Peter Pays Paul

The weather here in Northern California has been wet and overcast for the past few days. But this morning the sun is shining brightly, the hills are green with fresh growth, and the sky is a brilliant dark blue.

I know that in many parts of the country it can be overcast for weeks not days, but in California a few days of clouds is a big deal.

When the clouds are ominous, the lightning is flashing, the rain is beating down, and the wind is howling forgetting about the sun’s warmth, light, and energy is easy to do.

Stormy Financial Times

At the current time we are living in stormy financial times. The stock market is tumbling, companies are filing bankruptcy, unemployment is rising, and fear is on everyone’s minds.

It is easy to forget in times like this that “this too will pass.” The sunny times will return eventually.

Change Is Difficult

The financial system as we know it is undergoing a cataclysmic change.

Personal finance is undergoing a huge change as well. We are changing from a consuming society, to one that saves.

Change is difficult. It takes discipline. We will hit bumps, plateaus, and  valleys.

On the bright side, adversity breeds character. What will it produce in the generation that experiences this?

The Lens of History Gives Perspective

As I read about the economy and some of the foolish policies proposed to solve this problem, it has been easy for me to have a doom and gloom mentality and attitude.

However, looking at history has provided me with a measure of hope. (Not as much hope as this.)

The Great Depression

My grandparents were born, raised, and survived The Great Depression. Do a search for companies started during a recession.

People were resourceful. They found ways to make it. They lived on less. Worked harder and still found ways to save a little money.

The Dark Ages

From my recollection of the era known as The Dark Ages, the life of the common people was none too pleasant. No running water, indoor plumbing was reserved for the richest of the rich if at all, and personal hygiene was yet to be invented.

Many of the peasants in Europe were serfs and had no ownership rights to the property on which they lived. They were at the whim and mercy of their lord. They worked hard on the land, but the landowner received a portion of all they produced.

Yet, for all this hardship modern Europe still exists. It is not a vast wasteland with few inhabitants.

History provides example after of example of  human ability to creatively adapt to situations and to survive.

The Sun Will Rise …

The current financial turmoil is not permanent. At some point in the future the financial sun will rise again.

A state of normalcy and predictability will again settle on the markets. Industries will begin to grow. That growth will create jobs and wealth.

The storm raging around us is beyond our control. Focusing on the storm raging around us will distract us from the items that need to be accomplished today.

We can control our actions to today. Besides “Each day has enough trouble of its own.”

Photo Credit: phatman

In need of new sources of funding, brokers are calling lenders they have never reached out to before. Too often, the broker in the first 30 seconds is unable to make a solid impression on the lender to establish a long-term relationship.

Phone Etiquette

In the first 30 seconds you can make a good impression with the lender and establish a solid relationship with them. Or in the first 30 seconds you can demonstrate incompetence and a lack of civility towards the lender.

Here are some tips of what to do in the first 30 seconds of your initial call to set up a solid long-term relationship with a lender.

Repeat and use the name of the person who answers the phone. This helps you to connect with the person. If you have a short memory or forget names, write the name down so that you can reference it throughout your conversation.

Keeping the person’s name may help you the next time you call with a loan request. You will know with whom you spoke previously and can use your previous contact to build rapport.

Do not ask how the person is doing. Most of the time we ask out of a sense of “social propriety”, not out of genuine concern. What would you do if the person on the other end of the line answered “Terrible!”?

This can be awkward:

Lender: Hello this is Frank.

Broker: Frank, how are you?

Lender: Fine. How are you?

Broker: Good thanks.

Lender: Who is this again?

Next, clearly state your name, company, and briefly describe what you need in 30 seconds or less. “This is Peter from Owens Financial Group. I am calling regarding an office complex in Seattle worth $4 million in need of financing for $2.75 million.”

This is your “elevator pitch” of the project. In order to effectively make the pitch, you must have studied the financing request. You must know the location, loan-to-value ratio, loan amount, and property type in order to make this statement in 30 seconds.

Finally, end with a question about the lender’s ability to do this deal. You don’t want to leave the lender wondering what they can do for you.

“Can you finance an office property at 69% of value?” Or “Do you handle commercial construction projects like this in Idaho?”

I would advise against asking a question about pricing. If the lender is unable to finance your project, price doesn’t matter. You are requesting them to answer a fruitless question.

Summary

By knowing in advance the reason of your call and details of the deal, you evidence your professionalism and that you value the lender’s time. It also prepares you to leave a detailed message for the lender if they are unavailable at the time of the call.

When making a phone call, you want to establish rapport and accomplish the purpose of the call. Getting off on the right foot is imperative to achieving this goal.

The trial of the owners of Estate Financial, a now shuttered San Louis Obispo based hard money lender, has been postponed.

Trial for Paso lender Estate Financial pair delayed, co-owners remain in jail – Breaking News – San Luis Obispo.

No, I’m not writing about NASCAR or the IndyCar Series. And no it is not the video game.

I’m talking about those rare occasions where you need money and you need it fast.

If you are a commercial real estate sales agent or commercial loan broker, what do you do? Do you know who to turn to in a pinch?

