Private Mortgage Investing

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
AJ290
Posts: 3
Joined: Sat Mar 22, 2008 3:28 pm

Private Mortgage Investing

Post by AJ290 » Sat Mar 22, 2008 3:32 pm

Hello, all. I'm new here and glad and I found this place. Hoping to share what I know and what I need to know.
I'm looking to park some cash in an investment that is both safe and provides a healthy return, (aren't we all?).
I know a real estate investor who is offering an 11% return if I fund his deals and act as the bank for him. He would bring me the deal and I say yay or nay. I'm protected by the equity in the deal, (at least 30% below appraisal).
I've got the cash, and I'm not interested in earning 3% in a CD.
What do you think? Thank you.

Gordon
Posts: 331
Joined: Tue Feb 20, 2007 4:56 pm
Location: Lake Havasu City, Arizona

Risk

Post by Gordon » Sat Mar 22, 2008 3:46 pm

The 3% CD return is currently a relatively safe return. The 11% return is about 4 times riskier. I would ask for a promisory note whose primcipal and accrued interest is guaranteed by a bank.

Topic Author
AJ290
Posts: 3
Joined: Sat Mar 22, 2008 3:28 pm

Post by AJ290 » Sat Mar 22, 2008 3:54 pm

Hi, Gordon. Thanks for the quick reply.
I agree. Safety first always. With that said, I know the individual and he is an experienced real estate investor. Still, there are some assurances in place. These include: a promissory note from the individual; the mortgage is recorded with the County, of course; a homeowner's insurance policy will be in place on every deal; the LTV will be a maximum of 70%; and all funds go from my account to the attorney or the title company; and lastly, I can pick and choose the deals I want to fund.
So when I look at the big picture, in today's environment a return of 11% with what I consider low risk seems like a good thing.

User avatar
DiscoBunny1979
Posts: 2013
Joined: Sun Oct 21, 2007 10:59 am

Post by DiscoBunny1979 » Sat Mar 22, 2008 4:36 pm

AJ290 wrote:Hi, Gordon. Thanks for the quick reply.
I agree. Safety first always. With that said, I know the individual and he is an experienced real estate investor. Still, there are some assurances in place. These include: a promissory note from the individual; the mortgage is recorded with the County, of course; a homeowner's insurance policy will be in place on every deal; the LTV will be a maximum of 70%; and all funds go from my account to the attorney or the title company; and lastly, I can pick and choose the deals I want to fund.
So when I look at the big picture, in today's environment a return of 11% with what I consider low risk seems like a good thing.
-----------------------
Don't want to get too technical, but a promissory note to repay at a certain rate of return isn't necessarily all I would want as security. Depending upon the kind of $$$ we are talking about, I would much prefer to be added to title so there's some guarantee of repayment if he defaults.
For instance, a promissory note to repay a few thousand dollars might be ok, but to borrow 25K or 50K without additional security against the property, not just the borrower, is risky.

Just exactly how many deals is this person going to be involved with at one time? How many other people is he going to be "borrowing" money from that there's a pool of projects that you could pick and choose from, even if they come along at an individual basis over time?

One of the problems with this deal is that the "interest" is taxable income. However, if you were added to title and made to appear as your "Primary Residence" but flipped the property after 2 years, any profit would be tax free up to $250K. Therefore, I would have a deeded vested interest in the property for a certain %, rather than getting interest paid to me.

This brings up the subject concerning Home Owners insurance, and that as an investor I would want to see just exactly what is covered under the policy if the property is not going to be used as a Primary Residence. What kind of policy is in place concerning fire, flood, earthquake, theft, vandalism?

The other issue is that of time. How long will your $$$ be outstanding? Does this person have enough assets and ability to pay you off once the project is complete, but hasn't sold yet? Or, do you only get repaid once the project sells to someone else?

I suppose that the higher interest rate he is willing to spend is compensation for your risk, possibly the fact that he is taking on additional financial risk himself, and that you can't demand to get your money back, except to the extent to which the contract is written. So, since he has his own Lawyer helping with these deals, I suggest reading all contracts with a magnifying glass and when they say you don't have to read the small print, just 'sign here' - be extra cautious.

xenial
Posts: 2651
Joined: Tue Feb 27, 2007 1:36 am
Location: USA

Re: Private Mortgage Investing

Post by xenial » Sat Mar 22, 2008 5:07 pm

AJ290 wrote:I'm looking to park some cash in an investment that is both safe and provides a healthy return, (aren't we all?).
There's no such thing. Safe investments have low expected returns. High expected returns come with high risk.
AJ290 wrote:I know a real estate investor who is offering an 11% return if I fund his deals and act as the bank for him. He would bring me the deal and I say yay or nay. I'm protected by the equity in the deal, (at least 30% below appraisal).
I've got the cash, and I'm not interested in earning 3% in a CD.
What do you think? Thank you.
Question: Why do you think this entrepreneur is offering you 11%?
Answer: Because nobody will accept 10%.

