Would you have invested $32,089 to receive $44,872 four months later?
I hope you would say YES...but I would also expect you to be very cautious. The above before and after photos were from an investment I made in Cincinnati. I purchased the performing mortgage in February 2018, when I was testing the waters before creating an investment fund around this concept. The borrower had never missed a payment and the location was promising.
Protecting the downside is the name of the game in real estate. Below are the three main steps I take every time to reduce the risk of the investment through proper due diligence.
(1) The first thing I look at is the value of the property and Loan to Value.
The only picture I could find was the the image on the left, which obviously needed work on the exterior. It's usually safe to say if the exterior looks bad then inside is going to look similar or much worse. In this case, even in poor condition, comparable sales were around $70,000 which is approximately a 45% loan to value.
*This is important because if the borrower stops making payments, I need to have equity after I receive the property back from foreclosure.
*Additionally, you want the borrower to be vested in the property. Meaning that they would be walking away from equity/money if they stopped making payments.
(2) Review the pay history and supporting loan paperwork.
The borrower had never missed a payment since they purchased the home in 2012. Additionally, after having my attorney review the paperwork, everything was in order.
*This is important because the better the pay history, the more valuable the loan.
*We always have an experienced legal firm review documents because if we are missing a document or if it wasn't done correctly, we could have a difficult time selling the loan or foreclosing if necessary.
(3)Have a Realtor drive by the location.
I was pleasantly surprised when my Realtor sent me the photo on the right and comparable sales in the $100K+ range. Now I have a great investment that is protected with almost $70,000 worth of equity and annual returns are expected to be over 15%. All signs pointed to this being a great deal so I purchased it in February of 2018.
Everything was doing great until I received a call from loan servicing company asking what I wanted to do with a $43,797 check that arrived in the mail. The borrower had refinanced the loan. When this happens, or if they sell the property, we receive the full amount owed on the mortgage.
The best part of real estate is the "Do it once philosophy". If you find a great investment don't sell but instead manage the cash flow for years to come. Otherwise you will always have to find another investment that may never come.
However, locking in a 39% return in four months is great trade off.