LEGISLATION Keep NY From Killing Your Deal
4 Things to Watch The Official Magazine of AAPL November/December 2019
MARKET TRENDS The State of SFR
Vincent Balagia Driving Development in Texas Through Private Lending
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06 BUSINESS S TR ATEGY
I nve s t ing in I ndi v idu al Dee d s o f Tr u s t s v s . Fund s by Edward B rown
10 LOAN SERVICING
You C an' t Do I t "a L oan" by Chr is Ragland
14 LEGISL ATION N ew Yor k Wan t s to K ill Your Deal by Mat t G unter 18 MARKET TRENDS
18 4 T hing s T ha t Should Keep You Up At Nigh t by J ef f rey Levin
22 S t r ong Fundamen t al s D r i ve M a t ur ing SFR M ar ke t
by Rober t Greenberg
W ha t You N ee d to K now A b ou t t h e C en t r alize d Par t ner s hip
Au di t Regime by B eet a Lecha
30 LENDER LIMELIGHT
D r i v ing Developmen t in Texa s wi th V incent Balagia
36 C A SE S TUDY
O cean V iew Pr oper t y G e t s a M akeover
38 MARKETING & SALES
3 8 T he Do's and Don' t s f or a N ex t- L evel Pi tc h by Ruby Key s
42 T ur n Bac k T ime v ia C hec k b ook C on t r ol Sel f- Dir ec te d Accoun t s by Dan K r y zanowsk i
46 6 Pr ac t ic al Way s to De f end Your C ompany Ag ain s t Cy b er t hr ea t s by V incent Al f ier i
50 L e s s on s Fr om a Real Ran s omwar e At t ac k by B eet a Lecha
Under s t anding Sec ur i t ie s E xemp t ion in Pr i v a te L ending by Tae K im
58 L A S T C ALL B uilding on Your C api t al wi th Sam K addah NOVEMBER/DECEMBER 2019
FROM THE CORNER OFFICE
EDDIE WILSON CEO, AAPL
Managing Director, AAPL
KELLY SCANLON Copy Editor
SPRINGBOARD CREATIVE Design
Vincent Alfieri, Katie Bean, Edward Brown,
Robert Greenberg, Matt Gunter, Sam Kaddah,
Ruby Keys, Tae Kim, Jerry King, Dan Kryzanowski, Beeta Lecha, Jeffrey Levin, Chris Ragland
COVER PHOTOGRAPHY Benjamin Porter
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Looking back on 2019—the year that marked our 10th as your association—it’s clear that it’s been both our busiest and, in my perspective, our best. Although we’ve had a smaller team than ever before, we successfully launched some of our most ambitious initiatives yet: Government Relations // Our inaugural eight-person, memberled Government Relations Committee met with the offices of several members of Congress and state legislators, successfully making our opinions known on HMDA, Florida mortgage licensing and New York real estate transaction tax increases (check out p. 14 for Matthew Gunter’s legislative update). The Committee also launched nationwide bill monitoring, introduced a new online petition system and hosted four public Legislative Town Halls. Education // Our Certified Fund Manager designation course is going online, with our in-person courses to expand upon the new video course content. We’ve designed a new credit structure to maintain designations over time. Finally, we launched a new webinar archive and online member portal to make finding resources easier than ever. All-New Member Directory // We rebuilt our directory from the ground up to make it easier for potential borrowers and other parties to find and verify members’ status. Members can now personalize their listings with company descriptions, photos and video. Data // We’re excited to announce our partnership with national financial and housing research firm Zelman & Associates to launch the first private lender benchmark survey, tailored by our Education Committee. Respondents will receive access to the aggregated data, enabling them to track their position in the market like never before. If you’re not already, become a Friend of AAPL to participate. Private Lender // We’ve expanded our online archives to make it easier to “flip through” Private Lender magazine from the comfort of any device. We’ve automated nearly all our processes with our new portal for writers and advertisers. And, in 2020, we’re enhancing our print magazine to a larger, more in-depth quarterly publication that will include a new Resource Guide featuring service providers that specialize in working with private lenders. We're also excited to add a political cartoonist—Jerry King—as a regular contributor. He brings a fun, but important, perspective to our advocacy efforts. Annual Conference // We automated most of our conference processes to enable our smaller team to put on the nation’s largest private lender event with ease. We sold out of sponsorships more than six weeks ahead of the event, attendance was the highest it’s ever been and we hosted one of our industry’s most impactful—and infamous— personalities, former congressman Barney Frank. Although these are our most noteworthy accomplishments, each day we work with energy and enthusiasm to protect and advance what it means to be a private lender. Thank you for being with us on this journey.
without the express permission of the American Association of Private Lenders is prohibited. www.aaplonline.com
Copyright © 2019 American Association of Private Lenders. All rights reserved.
Managing Director, American Association of Private Lenders
BUSINESS STR ATEGYÂ
INVESTING IN INDIVIDUAL DEEDS OF TRUSTS VS. FUNDS Investors must consider regulations, liquidity, taxes and other factors that impact the rate of return. by Edward Brown
Options for investors clamoring for yields often include investing in individual assets. Those assets might be dividend-paying stocks, bonds, alternative assets such as mortgages and so on. But there’s another option: investing in pooled funds such as income mutual funds, alternative funds such as REITs, or mortgage pool funds. Many people aren’t as familiar with the second option—the alternative market. Let’s look specifically at individual deeds of trust with mortgage pool funds.
DOT RETURNS Often, individual deeds of trust (DOTs) provide a higher coupon than mortgage pool funds (Funds), but there are some specific downsides to choosing individual DOTs instead of Funds. First, choosing the right DOT takes due diligence and, in many cases, a certain amount of expertise. Investing in extremely conservative DOTs that have LTVs at lower than 25% may not require the investor to have a Ph.D. in economics, but the yields on these types of DOTs are usually much lower than an investor can earn in a Fund. So, an
investor has to start looking at less conservative assets in order to produce the desired yield.
REGULATIONS AND LIQUIDITY Another advantage to investing in individual DOTs is the investor can pick and choose which DOT to invest in compared to having the Fund manager choose which mortgage fits the desired yield. This is not much different from an investor choosing to invest in specific stocks instead of investing in a mutual fund. For some reason, however, the public seems to be more at ease trusting a mutual fund
BUSINESS STR ATEGY
manager than a Fund manager. Could this be because mutual funds are regulated under the Investment Act of 1940? Could it be the relative liquidity of a mutual fund? Could it be the perception that mutual funds are considered regular investments as compared to Funds, which are categorized as alternative investments? The answer is probably a combination of these. Although most, if not all, Funds are not regulated under the Investment Act of 1940, they are regulated, in most circumstances, by some division of either a federal government authority or the state in which they do business. It is rare that a Fund has no oversight. Regarding liquidity, most Funds have a lock-up period in which liquidity is either nonexistent or comes with a penalty, similar to an early withdrawal penalty imposed by a bank CD. After the lock-up period, withdrawals may be somewhat limited by the manager. Some individual DOTs may be able to be liquidated in a secondary market, but most offers, even for high-quality DOTs, are at a discount. A DOT that is 50% LTV or more usually has a
that must be reported on an investor’s tax return, subject to certain income limits.
substantial discount associated with it should the investor need to liquidate, making liquidation much less desirable and quite a hardship for many investors. There are some advantages for investing in a Fund (as compared to an individual DOT) that may outweigh the negatives. For one, there is diversification in a Fund, so the risk is spread among many DOTs. Unless the Fund experiences a major disaster, distributions to the investor should be uninterrupted. With an individual DOT, a default usually means months or possibly a year or longer (as in the case of a bankruptcy by a borrower). If foreclosure proceedings are necessary, the Fund will usually handle them without the investor needing to get involved or having to come up with money to pay the trustee, attorney or other costs. In the case of an individual DOT, the investor/lender has to front these costs. If regular dis-
tributions are a must, a Fund is a more conservative route. Although individual DOTs usually earn a higher interest rate than a Fund (about 1-1.5% on average), Funds may offer the advantage of a reinvestment program. In a reinvestment program, the interest can compound, usually adding about 35 basis points. With an individual DOT, on the other hand, the investor has to take the monthly distribution with no ability to reinvest.
TAX CONSIDERATIONS The gap between the interest rates of Funds and DOTs gets even narrower for most investors when income tax is considered. Under the Qualified Business Income Tax Deduction (QBID) introduced in 2018, Congress allowed Funds the benefit of reducing the income
Investing in individual DOTs does not allow for this tax benefit. This 20% reduction in reporting can have a significant impact on the after-tax rate of return of a Fund compared to an individual DOT. For example, if a Fund is paying 7% and an individual DOT is paying 8.5%, the after-tax return, presuming a 40% tax bracket, of the Fund is 4.76%, whereas the DOT’s after-tax return is 4.80%. This 4 basis point difference is not significant, especially if one were to reinvest the distributions in a Fund. The most important factor nowadays, at least in California, is the continuity of investing in a Fund compared to investing in individual DOTs due to the downtime many investors’ portfolios experience when a loan gets paid off. In these circumstances, the investor usually calls the broker to find another DOT to invest in. The investor may be told there are no good loans to look at for the moment. The investor is asked to be patient or may be forced to look at lesser quality DOTs.
There is tremendous pressure in the market right now for loans to fund because there is significant capital looking for a home. This competition for loans has driven down interest rates and, therefore, what an investor can earn on a DOT. The competition has also added to the length of time needed to reinvest capital that has been returned due to payoffs from borrowers. When you consider the time value of money, this delay in redeploying capital can significantly lower the net, after-tax, rate of return investors desire.
Money that is not deployed in new DOTs and that sits idle in low-earning bank accounts brings the net yield down for the investor. For example, if an investor desires an 8% return on an individual DOT, having money sit idle for three months at 1% produces a pretax return of 6.25% for the year. Money sitting idle for four months lowers the net yield to 5.67%. In addition, in many cases, Funds snap up the better DOTs, leaving the loans of lesser
quality available for individual investors. The main reason
for this is that Funds want to
ABOUT THE AUTHOR
produce steady, uninterrupted
returns for their investors. They usually desire to avoid loans
that have a more likely default rate, even if the yield could be
higher by taking on a bit more
risk. Some investors lower their quality investing standard in
order to keep their money work-
ing. Investors therefore must
carefully consider whether the
benefits of investing in individual DOTs outweighs the bene-
EDWARD BROWN Edward Brown is in the
public relations department of Pacific Private Money, a private lending company
based in Novato, California.
fits of investing in a Fund. âˆž
PART 6 OF A 6-PART SERIES
YOU CAN’T DO IT “A LOAN” b y Chris Ragland
Support networks of specialists are crucial at every level of a project in order to ensure success.
THIS IS THE FINAL ARTICLE IN A SIX-PART SERIES THAT COVERS ASSET MANAGEMENT AND THE DISPOSITION OF DISTRESSED LOANS.
