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

Everyone’s worried.  The media and candidates are having a field day blaming their favorite scapegoat.  Should we fire bank CEO’s? Should we nationalize banks? And how can we “Make sure this never happens again?”

Congress wants to make laws (of course) with more stringent regulations (that will probably only screw the small investor).  So, let’s take a step back and take an objective view of how this problem developed.

Craig Nichols wrote me last month with a very perceptive comment about the “mortgage meltdown:  “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.”

Let’s follow the trail from here. 

First, let’s understand, banks like insurance companies lend money (or write policies) based on a mathematical assessment of risk - it’s called underwriting.  For banks, based on credit score, debt to income ratio and other parameters, the lender can decide to whom and how much to lend to keep defaults (losing the investor’s money) to a minimum. 

Congress of course failed to understand this (or more likely ignored this) so they could get a social pat on the back from constituents who could now buy homes.

Now we get to the next disconnect.  The banks certainly knew the consequences of “relaxing their underwriting standards”.  However, with a mandate and pressure from Congress and the opportunity to make literally Billions in more revenue, the entire system of checks and balances was subverted.

Qualification requirements were certainly relaxed, but this is not what caused the major damage.    To really open the revenue floodgates that the banks’ shareholders were now expecting, the banks had to vastly expand the pool of available homebuyers.  They did this with the indiscriminate use of  ”no doc”, “stated income” and “adjustable rate mortgages (ARM)”. 

“No doc” and “stated income” allowed borrowers with decent credit scores to lie about their income.  Thus, allowing many who clearly would not qualify based on their ability to make the mortgage payments to get loans. 

The ARM’s gamed the underwriting system, since qualification was based on the income needed to make the payments on the abnormally low first 6 mo or 1 year “teaser rate”.   These rates got so ridiculous that homebuyers making $30,000 a year were qualifying to buy $500,000 homes!

But, the real killer with the ARM was, that when the rate re-adjusted, to a higher than average interest rate, default was virtually inevitable.  And this sowed the seeds for the enormous disaster that has come to pass.

So, how did the stock market become involved.  Well, most banks do not hold the mortgage notes they lend on.  They package these notes into “Mortgage Backed Securities” (MBS) and sell them to Wall St with the help of Freddie Mac and Fannie Mae - 2 semi-private (until now) corporations. 

 Now, these 2 corporations (probably also motivated by greed) did something that was financially unconscionable and unethical.  They packaged and sold these loans to Wall St as if they were “A” paper with investors paying premium pricing, for loans that were very likely to go into default.  That paper was actually worse than “sub-prime” because the possibility of default was almost certain.  I doubt Wall St would have bought these loans or at least downgraded them to junk bonds, if they knew the real risk.

So, when the foreclosures started mounting, everyone from the banks to the big Wall St brokerages houses went down, precipitating a worldwide financial crisis.  

Personally, I don’t know how to fix this.  It is certainly unclear whether the 100’s of billions of dollars are going to make a difference or even the right difference.  However, do have a suggestion to help avoid having this type of thing happen again.

First, we don’t need more regulations.  It wasn’t the banks that started this, it was Congress who made a bad law, whose consequences they didn’t forsee or chose to ignore.  After that, the profit motive, greed and human nature (none of which is going to change) took over.

So, what can we do, to protect us from our lawmakers.  In the Constitution, we have checks and balances.  An executive branch has the power veto, and the judiciary has power to strike down bad laws (after the fact).

What we need is a separate branch of government that can quash bad laws or laws with serious “unintended” consequences before everyone suffers.  So, let’s set up a new branch of government - the Oversight of Unintended Consequences”.  A branch that would be free political considerations and could point out to the American people and Congress the serious repercussions of ill-thought out laws and regulations.  Perhaps, there could a sort of “legal underwriting”  that could assign a “threat score” to any proposed regulation.  Only proposals with a threat score under a certain threshold would be eligible to become law.

What we have now is the consequence of a very bad law, that took 13 years to threaten total financial meltdown.  And by the way, even if the 700 billion solves the problem, it’s a cost that is coming out of our pockets, and is weaking the economic strength of our country. 

And how many other “bad laws” are going to have very unpleasant consequences that we have not yet forseen.  We have the intellectual resources and technology to make such forecasting a reality.  Maybe we should consider it before the next disaster overtakes us.

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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!

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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.

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In real estate, you don’t get what you pay for.  Instead, successful investors pay for what they get.  This is especially true for buying income properties. 

I saw a recent article with the headline “Office Fundamentals weaken in the 2nd Quarter (2008)”.   The article went on to point out that the vacancy rate in office buildings nationally was increasing due to decreasing demand even with low delivery of new space.  And that surburban offices are feeling the biggest crunch.  In fact, an accountant friend of mine, just gave up his surburban office in favor of his downtown office.

Obviously, this is a symptom of a weakened economy, brought by greedy banks that caused a mortgage crisis and credit crunch that are percolating through the economy.

