We recently completed the full payoff of a loan that had been in default for 183 days. In the end, investors received 100% of their principal and all accrued interest payments for a total 18.48% cash-on-cash return (14.85% annualized).
In an earlier blog post we talked about the different types of risks involved when investing in fix-and-flip loans and how we manage those risks on behalf of lenders. This success story illustrates how our risk management strategy actually played out.
We originated this loan on March 9th, 2016. The first distribution was for $137,940 which equaled 72.6% of the purchase price. We retained $11,834 for 3 months of pre-paid interest and another $128,575 to be disbursed as value was added to the property. The appraised ARV of the property at the time of origination was $449,000, for a Loan-to-ARV of 64.6%.
Our model projected the borrower would earn a 21.3% net profit on the project, further insulating the project from loss.
There were delays in construction due to some permitting issues. We began to closely monitor the project and disburse construction draws in smaller increments to protect against over-extending capital on the project.
The developer continued to make interest payments and was making good progress on completing the project according to the scope of work. In order to accommodate the additional time required to complete the project, a 3 month extension was granted to the borrower. Fund That Flip continued to monitor the progress closely.
The borrower completed the project towards the end of 2016 and began the process of refinancing the property as they intended to hold the property as a rental. At this time, they also stopped making interest payments.
As is our practice, we put the borrower on notice that they were in default and penalty interest would begin accruing at 24%. The borrower informed us that a refinance was imminent and would make accrued interest payments upon final payoff.
In order to ensure we were afforded all options to enforce our mortgage, we began the foreclosure process with legal counsel that specializes in such matters. We also began working with the borrower to explore all liquidation options.
The first refinance effort proved unsuccessful for the borrower, at which point they decided to continue to defer making interest payments, and accrue at 24%.
At this point, we ordered a new appraisal of the property to get an updated valuation and to better understand any new potential risks. The new appraisal came back at $620,000. Our total loan outstanding at this point was $290,000 plus accrued but unpaid interest. According to the appraisal, we had $330,000 of equity protecting our principal.
After the first refinance fell through, we increased the urgency to get to a liquidity event by advancing our rights related to formally foreclosing. Additionally, the borrower was accruing interest at 24%, meaning their equity position was being reduced each day our loan remained outstanding.
The borrower listed the property for sale in addition to engaging a new lender for refinance. We maintained close contact with the borrower, requiring weekly updates on the status of either a sale or refinance. We cooperated fully with the borrower and refinancing company, and after 183 days of non-payment, were paid in-full through a refinance.
Lessons Learned
The success of this project started on the day we underwrote and originated the loan. By having adequate downside protection combined with managing construction draws prudently, we maintained favorable loan-to-value ratios.
Further, at the first sign of trouble, our servicing team took a more active role in working with the borrower to develop a strategy forward. The borrower was provided options while we also pursued a “worst-case-scenario” strategy, positioning ourselves to have full rights under the terms of our mortgage.
Throughout the process we updated investors on the latest happenings and the actions we were taking to mitigate loss and work towards liquidity.
In the end, investors were paid back 100% and earned a higher return than they initially expected for the inconvenience of not receiving payments on time.
While we never hope for scenarios like this one, it is part of the business. Our strategy of sound underwriting and quick action to encourage liquidity is what helps ensure positive outcomes for all involved.
Email us at: InvestorRelations@fundthatflip.com to schedule a call with a member of our investments team, ask a question or provide feedback.
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