This article series has covered a topic that not many lenders are willing to talk about very openly: failed loans and the subsequent distressed assets they leave in their wake. We’ve covered several protocols to prevent loan defaults that begin before, and continue throughout, the life of a loan. At the outset, the underwriting
the finished property will fetch
more than just a few REO
process is crucial because that
its target value. Even then, loan
properties in your portfolio.
defaults still sometimes occur,
When juggling many separate
and you must act quickly to
aspects of multiple projects,
project and on the borrower to
complete and unload the asset.
you must rely on a broad
ensure the best possible chance
There are a lot of moving
network of organizations and
is your opportunity to conduct due diligence on the proposed
of success. Then while the project is in progress, you need a strict collateral monitoring process to maximize the chance
pieces in the process. And, if
individuals for support—
your lending operation makes
people you know and trust.
hundreds of loans every year,
There are a few ways that
then you likely end up with
these support networks can
be categorized: asset-level
support, portfolio-level support, and some that may be
internal or external functions of your business.
THE ASSET LEVEL The folks you need supporting you at the asset level are your “boots on the ground.” These
are the people who will help you complete and sell the properties that result from loan defaults.
As a lender, you probably have neither the time nor the skills
to take a foreclosed property to completion. The people you’ll
need supporting you at the asset level include contractors who provide specialized services—plumbers, electricians, roofers, landscapers and so on. You’ll also need the services of a general contractor to oversee the projects and the work being done. You need to trust that these contractors will provide you with the quality of work you expect and that they can do so quickly. The physical construction you need to complete on any given property is only one component in the asset disposition process. You will also need to rely on others who can help you evaluate, market and sell your properties. This includes appraisers, real estate brokers
(or perhaps a real estate agent) and someone to help you stage and photograph the property once you’re ready to put it on the market.
THE PORTFOLIO LEVEL
As a lender, it’s wise to have a relationship with an insurer you trust, either for referring borrowers or in the event you need to force place a policy on a property if a borrower lets it lapse. You also might require a blanket policy for
There are several ancillary services you’ll need at all stages of a project. These
portfolio-level services are less visible, but just as crucial, as the asset-level services.
multiple properties. If you’re a lender who’s been in the business for any length of time, it’s quite possible you have more than one REO property on your books. And,
For example, you need to
as you probably already know,
the asset. This goes not only
physical property and cover
protect yourself by insuring
it takes money to complete the
for REO properties but also
the carrying costs for whatever
for any property you lend on.
length of time you own it. Your business model will dictate your capital structure, but
typically you should also have a network of capital sources
you can access easily, whether
that includes banks, individual investors or both.
In addition to being sources
of capital, banks, investors or
other organizations can serve
as loan buyers. It's wise to form those relationships too. While you’re less likely to sell a loan that has gone into default,
selling off other loans in your portfolio is a good way to
quickly free up capital for the
completion and disposition of REO properties.
INTERNAL AND EXTERNAL SUPPORT A private lending office will
often have internal business units that help with many
of the functions necessary
for REO disposition as well
as for the prevention of loan
defaults. Both are crucial parts of the process.
From the prevention stand-
plays a critical role in monitoring the loan status and the progress of the project throughout the life of the loan. With the right protocols in place, they can help keep loans on track. It’s likely your private lending operation houses these functions internally, but there are some private lending platforms you can partner with to outsource underwriting and loan servicing.
working to dispose of your
From the disposition standpoint, Loss Mitigation and REO Disposition Divisions come into play once the loan has gone into default. A Loss Mitigation Division can either sell the property in its current state at the time of foreclosure or even reoriginate a new loan on the property to a trusted borrower. Short of that, you might have internal construction or REO disposition capabilities to complete the construction and sell the property. Either of these functions can be internal or outsourced, depending on your business model, resources and level of expertise.
preferred partner is unavail-
TIME IS MONEY
against loan defaults. Likewise, your Loan Servicing Division
costs can quickly cannibalize
ABOUT THE AUTHOR
any profits you might stand to make. And, often you’re just working to mitigate losses instead of making money. So, your network must include people you know and can count on when you need them. Additionally, you always need
backups—a “second tier” of
Chris Ragland is the chief
people you can call on if your able when you need them. Some people think they can save money by doing all the work themselves instead of paying outside parties. But remember that you’re racing against carrying costs and trying to achieve the highest possible market value when you get ready to sell the property. Regardless of your background or your level of experience, a project as large as building a
operating officer of Noble Capital, a private invest-
ment firm specializing in real estate. He is responsible for
the day-to-day operations of Noble Capital, as well as for
spearheading the expansion of
existing and new business lines for the company. He hosts The
Noble Capital Radio Hour, a talk radio show produced by Noble Capital. Chris spent 15 years
building firms that specialize in loan servicing, loss mitigation, full-service brokerage,
maintenance, rehabilitation and REO disposition.
new home or renovating an old one can’t (and shouldn’t) be done by one person. A network of specialists can help you get the job done more quickly and provide a much higher quality of work than you can by
point, underwriting the loan is the first line of defense
distressed assets. Carrying
It can’t be stressed enough how important it is that you are able to move swiftly when
yourself, so you have the best chance possible of achieving a profit, even on REOs. ∞
New York Wants to Kill Your Deal Senate Bill S3060E introduced in the New York state legislature would dramatically increase the transfer tax on fix-and-flip residential property. by Matt Gunter
talking a whole point increase.
This is a 15- to 20-point increase in the transfer tax!
This means that when you
go to sell your property, you
will pay the city of New York an extra tax equal to 15% to 20% of the sale price of the property—15% if the property is resold within two years of purchase and 20% if sold within one year.
DIFFERING AGENDAS Why would they do this? The answer is not straightforward, and the proposed law
hints at differing agendas that
are largely conflicting. The city is rightly concerned about an
affordable housing crisis. The
data show that rents are rising much faster than incomes,
Given this, one would think that our political leadership understands property flipping to be the main culprit. The data, however, do not bear this out. The city’s own analysis shows that one of the main reasons rents are rising is due to the current housing stock no longer falling under the requirements of rent stabilization regulations. The causes behind this trend have almost nothing to do with the flipping of rehabbed properties but instead to high-rent vacancy deregulation. Another substantial factor is the lack of total housing stock, including preserved existing units, in the affordable range
Share of Income Remaining
point increase. We’re not
We’re not talking a quarter-
directly from the city.)
from state legislation, not
code, the change must come
to the city’s administrative
According to certain New York state legislators, the solution is to tax the very people who are in the very business suited to address the problem. The purpose of the legislation, called the New York State Small Home Anti-Speculation Act, is to “deter property speculation and flipping in vulnerable neighborhoods.”
(Note: For certain changes
two years of original acqui-
transfer tax on certain fam-
Single Adult, Share of Income Remaining
to dramatically increase the
OK. So, there is a problem. What is the solution?
to pass a law
AF TER TA XES AND BA SIC EXPENSES
sition in New York City.
ture is trying
SHARE OF INCOME REMAINING
ily properties sold within
Monthly Income and Basic Expenses
causing more of the family dollar to be spent on housing. Additionally, there is less total housing available, driving up the demand for what is available, which in turn drives up the rent.
he New York
AVER AGE MONTHLY BA SIC EXPENSES
Total Taxes $1,147 (31.3%)
Housing & Utilities
Transportation $228 (6.2%) Other Necessities Health Care
Source: New York City Comptroller – Affordability Index
C AUSES OF DEREGUL ATION O ther
Rehab or Conversion
Tax Program Expiration
H igh-Rent Vacancy Deregulation H igh-Rent High-Income Deregulation
70% 60% 50% 40% 30% 20%
for lower income households. Thousands of additional units of housing are left vacant due to dilapidated conditions unsuitable for habitation. It is these units, already existing, that the city already has its eye on for reuse for housing. What our legislators are cur-
DISINCENTIVES Yet the proposed law aims to disincentivize the exact action needed to address the problem. While the proposed law makes an exception for “new housing,” this is limited to actual new construction, not the reuse of a
rently attacking, then, is our
currently vacant unit.
industry’s ability to assist in solv-
Legislators seem to assume
ing the problem. Our industry is uniquely poised to invest, lend and build our way to increased housing stock by reactivating and reusing existing structures to house those of lower income.
that every flip of a rental property results in an increase in rent. Although that is largely true, what they fail to realize is that when the previous rent was precisely zero due
Source: New York City Rent Guidelines Board
to a vacant unit or building,
Existing properties in more
any reuse would necessarily
severe states of disrepair, those
result in a dramatic increase in rent. Comparatively speaking, however, with rental comparables in the neighborhood, the rent may not be out outside the normal range. What is needed is not a disincentive, but a properly organized incentive. If legislators feel that not enough affordable housing is available for lower income individuals, then the answer is to provide incentives to invest in the types of proper-
in higher crime neighborhoods, those with poorer access to transit, or those that have any number of other negative attributes often need the highest amount of investment and are less likely to generate the return needed to accept the investment risk. Therefore, incentives—in whatever form—are needed to close the gap in funding or risk that has prevented these properties from being reused and
ties and in the neighborhoods
populated by those in need of
that need the most help.
UNINTENDED CONSEQUENCES Would you invest in a property to flip in New York City if you
had to pay up to 20% of its sale price as a tax? Most often, the answer is “no.”
The tax substantially erodes the return on investment, if not outright strips it away
completely. Even for those with higher ROIs to begin with, the tax will lower it
enough to make most projects
not worth the effort. Ironically, this tax may end up pushing
ing the city’s ability to fund its efforts to address the afford-
able housing crisis.
Remember, this bill does not
just affect the direct investors in these properties. If the
investor stops investing, then the investor stops borrowing
from the lender. The investor stops hiring attorneys. The
investor stops hiring contrac-
tors. The investor stops hiring agents. You get the picture— jobs will be lost.
THE GOOD NEWS
investors toward the higher
What’s the good news in any
increased costs to the ultimate
We still have time to stop
end of the market where the consumer could be borne
effectively, further reducing
the affordable housing stock
for lower income households.
this from happening. As you may be aware, AAPL and its
membership was instrumental in defeating a bill in Florida
The proposed law also has
last year that would have
consequences. The new pro-
engaged in business-purpose
current tax imposed on the
accomplished by discussions
city generates revenue from
committees; and letter-writing
tion of the new tax, there will
emails by our membership.
amount of property transfers
Committee is leading the
other unintended negative
required licensing for those
posed tax is in addition to the
loans within the state. This was
transfer of properties, and the
with legislators; testimony in
this base tax. With the imposi-
campaigns, phone calls and
be an overall reduction in the
AAPL’s Government Relations
within the city, thus reducing
charge against this transfer tax
the revenue generated by the
base tax and negatively impact-
bill, adopting as many of the
great lessons learned from the
campaign against the Florida licensing bill. We are scheduling upcoming meetings with the legislator-sponsors of this bill to discuss its disastrous impact. We have created a petition for our membership to sign and to pass around to all others affected by this bill. We have created draft letters for our membership to send to the legislator-sponsors (or any other New York legislator) telling them how you understand the severe negative impact this bill would have upon you, your livelihood and those living within the City of New York. What can you do to help? Sign the petition, send letters, call and email your legislators in New York, especially those who sponsored this bill. Legislators do listen, but only if you are loud enough. The issue of affordable housing isn’t going away any time soon. This is a very real and important problem to solve. Let’s be that solution. It would be advantageous to present to the legislators not only a chorus of “no’s,” but to propose alternatives. What we need is you, our endlessly creative membership, to propose legislative solutions to address affordable housing that would be an alternative to this devastating tax. ∞
Visit aaplonline.com/governmentrelations to access the petition and to share your ideas. With your help and your voice, we’ll have a real shot at defeating this bill!
