It seems every day I am asked about the market and how it might effect Alliance Portfolio and our clients.
Everyone knows that inflation is at a 40 year high. Many large companies like Carvana, Tesla, Netflix, PayPal have already made or plan to make layoffs. Maritage Homes showings are down 35%. Amazon is selling 30% of the new warehouses they currently have under construction. Retail stocks have lost a third of their value since their recent peaks. Despite all of this some businesses are doing well.
Our job is to anticipate problems and ask, what are we going to do about it? It’s not about being paranoid, it’s about being opportunistic – how do we leverage the opportunities that inevitabley will come about while minimizing risk. How can we avoid the avoidable traps. There are a lot of offensive things we can do and a lot of ways to be opportunistic. Economist can tell you why our recession is happening, but they can’t tell you what to do about it.
With the help of our business coach, I arranged to meet with 6 other business owners to share their battle tested wisdom. These business owners are seasoned veterans in Commercial Real Estate, Residential Real Estate, Raising Capital for growth, Loan Servicing, Family business and arranging banking relationships.
Together we participated in a strategic recession planning exercise. We used an agreed upon out line of 4 primary steps which included;
- Taking inventory of risk
- Identifying leading indicators of risk
- Forecasting various scenarios
- Developing risk mitigation strategies for the top risk.
Everyone had some very different insights that others hadn’t considered and it created some excellent dialogue. Here is a list of take aways from our session together.
1) Taking inventory of risk – what are the potential risks that can harm the company?
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- Litigation
- Cash burn rate
- Real Estate market collapse
- Concentration – property types, borrowers, geographic area/location
- Legislation
In Taking inventory of our risk, there is always litigation risk, anyone can sue anyone else for any reason, and they do so when things don’t go their way. Borrowers lose their property due to default and it was not their responsibility to make their payments. Investors lose their money on an investment that went sideways. Fortunately, we don’t have any of this and don’t believe that we will have, but anytime you’re in business, there is always risk.
Our cash burn rate is very long, thankfully we have been prudent with our cashflow and overhead and that we have a large loan servicing portfolio and mortgage fund that both provide recurring revenue streams. The real estate market is difficult to gage, there is still very little supply, Demand continues to be high and interest rates are still relatively low. However, it feels like values will not continue to increase and are likely to decrease at some point. The average loan to value in our entire portfolio is 57% and in Alliance Mortgage Fund it is 53%. A market collapse would have to be more than 40% to have a meaningful impact on our portfolio.
Considering concentration of property types, borrowers & geographic area. In the last recession, I learned this lesson very well and it was painful. Experience comes from poor judgment, and good judgment comes from experience. As painful as it was at the time, it is very valuable now. There will always be legislative risk.
2) Identifying leading indicators of risk – how can we know those risks are coming down the track before getting here?
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- Unhappy borrowers & investors
- Price reductions in listed properties, properties on market longer than 6 months
- Foreclosures & request for modification, forbearance
- Property taxes past due
- Unemployment rate increases
- Discounted notes
Leading indicators are measurable trends we see over 90 day periods. Keeping track of these leading indicators of things to come will help us mitigate the problems that will follow. They also allow us to take action to address these issues before they happen and identify the opportunities that will be missed by competitors who are not as flexible or as well prepared.
3) Forecasting various scenarios – what would it look like in action?
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- Increased number of foreclosure
- Legislated Foreclosure moratoriums
- Redemption request
- Discounted Notes
- Servicing Portfolios
I think it is inevitable that we will see an increase in foreclosures. Foreclosing is not always the best alternative. During the last recession in 2008-2009, I found that working with borrowers to keep them in their properties and paying a reduced payment while accruing the balance was helpful. Also converting all the payments we received as principal payments while accruing the unpaid interest. This decreased the risk to investors who would not pay tax on the return of capital, while reducing the overall interest paid by the borrowers as they only pay interest on outstanding principal balances. We have seen foreclosure moratoriums and eviction moratoriums resulting from the pandemic which is another perfectly good reason to work with borrowers. Ultimately, the market will rebound and we will be able to collect all of the principal balance and most if not all of the accrued past due interest.
