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The Private Lender Podcast - Keith Baker 6th April 2020
PLP-099: Creating A Lending Criteria During The COVID-19 Pandemic
00:00:00 00:19:52

PLP-099: Creating A Lending Criteria During The COVID-19 Pandemic

PLP 99 | Lending Criteria


We are in the midst of a global crisis. While we're all grappling to win over against its effects, it helps to gather a couple of lessons that we could take to aid us in these uncertain times. In this episode, Keith Baker guides us in creating our lending criteria moving forward. He talks about how to lend in preparation of price fluctuation for when the world becomes unhinged. Giving some context, Keith also talks about the effects of the COVID-19 Pandemic to Houston and to the rest of the world. Don't miss out on learning some important advice that might just help you stay safe in an unsafe market.


Creating A Lending Criteria During The COVID-19 Pandemic

How To Stay Safe In An Unsafe Market

I'd like to thank you for sharing your time with me. We are dedicated to teaching everyday people like you and me how to participate in the most passive form of real estate investing known to mankind. That is private mortgage investing while giving tips and advice on how to keep their money safe. It’s simple. If you're looking for practical tips and advice on being a successful private lender on how to create wealth without banks or Wall Street, then you're in the right place. If you want to learn from my mistakes and my screw-ups so that you avoid them and therefore shorten your own learning curve, then pull up a chair and you might as well go ahead and pour yourself a stiff drink or two because this is made for you.

I want to invite everyone reading to join me on Monday, April 6 at 8:30 PM Central Standard Time for Ask A Private Lender on Facebook Live. I will go live for hopefully 30 minutes minimum to answer any questions you may have regarding private lending, both from the lender’s perspective and for the borrower's benefit. I'm hoping everyone will find it helpful whether they want to lend or they want to borrow. I'm going to try to make Ask A Private Lender the place that gives the straight scoop. Please let other investors know that I will be going live and they can ask me anything they want about private lending. I hope to see you on Ask A Private Lender Facebook Live.

When episode 98 went live, I was in the great country of Scotland along the River Spey. I took my iPhone out and I recorded the sound of the water. I'm either one, completely off my rocker or two, an insane scotch alcoholic or three, all of the above. I’m getting high tech and fancy. When the last one dropped, I was canceling. I had planned to go to the Macallan and the Glenlivet distilleries and that's my thing when I get over there. Unfortunately, the conference was canceled so I had to go back to London and found myself literally 36 hours later on a plane flying back home to Houston with five days of unscheduled vacation ahead of me, which was great. It wasn't all that jet lag, but it allowed me to accomplish a few nagging chores around the house and get a billable hour or two here and there. After that full weekend, all hell broke loose and all of a sudden, I couldn't find a store to find any toilet paper in it or at least long enough to stay on the shelf for me to buy it.

It's been a while since I came home. I don't know where the time has gone. It's a complete blur and I haven't felt like I’ve been able to produce any content that that seemed worthwhile. I’ve tried, but it seems like it's crap and there's a lot of noise on the interwebs. I want to make sure that my content is relevant and has some value or not something that has value to two private lenders and not be a soapbox so that I can preach to the choir. Episode 99, how to lend in preparation of price fluctuation when the world goes to hell in a handbasket aka what your lending criteria should be moving forward.

PLP 99 | Lending Criteria


Like many of you, I’ve been watching a lot more CNBC and Bloomberg than usual, probably more than I would like to admit. I’ve made a few moves into the market and I like to see stuff like that. When stuff drops like this, this is where fortunes can be made. Honestly, I'm trying to figure out how much money do I want to take out of the old 401(k) and put into real estate and how much I want to continue playing within the market. I don't know how long this is going to last or how long these whipsaws are going to happen.

Three Things To Think About

Basically, I want to talk about three things that have got my mind, trying to wrap my head around with this whole coronavirus and where we're going.

The first thing is I do think we're coming into some recession. That's probably a safe bet. I think we'll bounce out of this a bit, but maybe we don't know a whole lot. There are three things that I'm mulling over in my head. Number one is that during a mastermind several years ago, blog 100’s guest, he eerily predicted that the next economic recession would come out of China, but he predicted that it would be in February of 2018. There was no biological component that I'm aware of. He simply thought it would be a financial recession that would be triggered by the Chinese economy. If this turns out to be the Kickstarter of a world recession, then how interesting is that? That's why I put in the qualifying word eerily.

It is a bit eerie if it comes out to be true, but that has yet to be seen. That's the thing. That's one thing that's going to irk me a little bit. I did the next blog so long ago that we didn't even mention it about the world recession or the coronavirus or anything like the situation that we're in. Moving on to number two, doing a little research. The Great Recession back in 2008 to ‘12 was caused by the real estate of the mortgage bubble. I don't see real estate being the pied piper this time around. It most likely will be affected but will it be affected as much as last time? Who knows? Given the circumstances going into ‘08 and going into 2020, they are a bit different. There will be some similarities, but I'm hoping that the price drops and the fluctuations don't go as deep as they did years ago, so we'll see. Three, from my position here in Houston, oil price and the oil price war, it has my attention for several reasons.