In baseball many teams have the left-handed specialist who will come into the game to get one batter out.

Basketball teams have their specialists as well. The Chicago Bulls had Michael Jordan. The Lakers, Kobe Bryant. Who is your “Go-To-Guy” when time is short and you need a “sure thing”?

“Clutch”

Coaches depend on “clutch” players that will perform when the game is on the line.

Do you have a lender you can depend on when there are 10 seconds left and you are down by two? Do you have a “clutch” lender that understands real estate and can salvage a deal when your client’s deposit is on the line and close of escrow is days away?

Built for Speed

Most hard money lenders are built for speed. Some models of business are faster than others, but in general this is one of the advantages of hard money.

Because most private money lenders don’t have FDIC and state banking guidelines to follow they can underwrite and make a decision much faster than a bank. This allows them to fund deals much faster than a bank.

Always Be Prepared

No one plans on a deal going sour at the last minute, but it is good to have a plan for a “what if” scenario.

Like the Boy Scouts’ motto Be Prepared, commercial real estate specialists should have a tool for every situation. Having a relationship with a hard money lender for deals that require them is just another tool in the commercial real estate professional’s belt.

The Essence of a Professional

Which do you think sounds more reassuring to a client and more professional?

“I never have seen this situation happen before. I’m not sure what to tell you Mr. Borrower. I will have to get back to you on our options.”

Or

“Mrs. Borrower this situation rarely happens. However, I have developed a relationship with a lender that specializes in closing loans quickly. They are a more expensive than bank financing, but they will allow us time to find a more permanent solution.”

Quick Close Scenarios

Mr. O’Skool Mr. O'Skool is an experienced real estate investor. He is very "old school" and doesn't like much leverage. He speaks slowly and always has interesting anecdotes about life. He drives a late model station wagon and brags that he has a second matching station wagon at home in the garage. You are not sure you have seen him without a sweater on.

Mr. O'Skool owns a variety of properties He owns two apartment buildings free and clear. Through his network he learns that another apartment house is available for purchase. He knows that he can purchase it from the current owner if he closes in 15 days time at a 15% capitalization rate, otherwise the owner is going to list it on the market.

Can you get Mr. O'Skool the money he needs to purchase the property in 15 days?

Ms. Forshewnat

Ms. Forshewnat is a very successful real estate investor. She began with a few properties her late husband left to her and has parlayed that into a multi-million dollar real estate empire.

Through the grapevine you have heard that she is not extremely pleased with the service she has received from her previous lender. You have been courting her business for a while and she has finally agreed to allow you a chance at winning her business. She tells you that she is has other notes coming due in the coming months.

She has asked you to finance an office building she owns as the note is coming due in 120 days. You take Ms. Forshewnat to one of your lenders that has a great program for office buildings.

Everything is moving along without a hitch until the lender runs a new credit report 20 days before closing. It seems that Ms. Forshewnat co-signed a loan with her 23-year old son who has missed two of his payments. Now her credit score has dropped and the lender is unable to extend financing.

Can you find a lender to close in 20 days in order to keep Ms. Forshewnat from having a default and jeopardizing future loans?

Buying Time

In general, hard money is not a long-term solution. But it can buy you time to find that permanent solution.

Having a reliable, direct hard money lender can be invaluable to commercial real estate professionals.

Jack M. Guttentag, “The Mortgage Professor” on Yahoo! Finance has written an article proclaiming the advent of good times for hard money lenders.

Like all disasters, the financial crisis has its share of beneficiaries who profit from it. The hard-money lenders, who lend strictly on the basis of collateral, have profited from the financial meltdown. These non-institutional lenders require a lot less paperwork than institutions because they don’t worry about whether or not borrowers can afford the payments, or whether or not they are creditworthy.

Read the rest of the article..

I would mostly agree with Mr. Guttentag. However, with the value of real estate hard to determine in a falling market it is also a potentially treacherous time for lenders as well. Making a loan at a high LTV on a property that is decreasing in value can be risky, because equity can be eroded quickly.

I can attest that we have seen an increase in the quality of deals that we are reviewing. However, many of the existing financing was underwritten at lower cap rates and higher values. (Remember that cap rates and values have an inverse correlation of each other. As cap rates rise value falls.)

Now with higher cap rates and lower values these properties are worth less than when the original mortgage was put in place. Without an injection of equity from the borrower many of these loans are unable to be refinanced.

The Golden State is going to be in for a rough year. The Associated Press is reporting that the state may deliver just 15 percent of the requested amount to California cities and farms.

Calif. to cut water deliveries to cities, farms – Yahoo! News.

Fewer crops may be planted if there is no water for the crops. In economic terms this could mean higher prices for some of the every day food stuffs that Californians enjoy.

Californians had better pray for rain.

The Wall Street Journal is reporting on the plight of Vallejo, CA today. The Journal reports that Vallejo is already down 20% of its police force since January and could loose another 20% of its force by the years end.

California Cities Cut Police Budgets – WSJ.com.

