One of the worst kinds of sub-prime loans was the infamous “pick-a-pay” (Payment Option ARM) under which borrowers had the choice of how much payment to make each month, with the lowest options being negatively amortized, i.e., reducing the equity in a property every month. These loans took the concept of house-as-piggy-bank to another level entirely. Human nature being what it is, the majority of borrowers took the easy way out and opted for the lowest payments they could make as long as they could get away with it. Sooner or later, of course, they have to pay the piper – these loans typically only permit the minimum payment for a limited period of time (such as five years) or when a specific level of negative equity is reached (110%-125%). After that, the real pain begins. Of course, once the financial crisis came along these loans were revealed to be particularly toxic – and borrowers started to default in droves, especially once the lowest-payment option period had been used up.

Many banks simply foreclosed. Others, such as Wells Fargo, have taken a different route. Wells Fargo, according to the Wall Street Journal, has converted thousands of such loans to interest-only loans, and, at least in some cases, have reduced the principal balance. Though derided as “extend and pretend” (that the borrowers won’t ultimately default), Wells’ move seems laudable to the extent that it can keep homeowners in their homes and reduce the number of foreclosures in the near future, which drag down the prices of other properties like a dog chasing its own tail.

However, a dose of reality is probably warranted. By now, as everyone realizes, the government loan modification program has turned out to be a spectacular failure. First, it has done nothing or virtually nothing to help out in many of the hardest hit areas, as people were too far underwater to qualify. Worse, perhaps, even those loans that got modified are defaulting at high rates: within six months after modification, almost a quarter of the mortgages that had monthly payments reduced by 20 percent or more were 60 or more days past due according to the Office of Thrift Supervision.

Either Wells Fargo is making an extremely smart business decision; or they are chumps. Time will tell how many Wells former pick-a-pay customers will fold their cards and walk away from the table before the real estate market has recovered.

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

The Interest-Only Loan “Extend and Pretend” Strategy

One study of mortgages during the Great Depression found that almost half of urban, owner-occupied homes (on which there was a mortgage) were in default by 1934. The government’s answer was to sponsor the creation of Fannie Mae in 1938 (or as it is really called, the Federal National Mortgage Association), which was, and still is, a private company, notwithstanding the government sponsorship and the official-sounding name. Fannie Mae has made billions by buying or guarantying mortgages issued to homebuyers — and there has long been an “implicit” government backstop behind Fannie Mae, since virtually everyone believes that the U.S. government would feel compelled to bail out Fannie Mae if it could not survive on its own. (Indeed, the company enjoys multi-billion dollar credit privileges with the U.S. Treasury.)

Fast forward to 2009: a year after the federal government imposed a conservatorship over Fannie Mae (and its sister company clone, Freddie Mac), the lending giants are again in the cross-hairs. Due to the lending crisis, the importance of these two companies has become greatly exaggerated in the recent past — since they provide (or guarantee) mortgages for up to 90% of the market, every aspect of their practices has a ripple effect. Thus, we should all be concerned to learn that, not only are their default rates increasing (remember–the taxpayers may eventually be required to make good these losses), but, at the same time, the companies have tightened standards to a point where they may be a factor in killing off what remains of the real estate market.

Many changes to their underwriting standards have been made, but at least two stand out. One is the “70%” rule — Fannie Mae simply won’t back a mortgage in a condo building where less than 70% of the units have been sold. This creates a chicken-and-egg Catch-22 for developers. Outside of Fannie Mae’s limits, virtually no lenders are willing to go — so what do you do if you have a new building that is just now coming online and need to unload the units? The answer up until recently has been seller financing (if possible, and it is increasingly less so as cash and credit evaporate) or cut prices to a level where cash buyers can step in. (This has apparently already happened in Miami– according to a recent piece on NPR, where condo prices have been slashed below $200 per square foot they have been attracting hordes of cash buyers from South America, since that makes a Miami condo cheaper than one in Bogota or Caracas!)

The other rule also has a broad impact, this time on existing condo buildings.

