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Private Money, Hard Money

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By Dan Harkey
Educator & Private Money Finance Consultant
949 533 8315 [email protected]
Visit my website at danharkey.com

Introduction:

“Private money, hard money, and bridge loans” are used interchangeably:

These loans refer to alternative lending sources separate and distinct from banks and institutional lending. One or more private investors/lenders fund each loan. Pools of investment capital accumulated with many private parties are also frequently used to finance private money loans. A sponsor/manager will be formed for pooled entities to fund many loans and manage the servicing.

Private money lending stands out when traditional banks decline, or the loan transaction is non-bankable. It’s a solution for property-related issues that need to be resolved, such as completing a partially constructed building or increasing occupancy in an income property with excess vacancy.

Transactions where private money loans benefit borrowers.

*Fast loan approval with possible 2-to-4-day funding for bank declines and fallouts: The bank may already have done significant underwriting, including opening escrow and title, obtaining an independent appraisal, and completing the application and financials. Some private lenders can use the banks’ information to fund faster, particularly when they have a mortgage pool or immediate capital available to invest.

*Debt consolidations for consumers, businesses, or a combination of both: In most cases, a funded loan is used for debt consolidation, lowering the borrower’s monthly payment obligations. The funded loan should give the borrower some breathing room to improve their credit and obtain a long-term bank loan. Also, if the loan is a second lien, the average interest rate between the first and second is calculated to show a ”net-effective rate.”

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*Marginal to poor creditworthiness, where a borrower is not bankable, and approval of a loan request is primarily property equity-driven.

*Special purpose-unique properties– Churches, synagogues, restaurants, bars, automotive repair shops, body repair shops, gas stations, and other single-purpose or limited properties.

*Limited document loans where the requirement is a loan application, credit report, and 3 to 6 months of bank statements. The objective is to prove the ability to pay the outstanding loan payments and other debt obligations.

*Fresh start loan. Borrowers may need to catch up and give themselves breathing room for accrued and differing payments.

*Payoff loans coming due or past due: Refinance and pay off existing first, second, and third lien position loans that may be due. Sometimes, refinancing the second and providing cash out is the appropriate answer to the loan request. Loans are available for both owner and non-owner-occupied residential and commercial properties.

*Cash-out for any reason refinances based upon the protective equity of existing real estate. Proceeds may be for business and consumer purposes. The Federal Government and some states, such as California, require a special license to engage in consumer-purpose lending.

*Junior lien or second-position loans on both owner and non-owner-occupied dwellings for business purposes.

*Construction completion, rebuilding, or upgrading properties in poor or marginal condition: The loan is usually necessary because the collateral property or the borrower needs to meet bank underwriting guidelines in its distressed or partially completed state. Loan approval by the lender will consider the as-is-value and the as-completed-value.

*A borrower may own and operate a cash-based small business with limited financial strength, as the books show. A lender will require 3 to 6 months of personal and business bank statements. The borrower must still prove that they can make the required payments.

*Leveraged existing real estate equity developed over time to borrow additional funds, purchase other investment properties or invest in a business enterprise.

*Purchase a property with some cash down payment, sweat equity, and seller’s agreement to carry back a subordinated junior lien. The property seller would have the borrower sign a promissory note and a deed of trust with a set interest rate, payment schedule, and due date. The subordinated second is recorded concurrently with the first trust deed but with a recording number after the first.

*Inherited property where family members and successor trustees who are beneficiaries need funds for distribution to the beneficiaries, pay the estate’s legal costs or fix up the property for a future rental. Another option is fixing it and selling it on the open market.

*Loan on unimproved raw land. Loaning on raw land can be a complex process. Is the land parcel part of an existing subdivision, referred to as an infill lot, a commercially or industrially zoned parcel within a subdivision, or a larger parcel held for future development? The borrower may need to use the property as collateral to raise funds for future entitlements, including engineering, architecture, various reports, and fees to develop a fully entitled parcel ready to be built. The borrower would pay the loan off as part of the construction loan.

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*Retail strip and community centers, industrial or other properties that require upgrades or repositioning: Many centers are distressed due to the COVID shutdown vacancies, where tenants could not pay rent.

*Fix-and-flip loans allow high-frequency purchasers to purchase a distressed property, rehabilitate it with the expectation of resale, and turn a quick profit. Borrowers need both experience and some of their capital at risk.

*Litigation settlements: A loan to buy out a business partner, pay off a pesky family member, an ex-spouse, a judgment lien, or a partition suit.

*Pay off civil judgments and liens, including arrearage in property taxes, association dues, and federal and state tax liens.

*Sale of existing promissory notes and deeds of trust to 3rd party investors: The sale is usually at a discount, whether the promissory note is performing or non-preforming. A deal will free up cash.

*Hypothecation or pledge of a promissory note and deed of trust: A borrower who owns a promissory note and deed will assign them to a third-party investor as collateral for a new loan.

*Cross-collateralization of more than one property: Multiple properties are required to meet the lender’s equity requirements. The borrower would sign one promissory note but have recorded liens that encumber two or more properties.

*Small mobile homes or trailer parks: properties that don’t meet the underwriting standards of intuitional lenders.

*Vacation, Short-term, and rental income properties; Financials and history are necessary to prove the ability to make payments.

*New ground-up construction or construction completion for a partially completed project: Most requests result from borrowers needing to fund additional dollars to complete the project when they deplete their capital or existing construction loan proceeds.

*Collateral combines real and personal property, such as a motel, restaurant, carwash, or gas station with mini markets. A recorded trust deed encumbers the real property, and a UUC-1 financing statement will be filed with the Secretary of State to encumber the personal property. The valuation and decision to make the loan must be on the real property only.

*A long-term lease on commercial property has or is expected to expire soon. The lease expiration could cause a vacancy and a disruption in rental income. If the master tenant vacates the property, this will disrupt other smaller in-line tenants because the master tenant is responsible for the primary draw of foot traffic to the center. Banks will usually not make this loan. This loan is generally a bridge loan until the owner obtains a long-term lease with a credit-worthy tenant and manages the center back into stabilization.

*Credit approval is subject to highly sophisticated lease analyses, with multiple tenants having different lease terms, including length, lease rate, and lease provisions. Some tenants are on long-term leases, and some are on a month-to-month tenancy. Lease documents may include go-dark requirements for the anchor tenant or provide for lease cancellation in the event of excess vacancy or loss of an anchor tenant.

*Some properties require mutual property access easements for ingress/egress or complex usage rights, such as reciprocal parking agreements. Many properties, such as churches and retail shopping centers, sign contracts with multiple property owners to use the entry/exit of the property or the parking in specific ways or at certain times.

*Foreign nationals with and without social security. The borrower must have a U.S. bank account(s). The borrower must have a process agent service arranged during loan processing.

*“Notice of a substandard condition” or “notice of property noncompliance” is recorded on public records by a building department notifying the public that the property is out of conformance or in disrepair for building and zoning codes. The bridge loan funded by private lenders will provide funds to make substantial improvements and modifications to bring the property up to acceptable building, safety, and zoning standards. Institutional lenders will not make these loans.

*Non-conforming property does not comply with current zoning and building standards. As a result, strict limitations exist on repairing or replacing structures in destructive acts such as fire, flood, windstorm, vandalism, or earthquake. The property may not be able to be rebuilt to an acceptable level after the destructive event occurs.

*Earthquake seismic retrofit. Many older properties require upgrades, such as engineered reinforced steel frames bolted into the existing structure and walls shored up with steel support fasteners to withstand earthquakes.

*Tenant improvements. Commercial building owners must provide funds to install interior or exterior improvements to satisfy the owners’ and prospective tenants’ leasehold improvements.

*Cannabis-related properties, manufacturing, and retail facilities: Some states have legalized lending in cannabis-related operations, and others have not.

In summary, private money loans are collateral-driven, even though the lender must review the borrower’s financials to prove that the borrower can pay the debts.

If you find value in this article, please forward it to friends and associates. You may use this article in your marketing efforts.

Thank you

Dan Harkey

Dan Harkey

Dan Harkey is a contributing author to Weekly Real Estate News and is a Business & Financial Consultant. He can be contacted at 949-533-8315 or [email protected].

Learn live and in real-time with Realty411. Be sure to register for our next virtual and in-person events. For all the details, please visit Realty411Expo.com or our Eventbrite landing page, CLICK HERE.

Ask the Right Questions! To Determine the Viability of a New Loan Request

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By Dan Harkey
Educator and Private Money Finance Consultant
949 533 8315 [email protected]
Visit www.danharkey.com

Introduction:

The following is an example sequence of questions that loan agents can use to obtain the information from the borrower. These are suggested. Each loan agent may set up their questioning sequence, which will vary but accomplish the same result.

Conversations with borrowers may be fluid and take the loan agent into complex life stories to obtain intended information. I often pause to let them talk because I know they are upset, not about me but their life circumstances.

Borrowers love to tell you their life’s problems while you are attempting to obtain material facts. Compassionate listening is a natural, thoughtful, learned trait that helps develop trust and lasting relationships.

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Any sales career endeavor involving products, goods, or services will have a similar best practices sequence of questioning. All salespeople should take the time to write down a sequence of questions as an effective platform for intended results. The intended outcome is to obtain the material facts, represent the customer with good intentions, explain and answer questions, determine the transaction’s viability, and close and drive the transaction forward. Or decline the transaction if it does not fit the company’s requirements.

Educating a client or customer is part of the job of any professional salesperson. The customer should come away with the idea that the salesperson honestly had their best interest in mind. A byproduct of this philosophy is a lasting relationship, spreading goodwill, and referrals.

Stage I: Questions as a best practices platform include:

• Loan amount, for what term?

• First or second lien?

• Type of property: single-family, owner- or non-owner-occupied, commercial, apartments, industrial, occupancy, or other.

• Loan purpose: This question is paramount if the loan request is single-family owner-occupied. Is the use of loan proceeds primarily for business purposes? Primarily means 51% or more of the loan proceeds. What portion will be used for consumer purposes?

• Where is the property located?

• Property value. How did the borrowers determine the
value? A borrower’s estimate of value is often incorrect or intentionally exaggerated.

• Cash out requested?

• Current total liens

• Are the liens current? If not, how much is the arrearage and the reason? Get the complete story in writing. Completeness may make or break your transaction. Some reasons may be rational, while others are just an attempt to conceal.

• Loan-to-value: LTV ratio total loans divided by appraised property value (APV)

• Description of collateral property.

• Property address

• Exit strategy: What are the borrower’s plans to repay this loan?

• Rental income stream? What gross rents, vacancies, and expenses are required to determine net operating income, often called NOI? The NOI calculation excludes debt service. Will the NOI cover the loan payments and property expenses?

• Most recent payment statement(s)-Please obtain.

• When was the property purchased, and for how much?

• Have they made any significant improvements or upgrades? Please provide a list of upgrades and costs.

• Pictures of the outside and inside: In most cases, pictures are found online, with Zillow, Redfin, Realtor.com, and Trulia. Photos of the inside and outside are necessary if the property has undergone significant upgrades that enhance its value.

• Is the property owner/borrower a private individual(s) or an entity? If an entity, what is the purpose of the enterprise?

• If the property is newly or partially reconstructed, inside and out pictures are necessary, as well as a list of improvements, costs, and what improvements remain to be completed.

• Any exceptional circumstances? Weaknesses in the transaction include a history of late payments, significant arrearages in payments, accrued unpaid property taxes, outstanding judgments and liens, state and federal taxes due, probate sales, bad credit, open bankruptcy, pending divorce proceedings, tax liens or judgments, the property has a recorded notice of substandard condition, red tagged for code violations, successor trustee acting on behalf of a family trust, multiple borrowers, multiple cross-collateralized properties, etc.

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• Forward the prospective borrower a loan application and authorization to obtain credit. Request the most recent property loan payment statement and at least three months of bank statements. Use a commercial loan application rather than a 1003 residential form when possible.

• Ask for a handwritten purpose of the loan letter.

• Does the borrower have an online presence? If they are a company, they may have a website. If they are individuals, they may have a presence on LinkedIn. Does the borrower have a promotional summary about themselves? Add these items to the executive summary sent to the lender. Positive promotional material will add credibility to the prospective borrower.

The above information is sufficient for the loan agent to write an executive summary and email it to a prospective lender. Then, follow up with a phone call.

