Hard Money Loans | ATHOL DICKSON

How to Conduct Due Diligence For A Crowdfunded Hard Money Loan

December 6, 2016 By Athol Dickson

Crowdfunded Hard Money Loans due diligence — Successful crowdfunded hard money lending depends on your due diligence.

Investing in so-called “hard money” loans is an excellent way to achieve significant income if it’s done in a way that controls risk. In a couple of earlier posts which you can read here and here, I discussed reasons why I’m investing in loans through crowdfunding platforms like Patch of Land and PeerStreet, and four criteria I look for in every loan. With this post, I’ll explain how I perform more detailed due diligence on loans that meet those four criteria.

The goal here is to verify that the underlying property is really worth as much as the crowdfunding platform claims. If it’s not, then the property can’t be sold for enough money to repay my investment. I look for a “loan-to’value” ratio (LTV) of at least 75%, meaning the loan amount is 75% (or less) of the market value of the underlying property. That way there’s a 25% cushion if the borrower defaults, meaning it should be possible to foreclose and sell the property for 25% more than the loan amount. Of course there are fees and holding costs associated with foreclosures, so in the real world I’d do well to get all of my investment back after those costs, but with a 75% LTV I have a fighting chance of breaking even or maybe even showing a small profit. That’s not a bad worst case scenario in today’s investing climate.

Patch of Land and PeerStreet both state the underlying property’s value when they post a deal on their platforms, and those valuations are done by professional appraisers or real estate brokers. I still go to the trouble of double checking the property value anyway, and on several occasions I’ve determined that their stated property values were too high. I don’t believe Patch of Land or PeerStreet would overstate a value deliberately. On the contrary, I think they’re both ethical companies, or I wouldn’t invest with them. Rather, real estate valuation is an inexact process due to the influence of numerous intangible factors. Therefore, just as I would never invest in common stock based solely on the information in a company’s own shareholder’s report, so I would never invest in a crowdfunding platform’s loan without looking outside of the platform’s data to confirm the investment’s value.

Here’s how I do it:

The goal is to compare the underlying property’s valuation to the sold prices of comparable recently sold properties in the immediate area. We want to make sure the average price of the most similar “sold comps” at least equals the crowdfunding platform’s valuation. For most properties, the information on sold comps is available online at websites like Realtor.com, Zillow, or Redfin. If you can’t find the underlying property on those sites, or if you can’t find recently sold comps in the immediate area of the underlying property, you should probably not make the loan.

Realtor.com and Zillow cover the entire USA as far as I can tell, while Redfin’s coverage area is more limited. But I prefer to use Redfin whenever possible, because in most of its covered cities it provides sold comp information in a list format which can be downloaded as a spreadsheet for more detailed analysis. So to follow along as I demonstrate the process, step one is to open Redfin.com.

If you clicked the Redfin link you should have their home page open in a new window. In this example, we will assume the underlying property address is 2926 Searchwood Dr., Jacksonville, FL 32277. Copy and paste that address into the search bar on Redfin’s home page and press your enter key.

You should now be looking at Redfin’s page for the house at that address. Scroll down until you see a map with the house indicated by a blue icon. Below the map click the “Map Nearby Homes For Sale” link. Click the link.

A new page will open which displays another map showing actively listed properties on the left, and a corresponding list of the same properties on the right. Let’s focus first on the map. The farther away a sold comp is located from the subject property the less valid it is, so zoom in on the map until it displays an area about six to eight blocks wide around the subject property. In this case, just click the “+” box once.

It’s also important to avoid comps in different neighborhoods, so if the map shows a major road or highway, a river, or other natural boundary which might form a separation between the subject property’s neighborhood and a different neighborhood, we’ll need to move the map view around to ensure that it displays as little of the other neighborhood as possible. Do this by hovering your cursor over the map, “grab” the map with a double click (tap twice and hold after the second tap). Then move the map view until the intersection of Merrill Rd. and Cesery Blvd. is at the extreme lower left. Notice as you move the map the houses listed on the right may change. This should ensure that no properties on the wrong side of those two major roads will appear in your results.

Now that you have zeroed in on the immediate area of the subject property, and made sure not to include any areas which look like they could be considered a different neighborhood, it’s time to replace the active listings with sold listings. Do that by clicking on the “More Filters” link at the upper right above the list.

