PRIVATE LENDER THE OFFICIAL EZINE OF AAPL MARCH /APRIL 2014
GOT MONEY? NEED MONEY? CONFERENCE PREVIEW INTERVIEWS WITH JJ PAWLOWSKI & MARK J. KOHLER WHERE TO GO IN KANSAS CITY
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Act S NS the JOB lan I SOpact of n exit p eal L A al im ed a ght d ne he ri re u e o t h ∞ T Why y pick to ∞ w o ∞H
Private Lender CONTENTS
March/April 2014
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Editor’s Note Much to look forward to By Matt Benson
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Lender Limelight JJ Pawlowski owns Kansas City Investors Funding, LLC, the title sponsor for the 2014 Got Money? Need Money? Conference.
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Got Money? Need Money? Conference Preview • Catching up with Mark J.Kohler • Staff Picks
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Timing Matters Private lending is like baseball. Pick the wrong deal, and you’ll strickout no matter what stadium you place in. By Harry Kunelis
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How to Manage a Reg. D Security Like raising a family, the responsibilities of a fund manager are complex and diverse. By: David Owen, Robert Buchanan & James Rincon
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Finding Value in a Rising Price Environment Non-performing second mortgage notes are worth a deeper look. By: Robert Hytha & Aaron Jones
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The Exit Plan By putting an exit plan in motion at the beginning of the deal, you are more likely to have a qualified client at maturity. By: Ian R. McSevney
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The Real Impact of the JOBS Act It covers so much more than crowdfunding By Jillian Sidoti
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Dodd-Frank: Your Investment and You Avoid inadvertent violations of Dodd-Frank by learning how to effectively communicate with appraisers. By Jason Ormiston
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Built to Scale Everybody starts small, but the smartest entrepreneurs create ventures that are destined for growth. By: James Hart
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AAPL Member Directory
ATTENTION REAL ESTATE LENDERS
SPECIAL OFFER: $50 OFF CONFERENCE REGISTRATION USE PROMO: PL50
Kansas City, MO | April 29-30, 2014
REGISTER TODAY!
www.AAPL-PREIMA.com 3
Private Lender
Editor’s Note
MUCH TO LOOK FORWARD TO
T
hank you for making 2013 a remarkable building year for the American Association of Private Lenders (AAPL). This past year marked the achievement of several new milestones, and we are making tremendous progress as we approach the end of the first quarter of 2014. Our dedicated team has done an incredible job of expanding our outreach while strengthening our membership relationships and building new educational services.
Association highlights We have many things to look forward to this year. First, our Got Money? Need Money? conference will take place April 29-30 in Kansas City. If you are a lender and are looking for deal flow opportunities, or if you are an investor looking for private money, you do not want to miss this event. We’ve also scheduled our AAPL West Coast Regional Event. This marks our first regional event on the West Coast, and it will take place in Sunriver,OR, on July 11. Likewise, we’ve scheduled our AAPL East Coast Regional Event. It will take place in Philadelphia on Aug. 4 and is similar to the event we hosted last year in Washington, DC. Both one-day events will be packed with education and networking. Our last event for the year is our Annual Conference at Caesars Palace in Las Vegas, Nov. 9-11. If you attended this conference last year, you do not want to miss out on
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what we have in store this time around. Our sponsorships for this event sold out in 2013, so you’ll want to get your tickets and sponsorship booths early as we have already started selling tickets for this event. In addition to our four events this year, we are working on building up an educational component for our members. Our goal is to be able to provide you with webinars and online courses to further your education in the private lending arena.
Association benefits How can AAPL mitigate risk and ultimately increase your cash flow? We have the privilege of working closely with some of the most well-respected companies in the real estate investment industry. When it comes to insurance, the National Real Estate Insurance Group provides tailored products and solutions for investors, private lenders, note buyers and alternatives to force-placed insurance needs. Contact us so that we can point you in the right direction to save you money and protect your assets. As a member of AAPL, you will be able to get “the right coverage at the right time.” Check out our website to get a free, no-obligation quote today. Further, we can provide unbiased feedback with industry-leading analytics to guide your real estate investment options. We have the capability to address critical decision points, including risk, rent and
Editor’s Note
income. Our RentFax product bridges the gap between data and decisions. Learn more about it here.
Unprecedented growth AAPL is stronger than ever due to our continually expanding community that comes together to donate time, resources and talent in support of our important mission. This year alone, our membership has grown more than 179 percent, and our Advisory Board has assisted us in expanding our educational and compliance focus needs. AAPL began with the vision that an industry association could serve as the catalyst for growth in an industry through three simple guiding principles — excellence, ethics and education. As a private entity, we regularly seek input from our members as we work together in building an industry to provide the next generation of real estate financing. If you are not a member of AAPL, I encourage you to join our association and become a part of our community. And, I look forward to meeting you soon. For those of you who are members of AAPL, thank you. We are looking forward to much more in 2014.
Matt Benson AAPL Executive Director PRIVATE LENDER MARCH/APRIL 2014
CEO
Mike Wrenn
CHAIRMAN
Larry Muck
EXECUTIVE DIRECTOR/ EDITOR IN CHIEF
Matt Benson
MANAGING EDITORS Chrissey Breault Susan Anderson Private Lender is a publication of the American Association of Private Lenders(AAPL.) AAPL is not responsible for facts as presented by authors and advertisers. Use of Private Lender content without the express permission of AAPLis expressly prohibited.
Let the Got Money? Need Money? keynote speaker, Mark J. Kohler, tell you why this is the conference to attend this year!
JJ Pawlowski JJ Pawlowski owns Kansas City Investor Funding LLC, the title sponsor of the 2014 Got Money? Need Money? Conference. PL: Describe your job. How long have you been in this position?
PL: What types of loans do hard money lenders provide?
JJ: I own a hard money lending company. The company is Kansas City Investor Funding LLC. I’ve been in the hard money lending business off and on for the past 10 years. I’ve also spent the last 12 years in real estate as an investor, property manager and real estate broker.
JJ: Hard money lenders routinely provide short-term bridge-style loans, rehab loans, acquisition loans, and cash-out refinance loans on investment and commercial properties. Each lender will have its own lending criteria on the types of loans it provides. Hard money lenders will usually not provide any loans on residential owner occupant property.
PL: Why did you choose this business as one to be in? JJ: As far as hard money lending, it is a critical element in the real estate investment business. It fills a void for real estate investors who don’t have all of the cash needed for the certain investment or cannot get financing from a traditional bank lending source for a variety of reasons. There aren’t a lot of hard money lenders in the greater Kansas City area, so my business fills the void in lending that some investors and commercial property owners need.
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PL: Can you tell us about some of the differences between a hard money loan and a traditional bank loan? JJ: A hard money loan will usually be easier and faster to obtain than a traditional bank loan. A hard money loan will have fees, oftentimes referred to as points, as well as a higher interest rate than a traditional bank. Many hard money lenders are asset-based, meaning the lender will put more emphasis on the subject property and the exit strategy than the borrower when considering a loan request. Traditional banks will almost always
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Lender Limelight put more emphasis on the borrower in the lending decision-making process. Hard money loans most likely are going to be a shorter term, such as 12 to 24 months, while a traditional bank loan can be 10, 15, 20, 25, or even 30 or more years. PL: What are some of the mistakes investors make in working with hard money lenders? JJ: Some of common mistakes include loan to value ratios that are too high, exaggerated expectations of subject property value, incomplete scopes of work, exit strategies that don’t make sense and incorrect/incomplete company documents. These are all just a few that come to mind. Earlier this year, I wrote an e-book, “The 19 Mistakes Many Investors Make in Working With Hard Money Lenders and How Your Process Can Be a Smoother and Easier Transaction for Everyone.” This is a free download on my website at www. kcinvestorfunding.com. PL: What does a borrower need to have in order to request a hard money loan? JJ: The borrower seeking a hard money loan should have the basic information about the subject property; the numbers related to the deal, such as purchase price, rehab amount, anticipated value, etc.; the exit strategy determined; and be able to sum up the deal in a few minutes. This should be enough initial information for a hard money lender to consider the deal.