Stage II: Driving the loan process forward:

• Private money vs. institutional lenders have different borrower requirements, requiring tax returns, recent pay stubs, w-2s, and 1099s.

• Profit, loss, and financial statements are necessary if the borrower is an operating entity. Two data sets, one for personal and one for business, may be required separately.

• In addition to a borrower’s signed letter of interest, loan application, and credit authorization, the agent will need other data, such as a property owner family trust document, an operating statement for a limited liability company (LLC), insurance broker contact information, and association management company contact information.

• If the loan request is for a junior loan, information about the senior loans will be required. Documents for review may include a copy of the promissory note, loan agreements, and a recent payment statement from the senior lien holder or loan servicer. Reviewing the recorded documents related to the senior lien associated with the deed of trust is prudent.

• Does the first lien have a written provision in the deed of trust referred to as an “alienation clause” or a “due on further encumbrance clause” that would require the lender to obtain written approval to place a junior lien on the property? If the loan agent is working on a second lien loan, they should review the deed of trust and the loan agreement to see if there is a prohibition of placing a junior lien without obtaining the first lien lender’s approval.

This fact is important because, in many cases, the original borrower may have been parents, possible deceased members, siblings, co-trustees of a family trust, ex-spouses, or other miscellaneous parties. Some earlier property purchases were taken “subject to” a lien that prior owners obtained in the past. Completing a property sale “subject to” means that the purchaser/borrower purposefully failed to notify the first lien holder of the transfer. Was the sale transfer kept a secret, deliberately to get a lower interest rate? Therefore, the loan documents still show the obligor as the prior owner on the note and deed of trust.

• Does the person requesting the loan have the sole authority to borrow and encumber the property with a new lien? Are there other parties of interest who may object to recording a lien on the property? An estranged ex-husband, ex-wife, business partner, or trust beneficiary would be an example.

• Are there multiple borrower parties that a lender must include in the application, processing, underwriting, and closing process? A lender’s frustration will occur when the discovery that the borrower has intentionally excluded an undisclosed hostile party. I assure you that an unknown borrower party will not fool a good loan processor or the title company. When the title insurer underwrites their coverage, they will ensure that the correct parties have signed the documents. Verifying the proper parties is part of their insurance underwriter and approval process.

• Additional documentation may be required to drive the process forward as a loan processor sets up their file. The loan agent should maintain a respectful and enthusiastic relationship with the processor.

Sifting through the maze of questions and answers to develop a well-written executive summary to send to the lender

Loan agents ask prospective borrowers questions to determine the transaction’s viability. They are responsible for obtaining specific information from the borrower or the borrower’s agent.

Some agents are responsible for asking appropriate questions but then calling a lender with fragmented and incomplete information to discuss the potential loan transaction. The lender will respond that they need more information. The agent will answer, “What do you need?”

There are dozens of questions that may be asked at the front end, but getting to the basics of whether the potential loan transaction is viable is the beginning. Sifting through the maze of complexities includes:

  • Property types, income generating, and occupancies,
  • Agent’s competency, property ownership variables,
  • Borrower creditworthiness,
  • Borrower’s propensity to withhold material facts,
  • Some borrowers will withhold information, unaware they will get caught while processing the loan. A critical thinking questioning sequence will avoid most of this.

The material facts of the transaction should be summarized and submitted to a lender via email as an organized written executive summary, followed by a phone call discussion. Usually, a request for more information is anticipated. Emphasize the positives first and the negatives later. However, do not bury the negatives so the lender discovers them later.

Lenders have long memories about who is professional and honest, supply only fragmented data, and summarily leave out adverse material facts. After a couple of repeated offenses, the assumption will be that the loan agent withheld the negatives intentionally. Reputations, both negative and positive, accrue quickly. Experience, understanding, and the propensity to fully disclose and protect the lender’s interest will ensure lasting relationships.

After reviewing the material facts, the lender may express an interest or decline the proposed transaction. Or the lender may ask for more information. If you receive a positive response, that is great, and if you receive a rejection, it is a rejection of your request, not a rejection of you. Move on to the next lender. Lenders have different risk assessment standards and pricing structures. For example, some lenders require an independent third-party appraisal, and some do not. Some lenders care about FICO scores, and some do not. Some lenders need assurances about the ability to pay, while others are less concerned. Some lenders should be more skilled in processing and underwriting and, therefore, take riskier deals unknowingly.

The loan agent looks forward to a term sheet or a letter of interest. The written term sheet will state the lender’s terms and conditions to make the loan subject to an appraisal and underwriting of the material facts submitted by the borrower.

The above is helpful as a platform for questioning borrowers for adequate information to submit to a prospective lender to obtain an expression of interest, a terms sheet, or a letter of interest.

I sincerely hope that you find value in this article. If so, please forward it to your associates. Please refer your friends and associates to me at [email protected].

Thank you,

Dan Harkey

Dan Harkey

Dan Harkey is a contributing author to Weekly Real Estate News and is a Business & Financial Consultant. He can be contacted at 949-533-8315 or [email protected].

Learn live and in real-time with Realty411. Be sure to register for our next virtual and in-person events. For all the details, please visit Realty411Expo.com or our Eventbrite landing page, CLICK HERE.

Deed of Trusts and Mortgage Investments

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Real estate lending encompasses both real estate and securities laws.
 
A) Deeds of trust and mortgage instruments are securities:
 
Promissory notes secured by deeds of trust or mortgages are security instruments. These contracts represent evidence of indebtedness. Ownership is a security under the Federal Securities Act of 1933.

  • The definition of security under federal law is as follows:

a) Property given or pledged to guarantee the performance of an obligation.
b) An instrument that functions as proof of a security interest in a public or private body. 

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  • Parties in a loan transaction:

Borrowers and private-party lenders are the principals in a transaction. A borrower will sign a promise to pay called a promissory note and the security instrument called a deed of trust. The deed of trust is an instrument recorded at the county recorder’s office, which becomes a matter of public notice of the charging lien against the property.

The note and deed of trust are contracts between the borrower and private-party lenders. After the loan closing, the investors/lenders, or the servicing agents of the investors, will retain the executed and recorded documents as evidence of the investment.

Promissory notes and deeds of trust (or mortgages) are considered personal rather than real property.

B) Deeds of trust and mortgage investments are securities requiring federal or state registrations unless there are applicable exemptions from registration.

Each state in the U.S. has its own securities laws and regulations. State statutes, known as Blue Sky laws, are designed to establish safeguards against fraud for investors.  Each state passed separate securities laws to protect the public from fraudulent schemes as far back as 1911 in Kansas. The term “blue sky law” originated in the early 1900s, gaining widespread use when a Kansas Supreme Court justice declared his desire to protect investors from speculative ventures that had “no more basis than so many feet of ‘blue sky.’”

  • What does securities registration mean?

Registration occurs when a company files the required documents with the Securities and Exchange Commission (SEC). The extensive process involves approving disclosures and other information related to the offering. There will usually be quarterly and annual reporting requirements.

Unregistered securities have fewer protections than registered securities. Companies can only sell unregistered shares to a limited number of qualified or high-income and high-net-worth investors.

  1. Securities overview:

Federal and state securities exemptions from registration are common and available.

  • Federal Exemptions:

Federal exemptions for privately funded loan transactions and loan pooled investors are referenced in Regulation D, Rule 506 section 4(a)(2), and 506(b), Regulation A, and Rules 147 and 147A. Information about these regulations can be found at:

https://www.investor.gov/introduction-investing/investing-basics/glossary/regulation-d-offerings

https://www.sec.gov/education/smallbusiness/exemptofferings/rega

https://www.sec.gov/education/smallbusiness/exemptofferings/intrastateofferings

Definitions and exemptions are on the www.sec.gov website.

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  • State securities exemptions: 

Each state has its own securities laws and exemptions.

I am using California as an example because that is my state of origin. However, those involved with loans and investors in other states should identify their dominion’s relevant state securities statutes.

  • California Corporate Codes relating to securities are 25000-31516

California Corporate Securities Law of 1968 regulates all offerings and sales of securities in California. All securities offered or sold must be qualified by the Department of Financial Protection and Innovation Commissioner or exempted from qualification and registration by a specific law or corporate rule. Securities references include 10CCR, Chapter 3, Sections 260.115 and 260.204.1, California Corporate Securities rules 25206, 25100 (p), 25102, (e) (f) (n), and 25102.5 which refers to the multi-lender rules.

a) 25100 (p), is referred to as a whole note exemption, one note purchased by one party

(p)  This is a promissory note secured by a lien on real property which is neither a series of notes of equal priority secured by interests in the same real property nor a note in which beneficial interests are sold to more than one person or entity.

b) 25102 for state offerings exemption

c) 25102 (e)

Under Section 25102 (e, f,), an exemption from the qualification requirement for issuer transactions is available for any offer of sale of evidence of indebtedness, a partnership, a joint venture, and certain participating interest in railroad rolling stock, or other equipment, if the transaction does not involve a public offering.

California state exemptions for fractional trust deeds are 25102(e), 25102(f), and 25102.5, which cover multiple investors who invest in real estate loan transactions.  25102(e) and 25102.5 allow a maximum of 10 investors.  Both exemptions, 25102 (e) and 25102.5 contemplate lending on California properties with California-based investors. Family members are considered as one in the same household.

d) 25102.5is referred to as the fractional note exemption.

California rules are promulgated in the Business & Professions Code 10237-10238, 10232.3, 10232.4, 10232.5, Civil Code 2941.9, and many others.

Under the 25102 (e) and 25102.5 exemptions, ten private investors can co-invest into a single trust deed as tenants-in-common. The difference between 25102 (e) and 25102.5 is that “e” requires disclosure documents in the form of an offering circular, subscription agreements, and a suitability questionnaire.  25102.5 provides a framework for suitability and investor disclosures within 10237-10238 of the Business & Professions code. Interested parties should consult a real estate or securities lawyer specialist

e) 25102(f) private offering exemption.

The Corporations code sets forth an exemption from the qualification requirement for transactions where (1) the sale is to 35 or fewer persons, (2) each purchaser has a preexisting relationship with the securities issuer, (3) each purchaser represents the purchase is for the person’s own account, (4) the offer or sale is not accomplished through advertising, and (5) the issuer files a notice with the Department of Corporations,  within 15 dates from of the issuance. Corporate commissioner’s rule 260.102.14 provides instructions for filing the notice and paying a fee. Failure to file the notice on time negates the exemption.

25102 (f) allows up to 35 investors, with conditions. 25102 (f) does not require California investors or California properties for a particular loan request. Discuss with counsel.

There are three instances when a 25102 (f) exemption may be helpful. (1) when a trust deed requires more than ten investors, (2) when an occasional (accredited investor) out of state party invests in a trust deed on a California property, (3) when a California real estate lender makes a loan on an out of state property.

(f) 25113 provides a path to eligibility for qualification by a permit process.  An issuer may apply for a permit to operate under this section and provide the accompanying documentation as required by the commissioner. These permits are usually renewable annually. Caution: Applying appropriate securities exemptions and actions to remain in regulatory compliance is most likely accomplished by consultation with a qualified securities attorney. The above is a general but not all-inclusive overview of securities compliance.

2)   California Corporate Commissioners rule 25206. 

A broker licensed by the Real Estate Commissioner is exempt from the provisionsof Section 25210(broker-dealers) when engaged in transactions in any interest in any general or limited partnership, joint venture, unincorporated association, or similar organization (but not a corporation) owned beneficially by no more than 100 persons and formed for the sole purpose of, and engaged solely in, investment in or gain from an interest in real property, including, but not limited to a sale, exchange, trade, or development. An interest held by a husband and wife shall be owned by one person for this section.

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3)   California Code of Regulations, Section 260.204.1

An exemption from the provisions of Section 25210 of the Code is hereby granted, as is necessary and appropriate in the public interest and for the protection of investors, to any person who is a real estate broker as defined in Section 10131of the Business and Professions Code, duly licensed to engage in the business of a real estate broker in this state, and whose business as a broker-dealer, in addition to any transactions within Section 25206 of the Code, is limited to any or all of the following:

  • (d)   Transactions in a series of notes secured by interests in the same real property, or undivided interests in a note secured by real property, according to qualification under Section 25110, Section 25120, or Section 25130 of the Code or according to the exemption contained in Section25102(e), Section 25102(if) or Section 25102.5, other than an offering which is made under a registration under the Securities Act of 1933 or a Regulation “A” exemption under that Act ( 17 CFR 230.231 et seq.).

