You've spent the last 4 months trying to get your client a mortgage on his investment property. You gathered all his personal, business and real estate financial information, for not only the property you're trying to finance but for all his business and property interests. You've done projections, forecasts and read through 200 page appraisals. You've put together a loan package, sent it to numerous commercial mortgage lenders, only to find out each one needed the same information filled out on their particular unique forms. So you've spent dozens of hours more transferring the same information to tens of different applications. You've spent numerous hours obtaining "additional information" for each potential interested lender. And now you've exhausted all possible institutional mortgage sources and still no loan.
Sound familiar? Perhaps you're new to the commercial mortgage field. You have been successful originating residential loans, took the NAMB Commercial Mortgage course and decided to expand your practice to include commercial and investment property mortgages. Or maybe you're already a commercial mortgage broker, successful in obtaining financing for some clients, but feel you just spin your wheels trying to obtain financing for others. The key to spending your time more productively is to understand when institutional commercial mortgage money is NOT available for your client. The key to earning a commission from these same clients is to understand what type of financing may be available for this same client.
Private mortgage loans are loans secured by real estate made by a private lender instead of a bank, lending institution or government agency. Private mortgage loans are short-term (ranging from six months to three years) hard money or asset based loans made to the professional real estate investor for the purchase, rehabilitation or equity cash out of real property. This means that the decision to lend is based on the equity and value of the property being put up as collateral, not on the borrowers credit. The security for the loan is enhanced because the loan represents a maximum of 65% - 70% of the appraised value of the income producing property. On non-income producing property (raw land, lots, construction money) a maximum of 55% loan to value is lent. Investors can expect to pay interest rates of 12% to 14% on first liens and 16% to 18% on second liens in this current low interest rate environment. Historically first lien yield of six points over prime has been obtainable.
Why are real estate investors willing to pay high rates to borrow private money? When interest rates of 14% to 18% are added to four-to-eight points, the real estate investor/borrower is paying 20% plus annually for the money borrowed. Its obvious why this is a good deal for the private mortgage lender, but why should real estate investors be willing to pay these high rates when conventional mortgage money costs 7% to 10%? There are many reasons, but all fall into four categories.
Qualifying Problems
The real estate investor/borrower and/or the real property does not qualify for an institutional mortgage loan. This can be anything from low borrower credit scores or too much borrower debt, to the borrower's properties not producing a sufficient enough income. Further, the property itself may not support the type of loan the borrower wants. Many institutional lenders will not loan amounts under $500,000; many will not lend second lien money even if there is significant equity in the property. If major repairs or rehabilitation is necessary, institutional lenders will not be interested unless the project is very large and the borrower has an extensive track record. In these cases the private mortgage lender may be the only resource available for the real estate investor/borrower. Institutional lenders are concerned with both the appraised value of the property and borrower and property credit. Private mortgage lenders are only concerned with the appraised value, as long as the appraised value represents a fair market price. Hence, if a property is producing or can produce sufficient income to pay the note and the value of the property will fully secure the note and provide sufficient equity, then the borrower's credit is not an issue for the private mortgage lender.
The Need For Speed
Speed of closing the transaction. Mortgage money obtained from banking or institutional sources, called conventional mortgage money, usually takes between 60 and 90 days to fund. Institutional lenders need not only obtain appraisal of the value of the property, but also require detailed examination of the borrowers credit history and current financial status, as well as financial statements and tax returns, not only for the property securing the loan but for all real property and business interests owned by the borrowing entity and the borrower himself. Private mortgage lenders on the other hand can usually complete a transaction within seven-to-10 days. Since the property itself is the main criteria to be used to determine loan eligibility, much less information on the borrower and the borrower's other properties are required, resulting in a much quicker approval process. The private mortgage lender can make a decision within 24 hours of receiving information; institutional mortgage money must be approved by a loan committee that may only meet twice a month, and that may send the loan request back to the loan officer for more information, necessitating a further two week delay until the committee meets again.
Privacy Concerns
Borrowers may not want or be able to provide personal financial information or go through the hassles of the application process associated with obtaining an institutional mortgage loan. The borrower may be going through a divorce or business separation and may not want his wife, partner, government, lawyers, etc. to obtain his personal financial statement. Additionally the borrower may not have all financial information on all his real properties and businesses up to date or complete; he may have filed for an extension on his latest tax return; his accountant may be behind in preparing his financial statements. While all these would negate or at least delay his getting an institutional mortgage, it should have no effect on the borrower's ability to obtain a private mortgage loan.
More Money
The real estate investor may be able to borrow more from the private or hard moneylender and therefore have less of his own capital invested in the property. Institutional mortgage lenders lend based on the lower of the cost of the property or appraised value of the property; private mortgage lenders lend based on the appraised value only. Hence the real estate investor utilizing a private or hard money loan is not penalized for purchasing the property at a significant discount to market value. Additionally, most private mortgage lenders do not have onerous seasoning requirements to make the loan.
Don Konipol has been a licensed Texas real estate broker since 1978. He is owner of Wolverine Mortgage Partners, LLC. in Houston, Texas and general partner of the Managed Mortgage Investment Fund LP. Mr. Konipol can be reached at (832) 577-8838 or emailed at dhkonipol@yahoo.com and will be happy to answer any questions or discuss any aspects of private mortgage loan investments
Saturday, July 2, 2011
Monday, April 12, 2010
A REAL ESTATE PORTFOLIO FOR HIGHER CURRENT YIELD AND GREATER POTENTIAL GAINS
Real estate investments are made for two main reasons. One is to provide a stable source of current income, the other is to provide a hedge against inflation. Popular thinking is that the investor can gain both through the purchase of income producing property. And while this is true, this investment may not yield the highest return possible with the least risk.
As in any passive investment, the investor will pay a price, either direct or indirect, for the management of his investment. Sure the investor can act as his own property manager, accountant, broker, etc., but that part of investing is really being in business. As such an appropriate amount of compensation must be deducted from income for the performance of these business services if we are to arrive at an accurate reading of the investment’s return.
Currently, owners of income producing real estate are holding out for high prices (low return to buyers) in this market environment. The owners can hold out because (1) they are collecting positive cash flow on their investment and (2) their interest rates on loans they were able to obtain years ago are at historic lows. This combination makes for few distressed sales in the commercial market of income producing property. The property that can be obtained at large discounts are non cash flowing properties, which investors reject because these properties do not meet the first reason for investing, providing a stable current income. About the best the investor can do is obtain property yielding 7 -8 % annually with little upside potential.
