REAL ESTATE

CROWD FUNDING HANDBOOK

The good, bad and dark side to crowdfunded investing & how to not lose your shirt

Dandrew Media, LLC

Copyright © 2015 Dandrew Media, LLC

First Edition

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ISBN-13: 978-0-9965690-2-6

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CONTENTS

Introduction: The Volatile Market . . . . . . . . . . . . . . . . . 1

Chapter 1: Real Estate Crowdfunding . . . . . . . . . . . . 3The Loss of Purchasing Power . . . . . . . . . . . . . . . . . . . . . . . 4

Residential Real Estate Issues . . . . . . . . . . . . . . . . . . . . . . . . 4

Commercial Real Estate Realities . . . . . . . . . . . . . . . . . . . . . 6

The Opportunities Available . . . . . . . . . . . . . . . . . . . . . . . . . 7

The Importance of Stabilized Properties . . . . . . . . . . . . . . . 9

Chapter 2: Types of Commercial Assets . . . . . . . . . . 9The Trick with Value Added Properties . . . . . . . . . . . . . . . 10

Opportunistic Properties Defined . . . . . . . . . . . . . . . . . . . . 11

The Exit Strategy for Opportunistic Properties . . . . . . . . 13

Chapter 3: Distressed Assets in Real Estate . . . . . . . 15Core Reasons for Commercial Real Estate Stress . . . . . . . 16

Why Good Deals Go Bad: Distressed Assets . . . . . . . . . . . 17

The Distressed Asset Lifecycle . . . . . . . . . . . . . . . . . . . . . . 18

Commercial Real Estate: The Whole Loan Matrix . . . . . . 20

Monetary and Non-Monetary Loan Defaults . . . . . . . . . . 23

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Chapter 4: Defaults and Disclosures . . . . . . . . . . . . 23Senior Loan Default Information . . . . . . . . . . . . . . . . . . . . 24

Distressed Asset Foreclosure . . . . . . . . . . . . . . . . . . . . . . . . 25

Distressed Asset Bankruptcy . . . . . . . . . . . . . . . . . . . . . . . . 27

Why REO Properties Must Be Sold . . . . . . . . . . . . . . . . . . 29

Chapter 5: Buying & Selling Commercial REO . . . . 29Where to Find These REO Properties . . . . . . . . . . . . . . . . . 30

How to Sell Commercial REO & the White Knight . . . . . 32

Capital Structures & the Mezzanine Lender . . . . . . . . . . . 33

The Five-Step Pre-Qualification Process . . . . . . . . . . . . . . 37

Chapter 6: Asset Classes & Types of Deals . . . . . . . 37Industrial & Multifamily Properties Explored . . . . . . . . . 39

Three Classes, Three Categories of Office Property . . . . . 40

Buying Retail Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

Rehab or Repositioning: Property Types . . . . . . . . . . . . . . 43

Chapter 7: Value Added Deals . . . . . . . . . . . . . . . . 43Value Added Deals & Investments . . . . . . . . . . . . . . . . . . . 44

Decisions and Critical Checklists . . . . . . . . . . . . . . . . . . . . 46

Incentives and Penalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

Chapter 8: Stabilized Assets: Analyzing the Deal . . 49Easily Analyzing Your Deal: NOI, Cash Flow, and Net Cash Flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

Easily Analyzing Your Deal: Rent Roll . . . . . . . . . . . . . . . . 50

Working With Lease Types and Operating Statements . . 51

Strategies to Maximize Profit & Minimize Risk . . . . . . . . 52

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Chapter 9: Questions and Structuring Your Deal . . 55Distressed Asset Questions . . . . . . . . . . . . . . . . . . . . . . . . . 56

Non-Performing Note Sales Facts . . . . . . . . . . . . . . . . . . . . 56

Types of Loan Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57

Minimizing Risk During Sales. . . . . . . . . . . . . . . . . . . . . . . 58

Chapter 10: 10 Questions to Real Estate Crowdfunding Success . . . . . . . . . . . . . . . . . . . . . . . 59

Questions 1–3: Personal Investment, Fees, and Exit Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

Questions 4–6: Smaller Investors, Money, and Operator’s Experience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

Questions 7–8: Overpaying on the Asset and Leverage . 62

Questions 9–10: Assets and Partner Transparency . . . . . . 63

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67

There is a new form of real estate investing that is taking the international market by storm. It is called real estate

crowdfunding, and it offers investors like you the opportunity to become part of large real estate deals without the risk of having to make a large investment.

If you have noticed the ever-increasing volatility of the stock market, you are not alone. These low interest rates do not seem to be improving any time soon. Worse yet is that you are slowly coming to terms with the fact that you will not be able to retire on your savings with interest rates below 1%, a real rock bottom return.

When the Obama Administration instituted the JOBS Act early in 2015, it changed some fundamental details for the private investor. You are now able to invest in private entities with less money for the first time since the Securities Exchange Act of 1934, created to protect the investing public.

INTRODUCTION

THE VOLATILE MARKET

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Removing these barriers to investment is incredible, but it also means that less sophisticated investors will be preyed upon by many in the financial and real estate industries. If you have been looking to invest in real estate syndication or crowdfunded real estate deals, you will need a lot of guidance on how it works so that you can sidestep the major pitfalls.

I know what you are searching for: yield! You want monthly coupons to supplement your existing retirement accounts. It is an unfortunate reality that the persistently low interest rates over the last 10 years have robbed you of your savings.

Plus, the Federal Reserve has been forcing private investors like you to buy riskier assets that you do not understand, like those in the equity market. If you are close to pensioner age or have already begun to collect your pension, the urgency is there to do what you can with the small amount of investment money you have left. Saving it is not an option anymore.

You are being poorly served by the asset management industry! As a private investor, you are far better off being served by small, unlisted, private partnerships than by global, publicly listed, full-service investment brands. This book offers you the opportunity to educate yourself on real estate crowdfunding.

That way, you will make smarter decisions than 90% of other private investors that never stop to perform their due diligence in the niche. Your money matters. This book will give you all the confidence you need when making tough decisions on future real estate crowdfunding deals. Learn to ask the right questions, and become a shrewd private investor.

Real estate crowdfunding1 brings together the investment potential of real estate with the funding flexibility of

crowdfunding as we know it today. In other words, you now have access to vast networks of people interested in pooling small investments together from multiple private investors in order to fund lucrative real estate deals.

For you, the soon-to-be retiree, real estate crowdfunding represents an amazing opportunity to get in on deals you would never have known about in order to earn those monthly dividends that you have been lacking from your retirement portfolio. Compared to many of the other investment classes, this is a relatively low-risk plan.

1 Brian O’Connell, Real Estate and Crowdfunding: A New Path for Investors, http://www.investopedia.com/articles/investing/072514/real-estate-and-crowdfunding-new-path-investors.asp

CHAPTER 1

REAL ESTATE CROWDFUNDING

“Now, one thing I tell everyone is learn about real estate. Repeat after me: real estate provides the highest

returns, the greatest values and the least risk.”Armstrong Williams

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The Loss of Purchasing PowerHere is a fact for you: Retirees today are poorer than retirees back in 1979, thanks in large part to the persistent lack of purchasing power that has developed over the years. The declining strength of our currency has impacted every retiree in America. It is time to calculate a real interest rate by subtracting this ongoing inflation!

Prices continue to rise as your purchasing power has plummeted all the way up to your retirement. The fact is that your dollar is buying less, and your savings are not growing at all. With an interest rate of virtually zero, for every year that passes, you lose your life savings. Any wise pensioner has already realized that something needs to be done.

Back in 19792 the average pensioner with $100,000 in savings earned enough to support a good middle-class lifestyle while maintaining their capital integrity. Now a million dollars in savings does not earn enough in real interest to pay so much as a gas bill. To lead a middle-class life on this kind of equation means that you would need a hundred million dollars!

With hyperinflation, the price of capital has gone up by 1,100 times in just 35 years. Capital, therefore, is no longer producing for conservative investors. Saving is sitting, and in this volatile market, riskier action needs to be taken to secure your financial future.

Residential Real Estate IssuesSmart real estate crowdfunding3 begins and ends with understanding and orientation. You are already a retiree or are

2 Keith Weiner, Yield Purchasing Power: $100M Today Matches $100K in 1979, http://www.zerohedge.com/news/2015-08-05/yield-purchasing-power-100m-today-matches-100k-19793 Chance Barnett, SEC Democratizes Equity Crowdfunding With JOBS Act Title IV, http://www.forbes.com/sites/chancebarnett/2015/03/26/infographic-sec-democratizes-equity-crowdfunding-with-jobs-act-title-iv/

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soon to be, and so your private investments need to be as low risk as possible. You have already entered the “dissemination” portion of your financial plan, which means that you will want to be as conservative as you can while making the right risk decisions.

That is why the first thing that you need to know is the difference between residential and commercial real estate crowdfunding. Residential real estate may not be an ideal investment for private investors that are looking to earn back decent monthly coupons. There are many reasons why residential real estate is not a viable choice for you.

The residential niche is littered with small-time sellers, and it takes a lot of work to organize and pool these sales. Then you have the emotional problems that inevitably come with the deal; these are rife in the residential niche. It makes far more sense to keep emotions out of these deals and ensure that they are managed through competent companies.