California is highly regulated, with other laws passed and pending future legislative bills that diminish property ownership rights and lessen processionary benefits. Real property ownership rights and benefits continue to be eroded.

There are hundreds of code sections about licensing, fiduciary obligations, operation of real estate and mortgage companies, and disclosure requirements for both borrowers and trust deed investors. I omitted the abundantly extensive list of all the code sections because the number is significant. Therein lies the continuous employment of lending consultants, expert witnesses, real estate lawyers, and securities lawyers.

C)  Disclosure requirements for trust deed Investors.

A California mortgage broker soliciting an investor to purchase all, or a fractional share of a trust deed must provide a lender/purchaser disclosure statement before taking funds.

  • A lender/purchaser, disclosure statement 851-C, revised 7/2018

https://www.dre.ca.gov/files/pdf/forms/re851c.pdf

  • A lender purchaser disclosure statement for the multi-lender form is 851-A, revised 7/2018

https://www.dre.ca.gov/files/pdf/forms/re851a.pdf

  • A lender-purchaser disclosure statement for the sale of an existing note 

https://www.dre.ca.gov/files/pdf/forms/re851b.pdf

  • Investor disclosures are in 10232.3 &10232.5 of the California Business and Professions Code. 

Business and Professions Codes 10232.3 and 10232.5 outline the disclosure requirements the funding lender must adhere to for a real estate licensee. I am highly familiar with these requirements since I co-sponsored Senate Bill SB 1554 in 1998 and wrote a portion of the language that resulted in adopting the code.

The purpose is to provide the investors with written disclosures to make them aware of the material facts and risks and to enable them to make an informed investment decision.

Section 10232.5 outlines required investor disclosures.

  • Address or other means of identification of the real property that is to be the security for the borrower’s obligation.
  • Estimated fair market value of the securing property as determined by an independent appraisal, a copy provided to the lender.  However, a lender may waive the requirement of an independent assessment in writing on a case-by-case basis, in which case, the real estate broker shall provide the broker’s reported estimated fair market value of the securing property, which shall include the objective data upon which the broker’s estimate is based.  A broker has the option of issuing broker’s opinion of value.”
  • Age, size, type of construction, and a description of improvements to the property if contained in the appraisal or as represented to the broker by the prospective borrower.
  • Borrower(s) Identity, occupation, employment, income, and credit data as represented to the broker.
  • Terms of the loan transaction.
  • Liens and encumbrances: pertinent information concerning all liens and encumbrances against the securing property and, to the extent of actual knowledge of the broker, relevant information about other loans that the borrower expects or anticipates will result in a lien recorded against the collateral property securing the promissory note, created in favor of the prospective lender.  As used in this paragraph, actual knowledge concerning any anticipated loans means knowledge gained by the broker through arranging the subject loan or other loans on behalf of the borrower. 
  • Title insurance: The broker shall provide the prospective lender with the option to purchase a title insurance policy or an endorsement of an existing title insurance policy covering the securing property.
  • Written loan application (signed) loan application.
  • Credit report.
  • Loan servicing provisions: including disposition of the late charge and prepayment penalty fees paid by the borrower. 

Industry standards and best practices may expand investor disclosures. Here are recommended guidelines on data accumulation.

  • Individuals/entities: The borrower may be one or more individuals or an entity such as a family trust, limited liability company, or corporation. The procuring loan broker should be able to articulate who the borrower is and provide a brief background.
  • Collateral property: Describe the property and its uses, along with the address. Describe the tenancy, income stream, and vacancy if the property is income-producing. Describe the condition of the property and its strengths and weaknesses. Will the property be improved because of this loan?
  • Purpose of loan: What is the intended use of the loan proceeds? What other debts are to be paid as part of the loan?  How much net proceeds will the borrower receive? What will the net proceeds be used for? Will the majority of the loan proceeds be used for consumer or business purposes?

Some lenders operate under a pooled limited liability format with a California Finance Lenders license.  Others operate under a Bureau of Real Estate broker’s license. Some real estate brokers also create pools using one of the various federal and state securities exemptions. Three questions arise: (1) does the entity or the security issuer have a fiduciary obligation to the investors? (2) is the entity required to follow real estate law? (3) can the entity or issuer wave or disregard reasonable and prudent underwriting processes without violating fiduciary or breaking the law?
 
 D)  Private-party investors:

Private-party investors may invest by purchasing 100% of a loan, co-invest fractionally, with a small group as tenants-in-common, or in a pooled entity format with other investors. Private-party investors include individuals, family trusts, corporations, IRAs, and pension plans.

Most investors invest with multiple ownership methods (holding titles), such as a family trust for a portion and an IRA custodian for a portion. I have noticed various titles for couples who establish a family trust for themselves and their descendants and invest in each. Multiple family members living in the same home are considered one investor for ten investors or less.

The entire trust deed investment percentage represents the investor’s beneficial interest portion of ownership. For example, if the trust deed investment is for $1,000,000 and the investor purchased $200,000, they would own a 20% undivided interest as tenants-in-common. A $100,000 investor would hold a 10% undivided interest as tenants-in-common with other investors. 

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Private-party Investors who desire to invest in trust deeds with their available capital understand that they are securing their investment by accepting a signed promissory note from a borrower, a signed and notarized recorded deed of trust on the security property. Investors’ names are affixed on a recorded trust deed as beneficiaries. Investors will also assume there is a title insurance policy with their names connected as beneficiaries.
 
Trust deed investments usually provide for receiving monthly interest payments from the borrower and are distributed to the investors. The annualized yields are comparatively reasonable. Investor distributions are generally a tiny fraction less due to being charged a servicing fee.
 
Interested parties should seek loan broker professionals who understand required regulatory compliance, best practices process & underwriting, and correct documentation. Lastly, interested parties should seek someone with an experienced track record as their agent and source of trust deed investments.
 
Thank You,

Dan Harkey.

Dan Harkey

Dan Harkey is a contributing author to Weekly Real Estate News and is a Business & Financial Consultant. He can be contacted at 949-533-8315 or [email protected].

Learn live and in real-time with Realty411. Be sure to register for our next virtual and in-person events. For all the details, please visit Realty411Expo.com or our Eventbrite landing page, CLICK HERE.

Why the Public is Not Happy with Inflation! (Part 2)

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Image from Pixabay

By Dan Harkey

Business & Private Money Finance Consultant

Cell 949 533 8315 email [email protected]

Consider the largest debt-bomb globally, the unfunded portion of social security, Medicare, Medicaid, Military, and public employee pension shortfall. This $150 to$200 trillion estimate does not show up on the government accounting books as a liability. Like a boiling pot of water, the debt simmers, soaking the working-class public through increased taxation, regulation, inflation, and reduced purchasing power (debasement). The retired public may or may not be aware that no trust funds exist because they have always received their checks.

These are loans to the government borrowed from the public that will never be paid back, except by a massive erosion of purchasing power of the dollar (debasement). The government understands that the nasty bogey called inflation will reduce the value of the debt.

The government leaders also encourage a massive influx of new legal and illegal foreigners, who are expected to pay taxes eventually. This is not an immediate solution since 63% to 70% of newly arrived illegal immigrants go on welfare or subsistence government transfer payments. Different articles and statistics differentiate between undocumented non-citizens, illegal immigrants, and non-citizens.

https://cis.org/Report/63-NonCitizen-Households-Access-Welfare-Programs

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In 2019 Social Security and Medicare programs cost an estimated 8.8% of gross domestic product (GDP). GDP is approximately 22 trillion. 22 trillion times 8.8%= $1.936 trillion annual expenses. If you use $1.936 trillion divided by the number of retired of 70 million, then each retired person cost $27,657 each year. Social Security is about .6% to administrate and Medicare about 2%. Private insurers may spend between 12% to 18% on administration costs. End-of-life medical expenses may exceed $150,000 per retiree. About 2% of retirees, about 1.4 million die per year.

There are currently 10,000 people retiring each day, or 3,600,000 per year. If 3.6 million arrive on Social Security rolls and 1.4 million dies, then the net increase is 2.2 million added to the rolls. Each retiree will cost the public an estimated $28,000 per year, or an additional $61 billion per year on top of the $1.9 trillion current

In 2019 there were approximately 64 million retirees (pre-COVID). Adding 3.5 million per year over the next 10-15 years will result in 100 million retires who will expect financial support for retirement income and medical care. But that statistic is in a pre-Covid timeframe. With Covid, the propensity for retirement drastically changed.

COVID brought about a massive spike in retirement and social security application. The number of Social Security recipients skyrocketed. In 2019 there were about 64 million receiving Social Security benefits. In 2021 this number rose to 69.8 million or 70 million. — 70-64=6 million additional retirees in a matter of 2 years. The increased number, including 2022 retirees, will reflect close to a dramatic increase in retirees who apply and receive social security in just three years.

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We are facing turbulent financial trade winds this year and next. Interest rates should rise to combat inflation. Wall Street, big banks, and large corporations will be beating the drums no to raise rates. Borrowing cheap money and leveraging investments is their mantra. With artificially low-interest rates projects, become profitable because borrowing is cheap. Valuations rise accordingly, even to irrational and exuberant levels. But the minute rates begin to rise, profits and irrationally high valuations evaporate and fall back to earth. Boom and bust cycles are not an inherent trait of capitalism but caused by central bank intervention.

Regardless of the conclusion, the Federal Reserve will be there with their trusty computers to readily inject many additional dollar digits (trillions) to continue the U.S. financial Ponzi scheme (spend now and expect someone in the future to repay).

Our economic entire system of governance requires a never-ending Ponzi strategy. Future taxpayers will always be necessary to pay for today’s government expenses. If future spenders have no money because of high taxes, excessive regulations, or refuse to buy stuff, the system will collapse.

Image from Pixabay

The government and mainstream media propaganda machine will have public observers thinking that everything is rosy. The propaganda objective is to keep the population preoccupied with revolving crises designed to frighten them into compliance and submission.

All new fiat currency created by the government is designed to keep the population happy, the government in power, and the voting block reliable. The Ponzi system’s pursuit is conning the public into submission of a perpetual-motion downward economic quagmire. It’s truly a wonderful day in the neighborhood when the government-backed borrowed money flows freely, knowing that it will never be paid back. Of course, most beneficiaries of free-flowing borrowed funds are directed to (FOGS-friends of government.)

The U.S. tax base is not increasing much. Our GDP is about $21-22 trillion. Federal taxes collected appx $3.5 trillion. If we add all state and other forms of taxation, the total is about $5 trillion. The federal government spends close to twice as much as they take in, meaning a $2 to 3.5 trillion shortfall that must be borrowed.

Image from Pixabay

The only viable solution that the U.S. Federal Reserve has is to keep creating fiat money to plug the financial drain dike. What used to be directly on the book’s debt under President Ronald Regan (1/20/1981 to 1/10/1989) of 2 trillion, which is now $30 trillion and will become $100 trillion in our lifetimes. Since that time, the U.S. has gone from the world’s largest international creditor to the world’s largest debtor nation.

The speed of issuing new currency into the system and the subsequent debasement of the dollar is accelerating into uncharted territory, more than any time in our adult life. There will be massive upward price pressure on all goods and services the public will be subjected to. Since inflation is caused by an increase in money supply relative to goods and services, the government’s propensity to print fiat currency is currently experiencing a more than a significant increase in the money supply. Never mind that there is a corresponding increase in national debt!

Government actions are always the root cause of inflation. There was no inflation in the American colonies because there was no mechanism to print fiat currency. Between 1775 and 1779, Congress issued $225 million in fiat Continentals (currency), a massive sum for the time. Subsequent inflation caused prices to rise years 1776=12.99%, 1777=21.84%, 1778=30.19%, 1779= -11.59%(minus). Any rational mind would think that our elite governing leaders would recognize that deficit spending feeds the inflation spiral and needs to be limited.

Image from Pixabay

There has been ceaseless financialization and globalization over the past 50 years of the Federal Reserve, Wall Street, and mega-banks. By manipulating interest rates to near zero and investing in derivatives contracts, the insiders boosted their wealth upward to an unimaginable level, at least $50 trillion. Greed by beneficiaries of inflation, including the Central bank, Wall Street firms, megabanks, and large corporations, will work hard to keep the illusion going in their favor. Their savvy public relations people might object to the above statement.