I have been able to create a real estate portfolio yielding significantly greater current returns with significantly greater upside potential. I have accomplished this by separating my real estate investments into two groups, one for income and the other for capital growth/inflation protection.
For the current income portion I own high yield trust deeds. These are hard money loans made using real estate as collateral. Yields are 15-18%, with low loan to value ratios. I lend a maximum of 55% of value on income producing property, 30% on city lots and 15-20% on raw land. My foreclosure experience has been fairly low (12-15%), so my return over time has averaged about 16% annually.
The second part of my portfolio is non cash flowing real estate. The reason for this is that I am able to obtain this type of property at 60% of value. Many owners of non cash flowing properties are highly motivated to sell as they have no income from the property. Many have over extended in far too many properties, and selling for a low price is their only way out. Picking up properties with a built in equity is quite an advantage, when the real estate market recovers profits on these properties will be twice the profits on cash flowing properties purchased at market value.
I believe that the proper balance for this portfolio is 2/3 in high yield trust deeds, 1/3 in properties purchased at large discounts. This is not as one sided as it seems because there will be some defaults and hence opportunities to own a few of the properties lent on at a fraction of market value. Further, I am talking about purchasing the properties for cash, so what little immediate cash flow can be obtained from the property will be enough to pay taxes, insurance and any other holding costs. Even land can be leased in various ways, usually for enough to pay taxes (insurance in usually not a concern on unimproved property).
So let’s see how my portfolio performs. With 2/3 in trust deeds, my overall yield on the portfolio is about 11 – 12 % (16 -18% on 2/3 of the portfolio, 0 current income on the other 1/3). If inflation hits as I suspect it may, prices may double in five years. Since I am into these properties at 50% of value, a doubling will actually increase the value of the non income producing portfolio by a factor of 4X. If we have no inflation and my property values stay the same, I merely double my money. So I am being paid 11-12% current return on my real estate portfolio and have tremendous upside.
As in any passive investment, the investor will pay a price, either direct or indirect, for the management of his investment. Sure the investor can act as his own property manager, accountant, broker, etc., but that part of investing is really being in business. As such an appropriate amount of compensation must be deducted from income for the performance of these business services if we are to arrive at an accurate reading of the investment’s return.
Currently, owners of income producing real estate are holding out for high prices (low return to buyers) in this market environment. The owners can hold out because (1) they are collecting positive cash flow on their investment and (2) their interest rates on loans they were able to obtain years ago are at historic lows. This combination makes for few distressed sales in the commercial market of income producing property. The property that can be obtained at large discounts are non cash flowing properties, which investors reject because these properties do not meet the first reason for investing, providing a stable current income. About the best the investor can do is obtain property yielding 7 -8 % annually with little upside potential.
I have been able to create a real estate portfolio yielding significantly greater current returns with significantly greater upside potential. I have accomplished this by separating my real estate investments into two groups, one for income and the other for capital growth/inflation protection.
For the current income portion I own high yield trust deeds. These are hard money loans made using real estate as collateral. Yields are 15-18%, with low loan to value ratios. I lend a maximum of 55% of value on income producing property, 30% on city lots and 15-20% on raw land. My foreclosure experience has been fairly low (12-15%), so my return over time has averaged about 16% annually.
The second part of my portfolio is non cash flowing real estate. The reason for this is that I am able to obtain this type of property at 60% of value. Many owners of non cash flowing properties are highly motivated to sell as they have no income from the property. Many have over extended in far too many properties, and selling for a low price is their only way out. Picking up properties with a built in equity is quite an advantage, when the real estate market recovers profits on these properties will be twice the profits on cash flowing properties purchased at market value.
I believe that the proper balance for this portfolio is 2/3 in high yield trust deeds, 1/3 in properties purchased at large discounts. This is not as one sided as it seems because there will be some defaults and hence opportunities to own a few of the properties lent on at a fraction of market value. Further, I am talking about purchasing the properties for cash, so what little immediate cash flow can be obtained from the property will be enough to pay taxes, insurance and any other holding costs. Even land can be leased in various ways, usually for enough to pay taxes (insurance in usually not a concern on unimproved property).
So let’s see how my portfolio performs. With 2/3 in trust deeds, my overall yield on the portfolio is about 11 – 12 % (16 -18% on 2/3 of the portfolio, 0 current income on the other 1/3). If inflation hits as I suspect it may, prices may double in five years. Since I am into these properties at 50% of value, a doubling will actually increase the value of the non income producing portfolio by a factor of 4X. If we have no inflation and my property values stay the same, I merely double my money. So I am being paid 11-12% current return on my real estate portfolio and have tremendous upside.
Monday, March 29, 2010
Trust Deed Investing After the Real Estate Meltdown
With real estate prices falling as much as 50% in the last two years, many real estate investors, as well as many trust deed investors lost a significant part of their principal. The real estate investors that used leverage ended up in an even worse position, sometimes losing their entire investment. Many trust deed investors ended up foreclosing on property and having to take large losses in order to sell in the current market environment. But it did not have to be this way. If these trust deed investors had followed simple common sense rules their principal would be intact today.
With property values skyrocketing in the first decade of the 21st century many trust deed investors were willing to lend high loan to value ratios on all types of properties. Sometimes income producing property carried loans as high as 80 to 90%. Even a small decline at these ratios resulted in a large loss for lenders. When one factors in the cost of foreclosing, back taxes, and real estate brokerage fees upon resale a small loss can turn into a large loss. These lenders got caught up in the euphoria of the moment and lent at unsafe ratios. This brings us to rule number 1:
Never lend more than 60% of property value on income producing property
The situation with non-income producing property is even more severe. Non-income producing property is more difficult to sell than income producing property. Further, non-income producing property is a total drain on a trust deed investor’s resources, should that trust deed investor needs to foreclose. While taxes, insurance, and legal fees are accumulating there is no income to offset these costs. This brings us to rule number 2
Never lend more than 50% of property value on non-income producing property.
