Due Diligence on a PML Deal

[Joshua Strohschein]

Hello BP,

I met someone at a REI meetup who is raising capital for an investor who does a large number of flips and buy holds around the country. The investor is knownish in the Pace Morby community and has an account here. Not naming as not sure if that breaks any rules. I've never lent before and am asking around first.

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The Deals:

Lending for closing costs and other fees

Minimum 10k

Interest is paid back to PML after 2 weeks at closing

Principle returned at 6 months

25% interest

They walk the property with two different contractors to estimate repair costs

We get photos, numbers, and address to pick which house to lend on

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Here are the protections they listed:

Promissory note

Personal guarantee

PMLs are added to the Operating agreement of the LLC that is purchasing the property - this is an equity interest in the LLC (in direct correlation to % of capital contributed to the deal). Once the property is sold, then the PML is removed from the LLC. (Note: we don't do this one for buy and holds because we are holding the property indefinitely.

Second Lien Position secured against the Deed of trust (I am aware of the difference between 1st and 2nd)

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Due Diligence I've Done/Doing:

Searched investor's name on Pacer.gov (No results)

Searched online for reviews or known lawsuits (nothing solid and no patterns of complaints)

Showed deal to other investors/lenders (general feedback is that it's higher risk but may be worth testing)

Asking for explanation of numbers. (Do the numbers make sense for all parties?)

Met local investor who has successfully lent with this investor.

Will personally interview investor on a call.

Reviewed provided settlement statements and deals they've closed. (If accurate, people are getting paid and deals are being closed)

Their (3rd party) capital raiser verbally stated they've observed PMLs being paid back.

For each property I will try to run my own comps and see if their math checks out. (What is that local market like, will property sell etc)

I would start with the minimum 10k to see how it goes first. While not insignificant, it won't impact me in a meaningful way if lost.

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Questions:

Does this scream run-away to anyone?

Are there any special legal considerations to lending that I'm not aware of? 

Will my bank give me problems with this kind of thing?

Should I do this through an LLC of my own?

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Thank you for your time.

*edit: formatting issues

[Jeff S.]

You’re being blinded by the promised interest rate, @Joshua Strohschein, and your list of protections requires further investigation and significantly more paperwork. Sorry, but paperwork is what protects you. Welcome to lending.

A personal guarantee is not worth the paper it’s printed on without substantial assets backing it up (and your willingness and wherewithal to obtain a judgment, as mentioned). You need a loan application from your borrower. Here, they declare their assets and liabilities, banking info, and SSN.

A bank statement will confirm where they bank. The value of this account is irrelevant. You want the bank name on a bank document.

The notary who stamps the deed of trust should also send you a copy of your borrower’s driver’s license. Do not accept this from your borrower.

In addition, since your borrower claims substantial deals around the country, he or she should easily be able to provide both purchase and sale closing statements to prove this. All of the above can form the basis for your interview with this investor. We prefer going to lunch. Make sure you prepare a list of questions.

Not mentioned in your list is being named on the borrower’s property insurance as a mortgagee and having them obtain a lender’s title policy for you. Title will (better) record your deed of trust and should provide you with a preliminary report, which you will have to read. These can be daunting, especially the exceptions. I’ve read many and still occasionally need the help of a lawyer. In addition, do you know what title endorsements you want? No? Lawyer time.

Title will also need lender’s instructions, which will define your insurance requirements and lots more, but most importantly, it will specify your loan position. In this case, you claim you will be in second position. Some nefarious borrowers stack many small liens up at once, and you could unknowingly be recorded in fifth position. Protect yourself. (I’m a fan of fractionalized loans, but that’s another topic.)

Last—and these should be first—a 25% annualized loan is almost certainly usurious. Unless you have an exclusion of some sort in your state, your loan could be illegal and easily contested. Similarly, make sure you obtain hand-written documentation from your borrower explaining the use of the money and confirm that this use is for a business purpose. Claiming a legitimate business-purpose loan was really for a consumer-purpose is currently the most popular lawsuit in private lending.

None of this is worth the whopping $1,250 you will make on a $10k loan at 25% over 6 months—and that’s before taxes—but this is up to you, Joshua.