Let’s revisit the project we looked at earlier. Maybe it isn’t such a crazy idea after all?
Photo 1: Home Before Re-vitalization
This project, like all of Steed Talker Realty & Investment projects was 100% funded with private money. Not one red cent of commercial funding goes into any of the Company’s projects. Projects like these infuse the Company with capital based on valuable collateral which is given to the Private Investor to provide them a secured, hassle free, and high return investment vehicle.
In this example, the value of the collateral is $215,000. That is the market value of the property. On this project, the Private Investor lent $150,000. The Loan To Value (LTV) in this example is 69% — $150,000 is 69% of $215,000.
Contrast this with typical home mortgages where banks usually offer much higher LTVs. Federal Housing Administration (FHA) LTVs are usually as high as 95% (5% down and 95% financed) and United States Department of Agriculture (USDA) LTVs are as high as 100% (0% down payment and 100% financed). Obviously, these high LTVs offer less security to the lender because the loan amount comes closer to equaling the value of the collateral.
Steed Talker Realty & Investments does not want its Private Investors to lose money on investments in the company. To better secure all Private Investment in the Company, LTVs are never higher than 70% and often lower. The Company can do this, because we know how to purchase below market value. As someone once said, “Wise real estate investors make their profit when they purchase. They collect their money when they sell.” Knowing when to buy and when not to buy are decisions that can be made only with expertise and knowledge to appropriately analyze projects and markets.
As has already been established, real estate is considered to be an appreciating asset but we know from the crash of 2008 that this is not always the case. Real estate can depreciate. Nevertheless, the private investor who lends with reasonably low LTVs is still protected against the threat of depreciation, as was the case with the project example we have been using. See the chart below.
The project or case we’ve been using for example purposes was started January of 2008. As most of us remember, 2008 turned out to be a devastating year for the economy and real estate did in fact depreciate. At the time this project began the market value of the property was $215,000. In any normal market the property once completed would easily have sold for that amount. Unfortunately, conditions turned south quite rapidly and the value of the house depreciated. Rather, than selling for $215,000, this property sold for $189,000. Because of below market purchasing ability and sound project management, the company still made a profit, though reduced from original projections.
Chart: Valuable Collateral
Furthermore, even in the midst of the worst recession since the 1930s, the Private Investor’s interest was also secured because purchasing below market value and sound project management practices allowed the company to keep LTV below 70%. Nevertheless, even if these factors had not been in place, the terms and return on investment were determined at the time the loan was made and so the terms and return would never be effected by the depreciation of the asset. In this example, even though there was depreciation of the asset it did not depreciate below the loan amount.
In October of 2008, millions of retirees who had their retirement primarily invested in the stock market were loosing a great deal of sleep as the stock market plunged. The Private Investor who invested in this project was sleeping just fine. While, millions of other American’s were wondering how they were going to manage on a retirement that was much less than they had planned, this Private Investor was feeling fine as the investment made was secured by depreciating but still valuable collateral. See Chart above: Valuable Collateral.
Suppose the collateral had depreciated below the $150,000 loan amount. Would that have changed the terms or return on the loan? NO, the terms and return would have remained the same. The loan would have become like that of an automobile loan. The collateral would have had less value than the loan principle but the principle and interest agreed to remains the same. The real estate investor assumes the loss, not the Private Investor.
We sometimes hear of people just walking away from their mortgages because their property values are less than the principle on their loans. People can do this but lenders do have recourse. It is known as a Deficiency Judgment. A Deficiency Judgment is a court order to pay the lender the difference between the value of the collateral and the principle/interest due.