Perhaps the most devastating situation to private, as well as institutional lenders in the commercial sector during the real estate meltdown occurred in land loans. Land is difficult to appraise in the base case. Even appraisers with years of experience have problems reaching an accurate valuation. The reason for this is that no two parcels of land are exactly alike. And so the appraisal of land is a best guess. Add to this the complexity of the situation when land is at some stage of development. Often times an appraiser will add the value of putting in utilities, roads and other improvements to the land. Even more dangerous is when an appraisal is based on the price that can be obtained by subdividing the land into smaller sections or lots. The appraiser will then add up the total value of all these proposed lots and work backwards using a time value of money constant in order to come up with a valuation. The problem with this from the lenders viewpoint is that if market activity comes to a standstill, as happened in 2008 -- 2009 then the value of all these improvements may be zero. This brings us to rule number 3
Never land more than 35% of property value on land.
Most experts on trust deed investing are only knowledgeable about lending on single-family homes, so naturally this is what they recommend. However, lending on single-family homes is much riskier than lending on commercial property. In many parts of the country the prices of single-family homes have fallen 50% or more in the last two years. Trust deed investor’s, who lent on single-family homes incurred large losses when they were forced to foreclose on these homes. Further, our court system is much more favorable to homeowners then it is to people who own commercial property. Bankruptcy judges will often times bend over backwards to help a homeowner in trouble. This means that a trust deed investor owning a trust deed secured by a single-family home may collect no payments for a long time while the property declines in value, and while the homeowner remains in the property doing no repairs and upkeep. As of this writing it was unclear what legislative moves the current administration would make in regards to foreclosing on home loans. However, it can be assumed that any new laws will be favorable to the homeowner and not the lender. And so rule number 4
Lend only on commercial property, never on single-family homes.
As a side note to rule number four. It has been our experience in the eight years of the Managed Mortgage Investment Fund that although only 20% of our loans were made on single-family homes these accounted for 85% of our problems.
We've all heard stories of the problems with bogus appraisals. Whether the appraiser was unqualified or corrupt, many properties were appraised for many times their real value. As a result, lenders lost billions of dollars across the board. These problems have only partially been corrected by laws concerning the state certification of appraisers. The truth of the matter is that to become a state certified appraiser one needs a minimum of education and experience. And even if this education and experience qualifies the appraiser to appraise residential property it most assuredly does not qualify the appraiser to appraise commercial property. Fortunately, there are appraisal organizations that do certify appraisers in various areas. The best of these is the Appraisal Institute. The Appraisal Institute offers the designation Member Appraisal Institute to appraisers who have vast experience with many types of commercial properties, who pass written exams and who continually update their education. Rule number 5
Make sure the appraisal is performed by an MAI certified appraiser. A state certified appraiser is not adequate to determine property valuation of commercial property.
With property values skyrocketing in the first decade of the 21st century many trust deed investors were willing to lend high loan to value ratios on all types of properties. Sometimes income producing property carried loans as high as 80 to 90%. Even a small decline at these ratios resulted in a large loss for lenders. When one factors in the cost of foreclosing, back taxes, and real estate brokerage fees upon resale a small loss can turn into a large loss. These lenders got caught up in the euphoria of the moment and lent at unsafe ratios. This brings us to rule number 1:
Never lend more than 60% of property value on income producing property
The situation with non-income producing property is even more severe. Non-income producing property is more difficult to sell than income producing property. Further, non-income producing property is a total drain on a trust deed investor’s resources, should that trust deed investor needs to foreclose. While taxes, insurance, and legal fees are accumulating there is no income to offset these costs. This brings us to rule number 2
Never lend more than 50% of property value on non-income producing property.
Perhaps the most devastating situation to private, as well as institutional lenders in the commercial sector during the real estate meltdown occurred in land loans. Land is difficult to appraise in the base case. Even appraisers with years of experience have problems reaching an accurate valuation. The reason for this is that no two parcels of land are exactly alike. And so the appraisal of land is a best guess. Add to this the complexity of the situation when land is at some stage of development. Often times an appraiser will add the value of putting in utilities, roads and other improvements to the land. Even more dangerous is when an appraisal is based on the price that can be obtained by subdividing the land into smaller sections or lots. The appraiser will then add up the total value of all these proposed lots and work backwards using a time value of money constant in order to come up with a valuation. The problem with this from the lenders viewpoint is that if market activity comes to a standstill, as happened in 2008 -- 2009 then the value of all these improvements may be zero. This brings us to rule number 3
Never land more than 35% of property value on land.
Most experts on trust deed investing are only knowledgeable about lending on single-family homes, so naturally this is what they recommend. However, lending on single-family homes is much riskier than lending on commercial property. In many parts of the country the prices of single-family homes have fallen 50% or more in the last two years. Trust deed investor’s, who lent on single-family homes incurred large losses when they were forced to foreclose on these homes. Further, our court system is much more favorable to homeowners then it is to people who own commercial property. Bankruptcy judges will often times bend over backwards to help a homeowner in trouble. This means that a trust deed investor owning a trust deed secured by a single-family home may collect no payments for a long time while the property declines in value, and while the homeowner remains in the property doing no repairs and upkeep. As of this writing it was unclear what legislative moves the current administration would make in regards to foreclosing on home loans. However, it can be assumed that any new laws will be favorable to the homeowner and not the lender. And so rule number 4
Lend only on commercial property, never on single-family homes.
As a side note to rule number four. It has been our experience in the eight years of the Managed Mortgage Investment Fund that although only 20% of our loans were made on single-family homes these accounted for 85% of our problems.
We've all heard stories of the problems with bogus appraisals. Whether the appraiser was unqualified or corrupt, many properties were appraised for many times their real value. As a result, lenders lost billions of dollars across the board. These problems have only partially been corrected by laws concerning the state certification of appraisers. The truth of the matter is that to become a state certified appraiser one needs a minimum of education and experience. And even if this education and experience qualifies the appraiser to appraise residential property it most assuredly does not qualify the appraiser to appraise commercial property. Fortunately, there are appraisal organizations that do certify appraisers in various areas. The best of these is the Appraisal Institute. The Appraisal Institute offers the designation Member Appraisal Institute to appraisers who have vast experience with many types of commercial properties, who pass written exams and who continually update their education. Rule number 5
Make sure the appraisal is performed by an MAI certified appraiser. A state certified appraiser is not adequate to determine property valuation of commercial property.