Fannie Mae will no longer provide a loan guaranty if more than 15% of owners are behind on their homeowners association assessments. In normal times, that does not sound so bad. These are not normal times. This lending guideline means the minute a building his the 15% tipping point, no one can sell to a buyer who needs a Fannie Mae/Freddie Mac (a.k.a. conventional) loans. The terms on non-conventional loans can be staggeringly more expensive, if the loan can be had at all — and fixed rates for non Fannie loans are apparently in particularly short supply.

What’s the practical effect of this?

As any real estate agent will tell you, the value of your property is markedly lowered by the reduced financing opportunities because it kills the affordability — which is a key to the real estate recovery. Thus, neighbors who are in financial trouble stop paying assessments (and, ultimately, their mortgages in many cases) and end up beggaring their condo neighbors in a double whammy — first by the reduced market value caused by adding a foreclosure to the marketplace, and second, by preventing potential condo buyers from getting a conventional loan, once the 15% delinquency tipping point is reached in the same complex. The price-chilling effect of hitting the 15% limit can’t be underestimated, and there is hardly a complex in the country that is immune from such a possibility. In fact, the very chance that virtually any complex could eventually hit the limit may make buyers afraid to buy any condo if they are relying on being able to get long term fixed rate financing at a reasonable price.

Commentators are calling for the government to pull out of Fannie Mae/Freddie Mac. One can only hope that, should this happen, there will be some source of reasonably priced financing available to home buyers. If not, the (golden) goose may be cooked.

Photo Credit: John Picken

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

Is Fannie Mae Killing the Golden Goose?

One of the great advantages of buying mobile home parks is the ready supply of seller financing. No other form of real estate investment offers as much seller carry, and at as favorable terms — with most of these loans being non-recourse and at below-market interest rates.

So how do you get a seller to finance the mobile home park?

One of the first strategies is to “bond” with the seller. A seller will not offer financing if he is not comfortable with the buyer and their ability to make a success of the park. If they are not feeling good about the buyer, then how can they lock up their investment and their future with them? Clearly, before there can be seller financing, there has to be a period in which the seller gets to know the buyer and develops confidence in their abilities.

This is called “bonding”. To bond with the seller, you have to spend quality time with them. Meet with them and talk about mutual goals and strategies, or maybe take them to lunch or dinner. If done properly, the seller comes away from the meeting with not only the desire to work with the buyer, but also, many times, to “help them”. “Helping them” may include a lower down-payment, or more attractive loan terms — sometimes even a reduced price!

How Seller Financing Will Benefit the Seller

After you have bonded with the seller, you need to learn how seller financing is a win/win solution for the seller — because it really is. Here’s why. If the seller takes all cash for the deal, he will pay income tax and then receive maybe 2% in interest on the money. If he carries the paper, he receives better tax treatment [ask your CPA] and gets 6% interest — fully three times more in income. I have had sellers who did not realize this benefit until the end of the deal, and then suddenly offer to carry the paper. The only times a seller is worse off carrying paper is if the buyer does a lousy job of running the park and drives it into the ground. You must let the seller know that you are not that person.

Finally, you have to ask for it. Many sellers have the ability to carry financing, but the buyer is too afraid to ask for it, because they think it makes them look like they are poorly capitalized. You have to understand that you are actually doing the seller a favor by pointing out this great way to effectively double or triple their income. Offering this is nothing to be ashamed of. Most of the biggest names in the mobile home park business pitch sellers on the benefits of carrying paper constantly.

There is nothing better than getting the seller to carry a 90% mortgage, non-recourse, for 25 years. And you can do that too, if you only follow these tips.

Photo Credit: Martin Pettitt

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

How to Get Seller Financing for a Mobile Home Park

Finding financing is one of the biggest challenges for most real estate investors.  I previously wrote How to Generate Private Money, where I broke this process into six steps; here I will break down the 5th and 6th steps (See: Steps 1-2, Steps 3-4) of dealing with private lenders.

Step 5:  Handle objections, ask for referrals

Goal:  Overcome objections to optimize success and get referrals

Solution:  Anticipate objections and have a solution to handle them.  You will find that the same 2 or 3 objections come up 75% of the time and you have to be able to handle them.  Common objections are: What if the deal flops, how is my investment secured, what is in it for me, why real estate, etc.

