How to Get Private Lenders & Lines of Credit to Fund Your Business

I got this response from Craig Nichols to one of my posts:

“In your email message, you made the following statement ‘the mortgage mortgage meltdown which was caused by greedy banks, ripping off the Wall St investors’.  The banks were fulfilling a mandate of Congress. Congress caused this mess. The Community Reinvestment Act of 1995 was revised/written to relax the underwriting standards, so that more people could qualify for loans to purchase houses.”

Craig, I agree that whenever Congress passes any law, there are usually “unintended consequences” that usually do more harm than good.  So, the less Congress does, the better.

And, in the case of the mortgage meltdown, what brought the situation to the “tipping point” was not simply relaxing underwriting standards.  A chief culprit was collusion by the banks in how they decided to underwrite ARM’s (adjustable rate mortgages). 

In particular, as most readers know, an adjustable rate mortgage starts out with some really low interest “teaser rate”.  Sometimes the rate is also interest only which lowers the monthly payments enormously.  Now, if the loan underwriters use this low introductory monthly payment to qualify potential borrowers, you get borrowers who only earn say $30K/y qualifying to buy $300,000 to $500,000 homes. 

Of course when the rate re-adjusts in 1 to 5 years, the interest rate jumps to double digits, and starts to amortize.  a $750 monthly payment jumps to almost $3300 which is more than their entire salary.  Obviously, foreclosure is inevitable.  This is now the fate of 100,000’s of homeowners.

And as I mentioned in my last post, the “Economic Recovery Act” just passed by Congress does nothing to address the problem.  It’s simply a hand out to Fannie Mae and Freddie Mac. 

What really has to happen is that the banks need to loosen their credit policies and only surgically correct those practices that got them in trouble in the first place–e.g., the underwriting of ARM’s and stated income loans. 

Maybe this is something we can write our congress-people about.

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This may sound a bit presumptuous.  And after investing in all levels of real estate for the last 10 years, I believe these insights will be very helpful to the general public suffering from the tightening of credit guidelines and especially our legislators, who could really stimulate the economy by acting on the suggestions in this article.

First, let’s be clear, that the “credit crisis” or “mortgage meltdown” was caused by institutional lenders gaming their own underwriting system by the way they approved adjustable rate mortgages or ARM’s.

You see, one of the primary determinants of whether a borrower gets approved for a mortgage is whether the borrower can afford to make the monthly payments, which in turn depends on income, debt payments and the amount of the monthly payments.  With fixed rate mortgages, the monthly payment is the same from the first payment to the last.  With ARM’s there’s a very low “teaser” rate for the 1st 6mos to 2 yrs, then the rate jumps enormously. 

So, when the banks decided to qualify the borrower based on the “teaser” rate, you had a situation where couples earning as little as $30,000 per year were qualifying to buy a half million dollar house!  Of course, when the rate adjusted, the monthly payment became almost as much as their monthly take home pay and foreclosure was inevitable.

The banks initially got away with this sleight-of-hand, because all these loans were packaged and sold to Wall St, before they defaulted.  It was the “meltdown” of these mortgage-backed securities that threw the market into turmoil.

The banks, decided to look like they were acting more responsibly by “tightening their credit requirements” across the board - basically making much, much harder for individuals, businesses and other credit suppliers to obtain loans.

Predictably, all this did was turn a problem into a huge crisis that is hurting the entire economy, and in particular is actually worsening the problem, the banks need to solve.  That problem is the accumulation of billions of dollars of foreclosed homes in the banks’ inventory–also known as non-performing assets.

Why did the credit tightening worsen the foreclosure issue? Because the only way to get rid of the banks’ inventory is to sell the property.  The tightened credit requirements have greatly shrunk the potential buyer pool for these properties.  And if you think about it, the foreclosures were and are being caused by lack of borrower income to pay the note, not their credit score!

So, what’s the solution that will get all these foreclosed homes off the banks’ books, and return the property to homeowners and relieve the burden on the economy.  It’s not going to be a government bail out, or the ludicrous Economic Stimulus Act, which is just a hand out to Fannie Mae and Freddie Mac.

