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Wednesday, February 14, 2007

Trouble With Louisiana Project

My hard money lending investment in Louisiana has hit a bit of a snag. There has been a big shake up in the structure of the LLC that is handling the renovation of these office buildings. The guy who was in charge has been bought out by another investor. The old manager just wasn't getting things done and seemed to have a very hands-off approach, resulting in delays. The new manager and the remaining principles are hands-on, micro-manager types, so I expect things will start moving forward much more quickly.

The snag is that the new manager wants six months of no payments in exchange for a higher interest rate. He is apparently in a bit of a cash crunch right now and is in the process of selling some of his other commercial properties. This guy is worth somewhere around $40 million and Les, one of the other investors, thinks he is a "smart cookie." In fact, he thinks this guy knows more about real estate than he does (and that's quite a lot). He also feels the guy will be good for the loan.

But since the February payment is late, technically the mortgage is in default. We (the other investors and myself) are currently voting on the course of action to take. We can restructure our loan and give the guy 6 months of no payments or we can start the foreclosure process. In Louisiana, the foreclosure process takes about 9 months. The mortgages are for $700,000 each on two buildings and the buildings are estimated to be worth roughly twice that.

So, do we delay payments for 6 months and get a higher return after that or delay payments for 9 months or more and get our principle back? In actuality, if we foreclose, it'll probably be a year or more before we get any principle back because we've got the 9 month foreclosure window, then more time to market and sell the buildings. Of course, my interest in the property could always be sold to someone else so I can get my money back sooner.

I voted for the 6 months of no payments with a restructuring of the note to a higher interest rate.

On a related note, our mortgage on the parking garage and lot is in the process of being refinanced with a conventional lender and we will get our investment back from that. I'll get $30,000 back, leaving $120,000 invested in the other two buildings.

This is just the simplified version of the saga. The whole thing is like a soap opera and it really boils down to incompatible people trying to work together. That didn't work out. But as Les says, when there is trouble, I make money, so I'm not too concerned.

8 comments:

Doug O said...

I guess this boils down to a few questions-

how well do you know les to take all his advice on this? (default is NEVER a good thing, even if there is a bright future ahead - you never buy into a deal hoping/expecting for a default)

where are these buildings located? ie, do you actually know that they could be sold for the appraised value that you mention? There are plenty of areas where a building SHOULD be worth $1 million, but because of where it is, it's only worth $400 thousand...

And, this new manager - is he willing to put any kind of guarantee on his end? ie, securitize the 6 month delay somehow? Maybe offer up his percentage of the total deal if there is a cross-default on the new note? At least that would be something additional for you investors, and would motivate to perform as he promises...

Just my .02 ...

Kenric said...

Actually as a HML you should always go into a deal hoping for a foreclosure. That's where your money is made.

If I make a $100k loan on a $200k house, I'm hoping for a default.

However, this is where using borrowed funds to lend out bites you. You won't get paid for 6-12 months and you are still paying out interest on your HELOC.

Doug O said...

Well, it's all relative... If I were lending, I would want a high rate on the money I lend, not want to foreclose... I always structure any deal to work from inception, and not hope for any other consequences... However, I always have an exit strategy in case the original structure of the deal falls apart... But that's different than hoping for foreclosure - it's a lot less complicated to be paid back on schedule and take the interest to pour it into the next deal...

Shaun said...

Yes, using a HELOC for the funds does bite me a bit, but I have the income to easily handle the missed payments. (I made sure of this before I lent the money.) I've been saving the extra money, so I have a nice cushion. I'll also get $30K back to pay down the HELOC and reduce my payments.

I agree with Doug that foreclosures and not the best outcome. Yes, you can make money, but at a considerable time and expense. It's much easier to get the checks every month. I look at foreclosures as part of doing real estate investing. They're a headache, but they still provide you with a profit if you've done things correctly.

Shaun said...

Doug - I've known Les for 5 or 6 years and trust him. Actually, Les prefers to foreclosure in this case, whereas I prefer the extension. We'll see how the other people vote.

We're asking the new manager if he would be willing to put up more collateral on the deal.

Doug O said...

Shaun, I wasn't even suggesting to collateralize the extension - I was just suggesting that if he is confident he can get the job done, he should guarantee his percentage of the total project to the other investors.. ie, if he defaults on completion, the remaining investors move to foreclose on the property, but their stake is increased proportionately with what this new manager forfeited by not completing the project... Unless he has such a minimal percentage that it wouldn't make a difference (ie, less than 5%) ... But at least that should shield you somewhat from the cost of the foreclosure, in that you'd get the money back upon sale...

Shaun said...

Very interesting idea Doug! I like it! I'll pass it along and see what others think. FYI, the new manager owns just over 75% of the property, so he's got a big stake.

Doug O said...

Ok, well in that case I doubt he'd be willing to cede his entire interest... However, it might be worthwhile to approach him about putting up 20-25% of that, which would go to other investors... At least at that point, you have some security in the event of a default on the extension and it would (hopefully) make the additional 6 months worthwhile in the event of a sale via foreclosure...
I've seen this type of thing done before, although the partner was never such a majority as this - it was always smaller percentages. But that shouldn't change the fundamental principle behind it...

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