ABOUT THE AUTHOR
MATT GUNTER Matt Gunter is an attorney working as assistant
general counsel for RCN Capital. Gunter focuses
on licensing compliance,
mortgage finance transactions, foreclosures, REO
property and tenant management, real estate closings, title clearing, bankruptcy management, business
litigation, contract manage-
ment and lobbying/lobbying
management. Gunter received his bachelor's degree in political science from California
State University Long Beach
and his Juris Doctor from the University of Connecticut,
School of Law. He presently
practices in the Connecticut state and federal courts.
4 THINGS THAT SHOULD KEEP YOU UP AT NIGHT Sure, interest rates are low, but there are still troubling economic indicators you should be paying attention to. by Jeffrey Levin
We all saw the housing market pick up strength this year, thanks to lower interest rates. Most prognosticators believe housing will maintain its strength through the winter and well into 2020. Mortgage rates are lower than last year, and recent moves by the Federal Reserve suggest they’ll continue to tick down. Although the Trump trade war with China is projected to weaken GDP growth, Freddie Mac’s September forecast indicates the housing market is healthy and will withstand those impacts.
Seeing the markets from our perch in the Washington D.C./ Northern Virginia/Maryland market, I have a bit more caution about where things are headed. We do expect interest rates to remain low and to dip even lower. Also, the nation’s supply of new housing stock is slowly but steadily increasing. We expect total residential closings to be healthy, although down slightly in 2020 compared to 2019. These are hopeful trends. But there are four bugaboos that keep me up some nights, and we should all keep an eye on them. They are:
04 T he inverted yield curve for bonds
While there will continue to
be regions with torrid demand
for housing, in most ZIP codes, the quality of the property and neighborhood will be more important than ever. Hard
money lenders like us must
remain vigilant about backing
only quality projects and sticking to borrowers with reliable
track records. It’s definitely not a good time to turn the deal
flow valves wide open! Let’s
look in more detail about my
four concerns around overall economic conditions.
01 A drop in consumer confidence
02 M anufacturing weakness
03 U ncertainty in the
CONSUMER CONFIDENCE IS DROPPING, DESPITE AMAZING EMPLOYMENT FIGURES.
political landscape In September, U.S. consumer
expected because Americans are gloomy about the U.S.China trade war. The Conference Board, an industry group, produces a monthly index of consumer sentiment. Their consumer “attitudes” index dropped from 134 in August to 125 in September. Their “expectations” measure—based on consumers’ short-term outlook for income, business and labor—dropped from 106 to 96. These are pretty stunning considering this summer’s unemployment rate of 3.7 was near a 50-year low. Yes, consumers have more cash in their pockets with virtually full employment and modest wage growth. But the countervailing pressure is the trade wars. The Trump tariffs are taking a bite out of discretionary income as prices for a wide variety of goods rise. The real pain hasn’t even hit yet. Pres-
ident Trump deferred steeper tariffs on Chinese consumer
goods until the holiday season. When consumers get nervous,
they put off large ticket expenditures such as cars, kitchen remodels and new homes.
THE MANUFACTURING SECTOR IS THE MAIN CASUALTY OF THE TRADE WARS. Although the economy is strong in many places, a weak manu-
facturing sector can indirectly
hurt real estate. Manufacturing is getting pummeled by the trade wars: the purchasing managers’ index fell to its
lowest level since the Great
Recession. This is a signal that the Trump Administration’s
confidence fell far lower than
despite having devalued their
“Yes, consumers have more
currency to make it cheaper for foreign customers to buy.
cash in their pockets with virtually full employment and modest wage growth. But the countervailing pressure is the trade wars.”
tiations—to reverse globalization, disrupt supply chains and levy tariffs on major trading partners—is backfiring. Factories are suffering almost everywhere. The eurozone
manufacturing index dropped to a seven-year low. Japan and India manufacturing also declined. China, the world’s second-largest economy, posted the slowest growth rate in nearly three decades. China’s exports continue to decline,
of uncertainty is being heaped on the markets. Markets hate uncertainty because it means more risk.
POLITICAL UNCERTAINTY MAY PUT THE PAUSE ON SOME HOME PURCHASING. Do homebuyers make decisions based on impeach-
bare-knuckle approach to nego-
impeachment hearings, a lot
ment hearings or presidential campaigns? Not directly. But does political noise have an indirect impact on overall spending behavior that impacts the economy? Absolutely. Between the democratic presidential primaries and the
So far, the U.S. equity markets mostly shrugged off the Trump-Ukraine scandal. This
may change over the months
ahead with all the boogeymen to unnerve investors in the political environment. For example, a surging Elizabeth Warren candidacy would unnerve Wall Street, Big Tech and pharma. Similar political instability is seen in the UK with the Brexit drama. The political shocks are likely to keep consumer confidence weak. Taken together, they
have the potential to make investors skittish and to impact the real estate market.
than for a two-year Treasury, it is called an inverted yield
curve. We had those condi-
tions at the end of August 2019. Historically, an inverted yield
THE INVERTED YIELD CURVE There’s been lots of chatter recently about this inversion. The yield curve is simply the spread between the return investors get from long- and short-dated Treasury bonds. During normal times, people pay a lower price for 10-year Treasury bonds than 2-year ones since they lock up money for eight more years. But when investors become fearful, long term bonds seem safer. When demand increases for such long-term bonds, their price goes up. And when its price goes up, its yield—the difference you earn when the bond matures minus the bond’s price—naturally goes down.
curve is a reliable indicator of recession happening over the next 2-3 years.
WHAT NEXT YEAR HOLDS IN STORE
gage origination remains
fairly stable at $1.8 trillion in
2020. Thanks to the increasing
supply of housing stocks,
and growing demand from
millennials who want to move out of their apartments, Fred-
die Mac expects home sales to
rise by about 1% to 6.03 million homes next year.
But as I laid out above, the economy has a lot of noise
Of course, the Federal
right now. I wish we could be
indicators like a hawk. Fear-
there are too many recession-
course on its earlier strategy
For hard money lenders, this
Reserve is watching all these
as confident as Freddie, but
ful of recession, it’s reversed
ary indicators at large.
of nudging up interest rates
and has been carefully reducing them instead.
level of uncertainty means it’s important to stick with triedand-true risk management
We expect three more rate
practices. Dig into the security
Without a crystal ball in
experienced borrowers who
in October, December and
in a turbulent economy. Look
ter of 2020. These cuts will
early by having the borrower
When people are fearful of recession, they have less demand for short-term bonds, so those prices drop and yields rise. Conversely, higher demand for long-term bonds cause their prices to rise and yields to drop. That is certainly the case today.
demand for 10-year Treasurys.
structure is built but before the
expected to average 1.8%,
with a mix of projects and
of 2.1% this year. Reducing the
Although 2020 may indeed
When the yield for a 10-year Treasury becomes higher
Freddie Mac estimates that
cuts of a quarter point each.
of your collateral. Stick with
hand, our best guess is cuts
aren’t “learning on the job”
midway through the first quar-
for deals where you can exit
help absorb the increasing
refinance with a bank after the
For 2020 the 10-year yield is
project is complete. Diversify
down from an annual average
10-year yield will, of course, help bring mortgage rates down even further.
lower rates will ensure mort-
ABOUT THE AUTHOR
be a good year for real estate— and I certainly hope it is—it is
JEFF LEVIN Jeffrey Levin is a bestselling author and the founder and
president of Specialty Lending Group (SLG), a boutique private real estate lending
company servicing the Washington, D.C., metro area.
Prior to launching SLG, he
was the co-founder and CEO of iWantaLowRate.com and
Monument Mortgage. Levin is a recognized authority on real estate investing
and a frequent lecturer and panelist. He is a member of
the American Association of
Private Lenders and serves on its Education Advisory Com-
mittee. He is the author of the
Amazon best seller “The Insid-
er’s Guide to Private Lending,” which details his experiences in private lending and advice for individuals looking to get into the business.
Levin earned a bachelor’s
degree from the American
University in Washington, D.C.
hard to argue against prudence and caution in these “very interesting” times. ∞
Strong Fundamentals Drive Maturing SFR Market Demographic trends should generally support strong single-family rental demand into the future and provide opportunities. by Robert Greenberg
inverted yield curve. Experts
sidelines. In a survey sponsored
don’t believe housing will be
the cause of the next recession,
by Zillow, a hundred real estate
and SFRs are still going full
for continued growth, even
weakening economy and
amid concerns about a
the potential for a market
correction as early as 2020, or possibly even in 2021.
As of September 2019, the Federal Reserve has cut rates twice this year, amid concerns over a slowing job market and an 22
experts, economists and strategists surveyed in the second quarter forecast annual price growth at the end of 2019 to be 4.1% and 2.8% in 2020. For the single-family rental
Although there’s been concern about a weakening housing market, a decline in mortgage rates during the second half
market, abundant capital via private lenders has bolstered opportunities for real estate investors to grow their port-
could rise even further if stock market volatility continues. “SFR underwriting appears balanced, as originators weigh recessionary timing concerns against the sector’s long-term positive outlook,” according to the second quarter 2019 Single-Family Rental Trends Report from Chandan Economics. “All else being equal, the SFR sector continues to benefit
of 2019 buoyed the industry
folios. It’s conceivable that
from institutional consolida-
and got homebuyers off the
interest in SFR investments
tion and economies of scale.
Even if the economy begins to
company. Single-family rents
Phoenix outpaced other metros
(Cleveland), Ohio; Allegheny
experience a slight slowdown,
have been on the rise since
in the most recent CoreLogic
County (Pittsburgh), Penn-
the SFR market should enjoy
2010, although during the past
analysis of single-family rents
sylvania; Milwaukee County,
moderate-to-strong growth due
year they have moderated into
with a 7.1% increase. Tucson
Wisconsin; and Marion County
to solid fundamentals.”
the 2.9 to 3.2% range.
(6.8%) and Las Vegas (5.8%)
(Indianapolis), Indiana, as “SFR
Investor interest in the
In another indication of stabil-
were close behind. Rents for
Growth” counties that have the
single-family rental market
ity, the average annual gross
lower-priced homes, those
potential for 2019 annual gross
has been driven largely by
rental yield (annualized gross
priced at 75% or less of a
rental yields of 10% or higher.
sustained rental growth and
rent income divided by median
region’s median rent, increased
SFR occupancy rates rose 0.6%
strong occupancy. U.S. single-
purchase price of single-family
family rents rose 2.9% year over
homes) analyzed by ATTOM
ing, CoreLogic said.
year in June, according to the
Data during the first quarter
ATTOM Data Solutions singled
85% early in the financial crisis,
most recent data available from
of 2019 was 8.8%, up from an
out Wayne County (Detroit),
according to the recent report
CoreLogic, a data and analytics
average of 8.7% in 2018.