What needs to be done, is for the banks to sell the properties they’ve accumulated at a sufficient discount so that investors will buy, fix them up, and then sell them to ender users.  Investors are, and have been a massive source of private money for this type of real estate acquisition.  And this is a common practice at most banks that has been going on for years. 

Now, what needs to be done, is that banks need to instruct their Loss Mitigators to sell these properties at whatever discounted price it takes.  And Corporate Management should incentivize them by giving them bonuses based on the number of properties sold.

Second, the banks need to roll back their credit requirements to the pre-2008 standards and tighten up the underwriting of ARM mortgages so that the adjusted payment (based on current interest rates) is used in the calculation of the debt ratio.

Why should the banks agree to do this?  First, they’ve written off these loans already.  Second, divesting themselves of these non-performing assets will increase their borrowing power.  Third, they are not going to recover any amount of their investment any other way, because these unoccupied homes are rapidly declining in value due to vandalism, and neglect.

This is a Perfect Solution, because it would remove the non-performing assets from the lender’s books and restore them to solvency.  Second, loosening up the credit requirements (which did not cause the problem in the first place), would stimulate commerce, and loan approvals which would increase the banks’ income.

And Best of All, it would stimulate the economy by restoring credit availability without costing the government or taxpayers a dime!

Posted to Business Lines of Credit, Buyer Financing, Institutional Lending, Money & the World, Uncategorized
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I got an email from a subscriber that asked: “If a investor can give you 100% money to invest in real estate. What is the best JV arrangement you can offer him to have a workable and sweet agreement acceptable to both parties? (investor is sophisticated accredited investor).”

This is a great question, and there are 2 issues you need to address to raach an answer:

1. What are the expectations of the lender?

2. What can your deal afford to offer?

The first question is easy.  Just ask the lender!  They’ll usually tell you.  Find out what kinds of returns they’ve gotten on other investments they’ve made.  Also, establish their risk level.  For example, someone who invests in start ups may have made a killing on one particular company, but other companies may have been a total bust.

It’s not likely you can offer 10 fold returns on a real estate investment if your investor is funding the total acquisition cost.  This is why it is important to establish with your investor, what their return and risk balance is.  Real estate has less risk and more security (when you know what your doing), than most other investments.  (Return OF investment is important to all investors).  And you can add an ”equity kicker” to your offer to increase the return for the investor.

However, how high you can go, or how much you can sweeten the pot depends on your deal.

To decide this question you need to consider:

1. The cashflow and profit generated by your transaction projected over the time until you pay off the investor.

2. The financial risk - that is, in the worst case scenario, you should be able to still pay your investor what you promise.  This is critical, because losing money for an investor is going to put a mighty big dent in your ability to raise money from other investors.

This is not a trivial exercise.  To project your return from the deal, you have to factor in rental increases, expense inflation, all the operational costs including managing the property, appreciation rates, carrying costs, selling or refinance costs, etc.  And you should make conservative assumptions.

The second and more difficult challenge is factoring in the financial consequences of what happens when things don’t go according to plan.  Like, what if you have to evict a tenant(s)?  What if the renovation takes longer and costs more than you predicted?  What if the property doesn’t appreciate as much as you’d hoped?

You cannot afford to look at your deal through “rose-colored” glasses.  You need to have a “Show Me the Money” attitude.  In other words, what do the numbers show when the deal is subjected to various “worst case” scenarios. 

And, finally, once all the numbers are in front of you, you have to decide how much you’re going to want to take away for yourself.  Once you have your bottom line, you can calculate the maximum amount the deal can pay your investor.

Now, all these analyses and calculations are probably daunting to most investors.  Especially the work of making the risk analysis.  However, there is one piece of software that can reduce this entire task to a 5 min exercise.  Just plug in the numbers and read off the results. 

It is an expert system we’ve developed, called the Deal Evaluation Tool.  It is the result of our 10 years experience doing all types of real estated deals, and conversations with many experts.

I use it for every opportunity that comes across my desk.  After fine tuning it with a nice return for us and our investors, and taking account of the risks, I use to to make offers, and negotiate deals.  With it, I am always in a strong negotiating position, because I know my bottomline and when to say “Deal or No Deal”.