The advanced filters menu should now be displayed. In the left column deselect every Property Type except for “House.” Select “Sale Records.” Finally, go through the “Home Facts” options to narrow the search to a set of metrics which closely match the subject property. For example, in this case the house size is 1304 square feet, so I selected a minimum square feet of 1000 and a maximum of 1750. The subject property has three bedrooms and 1.5 baths so I selected those options as well. the house was built in 1950 so I selected 1940 to 1960 under “Year Built.” You get the idea.

Finally, next to the “Sale Records” button is a drop down menu that lets you select a date range for the sold comps. Select “last 3 months.” Click “Update Search” and check the map to see how many sold comps appear. If there are fewer than five or so, go back to “More Filters” and increase the sale records period to “last 6 months.” If there still aren’t enough comps, try “last 1 year.” Be sure to pick the briefest period possible to generate enough comps ,because the more recent a comp is, the more accurate the comp is.

When you’re ready, click the orange “Update Search” button. The “More Filters” menu goes away and you should be looking at the map and list again, except now the icons on the map are all blue, indicating sold properties. Scroll down to the bottom of the properties list on the right. Clink the “download all” link just below the list. This will download a Microsoft Excel file directly to your computer. It’s in a .csv file format which should work with most kinds of spreadsheet software. Find and open the file.

I would never invest in a crowdfunding platform’s loan without looking outside of the platform’s data to confirm the investment’s value.

Find the “URL” column and use the links below to open each property’s individual webpage. Review the photos and written information for each of them to compare their condition to the subject property. If the condition or amenities are substantially better or worse than the subject property, you’ll have to add or subtract dollars from that comp’s sold price to make it a better match. For example, the subject property has no swimming pool, so if one of the comps shows a pool, you should lower the sold price accordingly for that comp. But the subject property has clearly been remodeled inside and out, with new flooring, paint, roof, and so forth. If you find a comp that’s a total “fixer” you’ll need to either delete it, or add the value of a remodel to the sold price for that comp. To do that simply go to the “Price” column and make the adjustment. (If you don’t know how, click here for a basic Excel primer.) The amount you add or subtract will be somewhat subjective, because the market value of a swimming pool or a new roof will vary from market to market. You may need to do some research. In most markets you can find real estate agent blogs that discuss the going rate for such improvements.

Once you’ve reviewed all of the sold comps and made adjustments to the price to ensure that they’re “apples to apples” comparisons to the subject property, it’s time to calculate the market value. The formula for this is simple:

(Average Sold Price / Average Square Feet) x Subject Property Square Feet.

So you find the average of all the entries in the “Price” column, divide that by the average of all the property sizes in the “”SqFt” column, and multiply the result by the size in square feet of the subject property. That’s your valuation. (To learn how to use the “average” function in Excel, click here.)

Now divide the crowdfunding platform’s loan amount by your own valuation amount. If the result is a loan-to-value (LTV) of 75% or less, chances are that the crowdfunding site’s valuation of the underlying property is solid, and you may want to invest. (Although you should also factor in your own criteria, and the LTV is just one of many risk points to consider, as I have pointed out before.) If your LTV is more than 75%, you should consider the possibility that the crowdfunding site has overvalued the property, and if you trust your own valuation, you may not want to invest. I wouldn’t.

For more on this subject, click here and here.

I received no consideration of any kind from Peer Street, Patch of Land, or Redfin for this blog post.

See disclaimer at bottom of page.

4 Criteria For Hard Money Loan Investments

October 29, 2016 By Athol Dickson

4 Criteria for Investing in Hard Money Loans

Every investment should be considered from a risk/reward perspective. Ideally of course you want minimum risk and maximum reward. From that perspective I think loans secured by real estate are one of the best investments out there at the moment. A few days ago I discussed Peer Street and Patch of Land, two companies that offer crowdfunding “hard money” investments which are indirectly secured by real estate loans. In that earlier post I explained my reasons for building a portfolio of these investments. The main appeal is the fact that the collateral—real estate—is theoretically worth more than the amount of the underlying loan, so a sponsor like Patch of Land or PeerStreet can sell the collateral to recoup your investment if necessary. Obviously, that only works if someone is willing to buy the underlying property for a price equal to, or more than, your investment amount.