Michigan; Cuyahoga County
from Chandon Economics.
faster than higher-priced hous-
to 93.4% in the second quarter of 2019, compared to 80% to
2020 TRENDS The SFR market should continue to benefit from strong housing demand, growth in
renting as a lifestyle choice, rising rents and abundant
capital from private lenders. The following single-family
rental trends likely will continue into 2020:
01 B uild-to-rent // This
subset of the single-family rental market continues
to expand. Investors have
included large, well-known brands such as Toll Brothers and Lennar and smaller players. ERC Homebuilders of Tampa, Florida, launched a Florida-centric business earlier this year specifically to fill this niche.
02 Technology // Private
lenders have led the way during the past five to seven years with technology-rich online lending platforms geared to single-family rental and fix-and-flip investors. These lenders
continue to innovate with new loan products geared specifically to investors and robust data analytics. Technology will continue to play an important role in the maturing SFR sector.
03 S hort-term rentals
(STRs) // With the explosive growth of Airbnb and other online rental platforms, more real estate investors are tapping into this market. The segment has had some growing pains that have resulted in
restrictions and outright bans in some cities. One of the biggest benefits of STRs is that they can produce higher returns than long-term rentals in the same market. Investors should keep close tabs on the increasingly hostile regulatory environment surrounding short-term rentals because it could impact their bottom line.
04 J oint ventures // Institutional investors who got into SFRs by buying
up foreclosures seven to 10 years ago are now joint venturing on large-scale build-to-rent communities. One of the latest examples is Tricon’s $450 million venture with the Arizona State Retirement System. A key focus of this partnership will be to target the development of single-family build-to-rent communities in U.S. Sun Belt markets.
05 C reativity in housing
stock // The lack of affordable housing presents numerous opportunities for real estate investors. Investors are increasing the affordable housing stock through creative methods such as rentable accessory dwelling units (ADUs). California and other states have reduced regulations surrounding ADUs to address the affordable housing crisis. Less red tape may make ADUs a more viable residential real estate investment option in California and other states. Multigenerational housing has also been growing in popularity, according to the Pew Research Center, and may present options
for investors who can meet that demand.
LOOKING TO THE FUTURE
ABOUT THE AUTHOR
06 M illennials // The aging
of the millennial generation should support robust demand for rental units for years to come, according to the Joint Center for Housing Studies of Harvard University.
“Rental markets are basically stable despite the upturn in homeownership,” according to the 2019 The State of the Nation’s Housing report from JCHS. “Demand from higher-income households is still on the rise, and construction of rental housing picked up again last year after a slight dip.” Single-family rental stock fell by more than 250,000 units in 2017, according to the report. Even with this sizable decline, single-family homes make up about a third of the national rental stock, or about 15.8 million units. JCHS believes most of the “losses” were homes that were converted to owner occupancy rather than homes that were permanently removed from the housing stock.
Going forward, demographic trends should generally support strong single-family rental demand into the future and provide opportunities to private lenders. The Joint Center estimates that renter household growth will total 4.2 million by 2028 if homeownership rates remain near their current levels. And even if the homeownership rate rises by 1.6 percentage points over the decade, renter household growth will still total at least 2.1 million, given expected increases in the adult population, according to JCHS forecasting. Stock market volatility during the second half of 2019, driven in part by trade wars, could also drive increased interest as investors seek out less volatility, higher yields or more diversity in their financial portfolios. Interest in real estate and SFRs specifically as an investment option will likely continue to attract the attention of many investors in 2021 and beyond. In all, the future for SFRs looks bright, even with some headwinds facing the economy. ∞
ROBERT GREENBERG Robert Greenberg is chief mar-
keting officer for Patch of Land. His professional experience
includes over 25 years in marketing, working with familiar consumer brands such as
Pepsi-Cola, Anheuser-Busch and Sara Lee as well as B2B
experience in retail, technology, finance and real estate.
Recently, he led the marketing efforts for B2R Finance, where
he helped originate more than
$1 billion of real estate investor loans that led to the industry’s
first-ever multi-borrower singlefamily rental securitization. At B2R, he was responsible for
branding, corporate commu-
nications, lead generation and integrated marketing efforts.
He was responsible for leading the development and implementation of the marketing
automation and CRM platform that helped to deliver sales
management and operational efficiencies to enhance the
customer experience for real estate investors nationwide.
WHAT YOU NEED TO KNOW ABOUT THE CENTRALIZED PARTNERSHIP AUDIT REGIME Fund managers may not be aware of their new role during an IRS audit of companies with partnered members.
tax directly from a partnership and shifts the responsibility
for the collection of tax to the partnership.
Under Sec. 6221(b), certain
partnerships are eligible to
elect out of the BBA annually. If electing out, the IRS would
generally make any adjustment relating to the partnership's
return in an audit of a partner,
not an examination of the partnership. The partnership would not owe any taxes, interest or penalties.
A partnership can elect out
of the CPAR if the partner-
ship meets specific eligibility requirements. A partnership
by Beeta Lecha
is eligible within a tax year
if it has 100 or fewer eligible partners. Eligible partners
are individuals, C corporations, S corporations, foreign
The new centralized partnership audit regime (CPAR) introduced by the Bipartisan Budget Act (BBA) started with the 2018 tax year.
entities that would be C
corporations if they were
domestic entities, and estates of deceased partners.
A partnership is not eligible if it is required to issue a
Schedule K-1 to any of the Under the old rules, there was no
old rules left the IRS with the
mechanism for the IRS to collect
inability to effectively collect
tax at the partnership level when issuing an IRS audit adjustment.
O ther partnerships
tax from partnerships that have
D isregarded entities
dozens, or even hundreds, of
Instead, the IRS had to seek pay-
ment of underpaid tax directly
The CPAR resolves the issue
from partnership members. The
by allowing the IRS to collect
A n estate of an
individual other than a deceased partner
“The CPAR resolves the issue by allowing the IRS to collect tax directly from a partnership and shifts the responsibility for the collection of tax to the partnership.”
A ny person who holds
an interest in the partnership on behalf of another person
F oreign entities that
would not be treated as a C corporation were it a domestic entity
With these restrictions, fund managers will often find that their fund does not meet the eligibility requirements to elect out of the CPAR based on the composition of the fund's investors.
ROLE OF THE PARTNERSHIP REPRESENTATIVE Section 6223 of the code provides that unless the partnership has made a valid election out of the CPAR, each partnership must designate a partner or other person with a substantial presence in the U.S. as the partnership representative who shall have the sole authority to act on behalf of the partnership. If an entity is designated as a partnership representative, the
partnership must also appoint an individual to act on the entity's behalf (a designated individual). To be a designated individual, the appointed person must also have a substantial presence in the U.S. The partnership representative (or designated individual) can be the fund manager or any other individual, such as a CFO or controller. With the CPAR allowing the IRS to make tax assessments and collections of tax, interest and penalties at the partnership level, there are a few issues for fund managers and partnership representatives to consider:
S hould the private place-
ment memorandum (PPM) or LLC operating agree-
ment be updated?
C an the fund withhold
the tax from current year distributions, and what
effect would that have on the fund's yield?
W ill a prior-year tax
liability be shouldered
unevenly by the current
investors whose composition has changed through the admittance of new
agreements with their legal counsel and tax advisors. Suggested changes include, but are not limited to, the following: R eplacement of a
"tax matters partner" with a "partnership representative"
A statement that under
section 6223, the partnership and its members are bound by actions of the partnership representative in dealings with the IRS
T he elections or opt-outs
that the partnership representative may make
T hat the designation for
a partnership tax year remains in effect until the designation terminates
investors, or can the tax be specially allocated?
H ow to plan for the collec-
tion of taxes from investors who have already
redeemed their invest-
ment from the fund
LLC OPERATING AGREEMENT REVISIONS Fund managers should review their PPM and LLC operating
T he partnership being
held responsible for remittance of additional tax rather than individual partners being taxed
C urrent partners may
be held responsible for the tax liabilities of prior partners
A disclosure that the
taxes, interest and penalties would be calculated based on the highest tax rates
OBSERVATIONS The 2018 IRS Data Book published in May 2019 accounts for the number of IRS examinations in 2018 of the 2017 tax year. Out of the 195 million tax returns filed in 2018 for the 2017 tax year, only 8,945 partnerships were selected for audit. Compare that with the 892,187 of individual tax returns audited, and it is clear to see that the IRS saw little benefit in pursuing audits
of nontaxable partnerships. The question arises of whether we will see the IRS increase the number of partnership examinations for 2018 and future tax years. Conversely, IRS audit rates are dropping overall due to a shrinking IRS budget. Examinations decreased by one-third in the past five years, down to only 0.5% of all tax returns filed. This decrease is anticipated to continue to trend lower. With such a low likelihood of an IRS examination, fund managers will want to ensure that their LLC operating agreement language is up-to-date for their changing responsibility
but will not need to be overly concerned about being selected for an audit. âˆž
ABOUT THE AUTHOR
BEETA LECHA Beeta Lecha is a principal at Spiegel Accountancy Corp,
leading the taxation and fund accounting practices. Lecha
has 13 years of private equity and alternative investments
experience, primarily focusing on private lending and real estate funds.
In addition to fund accounting and investor reporting, Lecha
provides tax strategy, tax planning and tax compliance for
fund managers and real estate investors. Lecha is a member of the American Institute of
Certified Public Accountants (AICPA) and the California
Society of CPAs (CALCPA).
Lecha is serving on the Educa-
tion Advisory Committee of the
American Association of Private Lenders (AAPL).
LENDER LIMELIGHTÂ WITH VINCENT BAL AGIA
DRIVING DEVELOPMENT IN TEX AS Vincent Balagia has kicked Stallion Funding into
full gear to provide hard money loans to real estate
investors in Austin, Dallas, Houston and San Antonio. by Katie Bean
was 26 years old
when he founded Stallion Fund-
have much entrepreneurial experience, but he knew he had to strike out on his own.
ing in Austin. It was 2007,
Twelve years later, Stallion
Recession. Balagia didn’t
than $250 million into Texas
on the cusp of the Great
Funding has deployed more
real estate markets and produced consistent, high-yield returns for investors.
He’s driven by the desire to
Balagia likes to be in the driver’s seat, whether at his company or in one of the several sports cars he owns.
also making a visible difference
create an environment that helps employees grow while throughout Texas, especially in Austin. Above all, he’s driven by his faith.
LENDER LIMELIGHT WITH VINCENT BAL AGIA
traditional asset management
“I asked for a job,” he said.
