Risk Management

Demystifying Property Analysis

by Scott Fahl
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Understanding property analysis can be the difference between a big profit and losing everything. By Scott Fahl Property analysis has long been a subjective practice, with as many different opinions on best practices as there are properties. Getting it right can mean the difference between a big profit and losing everything. Why is it so difficult to get an accurate property value? Surely with all the billions that have been thrown at the problem, there must be someone with a solution. Right? For decades, companies and individuals have been working to create the Holy Grail for accurately appraising properties using Automated Valuation Models (AVMs). Automated Valuation Models The AVM model uses mathematical modeling combined with databases to attempt to predict a property’s value at a certain point in time. In a nutshell, the model is trying to pull accurate comps. The more precise the comps, the more accurately they can predict the property’s value. The AVM model sounds good on paper. But it falls apart rather quickly when you realize finding accurate comps is much more complicated than the price per square foot, selling price and proximity to subject property. To lay it out for you, mathematical models can’t tell you that Property A was well taken care of by one owner who is a carpenter by trade and pulled permits for all the work he’s done and that Property B’s owner isn’t a carpenter, pulled zero permits and may or may not have redone the electrical. The AVM models are getting better because they have much more access today to data. But, unless you can get homeowners to willingly provide data about their property on a regular basis, AVM models will always have a margin of error and in some cases a large margin of error. Investor Success Model Now, move the conversation to investment properties and everything changes. Owner-occupants are looking for things like demographics, noise, schools, traffic, walk-score, number of restaurants, grocery stores, dog parks, bus routes, biking trails, crime, etc., etc., etc. For investors, it’s simple: They are looking for one thing—profits! You can make an argument that investors should also be looking at the list of what owner-occupants want since it’s the owner-occupants who will be purchasing or renting the investment properties. Good point. But today’s real estate investment tech companies argue that you are overcomplicating things. They claim they can cut out 95% of the confusion most investors face when analyzing a property’s investment potential by changing the conversation from demographics and AVMs to focusing on what other investors are having success with. Looking at where investors are buying, what they are paying, what they are doing to properties (construction levels) and what they are selling or renting them for gives you just about all the information you need. A key piece to understand is this: When investors set the tone for an area (investment strategy, purchase price, rental rates, remodel levels, selling price, etc.), it gives you a near-exact game plan for what works and what doesn’t, virtually eliminating the need for inaccurate AVMs and demographics analysis. The reason this works so well is the investors are creating comparable consistency. Example: Investors A, B, and C all bought in the same area, around the same time, around the same price, added similar upgrades with similar finishes and sold near the same prices. If you find a similar home in the same area, in a similar condition and a similar price point to A, B and C, how long should it take you to decipher that it’s a good investment? The answer? Minutes! With this model, you know the best investment strategy for the area, what to pay, what level of construction is appropriate and what you can sell the property for. This level of comparable consistency removes the variables and equations that cause inaccuracies. If all comps are created equal, then AVM models would be extremely accurate. The problem for owner-occupant AVMs is when you add years of wear and tear, upgrades, additions, lifestyles, pets, etc., it becomes very difficult to determine how closely owner-occupant comps are to one another. Without going inside each property, you’re left to make assumptions that dramatically increase your investment risk—and at some point, that is going to bite you. When using consistent comparables, you can make confident, low-risk, data-driven, educated decisions in minutes. Tracking Consistent Comparables This model of using consistent comparables is achieved by using sophisticated and proprietary algorithms and substantial data sets. The results go way beyond valuing a single property and can go as far as assessing the investment potential of an entire nation—in seconds! Tracking investment activity on a national level can currently be done. But it’s mostly left to the behemoth data aggregators and delivered in the form of monthly, quarterly or yearly reports to the public or more detailed reports to institutions. These reports will tell you things like foreclosures are on the rise. Or, the fix-and-flip market is up 10% in Dallas/Fort Worth. Or, rental rates are increasing in Denver. This sort of data has its usefulness. But it’s not much help to those in the trenches practicing investment real estate every day (investors, realtors, appraisers, hard money lenders, etc.). It’s simply too vague. Today new technologies are filling in the gap by providing real time investment market analysis for the entire nation as well as down to the street level with the click of a button. It starts with bigger, better, more accurate data sources and is taken to next-level usefulness by cutting-edge technology companies who specialize in creating user-friendly software tools that solve widespread industry problems. These tools are not simply regurgitating their findings but have opened the door to allow users to create their own findings by entering their individual needs and parameters. An example of this could be: Show me every property in Chicago that was flipped in the last six months and was originally purchased for 60% of the after-repair-value (ARV). Show me the

Accelerating the Debt? Consider Slowing Down!

by Randy Newman
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Limitation of Actions. Or, put colloquially, the Statute of Limitation. Three words that can derail your foreclosure and impair the legal validity of both the mortgage and the underlying promissory note. Not paying attention can be devastating to a lender. So, what is the Statute of Limitation and how does it work?

