About Ian Ippolito
Ian Ippolito is an investor and serial entrepreneur. He has been interviewed by the Wall Street Journal, Business Week, Forbes, TIME, Fast Company, TechCrunch, CBS News, FOX News and more.
Ian was impressed by the potential of real estate crowdfunding, but frustrated by the lack of quality site reviews and investment analysis. He created The Real Estate Crowdfunding Review to fill that gap.
Two Realty Mogul investments face bankruptcy/foreclosure issues
Hard money loans are not without risk. But is the risk higher in some places than others?
November 3, 2015 BY IAN IPPOLITO
IMPORTANT: See the "Comprehensive Guide to Hard Money Loan Investing" for detailed info on how to avoid the problems investors encountered on these loans.
Update: 7/8/2017: Realty Mogul took both properties mentioned in the article into foreclosure. Proceeds on the lower LTV loan (72%) paid investors back their principal (and some of the originally projected interest). Proceeds on the higher LTV loan (82%) would have caused investors to lose both principal and interest. Realty Mogul gets kudos for taking the painful step of paying investors from their own pocket so they ended up getting both principal and some of the originally projected interest.). The foreclosure process took 12 months and 14 months respectively to finish and Realty Mogul is no longer making hard money loans. More details are listed below this article.
In my opinion, it's very admirable that Realty Mogul made investors whole, because not every platform would do that and it speaks highly of them. At the same time, investors should keep in mind that bailouts are not a sustainable business model for any platform. I feel investors who rely on a knight-on-a-white-horse to ride in and save them from high-LTV loans that go bad, will inevitably be disappointed (especially during a downturn). In my opinion, prudent investors take their own steps to protect themselves.
Update: 11/19/2015: Peerstreet CEO claims their process leads to far fewer non-performing loans than Realty Mogul. Full information is included here.
Hard money loans can be very lucrative investments. You lend money to a borrower for a short period of time (generally less than two years). They use it to fix up a property, and in return pay you a healthy monthly interest rate (often 8 to 15%+). Then when they complete the improvement and sell for a higher price, you get back your principal. And if something goes wrong and they can't sell it, you foreclose and take ownership of the property for pennies on the dollar. In theory, it might sound like you can’t lose.
It's not called "hard" for nothing
However, things don't always end up going so perfectly. While the vast majority of these loans on the sites have been smooth sailing, a few have hit choppy waters.
Sometimes a borrower is late in making a payment (especially the balloon payment at the end). And sometimes this happens but they can do it several months later. The additional penalties owed, can actually make that a nice little bonus situation for the investor (if you weren’t needing the money back right away).
But if the borrower can’t make it up, then it can become a problem. If they can tie the property up in a bankruptcy, it might delay your taking ownership of the property for months or years.
Even if they don't do this, you can still lose money during the foreclosure process. You have to pay all sorts of hidden costs when this happens. There are legal and transaction costs to foreclose, potentially rehab and sell, and if the equity in the investment is too low, this will result in a loss. and no matter what, this will take months (or perhaps even years if you are in a judicial state).
Other things can go wrong too. If the market suddenly turns on you, you may have to take an unexpected loss, or be forced to own/hold the property for months or years, which locks up your money. In addition you may find yourself having to pay taxes as well as maintenance expenses to properly maintain it and/or convert it a rental to attempt to cut your losses.
And then there are just the simple mistakes with underwriting, unexpected problems with the rehab, etc. that can chew up your equity cushion and cause losses. ( Click here for a full article on all the different possible issues with hard money loans).
Realty Mogul issues
Recently, investors have reported that two Realty Mogul investments have run into trouble, and have stopped making promised payments. They say that one borrower has filed bankruptcy, and the other is headed to foreclosure.
Trouble in Texas
Investors say that the first investment was to a borrower in Houston, Texas who had claimed considerable investing experience and significant personal assets. Despite this, the borrower claims he could not pay back investors because the was victim of a rookie mistake: allowing his contractor to embezzle funds from him. And the borrower has also declared bankruptcy, which raises eyebrows since he supposedly had significant assets just a few months ago.
Hopefully Realty Mogul's attorney can remove the property from bankruptcy so it can be foreclosed. If they are successful, a further concern is that the loan was made at higher loan to value (70%), which may not leave enough equity to protect investors from a loss.
No California love
The second investment was to a borrower in California who alleged an internal dispute prevented him from making the promised loan payments. Realty Mogul is pursuing foreclosure, as well as attempting to negotiate with the borrower. Like the first loan, this loan was also made at a very high loan-to-value (82%), which may not leave enough equity to protect investors from a loss.
Excellent Realty Mogul customer service
Investors say that Realty Mogul has done a good job of keeping them informed on a timely basis, and even going the extra step of conducting a webinar to give them full information. (This is in contrast to what investors reported for Ifunding, which you can read about on their review).
