Support networks of specialists are crucial at every level of a project in order to insure success.
This article series has covered a topic that not many lenders are willing to talk about very openly: failed loans and the subsequent distressed assets they leave in their wake. We’ve covered several protocols to prevent loan defaults that begin before, and continue throughout, the life of a loan.
At the outset, the underwriting process is crucial because that is your opportunity to conduct due diligence on the proposed project and on the borrower to ensure the best possible chance of success. Then while the project is in progress, you need a strict collateral monitoring process to maximize the chance the finished property will fetch its target value. Even then, loan defaults still sometimes occur, and you must act quickly to complete and unload the asset.
There are a lot of moving pieces in the process. And, if your lending operation makes hundreds of loans every year, then you likely end up with more than just a few REO properties in your portfolio. When juggling many separate aspects of multiple projects, you must rely on a broad network of organizations and individuals for support—people you know and trust.
There are a few ways that these support networks can be categorized: asset-level support, portfolio-level support, and some that may be internal or external functions of your business.
The Asset Level
The folks you need supporting you at the asset level are your “boots on the ground.” These are the people who will help you complete and sell the properties that result from loan defaults.
As a lender, you probably have neither the time nor the skills to take a foreclosed property to completion. The people you’ll need supporting you at the asset level include contractors who provide specialized services—plumbers, electricians, roofers, landscapers and so on. You’ll also need the services of a general contractor to oversee the projects and the work being done. You need to trust that these contractors will provide you with the quality of work you expect and that they can do so quickly.
The physical construction you need to complete on any given property is only one component in the asset disposition process. You will also need to rely on others who can help you evaluate, market and sell your properties. This includes appraisers, real estate brokers (or perhaps a real estate agent) and someone to help you stage and photograph the property once you’re ready to put it on the market.
The Portfolio Level
There are several ancillary services you’ll need at all stages of a project. These portfolio-level services are less visible, but just as crucial, as the asset-level services.
For example, you need to protect yourself by insuring the asset. This goes not only for REO properties but also for any property you lend on. As a lender, it’s wise to have a relationship with an insurer you trust, either for referring borrowers or in the event you need to force place a policy on a property if a borrower lets it lapse. You also might require a blanket policy for multiple properties.
If you’re a lender who’s been in the business for any length of time, it’s quite possible you have more than one REO property on your books. And, as you probably already know, it takes money to complete the physical property and cover the carrying costs for whatever length of time you own it. Your business model will dictate your capital structure, but typically you should also have a network of capital sources you can access easily, whether that includes banks, individual investors or both.
In addition to being sources of capital, banks, investors or other organizations can serve as loan buyers. It’s wise to form those relationships too. While you’re less likely to sell a loan that has gone into default, selling off other loans in your portfolio is a good way to quickly free up capital for the completion and disposition of REO properties.
Internal and External Support
A private lending office will often have internal business units that help with many of the functions necessary for REO disposition as well as for the prevention of loan defaults. Both are crucial parts of the process.
From the prevention standpoint, underwriting the loan is the first line of defense against loan defaults. Likewise, your Loan Servicing Division plays a critical role in monitoring the loan status and the progress of the project throughout the life of the loan. With the right protocols in place, they can help keep loans on track. It’s likely your private lending operation houses these functions internally, but there are some private lending platforms you can partner with to outsource underwriting and loan servicing.
From the disposition standpoint, Loss Mitigation and REO Disposition Divisions come into play once the loan has gone into default. A Loss Mitigation Division can either sell the property in its current state at the time of foreclosure or even reoriginate a new loan on the property to a trusted borrower. Short of that, you might have internal construction or REO disposition capabilities to complete the construction and sell the property. Either of these functions can be internal or outsourced, depending on your business model, resources and level of expertise.
Time is Money
It can’t be stressed enough how important it is that you are able to move swiftly when working to dispose of your distressed assets. Carrying costs can quickly cannibalize any profits you might stand to make. And, often you’re just working to mitigate losses instead of making money. So, your network must include people you know and can count on when you need them. Additionally, you always need backups—a “second tier” of people you can call on if your preferred partner is unavailable when you need them.
Some people think they can save money by doing all the work themselves instead of paying outside parties. But remember that you’re racing against carrying costs and trying to achieve the highest possible market value when you get ready to sell the property.
Regardless of your background or your level of experience, a project as large as building a new home or renovating an old one can’t (and shouldn’t) be done by one person. A network of specialists can help you get the job done more quickly and provide a much higher quality of work than you can by yourself, so you have the best chance possible of achieving a profit, even on REOs.