ATHOL DICKSON

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4 Criteria For Hard Money Loan Investments

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4 Criteria for Investing in Hard Money Loans
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.

5 Reasons Why I Held My Nose and Voted For Trump

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This is the way to vote for Trump.
The way to vote for Trump.

Yesterday I voted for Donald Trump.

Sigh.

I understand and agree with many of the arguments against him, and people who vote for Clinton will get no argument from me. Frankly, there’s not much to argue about. Certainly not Trump’s positions on the issues, which had very little to do with my choice because I don’t trust him to keep his promises any more than I trust Clinton. Which is to say, not at all. But after lots of thought, this was a surprisingly easy decision.

Here are five reasons why:

  1. When your choice is between two corrupt candidates, choose the one the media hates most. The mainstream media actively supports Clinton, but does their best to keep Trump under a microscope at all times. That means he’s much less likely to get away with anything, whereas she would have carte blanche to screw things up without a peep from anyone.
  2. Trump deserves to be on the ballot; Clinton doesn’t. The people nominated Trump fair and square. Clinton’s pals at the DNC stole her nomination from Sanders with dirty tricks.
  3. We must stop doing the same things over and over and expecting different results. Clinton represents more of the same, which isn’t working (to say the least). At least Trump is all about trying something new even if some of his ideas are whacky.
  4. America is not a monarchy. It felt wrong when the second Bush was nominated, as if the Washington elites had crowned his family as royalty and rammed him down our throats. It feels like that with this second Clinton, too.
  5. No one should be above the law. When Bill Clinton had that private chat on the jet with the US Attorney General followed quickly by the Department of Justice and the FBI deciding not to prosecute, Clinton lost me forever. If any other government employee had kept those emails on a server in a bathroom linen closet, they would be facing prison time. But Clinton does it and gets elected President? Not if I can help it.

All the way home from the polling place I kept thinking it would have been nice to vote for someone I believe will be a good President. But who knows, maybe Trump will surprise me by governing well. Miracles do happen. But unless the Lord God Almighty intervenes, all I know is my hopes and expectations will be very low on November 9, no matter who’s elected.

Simple Gratitude

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Arek Trenholm stands for the flag.
Gratitude.

Look at this photo of young Arek Trenholm. Confined to a wheelchair because he has spina bifida, Arek is using his arms to “stand” at a parade while the honor guard passes by with the American flag.

In the comments at his uncle’s Facebook page some people call him a patriot.

I say he’s just a young man who has been taught by heavy trials (and probably by good parents) to appreciate his blessings and to say so with a heartfelt “thank you.”

Way to go, Arek.

At 16 years of age, you’re already wiser and more mature than several famous adults I could mention.

UPDATE (11/11/2016): A veteran who works for a company that builds “standing wheelchairs” saw this story and donated one of the company’s chairs to Arek. To see a video of Arek using his new chair for the first time, click here.

Investing In Investors

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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.