It may be a bit of a morbid subject, but the fact is that there are a lot of investors out there that have been hurt by the circumstances of the last few years. Countless investors have called me for my advice on what to do about their problems. A sad sight is seeing someone go down the tubes financially – especially when it could be avoided. Negative cash flows, vacancies, credit card debt, and even negative equities are not a hopeless situation. Some of the causes of these problems are:
- Lowering rents
- Lowering property values
- High vacancy or long term vacancy
- Paying too much for properties
- Extensive repairs or damages
- Over extended credit
- Foolish property purchases
These problems are not terminal. There are at least 27 cures other than bankruptcy and foreclosure. Don't give up. Almost any disease can be fatal without the medicine to treat it. Hang in there and give the doctor a chance.
How to recognize a problem:
- You try to get MacDonalds to take VISA or a note against one of your properties.
- The mailman is getting back trouble from the weight of all your bills.
- You hate to check the mailbox or play back the messages on your answering machine.
- Your banker steps into the nearest office or picks up the phone when he see you walk in the door.
- Rolaids makes up a large portion of your food budget.
- You're starting to get some stinkin' thinkin' and hardening of the attitudes.
- You think about your rental units every time you light a match or see a fire truck.
- Your sob stories can beat those of any of your tenants.
- You've learned how to pull cash out of the purchase of properties and live from purchase to purchase.
- You start looking around for appraisers that appraise real high.
That may be a little exaggerated, but maybe you get the point. I counseled one investor that was surviving by buying items or gift certificates on his store charge card and then taking them back for cash. Another had 100k in debt and hadn't had a job in 4 years. He lived off of his mother's Social Security check. Others are on the verge a nervous breakdown or have turned to alcohol.
One case I'll always remember was an investor that was not sure where the next week's food for his family would come from. I was excited to look at his portfolio and the potential involved. Using some simple techniques (that few people know) it is a simple job to restructure his portfolio and change his cash flow situation to the point where he could retire (primarily using the principles of “Equity Arbitrage” and “The Discount Refinance”).
Another case was an investor that came up to me after I spoke to an investor group in Denver. He waited around patiently until everyone was gone and had the most dejected look on his face. He had a condominium that had gone down in value way below the mortgage. He had good credit, yetcouldn't afford the negative cash flow or to sell the property. This was his only major problem, yet he could see no other option besides bankruptcy. It took just a moment to prescribe the medicine that would clear up this big financial wart. Let's look at his particular remedy.
The property was originally worth $70k and he had a loan for $60k. The value had dropped to $50k, so he was in a negative equity position. He owed ten thousand dollars more than the property was worth. This loan is to a bank and would foul up his credit if he let it go back. The bank didn't want it and threatened suing for a deficiency judgement if it went to foreclosure.
Talk to the Lender
If the bank had to foreclose, what would their situation be? If the value is $50k, they would probably end up taking close to a $20k loss on their $60k loan. Their net proceeds after the sale might be $40k or less. The first part of the remedy was to go see the banker with the words “I'd like to talk about OUR problem.” The banker may need it pointed out that it is his problem too, because he could be looking at a $20k loss. “Mr. Banker, I think there is a solution where we could avoid this.” One thing to remember is that the banker does not like losses, cannot afford foreclosures and may be as concerned about a possible foreclosure as you. Ask him how he feels about the security for his loan and inquire if he would like better collateral. Present to him the possibility of him substituting collateral provided it meets his approval and puts him in a much better situation than he is in now. If approached in the right way, most bankers will listen.
Find the Collateral
Ok, so how do we find this other collateral and what good would that do us? Most real estate investors and professionals are only vaguely aware that there is a “discounted mortgage” market. The basis of this market is the purchase and sale of privately held mortgages secured by real estate. These mortgages are generally created in the sale of a property between two private parties and sell at a discount at a later date. These discounts range from about 25-50% depending on the terms of the note (primarily dependant upon the length). In other words, a $10,000 second trust deed secured by a nice piece of real estate might sell for between $6,000 and $7,500 in the discounted mortgage marketplace.
What this means is that in the discounted mortgage market you can find a privately held note that is similar to the $60,000 loan with the banker and buy it at a substantial discount. At a 40% discount $60,000 in notes could be purchased for $36,000. In other words, using the “DiscountedSubstitution” technique, it is possible to pay off a $60,000 loan for $36,000.
Find the Financing
That sounds well and fine, but how does one obtain the cash needed to buy the note? If the lender agrees to take another note as collateral then the original property will be free of that loan and the funds could be obtained by financing that property. That means that the condominium that had the $60k loan is free and clear when the lender substitutes collateral. The $36k that is needed to buy the note could easily come from putting a new loan on the condominium. Ok, why would the lender do the deal and how is someone that is in foreclosure going to get a loan?
There is a bit of a catch 22 situation here. When the loan is behind in payments and foreclosure is pending, the banker may begin to be flexible enough to listen, yet the owner's credit and financing ability may be limited. If the loan is current and everything is fine at this point, the lender isn't too worried, yet the owner's financing ability is not impaired. I have had lenders tell clients that they are not worried and won't discuss any changes, because they know they will make the payments. One client is a dentist and the lender just has this euphoric feeling of “I know he'll make the payments” when the loans are actually killing him.
The benefits for the lender are plenty. Whether the loan is behind or not, it is a bad loan and a tremendous potential problem for the lender. The property is over leveraged, has a ridiculous loan to value ratio and is a potential $20,000 loss for the lender. It is easy to show him that the newcollateral is so very much better. Since it is only a substitution of collateral, the current borrower is still responsible, yet now it is a self-liquidating loan which bankers like a lot more than emptycondominiums. There is a different, more valuable property as collateral and the loan to value ratio is dramatically improved.
If getting the loan is a problem, there is plenty of profit margin to allow bringing in an investor to help finance the deal. A potential loan of $40k is possible leaving money for any points and a couple thousand left over to give an investor. There will also be $10,000 equity in the property after the transaction takes place. It could even be possible to give the investor some of that equity also. I'd love to tell you how tomake a continued profit of $20,000 each year from the note that the bankerhas as collateral, but I don't have room here.
Substitute Collateral and Refinance
All of these steps could all close at one time. The purchase of the note, refinance of the property and substitution of collateral can all close at the title company on the same day. The results are exciting for all concerned. Every party to the transaction wins:
Property owner – Prevents foreclosure, turns a $10k loss into a $10k profit, makes the property saleable, has a potential $20k/yr continuous profit.
Lender – Averts a foreclosure and bad loan, obtains better collateral, saves a client, probably gets a promotion for “his” ingenuity.
Investor – Gets a good property, cash, equity, good collateral and a good deeds merit badge.
Time to change the attitude, move on and be focused on profits not problems. If there are other problems yet to be solved, take a renewed determination and optimism into solving the next one. What happens when your problems are solved? Do you think the banker has other problems? You could make $10,000 equity and $20,000 per year in cash from every other similar condominium out there. In addition, a version of the same principle works well with a lender's REO property.
I used to bend over backwards to try and buy properties at market price with easy terms. Since the time I learned about real estate paper, I haven't had much of an interest in a property unless it was less than 70% of market value with nothing down and cash in my pocket.