Does this mean you should not invest in office buidings.  Not necessarily–especially if you only pay for what you are buying. For example, if you are considering a half-empty office building only offer a price based on the income from a half-empty building. In fact, considering the trend in office occupancy is negative, it is crucial to examine the stability of the current tenants in the property.

Also, just like we advise investors in single family homes to build a buyer’s list, buyers of commercial property need to created a “tenants list”. You also need to expect that in a buyers market, your prospective tenants are going negotiate harder for greater concessions, and lower rents.

You’d better take all these factors into your projections and factor them in to your offering price. Now, you may be thinking, “but, Richard, if I do that, who’s going to take that deal?” Hah. The answer is only the sellers who are motivated to do business with you on your terms. If not, NEXT! At least you’ve saved yourself the financial stress of a money-sucking investment.

I know it can be quite a chore to go through the complex analysis of the kind I’m suggesting. Well, I’m happy to say, you can cut the time to minutes if you use my Expert System, called the ‘Deal Evaluation Tool.’ Not only can you project for up to 10 years in the future, the profit, and cashflow of any type of property, and model any kind of scenario of financing, rent, and occupancy changes, etc. You also get expert advice on the amount of financial risk you are taking. A rosy profit picture isn’t worth much if the chance of failure is high. Anyway, if you want to get a copy of this amazing tool, just click here. (or you can get it for Free if you are a member of our Inner Circle).

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Posted to Commercial Lending, Institutional Lending, Marketing in Real Estate, Money & the World, Uncategorized
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Every real estate investor with half a brain, knew that when the banks started giving out ARM’s (adjustable rate mortgages) like candy, somebody was going to have to pay the piper someday.  Well that day has come!

But instead lambasting the banks who are now causing some much suffering throughout the economy, the Feds and Congress are devising “bail out” plans. Never mind the strapped homeowners who banks refuse to do workouts for… Nevermind the investors who can’t get lines of credit or investor home loans because of “tightened” credit requirements.

Just read the following sweet deal that the 2 largest mortgage lenders are getting, even though they’re losing massive amounts of money, and the equity from their stock price is in the toilet:

“The Fed said it granted the Federal Reserve Bank of New York authority to lend to the two companies “should such lending prove necessary.” They would pay 2.25 percent for any borrowed funds — the same rate given to commercial banks and big Wall Street firms.
The Fed said this should help the companies’ ability to “promote the availability of home mortgage credit during a period of stress in financial markets.”

Secretary Henry Paulson said the Treasury is seeking expedited authority from Congress to expand its current line of credit to the two companies and buy shares of the companies — if needed.”

Do you think maybe these institutions could extend investors (who really are the creative engines in the real estate market) increased lines of credit at lower interest rates?

Especially since real estate is really a good deal now for those who know how to choose wisely.  If you’d like to start choosing more wisely, and be able to convince private lenders of that fact, you should check out my Expert System called the Deal Evaluation Tool.  In not only precisely calculates your profit and income for 10 years down the road, it also quantifies the risk so you know what to avoid, BEFORE you sign the contract!

Posted to Business Lines of Credit, Commercial Lending, Institutional Lending, Money & the World, Private Lending
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I was forwarded an email the other day, that was apparently sent by Delta, and United (at least) to airline customers complaining about the high price of fuel and blaming the “speculators” for driving up prices, and urging the recipients to support “regulatory limits” (whatever that means).

This has got to be the stupidest, most hypocritical and whiny communication I’ve ever seen from a public corporation. 

Why is it stupid?  Because we live in a free market economy.  Without it there’d be no Delta or United Airlines, nor any of our blessed prosperity.  For these products of the American Free Market economy to complain about the free trading of oil as a commodity is ridiculous.  By their reasoning we should also have “regulatory limits” on gold, platinum, cocoa, pork bellies, orange juice, sugar cane and a hundred other items that are traded on the commodities exchanges.

And, oh yes, how is anyone, even the US going to regulate a commodity that is traded world wide?–Artificially impose a price control?  No one will sell us oil–obviously not a solution.

Why are the airlines hypocritical.  Because I bet that the airlines themselves buy and sell oil futures.  Just like farmers buy and sell corn and wheat futures.  Heck, if fuel were so important to my business, that’s what I’d do.   So what are they whining about?  Did they make a bad commodity play?

Aside from all this silliness, there is a fundamental truth that every successful entrepreneur should hold to.   Do not speak or think in ways that disparage money–like profits made by smart investors (who are no more speculators than anyone who buys a stock hoping it will go up).  If you express, envy, or anger at financial success of anyone, all you’ll accomplish is to chase money out of your life. Just look at Delta!

If Delta, decided to take an entrepreneurial approach, they’d be examining their business model to make it more competitive with the leading airlines, and raise ticket prices if necessary.  Why don’t they raise their price?  The only reason I can think of is that other airlines that operate more efficiently will take business away because they don’t have to raise prices.  That’s called competition. 

In dictatorships like China, they can just raise prices without improving service, efficiency or anything else.  If that’s what Delta needs, they should move to China.  Otherwise, they should get a grip, and take care of their business and stop whining to the public–it’s appalling and insulting.

Posted to Money & the World
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