“I tried to be a good employee,
before becoming interested
Balagia got it and worked at the
to treat the company like it
“I lead this business by faith,” he said. “I don’t know what’s coming around the corner, but I try to be diligent about it and do the best I can for God and for the people around me.”
in a new company that he
OFF TO THE RACES
was introduced to by a friend from church.
was my own, but I wanted it
ing the ropes. But after a while,
to be my own.”
he said, “I felt the call to try
So, in his mid-20s, he took
The company created its own
it out on my own.”
the plunge. Stallion Funding
investments using real estate,
“With other jobs, I felt boxed
started with one investor
in. They came with safety
and one loan.
and stability, but I was always
His goal was simple:
creating portfolios and invest-
willing to see if I could do
Stay in business for as
it on my own,” Balagia said.
long as possible.
and Balagia was intrigued— After studying finance at the University of Texas-Austin, Balagia started his career in
company for two years, learn-
he was passionate about
“I lead this business by faith. I don’t know what’s coming around the corner, but I try to be diligent about it and do the best I can for God and for the people around me.” — V I N C E N T BA L AG I A
personality test. Balagia said that when co-workers know more about each other, they understand and appreciate their differences. “When you read someone’s profile and it’s right on, you The plan is still working, and Stallion Funding now employs 15 people.
MAPPING PERSONALITIES For Balagia, one of the most rewarding aspects of owning a company is seeing personal development in his employees.
“As the owner, the boss, people are investing in me, and I’m investing in them,” he said.
“At the end of the day, I want
them to feel like that was time
Balagia approaches employment as an opportunity for growth— and that applies to him as well as his employees. At Stallion,
everyone maps their personality using the Enneagram, a popular
understand their motivation,” he said. Likewise, Balagia said using the assessment has helped him see personality quirks as a person’s unique strengths. “Knowing each other and being
Love Languages” to understand how individual employees feel most appreciated, whether through words of affirmation, gifts, acts of service, quality time or touch. “If you can understand what’s important to other people, that gives you a reference point,” he said. “You can really be a blessing to someone and not just a work relationship.”
EVERYONE TAKES OWNERSHIP
known is better for relationships and communication,” he said. In that same vein, Balagia also uses principles from “The Five
From a leadership perspective, Balagia said he has learned to speak truth to employees about the progress they’ve made at
LENDER LIMELIGHT WITH VINCENT BAL AGIA
GET TING TO KNOW VINCENT.
“I get to see them enjoying their position and have a sense of accomplishment, help other people and get traction, and take advantage of the gifts they’ve been given,” he said.
THIS OR THAT
TEXT OR CALL? PEN OR PENCIL? BLUE PEN HOT CHOCOLATE OR EGGNOG?
EGGNOG IS A DELICACY FOR ME.
SNEAKERS OR FLIP FLOPS? I'M A SNEAKERS GUY. I HATE FLIP FLOPS. MOUNTAIN OR BEACH? BEACH, BU T IN THE WATER. I DIVE A LITTLE BIT AND LOVE TO BE IN THE WATER. A BOOK ON THE BEACH DOES NOT CU T IT FOR ME.
NIGHT OWL OR EARLY BIRD? NIGHT O WL. SOME OF THE BEST TIMES AND BEST IDEAS FOR ME COME LATE.
MOVIE? “CONAN THE BARBARIAN”—THE OLD ONE WITH ARNOLD SCHWARZENEGGER. IT’S A TOSS-UP BETWEEN THAT AND “ROCKY.”
PLACE YOU'VE TRAVELED? GRAND CAYMAN ISLANDS BOOK FOR FUN?
MY NUMBER ONE FAVORITE IS THE BIBLE; FICTION IS “THE OLD MAN AND THE SEA” BY ERNEST HEMINGWAY
SEASON? FALL—IT FINALLY BECOMES TOLERABLE AFTER SUMMER, WITH A LITTLE CHILL IN THE AIR
GUILTY PLEASURE? CARS. I PROBABLY SPEND TOO MUCH MONEY ON SPORTS CARS.
work and the unique skills they bring to the company.
Even for employees who decide they’ve outgrown their role and choose to move on, Balagia said he’s seen the courage build in them over time to take that next step. Balagia said that the company’s core values relate to the culture at Stallion Funding. One of those values is relationships— understanding his employees leads to better relationships internally, and when employees gel, they can build better relationships with clients, vendors and others outside the company. Another is ownership. As stewards of investors’ resources, it is crucial for everyone at Stallion Funding to act for the benefit of others. “I love to see people own their piece of the business with a passion—to see them really caring, really activated
and caring about results,” Balagia said.
”CHARACTERBUILDING” YEARS Balagia cites the culture of ownership as one of the reasons the company was able to keep the doors open during the Great Recession. Balagia refers to that time period as “character-building years.” It was a particularly tricky time for a young real estate finance firm. “Everyone wanted to get out of real estate,” Balagia said. He briefly considered getting a side gig but decided to train his full focus on the company. He had brought investors into the market, so he focused on getting them out of it with the best possible outcomes. “We tipped our head down and did everything we could each day,” he said. Balagia learned valuable lessons during that time. Dealing with foreclosures “took away the fear factor,” he said. And he saw that the market eventually turns around. “When we have another recession—hopefully not a Great
Recession—we know that we don’t stop. We provide solutions that bless everyone rather than be vultures,” he said.
DRIVE TIME When he needs an off-ramp from work, Balagia turns to his collection of sports cars and a racetrack in Austin. “One thing I like about them is when you’re engaged in driving at the track, you get in the zone and the stresses of the day or the season melt away when you’re hitting that corner just right. It makes everything very real and brings you to the present moment,” he said. When driving at high speeds, “nothing really matters if you don’t get through this present moment.” Balagia’s interest isn’t in just the cars. It’s also in the power they have and how they make you feel when you’re in the driver’s seat, he said. His collection includes a Lamborghini Huracán, Nissan GTR, BMW M5, 1969 Corvette and a Honda S2000. He’s not clamoring to add a self-driving car. “I think the world will be a safer place, but I hate being put in a box and having to go with the flow. That’s why I like driving,” he said.
SEEING DREAMS COME TRUE
ABOUT THE AUTHOR
Although he can’t always steer the outcome, Balagia has enjoyed being part of the real estate industry. “Real estate is great because we see the benefit of projects we finance,” he said. Balagia has seen some parts of Austin visibly change, partly through Stallion Funding investments. He’s witnessed underutilized areas come back to life, rundown buildings get a facelift and even crime rates come down in some areas, thanks in part to redevelopment. He’s also seen builders “make their dreams come true” by starting out on smaller rehabs and moving onto increasingly larger jobs.
KATIE BEAN Katie Bean is a former newspaper and magazine editor
who loves telling the stories of businesses and great leaders. She is based in Kansas City.
“It’s very satisfying to see others in a much better place because they partnered with us,” he said. Seeing the tangible results of the company’s work makes it far more rewarding than traditional investing, Balagia said. “Real estate really connects with people. We all need to have a place we call home.” ∞
OCEAN VIEW PROPERTY GETS A MAKEOVER Transforming a dilapidated 1960s
structure into a mid-century modern home
his La Jolla, California, mid-century gem with an unbelievable ocean view had potential, but
Services in need of fast and reliable financing.
it needed a hefty remodel to maximize its
Once financing was in place, a full remodel began.
Originally built in 1964, the structure had only one previous owner.
To maximize the view, a 1,000-square-foot Moso bamboo deck and new frameless doors for an indoor/outdoor living space were added. Dividing walls were removed to create a more open concept.
The property boasted 1,988 square feet of space, with three
Wide-plank European oak floors, cabinetry and custom lighting
bedrooms and two bathrooms. Although the property overall
were installed to replace the outdated counterparts.
had potential, the original layout was boxy and very closed
Another bedroom and bathroom were added; ceilings were
in, with tiny bedrooms. And there was no deck to take advantage of the gorgeous ocean view.
offers on the table, the borrower contacted Civic Financial
heightened; and new doors, windows, air conditioning, roof and stucco were put in place. Plumbing and gas lines were
The investor, who is also the owner and principal interior
updated and reconfigured as well.
designer of Simply Stunning Spaces, immediately recognized
The investor planned to sell within 8-10 months in a
the possibilities for this property. Despite there being 15 other
Civic Financial Services Client/Borrower //
Location // La Jolla, California Architecture Style //
Originally Built // 1964 Square Feet // 1,988 Loan Amount // $1,509,500 LTV // 80% LTC // 84% Credit Score Considered //
Borrower Experience //
Accomplished interior designer who has partnered with an experienced investor on this rehab
Interest Rate // 8.75% Length of Loan // 12 months Rehab Costs //
Anticipated $317,500 Summary of Opportunity //
Civic Financial Services funded the acquisition and rehab of this property, delivering a high-leverage financing opportunity to an experienced investor looking to acquire, modernize and sell in a timely fashion. Construction is complete, and the property is currently listed for $2,295,000.
MARKETING & SALES
THE DO’S AND DON’TS FOR A NEXT-LEVEL PITCH DECK by Ruby Keys
f starting a mort-
products and services that is
your to-do list,
with the end goal of garnering
gage fund is on
you will need to
generate capital. Having a
solid pitch deck is vital for successfully acquainting
possible investors with your business plan.
tailored to a specific audience investments. Designing a workable pitch deck that
convinces potential investors
to back your business requires considerable forethought, but the return on investment is
What exactly is a pitch deck and why is it so important?
completely worth it.
Think of a pitch deck as your elevator pitch in a presentation format such as PowerPoint. It’s a captivating and compelling snapshot of your company,
to-implement tips to help
Here are some quick, easyyou achieve the ideal balance of detail and attention-
grabbing appeal in your pitch deck design.
DO S elect an eye-catching
format // You can build your pitch deck from the ground up or work off an existing template—just remember to select colors and design schemes that sync up with your overall branding strategy. Keep your slides consistent with the same colors and formats while tastefully incorporating images to compliment your comprehensive message.
Fuse your branding into
the pitch deck // While not all businesses have an established brand, you should still develop a recognizable thematic tone you can build off of. Before starting your pitch deck, ensure you have a default logo or icon and a complementary color framework that represents your unique brand. Additionally, generate a group of keywords that align with your corporate culture and strategically incorporate them throughout your presentation.
“Designing a workable pitch deck that convinces potential investors to back your business requires considerable forethought, but the return on investment is completely worth it.”
F ocus on functional
imagery // During the design process, devote
adequate time to developing a collection of dynamic images of your business’s key personnel, funded projects, or goods and services. As the adage goes: “A picture is worth a thousand words.” As cliché as that may sound, there’s an element of truth to it. Professional depictions of your business
investors than grainy clip art ever will. I ncorporate statistical
graphics // Charts and
graphs highlighting the success of your business (as long as you don’t go overboard with the amount of data) can offer positive reassurance to prospective financial backers that their money is being responsibly managed. Use straightforward graphics that
endeavors make a much more
give investors a clear insight
lasting impact on potential
into your business model.
I mplement iconic icons //
Opt for subdued icon themes to break up complicated data sets into organized, easy-todigest blocks. To take your presentation to the next level, color-coordinate your tiled layout to improve the audience’s comprehension. This approach can assist in organizing key information you want to introduce to investors without losing them in a deluge of numerical data.