Tuesday, March 23, 2010
How to Buy Real Estate at 50 Cents on the Dollar
It is a truism in real estate investing that money is made when you purchase; the profit is realized when you sell. The problem for the investor is that everyone is trying to buy at a discount. The competition drives the price of any worthwhile property near or up to full market value. Even so called distress sales; foreclosure, bankruptcy, probate, divorce, can result in competitive bidding.
The internet has been a great friend to the seller of property. Fifteen years ago someone with property to sell either had to accept a discount for a quick sale from one of the all cash “we close quick” buyers or spend months waiting for an offer while his property was listed in the “MLS Book”. Now, information about a property for sale is instantaneously transmitted to potential buyers worldwide. We have sold Houston apartment buildings to California based investors, a Bryan, Texas office – warehouse to a Singaporean transportation company, and an Austin church building to a Dallas based ministry looking to expand.
In years previous, being an all cash buyer allowed me to purchase property at 70 – 80% of real value. However, for the reasons mentioned above being an all cash buyer no longer warrants a 25% discount (by the way we are talking about REAL current value here, not some inflated appraisal done one year ago before prices dropped 30%). Going to auctions, subscribing to foreclosure listings, contacting probate lawyers, were no longer generating the deal flow I needed.
The need for financing (and lack thereof) combined with the current sour economic environment have combined to provide a once in a lifetime opportunity for the investor with cash to purchase quality properties at 50% or less on the dollar. What I do and what any real estate investor with cash can do is make hard money loans on property you would be happy to own. The foreclosure rate on loans secured by commercial property has risen dramatically, from 5% to 30% of all loans made in the last two years. So it becomes a win – win for the investor/lender. If the borrower makes his interest payments and eventually pays off the loan the lender earns 14 – 18% interest annually, a great return especially in this low interest environment. And the great news is that demand for private mortgage loans is so great that not only can 14 – 18% interest be obtained, but the loan can be made at a loan to value (based on real current value) of 55% or less! If the borrower defaults the lender/investor ends up owning the property at 50 -60 cents on the dollar. Beats chasing foreclosures any day!
The internet has been a great friend to the seller of property. Fifteen years ago someone with property to sell either had to accept a discount for a quick sale from one of the all cash “we close quick” buyers or spend months waiting for an offer while his property was listed in the “MLS Book”. Now, information about a property for sale is instantaneously transmitted to potential buyers worldwide. We have sold Houston apartment buildings to California based investors, a Bryan, Texas office – warehouse to a Singaporean transportation company, and an Austin church building to a Dallas based ministry looking to expand.
In years previous, being an all cash buyer allowed me to purchase property at 70 – 80% of real value. However, for the reasons mentioned above being an all cash buyer no longer warrants a 25% discount (by the way we are talking about REAL current value here, not some inflated appraisal done one year ago before prices dropped 30%). Going to auctions, subscribing to foreclosure listings, contacting probate lawyers, were no longer generating the deal flow I needed.
The need for financing (and lack thereof) combined with the current sour economic environment have combined to provide a once in a lifetime opportunity for the investor with cash to purchase quality properties at 50% or less on the dollar. What I do and what any real estate investor with cash can do is make hard money loans on property you would be happy to own. The foreclosure rate on loans secured by commercial property has risen dramatically, from 5% to 30% of all loans made in the last two years. So it becomes a win – win for the investor/lender. If the borrower makes his interest payments and eventually pays off the loan the lender earns 14 – 18% interest annually, a great return especially in this low interest environment. And the great news is that demand for private mortgage loans is so great that not only can 14 – 18% interest be obtained, but the loan can be made at a loan to value (based on real current value) of 55% or less! If the borrower defaults the lender/investor ends up owning the property at 50 -60 cents on the dollar. Beats chasing foreclosures any day!
Sunday, March 21, 2010
Evaluating Passive Real Estate Investments
TICS (Tenants in Common), 1031 exchanges, REITS, Real Estate Mutual Funds, LLCs, Limited Partnerships. The types and number of passive real estate investment opportunities are exploding. And as proclaimed by their sponsors, these investments can offer the benefits of diversification, professional management, access to “A” type properties, and potential high returns as a passive investor. But how does the investor determine which investments merit his attention, and which should be eliminated outright?
The first item to evaluate is the issue of fees. The investor needs to determine exactly how much of his investment is going into real estate and how much is being eaten by fees. The larger the percentage of his investment actually purchasing the asset, the greater the chance for a good return and the less the chance of taking a loss. As an extreme example, if 20% of the investment is eaten by various fees, and only 80% of the investment is actually invested in property, the investor faces a 20% loss of capital as soon as he makes the investment. Additionally, only 80% of his capital is working to earn income or appreciation. This is a huge amount to make up just to get back to break even.
Types of Fees
Front End Fees - These are the fees that are taken out of your investment before the money is invested in any real estate or asset. These can include organizational fees, sponsor fees, commissions to investment advisors, legal fees, accounting fees, underwriting fees, reimbursements to sponsors or any other fees you can imagine. These fees are transparent and usually listed in the prospectus or private placement memorandum. If these fees are greater that 10% I would eliminate the investment from consideration outright. I look for front end fees of less than 5% to make a deal worthy of consideration. Ideally I’d rather pay no front end fees and have 100% of my money invested in the property. This is possible if the sponsor sells directly, has no selling expense and is willing to take his profit on the back end when the investment is sold or as the investment earns current income. Although “no front end fee” arrangements are rare, some sponsors do offer them. These deals will have the best chance of success.
Hidden Fees – These fees are not accounted for separately. They are often “hidden” as part of the purchase price of the property or as part of an ongoing expense. A thorough reading of the prospectus will usually uncover these fees. An example of a hidden fee would be when the purchase of the property has already been completed and the fund is repurchasing the property from the sponsor at a higher price than the sponsor paid. The sponsor might also obtain a percentage of the property ownership for himself while having the investors pay all acquisition costs. If the fund is paying a commission to a real estate broker to represent itself in the transaction, then this is also a fee which must be evaluated. In summary, any money paid by the investors and not directly going to the original seller to purchase the real estate or the asset is a fee or expense which must be “earned back” by the investment before the investor can get to break even, let alone profit on the investment.