With regard to an Increase in request investment redemption, during the last recession, we experienced this scenario as well. Redemptions are derived from loan payoffs, if loans aren’t paying off, there is no capital to redeem investors. So again it is best to work with borrowers to keep cashflow coming in and monthly distributions going out even if the distribution rate is less. It is all about preservation of capital.
Discounted Notes is one of my favorite things ever invented. Banks will discount loans to get their defaulted loans off of their books and their cash reserves up. Hedge funds that hold mortgage backed securities will begin to sell large tapes of loans at discounts. When buying tapes of loans you have to buy all the loans, the good ones as well as the bad ones, usually there are enough good ones to offset the bad ones and it is all about the overall discount that is negotiated. Private lenders & individual trust deed holders that can’t weather the storm or do not know what to do will sell their individual notes at surprisingly low discounts. We will be actively pursuing opportunities in the discounted note market.
There are many small private money lenders with small servicing portfolios less than $50,000,000, often times they will release all of their servicing contracts for one lump payment. Generally, they do not have a sufficient critical mass of loans in their portfolio to provide sufficient recurring revenue to pay their overhead and to weather the storm. Acquiring small loan servicing portfolios for $10,000,000 to $40,000,000 can be a very profitable opportunity. We will be actively seeking to purchase loan servicing portfolios to add to our business.
4) Developing risk mitigation strategies for the top risk:
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- Keep LTV low
- AMF – current average LTV: 51%
- Total portfolio – current average LTV: 57%
- Lend in the very best area
- Stricter guidelines in the ability to pay and exit strategy
- Lend on the properties that are predictable and easy to liquidate
- Default Ratio
- Keep LTV low
To mitigate risk, we believe that continuing to keep our average loan to value below 60% will provide a solid equity protection. Staying close to home in Orange County and staying in the coastal communities of LA County, San Diego County and the Bay Area will reduce the large fluctuation in values that we see in areas like San Bernardino, Bakersfield, Sacramento/Stockton, and Riverside counties.
A rising tide lifts all boats and for the past 13 years real estate values have been increasing providing exit strategies for borrowers and lenders. Now the tides have changed, we have to underwrite a borrowers ability to make timely monthly payments and have a clear exit strategy before making them a loan. Keeping loan to value under 60% is prudent discipline, having stricter guidelines for ability to pay and viable exit strategies will increase the performance of our entire portfolio as well as overall value.
Single family residential property is always the easiest property type to liquidate or turn into cash flow. Today light industrial property is a very desirable. Inexpensive to operate, tenant pays for everything, very little tenant improvements & high demand for warehouse space, all make light industrial space easy to liquidate and we max out at 60% LTV on these property types. Retail property can be more difficult and longer turnaround time for dissolution. However, retail properties can generate substantial cash flow in the interim. The most difficult properties to liquidate are single purpose owner user commercial properties such as Restaurants, Gas stations, car washes and bars where a liquor license doesn’t transfer with the property. Any property type that will create a job and require special licensing or has deed restrictions should be avoided.
Overall, I am confident that we recognize the risk that we may encounter, we have measurable indicators to allow us to adjust & respond, We have forecasted which scenarios might take place, and we have a specific plan to mitigate any risk that we may be exposed to. Most importantly, we recognize some of the tremendous opportunities that will arise in this market and have a plan to capitalize on them.
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Contact:
ALLIANCE PORTFOLIO
120 Vantis Drive #515
Aliso Viejo Ca, 92656
Info@allianceportfolio.com
(949) 349-1322
http://www.allianceportfolio.com/
Real Estate Broker
California DRE
License #: 02066939
ABOUT US:
Alliance Portfolio is a Leading Full-Service, Private Hard Money Lender in California.
We serve borrowers who have unique situations that do not meet strict institutional guidelines while providing investment opportunities that are well secured and well underwritten with desirable returns on investment capital. Our services include private equity finance, hard money loans, bridge loans, fix and flip loans, cash-out financing, quick close loans and second mortgages on single family real estate, multifamily real estate, commercial real estate, light industrial, cannabis and land properties in California with an emphasis in hard money loans and private hard money lending in Orange County, Los Angeles, San Diego, San Jose, San Francisco, and the surrounding bay area.
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