Solution 2:  Always ask for referrals.  If they do not invest, ask them who they know that would be interested in your opportunity.  Just simply ask, “Do you know anyone else who would be interested in a great return on their money?”

Do’s and Don’ts:  If they give you an objection you cannot handle, do not stumble around.  Simply tell them you do not have an answer but you will get back to them on that.  Then ask them if that is the only thing holding them back from moving forward.  Thus, you are getting them to say Yes, if you can handle that objection. 

Step 6:  Treat them like your grandmother

Goal:  Get them to like and trust you.

Solution:  Pay on time, give them first chance to invest in a new opportunity, & tell them you do not offer this to everyone.  Give them periodic updates on the property so they stay comfortable.  It is also a great way to ask for referrals and get them to invest more. 

Do’s and Don’ts:  Continue to have contact with them.  Do not wait 6 or even 3 months in between communications.  Drop them an email or call just to see how they are doing.  This is about trust so show them some respect and a little love every once in awhile.

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

How to Generate Private Money, Steps 5 & 6 of 6

Finding financing is the biggest challenge for most investors.  I previously wrote How to Generate Private Money, listing the 6 steps in brief.  Over my next few posts I will break down each of these steps in detail; I will cover steps 3 & 4 today.

Step 3:  Find a great deal, illustrate a win-win, the deal and the risk

Goal:  Inform the potential investor about the deal, the risk and the opportunity

Solution:  Show some pictures, pro-forma, details on the property, what it will take to complete the project, exit strategies, length of time to complete, detail the risks and what’s in it for the investor.

Do’s and Don’ts:  Do not give best case scenario numbers.  Be realistic and set expectations that you can shatter.  Make it simple and easy to understand. If possible, reference similar successful deals.

Step 4:  Play the numbers game, all you need is one YES

Goal:  Get as many potential investors as you can to fight over funding your deals.

Solution:  Let as many investors as you can know what you do.  Network at REI Clubs, investment and professional groups.  Talk to everyone you know.  Get involved on online forums and social media.

Solution 2:  Market a professional website and give out free information.  With good content and useful information, you will build credibility and investors will come to you.

Do’s and Don’ts:  Do not stop once you get one or a few investors.  When you begin discussions with a prospect, get out there and find 10 more prospects.  You can never have enough private money.  Always follow SEC rules and remember, you are not asking for money you are offering the opportunity for investors to make a great return on their money.

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

How to Generate Private Money: Steps 3 & 4 of 6

Finding financing is the biggest challenge for most investors.  I previously wrote How to Generate Private Money, listing the 6 steps in brief.  Over my next few posts I will break down each of these steps in detail; we’ll start with the 1st and 2nd steps today.

Step 1:  Pitch your opportunity to everyone

Goal:  Get face to face meetings, get referrals, lots of them!! 

Solution:  Use an effective elevator speech, get prospects salivating to learn more and get the meeting.  Always ask for referrals. 

Solution 2:  Give out free quality information.  Giving out free information via articles, seminars, conference calls, webinars, etc is a great idea as it will build credibility, people will come to you and it makes it much easier to build trust.  Set up the meeting and ask for referrals.

Elevator Speech:  An elevator speech is simply a 15-30 second speech that tells what you do, what is in it for an investor and gets them salivating to learn more or refer others who might be interested.  You want them to ask questions, but do not under any circumstance answer them. 

Example:  I am Real Estate Investor.  We buy, lease and sell investment real estate and provide investment opportunities to the right people.  Typically these people have some knowledge or comfort in real estate but hate the thought of owning and dealing with the hassles of managing property.  We provide investment solutions to individuals who want to make good returns backed by real estate without the hassles.  Does that all make sense to you?  (Based on their response, ask for the meeting and referrals)

How to Ask for the meeting and referrals:  If they seem disinterested, simply say “I’m not sure if this is for you, but who do you know that would be interested?”  If they are interested, they will say me, otherwise they may give you some referrals.  If they ask questions, do not answer them under any circumstance.  Tell them “That is a great question, but there is much more to it.  Why don’t we sit down and I will go through it with you?”  If they hesitate, immediately say, “No pressure, it is not for everyone.  Who do you know that would be interested?”  If they are blown away and salivating, set up the meeting and ask them who they know that would be interested.  Do not push or act desperate.  Act confident, act like you do not need them to invest, act like your investment opportunities are the best thing since sliced bread.  It never hurts to have a fun success story about the guy who passed on a deal but another investor jumped all over it and is now laughing all the way to the bank.