Ongoing Fees - Ongoing fees are fees paid by the investors on a continuing basis usually from the ongoing income produced by the asset. These fees can be structured a number of different ways. The sponsor may receive a straight percentage of the current income, a percentage after the investors receive a preferred return, or a fixed fee to “manage” the operation. These fees should not be confused with property management fees which are fees an investor would pay for property management whether he had invested directly or through a passive investment entity. Of course, if the sponsor is the property manager, and the property management fee is greater than the fee charged in an arms length transaction, than the excess must be accounted for in the evaluation. Other ongoing fees would include yearly legal fees, accounting fees, directors payments, etc.
Back End Fees – Usually charged when the asset is sold or as a percentage of the “profit”. Other back end fees are real estate commissions paid to brokers to sell the property, points paid to mortgage brokers to obtain a mortgage on the property, and “dissolution” fees associated with the ending of the investment entity.
In any passive real estate investment, the sponsor must be provided an economic incentive for the promotion, management and risk of handling the “deal”. However, it is important for passive investors to know what they will be paying for these services. Many of these fees are difficult to quantify since they may be charged as a percentage of some profit number realizable in the future. Others may be stated as a percentage of ownership interest. To do a proper evaluation the passive investor must look at all fees under all likely scenarios and determine exactly how much extra in fees the investment is costing him. If the investor does not have the knowledge to accurately make this determination, professional analysis is available by CPAs, Real Estate Counselors, and Financial Analysts.
The first item to evaluate is the issue of fees. The investor needs to determine exactly how much of his investment is going into real estate and how much is being eaten by fees. The larger the percentage of his investment actually purchasing the asset, the greater the chance for a good return and the less the chance of taking a loss. As an extreme example, if 20% of the investment is eaten by various fees, and only 80% of the investment is actually invested in property, the investor faces a 20% loss of capital as soon as he makes the investment. Additionally, only 80% of his capital is working to earn income or appreciation. This is a huge amount to make up just to get back to break even.
Types of Fees
Front End Fees - These are the fees that are taken out of your investment before the money is invested in any real estate or asset. These can include organizational fees, sponsor fees, commissions to investment advisors, legal fees, accounting fees, underwriting fees, reimbursements to sponsors or any other fees you can imagine. These fees are transparent and usually listed in the prospectus or private placement memorandum. If these fees are greater that 10% I would eliminate the investment from consideration outright. I look for front end fees of less than 5% to make a deal worthy of consideration. Ideally I’d rather pay no front end fees and have 100% of my money invested in the property. This is possible if the sponsor sells directly, has no selling expense and is willing to take his profit on the back end when the investment is sold or as the investment earns current income. Although “no front end fee” arrangements are rare, some sponsors do offer them. These deals will have the best chance of success.
Hidden Fees – These fees are not accounted for separately. They are often “hidden” as part of the purchase price of the property or as part of an ongoing expense. A thorough reading of the prospectus will usually uncover these fees. An example of a hidden fee would be when the purchase of the property has already been completed and the fund is repurchasing the property from the sponsor at a higher price than the sponsor paid. The sponsor might also obtain a percentage of the property ownership for himself while having the investors pay all acquisition costs. If the fund is paying a commission to a real estate broker to represent itself in the transaction, then this is also a fee which must be evaluated. In summary, any money paid by the investors and not directly going to the original seller to purchase the real estate or the asset is a fee or expense which must be “earned back” by the investment before the investor can get to break even, let alone profit on the investment.
Ongoing Fees - Ongoing fees are fees paid by the investors on a continuing basis usually from the ongoing income produced by the asset. These fees can be structured a number of different ways. The sponsor may receive a straight percentage of the current income, a percentage after the investors receive a preferred return, or a fixed fee to “manage” the operation. These fees should not be confused with property management fees which are fees an investor would pay for property management whether he had invested directly or through a passive investment entity. Of course, if the sponsor is the property manager, and the property management fee is greater than the fee charged in an arms length transaction, than the excess must be accounted for in the evaluation. Other ongoing fees would include yearly legal fees, accounting fees, directors payments, etc.
Back End Fees – Usually charged when the asset is sold or as a percentage of the “profit”. Other back end fees are real estate commissions paid to brokers to sell the property, points paid to mortgage brokers to obtain a mortgage on the property, and “dissolution” fees associated with the ending of the investment entity.
In any passive real estate investment, the sponsor must be provided an economic incentive for the promotion, management and risk of handling the “deal”. However, it is important for passive investors to know what they will be paying for these services. Many of these fees are difficult to quantify since they may be charged as a percentage of some profit number realizable in the future. Others may be stated as a percentage of ownership interest. To do a proper evaluation the passive investor must look at all fees under all likely scenarios and determine exactly how much extra in fees the investment is costing him. If the investor does not have the knowledge to accurately make this determination, professional analysis is available by CPAs, Real Estate Counselors, and Financial Analysts.
High Yield Passive Real Estate Investments
Many investors are turned off by real estate because they do not have the time or inclination to become landlords and property managers. If the investor is a rehabber or wholesaler, real estate becomes more of a business rather than an investment. Many successful real estate “investors” are actually real estate “operators” in the real estate business. Fortunately, there are ways for passive investors to enjoy many of the secure and inflation proof benefits of real estate investing without the hassle.
Perhaps you, like I, want to capture the high yields and potential capital appreciation of investing in real estate, but don’t want the management hassles and time commitment involved in active property ownership. Maybe you have a full time job or business, or perhaps you’re retired looking for greater income than bank CDs and greater security than a volatile stock market. Or perhaps like me, having owned income producing property for many years, you’re tired of “tenants and toilets”. If so, consider passive real estate investments, i.e., investing in real estate securities.
Types of Passive Real Estate Investments
REITs
Real Estate Investment Trusts are companies that own, manage and operate income producing real estate. They are organized so that the income produced is taxed only once, at the investor level. By law, REITs must pay at least 90% of their net income as dividends to their shareholders. Hence REITs are high yield vehicles that also offer a chance for capital appreciation. There are currently about 180 publicly traded REITs whose shares are listed on the NYSE, ASE or NASDAQ. REITS specialize by property type (apartments, office buildings, malls, warehouses, hotels, etc.) and by region. Investors can expect dividend yields in the 5-9 % range, ownership in high quality real property, professional management, and a decent chance for long term capital appreciation.
Real Estate Mutual Funds
There are over 100 Real Estate Mutual Funds. Most invest in a select portfolio of REITs. Others invest in both REITs and other publicly traded companies involved in real estate ownership and real estate development. Real estate mutual funds offer diversification, professional management and high dividend yields. Unfortunately, the investor ends up paying two levels of management fees and expenses; one set of fees to the REIT management and an additional management fee of 1-2% to the manager of the mutual fund.