I ncorporate professional
headshots // When select-
ing images of your staff members, use professional headshots. It’s a worthwhile investment of time and money to get professional photographs taken of your leadership team. Doing so will improve the thematic consistency of your pitch deck and give your overall branding scheme a polished look. Although some startups attempt to feature cameos to give their presentation a personal feel, this approach may not be best suited for your target investor audience.
MARKETING & SALES
M aintain consistency //
When it comes to selecting font and format, stick to a uniform template throughout the pitch deck. Using a plethora of styles is distracting to your audience and may obscure your message. Develop a generic template and modify it slightly throughout your presentation to achieve a balanced, professional style for a subtle, yet impactful effect on potential investors.
T hink outside the box //
Some ideas are harder to convey than others, especially intricate business plans with an abundance of accompanying data. When formatting your pitch deck, take a step back and put yourself in your target audience’s shoes.
Is your content capable of capturing and holding their attention from start to finish? Is there a better way to convey your comprehensive message? Is all that data really necessary to win them over?
“The average investor only backs a minuscule fraction of the companies that present. Gaining the slightest edge can be the difference between your success and failure.”
S tart slow // No matter how
Asking yourself these questions now can pay dividends when it comes to presentation day.
DON’T Throwing together a hasty presentation isn’t going to cut it. The average investor only backs a minuscule fraction of the companies that present. Gaining the slightest edge can be the difference between your success and failure. Here are some common pitfalls to avoid to give you that all-important leg up on the competition. G o overboard with
details // In most cases, potential investors are not familiar with every
than mundane white pages. Your presentation should give the impression that your fund is revolutionary and professional. Today’s presentation software programs are brimming with effects and color templates that you can take advantage of.
detail of your company’s specific niche—and they don’t need to be. Steer clear of using technical language that your audience simply won’t follow. Opt instead for a concise message worded in easy-to-understand language. Try to design your pitch deck so that is comprehensible even to individuals with little to no understanding of your industry. Be careful you don’t oversimplify your pitch though, especially if your audience is comprised of sophisticated investors. Do the leg work, know beforehand who you will be presenting to and adjust the level of specialized info accordingly. R ely on outdated style //
By no means do you need a degree in graphic design to build an effective pitch deck. Still, it should feature more
cutting edge your company’s fund is, you will fail to get potential investors on board if you don’t make a strong initial impression. A stirring, catchy opening to your presentation will draw your audience in and make them eager to hear more about your brand.
Remember, investors hear countless pitches every day. Avoid getting lost in the crowd by showing them from the get-go why your business is the one they should invest in. D rone on…and on // Show
that you value your audience’s time by wrapping up your pitch well in advance of your allotted time. You want to avoid inconveniencing a room full of professionals who have a packed itinerary and can’t afford to miss their next appointment.
Importantly, be sure to finish your presentation in time to accommodate any questions investors may have. S kew the data // You may
be tempted to doctor the numbers in your pitch deck to make your business seem stellar. Don’t.
Doing so may make a stronger impression on investors, but they will find out about your dishonesty eventually. This can be devastating for your brand’s reputation and can even result in future legal trouble. To avoid any intentional or unintentional misrepresentation, make sure your data are accurate and
up to date before you start compiling your slides. F orget the big picture //
Many entrepreneurs don’t get the funding they need because they fail to communicate a comprehensive, longterm corporate vision. Convey to investors that you can scale your business once it becomes successful. Be realistic, but ensure that your ambition and drive are readily apparent.
B lank on an exit strategy //
Most investors want to invest their money in ventures that will yield a healthy return as opposed to letting it stagnate in a bank account.
One of the most effective approaches to grabbing investors’ attention is to show them how strong your company’s ROI will be a few years down the road. Presenting a viable exit strategy shows investors that you’re prepared—a favorable characteristic for someone they are entrusting their money with. As you can see, building an effective pitch deck is an involved process. If your goal is to convince investors to respect and ultimately fund you, be sure to be transparent, accentuate the inherent value of your ideas and be prepared. ∞
ABOUT THE AUTHOR
RUBY KEYS Ruby Keys joined Geraci LLP in 2015 as the marketing
coordinator for Geraci Law
Firm. As she enters her fifth
year with Geraci, she is now the vice president of Geraci Media,
a full-service marketing agency, which caters to the non-conventional lending space.
MARKETING & SALESÂ
Turn Back Time via Checkbook Control Self-Directed Accounts Discover how to access your share of the IRA dollars sitting on the sidelines. by Dan Kryzanowski
There are approximately 10,000,000,000,000 (yes, trillion!) of individual retirement account dollars sitting in bland assets such as target funds and community bank CDs. A Checkbook Control Self-Directed account is a mechanism for accessing some of those dollars.
What is a Checkbook Control Self-Directed account? It’s a self-directed IRA LLC with “checkbook control.” It allows the IRA holder to use IRA funds to make just about any investment, including real estate, precious metals and others. And they can be used
SDIRAs were legally estab-
lished in 1974. Per Forbes,
according to the Employee
Retirement Income Security Act (ERISA) and IRS codes,
only two types of investments are excluded (life insurance
and collectibles) as potential investments. Separately, the
to fund your projects.
Solo 401(k)—another Check-
TOO GOOD TO BE TRUE?
account—is the result of the
Let’s review a few basic questions you may be asking. Are Checkbook Control Self-Directed accounts illegal? Quite the contrary. IRAs and
book Control retirement
Economic Growth and Tax
Reconciliation Relief Act of 2001 (EGTRRA).
Are Checkbook Control Self-Directed accounts
complicated? No. They are as simple as writing a check to
any person or any entity that is
MARKETING & SALES
not a disqualified person (i.e., your linear family: grandparents, parents, spouse, children, yourself ). Note that siblings and in-laws are not disqualified persons, though you should be cautious not to give siblings, in-laws or extended family preferential treatment versus other investors. Are Checkbook Control Self-Directed accounts available only to the “1%”? Absolutely not. For nearly five decades, there has been a quiet group of one million Americans who have invested more than $100 billion into alternative assets and private funds.
SHOW ME THE MONEY How do you get started? Simply ask your current and future investors this question: “Did you know you can also use your retirement dollars to invest in my offering?” Copy and paste that question, along with a short explanatory paragraph to your website, monthly newsletter or social media channels. Once you start getting the word out to poten-
tial investors, they will begin to understand they are eligible to use their retirement funds to invest in your offering.
coming from a Checkbook Control account? If yes, then it is a simple as cashing a check (or verifying an ACH or wire).
Fellow lenders that have exhibited this simple strategy find that they may fund up to 25% of any and all offerings from their current investors’ retirement dollars.
Otherwise, be prepared to get out your phone—or at least a comfortable headset—as both you and your investor may each spend over an hour on the phone with a representative from a third party.
In the event you receive no immediate investments, you will have educated your audience about the potential, and you’ll plant a quiet seed for when the time is right (e.g., when an individual leaves their current job or generates significant self-employed income).
THREE DAY WEEKENDS— ALL THE TIME You need to consider one major factor when receiving Self-Directed dollars. Are they
REAL WORLD EXAMPLE Let’s say you need to raise $1 million to lend out on your next deal, confident that you can complete the raise by yearend across your 100 investors and qualified prospects. On prior deals, 10 people would each invest $100,000. This time around, Investors A and B are without liquid funds and Investors C and D are prioritizing
family and delaying commitments until the next year. So, what do you do? Fortunately, you have a solid reputation with a dedicated readership. You send out your December newsletter. A solid majority of the 50 investors who clicked open are now deeply engaged in the FAQ of a provider that offers Checkbook Control Self-Directed accounts. Investor A is ecstatic and calls you to commit $100,000 from her Checkbook Control SelfDirected Roth IRA. For Investor B, the light bulb goes off as he recalls taking his dad’s advice and maxing out his 401(k). After a few Google searches and a phone call, he learns he has benefited from (unconsciously) riding out the equity wave, now with
roll his TSP funds into a few
different Checkbook Control
Self-Directed accounts. He
texts to commit $100,000 on your next deal. Investor C
always honors his commit-
ments, so you are already a step ahead of the game come 2020. Finally, Investor D is winding down her first year as a very
successful one-woman consultancy. She formerly worked $50,000 across his “old 401(k)s.” Wary of the stock market since 2008, he instructs to sell out of all equities and transfers
these funds into a Checkbook Control Traditional (pretax) Self-Directed IRA.
Investor C is ex-military,
excited to learn that he can
for a big-name financial
planner and felt the double
whammy of being tied to the
“company store.” Compliance and regulations forced and
limited her hand to invest only in public assets, while being capped contributing only
$19,000 (i.e., paying more taxes on her net pay).
“For nearly five decades, there has been a quiet group of one million Americans who have invested more than $100 billion into alternative assets and private funds.
Investor D learns she is now eligible for a Checkbook Control Self-Directed Solo 401(k) (i.e., the “Solo K”). She can contribute not only $19,000 (as she did previously in her old W-2 job), but also a profit-sharing contribution of 20% of her net earnings. Investor D wisely read the fine print—which you kindly boldfaced and headlined for her in your email—ensuring that she will open the Solo 401(k) by the end of the calendar year.
graph) that you can then share with your investors. Please note this should cost you nothing and ideally take no more than five minutes of your time. ∞
ABOUT THE AUTHOR
She commits the full $56,000 of her 2019 contributions to you, after taking five minutes to sign up online for the Solo K. In summary, you have just raised six-figures—$206,000 to be exact. The Checkbook Control Self-Directed accounts are opened within minutes, funded within days or weeks, and you receive the $206,000 (along with the other $794,000 from other folks’ nonretirement accounts) by mid-December.
Dan Kryzanowski, executive vice president at Rocket
Dollar, is an active real estate investor and fundraiser,
accounts to create a diversified real estate portfolio
yielding double-digit returns.
JUST DO IT
He specializes in self-storage
investments, multi-family and hard money residential prop-
Reach out to a Checkbook Control Self-Directed account provider of both the Self-Directed IRA (SDIRA) and Solo 401(k). They should provide you with collateral (i.e., template para-
erty loans. Kryzanowski has
personally raised millions of
dollars from family offices and individuals, and empowered his partners to raise seven-
figures on multiple occasions.
6 PRACTICAL WAYS TO DEFEND YOUR COMPANY AGAINST CYBERTHREATS Ransomware attacks are becoming more common, but most businesses aren’t prepared for the battle. by Vincent Alfieri
rently living through
revolution. Entire businesses and industries are being
transformed—or, at the very least, changing—as they
adopt new technology that
allows them to become more efficient and competitive.
This sword has two sides, however. The more you rely on technology, the more you leave your business open to new security threats. You might not realize it, but your company’s digital data are one of your most critical and valuable assets. What would happen to your business if all your data were lost or held hostage? Would your business survive? Can you afford to pay a ransom? Can you afford to close your business for a few days—or possibly even weeks? Ransomware attacks are on the rise, yet most businesses are not adequately prepared for the threat. According to Symantec’s 2019 Internet Security Threat Report, enterprise ransomware attacks are up 13%. You need to start taking cybersecurity seriously, if you haven’t already.