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PL: How long have you lived in Kansas City, and what do you enjoy most about it? JJ: I’ve lived in Kansas City approximately 12 years now. Kansas City is a great city with a lot to offer. From sports to shopping to local attractions and destinations, we have it all. While it is a huge metropolitan area, most people agree it’s easy to get around due to the infrastructure and highway systems. PL: Many of our conference attendees have never been to Kansas City before. Do you have any recommendations regarding what they should do or see while they’re in town? JJ: I would suggest visiting the Country Club Plaza and the Power & Light District. Both are close to the convention, and both offer an array of shopping, restaurant and entertainment venues. Kansas City also has some great BBQ places to visit. My personal favorites include Oklahoma Joe’s Bar-B-Que, Fiorella’s Jack Stack Barbecue and Gates Bar-B-Q, and there are many others to choose from too. It’s hard to go wrong with BBQ in Kansas City! For those attendees who enjoy gaming, there are plenty of local casinos on both the Missouri and Kansas sides of the state line.
PL: What’s the message you’d like attendees to take away from the “Need Money? Got Money?” conference? JJ: Some attendees will be looking for a hard money lender for their
deals. Other attendees might be a hard money lender looking for deals. Don’t be shy! Meet people! Visit with the sponsors. Trade business cards. I would tell all attendees to be sure to network and talk to as many people as possible during the event here in Kansas City so they can take away some options for what it was they came to Kansas City looking to accomplish in the first place. PL: What advice do you have for private lenders? JJ: It’s important to have a process for considering loan requests. It’s a quality — not quantity — business. It’s important to have lending parameters and stick to them. The deal of a lifetime comes around once a day.
#GotMoneyNeedMoney2014 Maintain profitibility in the ever-changing real estate market by attending AAPLPREIMA’s two-day event, April 29-30 in Kansas City. By attending you will learn: How to manage mortgage pool securities, What to do when taking your fund public,
PL: What famous person would you most like to have dinner with?
Secret sourcing strategies leading you to profits,
JJ: Donald Trump. Love him or hate him, you have to admit he tells it like it is.
How to navigate in modern day real estate, Residential Lending in the post DoddFrank Era, How to explore rental investment potential, Plus much, much more!
Register for AAPL-PREIMA’s Got Money? Need Money? Conference before it sells out! PHOTO COURTESY: NOR CAL
You don’t have to have dinner with “The Don” to get a copy of JJ’s book! Sign up for a FREE copy by clicking ... Generously Sponsored by:
STAFFPICKS Wondering what to do or where to grab a bite to eat in Kansas City during the Got Money? Need Money? conference? Members of the American Association of Private Lenders (AAPL) and Professional Real Estate Investors and Managers Alliance (PREIMA) teams offer their recommendations.
MATT BENSON AAPL Executive Director
Located in the heart of the Country Club Plaza, The Capital Grille offers classic steakhouse fare and creative seafood dishes. “The Stoli Doli is the best, but remember to drink at your own risk!”
LINDA HYDE
AAPL Director of Operations & Member Services
Since 1989, Boulevard Brewery has remained dedicated to the craft of producing fresh, flavorful beers using traditional ingredients and the best of both old and new brewing techniques. “If you are a beer connoisseur, I would definitely suggest going on a tour of KC’s own Boulevard Brewery.”
CHRISSEY BREAULT
AAPL Director of Marketing & Education Services
“I like simple places where I don’t need to be dressed up and can get an inexpensive drink. In the Power & Light District, I stick to Johnny’s Tavern to catch a game or Pizza Bar — because who doesn’t love pizza?!”
DAVID LANG
AAPL SR. Director of Sales & Stragetic Partnerships
The tantalizing smell of hickory barbecue will draw you in the front doors of Gates Bar-B-Q. “Barbecue is my favorite, and Gates is the best!”
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#GotMoneyNeedMoney2014
Catching up with Mark J. Kohler The attorney, certified public accountant, entrepreneur and author of “What Your CPA Isn’t Telling You: Life Changing Tax Strategies” and “Lawyers are Liars” will deliver the keynote address at the Got Money? Need Money? conference.
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Got Money? Need Money? Preview PL: Can you describe your job for our readers? How long have you been in this position?
PL: Wow. So what’s the worst advice you’ve ever received?
MK: I am in the unique position of being a senior partner in both a CPA and law firm. I am one of the few lawyers out there who is also a CPA and specializes in tax planning. I still consult with clients daily, as well manage the affairs and direct the vision of the companies.
MK: “Trust me; we don’t need a contract.”
PL: How did you get your start?
PL: Who’s your hero and why?
MK: I started college as an entrepreneur and ended up choosing tax law as my education path because it was the most exciting and intriguing major in the business field.
MK: My Dad. He taught me how to be a man of integrity.
I had an amazing professor who was both a CPA and lawyer who changed my whole perspective on business and life.
PL: What do you do for fun outside the office? MK: Surf. I hope to get out of the office early today and catch some waves.
PL: What did you want to be growing up? MK: A stockbroker. I saw “Wall Street” in 1987 starring Michael Douglas and was mesmerized. PL: What’s your most challenging day at the office? MK: When I’m triple-booked due to a miscommunication, and my whole schedule is jacked up. I hate being late. PL: What advice do you have for private lenders? MK: Get security, even if they are family. PL: What’s the best advice you’ve ever received? From whom? MK: “Buy low … sell high” (from some guy in a dark alley).
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PL: What’s the message you’d like attendees to take away from the Need Money? Got Money? Conference? MK: Real estate investment is critical to the American Dream and saving taxes.
PL: How do you stay involved in the community? MK: I am a Scout Master and an Eagle Scout myself. My passion is to help boys grow up and be the best they can be. PL: What famous person would you most like to have dinner with? MK: Cameron Diaz. You said my wife isn’t going to see this, right?!
STAFFPICKS GABRIELLE LEVOTA PREIMA Executive Director
The urban dining room and beer garden at The Westside Local is known for its locally grown farm-to-table food. “The food is amazing, and the restaurant also supports local farms and businesses — a win-win for the dining experience and the community!”
JOHN SCHMITT
PREIMA Strategic Relationship Account Manager
“BB’s Lawnside Blues & BBQ is the place to kill two birds with one stone. It has great live blues and Kansas City BBQ.”
TWILLA MILLER PREIMA Membership Manager
Located in the Country Club Plaza, Gram & Dun is an American gastro pub with culinary-driven fare. “The service is wonderful and the food is amazing. I highly recommend the Burnt Ends Mac & Cheese!”
PATTI BREWER
Got Money? Need Money? Event Manager
“The City Market is how I like to start my weekend. I try to plan my next few menus based on the beautiful fruits and vegetables that are in season and for sale at the City Market. I always make sure to buy fresh flowers too; food tastes better served with fresh flowers! If you have time, check out Winslow’s Barbeque, an oldie but goodie barbeque joint.”