Asset Protection: That Thing You Should Have Done Yesterday

by admin
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Besides knowing the cost of the insurance, be aware of “gotchas” that can ruin you financially. There are more than 30 million lawsuits filed in the U.S. each year. If you own a home with equity, a business, rental income property or have large sums in stocks, bonds and cash, then you have a target on your back. It is human nature to think nothing bad will ever happen to us. The reality is that life is full of curve balls, and families and businesses get hurt. Wealth is not automatically protected against lawsuit-hungry individuals and companies, which is why asset protection planning is critically important. When structuring your personal and business assets, always think defensively by protecting your wealth, investments and business intellectual property. When people hear the phrase “asset protection,” they often assume it’s something that’s necessary only for the ultrawealthy. In other words, they mistakenly believe that individuals of more modest means have no reason to enlist the services of an asset protection attorney. Lawsuits and financial catastrophe can affect anyone, regardless of the value of their assets or their situation in life. Getting Started Proper asset protection is not as easy as zooming over to a legal do-it-yourself website. Creating defensible legal shields around your financial castle requires a skilled team that specializes in asset protection law. Importantly, remember that asset protection is not an “after-the-fact” solution. You cannot call the insurance company when your house is on fire to ask for more insurance coverage. Legal asset protection works the same way. You must get organized when the seas are calm. The most prudent course of action is to include asset protection as part of your big-picture financial plan. You work hard to build your assets. All that effort is a waste if they can be taken from you in one fell swoop. To be effective, proper protection must be in place before you are sued. Sometimes, protecting your assets involves acquiring additional insurance to protect against accidents and risks. Other times, a well-drafted estate plan can be used to ensure assets are properly protected against future claims against you. How to best protect your assets can be determined only after a competent asset protection planning attorney evaluates your situation. Sometimes, misconceptions and misunderstandings about legal matters can result in people foregoing important rights or jeopardizing the valuable property they have worked a lifetime to obtain. The field of asset protection planning is no different. Confusion about the work and service provided by an asset protection planning attorney leads many people to procrastinate until disaster strikes and property is threatened before they seek the help of a lawyer. Unfortunately, due to laws in California and elsewhere, it is usually too late to protect assets once an event has taken place. Procrastination is the enemy of good asset protection. Asset Protection and Real Estate Nowhere is asset protection procrastination more prevalent than in the world of real estate investing. While real estate is a great way to store wealth and create streams of passive income, it does come with myriad strings attached. Unlike stocks or bonds, real estate often requires a “hands-on” approach and exposes an owner to significant liabilities. For example, the mailman will never slip and fall on your Apple stock. Here is a sampling of situations where an owner may incur liability for their property: A tenant trips and falls down a flight of stairs due to a defective handrail A tenant’s child drowns in a pool that isn’t adequately fenced off A branch on a tree on your property that hasn’t been adequately trimmed falls on a third party’s car An environmental survey reveals significant mold or chemical contamination on your property that needs to be remediated These are all situations that could involve a lawsuit or a claim against your insurance. In certain examples, the liability may be so great that insurance doesn’t cover it, allowing the injured party to come after your investment properties or even your personal assets. The question here is “How do you reduce this risk?” Working from an estate planning context, the goals for investment real estate would be to: Protect ourselves from liability while we are living. Preserve our assets to maximize what we pass on to our children or other beneficiaries. Make it as easy as possible for this transfer to occur upon our passing. One simple and relatively inexpensive way to reduce the liability on investment property is to purchase an umbrella policy. An umbrella policy provides additional coverage above and beyond your primary policies. For instance, if you have insurance on your investment property for $300,000 and an automobile policy with limits of $500,000, a $1,000,000 policy will increase those limits $1,300,000 and $1,500,000, respectively. This provides a greater cushion in case you incur a significant judgment. Another way to protect yourself is to create a limited liability company (LLC) to hold your real estate. An LLC is a legal entity that provides significant benefits to its members. The primary benefit is that the liability of the owners of the LLC is limited to the assets of the LLC and does not extend to the personal assets of the owners. Let’s say a tenant falls down a flight of stairs, suffering severe injuries. In that case, the tenant can only go after the property held in the LLC. He can’t get at your personal home or other investments that you have outside of the LLC. If you have multiple properties, you can create multiple LLCs to maximize the amount of protection you have. Another benefit of LLCs is that they can be seamlessly blended into an existing estate plan. It is relatively simple to transfer LLCs into a living trust to allow your loved ones to manage things in the event of your death or incapacity. Furthermore, as you acquire more assets and build your net worth, you may want to start transferring some of your assets to your children to reduce