Unless the entrepreneur is really stupid, he wouldn't be offering such a high rate of return unless he had to. Apparently other investors (e.g., banks) consider this venture too risky to finance at a reasonable interest rate.

Best wishes,
Ken

User avatar
astroturf
Posts: 548
Joined: Sun Aug 26, 2007 9:40 pm
Location: Greater NYC Area

Post by astroturf » Sat Mar 22, 2008 5:11 pm

Find yourself a very good (and honest) real estate lawyer before you enter into such deal.

The mortgage business when done privately is very risky. With the passing of the bubble there's plenty of desperate sellers and it's just fertile ground for all sorts of fraud. And, if it's too good to be true, it's too good to be true.

pkcrafter
Posts: 13401
Joined: Sun Mar 04, 2007 12:19 pm
Location: CA
Contact:

loan

Post by pkcrafter » Sun Mar 23, 2008 8:36 am

Your idea has 'NO' written all over it. You are looking only at a fat potential return and the fact that you know the person. This does not diminish the risk. He's asking you because no financial institution will loan the money. Good way to lose your money and a friend.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

malloc
Posts: 459
Joined: Sat Dec 01, 2007 10:14 am

Post by malloc » Sun Mar 23, 2008 9:35 am

How are you with a hammer?

Seriously, I know of a case with all the safeguards you mention in place, but the new owners got into serious trouble.
By the time they vacated, the house was rundown and unfortunately had problems for which a contractor was required.
In such a case, to protect your investment you may end up owning the house.

I was recruited to help.
It was not fun.
Be VERY careful if you do this that YOU inspect the property yourself.
If it is your money on the line, make sure that your eyes are involved.

The broker makes his money by closing the sale and then he is no longer involved.
If the equity is not really there, then it is you who is at risk.

Valuethinker
Posts: 38122
Joined: Fri May 11, 2007 11:07 am

Re: Private Mortgage Investing

Post by Valuethinker » Sun Mar 23, 2008 10:07 am

AJ290 wrote:Hello, all. I'm new here and glad and I found this place. Hoping to share what I know and what I need to know.
I'm looking to park some cash in an investment that is both safe and provides a healthy return, (aren't we all?).
I know a real estate investor who is offering an 11% return if I fund his deals and act as the bank for him. He would bring me the deal and I say yay or nay. I'm protected by the equity in the deal, (at least 30% below appraisal).
I've got the cash, and I'm not interested in earning 3% in a CD.
What do you think? Thank you.
in a word: No.

If you have that kind of money to invest in real estate, do it yourself, directly.

Risk and return are correlated, and what you are being offered here is a high risk investment.
I am not interested in earning 3% in a CD
Then you should stay away from this forum. Most of us understand that 3% in a CD is better than, say the 1% that CDs in Japan have paid over the last 10 years.

And that stocks are likely to return about 8% in the years ahead. Which is about their long run average return (4.5% adjusted for inflation).

Topic Author
AJ290
Posts: 3
Joined: Sat Mar 22, 2008 3:28 pm

Re: Private Mortgage Investing

Post by AJ290 » Sun Mar 23, 2008 10:22 am

Valuethinker wrote:. . .Then you should stay away from this forum.
Wow. So if someone disagrees with you, get the hell out? Consider it done.

yobria
Posts: 5978
Joined: Mon Feb 19, 2007 11:58 pm
Location: SF CA USA

Re: Private Mortgage Investing

Post by yobria » Sun Mar 23, 2008 10:45 am

I have a friend who invests in private mortgages. He and his father, who's a real estate attorney, have been doing it for 20 years with no defaults. They go through a third party broker who finds the deals and spreads their investment among a number of properties.

While the notes do pay 11 - 14%, the broker takes a cut, and there's cash drag since the borrowers tend to pay off these high rate loans ASAP, and then you wait for the next one to come along. Also, these investments are not tax friendly and best done through an IRA (as my friend does).