Wall Street, megabanks, and large corporations’ benefit from high inflation by operating with exceptionally highly leveraged investments. Financial leveraging means investing very little capital, borrowing cheap money, and using derivatives to leverage-up at a much higher level. One percent capital and ninety-nine percentage leveraged borrowing are not abnormal until things go wrong. Leveraged investments with super cheap borrowing costs are why Wall Street, megabanks, and large corporations won’t raise interest rates.

The disparity is frightening. The wealthiest 10% has increased to at least 70% of all U.S. wealth applied to their asset ledgers. The bottom 50% held 2% of U.S. Wealth. They have now created the largest financial bubble since the 1680 tulip bubble.

https://www.statista.com/chart/19635/wealth-distribution-percentiles-in-the-us/#:~:text=As%20of%20Q1%20of%202021,another%20half%20at%2037.7%20p ercent.

Artificially low-interest rates harm savers who rely on bank interest for income, U.S Securities holders, corporate bondholders, and other interest income-related investment strategies.

Image from Pixabay

Distortion of economic reality created by artificially low-interest rates is hard to comprehend because Wall Street and megabanks have such tight control on government actions. They might object to that statement for public posturing. Butwait, if the market crashes, the elites will merely ask the government to bail them again. Elite leaders in the executive branch of the U.S. government are handpicked from Wall Street firms, particularly Goldman Sachs, BlackRock, The Vanguard Group, and JPMorgan Chase & Co. BlackRock has $10 Trillion assets under management. Vanguard has $8.5 Trillion assets under management. The magnitude of these figures is staggering, considering the U.S. has a total GDP of $22 trillion. You can rest assured that the oligarchs in the U.S. have control over almost all actions of government. Money begets power. Money and power beget influence.

U.S. direct on the book’s debt will balloon to $50 to $100 trillion in the next meltdown. Some Wall Street firms, megabanks, and large corporations will become insolvent from derivatives losses. They will be bailed out, just like they were in 2007-8. Once the next bailout is complete, they will high-five each other and issue big payout bonuses for their hard work creating a colossal financial mess. Just as they did in the 2007-8 bailout, they will take a vacation for all their hard work driving their companies into insolvency. The public is provided little or no information on these bailouts. Only the governing elites have full knowledge.

The ongoing strategy will eventually crash. No one knows when the cows will come home, and the entire system collapses. But the Ponzi strategy has been systematically successful, with a few bumps for over 225 years. Ponzi is an investment swindle strategy. Current participants rely on existing occupants/taxpayers to pay the government the costs now with borrowed funds and expect future generations of occupants/taxpayers to repay the debt. Those new taxpayers can only be paid back by collecting additional funds from subsequent new occupants/ investors. This strategy is the same for Social Security.

Image from Pixabay

The success of the future of your U.S. Ponzi assumes that the dollar will maintain the status of world reserve currency holder. If our leaders keep piss—g off world leaders en masse sooner or later, they will devise a mechanism to circumvent the dollar-based monetary system. Many of the strategies being followed by the current administration will cause the loss of world reserve currency holders. No one would be willing to buy our worthless treasury securities. Seventy-five years of dollar dominance would come to a suicidal end, and deficit spending financed by the other sovereign nations would stop.

Middle-class income earners and those who rely on retirement benefits may have limited ability to keep up with inflation. Living standards could collapse to those of third-world countries with visions of impoverished masses struggling to meet the most basic human needs (access to food, water, and shelter). With inflation, each year arrives with the reality that everything costs more, or dramatically more, to the point where most of the population will struggle to keep up or become stressed out debt-surfs.

Dan Harkey

Dan Harkey is a contributing author to Weekly Real Estate News and is a Business & Financial Consultant. He can be contacted at 949-533-8315 or [email protected].

Learn live and in real-time with Realty411. Be sure to register for our next virtual and in-person events. For all the details, please visit Realty411Expo.com or our Eventbrite landing page, CLICK HERE.

Why the Public is Not Happy with Inflation! (Part 1)

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Image from Pixabay

By Dan Harkey

Business & Private Money Finance Consultant

Cell 949 533 8315 email [email protected]

In 1913 folks could buy a five-course meal and iced tea for 10 cents.

That was about the time when the Federal Reserve system (central bank) was established. Since that time, approximately 109 years later, as of 2022, inflation increased by 2,740%. Many folks will argue that this is not true.

Inflation Calculator:

https://www.in2013dollars.com/us/inflation/1913?amount=1

Image from Pixabay

The Federal Reserve System is not our friend. A secret meeting was arranged by 6 of the wealthiest bankers at a remote location on Jekyll Island, off the coast of Georgia. This group of wealthy bankers-controlled appx 45% of the banking in the United States. They designed a cartel whereby members (privately owned banks) would lend between members to avoid bank runs. Participants laid the foundation around 1910 as a response to the financial crisis of 1907.

Inner-bank lending allowed higher leverage lending for member banks and eventually drove all non-members out of business. Bank runs occurred when large groups of depositors panicked and demanded the withdrawal of their money, either afraid of bank insolvency or creating it by their actions of mass withdrawal. Now the FDIC is subject to the same limitations about raising additional needed cash as the remainder of the government.

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The U.S. government liked and elected to adopt the inner bank lending system, merging the government’s interest with the private banking cartel. Congress created the Federal Reserve System to provide the nation with a safer, more flexible, and stable monetary and financial system. The Federal Reserve System was born on December 23, 1913, when President Woodrow Wilson signed the Federal Reserve Act. The Federal Reserve System now consists of 12 privately owned banks merged with government ownership and control and a Board of Governors located in Washington DC. While the Board of Governors is an independent agency, the Federal Reserve Banks are set up like private corporations. Member banks hold stock in the Federal Reserve Banks and earn dividends.

Reference-History of the Federal Reserve banking system:

https://www.federalreserveeducation.org/about-the-fed/history

https://www.federalreserve.gov/aboutthefed/structure-federal-reserve system.htm

A fascinating book about how the Federal Reserve System was created is Creature from Jekyll Island. It is a beautiful read that I could not put down once I started. I have a hard-bound copy in my office now.

Here is a summary of The Creature from Jekyll Island.

https://www.eetimes.com/book-review-the-creature-from-jekyll-island/#

Governments have three methods to raise capital for operational expenses. They tax, borrow, and print new fiat currency (money).

The Federal Reserve is responsible for injecting newly created fiat money into the U.S. monetary system by the tens of trillions of dollars when instructed.

https://www.investopedia.com/ask/answers/082515/who-decides-when-print-money-us.asp

In response to bank runs in 1928, the Federal Deposit Insurance Corporation (FDIC) was established in 1933. The FDIC was an independent federal agency whose purpose was to insure bank and thrift deposits in bank failures. The objective was to maintain public confidence and encourage stability in the financial system by promoting sound banking practices. The question today, almost 100 years later, is whether the FDIC has adequate reserves to insure deposits. They don’t without the usual borrowing from the Federal Reserve.

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The Glass-Steagall Act of 1933 required separating investment and commercial banking operations. This separation was a by-product of inner-mixing bank activities that led up to the great depression. Mixing activities of investment with banking operations was considered too risky and speculative.

Gramm-Leach-Bliley Act of 1999 reversed Glass-Steagall direction by removing legal barriers preventing financial institutions from providing banking, investments, and insurance services as combined business services.

Today banks and non-bank financial institutions are some of the most highly leveraged operating companies in the U.S. Banks and non-bank financial institutions regularly invest with minimal limits in extremely high-risk and highly leveraged securities. Little regard is given to safety measures of bank depositors. They ratchet up leverage positions to maximize yields by purchasing positions in casino-style financial bets in the form of derivatives contracts. Even reserve requirements have been eliminated so that banks are no longer required to keep any reserves on hand for protection in case of excess demands for depositor withdrawals.

Image from Pixabay

Inflation is the direct result of the government’s endless injections of new fiat currency into the economic system, which becomes a corresponding future debt of the taxpayers. Our future sovereign debt, of course, is a systemic fraud because the Federal Reserve and the leaders of this country never plan on paying the debt off or even reducing it. As the Federal Reserve pumps more money into the economic system, there is a corresponding reduction of the dollar’s purchasing power (debasement). Goods and services cost incrementally more. With debased dollars paying off the debt assumes that payments would be made severely diminished valued dollars (cheaper dollars).

Taxpayers can only see future debt piled upon future deficits that they view as their responsibility to repay, as a government national credit card for which they are on the hook. The top tier taxpayers of 1% paid 38.8%, the top 10% paid 71%, and the 25% of taxpayers pay 87% of the federal taxes. All these folks should have great concern about runaway government spending. The bottom 50% of taxpayers in the U.S. pay about 3% of federal taxes. Low-income earners and retired folds relying on Social Security for living costs get crucified by the devil called inflation. This lower socioeconomic tier is first and most severely harmed by inflation and reduced purchasing power because of their limited discretionary or nonexistent incomes.

https://taxfoundation.org/publications/latest-federal-income-tax-data/

https://theintercept.com/2019/04/13/tax-day-taxes-statistics/

Image from Pixabay

The U.S.’s financial problems include accumulated disclosed direct debt of about $30.3 trillion and an estimated $150 to 200 trillion of unfunded, underfunded, and not-disclosed future obligations for Social Security, Medicare, Military, and Federal employee pension obligations. These figures are well disguised on purpose. Remember George Bush Jr’s remarks and his debate with Al Gore when Gore’s economic figures were referred to as “Fuzzy Math”? How would the public react if they understood that their future retirement had been stolen or misallocated and not be available when they needed it?

https://www.usdebtclock.org/

Most, if not all, future financial obligations of the U.S. must come from a combination of current general funds based on tax receipts and newly minted fiat currency in the form of U.S. Treasuries as future debt. This future debt is sold to the public, corporations, and other sovereign nations as treasury securities, backed by the full faith of the U.S. Government. Some entities invest in treasuries for safety, and some are out of compulsion (forced for political expediency).

If one inquires of the solvency of the Social Security trust fund from the mainstream media or online web news, they will tell you that Social Security has almost $3 trillion in trust fund assets (so-called-not). But they will fail to tell you that all the Social Security trust funds are invested in U.S. Treasuries. Treasury securities are debt created by the government and must be repaid upon maturity. Social Security is currently a pay-as-you-go system paid by current taxpayers to benefit of retired folks. If financial demands for Social Security and Medicare exceed available current tax receipts from taxation, then the remainder must come from the Social Security trust fund. But there is little or no liquid assets or cash available in the fund?

Image from Pixabay

Any payments demanded from the Social Security trust fund would require that the government free up money by paying off a corresponding amount of U.S. Treasuries (IOU’s) that are held as assets of the trust fund. Where will the money come from for the government to pay off the Treasuries? If the government cannot locate liquid capital, then they must create it by issuing new treasuries for new parties to purchase to replace the old. What a great trick to pull upon the American public! I want to pay my bills and credit cards where someone else is responsible for repayment.

They swapped the accumulated liquid assets sitting on the books of these Trust Funds for debt instruments that are expected to be owed and paid from future taxpayer receipts. Switching debt that you owe and calling it an investment asset is the ultimate form of financial prestidigitation (magic trick). Yes, an asset that is held on your behalf is misappropriated into debt, and you are responsible for repaying in the future.

Special Studies by the Historian’s Office of Social Security and Research Notes:

https://www.ssa.gov/history/BudgetTreatment.html

Remember the 1980’s rock group, Queen? Freddy Mercury, the lead singer, was a British singer, songwriter, and record producer, and in my opinion, the most outstanding male singer ever. He was known for his flamboyant stage persona and four-octave vocal range. He could sing classic rock-in-roll as well as serious opera. Ironically, he was born, with the name Farrokh Bulsara, in 1946 in Zanzibar to Parsi-Indian Parents.

“The Show Must Go on. The Show Must Go On. Yeah, inside, my heart is breaking. My make-up may be flaking. But my smile still stays on.”