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#GotMoneyNeedMoney2014
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TIMING MATTERS Private lending is like baseball. Pick the wrong deal, and you’ll strike-out no matter what stadium you play in. BY HARRY KUNELIS
L
egendary investor Warren Buffet claims he shares a valuable philosophy with baseball great Ted Williams. Williams once wrote that the most important thing for a hitter is to wait for the right pitch. Buffet admitted he approaches investing with the exact same credo: “… wait for the right pitch, yeah and wait for the right deal. And it will come. It’s the key to investing.” This article will not necessarily reveal what the right pitch looks like. Ultimately, that is for you as a private lender to decide. Our goal here is to reveal what stadium (markets) might be best suited for today’s private lender to play ball in. Although this technical analysis represents current residential real estate trending data, commercial real estate activity oftentimes mimics the residential trajectory — only with a lag. Therefore, in the long run, this will benefit private lenders underwriting both residential and commercial deals. Before we get into the rabbit hole, let’s quickly define the three potential stadiums to ensure we’re all dancing to the same song: • Long-term secular downtrend markets • Equilibrium markets • High-momentum cyclical markets
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To best compare the differences, we will use technical analysis trend charts. I compiled this data from the Housing Alerts tool I use — an analysis tool developed by Ken Wade. As you know, technical analysis measures market psychology and buyer behavior. This sort of analysis does not use single-family median home prices in the analysis. When scanning these colorful graphs, keep in mind that:
• Blue line = short-term momentum indicators • Green line = intermediate-term momentum indicators • Red line = longer-term momentum indicators The key word here is momentum. Candidly, the long-term red line is our top priority. However, don’t underestimate the importance the shorter-term blue line plays in setting the course for the intermediate and long-term metrics to follow.
Long-term secular downtrend markets
Long-term secular downtrend markets are characterized by a slow and steady perpetual decline — even missing the bubble. Indianapolis and Rockford, IL, are examples of long-term secular downtrend markets. (See Figures 1 and 2.)
Features cyclical markets. What’s obvious about high-momentum cyclical markets is their characteristic roller coaster-like trend chart. Many cities along the west coast in America, as well as Chicago and New York, are examples of high momentum cyclical markets.
Figure 1. Long-term secular downtrend markets are characterized by a slow and steady perpetual decline, such as Indianapolis.
Therefore, high momentum cyclical markets are unique in that there is enormous wealth creation — and destruction — potential when playing in these stadiums, especially, from the borrower’s point of view. And that’s the point to nail down. If you are private lending, it pays to know these details so that you may align your interests with your borrower. For example, sharing upside profits with borrowers in equilibrium and long-term secular downtrend markets could be a less reliable source of revenue. Aside from lenders collecting upfront points and the traditional “spread” income, upside profit sharing in these two markets may be constrained by the lower kinetic energy characteristic of equilibrium and long-term secular downtrend markets.
Figure 2. Rockford, IL, is another example of a long-term secular downtrend market.
Equilibrium markets The next stadium is the equilibrium markets. Equilibrium markets are characterized by a narrow valuation of slightly positive, slightly negative. They barely offer 4 percent positive or negative annual home appreciation. Two prime examples of equilibrium markets are San Antonio and Pittsburgh. (See Figures 3 and 4.)
High-momentum cyclical markets
The final stadium — and certainly the most appealing — is the high-momentum
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Like a windmill located in a gusty corridor, high momentum cyclical markets offer hitters (investor and lender) a continuous velocity of energy. With that said, you still have to wait for the right pitch. Pick the wrong deal, and you’ll strike-out no matter what stadium you play in. The good news is you can swing on many deals in any stadium if that local market is in its wealth phase. Do wealth phases matter? If you ask some experts, they’ll tell you that wealth phases are single-handed the most important factor determining your success. If the government causes the leverage cycle to change course — which it does from time to time — then you will watch as your borrower’s exit strategy disappears right from under your noses. And that is a sure fire way for your capital as a lender to evaporate, because your borrower’s exit strategy is your exit strategy.
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Features be a good bet now. Meanwhile, on closing, I’ll toss in a snapshot of Las Vegas for the mere sake of reinforcing why we need to consider an aerial view of each local market, and remain sensitive to what type of stadium each is defined by. For starters, take an insider look at these two well-known, yet quite different, highmomentum cyclical markets: San Francisco and Chicago. (See Figures 5 and 6.)
Figure 3. Equilibrium markets are characterized by a narrow valuation of slightly positive and slightly negative, such as San Antonio.
Figure 4. Pittsburgh is another example of an equilibrium market.
San Francisco and Chicago
For the remaining discussion, let’s zoom in on two prime high-momentum cyclical markets in America. If you were interested to know what wealth phases look like, then you’re in luck because you’re about to see how these appear from a technical analysis perspective. One of these two high momentum cyclical markets entered its wealth phase two years ago (as you will see below). And the boat has yet to set sail on the other prime high momentum cyclical market — but it’s about to. Therefore, you might find both of these to
Clearly, these two local markets appear very different, despite the fact they are the same type of stadium. As far as their wealth phases go, they are different in timing, duration and magnitude. As you can see by their wealth phases below (green dashed areas), the San Francisco wealth phase is notorious for starting two to three years ahead of Chicago. In fact, you can see that our technical analysis reveals that Chicago has yet to enter its next wealth cycle. (See Figures 7 and 8.) Meanwhile, this tool alerted residential real estate investors to enter the San Francisco market (red arrow above) not much sooner than two years ago. So what’s the point? The point is: This is the sort of information you should be expecting from your borrowers. If a borrower is unaware of what type of stadium they are playing in and the wealth phase of that local market, then it’s your duty as a private lender to vet this. Don’t hang your hat on borrower experience alone. How many highly experienced borrowers lost loads of money (ended insolvent) by underestimating how their local market responds to the leverage cycle? All the borrower experience in the world is meaningless if they get blindsided by a permanent market cycle reversal. Or worse, prematurely assume a local market has started a recovery with positive annual home appreciation when, in fact, it hasn’t.
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Figure 5. What’s obvious about high-momentum cyclical markets, such as San Francisco, is their characteristic roller coaster-like trend chart.
Figure 6. Like San Francisco, Chicago is a high-momentum cyclical market — and a good bet for private lenders.
Figures 7 and 8. The San Francisco wealth phase (indicated by the green dashed areas) is notorious for starting two to three years ahead of Chicago.
The reason why I mentioned Chicago as a good bet for private lenders at this time is because of the timing that Chicago follows relative to San Francisco. Not only that, I have been following the technical analysis on these two cities for at least three years now. Chicago looked terrible until recently. As of late, Chicago has demonstrated the consistent and much needed escalation of short-term momentum needed for full reversal of its
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intermediate and long-term inertia. For example, check out this regional and national comparison (last quarter vs. three years ago) for Chicago below. (See Table 1.) It is clear that home appreciation levels have drastically improved as compared to other regional cities. It’s about time. San Francisco’s regional comparison (last quarter vs. three years ago) has worsened
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Table 1. Home appreciation levels in Chicago have drastically improved compared to other regional cities.
Table 2. Although San Francisco’s regional comparison has worsened slightly, it still remains a rock-solid market opportunity.
Home Appreciation rates Compared to Other States
Last Qtr. 2 Qtrs Ago Last 12 Mo. 2 Yrs. Ago 3 Yrs. Ago 5 Yrs. Ago 10 Yrs. Ago 15 Yrs. Ago 20 Yrs. Ago 30 Yrs. Ago
California 2 27 31 41 39 34 24 40 26 21
Illinois 23 2 2 43 32 50 2 1 51 39
Out of 51 locations Table 3. Shown here is a comparison of California home appreciation rates to other states, as well as Illinois home appreciation rates to other states.
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Figure 9. While Las Vegas historically would be considered an equilibrium market, lately it’s acted like a high-momentum cyclical market.
slightly. Undoubtedly, San Francisco still remains a rock-solid market opportunity to date. This data suggests that San Francisco might experience a short-term speed bump while its long-term yearly home appreciation trajectory upwardly ascends further. (See Table 2.) From these and other findings, I base my conclusion that private lenders might benefit from strategically lending at this time not only in San Francisco, but also in the Chicago.
Las Vegas
So what about Las Vegas? Historically, Las Vegas would be considered an equilibrium market as witnessed by its DNA chart. However, what’s intriguing about Las Vegas is how it’s acted like a high-momentum cyclical market as of late. (See Figure 9.) As these charts reveal, Las Vegas experienced the start of another wealth phase about the same time as San Francisco. (See Figure 10.) How will Las Vegas perform over the long run? In other words, will the long-term momentum (red line) trend flatten out and resume its historic performance? Or will Las
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Figure 10. Las Vegas has experienced the start of another wealth phase about the same time as San Francisco.
