five critical questions that every private lender must have answered before investing with you (even if they don’t ask them). If you can answer these five questions, you will dramatically increase your fundraising ability. By putting yourself in the shoes of the potential investors and knowing what they are asking when you approach them, you will help to position your offering in a way that greatly increases your odds of acquiring private money to grow your business.

5 Questions You Better Be Able to Answer Before Private Money Lenders will Invest in You and Your Real Estate Deals

“Am I going to get my money back?”

This is the number one question that private lenders want to know when approached. If they do not feel like they can trust you enough to know that they will get their money back, they will never invest with you. Essentially they are asking themselves if they trust you to do what you say you are going to do.

Investors invest with people they know, like, and trust. Potential investors have all heard the horror stories; at this point they are judging your ability to deliver, and they will not likely give you money until they deem that you’re trustworthy.

“What’s in it for me?”

If you have established trust, the next thing potential investors want to know is how they will benefit. Many people approach potential lenders with the wrong mindset, and tell them all about what the lender’s money will do to help their business. However, investors are concerned about what is in it for them, and you must address that up front.

 “What are my risks?”

Every investment has risks and private lenders want to know, if things go badly what is their downside? Will they lose all the money they invested, or just part of it? Is there a chance they could risk even more than they put into that investment? A realistic investor knows that there are things that could affect any real estate investment’s outcome.

They want to know if you understand them and are prepared, and that you have done everything you can to limit their risks. They want to know that you are realistic with your projections, and that they aren’t going to get hung out to dry when you encounter difficulties.

“How is my investment secured?”

If you are investing in single-family homes, is the investment secured by a first position on the mortgage, title insurance, and hazard insurance? If it is an equity partnership, how is it secured? Is it protected by the cash flow it generates, by hazard insurance, etc.?

“Do you have a plan and is it realistic?”

Before potential investors will invest with you, they want to know if you have a plan, if you’ve done this before, and have you thought it through or are you flying by the seat of your pants with their money? You must have a plan and it must be written down. You might think this is a “no-brainer” and that everyone has a plan before they approach potential lenders. However, I’ve seen it over and over again: people approach potential investors and they have a vision, but lack a step by step plan for achieving their investment goals.

They want to know that you’ve done this type of investment before or if they are going to be a part of a new experiment. This can be one of the biggest hurdles for new investors to overcome. But if you can show experience on your team (notice I didn’t say it had to be you alone) and have a written down, well thought out plan, you will greatly increase your odds of them investing with you.

If you do not answer these five essential questions when talking to a potential investor, they will not invest with you. However, knowing their concerns and answering them up front will greatly increase your odds of acquiring them as an investment partner, thus growing your business faster. The key to raising great amounts of private money lies in addressing potential investor questions before they are asked, having a realistic plan, doing what you say you will, and being amiable.

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

5 Things Private Money Lenders Want to Know Before Investing With You!

Google the phrase “HVCC Nightmare” and you’ll return over a hundred web pages discussing the horrible legislation  passed in April 2009 governing  how appraisals are to be conducted in the mortgage business.  For those who aren’t familiar with this legislation and how it impacts the lending process, here’s a quick overview:

• Appraisers can no longer communicate with or have any contact with other parties involved with the transaction (i.e. loan officers, agents, mortgage brokers, etc).
• Appraisals must be ordered through either third  party appraisal companies (AMCs) or through some other mechanism within an organization that randomly selects an appraiser.
• Lenders can’t own their own appraisal companies.

At initial glance, these points seem fairly reasonable.  I can appreciate the intent of this legislation and the need to rein in mortgage industry abuses. However, having been personally involved in numerous transactions since the new rules were enacted, it does feel like the pendulum now has swung too far in the other direction.