WHAT IS RANSOMWARE? Ransomware is a type of software/malware designed to deny access to your data or systems until a ransom is paid. Hackers will lock (encrypt) your data, making it impossible for you to access it without the correct (encryption) key. At that point, you and your business are at the mercy of the hacker. It is practically impossible to guess an encryption key. You’re probably asking, “Why would anyone want to hack my business?” As a lender, you hold valuable data. From borrower financials to Social Security numbers for credit checks, this confidential information is a hacker’s direct target. Private lenders and other small businesses are easier targets because they spend less on security and information technology compared to larger corporations.
YOUR VULNERABLE POINTS To understand what you are defending against, you must first understand the battlefield. What technology does your business use every day to interact with the outside world? Email!
According to Symantec’s
“layers” of defense to protect you
2019 Internet Security Threat
and your business from ransom-
Report, the chief ransomware
ware and other cyberthreats.
distribution method in 2018 was email. Email is the easiest way for a hacker to attack your business because it is a direct line to your employees. One wrong click on an attachment or link can compromise your business. Another part of the battlefield is your network. Your network
01 B ack up your data //
And back up your back-
ups. Store your backups in multiple locations
(e.g., with a third party,
in your pocket or in your home). Having backups completely segregated from your network is
“What would happen to your business if all your data were lost or held hostage?” (wireless or wired) is how electronic data are sent between your employees, devices and the internet. Once malicious software is inside your network, it can spread to other computers and devices.
MOUNTING A STRATEGIC DEFENSE
essential. It gives you an alternative avenue
to restore your systems and information in the
event your digital data are compromised. If
you store your backups in the same network/
system you use in your
day-to-day business, the backups can be ran-
You can think of cybersecurity as several layers. Here are some
somed as well. Storing
your backups in multiple
locations allows you to always have access to your data in the event of a security incident.
02 N etwork // You’ve probably heard of the term “firewall.” It does not refer to a literal wall of fire, but it is a network security monitoring system that controls all incoming and outgoing network traffic. A firewall is basically a security guard for your network. A well-configured firewall will help block malicious emails, links, documents, attachments and so on from even entering your internal network.
Protect your Wi-Fi access points. Separate your guest network from your main network. That could mean having a separate Wi-Fi for your guests and another Wi-Fi for your employees. Don’t let outside devices connect to your main company network.
03 A nti-malware and
anti-virus // Stop the malicious links and attachments from even
reaching your inbox by installing anti-malware and anti-spam mechanisms on your Office 365 or other third-party email provider. Finally, the last layer you need to protect is the end device—your computer. Installing an anti-malware and anti-virus service on all company devices can help catch malware that falls through the cracks.
04 S tay up to date //
Update everything. Software companies do not release updates just for fun. They release updates to fix bugs and security issues. Installing the updates is the easiest way to protect your systems. Hackers will exploit known security holes because it is easy and documented. Don’t give them that chance.
05 E ducate your employ-
ees // You can take all the recommended measures for securing your network and business, but you are only as strong as your weakest teammate. You’ve probably accidentally clicked a bad link or opened
an attachment from an unknown sender. It is extremely difficult to plan for human error. All you can do is arm your team with the knowledge and skepticism the digital world demands. Train your team. Teach them about phishing and other social engineering tricks. Educate them on best practices and how to spot fake emails. Take advantage of the vast library of online courses that focus on practical cybersecurity.
You have a responsibility to your customers, employees and yourself to protect your business’s digital assets. Cyberthreats will continue to grow. It is not a matter of if an incident will occur, but when. A little bit of prevention can go a long way. ∞
ABOUT THE AUTHOR
06 Practice makes perfect // Have you ever simulated a recovery from a ransomware attack? Has your IT team ever simulated recovering your systems and data? Probably not.
Having a well-developed and well-tested business continuity and disaster recovery plan is essential to handling a security incident. This is the playbook your business will follow in the event of an “incident.” Such a plan will clearly define how to restore your business operations quickly and keep your data safe and accessible.
VINCENT ALFIERI Vincent Alfieri is the head of
development operations and security at ProDeal, a high-
growth technology company focused on securing and
automating transactions. In just over a year, ProDeal has seen over $35 billion transacted
across its platform among over 650 organizations.
Alfieri is responsible for managing ProDeal’s AWS Cloud infrastructure and security. He is also responsible for
implementing and enforcing Information security policies and procedures to comply
with EU GDPR, ISO27001 and SOC II standards.
Use Discount Code PL15 For a 15% Discount To Attend!
Lessons From a Real Ransomware Attack Our firm takes cybersecurity seriously, but we were still impacted by attacks on our third-party providers. by Beeta Lecha
It never occurred to us that a ransomware attack on a third-party provider would affect our business.
Cybersecurity has been a big priority for our public accounting firm. Like private lenders, we are responsible for protecting the sensitive data of our clients, which includes tax returns, names, addresses, Social Security numbers and even bank information. Our firm has always strived to take every precaution to ensure data security—everything from working closely with IT professionals,
providers experienced attacks within 90 days. Both attacks
interrupted our business from several days to more than a week. With the increasing
reliance on third-party pro-
viders and integrated software systems, private lenders and
financial institutions alike are at risk of experiencing similar
indirect business interruptions.
installing firewalls and regularly communicating with our staff about staying alert for scams and other potential attacks. But, despite these precautions, our firm was impacted via third-party providers. With ransomware attacks on the rise, two of our third-party service 50
Our first indirect ransom-
ware attack was on Wolters Kluwer, a significant pro-
vider of accounting tools and resources. The ransomware
attack had such a substan-
tial effect on the accounting
industry that the IRS offered a
seven-day extension period for tax returns due around the May 15 tax filing deadline. The ransomware attack had a mild impact on our firm’s operations. We were unable to file tax returns electronically. We’re lucky to have a diligent administration team. Wolters Kluwer had not even announced the attack before our office manager was on the phone with our IT professionals and insurance broker. Both our IT team and our insurance broker reviewed the situation, put us at ease and assured us we were doing everything right. None of our client data was lost, and cybersecurity experts verified that none of our sensitive data was
compromised. Private lenders should read their cyber insurance policies very carefully. We were surprised to learn
that if a third-party attack that
may affect our systems was not
disclosed within five days, then our cyber insurance policy may not cover the attack.
What we didn’t expect was to experience a second ransomware attack on a different provider within a three-month window. Once again, no client data were lost, and cybersecurity experts verified that none of our data was at risk or stolen. Our service provider kept in
Since the attack had a more
touch with us and communi-
CPA firms, leaving some firms
quently; however, the updates
substantial impact on other
cated resolution statuses fre-
unable to prepare tax returns at
all, we began asking ourselves:
What would we do if any of our other third-party software providers systems went down?
This second business interruption affected multiple facets of our daily operations, bringing us to a halt for eight days and
We thought through every
leaving us unable to work.
uses, how each is integrated
party provider, we were com-
couldn’t access any one of them.
During the first three days
critical software that our firm
Since the attack was on a third-
and what would happen if we
pletely helpless to do anything.
of the attack, we were under the delusion that our systems would be up and operational at any moment. We made our staff come to the office each day, and they worked on their continuing education requirements, tax research and other things we did have access to.
LESSONS LEARNED We always hear the horror stories of lost data that couldn’t be recovered, at-risk client data and identity theft. More often, these horror stories are becoming shared experiences. Private lenders can take away some essential lessons from the not-so-dire business interruptions of outside third-party
providers. Your ransomware prevention plan will include addressing the technology components of firewalls and network security. Still, be sure to also incorporate into your disaster recovery plan the more subtle elements of communica-
tion, lost time and other hassles. Communication // The business experiencing a ransomware attack will be communicating directly with their cybersecurity experts and even law enforcement.
If your private lending business is not under a direct attack, the communication to you from your third-party provider will be vague. You may not receive clear information as to the measures being taken to restore NOVEMBER/DECEMBER 2019
your data until after your systems are restored. Communication and status updates to
around the clock to restore your
making backups of backups.
not to close a loan for five days?
not be back up and working the
speed of execution in closing
systems, more likely, you will
you are explicitly crafted to
same day or the next.
be vague so the attacker will
Will your team be able to close
not be privy to the steps being taken to resolve the attack. This will make it difficult for you to communicate effectively with your customers. Lost time // Plan for the business interruption to last any-
where from several days to a few weeks. Although the cybersecurity experts and IT professionals will be working tirelessly
that loan on time? What expectation will you have for your
employees to work during the
outage? What is the plan to catch up on work after the blackout?
Will you need to hire temporary employees to catch up?
They were making nightly and Once the ransomware attack started, however, the pro-
vider was unable to transmit
any backups to us. It is better
business practice to have backups in multiple locations and
through at least two providers or your computer servers.
Ensure the backups are in com-
Lack of access to backups //
pletely segregated systems. You
business interruption plan.
Building in redundancy may
Build redundancy into your
Our third-party provider was
can never be too careful.
be costly, but can you afford
Private lenders promote the
loans. What would happen if
you could not close a loan for two weeks?
Hassle afterward // Lesser
known is what happens after
the attack. We were not ready
for the lost time at the admin-
istrative and management level after the attack.
Expect to have follow-up calls with your cyber insurance provider, the third-party
service provider and IT pro-
fessionals. The most lost time we had afterward was related to describing the situation to our cyber insurance company, quantifying our loss and then negotiating a recovery with the third-party provider. You may even need to hire a forensic accountant to substantiate and quantify the lost revenue and impact on your private lending business and your customers.
DUE DILIGENCE You may have taken every precaution available to mitigate exposure to a direct cyberattack on your company. Your network has firewalls and closed access points. Your backups have backups in segregated systems. Your employees have been trained to avoid spam and malicious email links. Your IT professional is regularly monitoring for ransomware and malware. Have you ever wondered if your third-party accountant, fund administrator, servicing company, borrower or investor portal provider, or other thirdparty providers are taking the same measures? With cyberattacks on the rise, you need to ensure that any significant service providers who have your borrower or investor names, addresses, tax identification numbers and banking
information have secure cyberattack prevention practices and policies in place. Here are a few due diligence questions to ask when selecting and engaging providers. Does the provider have
secure methods available to transmit sensitive data?
W hat are the cyber-
security prevention policies? Are all the provider’s employees aware of the procedure?
I s the IT professional
regularly checking the security of the network and firewalls or monitoring for access points multiple times during the year?
A re there two-factor
verification processes in place for transmitting wires and ACH payments?
D oes the service
provider’s cyber insurance policy extend to cover you as well? Does it extend to cover your borrowers or investors?
H ow is data backed
up, how often and is it to multiple, separate locations?
A re there preventions
in place for remote or working-from-home
employees to ensure
firewalls and secure
networks protect their
ABOUT THE AUTHOR
D oes the company
have portable hotspots for the employees who are traveling, so that
your data is not accessed through public Wi-Fi?