Vegas morph into a true modern day highmomentum cyclical market? That is the million dollar question.
Swing for the fences
Undoubtedly, you can earn good yield in any local market if you maintain razor sharp awareness of that market. My personal bias leans toward the Chicago, New York and San Francisco types because I am fond of tall buildings — not because I like roller coasters. No matter what stadium you enter, be sure you acknowledge how its local wealth phase is responding to the government controlled (secondary market) leverage cycle. And then when you get that right pitch, swing for the fences. Harry Kunelis is the founder of HK Creative Investments, a turnkey real estate company that offers private wealth solutions for sellers, investors and real estate professionals. For more information, contact Kunelis at harry@hkcreativeinvestments. com.
Features
HOW TO MANAGE A REG. D SECURITY Like raising a family, the responsibilities of a fund manager are complex and diverse. BY DAVID OWEN, ROBERT BUCHANAN & JAMES RINCON
M
anaging a fund is a little like raising • What kind of return do you want to a family. Your investors are your create for your investors? beautiful wife or handsome husband, Once a manager establishes a clear objective and your borrowers are your petulant for the fund, an operating agreement must children. Your goal as the be written that lays out head of this household is the values and parameters THE OPERATING to nurture those borrowers by which the fund will be AGREEMENT IS into something that mom managed. The operating and dad can be proud of. THE ROADMAP TO agreement is the roadmap It takes communication to successful fund SUCCESSFUL FUND and commitment, as well management. It defines MANAGEMENT. as discipline, ethics and the fund’s underwriting principles. standards, manager
Setting up your fund
One of the most important things a manager must determine for a fund is the fund’s overall direction. Will it be a debt fund? Equity? A combination of both? Will you file as a Rule 506 or a Rule 506c? (A Rule 506c can openly solicit investors, but has more stringent investor underwriting requirements and cannot take in any unaccredited investors whatsoever.) •
What interest rates will you charge? How many lender discount points?
•
What is my competition like, and how will that impact how I set up and manage my fund?
and investor compensations, investor qualifications and expectations, and the types of investments the fund will be allowed to participate in.
Raising capital
In today’s climate of post-recession financial skepticism, investors are hypersensitive to the habits and behavior of their investment managers. It’s important for a fund manager to take a personal stake in his or her own fund, because other investors will feel more confident placing their hard-earned money with managers who are personally invested in the funds success. Personally investing in the success of a fund will also allow managers to keep operating fees low. Low management fees will further instill
AAPLOnline.com
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Features confidence in investors because investors know that the less overhead costs a fund incurs, the more profit is funneled directly to investor yields. Structuring managers’ compensation in this fashion presents an investor-friendly merit-based fund that puts investors first and rewards good management habits. With a business plan in place that shows
Underwriting
So how do you separate the good from the bad and the ugly? The key is in the underwriting. Some bad real estate deals start good and then go bad, but the vast majority of bad real estate deals start bad and only get worse. Establishing sound underwriting criteria is the most important responsibility of a fund manager. If a manager is not taking the necessary care to underwrite a loan, a fund’s portfolio will quickly fill up with nonperforming notes, and investors yields will plummet. Sound underwriting procedures include, but are not restricted to: • Verifying the borrower is an entity, not an individual. • Verifying that the borrowing entity is in good tax and legal standing. • Verifying the borrower doesn’t have a history of legal judgments or fraud. • Verifying the borrower has adequate cash flow to pay debt service. • Verifying the loan exit strategy is realistic and executable.
a clear upside for investors and low management overhead and a personally invested manager, raising capital should be the easiest part of managing a Reg. D fund. Good products tend to sell themselves, and with an investor-friendly fund, transparency is a manager’s best friend. Too many lenders operate in silence, as the only time investors hear from the manager is when they are getting a check, getting asked for a check or reading bad news in the paper. A good manager will always err on the side of over-communicating with investors, because under-communicating could foster the appearance of management trying to hide information from investors. As a fund manager, you’ll see all of the good, the bad and the ugly that the real estate market has to offer. It’s up to you to know the difference.
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• Verifying the asset’s ARV is accurately appraised. • Verifying the asset has a clear title without tax liens, mechanics liens or other liens. • Verifying the contractor is experienced and financially capable of doing the work proposed. • Escrowing any funds needed to finish out the proposed project. When a manager determines reasonable and responsible underwriting standards, it is imperative that the fund hold those standards sacred. There will be times when managers will be tempted to bend or relax its standards to make a loan that looks appealing, but remember: Most investors will be happier
Features receiving a lower yield because you stuck to your guns than they would if, just for the sake of making a loan, you risked their money on an investment that started bad and got worse. Bad things happen in this business when people get greedy, and like they say on Wall Street, the pigs always get slaughtered. Undisciplined lenders who cut corners to rush loans out the door are a risk to their investors, borrowers and the entire private lending industry. It’s hard to trust a fund manager who shows inconsistencies in their cost of money, underwriting practices or investor payouts — and trust is the foundation upon which all real estate investments are built. Investors have to be able to trust their fund manager, managers have to be able to trust their borrowers, and borrowers have to be able to trust their bankers. Fund managers who establish products and practices with trustworthy consistency ultimately build more than business; they build a brand.
Marketing
Branding is a powerful tool for a fund manager. A well-managed fund has a far greater number of successful loans than unsuccessful loans. Each one of those successes is a marketing opportunity to strengthen the brand and remind the community that this fund gets
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the job done — and any communication of fund news or market updates is a step toward greater transparency and communication with investors and potential investors. Managing a fund is more than crunching numbers. A business-minded manager should always be looking for avenues to promote a fund’s achievements and developments. In this age of ubiquitous Wi-Fi, countless social networks and e-mail streaming straight to smartphones, the opportunities to showcase the strength and success of a brand are endless. Effective fund management uses all of the free exposure that is available via LinkedIn, Meetup.com, Facebook, Twitter, Google+ and any other media/advertising/ branding that gets a fund’s products in front of its target audience.
What it means to manage
The responsibilities of a fund manager are complex and diverse. No one aspect of this management formula will, by itself, ensure the success of a fund. You can’t make loans without raising funds. You can’t raise funds without marketing. You can’t effectively market without establishing a brand of excellence. And you can’t establish a brand without consistently making good investments on behalf of your investors. The ability to effectively oversee the simultaneous completion of these tasks is the essence of good management. A fund, like a family, will always have its ups and downs. It will experience internal stresses and stresses from the market. At the end of the day, it’s up to the manager to set the fund up for success and learn from its mistakes, and maintain a happy home from investors, employees and borrowers. David Owen is managing partner, Robert Buchanan is managing partner, and James Rincon is vice president of business development for Pride of Austin Capital Partners.
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Features
FINDING VALUE IN A RISING PRICE ENVIRONMENT Non-performing second mortgage notes are worth a deeper look. BY ROBERT HYTHA & AARON JONES
E
xperienced note buyers already know that mortgage note investing allows the investor to become the bank. Note investors buy notes to harness the power of compounding interest as they collect monthly payments from the borrower and, of course, the investment is also secured by real estate. With income (monthly payments), growth (compounding interest) and security (promissory note backed by real estate), you already understand why note investing is so lucrative and why the demand for quality paper has increased exponentially. In this article, we will explore the market factors that are affecting the value of nonperforming second position mortgage notes and how, despite the increase in demand and the respective increase in price, there is still a subset of this niche left relatively untapped. To begin, let’s look at a snapshot of the pricing matrix of non-performing second mortgage notes secured by residential real estate nationwide as of Q1 2014. There are many other factors to stratify and value this asset class (trade size, bankruptcy, occupancy, geography, total arrears, legal status, etc.), but the first two factors you should review when making a bid are equity and the senior lien status. See Table 1 for the typical market prices as a percentage of unpaid principal balance (UPB).