This topic is fresh in my mind because I’m  working at the moment with a new investor who just received the appraisal back on his first investment property. He is buying the house for approximately  $81,000 and the appraisal just came back at $81,000. With other properties in the area selling in the $100,000 range, he was disappointed and wondering why the appraisal wasn’t  higher.  Unfortunately, under the current system, the appraiser usually has a copy of the sales contract and is simply determining if the sale price is justified – not necessarily determining true market value for the property. In this example, it’s a good bet if the sales price had been set at $95,000 the appraisal would have mysteriously come in at $95,000!

In light of the continuing high rate of foreclosures, and the mandated HVCC compliance, I’m usually satisfied when the third party appraiser doesn’t completely botch an appraisal! Talk to any real estate investor who has been buying and selling property over the last two years and chances are he’ll  have a story or two about how a horrible appraisal killed a deal.

Truth is, with real estate values all over the place and appraisers disincentivized to work hard for an honest  appraisal, most appraisals aren’t worth the paper they’re written on.  In fact, I’ve seen appraisals vary as much as 50% on the same property! One appraiser may choose to use good retail comparable sales while another appraiser chooses to use only foreclosure comparables to value a property. Who can say who’s right? This industry has become so subjective that it’s really evolved into one person’s opinion versus  another’s.

At the end of the day, investors need to do their own homework to determine whether or not an investment property makes sense.  I personally don’t care what an appraisal says; the appraisal in most cases is just a means to an end.  I’m going to conduct  my own due diligence to determine what I believe a property is worth (or will be worth at some point in the future). If the cash flow from the property fits into my investing strategy and there is good potential for long term equity gain, I’ll likely move ahead with the purchase regardless of one appraiser’s opinion of value.

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

HVCC Regulations & What’s the Deal with Appraisals?

Before you cut up your credit cards in an attempt to curb spending, or purge old accounts, stop and consider the consequences. It seems rational to close off old credit card and retail accounts that you no longer use, but it may end up hurting your credit score.

When it comes to getting a mortgage, car financing, or any other credit, your current score will play a factor. Keeping your score high can save you thousands of dollars by qualifying you for better interest rates and lending products.

Credit Score Factors

There are the 5 main factors that influence your credit score:

• 35% Payment History
• 30% Amounts Owed
• 15% Length of Credit
• 10% New Credit
• 10% Type of Credit

Length of Credit

Under the length of credit category there are a couple of metrics which impact your score.

First, how long have you had access to credit? The longer you’ve had credit and paid on time, the better.

Second, what is the average age of your various credit accounts? Again, the longer, the better.

Why Keep Old Accounts Open?

In most cases, it is best to keep old accounts open. Provided you have a good payment history on these accounts, closing them will only hurt your score. By closing an old account you will usually reduce the average age of your trade lines. In some cases, you may even shorten the length of your credit file. Keeping accounts open will also increase your total available credit which reduces your overall utilization percentage at any given time.

On the contrary, if you have a poor payment history on an old account that you no longer use, closing it may be best since it will eventually drop off of your file.

Either way, always think carefully before closing any old trades. Doing the seemingly logical thing may actually hurt your score. If you have trouble controlling your spending, you can still cut up the cards, just don’t close the accounts.

photo credit: kainr

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

STOP! Don’t Cut Up Your Credit Cards if You Care About Your Credit

Raising money from strangers is not so simple, especially when you have to deal with SEC guidelines and a real estate market that has brought about countless negative media headlines.   Despite the negative headlines, the real estate market is ripe with incredible deals – deals so good we will be talking about them for decades. 

Raising funds for these deals however is the biggest challenge for many investors.  Banks are extremely tight and cash is king; sellers flat out want cash.  Now, raising private money is not as simple as just asking family, friends and contacts.  You have to engage strangers and somehow convince them to start writing checks and wire money all while not violating SEC guidelines.  It absolutely can be done and is being done by thousands of investors.  Many struggle and make a lot of mistakes. 

Here are solutions to the most common mistakes when raising private money.