Using Insurance to Preserve Lender Capital

by admin
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How much more capital would your investors provide if you exceeded expectations for preserving their capital? Warren Buffett, the Oracle of Omaha, has a Golden Rule: “Rule No. 1 is never lose money. Rule No. 2 is to never forget Rule No. 1.” The standard investment rule Buffet follows is to preserve investor capital. This seems like a very easy rule to follow, yet most lenders never get past the numbers in their prospective deals. You probably did a great job underwriting the loan. You have the right to foreclose for nonpayment, and you may have even cross-collateralized against the borrower’s other properties. Did you forget something? Did you underwrite the risk in your borrower? Buffet tries to preserve investment capital, so should you as a lender try to preserve your capital? Absolutely yes! Once your loan is closed, will your borrower protect you and your investors? Most likely, no. Once you fund your deal, your borrower’s interest or need in you is over. This makes your borrowers the greatest risk to your loan portfolio. Builder’s Risk, Worker’s Comp and General Liability Coverage Simply put, what can go wrong, will go wrong. Consider your typical fix and flip borrower. The borrower provided information that allowed you to provide funding, including proof of insurance. Is the proof real? Is the policy currently in force? Is the coverage right? Some borrowers believe that a standard homeowner’s policy is all that is needed. Yet there is a vast difference in builder’s risk coverage and a standard homeowner’s policy. The traditional agent provides a homeowner’s policy that will not cover a typical, non-owner-occupied property. That is not the type of policy this lender needs. In addition, if this borrower was also the contractor, as a lender, you should have received a copy of your borrower’s workers’ compensation policy and general liability coverage too. Missing any of these important coverages could result in your borrower being sued and defaulting on your loan, leaving you and your investors holding an empty bag. Force-Placed Coverage Another common mistake for newer lenders is overlooking force-placed coverage. These are coverages for when the borrower’s insurance is cancelled, has lapsed or isn’t sufficient. First, force-placed coverages are expensive. Second, insurance carriers know that when you as a lender are force placing the required coverages, the relationship between you and your borrower is already in the proverbial toilet. Most insurance carriers want to know about your loan portfolio long before a loan is in trouble. Usually, your initial application is a disclosure about your loan portfolio. Consider the difference between a lender who has only two loans and both loans need to have force-placed coverage and a different lender who has 100 loans with only two properties requiring force-placed coverage. One of these lenders cannot underwrite. Who do you think the insurance carrier will accept? A different force-placed problem happened recently to a “new” lender in Las Vegas. The lender funded a short-term purchase loan. The borrower did initially provide a homeowner’s policy. A few months into the loan, payments stopped. Unfortunately, this lender made a key mistake. The loan included language allowing foreclosure for nonpayment; however, the note never required the borrower to maintain liability coverage. In this specific case, the lender could not force place the coverage because the contract did not state that as a condition of the loan. Eventually, after multiple court appearances, the lender was able to foreclose. The lender still needed to evict the borrower. Yes, a different court venue was needed to evict. By the time the lender got the house back, the house was missing all copper plumbing and wiring. Rehabbing the house the second time was entirely on the lender’s dime. Key Person Insurance Insurance cannot be used to guarantee an investment gain. What kind of coverages can a private lender require of their borrowers? Before that question is answered here, a quick review of other lenders is needed. The conventional lending world offers credit-life and credit disability-sickness coverages. You might have heard about that coverage. It is called mortgage protection insurance. Credit life cannot be a condition of receiving a conventional loan. Remember, these policies do not pay the lender “if” the borrower just decides to stop paying. The borrower must die or get sick for the lender to be paid on “credit” policies. Additionally, U.S. Small Business Administration (SBA) guaranteed loans above certain thresholds require key person coverage on the borrowers. Key person could be life insurance or disability-sickness policies on the borrower. The lender is the loss payee. Why place key person coverage on the borrower? Statistically, loss of work resulting from an injury or sickness is still one of the leading causes of foreclosure in the U.S. If your borrower cannot work, he or she cannot earn income, complete their project or more importantly, pay you back. For any risk you see as a lender, you may be able to seek insurance coverage. The ultimate benefactor of any insurance on a loan are your investors. The bottom line? As lenders, you underwrite the loan, and the insurance solutions you place on the loan preserve lender capital. Why would a private lender require key person coverage when you already have the right to foreclose for nonpayment? The answer is simple: How long do you want to wait before you get paid back? Foreclosure rules vary by state and municipality. Plus, the borrower’s family could get involved, making foreclosure time-consuming and costly. Key person coverage offers lenders an alternative source of repayment. Choosing which types of insurance coverages you, as a lender, should require on your borrowers is based on the risk aversion of your investors. How much more capital would your investors provide if you went above and beyond expectations when preserving their capital? Above all, finding a solutions provider that thinks out of the box and focuses totally on the private lending world is key. Insurance agencies and providers are specialized. Be wary of the insurance partner