I am private lender on a rehab property that is not selling.

20 Replies

I have loaned (2nd position) to a flipper using my SDIRA. A hard money lender was utilized for the 1st position loan. The property was purchased around mid-August 2018 and placed on the market in November 2018. It is beautifully remodeled, however, as of July 1, 2019, it still sits unsold.

The price has been dropped about $21,000 and is probably priced a little more than break-even (margins reduced by the interest paid to the 1st position lender the past nearly 11 months). The flipper only has $5,000 invested in the property. Any further reduction in the asking price and I will start losing my investment.

I am seeking advice on what should do next. The maturity date on my SDIRA loan has pasted (I have set an April 30, 2019 maturity date). The 1st position loan is due in one year. My private loan is secured by a promissory note and recorded Deed of Trust.

Your feedback is greatly appreciated. 

What is the due date of your second lien position note - if it has past then foreclose on him. - NOW!

Do not delay (unless you have to bey operation of law, i.e. Bankruptcy) !

Good luck 

Steve

Hey @David Espana , I have had loans that I owe go over the maturity date, but not because of the property not selling(contractors slow, city not cooperative, etc). I have always been in constant contact with my lenders. If it is getting close to the maturity date and more in contact if we are past the date.

You may have to have "The Talk" with your mortgagee that you need to get paid off immediately or you have to do things to protect your interest(i.e. foreclosure).

I would make that decision pretty quick. In Texas foreclosure is fast, but not so swift in other states. Do what you need to do, but do it NOW. 

@David Espana

I don’t see what advantage foreclosing would be, but the legal fees required would only add to any loss. Assuming that the owner is doing everything he can to sell the property, their would be not advantage to foreclosing.

If you were to obtain ownership of the property with the intent to keep as a rental, you would need to refinance.

Quite frankly, you invested in the very riskiest part of the deal. You provided the equity portion (on a debt basis) of a non stabilized property with the hurdle of having to overcome rehab cost over runs, interest at hard money rates, brokerage fees, sellers closing costs, etc before you get your money back. Often these type of deals go south. Experienced investors would only do this type of investment for a 25% plus annualized return, with the understanding that capital is at risk. Most deals wouldn’t be able to pay the first lien at hard money rates, plus the equity portion at investor rates, and still be profitable. In fact, the most successful fix in flippers utilize only their own capital; the less successful utilize hard money with their own capital as equity; by the time you get to the guys that need 97% financing your dealing with questionable flippers without a verifiable track record, so a loss is always a possibility.

I assume you don't have a personal guarantee? If not, what is the LTV of the 1st mortgage not including your lien? It may make sense to ask the seller to give you the deed in lieu of foreclosing and to refinance into a longer term loan once the property is rented. I know the original plan was not to be a landlord, but I have found that time fixes a lot of issues in real estate and waiting 5 or so years for the market to appreciate may allow you to avoid a loss while paying down some of that 1st in the interim. There are only two banks in the country that I know of that will lend to a SDIRA, so it probably makes sense to run through the scenario before executing.

@David Espana reading your post brought me back to 2017 where I was in your exact position that you described. I was in second position on 2 different properties (one in Phoenix and the other in Scottsdale, AZ). The more experienced rehabber also didn’t have much money in the deal and I had about 250k between the 2 properties. After only a few lowball offers on one and only one showing on the other one in an 8 month period of time, I asked him directly if I would be losing any money on the deals and he said that it looked like I might.  

At that point I went to one of my hard money lenders who has been a mentor to me and I asked him for his help and advice. He told me to set up a meeting between the rehabber and him and to go to my title company and get a quit claim deed written up for each property.

At the meeting, my experienced hard money lender asked they guy if there was any profit left in the deals for him and he said no (mind you when he took my money to buy the properties he used his real estate license and acted as the buyers agent and took 10k of my money on each deal as a commission for himself even though they were wholesale deals and he was the investor - I didn’t find out about this until afterwards). So my hard money lender told him to sign the quit claim deeds and he would pay off his hard money loans for each of the properties and take them over for me to take care of and sell.