Residential real estate also boasts a very hostile lender and regulatory environment. There is a good chance that at some point, you will come across a predatory lender that uses your situation for their own gains. The last thing that you want to deal with is numerous lenders and companies dealing with small residential sales; these can get tricky.

The residential real estate crowdfunding niche also has a low barrier of entry, which means that the market is flooded with loads of investors chasing the same deals. This high competition ratio is made even more complex now that so many inexperienced private investors are trying their hand in the market.

As a result, residential property sales can be very fragmented and inefficient. As a retiree, you want to target the deals that will earn you a consistent, reliable income, and that only comes with investment into the commercial real estate niche.

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Commercial Real Estate RealitiesAs a retiree, you would be wise to choose a commercial real estate crowdfunding deal. Traditionally, these deals were only accessible to people with a specific net worth ratio, who were then able to invest in these large deals to earn a lot of money in returns.

With the new JOBS Act, anyone with as little as $5,000 can invest in these deals and collect good returns. The key difference between residential real estate and commercial real estate is that the latter tends to attract professional dealmakers because of the profit potential, players, and deal size.

When you partner with these professional dealmakers, things tend to go smoothly. There are no emotions involved, and the deals move from one goal to the next until they are signed and sealed. There is far less trouble and far lower risk involved for the new investor.

Another excellent benefit is that you do not have “buyer beware” legal issues all over your deal. There is no dealing with HOOPA/RESPA Acts,4 which were put in place to protect consumers from predatory mortgage lenders that would charge them high settlement fees. This act is full of rules and can slow down and stall your average residential deal.

The more people involved, the higher the chance of your residential deal going south. With commercial properties, everything is controlled by a company and dedicated professionals that are used to handling large deals and tough negotiations.

The reality of commercial real estate is that it has always been the most lucrative area in real estate to invest in. It attracts serious players with serious money. Because of this, it is way

4 RESPA – Real Estate Settlement Procedures Act, http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/rmra/res/respa_hm

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more efficient at wealth creation, which is what you want. At the end of the day, your goal is to invest for returns. And your money is better placed in a commercial deal for that reason.

The Opportunities AvailableWhen you begin to seek out real estate crowdfunding deals, you will be offered a wide range of choices—from residential to commercial and even industrial properties. Deciding to limit your investment to purely commercial deals will be the best decision you can make.

Commercial real estate5 is a proven asset class, with strong returns that can be traced back over decades and decades of research, despite fluctuating markets. Shopping centers, industrial facilities, and office buildings make up 11% of the property market, and this will continue to grow steadily in the coming years.

Commercial real estate also happens to generate regular cash flow from rental income, making it a high-value investment. If the economy is doing well in that area, the buildings may even appreciate in value, adding capital to your existing investment.

Most crowdfunding platforms focus on the individual investor—big mistake. Those companies that have chosen to partner with institutional investors to co-invest in large commercial real estate deals are enjoying the same terms and returns while leveraging their partners’ experience in the industry. Being a commercial real estate investor has never been this easy or this rewarding—if you know how to select your deals.

5 Jordan Sale, Four Reasons Why Commercial Real Estate Is the Optimal Crowdfunding Investment, https://fundrise.com/education/blog-posts/four-reasons-why-commercial-real-estate-is-the-optimal-crowdfunding-investm

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Without the threat of capital calls, you can safely place your money into a commercial real estate investment deal. All that remains thereafter is for the building to be built and your returns to start rolling in at the agreed upon rate. While one of these commercial real estate pools may contain thousands of investors, each will get their regular return.

This makes commercial real estate crowdfunding an incredible opportunity for retiree private investors with small amounts to invest to create another income stream without compromising their invested capital. This means long-term coupons, which will successfully supplement your dwindling retirement savings.

There are various types of commercial assets that you can choose to invest in. Typically, there are four main classes:

office properties, retail properties, industrial properties, and multi-family properties. These commercial property types are prized because they all produce consistent income streams, which is what you want.

Before you decide which type of commercial asset to invest in, you need to know more about each class and how these property assets are commonly bought, built, and sold. There are many ways that you can purchase these properties. First, let’s explore the financing possibilities behind them.

The Importance of Stabilized PropertiesA stabilized property6 can be defined as a property where the

6 Stabilized Occupancy, http://financial-dictionary.thefreedictionary.com/stabilized+occupancy

CHAPTER 2

TYPES OF COMMERCIAL ASSETS

“Real estate investing, even on a very small scale, remains a tried and true means of building an

individual’s cash flow and wealth.”Robert Kiyosaki

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occupancy levels are reached by that property after the initial lease-up period is over. For a property to be considered as “stabilized,” it needs monthly rates that are similar to other properties on the market.

For example, if market occupancy is 92% and the average private pay rate is $3,500 a month, and if your property has an occupancy of 93% with a $3,400 income, it would be considered a stabilized property.

With stabilized properties, you need permanent financing, and most of it has to be assumable. That means you need a finance arrangement7 in which the outstanding mortgage and its terms can be transferred from the current owner to a buyer.

Your stabilized property also needs to be fully leased and should need no additional work done on it before the sale. That is what defines “stabilized”—a ready-made commercial property for investment.

You will not have to grow or groom your net operating income (NOI), because of the bond replacement possibilities involved with this deal. A stabilized property is an easy commercial property to invest in and is relatively low risk.

The Trick with Value Added PropertiesUnstabilized or value added properties are a little different. Instead of being ready for sale like stabilized properties, these require improvements that will enhance the value and ultimately increase the cash flow of the property.

There are plenty of real estate investors that target these properties because the potential for profit is high with the right expertise. Value added8 in this case quite literally means the enhancement that a company gives its product or service

7 Assumable Mortgage, http://www.investopedia.com/terms/a/assumablemortgage.asp8 Value Added, http://www.investopedia.com/terms/v/valueadded.asp

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before offering it to the customer. In this case, the product is a building, and the customers are the renters.

With these unstabilized properties, you need a shorter term or floating rate financing. This means that you will need a floating interest rate, a type of debt instrument like a loan or mortgage that does not have a fixed rate9 of interest over the life of the instrument.

Many of these unstabilized properties are not fully leased yet, or their rents are not at market. This poses an opportunity for the wise investor to transform a property that needs work into a stabilized, income-earning asset.

There is a certain degree of risk, definitely higher than direct investment in a stabilized property, because improvements need to be made. While you may be able to pick up a building for less, you will also have to take steps to convert that property into the kind of income-earning asset you need.

Something good does need to happen with this particular asset class. You need to partner with experts for their knowledge on transforming these properties into what you want. If you can find an educated company that does this well, many successful deals could result.

These value added properties often require a key event to convert them into a usable long-term income-earning asset. Do not invest in these without the right partners or expert information, or you may find yourself with an unstable asset that struggles to earn for you.

Opportunistic Properties DefinedAn opportunistic property, on the other hand, moves away from the core income approach to a capital appreciation approach instead. It is common for opportunistic real estate to be accessed through real estate opportunity funds, also called

9 Floating Interest Rate, https://en.wikipedia.org/wiki/Floating_interest_rate

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private real estate equity, or PERE. Much of the return from these comes from value appreciation.

The reason why it is called opportunistic10 real estate is because of the nature of the deal. These property investors will pursue an event that will result in the real estate being dramatically revalued—often from the development of raw property. It can also result from the general redevelopment of property or by purchasing an area of renewal.

These investments require specialized financing, which is why you need to make sure that you seek out the correct partners that have done this many times before. Leverage is often also included to enhance the total returns of the deal. You will need to determine your return expectations by calculating with the right percentile ranges.

Investing in a pool with a solid core portfolio with returns between 8.3–19% sounds right. Value added returns fluctuate because they are not stable, but you should aim for a range that reaches between the 75th and 95th percentile.

Your opportunistic properties will have negative reported returns at first; the capital will be deployed for development, and it should escalate your returns to within the higher percentile ranges again. These must be acknowledged so that you earn a stable, consistent income from your real estate crowdfunding pursuits.

Opportunistic real estate deals may have the highest potential for low investment, high return income. While it is a non-core strategy, there is a strong chance the real estate company you have partnered with does this professionally and knows exactly how to transform a low occupancy building into a high occupancy building.

10 Danielle Silva, A Look at Opportunistic and Value Added, http://www.brightonhouseassociates.com/web/a-look-at-opportunistic-and-value-added/

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They will also ensure that there are adequate exit strategies in place should anything happen during the deal. These are essential to review when considering opportunistic deals.

The Exit Strategy for Opportunistic PropertiesYou will soon realize that a competent opportunistic deal comes with a clean set of exit strategies that will help lower the risk involved in this type of investment. Exit strategies traditionally require residential sale exits or the ability to develop the property— placing it under construction until it is once again ready for market.

The risk is high11 at this point, and a number of good things need to happen in order for the deal to be successful. You need to make sure that your partners are ready and willing to manage the concerns that the building has in order to revamp it into something that will earn the projected amount of income they have stipulated.

That means extensive renovations are part of the deal. For a commercial building, this can mean a total facelift, with millions invested in the revamp, or it can mean some minor touchups to get what should be a bustling, popular building back in shape for customers. This requires extensive planning because of the existing occupants in the building.

The goal is to keep disruptions to a minimum while serving the needs of the investors, which is to target and acquire that stable income resource. Change of use also needs to be considered. This is when a building is converted from having one purpose to having another purpose, like converting a theater into a shopping mall.