One, I derive my steady paycheck, my W-2 so to speak, through the oil field insurance industry, but I'm also in Houston. I specifically remember the 1980s when oil went to complete crap. There were brand new strip shopping malls that sat vacant for months and years with leasing agent phone numbers in the windows and for lease signs. Houston's economy is not as dependent upon oil and gas as it wasn't the ‘80s, but it is still a major and significant influence. Every upstream news source that I follow and I’ve read does not have any positive forecast or news for the upstream industry, the E&P, Exploration and Production, whether that'd be onshore or offshore. Nonetheless, that's the energy capital of the world. It’s Houston, Texas.

[bctt tweet="The more that borrower has to lose, the harder they're going to fight to make that project a success." via="no"]

When oil goes to crap, we're going to feel it. How bad? I don't know. I'm not saying this is going to be the ‘80s by a long shot, but we're going to feel it. The layoffs are coming. Coronavirus came at a crappy time. This may upset the Houston market a little more than other markets in the country that aren't so dependent upon the oil and gas or in the petrochemical industry. If you're in another area, you’ll find out what sensitivities to industries that your area has. I go into the oil and gas because there's a good reason why the west side of Interstate 10 in Houston is called the energy corridor.

Lending Criteria

Anyway, what does all this mean for you and your lending criteria or for me? If I'm making loans, I can tell you this. My personal criteria got a little tighter and I'm not even talking about points or anything like that. On a flip, I'm talking about simple LTV, ARV, what I'm willing to go to, and I'm at 45% to 50% of the current ARV.

That's all in, 45% to 50%. That's purchased, rehab, the whole shebang. This way I have a lot of room for error going in if we experience short-term price drops and I have to, unfortunately, foreclose on the property at an inopportune time. I'd like to run through an example, give you an illustration that I look into the method in my madness. I do say madness with the pun fully intended because such the tightening of these lending criteria will no doubt anger borrowers as it will force them to either, A, find or negotiate deals with larger margins. It's getting tight now. Everyone wants to get into the real estate game.

The LTVs are going up, wholesalers. They're not deals to me. It's still a functioning sub-economy, but it’s not a deal. That brings the forces, either they can go to get hard money, which is suited for this risk, or they can bring in a deal that's a true deal to me. It has lots of room for their error and mine or B, this requires that borrower to put more of their own skin in the game, which further buffers your security there. The more that borrower has to lose, the harder they're going to fight to make that project a success and to return your funds to you. Let's take an example. For simple math, we're going to use a home property that has an After Repair Value, ARV, of $100,000 and that is retail, MLS ARV. It’s got all the bells and whistles and has been updated, it's got the right colors and all that and neutral stuff.

I'm talking about a listing agent who gets happy to see a house like that because it will move quickly at $100,000 because it's good. It's nice. If you’re talking about putting money on a rental, you know me, that $100,000 is not true. ARV, I like to come down to maybe 90%, maybe 85%. It depends because landlords do not maintain houses. A lot of them maintain the bare minimum. I could say that because I slumlorded it a little bit and I tried it. The point being is I'd spend as little money on the house as possible so that it would cashflow. Hence, I assume everyone else is going to be a landlord and is going to do the same thing. Why buy someone else's headache?

If it's a rental, cashflow property, it's not a true $100,000 ARV unless you look at the comps and say, “That is apples to apples, dollars to donuts.” That's good. Nonetheless, my little caveat, let me get back to my example. If you go to PrivateLenderPodcast.com, there will be an Excel sheet spreadsheet. The bad loan matrix that I have created from you after all my years in dealing with other people's safety and insurance. I’ve found a few matrices to be helpful. I’ve provided one here for you. I'm going to tell you about it. It's a matrix of $100,000 loan. There's the LTV, so at 80%, the next to that would be the corresponding loan amount.

PLP 99 | Lending Criteria


For example, 80% LTV would be $80,000. 50% LTV would be $50,000 loan on $100,000 property. Across the top, I start with 5% or 10% market hit. Let's say the sales price, if I get in a pinch, you have to foreclose and I want to get my money back soon. The values are $95,000, $90,000, $85,000, $80,000, and then $75,000, which represents a 25% loss in the market. This doesn't mean anything if you don't have to sell the house and you can hold onto it in cashflows for a while. This is how I look at underwriting a loan in case I need to bail out quickly. Let's look at 70% LTV. That's the max most people will go. In this example, a 5% hit brings you already up to 74% LTV value. If that same price drops to $90,000 or it takes 10%, now you're at 78%. A 15% market shift price fluctuation downwards puts you at 82%. God forbid, if it hit 25%, you are now at 93%. If you had to sell the house at $75,000, you are now at 93% LTV. There's no room for you, there's no room for closing costs. There's little room for closing costs and that's about only room for realtor fees. That's on 70% now. If you increase your lending criteria, you lower your LTV by tightening up. Let's say you get to that magic 50%, that's a good number.