He signed the quit claim deeds and then left. About 20 minutes later he called and said that he regretted signing them and that he had some money into them too because of the added carrying costs and such. He said that he had about 5-10k into them between the two.  I reminded him that he had already gotten paid 20k in commissions and that I would likely be losing money on the deals. He said that that 20k was his commissions and that was what he used to eat and that me losing money was the risk I take with investing. Then I asked how much money he was comfortable with me losing before he lost any money on the deals. He had a hard time answering that question. Then I told him that if I was made whole that I would make sure he was made whole before any profits were divided (of course, according to the numbers, I knew that I would be taking a loss).

I had my contractor go and make additional repairs on the properties (the ceiling was coming down in one of them and the curb appeal was awful on the other one). Then I dropped the prices to market value and my buddy was willing to sell them for me and only take a .5% commission on them and my contractor charged me minimally for the added work I needed to do to get them repaired well enough to sell. Then I had to put in another 10k into redoing the plumbing that was found to be bad during the buyers inspection.

All in all, I ended up losing 70k between both properties. But that was better than the rehabbers plan of just sticking to the sales price or lowering the price a little at a time and hoping the market goes up and then selling them hopefully before the hard money loan ate up all of my money. 

David, I’m not sure how much money you have into the property but you might consider doing a quit claim deed and having the rehabber sign it and taking ownership of the property over and then either selling it or getting a long term loan and renting it out to minimize your losses.  

I learned a lot from this experience. I now structure things differently in the way I lend or in the way I get private money lenders. Rather than splitting the investment deal with a private money lender who lends to me in second position, I just offer a straight interest rate of 8% APR on their money while it is invested and I also give them a deed of trust and a promissory note that only goes for 1 year. That way they know that they will get their money back within a year and they know the amount they will earn in interest too, regardless of the way the deal goes. I have had 3 deals go bad while using other people's money, 2 of which had to do with a contractor taking my money and not doing the work, and my private money lenders got all of their money back including all the interest promised in the promissory note. My private money lenders trust that I will do what I say I will do. And to me, that is more important than for me to not lose money on a deal.

Originally posted by @David Espana :

I have loaned (2nd position) to a flipper using my SDIRA. A hard money lender was utilized for the 1st position loan. The property was purchased around mid-August 2018 and placed on the market in November 2018. It is beautifully remodeled, however, as of July 1, 2019, it still sits unsold.

The price has been dropped about $21,000 and is probably priced a little more than break-even (margins reduced by the interest paid to the 1st position lender the past nearly 11 months). The flipper only has $5,000 invested in the property. Any further reduction in the asking price and I will start losing my investment.

I am seeking advice on what should do next. The maturity date on my SDIRA loan has pasted (I have set an April 30, 2019 maturity date). The 1st position loan is due in one year. My private loan is secured by a promissory note and recorded Deed of Trust.

Your feedback is greatly appreciated. 

 What is the value of the home, how much is owed, where is it located and how did you figure out comps?

@David Espana I am very sorry you are going through this. Thank you for sharing your experience with us. You will likely save someone else from going through the same thing. I hope you are able to get out of this situation as quickly and as inexpensively as possible.

@Shiloh Lundahl Thank you for sharing the details of your cautionary tale. I am wanting to form funding partnerships for fix and flips in Scottsdale and North Phoenix. Reading your insights makes me lean toward offering interest on money invested rather than the way going the way you and David both did, although that seems like a common approach. Just wanted to say thank you for the Mini Master Class on structuring a deal that ought to be a win-win for all involved.

First, pre-signed deeds-in-lieu or quit claim deeds are are completely unenforceable if contested by the borrower. No judge will allow you to circumvent a borrower’s rights under foreclosure. Plus, you become liable for all other liens and potentially unknown legal actions. Do you really want to take that risk? A DIL involves a separate contract, discussions with Title, the other lenders, and other possible lienholders. This involves an attorney and can be costly. It is not for a do-it-yourselfer.

To state the obvious, it’s impossible to plan the duration of a flip, @David Espana . Maturity dates are exceeded all the time and it’s silly to immediately jump to foreclosure, as suggested here. Nor is it in your interest. This is especially true if you loan in second position and even more true if you loaned through an SDIRA.

You didn't provide any detailed numbers, so it's difficult to know where you stand. If your SDIRA forecloses, it could own the property subject to the first. That is, your SDIRA will have to make payments to the first position lender and/or pay them off. Since this was a second position loan, I assume your IRA doesn't have enough cash for that (???). If so, the first could foreclose and wipe your lien out. Personal guarantees are generally not worth the paper they're printed on but if you had your borrower sign one, it could be used for some leverage depending upon his or her other assets. Both foreclosure and/or debt collection, even if successful, are expensive and these funds must come from your SDIRA.