…we’re looking for underlying real estate that could be sold for enough money to recoup our investment if it’s necessary to foreclose.

In a future post I’ll explain how to do a seat of the pants appraisal to verify the property value. It’s important to do your own estimate, because the values assigned by PeerStreet and Patch of Land are sometimes overly optimistic. That could mean the property can’t be sold for enough money to return your investment. But before we get to that, here are four preliminary criteria I use to quickly decide if a loan is even worth that effort. Remember, we’re looking for underlying real estate that could be sold for enough money to recoup our investment if it’s necessary to foreclose:

1. The underlying property’s planned selling price must be within the limits of a “conforming” loan. Most home buyers finance their home purchases with mortgages. Most of the banks or credit unions who originate those mortgages are insured by the Federal government through the FHA, Fannie Mae, or Freddie Mac. All of these organizations have the same top end limits on the loan amount they will insure. Currently those “conforming” limits are $417,000 in most places, up to $625,500 in areas where home prices are significantly higher than the national average. Real estate priced at or below those limits usually sells faster, because home mortgages to purchase them are widely available and relatively easy to get, with fairly low down payments. Fewer home buyers can qualify for non-conforming loans, and fewer still can pay all cash. So if a hard money loan investment is secured by a property worth more than the conforming loan limits, usually you should not invest.

2. The property must be in a major Metropolitan Statistical Area, or “MSA”. This is a term used by the U.S. Census Bureau to describe a geographical region with a densely located population of at least 50,000 people and close social and economic ties throughout the region. While 50,000 is the low end of the MSA spectrum for the Census Bureau, I only invest within MSA’s that are at least two to three times that size. This is because real estate sells faster when there are more people around to buy it. If a deal goes south, I want my money back as soon as possible, but rural real estate can sit on the market for years. While the Census Bureau publishes lists and maps of MSA’s, I find the fastest way to check is to locate the subject property on the satellite view (they call it “earth”) at Google Maps. Enter the property address in the search bar there and zoom to the view that shows 1 mile on the scale at the lower right. If your computer screen is mostly filled with streets and roofs, chances are there are plenty of potential home buyers in the area. On the other hand, if you see mostly Mother Nature, you should probably not invest. Leave this page open at Google Maps for the next step.

3. The property must have reasonably good curb appeal. Most people won’t buy an ugly house. It doesn’t have to be gorgeous, but it should at least match the other houses in the same neighborhood. Don’t judge a property based on your own taste. You don’t have to live there. You just want to make sure there are plenty of other people who would like to live there. To decide, start with a common sense reaction to the photos of the property on the investment page at PeerStreet or Patch of Land. Google the street address to find old real estate listings for the property and drill down into the photos on those pages, too. Finally, to see the property in comparison to others in the neighborhood, go back to the property’s address at Google Maps and this time zoom into “street view.” Move the view up and down the block. How does the subject property compare to the neighboring houses? It doesn’t have to be the nicest looking house on the block, but it should at least be average. Sometimes this process takes imagination, because the underlying loan is for a “fix and flip” investment, which by definition means the underlying property needs work. In those cases, you’ll have to try to visualize how the property would look with fresh paint, a new roof, and so forth.

4. The property must be in a state with a reasonably fast foreclosure process. Due to differing legal processes and the local volume of foreclosures, the process of gaining possession of real estate collateral after a borrower defaults can take as little as nine months (Alabama) to as long as three years (Hawaii, Oregon). You can view a table of the time frames at Fannie Mae’s website. Note that the times shown there are maximums. The average foreclosure time will be less, and in some states such as Texas, much less. I don’t invest in loans secured by properties in states where the maximum foreclosure time is 18 months or longer. You may want to set your limit higher or lower, but once the monthly payments stop on your investment, you’ll want your money back as soon as possible so it’s important to be aware of the worst case scenario where the investment is located.

There are very few perfect deals, so you’ll have to compromise on these criteria from time to time. For example, I recently lent against a condo in Provincetown, MA, even though that’s not in a major MSA (it’s a couple of hours outside of Boston). Why did I break my MSA rule? The condo is directly on the beach, so the “curb appeal” is beyond fantastic. And since Massachusetts has a reasonably fast maximum foreclosure time (15 months), and the exit price is within conforming limits, I think it’s a good investment. The risk/reward calculation is a personal decision. But with a clear investment profile based on the common sense criteria described here, at least you can make educated bets.