Real Estate Limited Partnerships
Limited Partnerships are a way to invest in real estate, without incurring a liability beyond the amount of your investment. However, an investor is still able to enjoy the benefits of appreciation and tax deductions for the total value of the property. LPs can be used by landlords and developers to buy, build or rehabilitate rental housing projects using other peoples money. Because of the high degree of risk involved, investors in Real Estate Limited Partnerships expect to earn 15% + annually on their invested capital.
Real Estate Limited Partnerships allow centralization of management, through the general partner. They allow sponsors/developers to maintain control of their projects while raising new equity. The terms of the partnership agreement, governing the on-going relationship, are set jointly by the general and limited partner(s). Once the partnership is established, the general partner makes all day to day operating decisions. Limited partner(s) may only take drastic action if the general partner defaults on the terms of the partnership agreement or is grossly negligent, events that can lead to removal of the general partner. The LPs come in all shapes and sizes, some are public funds with thousands of limited partners, others are private funds with as few as 3 or 4 friends investing $25,000 each.
Triple Net Leased Property
A triple-net lease property is an investment where one owns real estate (land and building). Leases to a tenant for a 15-25 year term, who agrees to occupy the property, operate their business on the premises, pay rent and all the property operating expenses (taxes, maintenance, and insurance) with the opportunity for rent to increase over time as a hedge against inflation.
Unlike owning duplexes, apartments, land, or an office building, owning a commercial property under a triple-net lease agreement to a business tenant is a passive investment (management and headache-free). In most real estate investments such as mini-storage facilities, apartments, and office buildings you as the property owner must perform property management duties, and pay operating expenses. You rent the property, collect the rents, refurbish the premises, pay the property taxes, insurance premiums, maintenance, accounting, legal, and other operating expenses. Whereas, under a triple-net lease arrangement the tenant agrees to perform all these functions for you as the owner of the property in return for a long-term lease agreement.
With a passive real estate investment, such as owning commercial property under a triple-net lease arrangement, the tenant operates its business in the location. As the owner of the property, you do not have to contend with monthly renters and operating expenses. Further, these types of commercial tenants are positive business renters. Unlike apartment renters who tend to abuse the property and then move out leaving the owner to refurbish and find new renters, commercial tenants have a vested business interest in seeing that a location is well maintained and attractive to customers. As a result, there is an economic incentive to enhance the owner's property over time.
High Yield Private Mortgage Notes and Trust Deeds
These notes are fully secured by income producing real estate, and the loan proceeds are used by the borrower for the acquisition, rehabilitation or equity cash out of residential and commercial properties. Investors have the opportunity to obtain above market returns of 12 - 15% in first trust deed position. These loans are usually for duration of one year and provide a monthly income with interest only payments.
Private Mortgage Notes usually do not exceed 60% of the current appraised property value. Private Mortgage Brokers originate these loans, and are able to obtain these high yields because of the unique advantages these loans offer to the professional real estate investor. They are able to close most loans in 2 weeks or less whereas institutional lenders require 6 weeks or more to close and fund a commercial mortgage loan. Further these loans are asset based; the real property itself is the basis of the lending decision. Hence, if the property is producing sufficient income to pay the note interest and the value of the property will fully secure the note and provide sufficient equity, then borrower credit is not an issue. Instead of concentrating on minute detail of the borrower’s credit history as institutional lenders do, private mortgage note holders concentrate their due diligence efforts on the real estate securing the loan. They provide a borrower with the ability to borrow on underwriting criteria not available through institutional lenders, hence investors in private mortgage notes are able to receive much higher yields with no increased risk.
Perhaps you, like I, want to capture the high yields and potential capital appreciation of investing in real estate, but don’t want the management hassles and time commitment involved in active property ownership. Maybe you have a full time job or business, or perhaps you’re retired looking for greater income than bank CDs and greater security than a volatile stock market. Or perhaps like me, having owned income producing property for many years, you’re tired of “tenants and toilets”. If so, consider passive real estate investments, i.e., investing in real estate securities.
Types of Passive Real Estate Investments
REITs
Real Estate Investment Trusts are companies that own, manage and operate income producing real estate. They are organized so that the income produced is taxed only once, at the investor level. By law, REITs must pay at least 90% of their net income as dividends to their shareholders. Hence REITs are high yield vehicles that also offer a chance for capital appreciation. There are currently about 180 publicly traded REITs whose shares are listed on the NYSE, ASE or NASDAQ. REITS specialize by property type (apartments, office buildings, malls, warehouses, hotels, etc.) and by region. Investors can expect dividend yields in the 5-9 % range, ownership in high quality real property, professional management, and a decent chance for long term capital appreciation.
Real Estate Mutual Funds
There are over 100 Real Estate Mutual Funds. Most invest in a select portfolio of REITs. Others invest in both REITs and other publicly traded companies involved in real estate ownership and real estate development. Real estate mutual funds offer diversification, professional management and high dividend yields. Unfortunately, the investor ends up paying two levels of management fees and expenses; one set of fees to the REIT management and an additional management fee of 1-2% to the manager of the mutual fund.
Real Estate Limited Partnerships
Limited Partnerships are a way to invest in real estate, without incurring a liability beyond the amount of your investment. However, an investor is still able to enjoy the benefits of appreciation and tax deductions for the total value of the property. LPs can be used by landlords and developers to buy, build or rehabilitate rental housing projects using other peoples money. Because of the high degree of risk involved, investors in Real Estate Limited Partnerships expect to earn 15% + annually on their invested capital.
Real Estate Limited Partnerships allow centralization of management, through the general partner. They allow sponsors/developers to maintain control of their projects while raising new equity. The terms of the partnership agreement, governing the on-going relationship, are set jointly by the general and limited partner(s). Once the partnership is established, the general partner makes all day to day operating decisions. Limited partner(s) may only take drastic action if the general partner defaults on the terms of the partnership agreement or is grossly negligent, events that can lead to removal of the general partner. The LPs come in all shapes and sizes, some are public funds with thousands of limited partners, others are private funds with as few as 3 or 4 friends investing $25,000 each.