1. Do not give up – Your success in raising private money does not hinge on your first try.  In fact, it may take 20, 100, maybe even 1000 times until you get a Yes.  Everything can snow ball in a positive direction after that first Yes.  Never give up and that next attempt could be the one that starts your lift off.  Mistake #1 is giving up too soon.
2.  Build credibility and a track record – For most it simply comes down to trust.  Investors will step to the plate if they trust their money is going to be safe.  To build trust, investors must find you credible; you must build credibility.  If you don’t have a track record like most beginners, then partner with someone who does such as a mentor or an expert in your area.  Do this ethically, do not just steal their track record; make it a win-win and build your own track record.  Mistake #2 is the failure to establish credibility and a track record.
3. Get them to come to you – What do you think of door to door salesman?  Especially when they sell items you don’t need?  Chasing private investors is like desperate begging.  The key is to get them to come to you.  Give out free information, use your track record and teasers to get them to come to you.  Mistake #3 is desperate chasing and begging.
4. Prospect potential investors – You are not borrowing money, you are offering a tremendous opportunity for investors to make a great return on their money.  It is a privilege to be your private investor.  It is as much about your investors’ being a good fit as it is you and your deals being a good fit for their money.  You must ask them prospecting questions.  Find out their experience in order to confirm they are comfortable with investments backed by real estate.  Make them show proof of funds, find out their expected return, timeframe and what due diligence they need to make a decision.  Always prospect potential investors to make sure they are a fit.  Mistake #4 is not prospecting potential investors which results in a lot of wasted time.
5. Make them commit – People flake. It happens all the time especially when it comes to money.  They say they will fund but they suddenly have questions and objections at the last minute that they clearly should have brought up a long time ago.  This can easily be avoided.  All investors must put up money before close, in fact at the beginning of the process.  Earnest money, inspection fees, entity creation, or a reserves deposit are all ways they can show commitment long before close.   Mistake #5 is waiting until close to find out that an investor is not committed.

There are many benefits to buying with cash.  You can get big discounts, buy fast and do deals not possible with conventional financing.  Cash is king and there is a lot of cash out there.  Money does not disappear, it just changes hands and right now a lot is sitting on the sidelines.  Stay persistent and implement these 5 solutions.  Raising private money could be the key to a successful real estate investing business for years to come.

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

5 Solutions to the Most Common Mistakes When Raising Private Money

You spot a house that you would like to rehab or flip and decide make an offer. You plan on financing through a hard money lender, but haven’t yet done this kind of deal, and wonder what happens after you’ve got the house under contract. Here’s a brief look at the process:

All hard money lenders have different requirements. You can learn about these from lenders on the new BiggerPockets hard money lenders directory or by attending your local real estate club meeting and talking with other investors about who they have used to successfully fund their loans.

Some will loan a percentage based on appraised value, while others will loan a percentage based on the purchase price. It is better to find the lenders that will loan on appraised value. The lender will give you a breakdown of your fees along with their terms, including:

1. Loan Points
2. Closing Costs (Escrow Fees, Document Fees, Notary Fees)
3. Interest Amount

A typical lender might say:

I will loan 60% of ARV (appraised repaired value), with 5 points, 500 in document fees and a 6 month interest only balloon payment loan at 10%.

To translate on a deal that appraises at $200,000:
They will loan you up to 60% ($120,000). To get the loan you will pay $7,000 in points + $500 in document fees, and you will pay $1,167.67 on the loan, until you sell the property or until 6 months is up. They will take a trust deed and make you sign the other documents like on a typical mortgage.

Before you present a property, you should get familiar with local lenders and pre-qualify with them. Their lending requirements are often-times different than that of a traditional mortgage lender. Hard money lenders are usually most worried about the amount of cash you have, your level of experience, the specific deal and your credit.

Here’s the typical hard money lending process:

Step 1 – Pre-qualify: talk to the lender and see what they require of you and your deal.

Step 2 – Find and put a good deal under contract.