This is just one of the effects that cities are experiencing due to lost revenue from development fees and property tax revenues. City councils bought into the myth that real estate would continue to go up in value indefinitely and city services would be adequately funded.

An underfunded police force will likely affect real estate values in Vallejo and other municipalities like Vallejo. If crime rises and the perception of safety decreases, real estate values in some areas of Vallejo will likely decrease as neighborhoods become less desirable.

This could be an unending downward spiral for cities as property taxes are assessed on transfer value in California due to Proposition 13. Lower real estate values would generate lower property tax revenue and the city would have to cut more costs from their budget.

This is a key reminder to real estate investors that local government issues can affect long-term real estate values.

Deals in cities with bankrupt or poorly funded city coffers should be given a higher degree of scrutiny and underwriting.

A Vortex for Trouble:How the Central Coast became the center of a specialized type of lender fraud.

Real estate investors that are seeking to grow their invested capital commonly use 1031 Tax-Deferred Exchanges.

These exchanges allow the borrower to apply more of the proceeds from the sale of an existing investment property to the purchase of a new investment property.

1031 Exchanges Defined

This is an explanation of an 1031 exchange according to the IRS website:

Generally, if you exchange business or investment property solely for business or investment property of a like-kind, no gain or loss is recognized under Internal Revenue Code Section 1031.

My explanation in a nutshell: a real estate investor can sell a piece of investment property, defer the capital gains tax until a later date, and roll the entire gain into the purchase of a new piece of investment real estate. The taxes are deferred (postponed) until the investment property is sold the final time.

Benefits of 1031 Exchanges

Deferring the taxes due on capital gains (appreciation) can reap huge rewards over time. Deferring payment of capital gain tax allows the savvy investor to apply more capital towards the purchase.

Leverage should allow the investor to generate a higher return through appreciation and/or cash flow.

1031 Exchange Hurdles

Now of course the government doesn’t make it an easy process and sets limits and restrictions on how a 1031 Exchange must be executed.

One of the main restrictions is the timing on completion of a 1031 Exchange. The exchange must be completed within 180 days of the transfer of the exchanged property. This deadline can put pressure on all involved to complete the deal within the 180 day period.

The costs of missing this deadline can be large. The borrower will be forced to pay capital gains tax on any gain as well as any penalties that might be incurred if the contract date is not met.

Most exchangers will typically qualify for standard financing. However, on occasion an institutional lender will be unable to provide financing within the mandated 180 days.

Using a Hard Money Loan to Execute a 1031 Exchange

If the primary lender is unable to close on time, what is the investor to do?

One of the benefits of using hard money is the speed that hard money lenders provide. A hard money lender that lends their own funds and is well operated can provide commercial financing within 14 days of receiving a complete package.

Another benefit is that most lenders offer loans on a short term basis. The hard money loan can help an investor close the transaction while a more permanent loan is arranged.

While the fees associated with hard money may be higher than a traditional source, the benefits of completing the transaction within the mandated time may outweigh the costs.

1031 Example

The following example should help demonstrate my point. Below are the assumptions we will use for our example.

Below are the costs that would be associated with a failure to execute the contract on time. I have only included what I would cite as the most basic and immediate costs. (There would be the potential loss of future returns as a result of cash flow and/or appreciation.)

The current capital gains rate is 15% but is set to increase in 2010. By including the deposit I am assuming that the deposit became non-refundable at some point.

Below I have computed the after tax costs of a hard money loan. The pricing below is on the high side for a short-term, conservative LTV loan.

Conclusion

As you can see from the example the after-tax cost of hard money may be less than the cost of not executing the 1031 exchange on time.

Hard money is not the best option for all scenarios. When a deal is on the line and speed is needed, hard money is a good alternative to institutional financing.

For more information head on over to Jeff Brown’s blog to find out more about 1031 exchanges and when to execute them.

Part of my job is to take incoming cold calls. We advertise in a commercial lending industry magazine that generates a good deal of call traffic.

On a regular basis I get requests for “construction” loans. After asking some questions to determine the nature of the loan, I usually find out that the broker/borrower is actually searching for what I would call a “development” loan.

What’s the Difference, Who Cares?

Why does it matter if you call it a construction loan rather than a development loan?

First, it reflects on the broker/borrower. If a lender has to educate the person requesting money, it sets a bad tone for the deal.

Second, some lenders offer construction financing but don’t offer development financing. Asking the right question allows you to get a correct response and save you time.

Finally, loan to value and equity requirements may vary depending on whether the loan is for development or for construction; I know ours do. This information helps the lender determine if the loan is within their parameters.

Construction vs. Development

Construction by definition has the connotation of putting things together. In my mind, moving dirt for roads or infrastructure does not meet this definition (no offense to those in the fields of civil construction).

The definition of the word develop includes the idea of being made usable. This is perfectly suited for the installation of roads, pads, and infrastructure; as the land has now been made usable for a building.

Defining Loans

Consequently, I would recommend that if you are asking lenders for a construction loan, a building should be in place when construction is complete.

Loans to improve land should be titled as development loans.