Triple Net Leased Property
A triple-net lease property is an investment where one owns real estate (land and building). Leases to a tenant for a 15-25 year term, who agrees to occupy the property, operate their business on the premises, pay rent and all the property operating expenses (taxes, maintenance, and insurance) with the opportunity for rent to increase over time as a hedge against inflation.
Unlike owning duplexes, apartments, land, or an office building, owning a commercial property under a triple-net lease agreement to a business tenant is a passive investment (management and headache-free). In most real estate investments such as mini-storage facilities, apartments, and office buildings you as the property owner must perform property management duties, and pay operating expenses. You rent the property, collect the rents, refurbish the premises, pay the property taxes, insurance premiums, maintenance, accounting, legal, and other operating expenses. Whereas, under a triple-net lease arrangement the tenant agrees to perform all these functions for you as the owner of the property in return for a long-term lease agreement.
With a passive real estate investment, such as owning commercial property under a triple-net lease arrangement, the tenant operates its business in the location. As the owner of the property, you do not have to contend with monthly renters and operating expenses. Further, these types of commercial tenants are positive business renters. Unlike apartment renters who tend to abuse the property and then move out leaving the owner to refurbish and find new renters, commercial tenants have a vested business interest in seeing that a location is well maintained and attractive to customers. As a result, there is an economic incentive to enhance the owner's property over time.
High Yield Private Mortgage Notes and Trust Deeds
These notes are fully secured by income producing real estate, and the loan proceeds are used by the borrower for the acquisition, rehabilitation or equity cash out of residential and commercial properties. Investors have the opportunity to obtain above market returns of 12 - 15% in first trust deed position. These loans are usually for duration of one year and provide a monthly income with interest only payments.
Private Mortgage Notes usually do not exceed 60% of the current appraised property value. Private Mortgage Brokers originate these loans, and are able to obtain these high yields because of the unique advantages these loans offer to the professional real estate investor. They are able to close most loans in 2 weeks or less whereas institutional lenders require 6 weeks or more to close and fund a commercial mortgage loan. Further these loans are asset based; the real property itself is the basis of the lending decision. Hence, if the property is producing sufficient income to pay the note interest and the value of the property will fully secure the note and provide sufficient equity, then borrower credit is not an issue. Instead of concentrating on minute detail of the borrower’s credit history as institutional lenders do, private mortgage note holders concentrate their due diligence efforts on the real estate securing the loan. They provide a borrower with the ability to borrow on underwriting criteria not available through institutional lenders, hence investors in private mortgage notes are able to receive much higher yields with no increased risk.
Securing Your Retirement Through High Yield Trust Deeds
If you're retired or saving for retirement, it's likely that your stock-laden portfolio looks a little less invulnerable than it did a couple of years ago. It's possible, too, that you're counting on a fixed income that doesn't fully meet your needs.
"If only I could increase my monthly income without depleting my nest egg," you think, "and without losing sleep over the stock market."
Well, there is a way to make this happen: by investing in trust deeds, or private mortgages loans. Simply put, trust deeds are short-term loans to real estate investors secured by the value of the real property as collateral. Investors who invest in trust deeds typically make a 12 to 18 per cent return, paid out monthly, with a minimum investment of just $50,000 and relatively low risk. As a result, they are able to enhance their lifestyle significantly without threat to their principal, or built a large nest egg, safely, in a relatively short period of time.
Case in Point
I'll give you an example: my wife's parents. My father-in-law has had a couple of concerns. First, he's significantly older than his wife--he is 77, she is 65. Second, women have a longer life expectancy than men. Statistically, my mother-in-law will live 13 to 15 years beyond my father-in-law. My father-in-law has an old-fashioned Sears pension which cuts in half when he dies, and Social Security, which also cuts down by about one-third when he dies. These diminished resources would fail to provide adequately for my mother-in-law.
The two of them decided that they needed more income, or some way to increase their capital base. At the time, they owned an apartment complex in Alvin, Texas, which was a good investment, but wasn't producing any income after the expense of vacancies, repairs, management, and so forth. So they sold the apartment complex and invested the proceeds in three different mortgage liens through my company. From the $200,000 he invested, we created a monthly income of about $3000. We did a projection showing that over 13 years, we'll be able to replace every lost dollar of pension income and social security income, should he pass on first, and at the same time double the principal in real terms.
In addition, my in-laws can now live higher than they did. In fact, they just decided to take a $10,000 trip to Europe, rather then the usual $2,000 cruise out of Galveston. They're glad they didn't opt for Plan B, an annuity, with a return of only 8 per cent and the guarantee that when you die, you'll lose your total investment. Now my in-laws have a 14 to 18 per cent return, plus their original investment.
How Trust Deeds Work
Private mortgage loans are never greater than 65 per cent of the appraised value, secured by income producing property only (apartments, homes, office buildings, warehouses), and only made on investor property. A lot of notes on the market are connected to primary residences. With Texas homesteads, for example, there are many different laws involved, many of which benefit the borrower. Most private mortgage companies lend only to professional real estate investors, not owner-occupants of residential properties, thereby by-passing the problems with homesteads. The company makes a profit by charging borrowers origination fees for the loans, while the investors collect all the interest.
We personally examine and select properties carefully to make certain that they truly are worth the appraised value. We look at the property as much or more than we look at the borrower, knowing that the property will always be there. Property doesn't get divorced, property doesn't declare bankruptcy, property doesn't have financial problems. Property is the basis of wealth in the United States, in nine out of ten families.
Should we have to foreclose, we can sell the property at 10 or 15 per cent off and still make a profit. We can put it on the market at 25 per cent off and still make a profit. But defaults are rare. Our portfolio for the last 20 years shows a 4 per cent default rate. When a default occurs, the mortgage company picks up the slack. They handle the foreclosure, any property rehabilitation necessary, and the property sale.
Many of my clients start with a small portion of their portfolio to see how it works. Once they put in an initial $50,000, and it works real well, they're eager to invest a greater amount of money because their comfort level rises. They receive the monthly income checks, become familiar with the process, all the safeguards that we use, and then they call me up and say, "Do you have anything else available?" Over the course of time, they increase their investment to a point where their comfort level meets their income need.
Low Risk
The risks are fairly limited if solid procedures are followed. All mortgage documentation has been standardized by the company originating the mortgage loan, so that the investor knows that the mortgage note and deed of trust has been drawn up in his favor.
The risk is going to be somewhat higher than government insured money market funds, or government bonds. But it will be substantially lower than stocks, gold, silver, or any assets that you hope will increase in price--assets that could go up or down in value.