Your future social security payments are an example of “The Show Must Go on.” Proceeds for social security payments are just a hollow shell of current taxation and debt, which may be paid from current taxpayer receipts or by the government issuing new debt instruments, sold to convert proceeds to cash, and spent now. This strategy has worked so far in our history. Still, the accrued government direct debt obligations and the interest due coupled with the under-funded pension and medical obligations will eventually eat up the entire national budget. It is bookkeeping magic. “But the smile still stays on.”

Dan Harkey

Dan Harkey is a contributing author to Weekly Real Estate News and is a Business & Financial Consultant. He can be contacted at 949-533-8315 or [email protected].

Learn live and in real-time with Realty411. Be sure to register for our next virtual and in-person events. For all the details, please visit Realty411Expo.com or our Eventbrite landing page, CLICK HERE.

Friends Do Business with Friends

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Image from Pexels

By Dan Harkey

Business & Finance Consultant

cell 949-533-8315 email [email protected]

“Being and Time” written in 1927, best discussed the concept of authenticity, of being, and caring. Martin Heidegger, a German philosopher, is an excellent read. In Heidegger’s study, he referred to as “Dasein,” which means “Being-there.” One may interpret it as “being-ever-present.” Also, to be fixed, embedded, and immersed in the physical, literal, and tangible day-to-day world. Another good read about the development of Heidegger’s concept of authenticity is in the book, Eclipse of the Self by Michael E. Zimmerman.

In the late-1970s into the early-1980s, I developed a unique strategy and grew from a high school business teacher to one of the highest producing real estate agents between Newport Beach to San Clemente between 1978 and 1984, and later in the mid-2000s to produce up to $10-25 million per month in sales volume in the real property lending business. On a side note, I developed the business curriculum in the 1970’s for Saddleback School District in Orange County, CA. The classes included word processing/keyboarding, typing, business math, consumer education, economics, and accounting. This was pre-computer science days.

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Before 1980, I was an early adopter of cross-selling. I created a real estate brokerage, a public escrow company to close the sales, a mortgage company to originate residential and commercial real estate loans, and a general insurance agency to place the insurance policies on the purchased property. Additionally, the insurance agency placed investment property coverage, liability coverages, auto insurance, life & disability insurance. An adjunct company that I formed was a property management company to manage residential and commercial rental income property, including commercial leasing.

Effective salesmanship is a learned skill set but developing into an authentic and unique being is the treasure. Confucius and Dan say, find a man who enjoys his work, and you will find a person that will never work another day in his life.

If one’s objective in the sales business is to follow up with your few friends, the potential success will be minimal. An effective sales network starts with a few but grows into thousands and tens of thousands.

The 80/20 rule applies to the sales profession. 20% of the salespersons develop 80% of the sales. Conversely, 80% of the salespeople develop 20% of the sales and resulting profits. Successful salespersons are willing to do the heavy lifting and do tasks others refuse to do.

It will help if you start by defining your universe of possibilities. In other words, what is the maximum and broadest number of individuals or prospects that you may develop to sell your products, goods, or services? Is it 1 or 1000 or 10,000? Size matters! A salesperson’s understanding of this process may be limited by lack of experience, willingness to take the risk, or just plain lack of enthusiasm for engaging in a long- term systematic enterprise. A more straightforward explanation is that some people are just plain “lazy and irresponsible.”

Image from Pixabay

I have consulted with many eager salespersons. Yes, the size of one’s prospect lead base matters. But relationships matter more. The size of a prospect network may start with 10 or 20 but grow to 1000 or more. You may start with a smaller number but limit the number of lead potentials unless you sell multimillion-dollar products with a considerable profit margin. Two examples may be Caterpillar and airplanes. These items cost from mid five hundred to hundreds of millions of dollars.

You may want to formulate a strategy to communicate daily to develop new business leads that, hopefully, will become lasting friendships. Therein lies the process, how do you turn prospects into friendships. I do not want to suggest that you create superficial but develop friendships that are bonded by authentic caring and communication. Can you call a friend and have a general conversation and enjoy the time spent without the thought of getting something out of it?

Herein lies the struggle between the salesperson who will never or only marginally become successful and one that can develop into a master salesperson with life fulfillment in relationships with others.

Image from Pixabay

Yes, you locate a buyer; you do not create one. In other words, if you were taught that slick language, like handling the objections and then switching to assumptive close works, Fuller Brush Company and Encyclopedia Britannica may have a job for you. Also, using online tools like LinkedIn and Facebook may be effective or a complete waste of time. A new link with a new person is only the most minute beginning and introduction to developing a future relationship and eventual friendship.

To be effective, a salesperson needs a good customer relations software package (CRM) to manage prospects, memorialize conversations, histories, families, events, interests, backgrounds, and essential aspects of developing a friendship. The effective salesperson needs an email marketing system like Salesforce or MailChimp.

The more you understand your friends more the relationship will grow. They will look forward to talking with you, and you will have mutual interests. And, of course, you will enjoy talking and sharing things that are interesting to you.

Now comes the strategy of calling 10 to 25 prospects per day to become friends over time. What can you do for them? How can you assist them in accomplishing their goals? Continue the exercise until you develop so much business that you can hire assistants. Delegate as much of your job tasks to others, then get back on purpose.

Image from Pixabay

If you make your outbound calls and receive an answerphone, leave a message, then follow up with an email with a purpose message. “Just calling to catch up,” or “Just called to check if I can do anything for you or your clients,” Or “just called to share an interesting article or news segment that I read.”

A difficult part of any conversation is developing the habit of listening rather than doing most of the talking. No, I am not that interesting, no matter who told us we were. It is easy to talk about me when having conversations with others. We can all become amused about ourselves and our life histories. It is imperative to stop talking and start listening.

Developing authentic friendships that will choose to work with you will be a natural transition from acquaintance to business prospect to genuine friendship. The process requires you to learn about your friend’s background, family, and what is important to them, not about you. What can you do to improve their lives, help their client, or help them put bread on the table?

Find a person who develops enough friendship relationships to do business, and you will both have a whole and enriched life. The journey is never complete!

Developing your unique ability will create a positive magnet around you so that people will be drawn to you through developed friendships, social networking, enhancing your satisfaction, professional career, and the same for those who meet you.

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My opinions, which comes from experience:

  • 20% of the people and friends in your life give you 80% of life’s satisfaction. Conversely, 20% of the negative, disrespectful, and unreliable people will result in 80% of the dissatisfaction. Tolerating people with negative attitudes, belligerent, rude, condescending, game playing, or jealousy does not fit into a satisfying life journey. Included in this group are superficial, sycophantic, and parasitic friendships. Eliminate all these people from your life, pronto?
  • Develop a management infrastructure and support system around you. These may be employees or independent contractors. Only with a whole support staff and operational techniques and strategies can you develop into high sales volumes and consistently deliver a quality outcome. If you allow weak staff members or weak systems, this will drag you down and make you marginally effective.

Thank you for taking the time to read this article.

Dan Harkey

Dan Harkey is a contributing author to Weekly Real Estate News and is a Business & Financial Consultant. He can be contacted at 949-533-8315 or [email protected].

Learn live and in real-time with Realty411. Be sure to register for our next virtual and in-person events. For all the details, please visit Realty411Expo.com or our Eventbrite landing page, CLICK HERE.

Real Property Easements, An Overview. the Purpose & the Risks? (Part 2)

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Image from Pixabay

By Dan Harkey
c 949 533 8315 e [email protected]

Real estate development patterns on a going-forward basis:

Laws have changed, sometimes dramatically, as we have experienced in California. California leadership has recently passed multiple laws to modify the nature of housing occupancy by the public. The changes include urban and suburban housing. The goal is to replace single-family buildings with high-density stack-and-pack cluster apartments and homes. Parking requirements and setbacks have been eliminated to pack them in.

Image from Pixabay

Many developers prefer high-density or cluster zoning and housing to maximize density, space, and profits. Cluster housing was initially defined as housing placement near each other, reducing individual land parcels and yard space to increasing open space and common area amenities. Larger areas of open space within the development form a buffer for adjacent land uses- additionally, cluster housing with homeowner associations would be responsible for the infrastructure maintenance.

There is a distinction between the written physical layouts or placement of easements and written usage agreements memorializing rights and responsibilities between the parties. A well-written agreement is designed to understand the terms and conditions and enforce them among the parties.

A part of centralized development planning is to determine the need and locations of property usage easements. They will be plotted and engineered as part of the approval and development process.

Suburban areas have historically consisted primarily of low-density residential, commercial, and industrial communities away from urban areas but within commuting distance for employment. Suburban communities have had their own political and governmental services jurisdictions.

Populations grew in suburbs because people wanted autonomy from the tightly controlled rules and hectic and congested lifestyles in densely populated urban settings. Suburbs usually provide an overall higher standard of living for a comparable income than the metro or urban lifestyle. Traffic congestion, commercial corridors, shopping, schooling, environmental issues, and freedoms that go with more land and open space make it worth the cost for people to commute into a city for work.

Image from Pixabay

Past President Obama issued a regulation known as AFFH (Affirmatively Furthering Fair Housing). The objective is to create progressive mini-urban cities within the suburbs. The objective was to have suburbs swallowed up by larger cities. These new mini cities would be subject to federal regulations and mandates taking control of zoning and development. This includes eliminating single-family zoning and forcing the building of medium to high-density low-income housing, thereby creating mini-urban-styled downtowns.

Eliminating local government control is the plan to destroy the suburban lifestyle.

Affirmatively Furthering Fair Housing (AFFH) works by holding the development process hostage to the U.S Department of Housing and Urban Development (HUD’s) Community Development Block Grants and federal-planning demands. Suburbs will be prohibited from receiving millions of dollars in HUD grants unless they eliminate single-family zoning, install low and moderate-cost housing, and consolidate and densify commercial and residential districts into stack-and-pack neighborhoods. Highway funds are also planned to be withheld for failure to comply.

Any objections by a local municipality will get municipal leaders of the suburbs sued for discrimination by civil rights groups and by the federal government.

The current administration has reactivated and placed Obama’s AFFH strategy a high priority.

Municipalities commonly use a tool of extortion to gain easements on specifically targeted properties. When the owner applies to process a tentative tract map, the city planners frequently condition the approval to include easements that have little or no benefit to the property owner. In many cases, property owners are even required to pay for the improvements. An “eminent domain action” is frequently used to force property owners to sell their property or allow specified easements. I refer to this as “easement by extortion.” In many cases, property owners are forced to pay for the improvements

In many cases, multiple parties who own adjacent properties, shopping centers, retail centers, industrial, and historic registry facades all require written easement agreements for mutual benefits to protect the interest of all participants. Examples include easements for parking, reciprocal access of ingress/egress corridors, access for installation and maintenance of utilities, operation and management of common areas, and many others.

https://www.nps.gov/tps/tax-incentives/taxdocs/easements-historic-properties.pdf

Actual case studies:

1) Two adjacent property owners who were friends owned and occupied two separate contiguous industrial parcels. The properties are in Gardena, CA. Each land parcel was 40 ft wide by 100 ft deep. The property owner on the right side wanted to build a zero-lot-line building structure that was 40 in width. A zero-lot-line means that the property was initially built-up to the property line with no setbacks. The left-side property owner agreed to construct his building only 30 feet wide so that there would be 10 feet available for ingress/egress of automobiles for use by both properties. The actual physical location for ingress/egress was only 10 feet of the left-side property. The right-side property possessed no other method of entry other than his left neighbor’s property. No written agreements existed, but merely two good old boys who agreed with a handshake and hopefully an occasional cold beer at the local Kelsey’s bar.

An argument and litigation for a prescriptive easement right would be justified since the buildings were built in the 1960s. The original owners and subsequent owners have operated that way ever since.

The right-side property owner owned his property free and clear. The left-side property owner had the first lien of $300,000. A lender suggested that the property owners hire a civil engineer and a lawyer to draft a reciprocal usage easement for ingress/egress. The owners must submit the plans and agreement to the building and planning department for approval. Upon city approval, the reciprocal easement agreement could be recorded. Once the contract was signed and recorded, the easement would remain on the property title.

In this fact-specific case, the problem was that the newly drafted easement would be recorded in the first lien position on the right-side property but as a second lien position on the left-side property. The left-side property’s recorded easement would be in a second lien position behind a $300,000 first trust deed lender. If the borrower on the left side defaulted on his loan and the property was lost in foreclosure, the recorded usage easement would be foreclosed, extinguished, or ceased. Subsequent owners would be damaged and have no right of access. Lack of access for automobile ingress/egress would drastically diminish the functionality and desirability, and the value would be severely affected.