A couple of years ago I convinced my friend to diversify out of these things and invest half his portfolio in low fee index funds. He did; his father ignored my advice. So far, I don't look so smart. :)

Nick

smackboy1
Posts: 1084
Joined: Wed Mar 14, 2007 9:41 pm

Post by smackboy1 » Mon Mar 24, 2008 12:42 pm

In theory there's nothing wrong with investing in private real estate deals. As long as you understand the risk/reward equation and it's part of a diversified portfolio. Here some things to think about when analysing these investments:

1) How are these investments set up? Are you an equity partner with a piece of the upside if the property returns more than expected? Or just a lender who gets paid a fixed rate?

2) Does the developer have their own capital at risk? How much? When does the developer get paid? First? Or last, only after all the lenders and other partners get paid.

3) How is the debt securitized? Mortgage against the property? What is the lien priority? Is there a commercial lender first in line? Is there a personal guarantee or there only recourse against the property? Are there cross collateralization agreements between many properties?

4) What is the nature of the income stream from the property? Zero e.g. raw land, vacant? Single tenant? Multiple tenants? Residential or commercial? Gross leases or triple net leases?

5) How is the developer going to add value to the property? Physical improvements? Increase tenancy? Rezone?

6) What is the term of the investment debt? Can the developer prepay the debt after a short time by say, establishing a stable income stream, then refinancing at a lower rate?

7) Brokers and developers like to emphasize only the good things in the teaser materials, but what would the outcome be if it all went to hell and the developer walks away? What is your liability?
Disclaimer: nothing written here should be taken as legal advice, but I did stay at a Holiday Inn Express last night.

Valuethinker
Posts: 38122
Joined: Fri May 11, 2007 11:07 am

Re: Private Mortgage Investing

Post by Valuethinker » Mon Mar 24, 2008 1:23 pm

AJ290 wrote:
Valuethinker wrote:. . .Then you should stay away from this forum.
Wow. So if someone disagrees with you, get the hell out? Consider it done.
Sorry no I didn't mean that.

What I meant was the contributors of this Forum are likely to tell you things you don't really want to know. Hence stay away:

ie that risk and return are correlated, and that there are no free lunches.

3% CDs pay 3% because they are safe.

Valuethinker
Posts: 38122
Joined: Fri May 11, 2007 11:07 am

Re: Private Mortgage Investing

Post by Valuethinker » Mon Mar 24, 2008 1:24 pm

yobria wrote:I have a friend who invests in private mortgages. He and his father, who's a real estate attorney, have been doing it for 20 years with no defaults. They go through a third party broker who finds the deals and spreads their investment among a number of properties.

While the notes do pay 11 - 14%, the broker takes a cut, and there's cash drag since the borrowers tend to pay off these high rate loans ASAP, and then you wait for the next one to come along. Also, these investments are not tax friendly and best done through an IRA (as my friend does).

A couple of years ago I convinced my friend to diversify out of these things and invest half his portfolio in low fee index funds. He did; his father ignored my advice. So far, I don't look so smart. :)

Nick
If you look at the current experience of Residential Mortgage Backed Securities, and what some of the data on CMBS are saying, then the thing may yet come your way.

The market is signalling some pretty unpleasant defaults to come. Yes, things are oversold, but that also can become a self-fulfilling prophecy.

I don't think we are anywhere near the bottom, yet.

Note with exceptions like New England and California in the early 90s, and Texas in the mid 80s, the US has not been through anything like the current property situation in a very long time.

And that when inflation is low, valuation corrections take the form of price falls and losses on *nominal* assets, not just the case when inflation was running 10%, and prices went nowhere for a couple of years (real fall of 20%, but nominal fall of 0%).

*that* makes the situation quite different, and more like the 1930s than any time since.

I wouldn't say the US is headed for a Japan (if only because the Fed is being much more proactive) but that risk is out there.

Splash
Posts: 102
Joined: Sat Aug 18, 2007 10:25 pm

Post by Splash » Mon Mar 24, 2008 1:36 pm

This has troll written all over it.

As they say: If it sounds too good to be true......

User avatar
stratton
Posts: 11082
Joined: Sun Mar 04, 2007 5:05 pm
Location: Puget Sound

Post by stratton » Mon Mar 24, 2008 2:49 pm

Credit crunch brings business to hard-money lenders
His company's loans typically carry annual interest rates of 9 to 10 percent, says Odegard, while the broader hard-money sector is "anywhere from 9 to 18 percent, depending what kind of borrower, what kind of risk."

Key to a hard-money loan is that the lender finances just 60 or 70 percent of the property's value — unlike conventional lenders and their 80 or 90 percent loan-to-value programs.