Equity
To further clarify, “high equity” typically refers
to assets with a CLTV<100% (Combined Loan to Value = Junior UPB + Senior UPB/Fair Market Value). “Partial equity” means there is some equity above the second lien but not enough to cover the entire second lien balance, and “underwater” means the senior lien is equal to or greater than the fair market value of the home.
Senior lien status
Pricing based on equity is fairly straightforward, but pricing based on the status of the senior lien needs a little more explaining. Defaulted second mortgage borrowers who consistently make their first mortgage payment on the same property are more likely to come to a resolution with the second lien holder. When you see a current senior lien, the borrower is telling you they have current income and they probably want to stay in their home (emotional equity). Now that we have the current market prices in mind, let’s look at the dynamics affecting the future of pricing in the non-performing second mortgage note niche.
Pricing trends
The most obvious driver of pricing this year will likely be the increase in the value of the underlying collateral. Over the past year, a decline in the overall housing inventory has created an increase in housing prices. In turn, the available equity in homes continues to increase nationwide. As the equity securing these notes increases, so does the price to
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Features
Senior Performing
Senior Semi-performing
Senior Unknown
Senior Foreclosing
High Equity
35%+
25-30%
20-25%
15-20%
Partial Equity
25%+
20-25%
15-20%
10-15%
Underwater
20%
15-20%
10-15%
5-10%
Table 1. Shown here are the typical market prices as a percentage of unpaid principal balance.
purchase these secured liens. In addition to the market appreciation seen in home values, there is another factor that is less obvious to investors. Although investing in second position mortgage notes is still a niche business, the increase in demand for these assets will likely be an even greater driver of price in 2014 than market appreciation. As new investors are taught the basics of this business, they are instructed to only purchase the top-tier assets (high equity, senior performing) to mitigate risk. As note investing becomes more mainstream, the majority of new note investors enter the market with very narrow target asset criteria. As a result, new investors end up competing to purchase the same type of notes, further driving up the price, and leaving ~70 percent of the potential deals to the “experts.” The price forecast for top-tier second mortgage notes is on a trajectory much steeper than “lower quality” notes that still offer incredible upside potential at a lower price point. Simply put, the best way to find value in the rising price environment is to expand your investment criteria outside of the most competitive realm. What if you were told there were nonperforming seconds for sale for a fraction of the price that could still generate a substantial
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return? Then would you be interested in stepping outside of your comfort zone? There are a few ways to separate yourself from the most competitive market and still find value in this rising price environment. The following will provide some advice to become an expert in a niche within the niche.
A niche within the niche
First, investors should take a deeper look into non-performing seconds that have a senior lien in front of them that is not reporting. It is very easy to skip right over these notes because of the uncertainty they present. But, this uncertainty may allow investors to acquire notes at a much lower cost. A senior lien may not be reporting for a few reasons. Either the loan was transferred to a different lender and hasn’t been reported, or the borrower is filing for bankruptcy and the lender has stopped reporting payments. But remember, not reporting does not mean not current! If the senior lien has been transferred, there are a few ways to find out whether or not it is current. If you know whom the loan has been transferred to, it is possible to call the lender and receive information about the loan via an automated system. If you are unaware of whom the loan was transferred to, contacting the county or paying for a title report would be beneficial.
Features
While you are checking the county, take a look at the current property tax situation. (Most counties provide online tax reporting.) Since the majority of senior lien servicers escrow taxes and insurance, seeing that the taxes have been paid is a helpful indicator of a potential current senior lien. It is also common to have a trade line that is no longer reporting because a borrower has filed for, or is in the process of filing for, bankruptcy. Once again, many investors are deterred by this and will quickly filter out borrower’s currently facing bankruptcy. With resources such as PACER, investors are able to uncover the borrower’s intentions for filing bankruptcy and also get information on the senior lien. A good note dealer should be able to provide bankruptcy petitions/schedules and may even help new investors make sense of them.
Know your note dealer
When choosing a source to acquire nonperforming mortgage notes from, it’s important to ask some very specific questions in order to ensure the quality of the paper you’re interested in purchasing, as well as pre-empt any hurdles to your due diligence process: Have these assets been worked? Many note sellers squeeze as much “juice” out of a population of assets over a period of time and then liquidate the “tail” when their cost/ benefit analysis meets equilibrium. Follow-up questions here are: When were these assets acquired? Where were the purchased from?
Do you own these assets? Watch out for broker daisy chains. While there are many good brokers who have access to great deals, the best pricing and execution is typically achieved direct with sellers. How can you help with my due diligence? The best note dealers offer their due diligence to kick-start your analysis. Ask for credit reports, BK petitions, BPOs and original collateral. Do you possess an enforceable collateral file? Before pulling the trigger, make sure your note seller has the four documents you are purchasing: Original Note, Mortgage (copy is acceptable), Assignment and Allonge. When dealing with an unfamiliar seller, you may wish to execute an escrow agreement to have a third-party ensure you are getting exactly what you paid for. Robert Hytha is director of sales, and Aaron Jones is marketing manager for US Mortgage Resolution. For more information and access to US Mortgage Resolution’s current inventory, contact Hytha at rhytha@usmresolution.com. For more articles, webinars and virtual meet-ups, join US Mortgage Resolution’s Note Investing Community by contacting Jones at ajones@usmresolution.com.
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Features
THE EXIT PLAN By putting an exit plan in motion at the beginning of the deal, you are more likely to have a qualified client at maturity. BY IAN R. MCSEVNEY
I
n the exciting world of private mortgage investing, fittingly referred to as hard money lending, there often can be hard lessons to be learned for the investor and the borrower alike.
Overwhelmingly, what I found was the repeated failure to have a viable exit plan in place right from the origination of the deal.
What is an exit plan?
As a mortgage broker, I have witnessed this When it comes to a private or hard money firsthand. I have had investors come to me mortgage loan, an exit plan is the proposed asking if I can assist them in finding new plan to successfully conclude the deal at financing for their borrower in order for maturity of the loan. In an ideal world, them to be paid out we would like to in full as originally assume that our IN AN IDEAL WORLD, WE planned and be borrowers will be in WOULD LIKE TO THINK THAT relieved of their the position to pay non-performing out their loan at OUR BORROWERS WILL BE IN loan. I have also maturity, and as an THE POSITION TO PAY OUT had borrowers come investor or lender, THEIR LOAN AT MATURITY. to me asking me we can take our to find them a new proceeds and place mortgage. This is them into a new loan because the private lender who funded their to earn another handsome fee and superior deal is not offering a renewal, even though rate of return. After all, making money is the they have paid in a timely manner but do not nature of the lending business. qualify yet for an institutional mortgage. If a loan cannot be paid out as expected at We all know it can happen. Circumstances can change over time for better or for worse, and mortgage investments are no different. Having faced such circumstances many times, I began to look more closely at the deals where such circumstances arose to understand what was really taking place.
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maturity, investors or lenders may be able to renew even if they donâ&#x20AC;&#x2122;t really want to. They can secure a new term and rate, even a new lender fee for renewing. But they may be forced to capitalize these fees to the renewal balance on the loan impairing their flow of capital.
Features or lender into a profitable deal so that upon a successful payout, they seek to have their money placed into a subsequent mortgage. This becomes a reliable and useful conduit for funding your deals. The result is successfully growing your business and organically increasing your volume of mortgages.
