Lessons Learned - Rentals, Private Lending And More
Below are the meeting notes from our 4th San Mateo Real Estate Meetup, where our small group of investors discussed some of their real estate experiences.
Lesson #1 - Is a two month deal with 41% ROI (return on investment) upside and 200% downside (collected in 12 months at foreclosure) for private lending a good deal?
First, all investments have risk. But when you have a team of lawyers, title insurance companies and investors, you may be (overly) confident that someone will catch a mistake. A borrower applied for a $340,000 loan for two months (I had stated two weeks incorrectly in the meeting) to qualify him for a commercial loan. This loan was to be used to finance his partner out of their shared LLC and enable him to buy more properties. The borrower preferred to acquire short-term financing over a longer financial institution's portfolio loan process for his six properties (cash flowing at $7K/ month). These homes owned by the LLC were free and clear (i.e. no other loans on the properties) and totaled a value of $680K (conservatively), providing our investors 50% protected equity on their $340K investment. The borrower also had been pre-approved by two lenders.
The lessons learned on this early deal were numerous:
Background check. Everyone. Lawyers included.
Don't lend to people without money.
Don't chase the returns.
Validate ALL members of an LLC have authorized the use of properties being offered as collateral.
Do your own due diligence; do not rely on others.
At the end of the day, the borrower was sentenced to seven months in jail for defrauding us and other investors. His attorney is also being sued. All six properties have been collateralized and awaiting sale upon resolution to this lawsuit.
Lesson #2 - Is a CAP rate of 16% for a rental a good deal?
A seller approaches a potential buyer with a great opportunity. The seller has a rental property recently rehabbed offering a CAP rate of 16%. The potential buyer started to vet the deal and called the property management company who then disclosed the issues with the neighborhood, tenants and overall deal. The 16% was highly optimistic after factoring in operating expenses (capital expenditures, repairs, HOA fees, property management fees, vacancies, taxes) and debt servicing. The pro forma was for a much higher rent than market conditions dictated. Lessons learned:
Trust but verify.
Run your own numbers and comparables (aka comps).
Know your neighborhood and understand your comps (stay within 1/2 mile and be mindful of disparate bordering neighborhoods and major boundaries (double yellow line roads, freeways, rivers, same square footage, bathroom count, etc.)
Lesson #3 - In the SF Bay Area today, is it cheaper to build or rehab?
A landowner is evaluating options on his long-term land purchase of 20+ years and determining what his best option is - pull permits, pay for architectural drawings (estimated 8 - 24 months in duration) then build in West Oakland, East Oakland? Or rehab? Lessons learned:
Evaluate the market to determine best locations for rent or appreciation.
Analyze the costs to build versus prefab versus rehab.
Determine your exit strategy and backup strategies (long-term or short-term) if market corrects.
Other lessons we discussed:
California does not have a state standard for home inspection licenses.
Use http://city-data.com to better understand demographics such as average salary, age, median # of rooms in houses, etc. Other helpful websites - neighborhoodscout.com, cia.gov
Do you have any lessons you'd like to share? Feel free to post here. For more details, please feel free to drop by our next Meetup.
Kevin + Kiri