Image from Pixabay

2) An auto body and fender shop fronted on a busy street but had no direct access to the auto storage yard. Entry into the repair shop was available only through an alleyway. All the properties along the street have the same issue and potential risk.

The lender’s task in processing and underwriting a requested loan was to verify that the alley right-of-way was either a publicly owned street or a written reciprocal easement agreement signed and approved by the property owners who required continued access through the alleyway. The recorded easement was verified that it existed and did run with the land. Risk abated.

Image from Pixabay

3) A barbershop operator had the chance to purchase the real property at the location of his operating business. The location was an A+ situated at the entry to a regional shopping mall. Part of the lender’s processing and underwriting staff’s task was to verify a reciprocal parking easement agreement for all the tenants in the shopping center and the inline retail shops near the entry. The recorded easement was verified and did, in fact, run-with-the-land. Risk abated.

4) A small shopping owner and adjacent church struck an informal deal to use each other’s parking. An informal letter arrangement was arranged between two property owners who mutually benefited by being able to use the other owner’s property. The informal agreement does not run with the land. The arrangements are usually for a specified time and are cancellable with a 30/60/90-day notice. Although Sunday mornings were problematic, a large church occupied one side of the street, with marginally adequate parking. Church attendees were able to use the available parking across the street. There is a shopping center across the street with semi-adequate parking, although Saturdays are problematic. A letter agreement was drawn up for common usage of parking rather than an easement. The agreement specifically spelled out the terms of times for needed use of both parties and was cancellable by either party with a 60 days’ notice. There is an unsolved risk because of the informal nature of the agreement.

5) Land loan. A lender made a commercial loan on a vacant parcel adjacent to a large shopping center. The parcel was located strategically at the most prominent entry to the shopping center.

Image from Pixabay

An appraisal was obtained that reflected values as a developed small commercial for drive-through fast food or coffee establishment.

The parcels necessitated every square inch for development with little flexibility. Parking was adequate because it was adjacent to the large shopping center with no prohibitions on the number of spaces. There were no parking easements, but there was also no prohibition.

The borrower’s attorneys drafted an agreement. The principal property owner made a deal with the largest shopping center tenant to place prominent entrance monument signage on the subject parcel without the knowledge of the land lenders. The property owner/borrower attempted to strongarm the land lender into signing it the subordination agreement making the land lender’s first lien junior to the signage easement.

Image from Pixabay

What a preposterous and foolish request! But the borrower/owner of the property was looking for a fool of a lender. How about a massive unforeseen risk for a lender? The lender rightly refused the request.

If the lender had agreed to sign the subordination and allowed a colossal monument sign in the middle of the vacant commercial parcel, the parcel value would have plummeted to a small park to donate to the local municipality as a feel-good exercise.

Understanding easements in relation to real estate ownership and development is full of complex issues. Civil engineers and land planning lawyers specializing in this section of real estate law should assist in drawing the property boundaries, alignments, and applications for municipal approvals. Work with a title company to have the easements recorded and insured. Assess the benefits and risks. Do not circumvent best practices.

Thank You

Dan Harkey

This article is an overview for a general educational purpose only. The information presented should not be relied upon without the advice of counsel.

Dan Harkey is a contributing author to Weekly Real Estate News and is a Business & Financial Consultant. He can be contacted at 949-533-8315 or [email protected].

Learn live and in real-time with Realty411. Be sure to register for our next virtual and in-person events. For all the details, please visit Realty411Expo.com or our Eventbrite landing page, CLICK HERE.

Real Property Easements, An Overview. the Purpose & the Risks? (Part 1)

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Image from Pixabay

By Dan Harkey

c 949 533 8315 e [email protected]

This overview of real property easements has relevance to property owners, real estate agents & brokers, mortgage agents & lenders, insurance agents & brokers, escrow officers, and title insurers.

What are real property easements?

An easement is a non-possessory right conveyed from one property owner (#1) to another property owner (#2) to use, enter, or cross over a parcel (or a portion) that is owned by the party (#1). Non-possessory means that party (#2) possesses a right to use, enter, or cross but does not own or have no property ownership claims. claims of ownership to the property.

A non-possessory interest in a property restricts its free use because it is an encumbrance on the property. The non-possessory interest (easement) is generally recorded against the property in municipal public records and serves to cloud the title.

There are two types of possessory interest: freehold and leasehold estates.

Fee ownership Interests are generally subject to certain easements such as utilities and public rights of way.

“A public right of way easement gives the public or organization the right to access and use property in specific situations for limited purposes. A right of way is an easement that established the freedom to use a pathway or road on another person’s property without conferring ownership.”

Easements generally run with the land into perpetuity (for all time) unless expired or canceled by the parties. They may be expressed, implied, by necessity, or by prescription.

https://www.forbes.com/advisor/mortgages/what-is-an-easement/

https://www.lorman.com/resources/easements-in-california-creation-of-easements-16986

https://www.clta.org/page/article6/A-Legal-Introduction-to-Easements.htm

What are reciprocal usage easements?

Reciprocal easements are non-possessory interests conveyed between two or more property owners. An agreement establishes the terms for easements, restrictions, and covenants between two or more different parties. The agreement is mutual between two or more parties to benefit each other, usually equally.

Using the example above, property owner (#1) may use the owner’s (#2) property. Reciprocally owner (#2) may use the owner’s (#1s) property. You scratch my back, and I will scratch yours for mutually beneficial purposes.

https://www.davis-stirling.com/HOME/reciprocal-easements-defined

What are reciprocal easement agreements?

Image from Pixabay

https://www.coxcastle.com/news-and-publications/2013/fall-2013-retail-perspectives-newsletter/understanding-reciprocal-easement-agreements#:~:text=Typically%2C%20reciprocal%20easement%20agreements %20(%22,as%20an%20integrated%20shopping%20center.

https://www.contractscounsel.com/t/us/reciprocal-easement-agreement

Consider two adjacent commercial parcels, each with 20,000 square feet of land. One land parcel has a local grocery store, and the other has a restaurant. The owners structured a reciprocal easement agreement to allow both parcels to provide entry to commercial supply trucks and for parking. With the building footprint, required setbacks, and parking, there is not enough room for large trucks to deliver supplies without overlapping parcels.

What are prescriptive easements?

Conflicts and litigation may arise to prove what may be referred to as claimed rights to pass over a property. A “prescriptive easement” is a “claim of possessory right to pass” across another person’s real property that was acquired by continued use without permission of the owner for a legally defined period. Usually, a claimant has the burden of proof of the elements necessary to establish that the easement has been created over time by prescription (California Code of Civil Procedures 321). In California, a claimant is required to adequately prove that they have possessed the prescriptive easement by continuous use for at least five years. Other states have similar regulations.

The statutory time for prescriptive easements varies from state to state. Each claim is fact-specific, with the possibility of winning some and losing some. Proving the claimant’s rights can take time, resulting in litigation and being fraught with the risk of losing. All this frustration could have been avoided with well-documented agreements.

The issue of exclusive vs. non-exclusive easements must also be proved-up. Will the easement run with the land and bind all future owners? In California, 2d 872 (2002). California Civil Code 1104 provides that a transfer of real property passes all easements attached thereto.

There are many types of easements for dozens of different purposes:

https://en.wikipedia.org/wiki/Easement

Are easements transferable from one party to another?

Image from Pexels

Most easements are recorded and are a matter of public record. When a property is transferred to another party the easements are transferred and remain on title. An easement generally remains with the property.

https://www.findlaw.com/realestate/land-use-laws/easements-and-transfer-of-land.html

Why should property owners, real estate brokers, and lenders make such a big deal about easements? What’s so important?

Owners, realtors, and lenders should be aware of the vast reservoir of property usage limitations caused by property easements limiting property usage and reducing a property’s development potential and value.

“Easements are like having a giant network of squid-like tentacles on your property that you can’t touch, see, or hear but had seriously better handle. Failure to deal with each easement (tentacle) could result in catastrophic consequences, including diminished property value and limited or total inability to develop the property.”

Easements are clouds on the title. An easement is an encumbrance against a property referenced by agreements and claims to enforce rights and obligations. Whether recorded or not, the easement still reflects a clouded title.

When a realtor or lender drives up to a property, they may admire the beauty and tranquility of the setting. The home elevation, topography, floorplan, panoramic views, and hardscape are outstanding. The property location may be the best. Selling the sizzle is appropriate but limited to the realtor’s spectacle performance and buyer’s immediate response. But there is a large prohibitive easement for a neighborhood storm drain running across the yard where the purchaser planned on placing a nice swimming pool. They were not disclosed of the storm drain easement.

Legal risks for an agent may be devastating. “I am the buyer’s agent. I did not read the preliminary title report, ask the title company for copies of all easements, nor ask them to chart out all easement placements on the property.” But the buyer’s confession that they did not read the preliminary title report does suggest a breach of fiduciary duty and constructive fraud. Failure to disclose was felony stupid.

Image from Pexels

“Constructive fraud comprises of any act or omission or concealment involving a breach of legal or equitable duty, trust or confidence which results in damage to another, even though the conduct is not otherwise fraudulent.” Salahuddin vs. Valley of California, Inc. (1994).

Constructive fraud means that fraud was created because any reasonable real estate fiduciary should possess this knowledge or know about these facts/circumstances. Failure to disclose constructive fraud.

What lurks underneath the ground is a web of easements that limit land usage, building size, and economic feasibility, inhibiting overall value. A 100,000 sq ft parcel may only have 10,000 square feet of a buildable pad because of restrictive easements.

A 20,000-square-foot property that appears to be worth $100 per foot, but 80% has limited use because of restrictive easements. Only 20% of the parcel is buildable. A buyer may not be willing to pay $100 per square foot for 20,000 of land when only 4,000 square feet are buildable.

Risk and liability flash red for the principal parties and their agents:

Image from Pixabay

Knowledge is the key. On any transaction, the parties should obtain a preliminary title report, obtain written copies of all easements, and request a survey performed by the title company to determine survey boundaries and potential adverse effects on the property. An appraiser will be interested in the results.

Principal buyers and their agents will decide what easements are appropriate and acceptable and what easements are not. Accepting the property as-is, renegotiating the price, or outright rejecting the purchase are possible options.

History:

Image from Pixabay

Many buildings that were constructed in the earlier part of this century, before the 1960s, lacked adequate parking and, in most cases, lacked formal agreements about common on-site usage for ingress/egress for walking and automobiles. In property law, ingress/egress refers to the rights of a person to pass over a real property for entry, leaving, and return across the property.

Familiar transportation sources were walking, bicycles, horseback, and horse-drawn carriages. Building growth clustered around the center of town was standard. The advancement of the automobile, which made transportation more flexible, had not yet matured. The requirement for expanded parking areas had not matured.

In days gone by, two or more property owners might verbally agree that they would build adjacent buildings and use a small portion of one of the land parcels for ingress/egress, as oral agreements tend to do. Many old verbal agreements have gone wrong, as oral agreements tend to do. Handshake agreements broke down, and conflicts arose with future ownership. Problems also arose when descendants and partners disagreed with the interpretation and or benefits of the original verbal easement agreement.

https://www.findlaw.com/realestate/land-use-laws/express-and-implied-easements.html

Municipalities, property owners, and lawyers began memorializing the agreements in written form. At the same time, the creation of municipal planning departments and zoning ordinances came into being. Owners were then required to hire civil engineers to draft a written placement of physical easements and obtain approval from the municipality. It is common practice to hire a land planning lawyer to handle the application process for various approvals with the respective city planning department.

Upon approval by the city, the agreements and drawing of physical placement of the easements encumbering the property were generally recorded in public records. The objective was for the recorded agreements to provide public notice that the easement existed and would bind all future owners in perpetuity.

Many older structures were built prior to creating and enforcing building and zoning ordinances. Zoning ordinances were adopted in California as early as the 1920s and have continued to evolve. Prohibitions related to setbacks, height & density restrictions, floor area ratios, required parking, deed restrictions, necessary amenities, and acceptable building materials all have occurred over time. Laws have been passed that now control aspects of ownership.

(to be continued…)

This article is an overview for a general educational purpose only. The information presented should not be relied upon without the advice of counsel.