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You may have heard, the President signed the “Economic Stimulus Act of 2008″ into law.  Basically, it’s a big hand out to Fannie Mae, and Freddie Mac.  The Banks that caused the whole mortgage meltdown in the first place, are also likely to scoop up some of the cash.

But how will it affect us investors, let alone the homeowners?

Well, for starters, homeowners are still screwed.  You see, the act allows Fannie Mae to underwite mortgages to a higher amount, and it raises the limit for FHA loans requiring a 3% down payment.  Sounds, great, right? 

But think about it?  If you’re selling home and requiring your buyer to obtain financing, what is the major challenge?  It’s not the down payment or the limit on the loan amount–it’s the buyer’s credit qualification.  And as you are probably aware, banks have raised the bar considerably.  The minimum credit score is much higher, stated income loans and no doc loans are virtually non-existent, debt-to-income ratios are lower.  That has pretty much eliminated a large chunk of the buyer pool.

So, selling to owner-occupying buyers is going to remain difficult, and if your potential buyer has to sell their current residence before they can buy yours- well… Let’s just say I would NOT advise a seller to allow a financing contingency in the purchase and sale agreement.

Now, how about another benign sounding provision–a hand out to cities and towns with high foreclosure rates to buy up REO’s, fix them and sell them.  It’s obvious, that if you are an investor competing against one of those grants, your out of luck.  Banks of course, are going to benefit, because they’ll be able recoup practically all their costs on these bad loans, with free money.

And what else will happen?  These grants are going to depress property values in any area they are used.  Why, because the government entity is going to be motivated “as a public service” to sell these houses cheap, so more of their residents can own the American dream.  If you’re in the real estate buying mode, wait for the drop before you buy.  If you’re in the selling mode, you are just going to have to wait even longer to cash out your equity.  Be sure you have a positive cashflow, because you’re going to be waiting for quite a while.

So, as usual, the government has meddled with the economy using our tax money, to support the big campaign donors - the banks and the mortgage establishment.  Everybody else, is just SOL.

The solution to the housing crisis is one heck of a lot simpler and straightforward.  To slow down the foreclosure firestorm, give all homeowners with adjustable mortgages the right to negotiate loan modifications to convert to fixed rate, retroactive to the beginning of first adjustment period.

Second, and most importantly, is get the lending institutions to roll back, some of their stiff borrowing requirements.  The lending criteria were not unsound in the first place.  It was the banks own underwriting sleight-of-hand, that caused the crisis.  Because, they allowed the borrower to qualify for the mortgage based on the artificially lowered 1st year (or 6mos or 2y) payment, instead of the rate when the loan readjusted.  This allowed them to collect big loan origination fees from people who couldn’t possibly afford to pay the mortage payments once they adjusted.

Of course, to implement this, banks would have to admit to their greed and avarice that caused the problem.  That ain’t gonna happen.  Speak about “truth in lending”! Ha.

Posted to Buyer Financing, Institutional Lending, Money & the World
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WIIFM

This acronym stands for “What’s in it for ME”.   And if you want to interest anybody in your project, it is the first question in their mind that you have to answer.  It’s not about your deal, or how much you know.  It’s about them and what they want.

Remember Dale Carnegie’s famous book “How to Win Friends and Influence People”.  It was published in the 1930’s and is as true today as it was then–because it talks about a fundamental truth of human nature!  After all, what you are looking to do with a private lending prospect is to:

1. “win friends” - that is build their trust

2. “influence them” to invest in your project.

Well, it is part of human nature to ask “What’s in it for ME”.  Even altruists, and saints ask that question same as a business person or a wealthy person.  The only difference might be what they consider a good reward to be.

So, in order to communicate with anyone, you have to first get their attention, and keep their interest.  And the  best and simplest way to do that when you want their money, is to tell them what their going to potentially get if you listen to you.

You could start off a conversation by saying something like, “Joe, Do you have an IRA or other investment capital, that’s not earning 15% and secured by real estate?”  Of course you will modify this depending what return your planning to give, and what security (if any) there is for the investment.   Or you could try: “Pam, would you be interested in earning 15% on an investment secured by real estate?”