Step 3 – Call the hard money lender and inform them of what your contract price is, the estimated cost of the repairs, and what you think the ARV value is. Here’s a good worksheet to help you out.

Step 4 – The lender will either send their appraiser or give you an approved list of appraisers, and you will then get the property appraised.

Step 5 – They may request some of the escrow documents to verify the paperwork.

Step 6 – They will agree or disagree to fund the loan and will tell you what amount and under what terms it will be.

Step 7 – You close the loan — In many ways, its just like a conventional loan in that you do the closing at a title company or lawyer’s office. The lender puts the loan amount into escrow at the title company. The buyer might have to put in money or might get money back, depending on the deal. The title company issues checks as specified on the HUD; typically, a big one to the seller and points back to the lender. If there’s cash to the buyer, they would issue that check, too. The title company will ensure that all the proper paperwork is completed in the correct order and that funds are sent to the appropriate people.

Thanks to Steve L. and Jon Holdman for their generous contributions to our real estate forums where this article was compiled from.
Photo: Doug Shick

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

The Hard Money Loan Funding Process: A Guide for Rehabbers

Earlier this week, my husband and I refinanced one of our rental properties working with a private money lender.  It was the simplest transaction ever.  Our private money lender is thrilled because she’s getting a fantastic return on her investment (using her self-directed IRA funds) and we’re happy because not only is she happy, but we were also able to structure the loan in a way that saved us money on upfront fees plus increases our monthly positive net cashflow.

The experience just reminded me of how great it is to work with private money lenders because there are so many options made available to you with regards to structuring the loan terms. For example:

Available Loan Term Options when Working with Private Money Lenders

Short Term Loans

You can do short term 6-month loans for your rehab flips.  You can pay your lender 1 point on the loan or no points at all.  You can offer to make monthly interest payments with a balloon payment at the end of the 6 months.  You can make no monthly interest payments at all, but rather pay a higher interest rate on the loan and just have the one balloon payment at the end after you’ve sold the property. There are so many options available to you, and it’s just a matter of determining (by asking) what is important to the potential lender.

You may find some lenders who want to receive payments the first time around with you, but once that loan is paid off and they are ready to do another one, they may be willing to wait the entire 6 months without payment for the next round because of the established trust.

Mid-Term Loans

Perhaps your exit strategy is to do lease options and you only anticipate holding properties for 18 months – 3 years.  Or, you have an awesome deal that will cash flow well and you haven’t found a lender willing to hold for a long term yet, but you want to establish a relationship and get a loan started.   In these cases a mid-term length (typically 2-5 years) interest-only loan may suit you.

The risk is that you may be forced to refinance or pay off the property in the short-term, but if you don’t overextend yourself with these mid-term loans by doing too many at once, the risk isn’t all that bad.  You can either work towards a conventional loan when refinancing or refinance with another private lender (like we just did). Don’t be surprised when a lender who originally agreed to only 2 years later decides that he or she wants to continue the loan after the term is up.  The yields that lender is getting from you very likely exceeds what they are getting in the stock market and certainly exceeds the low yields from CDs, bonds, and the like.  Check out the average yields on CDs on November 24, 2010 (source: Bankrate.com):

Long Term Loans

If you’re a buy and hold investor, obtaining a long term (10 years or more) loan from a private money lender is like finding gold.  While these lenders may be harder to find, they absolutely exist so don’t rule out the possibilities.   Remember that even if you’re offering an interest rate as low as 6% (substantially lower than what you may offer on short and mid-term loans), that rate will attractive to some lenders depending on their current portfolio and investment strategy.

Second Mortgage Loans

Don’t forget about the option of having private lenders hold a second lien holder position on a property.  Let’s say that you are need of a small loan of $10-20K to do renovation work on a property.  There are individuals who will be willing to loan you money for this and hold a second mortgage for you.  In fact, I run into a number of people who have small retirement accounts and want to put their money to work in asset backed investments such as real estate.  These are the perfect types of loans for them.  My only caution is that you want to ensure you have equity in the property and provide your lender with the peace of mind that if the property was ever foreclosed on, there would be enough money to pay them back too!