11 Nick Ryan, Recapitalization: An Efficient Way to Invest in Multi-Family Properties, http://www.rejournals.com/2014/11/12/recapitalization-an-efficient-way-to-invest-in-multi-family-properties/

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Many urban redevelopment programs have buildings that are waiting for investors to revamp and change the use for the general population based on what will work. Opportunistic properties also need commercial exits, meaning that the company you partner with must manage the property portfolio from completion to exit, with regular reviews and valuations.

Again, this can be a risky business—but far less so for experienced individuals with the right expertise. Many good things need to happen in order for these deals to be successful. This is why these are some of the highest risk deals in commercial real estate.

A distressed asset12 is usually put on sale at a somewhat cheaper price than what it is actually worth because the

owner has been forced to sell it. Understanding why assets end up distressed in the commercial real estate niche will help you make educated decisions about where to invest your money.

Also called troubled assets, these commercial properties arise as a result of a sluggish economy, and companies are then forced to sell to optimize their existing portfolios. For the investor looking for a great deal, opportunity exists here.

12 Definition of Distressed Asset, http://lexicon.ft.com/Term?term=distressed-asset

CHAPTER 3

DISTRESSED ASSETS IN REAL ESTATE

“Certainly the advent of technology and electronic commerce has had an immense

impact on the real estate industry.” Michael Oxley

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Core Reasons for Commercial Real Estate StressI would have to say the most common reason why commercial real estate becomes distressed is due to debt. Some 40% of the distressed commercial asset market, in fact, exists as a direct result of debt mishandling.

What this means is that some of these properties might have maturity defaults,13 whereby the borrower under a mortgage loan has failed to pay the lender their balloon payment or principal balance when it is due.

Term defaults are also reasonably common, which is when the debtor has failed to meet their legal obligation of debt repayment for the loan term agreed upon. Third-party stress and bank regulatory stress are another two concerns that plague borrowers.

The asset itself is also the reason why distress happens 30% of the time. This is when the buyer has miscalculated and has purchased an unattractive asset that is expensive and difficult to rehab. After going through the deal, they may find that those key events that needed to happen did not, and now they are left with an unstable asset.

Missing leasing opportunities with key tenants and having serious occupancy problems are usually what result in distress. The sponsor or operator of the company may be inexperienced or weak, with absentee owners leaving inexperienced staff to run the company. This is the cause of 20% of the distressed commercial asset market.

Finally, equity issues consume 10% of the market. Some equity holders pull out, and subordinated equity defaults happen, along with preferred equity concerns. All of these reasons result in stress for real estate commercial developers.

13 Michael Sternlieb, Maturity Default, http://www.realestateandconstructionlawmonitor.com/2009/03/articles/real-estate/finance/maturity-default/

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Why Good Deals Go Bad: Distressed AssetsWhen a good deal is struck with a company in distress, there are many reasons why a deal of this nature might fall through. It is important that you understand what could happen after you have decided to invest in distressed commercial assets.

The first reason why deals fall through is because of bad sponsors or borrowers. Serious real estate players understand that when a deal is on the rocks, negotiation or writing another check is the only thing that will save it. If there are bad sponsors involved, however, a lot can go awry. The moment the market turns down, bad sponsors want more money.

You need to be comfortable14 with the valuation, the exit strategy, and the sponsor’s numbers along with the risk that you are assuming. If you become uncomfortable at any time, you can always pull out. Sometimes deals will become so tricky with these difficult sponsors that a long time will go by, changing various projections and estimates.

This can prevent a deal from being closed. When a sponsor allows a lot of time to go by, there is a strong chance that the deal will fall through. Another common issue with these distressed asset deals is that costs can be underestimated. With the more inexperienced companies, this is often a good reason for a deal to cave in.

With incorrect cost estimated, the returns are all wrong, the capital investment required is all wrong, and the deal will go south. Key leasing or the sale itself did not generate pro forma revenues as projected. When this happens, the deal might be canceled to prevent further losses on the side of the investor.

A few other reasons that you should know about include property that has been overleveraged and is no longer viable;

14 Joshua Stein, What Happens When a Crowdfunded Deal Goes Bad?, http://commercialobserver.com/2015/07/what-happens-when-a-crowdfunded-deal-goes-bad/

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changing market conditions, which always impact projections and estimates; and, of course, a rise in interest rates, which would affect the returns outlined in the deal.

The Distressed Asset LifecycleThe next step in your commercial crowdfunding education is to learn about the various stages of the distressed asset lifecycle. This lifecycle15 is useful to understand because it is also a prime indicator of risk. Typically, risk rises as you move further down the lifecycle, increasing over time.

• A performing loan: This is a well-serviced loan that has no problems.

• Sub-performing loan: The lender gets out early as the borrower has begun to pay intermittently or irregularly or is skipping payments. There may be document deficiencies and “scratch and dent” concerns.

• A non-performing loan: Most note sales happen during this stage of the distressed asset lifecycle. It is also the stage where the most risk is absorbed because the borrower can still file for bankruptcy.

15 Commercial Real Estate Triage Financier, http://www.dandrewmedia.com/wp-content/uploads/2015/05/The-Distressed-Asset-Lifecycle.pdf

Performing Loan

Sub-performing

Loan

Non-performing

Loan

Lender Has Filed For

Foreclosure

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• Lender has filed for foreclosure: Note sales happen during this time. It is when you get the deepest discounts. The buyer inherits the good, the bad, and everything in between from the lender. The lender’s reps and warranties are important here.

• Bankruptcy period: This is the borrower’s last chance. The lender risks time delays and possible cram downs.

• Foreclosure: The borrower can buy back the note, but this does not happen often. This is also known as the redemption period.

• REO: This is when the asset is sold. It has a clean title and the least risk. It has the highest purchase price in this distressed asset lifecycle because the asset is considered clean. A cleansed asset is ready to be resold for profit.

For the investor that is looking to pool with other investors and lenders, understanding at which stage your commercial property is in can help you make the right choices about whether or not to invest. Sometimes deals that seem simple can become complicated and vice versa, so orientation and understanding of due diligence is always a requirement.

Lender Has Filed For

Foreclosure

Bankruptcy Period

Foreclosure Sale Final REO

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Commercial Real Estate: The Whole Loan MatrixNow that you understand the distressed asset lifecycle, you need to know what kind of partners you will link up with as you search for viable commercial crowdfunding deals. That means understanding the risk when partnering with each and what your projected loan-to-value ratios (LTV) might be if you use them as a lender in your deal.

A whole loan16 pertains to a single or commercial mortgage that a lender has issued to the borrower that has not been securitized. Whole loan lenders sell their whole loans in the secondary mortgage market to big buyers like Fannie Mae.

• Equity investors are at the top of the list, with an LTV of between 75–95%. These investors generally have the “first loss piece” of the transaction and the uncapped upside. (A first loss policy is a type of partial insurance.)

• Opportunistic lenders are second on the risk scale, with an LTV of between 80–95%. Lenders that hold whole loans on a balance sheet fit into this category. It can include opportunity funds, finance companies, mezzanine lenders, and mortgage REITs.

• Conduit lenders are next with an LTV between 75–80%. They are also known as securitized lenders. They tend to aggregate loans and then repackage them as rated bonds or securities.

• Banks are second to last, with an LTV of between 70–75%. This includes local banks, regional banks, and money center banks. Most of these banks, however, will no longer portfolio 10-year loans.

16 Whole Loan, http://www.investopedia.com/terms/w/wholeloan.asp

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• Life insurance companies are last, with an LTV between 60–75%. These companies are considered the most conservative underwriters of all.

The loan to value ratio17 is a financial term that is used by lenders to express the ratio of a loan to the value of the commercial asset they have just purchased. For example, if someone borrows $130,000 to buy a house worth $150,000, the LTV ratio is $130,000/$150,000, or 87%. The higher the LTV ratio, the riskier the loan for the lender.

As you can see, equity investors and opportunistic lenders take the highest risks when lending money because they expect to see larger returns. It has always been this way; the bigger the risk, the higher the potential for a sizable return.

17 Loan-To-Value Ratio, https://en.wikipedia.org/wiki/Loan-to-value_ratio

In this chapter, you will learn about defaults and disclosures. You need to know this information in order take advantage of

deals that are primed to earn you money. From monetary and non-monetary loan defaults to distressed asset information that will help you make good decisions, this is not an area to skip over.

Fully understanding the loan process and how loans become distressed asset sales will show you how to take advantage of commercial properties in a specific transition phase so that you can get the most returns for your investment money.

Monetary and Non-Monetary Loan DefaultsThere are two basic types of loan default: monetary and non-monetary. Getting a fair grounding in these will add to your

CHAPTER 4

DEFAULTS AND DISCLOSURES“In the real estate business, you learn more about

people, and you learn more about community issues, you learn more about life, you learn more about

the impact of government, probably than any other profession that I know of.”

Johnny Isakson

24

growing arsenal of crowdfunding knowledge. All defaults have time for the borrower to fix or cure the problem; these are known as “cure periods.”

A monetary default18 is a default for non-payment of a principal or of interest. These are more serious defaults and will often trigger foreclosure. When a borrower fails to pay the noteholder, this default is initiated.