An Individual Decision
Deciding how much of your portfolio might ultimately go into mortgage liens is an individual decision. I personally have 75 to 80 per cent in mortgage liens, which represents the proceeds from the sale of my automotive business. Before I became active as a mortgage broker, I was an investor, looking for a way to replace the income from the business with a less time-intensive instrument. I spent two years researching the possibilities. My father-in-law has 50 to 60 per cent of his portfolio invested in mortgage liens through our company. It depends on the size of your portfolio, what you're trying to accomplish.
I can't recommend mortgage liens highly enough. I've studied finance and investment for many years, have been an investor in many different vehicles, and it's all a trade-off between risk and return. The mortgage lien, when properly executed, is absolutely excellent; I don't know any investment available to the public that has that match of investment return versus risk.
You may hear about people who go into venture capital funds and make 40, 50 per cent, but most individuals can't take part because they don't have the minimum investment--usually one million dollars or more--required. A minimum investment is fifty thousand dollars. You won't make a 40 or 50 per cent return, but you will make a solid, guaranteed 14 to 18 percent, which is superior to most other investments. That amount of yield can go a long way toward making your retirement both secure and more comfortable than you ever dreamed.
If you have any doubts, just ask my in-laws--when they get back from Europe.
"If only I could increase my monthly income without depleting my nest egg," you think, "and without losing sleep over the stock market."
Well, there is a way to make this happen: by investing in trust deeds, or private mortgages loans. Simply put, trust deeds are short-term loans to real estate investors secured by the value of the real property as collateral. Investors who invest in trust deeds typically make a 12 to 18 per cent return, paid out monthly, with a minimum investment of just $50,000 and relatively low risk. As a result, they are able to enhance their lifestyle significantly without threat to their principal, or built a large nest egg, safely, in a relatively short period of time.
Case in Point
I'll give you an example: my wife's parents. My father-in-law has had a couple of concerns. First, he's significantly older than his wife--he is 77, she is 65. Second, women have a longer life expectancy than men. Statistically, my mother-in-law will live 13 to 15 years beyond my father-in-law. My father-in-law has an old-fashioned Sears pension which cuts in half when he dies, and Social Security, which also cuts down by about one-third when he dies. These diminished resources would fail to provide adequately for my mother-in-law.
The two of them decided that they needed more income, or some way to increase their capital base. At the time, they owned an apartment complex in Alvin, Texas, which was a good investment, but wasn't producing any income after the expense of vacancies, repairs, management, and so forth. So they sold the apartment complex and invested the proceeds in three different mortgage liens through my company. From the $200,000 he invested, we created a monthly income of about $3000. We did a projection showing that over 13 years, we'll be able to replace every lost dollar of pension income and social security income, should he pass on first, and at the same time double the principal in real terms.
In addition, my in-laws can now live higher than they did. In fact, they just decided to take a $10,000 trip to Europe, rather then the usual $2,000 cruise out of Galveston. They're glad they didn't opt for Plan B, an annuity, with a return of only 8 per cent and the guarantee that when you die, you'll lose your total investment. Now my in-laws have a 14 to 18 per cent return, plus their original investment.
How Trust Deeds Work
Private mortgage loans are never greater than 65 per cent of the appraised value, secured by income producing property only (apartments, homes, office buildings, warehouses), and only made on investor property. A lot of notes on the market are connected to primary residences. With Texas homesteads, for example, there are many different laws involved, many of which benefit the borrower. Most private mortgage companies lend only to professional real estate investors, not owner-occupants of residential properties, thereby by-passing the problems with homesteads. The company makes a profit by charging borrowers origination fees for the loans, while the investors collect all the interest.
We personally examine and select properties carefully to make certain that they truly are worth the appraised value. We look at the property as much or more than we look at the borrower, knowing that the property will always be there. Property doesn't get divorced, property doesn't declare bankruptcy, property doesn't have financial problems. Property is the basis of wealth in the United States, in nine out of ten families.
Should we have to foreclose, we can sell the property at 10 or 15 per cent off and still make a profit. We can put it on the market at 25 per cent off and still make a profit. But defaults are rare. Our portfolio for the last 20 years shows a 4 per cent default rate. When a default occurs, the mortgage company picks up the slack. They handle the foreclosure, any property rehabilitation necessary, and the property sale.
Many of my clients start with a small portion of their portfolio to see how it works. Once they put in an initial $50,000, and it works real well, they're eager to invest a greater amount of money because their comfort level rises. They receive the monthly income checks, become familiar with the process, all the safeguards that we use, and then they call me up and say, "Do you have anything else available?" Over the course of time, they increase their investment to a point where their comfort level meets their income need.
Low Risk
The risks are fairly limited if solid procedures are followed. All mortgage documentation has been standardized by the company originating the mortgage loan, so that the investor knows that the mortgage note and deed of trust has been drawn up in his favor.
The risk is going to be somewhat higher than government insured money market funds, or government bonds. But it will be substantially lower than stocks, gold, silver, or any assets that you hope will increase in price--assets that could go up or down in value.
An Individual Decision
Deciding how much of your portfolio might ultimately go into mortgage liens is an individual decision. I personally have 75 to 80 per cent in mortgage liens, which represents the proceeds from the sale of my automotive business. Before I became active as a mortgage broker, I was an investor, looking for a way to replace the income from the business with a less time-intensive instrument. I spent two years researching the possibilities. My father-in-law has 50 to 60 per cent of his portfolio invested in mortgage liens through our company. It depends on the size of your portfolio, what you're trying to accomplish.
I can't recommend mortgage liens highly enough. I've studied finance and investment for many years, have been an investor in many different vehicles, and it's all a trade-off between risk and return. The mortgage lien, when properly executed, is absolutely excellent; I don't know any investment available to the public that has that match of investment return versus risk.
You may hear about people who go into venture capital funds and make 40, 50 per cent, but most individuals can't take part because they don't have the minimum investment--usually one million dollars or more--required. A minimum investment is fifty thousand dollars. You won't make a 40 or 50 per cent return, but you will make a solid, guaranteed 14 to 18 percent, which is superior to most other investments. That amount of yield can go a long way toward making your retirement both secure and more comfortable than you ever dreamed.
If you have any doubts, just ask my in-laws--when they get back from Europe.
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