Step 2:  The Face to Face Presentation

Goal:  Build trust, credibility and get them to like you.

Solution:  Give a presentation.  Be on time, professional and respect their time.  Small talk for a few minutes getting to know them, find similar interests, compliment them where appropriate.  Ask about their investing experience and almost qualify them.  Then get into your presentation:  who you are, what you do, what is in it for them and details of the opportunity.  You can find example presentation all over the internet, customize your own and make it simple and easily understood.

Solution 2:  Use a credibility kit to show a track record of successful past deals.  That will show that you have experience, expertise and will build trust that you will be successful in future deals.  Give them a credibility kit to take with them.

Solution 3:  Seminars, Webinars, Conference Calls, even online or youtube video presentations.

Do’s and Don’ts:  Make sure all decision makers are present.  Do not act desperate.  Act like you have a ton of investors, you don’t need their money and it is the investment opportunity of a lifetime without being overly cocky of course.  Do not ask them for money, rather offer them the opportunity to make a great return on their money.  Always ask for referrals.  Finally, always always always make sure you are following SEC rules.

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

How to Generate Private Money: Steps 1 & 2 of 6

Let’s face it, money does not disappear, it changes hands.  So where is it?  There is so much money sitting on the sidelines or in investments making little or negative returns.  Many of these individuals would love to have a double digit return backed by real estate.  

For many investors, financing deals is the challenge.  Here are some steps to get more Private Money then you could ever need.

1. Pitch your opportunity to everyone – You are not asking for money, you are inviting people to make a great return on their money. The purpose of this step is to get them excited and begging for more information.  Usually just an elevator speech and a success story if needed.  Do not answer questions, set up a face to face meeting and present your program. Opportunity awaits the savvy investor.  Many investors give out free information.  If you can build credibility and get investors to come to you, even better!!
2. Face to Face Presentation – Set up a face to face meeting with all decision makers.  At this meeting you can build the most important thing when it comes to generating private money, build TRUST.  You can also present using a net meeting if face to face is not possible.  Try Yugma, free software allowing you to share your computer screen.
3. Find a great deal, illustrate a win-win, the deal and the risk – Educate interested parties on what is in it for them, the numbers on the deal and how the deal can withstand the worst case scenarios.  The best private investors have some knowledge or experience in real estate, are comfortable with an investment backed by real estate, know a good deal when they see one, but do not have time or do not want to deal with the hassles.
4. Play the numbers, all you need is one YES - Do not give up after 3 people, you may need to present it to 100 people before you get the desired results.  It is never a bad thing to have people fighting to give you their money.  Group presentations can work as well.
5. Handle objections, ask for referrals – Learn how to handle objections, anticipate the most common ones.  And always ask for referrals. If you are leaving a presentation without a YES you should have 3 referrals.
6. Treat them like your grandmother – Be great to them, not good, great.  Also be completely honest and set expectations so you can shatter them.

Whether you are starting out or a savvy investor with decades of experience, private money can take your business to the next level.  No down deals, close fast with cash, no hassles with brutal conventional or hard money requirements and underwriting, you set the terms, the advantages go on and on.  One last tip to make sure your private investor is committed, make them cover the earnest money, inspection and other fees before close.  If they are not willing to cover those fees, they are not committed and will not fund at close anyways.  Happy Investing!!

9/15/09 Update: Please note that we’ve dedicated a series of posts to the six points above. Here’s the rest: How to Generate Private Money: Steps 1 & 2, Steps 3 & 4, Steps 5 & 6

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

How to Generate Private Money for Real Estate