A non-monetary default is also known as a technical default. It applies to things like not seeking appropriate lender approval on key decisions or not providing information in a timely manner.

These involve the borrower taking some action that is prohibited or their failure to take action, which is required by the lengthy rules that appear in the loan documents. Loan agreements sometimes require more from the noteholder when non-monetary defaults occur than when monetary defaults do.

It is possible to convert non-monetary defaults into monetary defaults, although it often requires a lot of extra time, effort, and money.

Senior Loan Default InformationA senior loan19 is a floating rate instrument that provides a natural hedge against rising interest rates. They are often secured by a first priority lien on a borrower’s assets, which results in higher recoveries than unsecured corporate bonds.

A senior loan default happens when this loan is not paid. Fortunately, it is a secured loan, and so the lender is able to begin the distressed asset process to claim the property that was put up as security for the loan initially.

18 Keith Mullen, Loan Defaults – Monetary vs. Non- Monetary, http://www.lenders360blog.com/2009/05/loan-defaults-monetary-vs-non-monetary/19 Senior Bank Loan, http://www.investopedia.com/terms/s/senior-bank-loan.asp

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Senior lenders have the most control over this process. They drive the “workout” process, which takes the borrower through a number of steps. The process usually follows a typical set of predictable outcomes and leads to bankruptcy.

• Forbearance agreement: This is a special agreement between the lender and the borrower, which delays foreclosure. The literal meaning of the word “forbearance” is “holding back,” so loan borrowers can invoke this agreement to buy more time when they have payment problems.

• Loan restructure: When a loan is restructured, a new loan replaces the outstanding balance on an older loan, and it is often paid over a longer time period with lower installment rates. This is done to accommodate a borrower in financial distress and is used to avoid a default.

• Deed in lieu of foreclosure: This is another financial instrument in which the borrower conveys all interest in a real property to the lender to satisfy a loan that is in default to avoid foreclosure proceedings.

• Foreclosure: This is the legal process in which a lender attempts to recover the balance of their loan from the borrower that has defaulted on their monetary agreement. The lender will force the sale of the asset, which was placed as collateral for the loan.

• Bankruptcy: The legal status of a person or company that cannot repay the debts it owes to its creditors, this is imposed by court order and is often initiated by the debtor.

Distressed Asset ForeclosureWhen a borrower reaches the point where they are in foreclosure, many things happen. When a distressed asset

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foreclosure is invoked, it wipes out all liens and claims on the property. This means that a new buyer can step in and offer the lender a fair fee for the property before it goes up for auction.

Without liens and claims, the bank or the lender involved is then free to sell the house to the highest bidder to reclaim their loan money. There are two types of foreclosure, namely judicial and non-judicial foreclosure.

As implied, the judicial foreclosure20 goes through the court system, while the non-judicial foreclosure does not. Some states insist that all foreclosures must be judicial, while others create a set of procedures for non-judicial foreclosure proceedings. The type in question impacts how the borrower can defend against the foreclosure sale of their property.

Within six months of a judicial foreclosure, for example, if the property has been abandoned, the redemption period becomes 30 days. This is not so with non-judicial foreclosures and not if the mortgage or deed of trust waives the right to redeem. The redemption period is a specific time period in which the borrower can buy back their property.

One such foreclosure strategy involves “bidding in”’ the loan, or credit bidding. A credit bid21 happens when the lender needs to sell the property after foreclosure. A buyer will approach the lender and prove that they have substantial cash available for a large down payment on the property.

If the buyer bids to win, they will need cash to complete the sale. Often buyers are not willing to pay enough money at the auction to satisfy the entire outstanding loan to the bank. When this happens, the lender bids in the amount that is owed and secured by the property. Bidding in the amount

20 Judicial vs. Nonjudicial Foreclosure, http://www.nolo.com/legal-encyclopedia/judicial-v-nonjudicial-foreclosure21 What Is a Credit Bid?, http://www.drescherlaw.com/faqs/what-is-a-credit-bid.cfm

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owed by the bank or bidding in cash as an outside buyer is known as credit bidding. There are also tax liens and trade liens to be aware of at this time.

Distressed Asset BankruptcyWhat happens if the borrower files for bankruptcy? What becomes of these distressed assets? Sometimes you will find that a borrower only files for bankruptcy to avoid foreclosure and to buy enough time to source new financing and reclaim their commercial property.

This is usually governed by a set of strict state and federal laws. The outcomes of a bankruptcy case largely depend on the judge that has been placed in charge of the case. For the lender, this can become difficult because there is no way that they can negotiate away a borrower’s right to declare bankruptcy.

This will free up the property for sale by the lender, but there is always a waiting period. The recurring takeaways from this process that we have learned will help you navigate your investment decisions. First, borrowers try to show that their property has equity and value. At the same time, the lender tries to show that the asset has no equity.

This way they can speed the property into the foreclosure process. The lender will try to consolidate all secured creditors to vote against the bankruptcy filing. They may even offer the borrower incentives not to file for bankruptcy, like a post foreclosure purchase option.

Some terms that you should understand include:

• Special purpose entity (SPE): An SPE22 is a legal entity created for one limited task, which is to isolate risk. SPEs

22 Special Purpose Entity/Vehicle, http://www.investopedia.com/video/play/special-purpose-entityvehicle/

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are set up to acquire or finance specific assets while the parent corporation is protected in case of bankruptcy, loan defaults, or loss.

• Real Project Equity: This is when the project has real equity investment and this can be proven.

• Bankruptcy Plan: A repayment plan that is put in place to help the borrower pay back what they owe the bank over the next five years, bankruptcies delay property sales, which is why they are not ideal.

• Motion to Lift Stay: If a lender wants to continue to collect from the borrower during bankruptcy, they can seek permission from the court to do so. This is known as “lifting” the automatic stay. A motion needs to be filed for this to happen.

REO, or real estate owned, properties is a term that is used to describe a specific class of property that is owned by a

lender. These lenders are usually one of the several we have already named. A commercial property becomes an REO sale after the unsuccessful sale of that building at a foreclosure auction.

Commercial REO properties can be picked up at a greatly reduced capital investment, revamped, and converted into income-earning assets. This is what many companies are doing to keep investment costs low, returns high, and their investors happy.

Why REO Properties Must Be SoldAn REO property is a property that has been taken back by the lender at the foreclosure auction. Because lenders need

CHAPTER 5

BUYING & SELLING COMMERCIAL REO

“Real estate is the key cost of physical retailers. That’s why there’s the old saw: location, location, location.”

Jeff Bezos

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free cash to lend and invest, they cannot afford to sustain large, regulated REO portfolios.

When the lender or bank is the highest bidder23 at the foreclosure auction and no third party bids on the property, it reverts back to the lender and becomes an REO property. Once the bank or lender has secured the property, most outstanding debts and liens are expunged.

That means that a third party can step in and buy a commercial REO for a great price. Since 2007 many large non-regulated lenders cannot afford to have large REOs on their books. They are desperate to sell these properties fast and to convert the assets into cash.

Free cash is far more valuable to a lender than a standing commercial asset that is not supporting itself or generating any kind of income. These lenders want to get rid of these REO properties quickly, which means plenty of opportunity for investors and their partners.

The buying and selling of commercial REO properties is big business but more so for retirees that are looking to invest small amounts into a crowdfunded real estate pool. Converting these into viable income-earning properties will get you the income you desire.

Where to Find These REO PropertiesThere are a number of locations where the educated investor and their partners might gain access to these REO properties. Timing is very important, along with the viability that the building will be easily converted into an income-earning asset.

23 Bank-Owned Properties and REO (FAQS), http://www.realtytrac.com/real-estate-guides/how-to-buy-foreclosures/bank-owned-homes/bank-owned-reo-property-faqs/

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You will find REO commercial properties available through negotiated sales.24 This process includes a limited number of potential buyers and includes one interested party that has a high probability of closing the transaction. These sales are kept confidential, and they are efficient and speedy—between your pool and the lenders involved.

It is also common to attend REO auctions, which are strategically run by the lenders and banks in your area. Approaching private lenders and smaller banks and asking them when their commercial REO properties are coming up for sale will put you ahead of the pack. There is always one person at the lender that is in charge of their REO properties.

Then there are absolute auctions,25 a type of auction where the sale is awarded to the highest bidder on the day. There is usually no reserve price, which sets a minimum required bid for the property. When a foreclosed property goes to absolute auction, the winning bid acquires that property as soon as they pay for it.

This is in contrast to the lender confirmation auctions, where the lender must approve the bid in order for the transaction to be complete. You could also end up at an “as is, where is” auction, which is when the lender sells you the property “as is.” As the buyer, you then inherit all of the physical and legal conditions of the foreclosed property.

There are dangers with these purchases as you may find that squatters have taken up residence in an abandoned shopping mall or that the property is located next to a cemetery, which causes devaluation over time. This is why due diligence is so important and why you need to review any investment you make in REO thoroughly throughout the process.

24 Negotiated Sale, https://www.divestopedia.com/definition/882/negotiated-sale25 Absolute Auction, http://www.investopedia.com/terms/a/absolute-auction.asp

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How to Sell Commercial REO & the White KnightSelling commercial REO properties is all about financing. Usually the lender provides financing to a buyer, or they list with a broker, which is the traditional way to sell. These distressed assets often end up in mortgage pools that are managed by fund managers that collect individual, private investor capital for use in the purchase and rehab process.