Again, there are numerous options made available to you when you’re working with private money lenders.  If you’re a rehabber or buy and hold investor, I strongly recommend making it a goal to work on securing them!

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

Working with Private Money Lenders: Possible Loan Term Options

One of my favorite conversations is with real estate investors sportin’ lots of capital who insist on paying cash for investment properties. They’re almost universally flabbergasted when I tell them they can do better in today’s environment by using a bit of leverage. When they ask me to prove it, I begin by asking them a couple questions.

Is the cash on cash return of their acquisitions important to them?

Are they investing so they’ll have future retirement income?

If their answer is yes to both, I then proceed to demonstrate — empirically — exactly how the ‘always pay cash’ strategy will sometimes produce significantly inferior results. Let’s be clear about how we’re defining results here.

The successful attainment of maximum retirement income through a strategy created to use the finite capital immediately available at any given time.

An investor has half a million bucks to invest with the above mentioned agenda in mind. His plan is to retire in 15 years — at which time he’ll be 65 years old. He finds a couple duplexes for $250,000 apiece. They’ll generate roughly $36,000 a year in income. (For the purpose of this post, we’ll use just the purchase price without closing costs to keep things simple.) They’re well located, new or newer, and have a strong demonstrated track record attracting quality tenants.

He’s excited. I tell him to look at what’s possible if he were to use a slightly different strategy. Rolling his eyes, he agrees. What could possibly beat the return provided by paying cash?

Let’s establish his cash on cash return generated by his all cash approach.

That return is calculated simply — divide cash flow by cash invested. In this example it’s $36,000/$500,000 = 7.2% — pretty straightforward.

But what if he puts 1/3 down payments on six of these duplexes? Today’s available financing allows him to obtain 30 year fixed rate loans sporting 5% interest. Let’s see what his cash on cash return would be.

$43,580/$500,000 = 8.7% cash on cash return. Don’t miss the fact that the cash flow in dollars has increased by $7,580 annually — a 21% increase in cash flow from Day 1.

He’s not rolling his eyes any more.

By using what I’ve come to call the Domino Approach, he’ll have used the cash flow from all properties to pay off one duplex at a time. It’ll take almost 3.5 years to free and clear the first property, but then he begins realizing the immediately increased cash flow and the velocity increases as each domino falls.

In less than 13 years — 12 years, eight months — he’ll be the proud owner of half a dozen debt free income properties. They’ll be spinning off about $108,000 in annual retirement income — well over two years before his scheduled retirement.

He’s also retiring with triple the income his plan would’ve produced.

I pointed out that in the process his actual cash flow and cash on cash return were much higher than if he’d applied his approach — from beginning to end.

It’s important to note that the NOI (net operating income) and the property values were not projected to increase — ever. Yet, look what also happened to his capital growth rate — then compare it to how his capital would have grow in his ‘all cash’ scenario.

In Year-0 he invested $500,000. 12.67 years later his equity was $1.5 Million. His capital growth rate was just under 9% (8.96%) Again, no appreciation was applied.

His way?

Year-0 — the same $500,000 invested. 12.67 years later his equity is the same $500,000. He literally has no capital growth. In fact, it can be credibly argued he lost money due to inflation.

Forget cash on cash — forget capital growth — just concentrate on the difference in retirement income he generates from each of the two strategies.

$36,000 as a result of paying all cash — $108,000 as a result of using moderate leverage.

It’s at this point I ask them to put me on speaker, and stand up. Then I tell ‘em to extend their arms straight out, palms up, as if they were weighing different objects in each hand. Then to move each hand slightly up and down, as if determining which object is heavier. When they tell me they’re doing that, I recite the following, not making any effort to hide my glee.

“I dunno, $36,000…..$108,000 — which one do I want? That’s a poser.”