Forming a plan
When considering an application for a private hard money mortgage, focusing on these five key areas can help to formulate a viable exit plan:
Private hard money mortgage loans can also leave borrowers in a perpetual cycle of costly renewals. Year after year, they are simply incurring renewal fees but never really getting anywhere on their mortgage and may even be increasing their principal balance on their mortgage. The magnitude of this problem can differ depending on your perspective. If you are a borrower, you want to graduate to a more prime level of borrowing where your borrowing cost can be reduced. If you are an investor or lender, you also want to participate in deals where your capital is secure and your cash flow, along with your return on investment, are positive. Nobody wants to see a potential foreclosure because a loan lacked a proper exit plan. As a mortgage broker, when I am faced with a deal that requires a private mortgage or a hard money lending solution to get funded, I put a significant amount of thought into the exit plan as I want to set in motion the right terms from the start. The goal is to get the clients the funds they need and also to place the investor
Does the deal require a private hard money solution? Determine if private money is really needed to close the deal. Consider the reasons why hard money is required, such as soft income, poor credit or unique property status. How long will the client require the money? Determine if the borrowersâ&#x20AC;&#x2122; needs are short term or long term. If they are simply borrowing to flip a property and will be borrowing short term, they may be more open to higher borrowing costs of private money in exchange for other flexible terms such as interest-only payments. If they are long-term needs, they may want terms with blended principal and interest payments in order to ensure the mortgage balance is decreasing over the term. Can the borrower qualify in the future for an institutional mortgage loan? Determine if the borrower will be able to qualify for institutional financing by the end of the term so that they can refinance and pay the loan out in full with a new mortgage. How long will the investor or private hard money lender commit their funds? Determine how long the investor/lender can place their money. Match this to a suitable borrowerâ&#x20AC;&#x2122;s time frame for future qualification of institutional funds. When this point is not
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Features considered you often see a situation where a borrower is not in a position to pay out the mortgage at maturity. This causes the investors’ or lenders’ capital to be committed longer than expected.
What needs to be done to ensure the clients qualify in the future for an institutional loan? Determine if the clients need a credit rehabilitation plan to increase their credit score so they may qualify for a new mortgage in the future. Determine if they need a term with blended payments to bring down their balance owing to meet certain loan to value parameters for future qualification, if they need time to meet standard job tenure requirements for qualifying for future financing or simply need to reduce their debt load to do so.
Be pro-active
These are simple steps that can be applied in our underwriting assessment as brokers and our underwriting criteria as lenders to better plan at the beginning stages of a deal the eventual exit plan of that deal. It is easy to get caught up in trying to develop and grow our volume of business on the books. After
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all, for many of us, this is a transactional business, and our lender fees and broker fees are a fundamental component to our success and livelihood. When looking for that next deal to fund or client to get funded, you must always consider the question: “What is the exit plan”? If you don’t, you are in danger of creating a deal in which everyone is happy at the start, but no one is happy at maturity as the deal can turn stagnant. This leaves you with an unmotivated borrower who is no longer motivated to pay because they have become trapped by the terms of their mortgage loan. Develop an exit plan, and figure out what needs to be done to meet that plan. Put that plan in motion at the beginning of the deal, and you are more likely to have a qualified client at maturity. This creates the opportunity for a new institutional deal and frees up your investor or lender for a subsequent hard money deal. It’s simply pro-active and sound underwriting practice. Ian R. McSevney B.A., AMP is president of Altmore Investment Corporation. He is currently practicing in both commercial and residential mortgage financing, as an MIC Manager, as well as the Principal Mortgage Broker of a boutique-style brokerage firm in Ontario. For more information, contact McSevney at ian@altmoremic.com.
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Legal
THE REAL IMPACT OF THE JOBS ACT It covers so much more than crowdfunding. BY JILLIAN SIDOTI
I
f you’ve read about the Jumpstart Our Business Startups Act of 2012, you’re probably aware that it makes it possible for entrepreneurs to sell equity in their ventures via online crowdfunding portals.
• Scaled disclosure requirements. • No restrictions on test-the-waters communications with qualified institutional buyers (QIBS) and institutional accredited investors before and after filing a registration statement.
While that feature has attracted the most attention, the JOBS Act is about much more • Fewer restrictions on research around than crowdfunding. The legislation impacts the time of an offering, including research three other areas of securities law that by participating underwriters. should interest real estate investors. Here are some advantages (This is a summary of Title and disadvantages to I’s effects. For more THE LEGISLATION these four pieces. specific information,
Title I: Helping the little guy go public
IMPACTS THREE OTHER AREAS OF SECURITIES LAW THAT SHOULD INTEREST REAL ESTATE INVESTORS.
Title I creates a new “emerging growth companies” class of public companies that earn less than $1 billion in annual revenue. Under Title I, these companies qualify for a series of exemptions that are designed to help them more easily and confidentially file for an initial public offering, without fear of not fully complying with certain SEC rules or sections of Dodd-Frank. Those exemptions include: • Confidential SEC staff review of draft IPO registration statements.
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visit the website.)
SEC’s
It hasn’t always made sense for a small fund or issuer to go public because they often lack the operating history and the financial resources for the required audits, legal work and ongoing compliance. However, many smaller issuers have found that going public opens the doors to a larger capital market.
James River Holdings Corporation (OTCQB: JRIV), a small asset holding company, initially specialized in single-family residence investing in the Ozarks of Missouri. The founder and CEO, Barry Watts, discovered
Legal
that he was running out of funding sources for deals and was interested in expanding outside of just single-family investing. On Feb. 1, 2012, the company’s initial public offering was declared effective by the SEC. Since going public, JRIV has been exposed to a variety of hedge funds, investment bankers and other “funders” in the stock market space at a variety of events such as the National Investment Banking Association. These presentation opportunities are generally not available to private companies of similar size. Within six months of going public, JRIV was able to enter into an agreement to acquire a multistate paving company, fulfilling Watts’ desire to expand the company’s portfolio and business lines.
Title II: Despite the hype, it’s not for everyone Title II creates a new Rule 506(c) under the
Securities Exchange Act’s Regulation D. That rule, which took effect in September 2013, allows small companies and private investment funds to use “general solicitation” to reach accredited investors, which means they may advertise or publicize an offering on the Internet, radio, television, billboards and other mediums. Offerings under Rule 505 and Rule 506(b) will still continue to be prohibited from using general solicitation to reach investors. This newfound “soliciting” freedom under Rule 506(c) does come with restrictions, though:
506(C) offerings may be sold to accredited investors only. Generally speaking, an “accredited investor” is defined as an individual who earns $200,000 per year; a married couple that earns $300,000 per year; or an individual or married couple with a net worth of $1 million exclusive of their primary
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Legal residence. This, for many issuers, may exclude many family members or previous investors who do not meet the income or net worth requirements of accredited investors.
Those accredited investors must be verified as accredited. Title II also shifts the burden of verification from the investor to the issuer. Issuers can verify an investor’s status in a number of ways:
TITLE III IS GREAT IF AN ISSUER JUST NEEDS SMALL AMOUNTS OF MONEY FROM SMALLER INVESTORS. Income-based verification. Copies of any IRS document that shows income (W-2, K-1, 1099, 1040, etc.) for the two most recent years, along with written verification that investor will reach accredited limits in the current year. Verification based on net worth. A copy, within the past three months, of the following: bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments and appraisal reports issued by independent third parties; a credit report from at least one of the nationwide consumer reporting agencies; and a written statement that all liabilities necessary to make a determination of net worth have been disclosed. Third-party verification. Written confirmation from a registered broker-dealer, an SECregistered investment adviser, a licensed attorney or a certified public accountant that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months and has determined that such
36 Private Lender
purchaser is an accredited investor. Other persons could potentially serve as third-party verifiers, subject to additional rules. Roll-over accredited. Those people who were treated as accredited investors under a prior 506 offering by the same issuer are deemed to be accredited investors in future 506(c) offerings, provided that such investors certify they are accredited investors. The SEC has also created a portal on its website for uploading of advertising materials by those relying on Rule 506(c). Uploading is entirely voluntary and is kept confidential. The portal may be found at https://www. sec.gov/forms/rule506c. Anecdotal evidence suggests that Rule 506(c) may not truly benefit the smaller issuer, but rather the big hedge fund or REIT looking to spread its message faster and easier to accredited investors. These are the issuers who can readily place an ad in The New York Times or The Wall Street Journal without fear of cost or consequence. That kind of competition can be difficult for a smaller issuer to overcome. Coupled with the hassle of accredited verification, many issuers have elected to instead stick with a Rule 505 or Rule 506(b) offering and take a more personal approach to attracting investors.