Anyone can buy REO26 properties, it is true. So where does the real opportunity lie for conservative, low-risk, high-return investors that are already in retirement? The answer lies in the White Knight method of brokering REO sales.

This is when a third party “savior” enters the transaction at the 11th hour to help with the negotiated settlement between the lender and borrower. The borrower is desperate to keep their property and needs financial investment to do so. The lender needs to sell the property quickly to recover costs. In steps the White Knight broker.

This kind of broker steps in as a new equity partner, or they negotiate lender profit participation or ownership interest. Either way, this intelligent broker sidesteps the hassles involved with traditional REO buying and selling and instead earns money by helping people in need. The end result is happy lenders, happy borrowers, and income for the broker.

If the broker has managed to invest in the commercial property, it will continue to generate coupons for them and their mortgage investment pool. Plus, the REO buyer helps the lender get their asset off the books. The goal is to step in and facilitate the sale, offering finance, expertise, and a proven rehab process to convert the property into a viable one.

26 Maureen O’Toole, Listing and Selling REO Properties, https://support.propertyradar.com/hc/en-us/articles/204173330-Listing-and-Selling-REO-Properties

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The White Knight strategy works exceedingly well in the field of commercial REO real estate crowdfunding. You pool your investment with many other people, placing it in the hands of a White Knight broker with an eye for REO properties. They find the deals and convert your investment capital into long-term income generation.

Capital Structures & the Mezzanine LenderYou need to know about the capital structure used and how it works if you are going to become a commercial real estate investor at the crowdfunding level.

Product Collateral Repayment Preference Remedies

First Trust Debt First Trust Deed First Priority Foreclosure of Collateral

Mezzanine “Junior Mortgages” “Participating Debt/Equity”

Collateralized by an assignment of Partnership interests. If a default occurs on the mezzanine loan, the lender can step into the shoes of the general partner.

Repayment preference. The mezzanine debt is paid after the first debt is repaid and before the equity is repaid.

Default remedies: The mezzanine loan will pay off the first trust loan and become the senior lender or assume the first trust loan and keep the senior in place.

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Product Collateral Repayment Preference Remedies

Equity High Leverage Mezzanine Preferred Equity Pref Equity

The preferred equity investor is unsecured and relies on the Partnership Agreement to determine their rights/benefits.

Is the current or accrued pay rate that must be repaid (principal and interest) to the investor first prior to the return of capital.

In a preferred equity transaction, remedies involve the general partner, not the property. A typical remedy is the dilution of the General Partnership’s economic interests and their ability to manage/control the property.

Hard Money Bridge Loans Distressed Value-Add

First Trust Deed Low Loan-To-Value

First Priority Foreclosure of collateral, including any additionally cross collateralized assets.

Debtor in Possession Loans (DIP)

Super Priority First Trust Deed Senior to any mezzanine financing and any senior trust deeds in the capital structure

Absolute First Priority as mandated by the bankruptcy court

Foreclosure of collateral, wiping out any mezzanine and senior trust deeds

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Product Collateral Repayment Preference Remedies

Super Collateralized Loans (Super C) Triage Loans / LOCS

Very low LTV First Trust Debt (Less than 30%)

First Priority Foreclosure of collateral, including any additional cross collateralized assets

With mezzanine financing, debt capital gives lenders the right to convert to an ownership or equity interest if the borrower defaults. A mezzanine lender relies on an intercreditor agreement, and they will assume senior loan rights if they can. They must pay off senior loans if they do not have the right to assume the senior loan position.

Take a look at these two unique situations:

1. Senior Lien in default, Mezzanine Lien current. The mezzanine lender will foreclose on their partnership interest, and assume 1st lien OR the mezzanine lender will foreclose on their partnership and will pay off the 1st lien to own the asset.

2. Senior Lien current, Mezzanine Lien in default. The mezzanine lender has no option but to foreclose. If the Intercreditor Agreement allows, the mezzanine can assume senior lien status. If it does not allow it, the mezzanine is forced to pay off the senior lien.

In order for you to become a shrewd real estate crowdfunding investor, you need to understand, with depth, each of the

main commercial asset classes. To do this, you need to know what each of them are and what types of deals go hand in hand with them.

That means clearly defining each asset class, understanding how to find deals that include that class of asset, and knowing why they are important. When you do, you will be able to audit crowdfunded deals with a more certain eye and will be able to steer clear of deals that do not suit your best interest in the commercial real estate field.

The Five-Step Pre-Qualification ProcessThere is a five-step pre-qualification process that you need to understand when dealing with real estate crowdfunding

CHAPTER 6

ASSET CLASSES & TYPES OF DEALS

“Real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care, it is about

the safest investment in the world.” Franklin D. Roosevelt

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deals. These involve your many asset classes and the types of deals that you will end up making. Here is what you need to know.

• Current NOI (Net Operating Income27): The cash flow being thrown off by the asset. It is found on the property’s financial statement and tells you how the asset is performing, which is neatly expressed as a dollar figure.

• Proforma NOI (Target NOI): Also known as stabilized value, it is found on the property’s financial statement, and although is it an educated guess, it gives you an indication of what your borrower is trying to get to after repairs and improvements. This is represented as a dollar figure.

• Existing Debt Structure: This tells you how many loans are on the property and what their unpaid principal balances are. It is also found on the property’s financial statement; otherwise, ask the owner or current occupant for this information. It allows you to understand if the property is over leveraged or not and allows your fund manager to structure accordingly. It is expressed as a line position, loan amount, interest rate, and term.

• Sources and Uses: These show you where funds are coming from and how they will be used to improve the property. It should be found by your sponsor, who will tell you about it, and needs to be on an itemized list form from your borrower. It is expressed as a repair/improvement cost.

• Exit Strategy: Exit strategy details how your borrower intends on cashing you out. It needs to be communicated clearly on the executive summary and will allow you

27 Net Operating Income - NOI, http://www.investopedia.com/terms/n/noi.asp

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to understand if the deal is viable. It is expressed as a narrative.

Industrial & Multifamily Properties ExploredThe first asset class in commercial real estate belongs to industrial properties. The differentiating factors for industrial properties are:

Locations to major transportation routes. Look for ceiling heights—the higher, the better for more storage. Docks and bays are also great—bays for tractor trailers and docks for delivery trucks.

Rents on industrial properties are driven by supply and demand. It is difficult to drive price via asset quality, like investors might do with office and multifamily assets.

The second asset class is called a multifamily asset.28 These are the safest asset class because everyone needs a place to live, and sponsors can drive occupancy by lowering the rental if there are ever any problems. The multifamily drivers include the following:

• Vacancy factors, including the rent level and concessions (free rent, giveaways)

• There are two types of vacancy used to underwrite multifamily properties.• Actual vacancy is the amount of unoccupied space or

square feet.• Economic vacancy is the total vacancy when dark or

vacant units and concessions are taken into account.

28 Why Multi-Family Real Estate, http://venterraliving.com/investor_services/why_multi-family_real_estate

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The FORMULA for determining economic vacancy is this:

Total economic collection = total potential rent (full rent at 100% occupancy) – total rent collected. Then economic vacancy cost = total economic collection/total potential rent. Therefore economic vacancy = economic vacancy cost/total potential rent.

Three Classes, Three Categories of Office PropertyThe third asset class belongs to office properties. These are viewed in three classes and three categories. This is what you need to know.

• Class A: The newest, nicest, and best on the market• Class B: The 1970s vintage that does not have modern

features • Class C: The older, “unkempt” properties

• Urban: Downtown locations, typically with a high barrier to entry

• Suburban: Fewer barriers to entry but closer to employment bases

• Flex space: Mostly suburban, one story, and used as part warehouse, part light manufacturing with drive-in doors and some warehouse space

Greg Johnson tied up an 80-unit condo building in Los Angeles that was only 65% complete. The borrower defaulted, and the Asian community bank took it back. Greg negotiated for the bank to do a purchase loan and construction loan at 95% LTV, and he negotiated profit participation!

TIP!

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With office properties, the three classes29 you need to know about are new, vintage, and old. Building classification allows you to differentiate buildings and rationalize market data. The categories are urban, suburban, and flex space.

There are some important factors to consider when buying office buildings. First you need to check out the lease-up period. Then you need to review the occupancy level and what this means for the building. Rent concessions should be taken into account along with what tenant improvements can be made. Finally, operating expenses should be on the list.

Buying Retail PropertiesThe fourth asset class belongs to retail properties. There are five different types of retail property that you should focus on:

• Grocery Anchor: A retail building with a prominent grocery anchor customer that attracts shoppers to the establishment

• Power Center: A large retail establishment—usually owned by a corporate giant like Target or Walmart

• Unanchored: A retail building without a prominent customer to attract shoppers

• Neighborhood Center: A center designed to meet the daily needs of the neighborhood that surrounds it

• Regional Mall: A very large mall with multiple rents being paid by big corporate stores. These are high trafficked and popular.

When buying a retail property, you will want to consider a few basic factors. Look at your tenant credit list, and see who is renting there. If your building is unanchored, it may be a lot

29 Troy Golden, Primer: Differentiating Class A, B and C Office Space, http://www.areadevelopment.com/AssetManagement/Directory2013/primer-differentiating-office-space-class-26281155.shtml

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harder to rent out the space there, and the traffic may be low or slim. Neighborhood centers are always a great place for smaller business owners, but irregular rents might happen.