Dan Harkey is a contributing author to Weekly Real Estate News and is a Business & Financial Consultant. He can be contacted at 949-533-8315 or [email protected].

Learn live and in real-time with Realty411. Be sure to register for our next virtual and in-person events. For all the details, please visit Realty411Expo.com or our Eventbrite landing page, CLICK HERE.

Relax and Recharge in Your Mental Hobby Shop

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Image from Pixabay

By Dan Harkey

Most people have a place they go to or an activity they engage in that helps them move into peacefulness, serenity, and resolve. They can spend time happily away from exterior societal pressures. I refer to that state of being as their Mental Hobby Shop, which will help them to exclude all the extraneous life pressures and extraneous violations of their sovereignty. Each of us needs to define where our mental hobby shop is located and conscientiously try to spend more valuable time there.

Here are a few examples of preferred hobby shops:

Image from Pixabay

  • Garage tinkering: Time spent in the garage with things like bicycles, cars, or motorcycles. There is nothing like washing and waxing a bike to take you into another world. How about repairing something, organizing useless stuff, or inventing something useful?
  • Golf and active sports: Time spent on a golf course, tennis court, or workout facility. How about riding horses or cruising on a street bicycle or mountain bike?
  • Personal activities: Time spent with individual activities such as painting, scrapbooking, reading a good novel or playing a musical instrument.
  • Family: Time spent with family and pets at a picnic or outing where life’s daily pressures are minimal, and enjoyment is paramount.
  • Outdoors: Time spent walking on a trail, park, or beach. Being outdoors has excellent therapeutic value. Getting close to nature is always rewarding. I have enjoyed walking in the rain on the beach with a raincoat.
  • Vacations: Great time to explore, whether at local parks, national parks, or leaving on a jet plane. How about a local harbor getaway or an extended cruise ship vacation?
  • Camping retreats: Time spent camping, with a BBQ, or RV with friends and family.
  • Tranquility: Reading books, listening to tapes or videos that reflect positive thoughts rather than anguish, disgust, or pain. There is no need for intensive inquiry or into searching for meaning. That includes avoiding watching news that portrays our circumstance as an inevitable Armageddon. Just positive thoughts!
  • You are helping others: Volunteering for various activities that help others without expecting a financial return.

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My Mental Hobby Shop consists of the activities.

  1. My garage: Time spent tinkering in my garage, maybe even having a beer, and listening to classic rock or country music.
  2. Out on the road: Time spent with my motorcycles and electric bicycle, washing, waxing, checking the tire pressure, or riding out on the road. Just head out on the highway, looking for adventure. Where have I heard that before? Much like being in the movie, Born to Be Wild, only with much less wild at my age. I may head out for a destination to meet my buddies who belong to the 4-B Club. 4-B stands for bikes, buddies, beer, burgers, and discussing buddy things.
  3. Walking: on the beach, around the harbor, through a delightful park, or around the neighborhood. 3 to 4 miles is my goal. I get sunshine, vitamin d, exercise, a nice breeze, and peace of mind. After a shower, I feel great.

Image from Pexels

Identify where your Mental Hoppy Shop exists and conscientiously spend more time there. Life will be more rewarding where your state of happiness dwells. Happiness creates renewed energy and motivation, stimulates creative thought, and feeds overall physical and emotional health. The key is to detach from work-related issues and societal pressures and stop reading and listening to mainstream news propaganda.

News media outlets spew news full of sensationalism followed by a barrage of advertisements. The news is designed to sell you something and to create strife about how terrible everything is. Of every one-half hour segment that someone watches mainstream news, only about thirteen minutes is considered news, although the content is always filtered through an ideological kaleidoscope. Then ad nauseam advertising segments follow for about seventeen minutes.

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Within mainstream news, the commentators and the guest experts consistently deliver the narrative as subscribed to by the media company. FOX, MSNBC, AND CNN present material from an opposite perspective. Experts will work within an approved framework for acceptance and consensus-building, rather than seeking truth. Experts will act to ensure job security, cultivate kindred relationships, expand their careers, and seek more notoriety.

Little independent critical thinking and unbiased scientific analysis can be found in the mainstream media. Those who want actual and truthful content can find alternative news sites and information sources online.

Yes, turn off the toxic tube and cell phone! Yes, turning off is difficult to do for a few of us who are extroverted, outgoing and task oriented. Those folks tend to be direct, decisive, driven and demanding. But they can also become addicted to staying connected and watching 24/7 biased propaganda news.

This article is intended for educational purposes only and is not a solicitation.

© Dan Harkey. This material’s unauthorized use or duplication without express and written permission from this author or owner is strictly prohibited. The article may be used in marketing efforts, provided that full and clear credit is given to Dan Harkey. The credit displayed when you forward any article must include Dan Harkey, Business & Finance consultant. You are not authorized to modify the articles title or the content.

This article is an overview for a general educational purpose only. The information presented should not be relied upon without the advice of counsel.

Dan Harkey is a contributing author to Weekly Real Estate News and is a Business & Financial Consultant. He can be contacted at 949-533-8315 or [email protected].

The Capitalization Approach to Income Property Valuation

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Image from Pixabay

By Dan Harkey
Real Estate & Finance Consultant

Definition of capitalization of earnings:

The concept of the capitalization approach is a method of estimating the fair value of an asset such as income-producing real estate by calculating the net present value (NPV) of expected future net profits or net cash flow referred to as Net Operating Income. The capitalization of earnings is determined by taking the property’s projected annual net income and dividing it by the market capitalization rate (Cap Rate).

Understanding the income capitalization approach (Cap Rates) in the property valuation process is critical when investing in income-producing real estate or obtaining a loan. This concept is essential to commercial realtors, lenders, developers, and investors in income-producing real property. The concept is commonly referred to as the income approach.

Net income divided by the capitalization rate will reflect the expected value of the income-producing asset. Re-stated: Net operating Income divided by the capitalization rate= value (NOI/Cap Rate=Value).

Example: Property Income and Expense Statement Format
The calculation to arrive at the Net Operating Income

Stated one more time: Capitalization Rate represents the annual Net Operating Income (NOI) divided by the cap rate to derive the property asset value (NOI/Cap Rate= Value).

Why do we use Capitalization Rates?

The capitalization approach is a “comparative method” of valuing property with similar properties, similar income streams, in similar geographic locations, and similar risks that will yield a comparable rate-of-return. Once the value is established, the comparative method can calculate the loan-to-value to determine if property value falls within the lender’s loan underwriting guidelines.

Cap Rates are only one metric. Since the capitalization approach is calculated as if the property is debt-free the value will be the same whether the property has leveraged debt or is debt-free. It represents a market snapshot at the investment time and does not consider loan debt service or financing costs.

If an investor finances his acquisition, as most people do, further analysis such as cash-on-cash return will be helpful. Sophisticated loan underwriters and investors may also calculate an Internal Rate of Return. These calculations assist in establishing that the property is income-producing and a worthwhile investment.

Image from Pixabay

A licensed commercial appraiser may perform a rent survey to determine market rents for a property type in a geographic area. Market rents may or may not be the same as actual rents (contract rents). There are many instances where the existing rents are above or below-market rents. A tenant with a long-term lease may have locked in lower rents sometimes in the past.

I once underwrote a loan transaction on an industrial building near San Francisco that was about 100 years old. The property has a long-term lease of 18 cents per square foot, while the current market was $1.75 a square foot. Since current market rents were much higher, the valuation metric used was based upon the locked-in lower rental rate.

A property owner may own the property in one title method such as The Archie Bunker Corporation and occupy all or a portion of the building in different title method such as Archie Bunker Limited Liability Company. He may charge above or below-market rents to himself for tax purposes. Actual rents may also be higher than the market. In this case, the appraiser would use market rents rather than actual rents to determine the Cap Rate.

There are other instances where a conventional market Cap Rate analysis is inappropriate. The alternative method is a discounted cash flow analysis such as original ground-up construction. The building cost and the cash flow from a lease-up need to be projected over a reasonable time to the point of stabilized occupancy. This is done by a competent appraiser who can construct a model estimating a future projected cash flow and using net present value discount formulas to estimate the capitalization rate. The result may differ from the market comparison method.

Suppose you have income properties with similar characteristics in a geographically close location sold in arm’s length cash transactions, and the income stream data is available. In that case, there are web-based databases that track comparison capitalization rates (Cap Rates.)

Market rents are the amount of rent that can be expected for a property, compared to similar properties in the same geographic areas. Contract rent or actual current rent is what the same units are being rented for today. Many lenders will request a rental survey from an appraiser as an add-on task to the requested appraisal job.

There is an essential difference between market rents and current actual(contract) rents in the Cap Rate valuation process. Compare two different buildings, both identical, but the first property is well-kept and rented at a market rate, and a second building that has deferred maintenance. The property with deferred maintenance is rented for under-market rates by under 30%. In both cases, a lender and the appraiser will use market rents to determine the (NOI). The assumption about the second building is that a new owner will upgrade the building and adjust the rents upward to a market rate. The value of the second building would be adjusted downward or discounted to offset the cost to cure (cost to upgrade the building).

The only time that a lender, or appraiser, would use the lower rents is when those rates were locked into a long-term lease or a rent-controlled property. I underwrote the following example: A prospective loan for an industrial building in Richmond, California. The property was leased fee, leased out to a third party for 99 years, with 50 years remaining. The locked-in rent was only 18 cents per square foot triple net. The property owner and broker argued belligerently that current value should be based upon today’s rents.

An inconvenient fact in this example is that the property owner is locked into an 18 cent per square foot monthly income stream for the next 50 years. Capitalized rents will be based upon 18 cents per square foot lease rate. The capitalized value with an 18 cents per square foot will have a dramatically lower NOI compared to a similar building next door that rents at $1.75 per square foot lease rate monthly.

Image from Pixabay

A historic rents comparison databases are available to determine market rents to calculate a correct capitalized valuation. Historic market Cap rates may vary, even in the exact geographic location, depending upon the building improvements, effective age, class of construction, off-street parking, furnished or unfurnished, condition, compliance with zoning, easements or lack of needed easements, and amenities. Examples include Class-A vs. Class-C office, industrial, apartments, older dated, economically obsolete and under parked compared to a new modern building with adequate parking and currently popular amenities.

Advantages and disadvantages of the Capitalization approach to value:

Advantages:

  1. This method converts an income stream into an estimate of the value of the income-producing real estate.
  2. The method is a common standard in the appraisal, lending, and development business.
  3. While the income capitalization approach is common in evaluating commercial income-generating properties, it can theoretically be applied to any income stream, including businesses.
  4. Commercial appraisers are a reliable source for determining market cap rates.
  5. Commercial realtors provide an excellent source of cap rates with websites such as Costar and Crexi
  6. There are online databases such as the CBRE/US-Cap-Rate-Survey-Special-Report-2020 to obtain reliable data.

https://www.cbre.us/research-and-reports/US-Cap-Rate-Survey-Special-Report-2020

Disadvantages:

  1. The method is used for “comparison only with similar properties in a close geographic area.” The method does not consider liens on the property and debt service. A cap rate calculation is done as though the property is debt-free. Cap rates cannot be used to calculate overall net cash flow or cash-on-cash yield when a loan attached to the property (Income, less operating expenses, less debt service).
  2. The results of a cap rate calculation are specific only to a similar area with similar properties in certain segments of the market. You could no use Newport Beach, California cap rates to compare with a similar building with similar usage in Riverside, California. Also, the demand for properties and cap rates for different segments of the real estate market change. Current examples are residential income properties and Industrial are and will continue to be in demand. I read one estimate that industrial in the U.S. will require an extra billion square feet of warehouse by 2025. Office and lodging/resort related properties, not so will. Patterns change!
  3. The method contemplates stable economic market conditions. If a market experiences a significant downturn, collapses, or is subject to extreme political uncertainty, the calculations using market cap rates may be rendered irrelevant.
  4. Relying on a cap rate with an unstable market condition is difficult. Using market rents may become suspect because higher rates of foreclosures, tenants’ default much more frequently, vacancy rates go up, and replacement tenants will ask for higher rent concessions, thereby bringing the market rents down. Additionally, owner operating expenses may become constrained.
  5. Calculating forecasting future income streams involves a high degree of professional judgment, and therefore subject to variation.
  6. Professional judgment is subject to subjective vs. objective interpretations about expectations of future benefits.
  7. The method may result in miscalculations when estimating the cost of capital outlay for upgrades to bring the property up to current standards. All subsets of the job have a cost, time and frustration allocation, including municipal approvals, reconstructing the building, modern materials, safety, zoning, environmental, and social equity requirements.
  8. Property amenities, parking, easements, recorded encumbrances, and compliance with building and zoning regulations require a complex analysis.
  9. The lease-up period is only an estimate and may not be correct.
  10. Alleged appraiser and lender biases for racially segregated neighborhoods have been known to exist.