I won’t repeat what many of ‘em reply to that.

BawldGuy Takeaway: When it’s possible to make use of positive leverage, i.e., the cost of borrowed money is less than your investment’s return, paying all cash is the inferior strategy. This is true for cash flow, cash on cash return, and the ultimate cash flow generated long term.

Paying cash for income property isn’t the slam dunk no-brainer so many folks think it is. Sadly, most of ‘em won’t figure this out ’till they retire — if ever.

The most underrated task in the investment world is solid analysis. You can pay for it before you invest– or pay for it afterward, which will be the rest of your life.

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

Buying Properties For Cash Can Be BIG Mistake – A Hugely Expensive Mistake

It seems that the recent financial meltdown and lack of financing has invigorated hucksters and those pushing “new” financial products.  I have seen a spate of posts about supposedly innovative financial products for simplistic funding needs.  Fully 40% of every dollar of profit in our country was made on financial products at the height of the mania so I am rather skeptical when I see posts that claim patents and use abstruse commentary to describe their merits.  The recent posts have had these common themes:

1. The poster doesn’t understand the product and pounds marketing half-truths
2. Monies are exchanged outside of a title company and closing.  This is a BIG no-no
3. Fees are charged to evaluate things instead of based on performance or success
4. The schemes are generally elaborate
5. Official government names are used that are really guised LLCs

One of my favorite commentators online is Dr. Jack Guttentag, The Mortgage Professor.  Many of his pieces speak about his consistent amazement about people’s belief in what he calls a “Good Fairy” that will solve their financial troubles.  This belief sustains the business of financial hucksters and what a business it is!  Playing on people’s greed and lack of responsibility will always be profitable. 

People seem to have an inherent belief that the path to success is to discover some secret product that suddenly catapults them to the height of success.  While innovation and sound business models are good ingredients to success, many of the successful people I know are just good old-fashioned hard workers with above average investing skills.  One of the beliefs that I have found is common for these folks is that innovative products are met with skepticism. 

My advice to anyone considering one of these programs is to double your money by folding it over and putting it back in your pocket.  Get some ultra-cheap 30-year debt, put some money down, and move on with life.  If you want to get cheaper debt put more money down and improve the lender’s security interest.  If you want to pay the mortgage off early pay more money each month.  If you want to reduce interest rate risk get a fixed-rate mortgage.  You get the idea.  This stuff has been done forever and is tried and true.  Instead of figuring out how to game the system get busy working and making money!

Photo: Alicia Nijdam

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

Charming the Den of Snakes – Where Have the Honest Financial Products Gone?

This week I met with one of my commercial lenders, whom I will refer to as Barry, for lunch.   Barry thought I might be interested in some of the business banking options his bank could offer my law firm.  Essentially, Barry was prospecting for additional banking business.  The services and fees he offered sounded very appealing but I had to ask “would his bank call in a loan if the borrower is current on his payments.” I could tell from the look on his face that this question came from left field.  So I repeated my inquiry by asking why a bank would foreclose on a property if the borrower were performing on his obligations under the note.  Isn’t this considered a “good loan” versus all of those non-performing loans banks keep crying about?  Barry told me it’s “complicated.”  Actually it’s not if you understand what is taking place behind the scenes and why you need to be concerned. 

In today’s crazy lending world anything can happen and does which, for the unwary, can have devastating financial ramifications.  Within the past year I have had several business clients lose their property or end up in litigation with commercial lenders over their “performing” loans.  Typically the scenario centers on construction loans, income producing commercial property or multi family apartment buildings.  In every situation brought to my attention, my client was current on his loan, never missed or been late on a payment, and generally working fives times harder to produce income in a difficult environment.  Then without so much as phone call one of two scenarios occurs:

• Monies on deposit with the lender are suddenly and without notice removed from the borrower’s account(s) (both business and personal); or
• The bank sends the borrower a letter informing him the bank will not renew the loan (remember these are typically 5 year balloon notes) and or may call it into default.