A power center is the most stable of these as it is held by a corporate giant with guaranteed rental payments and a stable return every month.

The key to any successful real estate deal is to understand how improvements and general rehabbing can transform

a commercial block into a high-earning asset. This depends on how much money is sunk into the rehab and what the projected future outcomes and earnings are for that building.

Once you understand how each asset class is impacted by their future NOI, you will come to terms with the revenue potential and will be better poised to make decisions. Value added deals can be an incredible source of income when you team up with the right partners.

Rehab or Repositioning: Property TypesWith value added deals, you are able to build wealth for yourself by investing in these properties. The trick is to know how to improve the property so that the future NOI increases from rehabbing or repositioning.

CHAPTER 7

VALUE ADDED DEALS

“As long as you have more cash flowing in than flowing out, your investment is a good investment.”

Robert Kiyosaki

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Below is a representation30 of each type of rehab project that you could perform on a commercial asset. From minor to major, each form will have different results.

• Multifamily Minor: basic painting and landscaping• Multifamily Moderate: redoing the kitchens, bathrooms,

and carpets• Multifamily Major: total gutting of the property and a

complete overhaul

• Retail Minor: facelift to center, new parking lot, fresh sign boards

• Retail Moderate: new center façade, rearranging the physical spaces (sub-dividing)

• Retail Major: de-malling centers, eliminating shop space with junior and anchor tenants, building parking lot space, additional construction

• Office & Warehouse Minor: improving the general appearance, new parking lot, renovation of common areas like hallways

• Office & Warehouse Moderate: increasing the efficiency, new electrical/HVAC systems, redesign of floor layout

• Office & Warehouse Major: total gutting of the property, take the property down to concrete and rebuild from the inside out, new systems and new interiors

Value Added Deals & InvestmentsWith value added deals, these select property types have specific revenue effects for the investor depending on how you choose to rehab and what the NOI potential might be.

30 John Caulfield, Rehab ROI: Which Upgrades Cause the Biggest Rent Bumps?, http://www.multifamilyexecutive.com/design-development/renovations/rehab-roi-which-upgrades-cause-the-biggest-rent-bumps_o

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• Multifamily: Take a look at how the new rents will compare with your current market rentals. The first thing to ask yourself is, are the projected rentals in line with the current market OR is the project trying to push or lead the market into new heights? An investment is most sound when the exit strategy works with rents and occupancy underwritten to current market conditions. If not, you are essentially making a “market bet,” which is risky.

• Retail: Take a look at how the new rents will compare to the current market rents. Again, ask yourself, are the projected rentals in line with the current market OR is the project trying to push or lead the market into new heights? Like in multifamily investing, you need to make sure that you are investing on face, not making a market bet.

• Office/Warehouse: Take a look at how the new rents will compare with the old rents. Then ask yourself three questions:

h Can the property be transitioned from a C to a B to an A and then command a greater rent?

h Will the rehabilitation increase occupancy at the current rental rates?

h Will the rehabilitation help with tenant retention?

With value added31 investments, value added lending provides some of the greatest wealth-building opportunities in real estate. You need to master these techniques, and you will be on your way to building wealth with income-earning commercial asset investments.

31 Clifford Booth, Stephen Kanoff, Value-Added Investing Is Gaining Traction, http://nreionline.com/commentary/value-added-investing-gaining-traction

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Decisions and Critical ChecklistsNow for some value added basics to round off your knowledge on these deals. First of all, what are value added transactions?

This is when the asset is not yet ready for sale or for permanent financing. There is a “bet” that the value can be increased by improving the NOI. The value added loan is typically higher leverage than the stabilized loan and a higher rate than the stabilized loan. The investor’s goal is always to increase the NOI and achieve an increased, stabilized NOI.

What differentiates value added investing from stabilized investing? In value added transactions, the investor or lender analyze what the property could be, not what it is now. The investor has a story or plan on how to make the asset better. The exit strategy for the bridge loan is a refinance option to permanent loan or sale.

Once stabilized, the investor then has the opportunity to be cashed out, which creates wealth for them. That is why you need a checklist of requirements so that you make the right decisions about your investment.

Take a look at your rent roll document. It should detail the following:• Your tenant credit• Lease expiration dates (check these!)• Extension options• Co-tenant provisions

To avoid making a bad deal, you must avoid these common mistakes:

• With Project Pro Forma, stabilized NOI is the wealth driver. The Pro Forma purpose is to derive exit value.

• With exit value, there is a formula: stabilized NOI/exit cap rate.

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Picking the exit cap rate is one of the most important decisions a value added investor will make.

Incentives and PenaltiesLenders and equity providers will often use incentives and penalties to shape the behavior of borrowers and sponsors. Here is what you need to know:

• Incentives: collateral release, burn offs, and credit migrations

• Penalties: springing recourse, capital calls, cash flow sweep

• Performance tests: NOI tests, lease term, tenant credit, lease rates, tenant improvements, and concessions

• Guarantees: full recourse,32 partial recourse, debt service, maintenance, deficiency

Baird Hawkins once invested in Grand Rapids, MI, converting a warehouse into a condo. The owner was in financial trouble, so he removed the land contract from the stack. This created $1.6M in equity. Then he structured “earn outs” based on key events while inserting himself as a co-developer into the investment.

Hawkins borrowed $1M in equity from the phase 1 payout to fund phase 1 development; no money of his own was taken out of his pocket. The property is now worth $10.8M; he pocketed $100,000 up front and 5% of the backend ($900,000). Success!

32 Full Recourse Debt, http://www.investopedia.com/terms/f/full-recourse.asp

The second kind of real estate deal that can be made within these various asset classes is called the “stabilized asset

deal.” These properties are already producing income for their shareholders, so there are fewer margins for error when acquiring a property. You need to know how to analyze your deal to determine if it is a viable investment or not.

Your operating statement, for example, will sit at the center of your in-depth analysis. This document is critical when determining a deal’s viability. This information will help prepare you for the choices that you may have to face in the future.

CHAPTER 8

STABILIZED ASSETS: ANALYZING THE DEAL

“Everyone wants a piece of land. It’s the only sure investment. It can never depreciate like a car or a

washing machine. Land will double its value in ten years. In less than that. Land is going up every day.”

Sam Shepard

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Easily Analyzing Your Deal: NOI, Cash Flow, and Net Cash FlowBeing able to analyze stabilized assets is key to making good real estate crowdfunding investments. There are four main areas that you need to focus on when analyzing these assets. The first three will be outlined here.

1. NOI: total revenues – operating expensesTo calculate your net operating income, you must deduct your total operating expenses from your overall revenue.

2. Cash flow: NOI – debt serviceTo calculate your cash flow, you need to deduct your debt service costs (including P&I) from your net operating income.

3. Net cash flow: cash flow – reservesTo calculate your net cash flow, you need to deduct your reserves from your available cash flow.

Without a strong understanding of net operating income,33 it is impossible to invest in any real estate transaction with a degree of safety and certainty about the success of the deal.

Easily Analyzing Your Deal: Rent RollThe fourth factor that you need to understand in order to effectively analyze stabilized properties involves your rent roll document. In many ways, stabilized properties are driven by rent rolls. Let’s take a closer look at them here.

For a rent roll analysis, you need the following:

• The percentage of the building that is leased• The rate of release, lease term, and lease expiration date

33 Robert Schmidt, Understanding Net Operating Income in Commercial Real Estate, http://www.propertymetrics.com/blog/2014/03/05/net-operating-income/

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Take note of:

• Renewal clauses: When automatic,34 this is a provision in an agreement that is renewed for another term after the expiration of the current term unless one of the involved parties gives notice of discontinuation.

• The credit quality of tenants: It is wise to check on the credit quality of your tenants by assessing their ability to pay every month. One method of doing this is to assess each tenant’s credit score.

• Roll schedule: The rent roll is the total income arising from a rented property. You need to sit down and assess your roll schedule in detail.

Working With Lease Types and Operating StatementsThere are two main lease types that you should take notice of:

• Full service: This is when the landlord pays all of the expenses, like maintenance, taxes, and insurance.

• Triple net lease: The typical charges to triple net include your taxes, which are paid by your tenant, and insurance and maintenance—also paid by your tenant.

Once you have checked out the two lease types available to you, you also need to take a long, hard look at your operating statement. This is the most important document that you can analyze when deciding whether or not to invest in commercial real estate.

34 Automatic Renewal Clause, http://www.businessdictionary.com/definition/automatic-renewal-clause.html

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An operating statement,35 also called a statement of operations, is one of three financial statements used to assess the performance and financial position of your asset. Together with the balance sheet and cash flow statement, you will be able to see a complete financial picture of what your potential investment is currently earning.

Your operating statement summarizes your asset’s revenues and expenses over a specific period of time, which is always useful when making market decisions.

Strategies to Maximize Profit & Minimize RiskWith these triage banking business strategies, you should be able to get the most out of your asset, while minimizing the risks involved, for a quality investment.

• Who is the lender? Many lenders are having problems, which is why you should always find out who the lenders are on your deals! This could lead to an opportunity to sell or fund the note at a discount. If there is a single asset that is not performing, there is a good chance that the lender may have several others, and this asset could be nothing more than a money pit or sick bank.

