The better you become at loss mitigation and REO disposition, the better positioned you’ll be to gain prosperity through property.
It’s not ideal, but it’s all too common. You just wanted to be a private lender, providing capital to real estate investors, a relatively hands-off proposition. But something went wrong, and here you are—the proud owner of a property that your borrower, for whatever reason, couldn’t complete.
Throughout this article series, we’ve discussed every way possible to avoid ending up in this position—from proper underwriting to loan servicing, collateral monitoring, up to and through the foreclosure process.
If you were unable to take advantage of an internal or external loss mitigation process and had to develop the property yourself, you’re now responsible for the most important part—disposing of the asset. But can you sell it? Your investors are probably asking the same question.
Much of your ability to sell the property is really “built in” to the home itself. From the outset of the original loan, you should have had a good idea of what value could be achieved, given the property’s location, characteristics and build out. Upon foreclosure of the property, hopefully you evaluated the stage and quality of construction to determine if the borrower followed their original plans and budget. And if they cut corners, by now you should have course-corrected, so the finished home can fetch the price it needs to be profitable.
During the finish out of the property, it’s wise to keep a few things in mind. First, the work must be up to par—meaning the appropriate quality of materials and craftsmanship were used. These standards should have been laid out in the budget detail during the underwriting of the loan. In other words, if the budget called for granite countertops and the borrower installed laminate, that’s a problem. Correcting “oversights” like this before the home hits the market may cost you additional capital up front, but it will make you money at the sale.
You need to understand the architectural style of the neighborhood. If your property is surrounded by craftsman-style bungalow homes and you build a house with modern architecture, you might have a hard time selling it (and you might tick off the neighbors). Whichever style is appropriate to blend with the surrounding neighborhood, make sure that your property maintains stylistic consistency throughout. Don’t take prospective buyers on an architectural tour through time; again, you’ll have difficulty selling a house that doesn’t make sense.
Understanding conditions and trends in the market will help you anticipate the outcome of the REO disposition. But it doesn’t start when you get ready to sell. Throughout the process of developing the property, be aware of a number of things that will affect your ability to sell it, as well as how much you can expect to sell it for. Before you continue construction on the property, get a Broker’s Price Opinion (BPO) or have an appraisal done. That way you know where the property value stands and what you need to do to build the appropriate value into the home.
Conducting price comparisons of similar properties in the area that have sold in the past few months will provide an additional point of reference. It will also give you some direction as you work toward completing the project, so you’ll have the best chance of achieving your target after repair value. Your local board of realtors or other real estate organization probably tracks metrics like median home values, days on market, months of inventory, etc. The more you know about your specific area, the better equipped you’ll be to mitigate your losses or, in a best-case scenario, the better chance you’ll have to turn an REO property into a successful project.
Remember, this isn’t all just about you and your money. If you’re a private lender, then more likely it’s about your investors and their money. Knowing the project and understanding your market will not only help you achieve a better outcome, it will allow you to communicate more intelligently with your capital providers. And, even if you’re accustomed to reporting regularly to your investors, reporting on REOs is very different from what you’re probably used to.
Once a loan defaults and your investors begin missing returns, you can expect them to start lighting the torches. And, well they should be. So, it’s in your best interest to quickly become a master communicator. As soon as you’re able to thoroughly evaluate the property post-foreclosure, before you make a single movement on the project, before you do absolutely anything else, you must allay the fears of your investors. Start by putting together a pro forma outlining your plan for disposition and forecasting the favorable outcome you hope to produce.
Your communication with the investors who are potentially impacted by any foreclosure should be reliably regular and brutally honest every step of the way. If there’s a positive development, let your investors know quickly to relieve their anxiety. If there’s a setback, let them know even quicker and be ready to present them with a plan to overcome whatever that obstacle may be.
Whenever there’s a problem with a project, the frequency of communication with your investors should increase. All too often, lenders cease communication when they are trying to work through an issue. But communicating frequently as you work to rectify a problem is an opportunity to be transparent and show your investors that you can be agile and accountable when a problem arises.
Finally, when you are about to sell the property, let your investors know that you are about to pay them back, fulfilling your mandate as a private lender. You can’t always control whether a loan goes into default, but the way you handle yourself and the situation when it does, speaks volumes about you and builds investors’ confidence in your ability to be successful.
This Is Not the End
If you’re a private lender dealing with REO properties, you’ve had to become an operator, a market strategist and an investor relations specialist. But the skills you acquire from learning to dispose of distressed assets will put you a step ahead of many other private lending operations in the industry.
As the next few years unfold, the private lending industry will begin to see the accumulation of these distressed loans bubbling up to the surface. All lenders have them, big banks and small shops alike. They just may not be out in the open yet. The more adept you become at loss mitigation and REO disposition, the better positioned you’ll be to turn a property into prosperity.