So we applaud Realty Mogul for demonstrating a continued commitment to investors during this unpleasant stage of the investment process.
And Realty Mogul (like all crowdfunding sites) does warn investors up front that they can lose their money. So investors were fully aware that their money was at risk, and that success was not a "sure thing".
Does it mean anything more?
At the same time, we are currently in a real estate up cycle (See our tutorial on the real estate cycle). At this stage, defaults should be a fairly rare thing if the due diligence is done properly.
So has Realty Mogul simply run into a string of bad luck? Or are these two incidents indicative of deeper issues?
We were hoping that Realty Mogul would provide us their default statistics, so that investors could compare it to competitors and decide for themselves. However, when they were asked to comment on this article, they declined, saying "Due to regulations within our industry, RealtyMogul.com cannot comment, confirm or discuss outstanding transactions or borrowers."
(Note: There has been some controversy and discussion between investors on whether 506B crowdfunding regulations truly prohibit marketplaces from discussing investments which are no longer soliciting any new money… or not. We will have an interview on this topic with an authoritative and prominent real estate crowdfunding attorney, shortly. Be sure to subscribe to be notified.)
How are other sources for hard money loans doing?
(This paragraph added 11/19/2015) Peerstreet is another hard money loan marketplace. Brew Johnson, the CEO, told us, “PeerStreet has completed 28 loans without a single default of any type (both cured and uncured defaults). We also have 43 loans that are open and paying interest to investors. None of those have had any type of default either. ” Johnson credits "conservative underwriting standards, data analytics, and local lending experts."
We spoke with a professional hard money loan fund manager. Adam Fountain is Managing Director of Broadmark Capital, and co-owner and manager of two hard money loan funds. He states: “PBRELF I has funded 329 loans since August 2010 and has experienced only 6 defaults (a 1.8% default rate), two of which have already been cured in full (1.2% uncured default rate). Fund II has funded 60 loans since May 2014 and has experienced only 1 default (a 1.7% default rate). Neither fund has had any losses of principal.”
To get another perspective, we spoke to an investor who sources his hard money loans himself, locally. He said he had funded “35 to 40 loans this year” with a “0% default rate” which he claimed was “consistent with previous years”.
Ultimately, it would be much easier if Realty Mogul would provide their default statistics. In the absence of that, some investors seem to be making up their minds anyway. One investor who invested in both Realty Mogul deals, told us, "Where there's smoke there's fire. I won't be investing with Realty Mogul again."
Is there an industry problem?
Some investors we spoke to believed that this isn’t a Realty Mogul issue, but an industry-wide one. Traditionally, hard money loans were sourced by local experts with intense local knowledge. Some of the investors questioned whether a national company could ever duplicate this on a national scale.
We will look at both sides of this issue in part two of this article. And will also talk about what’s utmost on most investors minds: the best techniques for protecting the hard money loans in your portfolio.
Update on 7/8/2017 from Realty Mogul:
Loan 1 Resolution
o The property was a residential, single-family home roughly 50 miles North of Houston, and the plan was to fix and flip.
o Realty Mogul projected an 8.5% annualized return, paid monthly.
o In October 2015, the borrower filed for Chapter 7 Bankruptcy claiming that he did not have sufficient funds to continue with his various projects due to his contractor embezzling from him.
o In February 2016, after several months of bankruptcy court hearings and attempting to remove the property from bankruptcy Realty Mogul Co. decided to purchase the borrower payment dependent note from our investors for 100% of their principal investment.
o Eventually Realty Mogul successfully removed the property from bankruptcy, foreclosed on the property and sold it.
o Investors received their full anticipated interest payments until the borrower filed for bankruptcy, and experienced no loss to principal.
o Investors realized returns were 5.36%.
o It took one year for investors to receive their full principal return (Feb 2015 – Feb 2016).
o LTV: 72% (day 1).
o Ending LTV (if full loan were hypothetically given on Day 1): 88%.
Loan 2 resolution
o The property was a residential, single-family home in the Hollywood Hills of Los Angeles, CA and the plan was to fix and flip
o Realty Mogul projected a 10% annualized return, paid monthly
o The borrower was a joint venture between two groups. The group experienced an internal dispute that prevented them from making the promised loan payments in August 2015.
o Realty Mogul foreclosed on the property and put it on the market.
o Realty Mogul ended up selling the property in February 2016, and disbursing all net proceeds from the sale to investors, which included 100% of their principal investment. Investors received their full anticipated interest payments until the borrower defaulted on the loan and additional interest payments after the property was sold.
o Investors realized returns were 4.9%
o It took 14 months for investors to receive their full principal return (December 2014 – February 2016)
o LTV: 82% (day 1)
o Ending LTV (if full loan were hypothetically given on Day 1): 102%
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