• Clients that need liquidity: Some people you will come across will have invested in other assets that did not increase in value and now need liquidity. These could be clients that have assets that they can borrow against, cross collateralize, or sell to you. Make sure that you ask your partners about the other investments.

• Create mezzanine lender relationships: Many high dollar assets are now changing hands for pennies on the dollar as mezzanine lenders are selling their stakes cheaply

35 Statement of Operations, http://www.investinganswers.com/financial-dictionary/financial-statement-analysis/statement-operations-2371

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and other investors are coming in and taking over the projects subject to the existing debt. There is great opportunity to buy these assets cheaply or to assign them to other buyers for profit and an equity stake.

• Clients in default: If a client’s loan is in default, this is a textbook way for you to provide bridge or DIP financing. This can also be an opportunity for your company to provide advisory work through a workout, restructuring, or bankruptcy.

• Sale leasebacks: Owners are looking at several ways to raise money. Sale leasebacks will become more popular over time—count on it.

• Projects that have recent vacancy: Asset receivers, trustees, and bankruptcy attorneys will be your biggest clients. They all have the potential assets and decision-making control for you to buy, sell, or fund.

At this stage, you have a strong understanding of the various real estate classes and deals that can be made.

Now you need to ask some basic questions to fill in the gaps of your real estate crowdfunding knowledge. Questions shed light on whether a deal is worth doing, and knowing how to ask them can save you from a bad investment.

I will also review how many of these deals are structured and give you tips on the non-performing note sales process. This is critical information for the crowdfunding investor, who needs to be orientated on the viability of the purchase, investment, and return at all times.

CHAPTER 9

QUESTIONS AND STRUCTURING

YOUR DEAL“Real estate is an imperishable asset, ever increasing

in value. It is the most solid security that human ingenuity has devised. It is the basis of all security and

about the only indestructible security.” Russell Sage

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Distressed Asset QuestionsYou will need to ask your operator or fund manager a number of distressed asset36 questions to satisfy your investment due diligence requirements. The answers to these questions will drive your strategy to either purchase or finance distressed properties and opportunities.

• Is the loan current?• Is property cash flowing?• Is the loan institutional sale quality?• Will the borrower want to repurchase?• Is the property under legal distress? Is there an FC or BK

lawsuit?• Is there any liability for outstanding costs if you become

an owner?• Is the property and location marketable?• What’s the likelihood of the loan remaining current?

Non-Performing Note Sales FactsHere are some important facts regarding the non-performing37 note process.

• A prior promise: Borrowers might claim that there were other verbal promises or agreements by the prior lender.

• Financing the note: Buyers will have to finance the purchase of the note. This may come from the selling lender or from a third party in the form of a collateral assignment or an absolute assignment.

• Default provisions: The new note buyer will seek to enact

36 Definition of Distressed Assets, http://www.davemanuel.com/investor-dictionary/distressed-assets/37 Nonperforming Loan – NPL, http://www.investopedia.com/terms/n/nonperformingloan.asp

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the default rate and fees if the loan is in default. These terms are set by the existing note holder.

• Existing documents: The new note buyer inherits all the existing documents and must live with the existing documentation. This may be good or bad.

• Note discounts: If the note is sold at a discount less than the purchase price, the borrower will have a few advantages.

• Lower basis: A low loan basis will give the new note more flexibility in working out a loan restructure with the borrower.

• Higher yield: If the loan is bought at a discount and the interest is current, the new note buyer will instantly have higher yield.

Types of Loan SalesWhen structuring your deal, you need to pay attention to non-performing note sales. Here are the different loan types you will encounter:

• Performing loans: There are no defaults on this loan; it is being paid as agreed. The lender may not like the borrower, the pricing, or the structure and will seek to get cash in exchange for the note. A performing note may sell at a discount if the pricing and terms are no longer considered “market.” Scratch and dent sales happen here.

• Sub-performing loan: The loan38 may not be in default just yet, but it was before and has been cured. The loan can also appear to be heading for default, or the loan is already in default, but the lender has not yet declared a default.

38 Sub-performing Loan, http://www.realestatewiki.com/wiki_content/Sub-Performing_Loan_cat40834034_cid33855863.htm

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• Non-performing loans: These are loans that are not being paid as agreed. An official default may or may not have been issued in a formal legal process, like the filing of an NOD.

All of these notes share these factors in common:

• Assignment of the note: The buyer inherits the existing note “as is,” and all of the terms are pre-set. The buyer must be comfortable with the structure, terms, remedies, default rate, recourse, and any other details stipulated.

• Representations and warranties: The selling lender will not provide reps and warranties to the buyers unless the note is valid.

Minimizing Risk During SalesTo minimize risk when dealing with non-performing note sales, you as a new note buyer must assume the same risk as the previous lender. Most note buyers are prepared to foreclose and own the property should the need arise.

• Document deficiency: Missing documents might hinder the note buyer’s ability to enter foreclosure.

• Foreclosure: Depending on the situation at hand, foreclosure could be a very long process.

• Borrower bankruptcy: The new note holder assumes the risk of a borrower’s bankruptcy.

In this final chapter, I will review the ten most common real estate crowdfunding questions, and I will answer them for

you. Once you have reviewed these Q&A’s, you will officially know more about real estate crowdfunding than 90% of the investors jumping into the niche. With adequate orientation comes better decision making and higher returns.

For retirees, nothing is more important at this stage of your life than finding income-earning investments to inflate the money that you have to live off every month. Real estate crowdfunding can be an incredible arena to invest in as long as you keep what you have learned in this guide in mind. As you invest, your knowledge will grow.

CHAPTER 10

10 QUESTIONS TO REAL ESTATE

CROWDFUNDING SUCCESS

“To be successful in real estate, you must always and consistently put your clients’ best interests first. When

you do, your personal needs will be realized beyond your greatest expectations.”

Anthony Hitt

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Here are some of the hardest questions asked by investors and the responses that you are supposed to get from your operator or deal promoter. Use these questions along with the information you have learned in this guide to make educated investment decisions.

Question 1: How much is the operator (deal manager) investing personally?You need to know where the money is coming from. Is it theirs, from their family, or from friends? When the operator has their own money in the deal, it says that they have an alignment of interest with you as an investor. Financially speaking, if you get hurt,39 they should also get hurt. Otherwise, there is no alignment, and the risk is too high.

Never take advice from someone that does not have their own money in the game and does not have to live with the consequences. You will lose every time.

Question 2: Is there a huge upfront fee or load?Funds and deals that use this model are set up to make their promoters and operators rich, not their investors. They are in it for the fees, not the performance of the fund, and they do not have an alignment of interest with you.

39 David Kaufman, How Fees Align Managers With Their Clients, http://business.financialpost.com/investing/how-fees-align-managers-with-their-clients-2?__lsa=847c-0db6

QUESTIONS 1–3: Personal Investment, Fees, and Exit Strategy

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Question 3: How will you get taken out? What is the exit strategy?Many operators do not keep this essential knowledge in mind. In commercial real estate, there are only two exit strategies: a sale or refinance. Is your operator financially qualified enough to get refinanced out of the deal? How long before you would be taken out of your deal and would get your money back? This is an important one to ask.

Question 4: How many smaller investors do they have?This is an indication that the operator may have dropped his minimum investment in a desperate attempt to raise funds.

Generally, if there are more smaller investors, which is always made apparent by the smaller minimum investments of less than $5,000 or $10,000, then it may mean that you are joining a throng of unsophisticated investors that do not understand that this is an illiquid investment.

Your operator at this point may have to focus his time on getting those smaller, needier investors cashed out by raising money from others, rather than doing what he or she should be doing, which is managing your deal.

Question 5: Where does your money go?You might believe that it goes towards buying a piece of real estate, but this may not be the case. Where in the capital structure are you? Are you debt (safe), equity (riskier), or something else? Stay away from “cash flow notes” and “cash flow certificates” as these are basically IOUs that are not secured by anything at all.

QUESTIONS 4–6: Smaller Investors, Money, and Operator’s Experience

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Ask your operator how you are secured. Then keep quiet as they explain it to you. If you want to go crazy, then ask them, “Where in the capital structure will my investment be?”

Question 6: What is your operator’s experience?Resumes can be embellished,40 and inexperienced real estate investors are always impressed by throwing around the names of Fortune 500 companies. Being a real estate entrepreneur is just that, however, and nothing else—no nets. There is no company middle management to hide behind.

You need to know if your operator has managed (as a principal) an investment similar to the one you are arranging. Have they ever invested in their own pool before? What is the track record? Are they expecting you to be the stupid monkey that funds their first deal, where a huge amount of mistakes will happen?

Ask where the asset is located; it should be within 20 minutes of where your operator lives. Otherwise, they will go broke or worse—incur travel fees to manage the faraway asset.

Question 7: Are they overpaying for the asset?Real estate becomes the most popular asset class at exactly the wrong time—when prices are going up. If your operator is not using any of his own money, what does he care if he overpays or not?

40 Jennifer Hill, Fund Managers Admit Their Biggest Mistakes, http://citywire.co.uk/money/fund-managers-admit-their-biggest-mistakes/a799147

QUESTIONS 7–8: Overpaying on the Asset and Leverage

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Most buyers and investors will be easily seduced by the Pro Forma Net Operating Income, not the Current Net Operating Income—which is essentially smoke and mirrors.41 Any experienced multifamily operator will tell you that it is impossible to get 10% rent increases year over year when the majority of Americans have seen their paychecks shrink.