[caption id="attachment_2772" align="aligncenter" width="600"]PLP 99 | Lending Criteria Lending Criteria: Coronavirus came at a crappy time. This may upset the Houston market a little more than other markets in the country that are aren't so dependent upon the petrochemical industry.[/caption]


You'll see on the matrix, that's where the dark green starts. The light green is in the 60%s but the dark green, that's the nice part. Obviously, you can go all the way. If this thing drops 25% and you had to sell it, you're still at 60% LTV. If you did 50% going into it, you had to sell the house at $75,000, 25% loss. You’ve still got plenty of room to get your money back and to cover the expenses. If you're good and you do the 40% LTV, if you can find those deals, and they do come around not often. About as often as a blue moon. Even if you dropped at 25%, if it went from $100,000 to $75,000, if you loaned on it at 40% LTV, you would still be at 53% well in the green and a good comfortable position if you had to foreclose and get that money back.

Macro Data And Microdata

When it comes to looking at this matrix and looking into how I'm going to lend on a particular deal, I like to take a two-pronged approach. I like to look at macro data and I like to look at microdata. When it comes to the macro, the first I like to use is the good old Case-Shiller Index, which is curated by this Standard and Poor's Company. It not only tracks overall, it gives you a view of the overall national average, but it specifically indexes the following twenty markets in the United States. The Phoenix area, greater Los Angeles, San Diego, San Francisco, Denver, Washington, DC area, Southern Florida so Miami, Fort Lauderdale, Tampa Bay area, etc. The Atlanta metropolitan area, Chicago, Boston, Detroit, Minneapolis, St. Paul, Charlotte, North, South Carolina area, Las Vegas metropolitan area, New York, greater Cleveland, Portland metropolitan area, and our backyard, the Dallas Fort Worth metroplex. I’m always saying this is a great place to start because it also gives you this national angle.

I’ll have an article in PDF from 2009 where the index posted 2018 and 24% price drops in certain markets and where it had declined 27 months in a row. When you go into thinking I want to make this loan, this might not be the best time for you to do it, especially if you need to have the money within the next few years. These are factors that could play into it. The Case-Shiller index is a great, nice, round number that I like to look at when I start off when I want to start off underwriting a loan. For the microdata or if you don't live or invest anywhere near the cities I mentioned, the best thing to do is go to your local MLS website, multiple listing service, and find what's trending in your market.

In the Houston area, it's HAR.com. I believe it stands for Houston Area Realtors or simply google what happened to the house prices in your market in the last downturn, in the Great Recession. Look for historical data. A lot of local newspapers will keep that stuff. You may have to do a little research, but this will give you an idea of the last three cycles, what caused them, what their influences were and how bad were they. It gives you an idea here. We've never seen a pandemic before. Humankind has, but we haven't seen it. This generation, I mean. I'm going off on another tangent there, but MLS is the best place to keep it local. MLS will take into account the oil and gas markets, commodities, and whatnot that affect Houston.

Other markets that you may live in, maybe it's a university, maybe it's agriculture, or some cases in Texas, prison system or whatever. Maybe it is government contracting, who knows? Your local MLS will take in this by default, taking those factors into account on a local basis. What if someone said, “What am I looking at?” I'm preparing for a 25% drop in housing prices in Houston. I'm looking at loans and I haven't done a whole lot of loans. I'm working on to come and get paid off so I can put them into other places. I committed to commercial syndication that I wanted to put some money in. The private loans on the properties were single-family residents or some of them come. Some of them are getting renewed. I renewed one with Landon, my partner. I’m playing with all of that, but trying to find out on the loans going forward, when I renew them, where do they fall from an LTV standpoint.

Most of those loans that I have out aren’t for flips or rentals. These are owner-financed deals and also trying to accumulate a little cash so that when crap hits the fan, there will be money for flips and doing all that stuff. Look at that matrix I put on the PrivateLenderPodcast.com because that's what I'm looking for. I'm building in a 25% drop. I hope it doesn't go that much, but at least when I'm looking at my loans, I'm stress testing that 25% drop. Who knows what's going to happen with this coronavirus? Maybe everything I said gets turned upside down in a week or a month or two. I hope not. I hope you found value in this blog. If you did, even a little, please help me out and spread the word, increase awareness by leaving an honest rating and review over at iTunes, Google Podcast. That is the best way you can help contribute. Your review helps not only feed my ego, but it helps other people find this.

PLP 99 | Lending Criteria


If you're trying to develop your own private lenders for your own deals, then by all means, please share this and drop me a line. Say, “I'm sending it to so-and-so. I'm trying to make him or her into one of my private lenders.” I'd love to get into the conversation, see what of investing you do and what your private lender would or may not be expecting. I'd love to help out in any way that I can, especially that I'm on day whatever of the self-isolation or quarantine and we're all having such a lovely time. Anyway, pass the word. Please remember, Monday evening, 8:30 Central Standard Time, April 6, 2020. Ask A Private Lender on Facebook Live. Go to the PrivateLenderPodcast.com for more information and to connect with me, and also on social media. I hope everyone stays healthy and gets through this crazy time and we're all in it together. Besides self-awareness, I wish everyone out there a safe and prosperous private lending. I’ll catch you on the next blog. Take care.

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