Unfortunately, it sounds like your borrower has little to lose and much to gain by being greedy.

Your best friend now is not the borrower but the first position lender. Have you been in contact with them? (You should have, even before you made the loan.) No one wants to foreclose. Both of you should be talking your borrower into coming to their senses and lowering the price of the property to sell. With a completely rehabbed property, there could be enough equity to keep you and the first whole, or at least minimize your loss.  Good luck, David.

@Caleb Heimsoth you would lend in second position if you do not have enough money to lend in first position and you want to lend on a deal. That is why you would lend in second position. This is done all of the time. And when you are working with someone who knows what they are doing, and they have integrity, it works out really well.

Originally posted by @Shiloh Lundahl :

@Caleb Heimsoth you would lend in second position if you do not have enough money to lend in first position and you want to lend on a deal. That is why you would lend in second position. This is done all of the time. And when you are working with someone who knows what they are doing, and they have integrity, it works out really well.

I understand why or how you lend in second position, I was mostly asking the OP, why would they do it under these terms. More information is needed, but anytime a rehabber has two lines on a property and very little of their own money at risk, that is not a good sign. There's a reason most hard money lenders only do 65-75 ARV, and only lend money after work has been done.

Likely in this case money was given up front and they didn’t say but being they’re from CA there’s a decent shot this is long distance as well..

There are only a few viable options. Most of them have been said, but I'll echo and synthesize:

  • Encourage (nice word for "Force") the developer to switch realtors, reduce price further, sell at a loss, and bring money to the table to pay off all liens. 
    • If developer is a "good guy", offer him a FIRST position lien on his next project to help him get back to even. 
    • If developer is a doofus who loses all integrity when you suggest he eat the loss, get out and run. 
      • Consider eating some of the loss yourself. Getting 90% of your principle back today, putting the money back on the street, and moving on is better than dragging this out for another couple months.
  • Take over the property. 
    • Request a payoff from the first position lien holder and if it makes sense, buy it yourself and assume a position of control. 
    • You can try your hand at selling it, rent it out, move in yourself, etc. etc. At least you're driving.  
  • Foreclose - this is probably the last thing you want to do. I do not recommend this route.
    • Depending on where you live, this can take 6+ months and cost $10K+. 

I'm a Private Money Lender and this **** happens. I went through a similar situation as well. It didn't go over time as much as yours did, but the developer had to suck it up and come to close with a check for ~7-8K to pay me off. I've gone on to do many more and much bigger deals with this same developer because he showed me a level of integrity I had no choice but to admire. The big difference in my deal was I had the first position lien. However, I financed 100% of the deal so I'm not that smartest guy either. If you want to read my blog post detailing my experience, DM me. I don't know if I'm allowed to post it here and don't want to get in trouble for self-promoting. If you want to talk on the phone, DM me. We can talk through your options. Either way, good luck! Stay optimistic and be kind. Don't let this turn you into a sour grinch.

Personally I wouldn't use IRA retirement type money on second position flips. Retirement money is typically put in one of the most safest type investments and not the riskiest.

Established investors as they have a track record tend to dictate the terms they will allow passive investors to come in at and not the other way around. This is why hard money lenders often price in heavy risk even on first position notes because investors doing projects tend to be less experienced ( After the investor does a few successful properties they tend to seek cheaper capital). Many of the hard money lenders are often former or retired flippers themselves. Same thing wth retired developers where they no longer want to do projects directly anymore they lend or partner on projects but just do not want to do the day to day stuff anymore.

Have you thought about getting a lender BPO completed on the property? This is typically a third party objective opinion of current value and what updates or repairs are needed for full market value. You need to try to get your own independent valuation not what the flipper thinks or HML in first position thinks with looking at options.

Originally posted by @Morris Cohen :

I assume you don't have a personal guarantee? If not, what is the LTV of the 1st mortgage not including your lien? It may make sense to ask the seller to give you the deed in lieu of foreclosing and to refinance into a longer term loan once the property is rented. I know the original plan was not to be a landlord, but I have found that time fixes a lot of issues in real estate and waiting 5 or so years for the market to appreciate may allow you to avoid a loss while paying down some of that 1st in the interim. There are only two banks in the country that I know of that will lend to a SDIRA, so it probably makes sense to run through the scenario before executing.

 this issue here is its  SDIRA as U point out.. refi probably not possible..  to me this one just has to get sold and take your lumps.

if there is a PG one could press that point but usually throwing good money after bad..  Gap funding is not a great place for beginner investors.. plus usually a SDIRA does not have the funds to pay the first off..  