Title III: Great for starting, not for growing Title III allows issuers to raise up to $1 million within any 12-month period without triggering the registration requirements of the Securities Act of 1933, as long as the transactions are made through an SECapproved broker or funding portal. It’s great if an issuer just needs small amounts of money from smaller investors, but it’s not that helpful for those who want to expand to bigger profits and deals. No investor may
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invest more than 10 percent of their net worth or a maximum of $10,000. This leaves a small issuer with the need to convince at least 100 investors to invest in their deal just to raise a mere $1 million.
Title IV: Expanding the forgotten exemption
A common complaint in the capital-raising world involves the limitations that Regulation D places on advertising and solicitation. Feeling trapped, issuers are not able to effectively grow their business because they can’t obtain sufficient capital in their current circle of investors, and they don’t know how to find new investors without advertising. For some issuers, Regulation A can solve this problem. Currently — and even before the JOBS Act — Regulation A allows an issuer to raise up to $5 million in a 12-month period through the means of general solicitation. There is little to no qualification required of investors, who need not be accredited under Regulation A. Unlike a public “registered” offering, however, Regulation A filings do not have ongoing reporting requirements or require financial audits. Under Title IV, the JOBS Act will carve out a new section of Regulation A, referred to as “Reg A+” or “Tier 2.” This will allow the issuer to raise up to $50 million in a 12-month period with few, if any, investor suitability requirements. Despite its flaws, the JOBS Act truly has been for the betterment of the small issuer. It offers multiple opportunities to jumpstart their fundraising. Everyone — issuers, auditors, attorneys, investment banks, brokers, marketers, investors, regulators — is waiting to see the good, the bad and the ugly as the rules unfold and the capital starts flowing. Jillian Sidoti is an attorney with the firm of Trowbridge Taylor Sidoti in Murrieta, CA. She specializes in private placement memorandums, Regulation D filings, public offerings and other transactional legal matters. For more information, contact Sidoti at jillian@syndicationlawyers.com.
Legal
DODD-FRANK: YOUR INVESTMENT AND YOU Avoid inadvertent violations of Dodd-Frank by learning how to effectively communicate with appraisers. BY JASON ORMISTON
W
henever speaking with realtors or loan professionals, I’m often asked the same question: What can I say to the appraiser? The Home Value Code of Conduct (HVCC) was retired a few years ago, but the regulations that replaced the code, the Dodd–Frank Wall Street Reform and Consumer Protection Act (or simply Dodd-Frank), changed little in the “new normal” that was established after the real estate industry had absorbed and accommodated the changes established in the early days of the HVCC. A property owner or realtor doesn’t need to be familiar with the intricacies of the 16 provisions and 2000-plus pages of DoddFrank to know that intimidating or coercing an appraiser is not in keeping with the letter or spirit of the law. However, short of bribery or extortion, violations of appraisal independence requirements (AIR) are very much in the eye of the beholder concerning pressure or unwanted instruction.
What to provide to the appraiser
appraiser’s perspective, looking for what could go wrong. Start by reviewing your investment process, and begin developing a packet of information that you can provide to the appraiser to preemptively counteract problems. Consider the order itself. Was the entire contract received by the appraiser for analysis? It isn’t uncommon for appraisers to receive a contract and for someone to neglect to forward the counteroffer. If the omission isn’t discovered until the appraisal is complete and submitted to the lender, the probability for an increased appraised value without a value-add (ie, a finished basement) is low. A contract summary page should be provided to the appraiser with the following information: • legal name of the seller; • buyer name (as it appears in the loan packet and contract); • number of pages in the contract (including all addenda);
If all communications are to be broken down into a rule of thumb, it would be this: Keep it professional. It’s important to remember that staying compliant isn’t only what is presented; it’s how information is presented.
• purchase price;
Let’s view the appraisal project from the
Also helpful is whether there is any private
• any sales concessions; • date the contract was effective; and • expected date of close and possession.
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Legal property included in the sale, such as a flatscreen television or a hot tub. Include your renovation budget with your research, as well as before and after photos of the property. This is especially important if the property was recently listed or sold. Realtors always shoot flattering photos of the property they’re marketing, even if there’s little flattery to be found. The last thing you need is for the appraiser to conclude, based upon prior market information, that your upgrades to the property are insignificant, or worse, that you’re trying to take advantage of someone. Underwriters have more tools at their fingertips than ever before. Thus, it’s very likely they’ll have access to prior listing information and will need concrete reasons for dynamic value increases. Be sure you give it to them.
more than what is available on MLS. Tour distressed homes on the market and provide relevant information. When you purchased the property, did you have a model match sale and tailor your rehab to suit market acceptance at that price? If so, this is extremely relevant to the appraisal process, even if the comparable is slightly dated. Data concerning market trends is widely available, and most appraisers recognize that a well-supported adjustment of 3 percent accounting for market appreciation is at least as relevant as a recent sale with a 15 percent subjective adjustment for condition or updating.
Vulnerability to charges of improper attempts at influence arise when conclusions are prepackaged: “You can’t use this sale PICTURES ARE WORTH A The most sensitive because …”, “Anyone THOUSAND WORDS, AND information to who knows anything PHOTOS OF THE BLACK provide is what about this market MOLD IN AN REO SALE’S you’ve discovered would include this about your market sale …” The appraiser MASTER BATH OR THE that may not be will perceive real value CRACKED FOUNDATION immediately available to your research if you IN THE BASEMENT to the appraiser or show the reasons for other real estate your conclusions and COULD NET YOU TENS OF professional. When forgo drawing those THOUSANDS OF DOLLARS. you are purchasing an conclusions. Pictures investment property, are worth a thousand presumably you’ve performed your due words, and photos of the black mold in an diligence in ensuring a profit can be made. REO sale’s master bath or the cracked During the rehab process, you’ve kept an eye foundation in the basement could net you on the market, noting what has and hasn’t tens of thousands of dollars. sold, as well as what’s gone under contract, Know your customer, know your been discounted or recently been offered to lender the market. Don’t leave this information at Finally, no review of post Dodd-Frank your office in hopes the appraiser arrives at appraisal procedures would be complete the same conclusions you’ve reached. without addressing the selection of the Is the foreclosure that looks great in MLS and appraiser. There is no apparatus for choosing closed last week a bad comp? Why? View the your favorite appraiser, but to willingly accept home, and inoculate yourself against the use an offer without considering the institution of bad or unrepresentative sales by knowing that backs that offer is inviting trouble. Not
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Legal all lenders are created equal. Thereâ&#x20AC;&#x2122;s a series of banking rules that have been enacted over the last 10 years, ultimately leading to Know Your Customer, finalized (for now) in 2012. I would turn that around by telling real estate professionals to Know Your Lender. Everyone has reacted to the alphabet soup of agencies and acronyms for regulations slightly differently and with various levels of success. Some have accommodated rules with little change in their lending practices, while others have had an extraordinarily difficult time making the leap to the new lending paradigm. The most difficult, least flexible lenders are serviced by giant processing centers or AMCs, who qualify their appraisers using a mirror to verify theyâ&#x20AC;&#x2122;re still breathing. From there, their only concern is price and turn time
for assignments. Those servicers will auction assignments to the lowest bidders in both price and turnaround (known in the industry as a reverse auction). Quality can take care of itself. This model might be adequate for the middle of the road homes, but recently renovated properties often comprise the high end of the market and are just the type of assignments that may require an appraiser to do slightly more than merely report the last three sales in the area. While appraisers have a duty to not allow the fee for an assignment influence the scope of work or the reporting, human nature is a powerful motivator. The best, most accomplished lenders all have one thing in common: They close loans. It may appear redundant to recommend an investor wait for a buyer backed by a lender that closes loans, but when considering properties that are in excess of 20 percent higher than the
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Legal predominant value in a market, closing loans has unfortunately become a niche skill. And, most important to the ability to close loans is for the underwriter to have the latitude to agree that a value is legitimate. Big box lenders will addendum an appraiser to death because they won’t have enough experience or confidence in their appraisers or in their own market knowledge. The cascading underwriter effect feeds on itself until a lender is never confident enough to fit your round peg into their square hole. In the old days, good underwriters had enough familiarity with their local appraiser and market and were able to rely on that experience when viewing a home with a high level of improvements. Today, those competent lenders still exist. They keep a small rotation of professional appraisers and allow underwriters the freedom to make decisions based upon the supported value opinions of those appraisers. Familiarize yourself with your lenders. How do they qualify for appraisers? How many appraisers are on approved lists for your market? How are orders placed? Sometimes, accepting a slightly lower offer with a more agile lender is preferable to taking the top offer from a bank with a poor track record for closings. Struggling with inept underwriting or a cut-rate appraisal for 45 days, only to have the sale fall through, isn’t good for anyone. And getting a poor FHA appraisal that attaches a low value to a property for six months can be a disaster for a renovation project.