"Borrowers with a high percent of equity at stake have a tendency to protect that and make their payments," says Odegard.

"At any given time we could have as much as 10-12 percent of our portfolio in nonperforming status," he adds, but only about 1 percent of properties are actually taken back.
Paul

Valuethinker
Posts: 38122
Joined: Fri May 11, 2007 11:07 am

Post by Valuethinker » Mon Mar 24, 2008 3:33 pm

Splash wrote:This has troll written all over it.

As they say: If it sounds too good to be true......
There may be a real business there... from the quoted article, there is. Perhaps a bit akin to owning and operating commercial real estate.

But it's a business .

A business is something that you devote real time to, real hours, and real sweat.

I've owned a business. It's not something that you do in alternative to owning 3% CDs.

Valuethinker
Posts: 38122
Joined: Fri May 11, 2007 11:07 am

Post by Valuethinker » Mon Mar 24, 2008 3:37 pm

stratton wrote:Credit crunch brings business to hard-money lenders
His company's loans typically carry annual interest rates of 9 to 10 percent, says Odegard, while the broader hard-money sector is "anywhere from 9 to 18 percent, depending what kind of borrower, what kind of risk."

Key to a hard-money loan is that the lender finances just 60 or 70 percent of the property's value — unlike conventional lenders and their 80 or 90 percent loan-to-value programs.

"Borrowers with a high percent of equity at stake have a tendency to protect that and make their payments," says Odegard.

"At any given time we could have as much as 10-12 percent of our portfolio in nonperforming status," he adds, but only about 1 percent of properties are actually taken back.
Paul
Further to that (from the same article)
But higher loan rates don't mean hard-money lenders can't collapse just like some of the big subprime lenders did.

Partners Mortgage of Seattle, with an $80 million portfolio of real-estate loans and foreclosed property, filed for bankruptcy protection in late 2003. Soon after, an outside consultant concluded its holdings might be worth only $54 million.

An interim CEO found that its many management problems included poor lending practices, inadequate staffing, questionable appraisals and insufficient reserves for bad debt, according to court documents. These days, that sounds familiar. Odegard says times like these attract more people into the private lending business, "but they all get in with the fantasy that it's easy. ... You've got to remain disciplined."

"Private lending, when done right — every loan makes sense," he says. "Subprime had the actuarial approach — the good will pay for the bad. They factored in that some of it was crap; they just didn't realize how much of it was."
I thank the original poster for alerting me to the existence of this business (which is intellectually interesting to know) but I stick with my assessment: if you are a principal, doing the deals, learning with each deal, then great.

If you are an investor in such a business, providing credit, then you have a very different risk-return profile.

User avatar
stratton
Posts: 11082
Joined: Sun Mar 04, 2007 5:05 pm
Location: Puget Sound

Post by stratton » Mon Mar 24, 2008 5:20 pm

Valuethinker wrote:If you are an investor in such a business, providing credit, then you have a very different risk-return profile.
It looks like junk bonds. If you're looking at ~12% interest then its probably low rated junk. Definitely not the same as a CD.

Paul

JDCPAEsq
Posts: 1835
Joined: Mon Mar 05, 2007 3:58 pm
Location: Southwest Florida

Post by JDCPAEsq » Mon Mar 24, 2008 7:06 pm

There was a wealthy high-roller-type fellow in Naples, Florida a few years back who was taken for millions funding mortgages just like you describe. Turns out he was being furnished with phony documents and the funds were going straight into the agent's pocket. As others have advised, run don't walk.
John

malloc
Posts: 459
Joined: Sat Dec 01, 2007 10:14 am

Post by malloc » Mon Mar 24, 2008 9:42 pm

This is a business where you can make a very good income (good income = risk in this market as well).

Success depends on your judgement. The broker should be a big help, provided he is interested in an ongoing relationship and not just a quick buck for himself.
It is an arrangement that should be mutually beneficial for both.

But if the market turns south - and we know now that that is possible - or if the owner gets into trouble with his job, marriage, the law.....or whatever, YOU are exposed.

Make sure that you are very selective in the people, the property, the equity in the house, and the local market.
You can get burned (see previous post).

User avatar
stratton
Posts: 11082
Joined: Sun Mar 04, 2007 5:05 pm
Location: Puget Sound

Post by stratton » Mon Mar 24, 2008 10:54 pm

malloc wrote:Make sure that you are very selective in the people, the property, the equity in the house, and the local market.
You can get burned (see previous post).
You'll come closer to the risks if you consider this like small cap equities.

Paul

Post Reply