People that buy off the Pro Forma are losers as they will use your money faster than you can say “exit strategy.” Ask your operator how they valued their deal. Is it based on recently sold assets of a similar size and unit number? Then go silent. You will learn more about your operator here that you will want to know.

Question 8: How much leverage are they using?Leverage is good sometimes—but if your operator is using too much of it, then they are probably trying to use that juice to make a marginal deal look like a home run. Debt can amplify your returns if used wisely but can also destroy you if the markets crash.

Question 9: What other assets does your operator currently have?This question is similar to question five but a little more dangerous. Do they have a portfolio of legacy assets that they are using your money for? They could be paying off other investors or expenses this way due to bad investments. This

41 Spencer Cullor, Multifamily Real Estate Sales Comparables – Don’t Overpay When You Buy, http://apartmentvestors.com/blog/multifamily-real-estate-sales-comparables-overpay-buy

QUESTIONS 9–10: Assets and Partner Transparency

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happens way more often than most people imagine. Putting in good money to cover up bad investments is bad business.

Question 10: Do they have partners?Does your operator have partners? If they do, ask how they know each other. Do they all live in the same town or vicinity? The best case scenario here is that they have worked together on real estate transactions for many years. Perhaps they took some time off and decided to bring everyone together again because of a great opportunity.

These are the good management and operating teams that you want. The last thing that you need are a pack of people that are “friends” that do not know each other at all. They have no idea about each other’s financial position or experience level. Husband and wife teams can be red flags as well.

If they really are partners, they will have an operating agreement42 that will dictate who does what, and when and if a breakup occurs—who does what and who gets what out of the divorce. If a partnership breakup happens, you will never know about it until it is too late.

Remember to always ask the hard questions no matter what. Operators with experience will respect your position and will take the time to answer you. If they do not want to answer you or cannot, it is better to move on to another more viable opportunity.

42 Operating Agreement, https://en.wikipedia.org/wiki/Operating_agreement

You have reached the end of your real estate crowdfunding guide. Real estate has always been the prime wealth

creation tool for investors. You do not need a fancy degree to participate in it; you only need to know how.

With crowdfunded real estate deals, it has never been this easy to invest in the market—with less money up front and more profit every month!

However, the lower barrier for entry is seen as a siren call for fraudsters, and they tend to take advantage of the less savvy investor that will want to place most of their life savings in these deals. Real estate has always been full of scams, and this is no different.

Using this guide, you have successfully educated yourself on the basic principles, terms, assets, and deals that can be made in crowdfunded real estate.

CONCLUSION

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With this knowledge, you should be able to navigate the often tempestuous waters of investing without too many problems getting in your way.

As a retiree, it is essential that you take the steps required to increase your monthly income by choosing the right, qualified commercial real estate deals.

Now that you have come to the end of this guide, you are better prepared for what you may encounter, and your chances of success are infinitely higher.

To future investments!

Chapter 1Real Estate Quotes, http://www.brainyquote.com/quotes/keywords/real_estate.html

O’Connell, Brian, Real Estate And Crowdfunding: A New Path For Investors, http://www.investopedia.com/articles/investing/072514/real-estate-and-crowdfunding-new-path-investors.asp

Weiner, Keith, Yield Purchasing Power: $199M Today Matches $100K In 1979, http://www.zerohedge.com/news/2015-08-05/yield-purchasing-power-100m-today-matches-100k-1979

Barnett, Chance, SEC Democratizes Equity Crowdfunding With Jobs Act Title IV, http://www.forRESPAbes.com/sites/chancebarnett/2015/03/26/infographic-sec-democratizes-equity-crowdfunding-with-jobs-act-title-iv/

RESPA – Real Estate Settlement Procedures Act, http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/rmra/res/respa_hm

REFERENCES

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Chapter 2Real Estate Quotes, http://www.brainyquote.com/quotes/keywords/real_estate.html

Stabilized Occupancy, http://financial-dictionary.thefreedictionary.com/stabilized+occupancy

Assumable Mortgage, http://www.investopedia.com/terms/a/assumablemortgage.asp

Value Added, http://www.investopedia.com/terms/v/valueadded.asp

Floating Interest Rate, https://en.wikipedia.org/wiki/Floating_interest_rate

Silva, Danielle, A Look At Opportunistic And Value Added, http://www.brightonhouseassociates.com/web/a-look-at-opportunistic-and-value-added/

Recapitalization: An Efficient Way To Invest In Multi-Family Properties, http://www.rejournals.com/2014/11/12/recapitalization-an-efficient-way-to-invest-in-multi-family-properties/

Chapter 3Real Estate Quotes, http://www.brainyquote.com/quotes/keywords/real_estate.html

Definition Of Distressed Asset, http://lexicon.ft.com/Term?term=distressed-asset

Sternlieb, Michael, Maturity Default, http://www.realestateandconstructionlawmonitor.com/2009/03/articles/real-estate/finance/maturity-default/

Stein, Joshua, What Happens When A Crowdfunded Deal Goes Bad? http://commercialobserver.com/2015/07/what-happens-when-a-crowdfunded-deal-goes-bad/

The Distressed Asset Lifecycle, http://www.dandrewmedia.com/wp-content/uploads/2015/05/The-Distressed-Asset-Lifecycle.pdf

Wholeloan, http://www.investopedia.com/terms/w/wholeloan.asp

Loan To Value Ratio, https://en.wikipedia.org/wiki/Loan-to-value_ratio

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Chapter 4Real Estate Quotes, http://www.brainyquote.com/quotes/keywords/real_estate.html

Mullen, Keith, Loan Defaults – Monetary Vs. Non-Monetary, http://www.lenders360blog.com/2009/05/loan-defaults-monetary-vs-non-monetary/

Judicial V. Nonjudicial Foreclosure, http://www.nolo.com/legal-encyclopedia/judicial-v-nonjudicial-foreclosure

Drescher, Ronald, J, What Is A Credit Bid, http://www.drescherlaw.com/faqs/what-is-a-credit-bid.cfm

Special Purpose Entity/Vehicle, http://www.investopedia.com/video/play/special-purpose-entityvehicle/

Chapter 5Real Estate Quotes, http://www.brainyquote.com/quotes/keywords/real_estate.html

Bank-Owned Properties And REO (FAQS), http://www.realtytrac.com/real-estate-guides/how-to-buy-foreclosures/bank-owned-homes/bank-owned-reo-property-faqs/

Negotiated Sale, https://www.divestopedia.com/definition/882/negotiated-sale

Absolute Auction, http://www.investopedia.com/terms/a/absolute-auction.asp

O’Toole, Maureen, Listing And Selling REO Properties, https://support.propertyradar.com/hc/en-us/articles/204173330-Listing-and-Selling-REO-Properties

Chapter 6Famous Real Estate Quotes, http://nestabode.com/famous-real-estate-quotes/

Net Operating Income – NOI, http://www.investopedia.com/terms/n/noi.asp

Why Multi-Family Real Estate, http://venterraliving.com/investor_services/why_multi-family_real_estate

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Primer: Differentiating Class A, B, and C Office Space, http://www.areadevelopment.com/AssetManagement/Directory2013/primer-differentiating-office-space-class-26281155.shtml

Chapter 7Famous Real Estate Quotes, http://nestabode.com/famous-real-estate-quotes/

Caulfield, John, Rehab ROI: Which Upgrades Cause The Biggest Rent Bumps? http://www.multifamilyexecutive.com/design-development/renovations/rehab-roi-which-upgrades-cause-the-biggest-rent-bumps_o

Booth, Clifford, Kanoff, Stephen, Value-Added Investing Is Gaining Traction, http://nreionline.com/commentary/value-added-investing-gaining-traction

Chapter 8Famous Real Estate Quotes And Sayngs, http://www.cebu-properties.net/resources/famous-real-estate-quotes-and-sayings/#.VgenthGeDGc

Schmidt. Robert, Understanding Net Operating Income In Commercial Real Estate, http://www.propertymetrics.com/blog/2014/03/05/net-operating-income/

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Chapter 9Famous Real Estate Quotes And Sayings, http://www.cebu-properties.net/resources/famous-real-estate-quotes-and-sayings/#.VgenthGeDGc

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Non-Performing Loan – NPL, http://www.investopedia.com/terms/n/nonperformingloan.asp

Sub-Performing Loan, http://www.realestatewiki.com/wiki_content/Sub-Performing_Loan_cat40834034_cid33855863.htm

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Full Recourse Debt, http://www.investopedia.com/terms/f/full-recourse.asp

Chapter 10Famous Real Estate Quotes And Sayings, http://www.cebu-properties.net/resources/famous-real-estate-quotes-and-sayings/#.VgenthGeDGc

Kaufman, David, How Fees Align Managers With Their Clients, http://business.financialpost.com/investing/how-fees-align-managers-with-their-clients-2?__lsa=847c-0db6

Cullor, Spencer, Multifamily Real Estate Sales Comparables - Don’t Overpay When You Buy, http://apartmentvestors.com/blog/multifamily-real-estate-sales-comparables-overpay-buy

Operating Agreement, https://en.wikipedia.org/wiki/Operating_agreement