The other alternative to the entire ordeal is to track down the unicorn of the rehab industry: The elusive cash buyer. It would be nice to be able to consistently rely on cash buyers only, but it’s probably safe to assume that most rehabbers will be faced with marketing to the general public and working within the bounds of DoddFrank. Familiarity with the process can be a competitive advantage in an already difficult industry, but most of the recommendations for compliance are tasks that rehabbers and investors already perform in the normal course of investment.
In summary
Taking a few extra minutes each day to document those tasks in order to effectively communicate with the appraiser can only help your bottom line and go a long way in protecting you from inadvertent violations of Dodd-Frank. The rehab industry is a significant and necessary force for economic good in today’s recovering housing market. Reclaim some control of your livelihood by ensuring that the appraiser who visits your property is at least as informed as you are about the market you’ve invested in so heavily. Jason Ormiston has been appraising real estate and consulting since 1993. He is currently certified in Missouri and Kansas and is on the FHA roster in both states. Jason has experience in residential, REO, complicated and high value properties. For more information, visit www.toddappraisal.com. Chris Wolfenbarger has been an appraiser since 1996 and has performed countless valuations in Kansas, Arizona and his home state of Missouri. He has performed primary residential appraisals with a specialized focus in high-end and unique properties as well as HUD REO properties.
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44 Private Lender
Legal
BUILT TO SCALE Everybody starts small, but the smartest entrepreneurs create ventures that are destined for growth. BY JAMES HART
I
t’s hard to look at the world’s most successful entrepreneurs and not feel a little intimidated.
The one thing you must remember is that every business starts small, says George Antone, the investor, author and educator who created MPactWealth, formerly WealthClasses, a company that specializes in training for private lenders and entrepreneurs. The big guys are just small entrepreneurs who built operations that were capable of scaling up, and you can do the same thing, he said. You just have to master three basic concepts: metrics, systems and teams.
Metrics
Business is like basketball: You can’t tell if you’re winning unless you keep score. That’s why it is essential to keep track of your business’s key performance indicators — the metrics that show how your operation is truly performing, not what it “feels” like. Measure the things that matter. What’s your average acquisition cost for a property? What
are your earnings? How many deals do you have in the pipeline over the next 90 days? On average, how long does it take you to sell a property? Even the smallest operation will have at least 10 high-level metrics to follow. For example, Antone recommends that entrepreneurs keep track of their “runway” — how long they can stay in business without turning a profit. If you have $100,000 in the bank, and it costs $50,000 to keep your enterprise running for a month, you’ve got a runway of two months. That’s the whole point of knowing the numbers. They serve as an early warning sign when things aren’t working right, so you can attack those problems. And if the numbers are good, they might indicate the most productive places to invest extra time and money. “Without understanding the numbers,” Antone said, “you’re shooting in the dark.”
Systems
Have you ever seen a NASCAR driver change his own tires during a
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race? No, they have pit crews. The crew keeps the car running so the driver can focus on winning the race. And have you seen a pit crew work? They’re shockingly fast because they’ve got an efficient system. A big job is broken down into a series of smaller tasks divided among a well-trained team. When they’re starting out, a lot of property investors collect rent, manage their own books and handle upkeep; they take care of everything. To grow their business, though, they eventually need to hand those tasks to someone else, whether that’s an employee
AS YOU GROW, IT’S A GOOD IDEA TO HAVE MULTIPLE PEOPLE WHO CAN STEP INTO A ROLE. or a third-party service provider, so they can spend their time on finding deals, raising money and other activities that generate revenue. For an individual entrepreneur, it can be nerve-wracking to let someone else take on a critical responsibility. Keep in mind, most businesses only have three to six processes that represent the bulk of their activities, Antone said. Those processes can almost always be boiled down to a repeatable set of steps that can be taught to someone else. (And someone else, and someone else, as your operations keep expanding.) Maybe you’re a one-man band right now, but you should start documenting your systems so, one day, your teams can run them for you.
46 Private Lender
THE DELEGATION TEST George Anton has a quick exercise that can show you when you should hire someone else to do a job for you. How much did you earn last year? Divide that number by 2,000. That’s how many hours the average person works in a year, assuming a 40-hour workweek and 10 days of vacation. If you brought in $100,000, then an hour of your time is worth $50. Now, for the next two weeks, record everything you do at work, in half-hour increments. At the end of that period, go back and examine how you spent your time. Let’s say you spent three hours a week on bookkeeping. Could you get someone else to do that work for you for less than $50 an hour? If so, then you should hire it out. You can use the time you spent on bookkeeping — and any other task you delegated — to put together deals, look for investments and generate income.
For more information, visit www.thebankerscode.com
Teams
Once you’re ready to bring extra help aboard, what position should you fill first? Antone recommends that you start with an assistant, someone who can handle administrative tasks and free you up for higher-value work. After a few months, he said, you’ll wonder how you ever got along without one. As you grow, though, it’s a good idea to have multiple people who can step into a role. That way, if any one of those people gets run over by a bus (or up and quits), your entire operation isn’t at risk of shutting down. For private lenders, it’s usually good to be working with at least five borrowers. If any one of them goes down, you only lose part of your business and not the whole thing. “We don’t want everything to depend on one person,” Antone said. “We have a term we use — single point of failure.” Scaling up a business takes a different, more strategic way of thinking. But the rewards are worth it. As Antone said, “There’s a lot more money to be made at the strategic level.” James Hart is managing editor of Community Investor magazine.
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COLORADO Company Name
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Bridge Capital Resources LLC
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Osborne
(303) 475-5873
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Wilmington Investments
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Diversified Equity Advisors, LLC
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Dyer
(913) 402-2513
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Bortnem Services LLC
Roger
Bortnem
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NEW YORK Company Name
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Last Name
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1839 Asset Management
Vincent
Spreuwenberg (917) 797-3452
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TENNESSEE Company Name Heritage Capital
First Name Shelley
Last Name Phone Number Mosher (866) 210-0158, x1
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TEXAS B2R Finance
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Herriage
(972) 755-1880
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(214) 420-7304
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Speed
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UTAH Company Name
First Name
Last Name
Phone Number
Type
Credit Circle formally Debt Dog Inc
Perikles
Konstantinides
(917) 705-5940
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The Aclaime Group
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Luettgerodt
(801) 836-5985
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WDB Funding LLC
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Watkins
(801) 244-0312
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VIRGINIA Asset-Based Wealth and Capital, LLC
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Skeete
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Sexton
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Dangler
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Coons
(800) 706-4741
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Eley
(425) 818-2225
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Nemo-A Investment Corp
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Rea
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WISCONSIN The Fresh Corp
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Jones
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WEST VIRGINIA TIC Investments
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Moore
(304) 345-2694 Lender
QUEENSLAND, AUSTRALIA Biddle Lawyers
Russell
Biddle
+61 417578879
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Biddle Lawyers
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