Ensuring Your Real Estate Investment Is Solid: The Checklist
No lender wants to be left holding the note on a property that won’t sell or has to be foreclosed upon. The goal of an ethical and successful private lender is to build mutually profitable relationships with builders, resulting in gains for both parties and, in turn, additional deals. Due diligence before funding the deal is in both parties’ best interests. A private lender taking the time to learn the building industry also can provide value-add opportunities for the borrower.
When assessing potential projects to include in your portfolio, the idea of following set procedures before deciding “yea” or “nay” on each investment holds significant merit. A detailed checklist helps you drill down and evaluate the many important considerations of the deal so you can make an educated decision about funding. What may seem like a fair amount of additional work up front pays back many times over by helping you select the best, most profitable deals.
Many lenders are comfortable qualifying the property and do so, to some degree, for each deal. But qualifying the borrower is just as important. Remember, it’s not only the horse that wins the race but the jockey as well!
Qualify the Property
A plethora of data for nearly every property is readily available. The key to this abundance of data, however, is proper interpretation and extrapolation to gauge the viability and profitability of a potential deal.
Perform exhaustive property research
The tried and true method of identifying prospective properties is through multiple listing services (MLS). An MLS listing offers hundreds of data points for nearly every residential property, including sale history, days on market, physical description, lot size, and nearby schools. You can obtain even more information about the neighborhood by checking local crime statistics and listservs for current issues or problems.
Analyze results with an enhanced CMA
You can then use the collected data to create a detailed comparative market analysis (CMA), which examines the sales statistics for comparable properties in the same neighborhood. A CMA also enables you to analyze the velocity of trading in the neighborhood, the average days on market (DOM), and the quality and level of finishes. This data helps you gauge the appropriateness of the proposed renovation and expected time on the market. DOM data is especially valuable when determining the loan term and vitality of the submarket. You can further enhance the analysis by overlaying the CMA with additional knowledge of the neighborhood, quality of other renovations, and any other adjustments that you feel are warranted.
Check existing liens or encumbrances
Tax and other public records are another important elements of property research. You should know whether any taxes are owed on the property, encumbrances exist, or title is unmarketable. Some sellers of distressed properties have complicated ownership and title issues, which are best discovered ahead of time. It is less than ideal, though somewhat common, for a borrower and lender to spend a fair amount of time and money on a project, only to find out just before closing that serious title issues cannot be resolved without delay and additional expense.
Check zoning regulations
Can the addition that your borrower is planning even be done on the lot he wants to buy? Local zoning laws, especially in more urban neighborhoods, are very specific about how much building per lot square foot is allowed, how close to the property lines the addition can be, and so forth. Make sure your borrower understands these rules and ratios before he buys the property. And don’t forget about homeowner’s associations–they often have rules about everything from paint colors to the selection of materials.
It is imperative to make site visits to the property and see the neighborhood firsthand. You might find that the MLS pictures are overly flattering or incomplete, or that adjacent properties are dilapidated. Observing the property and its surroundings in detail can give you a first-hand check of all of the MLS and CMA data and give you a true feel for the neighborhood.
Get independent appraisals
A full-blown third-party appraisal might be expensive, but it gives you greater assurance that the resulting price estimate accounts for all significant factors. You can save money by settling for a simpler broker price opinion (BPO), but these are less intensive and detailed.
Qualify the Borrower
The other half of the lending decision rests on the profile of the buyer. In private money lending, lenders often care more about the value of the property than the creditworthiness of the borrower. That said, you may not want to lend to a person with, for example, no experience managing a rehab and a checkered past. Trust is an important consideration in any relationship, and the lender-borrower relationship is no exception.
Does the potential borrower respond quickly to your questions and your requests for information? You shouldn’t have to chase material information from the borrower. It’s your money, and even though the loan is collateralized, you want to feel that the borrower understands your intense interest in the success of the deal.
Does the borrower have a realistic plan and budget for improvements? You should be confident that the borrower’s scope of work represents the tasks that are necessary and sufficient to achieve the target resale price.
Notwithstanding the nature of a private money loan, it’s wise to check the credit of borrowers for past bankruptcies, foreclosures, and liens. Not necessarily a deal breaker, but a compelling property in the hands of a questionable borrower may not make for a solid deal.
Does the flipper/builder have a track record? What do former lenders and associates have to say? The borrower may provide you with a list of references, but it behooves you to contact others who are not on the list, if possible and see what they have to say. You can also contact the owners or tenants of properties the borrower has flipped and found out if there have been problems with the condition of the property.
It’s very important to get to know your borrowers face to face, establish a relationship, and form a solid human connection. Some lenders never meet their borrowers, which means they don’t get to evaluate first-hand whether the borrower is someone they can trust. Look for traits that help achieve success — organization, intelligence, responsibility, skill, empathy, maturity, and honesty.
In summary, many lenders know and follow the steps just noted, but the real way to ensure you are financing the right deal is to get to know your borrowers and establish trusted relationships with them. This will help you to key in on any red flags that could lead to potential defaults. In addition, a trusting relationship means you can assist with problems sooner rather than later. In the long run, this will help encourage repeat borrowers, a win-win for all concerned.