Now, if the person says no–end of conversation.  However it’s been my experience that most people will at least want to hear you out.  And, of course, it’s much easier talking about your deal to someone who is already interested, than someone who’s resisting or bored.

Now, a lot of students ask me “how much should I offer a private lender”.   Well, the only true answer is that depends.  The key is to know what kind of return the person is normally getting from their investments, and what would be a significant improvement over that. 

For example, with friends and family who I would generally classify as unsophisticated investors, their investment experience consists of savings, CD’s, stocks and mutual funds.  Savings and Cd’s don’t even keep up with inflation.  The stock market has been rather pathetic over the last ten years producing a measly 2.5% annual return.  So for these private money prospects, a 10-15% return should sound pretty good.

For more sophisticated investors and high net worth individuals, a higher rate of return is expected since they have many more investment options. 

However, there is one more key consideration:  How much can your deal or project afford to pay an investor.  If you are offering regular interest payments is the cashflow sufficient so that you can pay your investors, even in the worse case scenario.  The answer had better be yes.  More on that next time.

By the way, if you want to learn everything you need to know for private lending success, I’ve created the absolute best and most comprehensive funding manual you will ever see called “Show Me the Money“.  It contains step by step instructions on how to get money from private lenders, high net worth individuals, lines of credit, financial institutions, buyers, sellers, notes, and much, much more.   And, it’s a ridiculously low investment (for now!).  Click here and Get in NOW.

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I saw an article in a recent issue of Forbes about guy who is buying foreclosed properties at the steps.  The article relates how he bought 2 properties worth $725K for $400K each using $120K in savings and $680K from a line of credit.  He sold the homes 6 weeks later for $689K each, and netted $485K from the total transaction. 

Not bad for 6 weeks work.  Now this guy had a credit score of 819, which allowed him to get preferential treatment from the bank offering the 680K mortgage.  The article didn’t say what his income was.  However, you can see what a really good credit score can do for you.   Now, most folks don’t have credit scores in that range, but I know where you can go to raise your score to that level and you don’t have to do a thing except fax in credit reviews that you recieve in the mail (you also have to stop doing any stuff that’s ruining your credit, like paying late, etc.).  For those of you that want to check it out, go to: http://www.investorwealth.com/credit.

Now, as big money goes, the $800K that this guy used, sounds like a lot, but it really isn’t.  Let’s suppose you really wanted to flip houses in bulk.  After all, most real estate investors know how to do this.  They just don’t have the money.

Well, suppose you found some private lenders, that you agreed to pay 15% for the use of their funds and that money would be paid back in 3-6 months.  That’s a pretty awesome return on their investment.  Furthermore, why buy properties on the steps?  It’s hot, sweaty, takes a lot of time, and your carrying around big cashiers checks you may or may not use.

Better, call the banks directly and ask for the REO department.  Now, if you want to buy a single house, they may not be interested.  However, if you want to buy say 10 per month, that will not only get their attention, you can probably get an even better discount.  In fact, a colleague of mine is doing exactly that, and picking up homes at 40 cents on the dollar.

Now suppose after all is said and done, he makes $100,000 per house and is selling them well below market.  That would net him $1 Million per month!  Great plan–yes?  If your buying 10 homes at $200K each, that’s $2Million per month of funding.  So all we need is the money.

Unless you’re fantastically wealthy this is not a game you’re going to be playing with your own resources.  You’ll want to be talking to high net worth individuals like angel investors, private fund managers, and financial planners with high net worth clients.  For some this would still be too small an investment.  And there are others that would be excited to participate in the opportunity.

Want to get stared.  There’s some groundwork and preparation you’ll need to establish yourself as a credible investment option to these sophisticated investors.  Doing so, is a pretty straightforward process.   

To get started I highly recommend you get your hands on my “Show Me the Money” training manual.  There are several chapters devoted to raising private money, including millions from high net worth individuals.  Just use this link or click on the icon on the right side of this page.

Do this right and the current foreclosure crisis will make you one the high net worth individuals your desiring to borrow from right now.

Posted to Angel Investors, Business Lines of Credit, High Net Worth Lenders, Multiple Funding Strategy, Private Lending
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