Tenancies: A landlord and tenant may enter into four types of rental or lease agreements. The type depends upon the agreed-upon terms and conditions of the tenancy. All rental amounts and terms of a lease will be reflected in the capitalization evaluation.

Types include:

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1) Fixed-term tenancy is a tenancy with a rental agreement that ends on a specific date. Fixed terms have a start date and an ending date. According to the written lease document, time terms may be short or long such as ten years with multiple extensions.

A landlord can’t raise rents or change lease terms because the terms are codified in a written agreement. A key advantage for a landlord is to receive today’s market rents.A key for a tenant is to lock in a long-term lease where the rents are or become below market over time.

A tenant’s company’s profits are enhanced if they pay substantial under market rents. On the other hand, if a tenant’s company is making a good profit with rents substantially below market and a lease is coming due soon, the increased or negotiated upward lease rate may wipe out some or all the profits.

2) Periodic tenancy is a tenancy that has a set ending date. The term automatically renews into successive periods until the tenant gives the landlord notification that he wants to end the tenancy. Month-to-month tenancies are the most common.

The strength of the tenancies from national credit with long-term leases and corporate guarantees down to mom & pops month-to-month tenancies will result in a substantially different Capitalization Rate. National credit tenants with corporate guarantees have a considerably lower cap rate. Mom & pop tenancies will reflect a higher cap rate because they inherently have more risk.

The lower the market Cap Rate, the lower the perceived risks of property ownership. The higher the market Cap Rate, the higher the perceived risks. An exception would be where the national credit tenant locks in a lease rate that does not increase as the market dictates or anticipates increases. Eventually, over time, this tenant will reflect below-market rents.

A mom-and-pop tenant could be converted to a market rent more quickly because the term is usually shorter.

Market rents are obtained by surveying local brokers and appraisal data- bases of local market rents.

3) Tenancy-at-sufferance (or holdover tenancy). This form of tenancy is created when a tenant wrongfully holds over past the end of the duration of period of the tenancy.

I bring up this type of tenancy because of because of COVID. The government allowed tenants to skip out and default on paying rents without consequence. The tenants either defaulted on the rent or overstayed the term.In either event, the tenant becomes delinquent, and the owner attempts to evict them. The tenant or affiliates may become illegal trespassers.

There are many examples of a landlord attempting to get rid of an illegal tenant only to be jerked around through the court system, with multiple appeals requested by the tenant. They are usually granted.Then comes multiple bankruptcies, not only of each tenant, one by one, but unknown people who supposedly moved in without notice to the landlord.Then comes the transients and fictious folks who show declare that they are a tenant and request that the process start all over because of their fraudulently claimed tenancy. The courts, particularly in states like California just turn their backs on this behavior.

The focus for the property owner becomes using legal avenues to evict the tenants and regain occupancy of the property. This process has great cost and frustration.

4) Tenancy-at-Will. This form of tenancy reflects an informal agreement between the tenant and landlord. The landlord gives permission, but the period of occupancy is unspecified. The term will continue until one of the parties give notice.

Rehabilitated property or New Construction:

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Establishing market rents becomes essential in underwriting a rehabbed or new building. When there is an extended time delay for a lease-up period, such as with the new construction of an income-producing property, future cash flows need to be estimated to the point of income stabilization. Then the future stabilized income will be discounted, using an estimate of a market capitalization rate and a discount rate formula.

Work with a competent commercial appraiser to assist and calculate the correct market Cap Rate. Do not try to do this yourself without the help of an appraiser who knows the type of real estate and local market.

Below is an example: The market Cap Rate for a commercial property with triple net leases (NNN) has been determined to be 6.5%. Triple Net or (NNN) refers to a leased or rented property where the tenant pays all expenses related to the operation such as taxes, insurance, maintenance, and occasional capital improvements. The 10,000 square foot multi-tenant property under consideration generates monthly rents of $1.50 per foot. On a (NNN) example for a Cap Rate analysis, one would apply a 10% vacancy collection and loss factor and 5% for non-chargeable expenses that tenants usually do not pay including reserves. The NOI would be $153,900.

The NOI and Market Cap Rate are known so you can calculate the value:

10,000 SF rentable X $1.50 = $15,000 Per mo. X 12 Mos. = $180,000 = potential gross income.
$180,000–$18,000 for 10% vacancy = $162,000–$8,100 for 5% non-chargeable expenses to the tenants = NOI = $153,900
$153,900 NOI /.065 Cap Rate = value = $2,367,692

From an investment standpoint, market Cap Rates can show a prevailing rate of return at a time before debt service. The cap rate procedure will assist a lender and investor to measure both returns on invested capital and profitability based on cash flow. An informed lender or investor should understand that there may be dramatic variations in a property’s value when unsupported or unrealistic Cap Rates are applied.

Cap Rates as well as demand for income-producing properties will move up or down depending on market conditions. The term Cap Rate compression reflects a movement of the rate down because investors perceive real estate as a lower-risk, higher reward asset class relative to other investment options. Cap Rate decompression may result from demand for real estate purchases where cap rates increase, reflecting lower valuations. This may be a byproduct of higher interest rates or government intervention such as rent control.

Loan-To-Value Ratio (LTV):

Cash-on-Cash Return:

Cash on cash return is a quick analysis to determine the yield of an initial investment. The cash-on-cash return is developed by dividing the total cash invested (the down payment plus initial cost) or the net equity into the annual pre-tax net cash flow.

Image from Pixabay

Assume the borrower purchased the property, which costs $1,200,000 and provides an NOI of $100,000, with a $400,000 down payment representing the equity investment in the project. The cash-on-cash return for this property would be:

$100,000/$400,000 = 25% = cash-on-cash yield.

If the borrower were to purchase the property for all cash, as contemplated in a Cap Rate calculation, then the cash-on-cash return would be:
$100,000/$1,200,000 = 8% (this example the 8% is both the cash-on-cash yield and Cap Rate).

It is clear from this formula that leveraging or financing real estate transactions will yield a higher cash-on-cash return, provided the transaction is financed at a favorable interest rate.

Internal Rate of Return (IRR):

Internal rate of return (IRR) refers to the yield that is earned or expected to be earned for an investment over the period of ownership. IRR for an investment is the yield rate that equates the present value of the outlay of capital and future dollar benefits to the amount of money invested. IRR applies to all dollar benefits, including the outlay of the initial down payment plus cost, the positive monthly and yearly net cash flow, and positive net proceeds from a sale at the termination of the investment. IRR is used to measure the return on any capital investment before or after income taxes. Ideally, the IRR should exceed the cost of capital.

Is there an ideal Cap Rate?

Each investor should determine their risk tolerance to reflect their portfolio’s ideal risk-reward level. A lower Cap Rate means a higher property value. A lower Cap Rate would imply that the underlying property is more valuable, but it may take longer to recapture the investment. If investing for the long-term, one might select properties with lower Cap Rates. If investing for cash flow, look for a property with a higher Cap Rate. Declining Cap Rates may mean that the market for your property type is heating up, and demand is intensifying. For Cap Rates to remain constant on any investment, the rate of asset appreciation and the increase of NOI it produces will occur in tandem and at the same rate.

Below are examples of changes in NOI and Cap Rates that cause asset values to rise or to go down:

As NOI increases and Cap Rates remain the same, asset values will increase.
($300,000 reflects net operating income and .06 reflects a 6% cap rate)
$300,000 /.06 = $5,000,000
$350,000 /.06 = $5,833,000
$400,000 /.06 = $6,666,666
$450,000 /.06 = $7,500,000

As NOI remains the same and cap rates rise asset value will go down:
($500,000 reflects net operating income and .03 reflects a 3% cap rate)
$500,000 /.03 = $16,666,666
$500,000 /.04 = $12,500,000
$500,000 /.05 = $10,000,000
$500,000 /.06 = $8,333,333

Correlation Between Cap Rates and US Treasuries:

The US Ten Year Treasury Note (UST) is deemed to be the risk-free investment against which returns on other types of investments can be measured. USTs yields have been on a broad decline for many years but may soon rise. As interest rates increase those investors who bought USTs at a lower rate will find that their bonds will go down in value. Bonds purchased at the new higher rates will be in high demand.

Image from Pixabay

As interest rates rise, cap rates will go up, and consequently, there will be a reduction in asset values over time. With so many uncertainties in the market and growth projections constantly being revised, the spread between UST and Cap Rates has not remained constant.

When the government intrudes in the market, the results are artificial. This has caused capitalization rates to go down, reflecting higher values. Near-zero interest rates have also caused a dramatic inflationary spike in all goods and services.

Summary:

Property appreciation from excess demand has been one of the most significant reasons for investing in real estate Appreciation is not part of the Cap Rate calculation. For investors, lower interest rates, tax benefits of owning commercial real estate may, in and of themselves, be the driving force to make such an investment. If the property is to be leveraged, there may be write-offs for loan fees, interest expenses, operating expenses, depreciation, and capital expenses.

As interest rates have been forced down to extremely low rates, below inflation, by government mandate! Refinancing at lower rates has resulted in lower debt service payments. Cash flows of income-producing properties have gone up, reflecting a higher net operating income.

The government intentionally creates market distortions that benefit the insiders at the top of the economic spectrum. The results are artificial. This has caused capitalization rates to go down, reflecting higher values. Near-zero interest rates have also caused a dramatic inflationary spike in all goods and services. All asset classes have now been “spiked with 200-proof illusions” that make everything seem fantastic on the surface. But hangovers the day after the party ends are no fun.

A one-to-two hundred basis points increase in lending rates (1% to 2%) would shatter the punch bowl into fragments. It is my opinion that an imediate 2% interest increase would collapse the economy overnight. Main Street and small capitalist entrepreneurs would bear the brunt of the widely spread financial damage.

Interest rates are increasing because the government realizes that inflation will only accelerate if they do not stop or slow it. Increased interest rates will result in newly originated loans having higher payment structures. Higher loan payments indirectly and over time cause cap rates to rise and values to go down.

Values may not go down immediately, but the demand to purchase income- producing properties will subside because ownership makes less economic sense. To add flames to this fire government, including federal and state, is passing legislation that will destroy investor motivation to own.

Over time the four-pronged whammy will become apparent. 1) Rising interest rates, 2) increase in interest rates reflecting larger loan payments, 3) general loss of investor confidence in the overall economy, 3) loss of investor interest in purchasing an income property, 4) overburdening & abusive government intervention into property ownership will come home to haunt the entire real estate market across the United States. 5) All of the above will cause cap rates to go up, and property values go down.

Image from Pixabay

Remember that increased debt service based upon higher interest rates is not considered in the capitalization approach. But, over time, as interest rates go up, borrowers will feel the sting of higher debt service payments. Some property transactions may become less appealing financially. As purchasers and borrowers elect not to purchase, that may compound and create more unsold inventory. Some sellers may get desperate and reduce the price to sell quickly. The lowered price would result in a higher cap rate. Higher interest rates will lower all real estate prices on a macro level.

How dramatic will lower real estate prices be over time? Between 2007 and 2010 we witnessed the downward value contagion spread resulting in substantially lower values and increased Capitalization Rates.

The four-pronged whammy is not a new phenomenon. It has just been forgotten while enjoying the Federal Reserve’s “free-for-all 200-proof infused financial punchbowl.”

Dan Harkey

Dan is President and CEO at California Commercial Advisers, Inc. He consults on subjects of Business Growth & Private Money. Dan often creates articles interrelated to these subjects. He has been active in the real estate and financial services industry since 1972 & possesses a lifetime teaching credential for secondary and adult education. He has taught over 350 educational seminars on subjects related to real estate lending, private money lending & loan underwriting for commercial/industrial properties.

Contact Dan Today
Mobile: 949.533.8315
Email: [email protected]

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