For more on this subject, click here and here.

I received no consideration of any kind from Peer Street or Patch of Land for this blog post.

See disclaimer at bottom of page.

Investing In Investors

October 24, 2016 By Athol Dickson

Loans to real estate investors can be a good investment, — Loans to “fix and flip” investors can generate high yields with low risk

Loans are an excellent asset class to hold in an income focused portfolio for a couple of reasons. First, they’re a good way to diversify, because most borrowers continue making loan payments even when the stock market is down. Second, income from some kinds of loans can be significantly better than most bonds, with less risk. This is especially true of commercial loans secured by real estate.

That’s why I’ve been lending money lately to a couple of companies, Peer Street, and Patch of Land, both of which in turn lend to real estate investors. The companies are in the business of making what is called “hard money” or “private money” loans. Their borrowers are real estate investors who use the cash to “fix and flip” a property, or to buy or renovate a rental. They don’t lend to owner occupants.

It’s a “heads I win, tails I don’t lose” kind of investment, which is rare indeed in the current economy.

The origination fees and interest rates on hard money loans are high, and the loans are secured by a first lien on a property that is worth at least 25% more than the amount loaned, so if the borrower defaults the lender can take possession of the property, sell it, and get the loan principal back. Sometimes, even after all the fees and costs are paid, it’s still possible to make a profit on a defaulted loan when the underlying property is sold. It’s a “heads I win, tails I don’t lose” kind of investment, which is rare indeed in the current economy.

Real estate investors borrow money this way in spite of the high costs for several reasons. Traditional lenders like banks and credit unions typically lend based on a loan-to-income ratio, whereas many real estate investors live from deal to deal, so they have no salary, and thus no earned income. Hard money lenders base their lending decisions not on the borrower, but on the property (a loan-to-value ratio). So the borrower’s earned income history doesn’t matter. Real estate investors also like hard money loans because unlike banks which can take two months to close a loan, a hard money lender typically closes in just a few days. That gives the real estate investor a significant advantage in the highly competitive market for “fixer” properties that will cash flow.

In the spirit of full disclosure, although I previously wrote that hard money loans are secured by a first lien on real estate, in the case of Peer Street and Patch of Land, that isn’t technically correct. Technically, when I lend to those companies I have zero legal claim on the underlying real estate. But every loan I make to them is secured by a contract that links my loan to another specific “underlying” loan they make to a real estate investor. In turn, the underlying loan is secured by a particular property. My contract requires them to pay me a pro rata portion of all income they receive from the underlying loan, including principal or interest payments, and anything they receive by selling the property if they’re forced to foreclose.

Several companies are competing in this space, and I believe I’ve looked at all of them. I chose Peer Street and Patch of Land because of another legal technicality. Both of them have established third party LLC’s, called “special purpose entities” or “bankruptcy remote entities” which are stand alone companies designed to protect me in the event Peer Street or Patch of Land were forced to close their doors for any reason. If that happened, my contract with Peer Street or Patch of Land stipulates that their underlying loans, (the ones secured directly by real estate), would be automatically transferred to the third party LLC, which would then be operated by a trustee who is obligated by our contract to represent my interests in dealing with the loans.

In other words, even if Peer Street or Patch of Land went bankrupt, the trustee would continue to manage the underlying loan on my behalf, sending payments to my account when the borrower makes payments, dealing with late fees, defaults, foreclosures, and the disposition and sale of any properties possessed through foreclosures. Again, it’s heads I win, tails I don’t lose.

As far as I know, Peer Street and Patch of Land are the only two companies operating in this space which have that third party “special purpose entity” protection in place for their investors. If you know of another company doing the same thing, please mention it in a comment.

Of course, nothing in investing is a simple as it sounds. There are several possible ways to lose your investment in this process, which I will discuss in another blog post soon. But until then, if you’re an accredited investor looking to diversity your income portfolio, I recommend you check out Peer Street and Patch of Land.

For more on this subject, click here and here.

I received no consideration of any kind from Peer Street or Patch of Land for this blog post.

See disclaimer at bottom of page.