D oes the provider use
offshore staff, and how
secure are their networks and firewalls?
BEETA LECHA Beeta Lecha is a principal at Spiegel Accountancy Corp,
leading the taxation and fund accounting practices. Lecha
has 13 years of private equity and alternative investments
experience, primarily focusing on private lending and real estate funds.
The news features stories about large companies and government agencies falling victims to cyberattacks, such as the Pitney Bowes attack in October 2019. Private lending companies and CPA firms alike are great targets for hackers due to the amount of sensitive and confidential data we are entrusted with.
In addition to fund accounting and investor reporting, Lecha
provides tax strategy, tax planning and tax compliance for
fund managers and real estate investors. Lecha is a member of the American Institute of
Certified Public Accountants (AICPA) and the California
Society of CPAs (CALCPA).
Lecha is serving on the Educa-
tion Advisory Committee of the
American Association of Private Lenders (AAPL).
Many private companies choose not to disclose ransomware attacks, as they do not want to be perceived as being unsecure. We hope that by sharing our experiences of the indirect attacks, you can implement strong cybersecurity policies, business interruption and data recovery plans. ∞ NOVEMBER/DECEMBER 2019
Understanding Securities Exemption in Private Lending by Tae Kim
What you need to know about the legal implications of direct investments vs. indirect investments
There are two common categories of private lending investments an investor can make: 1. Direct investments 2. I ndirect investments, which are made by investing in a Fund
Let’s look at the securities exemptions related to these types of investments as well as the potential trade-offs, limitations and legal implications that managers and servicers should be aware of when facilitating these types of investments.
DIRECT INVESTMENTS Investors can make direct investments through what are sometimes called “trust deed” 54
investments. These investments take the form of investing in fractionalized interests of a loan (i.e., multibeneficiary loans) or whole notes. The investor generally becomes the lender of record under the promissory note and related loan documents. As a lender of record, the investor has enforceable remedies and rights from the loan documents, including, among others, the right of payment of principal and interest and the right of foreclosure on the loan.
The lender (i.e., investor) can control the outcome of the loan and can enforce the terms.
ARE DIREC T INVE S TMENTS S TILL SECURITIE S?
03 T he profits go to a
04 P rofits are derived
from a promoter or a third party.
Generally, yes. Under the Howey
The Howey test is reiterated in
security if it meets the following:
tings in People v. Schock, which
test, a transaction is considered a
01 I t is an investment of money.
02 T here is an expectation of profits from that investment.
the multibeneficiary loan setclearly indicates that fractional interest in a promissory note constitutes a security because the investor is “committing relatively modest sums” with the expectation of a profit based on
the reliance of “skill, services and solvency” of a promoter or a company. The promoter
an investment is a security is whether the investor controls such investment.
goes out to the market to seek investors to arrange the loans funded to borrowers. In these instances, direct investments are generally constituted as purchase of securities. On the other hand, if the lender also actively controls the direct investments, it is arguable whether the interests are considered securities. The key element of determining if
ARE THERE ANY E XEMP TIONS IN DIREC T INVE S TMENTS? Before delving into any available exemptions in this type of investment, we must first ask, “Exemption from what?” The securities laws generally require an issuer of securities to register with the government body regulating the securities NOVEMBER/DECEMBER 2019
laws—either with the Securities and Exchange Commission (SEC) or a state counterpart (e.g., in California, the Department of Business Oversight, or DBO. However, the registration process is extremely burdensome and cost prohibitive.
notice with the DBO and pay a filing fee.
In California, a manager or
Think of the stock market. S&P 500 companies must register with the SEC before going to the public to raise money. In order to avoid this registration process, agencies provide several exemptions from registration. Here are a few examples:
existing or business relation-
Many other states provide similar exemptions. For example, in Delaware, the issuer may be exempted from registration if the issuer complies with, among other things, that the issuer has sold its securities to no more than 25 persons in the state during any 12 consecutive month period. The issuer must also reasonably believe all investors are purchasing for investment in its own account.
Code Section 25102(f) //
a company may rely on a
25102(f ) exemption. California Corporations Code section
25102(f ) exempts an issuer for
up to 35 investors who have preships with the issuer, provided the investor is making an
investment for its own account and the issuer has not made
any advertisement to offer the security. California requires the issuer to file a 25102(f )
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California Business & Professions Code Section 10237 and California Corp Code Section 25102.5 // California has a unique real estate investment exemption for real estate brokers issuing securities—California Business & Professions Code Section 10237. The broker-issuer must have a California real estate brokers license from the California Department of Real Estate and must generally comply with the following: F ile a notice provided in
Business & Professions Code Section 10238(a) within 30 days from the date of closing
E nsure advertising com-
plies with California law
R eal property securing
the interests is located in California
N otes or interests must be
sold by or through a real estate broker
T here are no more than
10 investors securing the fractionalized interests
T he rights of these inves-
tors are identical in terms, including foreclosure rights, interest rate, etc.
L oan-to-value ratios com-
ply with Section 10238(h)
In addition, because California law governs this transaction, the real estate broker cannot rely on this exemption if an investor resides outside of California. All transactions—investment funding, loan closing, real property location—must be conducted in California.
LIMITATIONS ON S TATE E XEMP TIONS As an issuer gains additional experience and a positive reputation among investors, word travels and the issuer gains traction and obtains more investor funds for fractionalized interests and whole note investments. Now comes the issue: How far can the issuer rely on state exemptions? One-off transactions (or limited transactions) appear to be the target of these limited state securities exemptions. However, when multiple deals with
“When multiple deals with numerous investors across the U.S. come into play, there is a higher risk of violating state securities laws.”
numerous investors across the
preempts state laws, in that the
higher risk of violating state
about state regulations. In
must conduct due diligence in
in a different state than the
resides to determine whether
be concerned about out-of-state
the securities laws of that state.
Fund investments also have
U.S. come into play, there is a
fund manager is not concerned
securities laws. The issuer
the event an investor resides
any state in which an investor
issuer, the manager need not
the issuer is compliant with
securities laws compliance.
Along with the possible integration doctrine that may be
applied, establishing a fund is
likely the proper route to take.
FUND INVESTMENTS On a long-term basis, invest-
ments by way of establishing a
Fund would be more feasible for
both the issuer and the investors. The most popular and costefficient rule on which an
issuer generally relies is Rule 506 of Regulation D. From a securities laws perspective,
the reason a fund should be
created is twofold: (1) It creates an exemption from registration with the SEC and (2) it
Investor funds are more centralized. They are all in one account, and deployment of
capital becomes much easier and more efficient to fund loans. The Fund becomes
the lender of record, and the control of the loans and the underlying property is all
within the control of the Fund and its manager.
The investors become “passive” because of limited control on the governance of the Fund,
as reflected in the governance documents. On the other
hand, investors have certain
remedies under the securities laws, including allegations
of violation of Rule 10b-5. The SEC, as a matter of public policy, disallows Fund managers from circumventing Rule 10b-5 violations. What happens when the issuer violates securities laws? Penalties for violation of securities laws are generally draconian. Penalties are harsh for the issuers and managers. Fraud (whether intentional or negligent, or whether malicious or not) are at the crux of these penalties. As a historical context, the penalties, in one form or another, originated from the 1929 stock market crash, which led to severe economic consequences for the U.S. During this time, fraudulent practices were rampant, and the SEC (and state regulators) took on the role of safeguarding investor money. An exemption rule violation may require the issuer to register with the SEC or a state government agency. Rescission of investor money and/or fines may also be required. Issuers should be cognizant of the consequences and consult with a lawyer, especially if the issuer is unsure of securities law implications when managing a fund. As discussed, there are various securities laws implications when making direct and/or indirect investments, and
securities laws pertaining to exemptions vary widely. In certain instances, securities laws may not apply, as “control” appears to be one of the main aspects in determining whether an investment is a security. When making these types of investments, issuers and investors alike should be cognizant of the securities implications and consult with securities counsel for assistance. ∞
ABOUT THE AUTHOR
TAE KIM Tae Kim is a corporate and
securities attorney at Geraci LLP whose practice involves
advising clients on securities compliance in private and
public offerings, fund designing and preparing offering documents. Kim and the
corporate and securities team work closely with clients to
establish mortgage funds,
real estate acquisition funds, syndications, real estate
investment trusts (REITs) and
Qualified Opportunity Funds.
L AST CALL WITH SAM K ADDAH
BUILDING ON YOUR CAPITAL b y Sam Kaddah
Take for example the power of knowledge. Knowing the market, the business processes and the industry you are in can help you out in many ways. It allows you to quickly ask the right questions and get to know the strengths and weaknesses of a person you may be working with. Now, just imagine using this knowledge to help someone enhance their business, perhaps to make their operations better, faster and more efficient.
rowing up, I was very confused by my dad and the way he chose to invest. I thought investing was just a way to get money fast and to turn money you have now into even more money for the future.
Yet when my dad was asked to name the price for a building he owned, he passed. He could have easily made a seven-figure return. This absolutely baffled me. It wasn’t until later that I fully understood why he chose to keep the building. As it turned out, he chose to enhance his social capital over his economic one. I have come to learn that there are more types of capital than just economic capital. For my father, keeping the building helped preserve his vision of his social capital. Now, several years later, I recognize the power of different types of capital. It is very important to understand the types of capital and how each comes with a plethora of powers and burdens. 58
Most people underutilize the capital of knowledge. It can be a powerful sales and marketing tool. This leads me into my second point: social capital. We all have heard the cliché: “It is not what you know, but who you know.” I fundamentally disagree with this statement. You may know a thousand people; however, you can be completely invisible to them. But, if you can convey what you know to these people, you can develop relationships and expand your network. Through experience, I have learned that you must be a sincere and genuinely good person. By building trust with a person, you can become a true asset to them. I believe that I should always give more than I get. People will sometimes question me and say that it is not sustainable. My take on it is that you can always give more than you receive. Once you truly become genuine, you will start to see those people in your network start to benefit you as you build mutual relationships. I am constantly looking to increase my social
capital and build stronger relationships at the same time. Political capital stems from how you can enhance economic capital for yourself and others. These seem to always tie together. When you follow the money, you will often find out it is concentrated in a group that shares knowledge and social influence. Your dedication to building your social capital to enhance your own economic capital and that of others will ultimately increase the benefits. Obviously, human capital is the most important type of capital for an organization. I cannot tell you how wonderful it is to find the right “group.” I strive to foster an environment where employees can excel in their own knowledge, live a full life and enjoy economic prosperity. It is inspiring to be able to sit back and watch the group morph into what we call our office family. Ultimately, for me, the power is in making the best use of the assets we have. For example, I realized I had a weakness in marketing, so I leaned on my knowledge capital in other areas to grow my company and provide value to customers at Liquid Logics. I once responded on a marketing panel, “I am here on this panel because I suck at marketing, yet I managed to convert my weakness into a strength to make Liquid Logics successful.” My takeaway for you is to find your capital and do what you do best. Spend it gener-
ously in the best way possible so it benefits you and those you work closely with. ∞
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