@Jay Hinrichs agreed- Refis are possible in a Self directed IRA, but very difficult. Expect high rates (mid 6's with prepayment penalties and points). The LTV must be low and the property must cash flow since you can't sign personally, but it is possible.

Originally posted by @Morris Cohen :

@Jay Hinrichs Refis are possible in a Self directed IRA. The LTV must be low and the property must cash flow since you can't sign personally, but it's possible. I've done them.

OH I know they are but I suspect it wont work in this scenario.. without bringing in a ton of cash and most folks don't have a ton of cash sitting in their some HML will do them I do them.. but its a niche we carved out..

@David Espana ,  I like @Sunny Shakhawala 's suggestion to buy the property yourself (if you have the means) in order to take control.  However, I might suggest a side-door approach.

You could probably buy the 1st position lien from the lender for well-below payoff.  Notes routinely sell at a discount to the unpaid balance and a loan with no payment history that has documented project issues on a property that isn't selling seems ripe for a strong discount.  The first lien holder, if they are aware of the situation, probably wants out just as much as you do.

In addition to the discount off the st lien payoff, you would also not have to come up with the money necessary to payoff your SDIRA's 2nd lien because you wouldn't be buying the house, just the note. If you did buy the house you couldn't take it subject to the 2nd lien because you would then have a loan from your IRA which isn't allowed. But, so far as I know, you investing in a note on a property while your SDIRA holds a completely different note on that property would not be a prohibited transaction. *ABSOLUTELY consult a tax professional on that point*

Once you own both notes, you are at the very least in control.  At that point you could perhaps negotiate a loan modification with the borrower that reduces principle in exchange for a shortened term.  That would force him to sell for less in order to sell faster and the principle reduction wouldn't hurt you because of the discount you'd bought the note for.

If that failed, you could negotiate a deed-in-lieu which would cost pennies on the dollar vs a foreclosure. Although that might get you back into prohibited transaction territory.

Or, here's an idea. Once you own both notes, negotiate a short-sale basically with yourself wherein you personally agree to buy the property from the borrower for the payoff amount of the SDIRA's 2nd lien plus $1 if the borrowers 1st lien holder (now you) will agree to take $1 for the payoff and release the lien (to which you s the lien holder would agree). That way:

  • your SDIRA is made whole
  • there s no prohibited transaction between you and your SDIRA
  • the borrower doesn't benefit from his failed flip but loses only his investment and can't refuse to come up with additional payoff money
  • you get ownership of the house for a total investment of a) the original SDIRA loan amount plus b) whatever discounted price you had paid to the 1st lien holder.
  • You could then either sell it yourself or hold it for rental and sell at a better time

This is, of course, based on many assumptions that may not be true, not the least of which is your capacity to buy the note. I don't think there is any magic way to turn this loss into a gain but perhaps a way to minimize the loss, take the loss against taxable money instead of in your IRA and perhaps let time and rent checks erase some of the loss.

Also, I am learning about notes but have never actually invested in one and I have a whole one rental and zero flips in my experience so treat all my advice accordingly.

@Shiloh Lundahl , Thank you for your insite. The option to have the rehabber sign a quit claim deed to me makes sense. This is something that I need to do soon because every month that goes by the 1st position lender gets paid their interest (which eats up profits). Having a quit claim deed done sounds like a better plan compared to recording a notice of default. If I get the quit claim deed, I assume that I will now become responsible to pay the 1st position lender's interest.

If I have a quit claim deed done, I will have the option to refinance and rent it out (I may almost break even - I may have a up to a few hundred dollar per month shortfall). The other option is to reduce the price at the realistic market value in order to sell it quickly. If I do this I will lose between $30,000 to $40,000 of my investment (I have $110,000 into it). So my other question on the option to sell the property, sInce I had the rehabber sign a promissory note, will I have recourse on money that I lost? The thought being, if I have recourse , I would place a lien on the rehabber's next project. 

Thank you, 

Dave Espana