If you eyes are bulging out of your head as your reading this let me tell you it can happen to you at any time.  Why – because it all has to do with the federal regulators and auditors definition of a “performing loan.”

Being current on your payments is only one facet of a performing loan the other is adequate security!

As many of you know commercial loans typically require 20% to 30% down and additional security (this has to do with the property’s general liquidity versus residential property.)  When values decline the commercial loans become less secure and the banks are forced to bring these loans back into line despite the payment history by the borrower.  To meet the regulator’s security guidelines banks can take your deposits (you grant your lender in the loan agreement the right to these deposits as security for your loan) and/or force you to bring additional collateral to the table.  If you cannot meet the banks demands, then unless you can find other financing, your loan will be reclassified as a non-performing loan and subject to foreclosure.

To protect yourself I recommend you never keep personal or business accounts with any bank where you have a commercial loan, do not allow the LLC that holds your commercial property to build up cash reserves, and protect all of your investments with LLCs.

P.S. – Barry told me his bank has never done any of the above but he did concede that federal regulators could force his bank to take similar action.

Photo: Sookie

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

How Does Your Bank Define “Performing Loan”?

As a real estate investor it is critical that you have access to readily available capital in order to capitalize on the numerous opportunities that are present in today’s market. One way to do this is by acquiring properties through syndication.

Real Estate Syndication is simply the pooling of funds from numerous investors and channeling those funds into real estate projects. These funds can be used to acquire a property in its entirety, or these funds can be used as an equity contribution to the project in addition to a commercial mortgage, which would fund the majority of the project’s costs.

As a real estate investor, especially as a commercial real estate investor, you should constantly be looking for ways to syndicate real estate opportunities. By successfully syndicating real estate deals, you will be able to acquire more property and profit in numerous ways.

Here are the 3 Ways You Can Profit from Real Estate Syndication

1.) Acquisition Fees – As a syndicator of real estate you will typically receive compensation for finding the property, conducting due diligence, and structuring the deal. Acquisition fees can range anywhere from 1% – 5% of the acquisition costs, or it can be a flat fee (i.e. $25,000). These fees are generally negotiable with the other investors that you bring into the deal. If your fees are too high, other investors might be leery to invest with you, however, finding and structuring deals can be a tedious task, so make sure your are compensated for your time and effort.

2.) Asset Management Fees – Another way to profit from real estate syndication is to receive an asset management fee. This fee, generally 1% of gross revenue, is typically paid to you as the syndicator of the project because it will be your responsibility to manage not only the property but the syndicate partnership as well.

You will have to constantly ensure that the property is being managed and operated efficiently by communicating regularly with the property manager. If the property is under going renovations, it will be your job to ensure that the renovations are completed on-time and hopefully under budget.

In addition to managing the investment, you will also be responsible for managing the syndicate. This duty will require that your investors are communicated with on the regular basis in regards to their investment and ensuring that they receive their compensation on a regular basis i.e. monthly, quarterly, or whatever time period that was agreed upon.

3.) Equity Participation (Cash Flow & Appreciation) – Finally, you will be compensated through your equity participation in the project. Your equity stake in the project could range anywhere from 5% – 50% depending upon your experience and the details of the deal. Normally, your investors will receive a preferred rate of return ranging from 8% – 12% or higher, on their invested capital first, then the remaining cash flow and/or equity will be split between you and your investors at whatever percentage that was agreed upon.

For example:

Let’s say that you and a group of investors acquire a building for $1,000, 000 – all cash, no mortgage. Your investors put up the entire amount, which included your acquisition fee. After all of the expenses have been paid including your asset management fee, the property generated $120,000 a year in profit. Your investors would generally be entitled to a preferred interest payment first. Let’s assume that it is a preferred interest rate of 8%. That means that your investors would get $80,000 in interest first out of that $120,000 profit (8% of $1M). The remaining $40,000 would be split between you and your investors at whatever percentage you previously agreed upon. That could be a 50% – 50% split or it could be a 75% – 25% split with your investors getting the larger portion.

So, with an 8% preferred rate of return and a 50% –50% split, your investors would have made $80k in interest and another $20k from its equity participation in the cash flow from the property. This would equate to a 10% cash-on-cash return for them, PLUS, they would still have an equity percentage in the appreciation of the property, so there is still an opportunity for them to make more money on the back end, once the property is refinanced or sold.

As the syndicator, you were able to participate in a deal with little money out of your own pocket and you will have been paid through an acquisition fee, asset management fee, and an additional $20k in cash flow. PLUS, you will still have a 50% stake in any future equity appreciation in the property.

Overall, this would be a win-win situation for all of the parties involved and would lay the foundation for syndicating additional deals in the future.

Hopefully, this article was helpful and provided you with more insight on how you can profit from syndicating real estate. If you have any questions, we can carry the conversation over into the comments below so please let me know your thoughts and comment below.

Comments are always welcomed and encouraged! Let me know your thoughts below in the comment section and feel free to retweet this post on Twitter or share on Facebook.

Photo: Osvaldo Zoom

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

Real Estate Syndication: 3 Ways You Can Profit

As my husband and I began focusing on finding private money lenders to fund our rental property acquisitions and speaking with these potential lenders about the benefits of using IRA funds, it became evident that this was something we’d want to do personally as part of our own retirement planning. Not only does it allow us to make a solid return on our investment to grow our retirement account, but it also gives us an opportunity to create mutually beneficial partnerships with other investors. I’m not a tax professional or an accountant, but I thought it would be helpful to give food for thought for others who may benefit.

What is a self-directed IRA?

Self-directed IRAs are very similar to the standard IRAs which you are likely familiar with. The key difference with a self-directed IRA retirement account is that you have more flexibility in terms of your investment options. Instead of being limited to mutual funds, stocks, bonds, and CDs, you also have the ability to invest in real estate, notes, tax lien certificates, private placements, and more. I personally find this to be a very attractive option because it allows me to invest in things I have more knowledge, experience, and influence with.

There are a number options available to you and you’ll want to do your research and consult with your financial professionals to determine what’s best for you. Here’s a quick rundown:

Traditional Self-Directed IRA:
With the traditional IRA, you may be able to receive tax breaks today and your contributions will grow tax-deferred. When you take withdrawals at retirement, you will be taxed on them.

Roth Self-Directed IRA:
With the Roth, you won’t get tax breaks today, but your contributions will grow tax-deferred and can be taken out completely tax-free.

Self-directed IRA LLC:
These are also known as “checkbook” IRAs because you can write a check right there on the spot for your investments. Depending on the kind of investments you’re doing, being able to move within seconds instead of a few days can be incredibly useful.

I personally chose to take my 401(K) from a previous employer and convert it to a self-directed Roth IRA to invest in real estate and potentially tax lien certificates in the future. Every individual’s situation is different so you will really want to see what works best for your financial scenario. One of the best parts of having this self-directed IRA account is the fact that I have a much better level of confidence in my investments because I’m able to choose exactly who I want to lend to and have a clear view of that investor’s experience.

There are unlimited lending options available to you. There are so many investors who have outstanding investment opportunities, but are simply in need of private money lenders because its increasingly difficult to get bank financing. Networking with other investors nationally online (for example, right here on BiggerPockets) and locally offline (via meetups, REIA meetings, etc) will provide you with great lending opportunities. There are also a number of custodians you can work with for your self-directed IRA. I work with Equity Trust because they were highly recommended to me, but there are plenty of other options as well. A quick search on “self-directed IRA” will yield you with several options to research!

Would love to hear about others’ experiences with using self-directed IRAs or 401(k)s to build wealth and fund retirement years!

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

Self-directed IRAs: A Great Way To Retire via Real Estate Investing