Released four draws on photos and texts, then two subs' liens beat my deed of trust

$142,000 bridge on a gut rehab the borrower already owned. He'd bought it a year earlier with cash, torn out most of the interior, and run dry. My money went in as a refinance, $98k to clear a private loan and back taxes, $44k held back for construction. Appraised ARV $245k, so I was at 58 percent of finished value and felt fine about it. 11 percent, 2 points, 12 months.

The draw process was me looking at photos he texted, sometimes a video walkthrough, then wiring. Four draws over five months, roughly $38k released. No lien waivers, no title update, no inspector. He was responsive and the photos always showed work.

He stopped paying in month 6 and stopped answering in month 7. Two subs recorded mechanic's liens totaling about $27,000 for labor that predated my loan, from the demo work he'd done the year before. In that state, mechanic's lien priority relates back to when work commenced on the property rather than when the lien is recorded, so those claims sat ahead of my deed of trust even though I recorded first. Whether that's true where you lend depends entirely on your state's lien statute, and mine was one of the unfriendly ones. My attorney told me this in month 8, which is roughly eight months later than I needed to hear it.

Foreclosure took eleven months. I paid the $27k of liens to clear title, about $9k in legal and another $4k in taxes and vacant property insurance. Sold at $203k with the rehab still mid demo, which is a price that reflects a buyer pool of four people. Recovered around $118,000 against $142,000 out, no interest after month 5.

So about $24k of principal gone and nineteen months of dead capital, on a loan I underwrote at 58 percent LTV.

What I'd do differently, plainly: get a sworn contractor statement from the borrower before funding, listing everyone who has touched the property and what they're owed, and confirm with an attorney how my state handles relation back before I ever lend on a property with existing work. Then title update and signed lien waivers as a condition of every single draw, no exceptions for the responsive borrower.

Answer

1gregpowell66AG4BPRO8

I've been the sub who records the lien, so let me give you the construction side of what went wrong.

Draws on photos are not draws. A photo shows that something happened, not that it was inspected, permitted, or paid for. On a gut rehab the sequence has verifiable milestones, and a $250 to $500 inspection per draw against $38,000 released is nothing. That inspector's job is to say what percentage of the scoped work is actually complete, so you catch it when your borrower has spent draw money on his own back rent.

The lien waivers matter more than people think. Standard practice on a funded job is that every check to a sub gets a conditional waiver going out and an unconditional waiver coming back for the prior payment. If your borrower can't produce those, either he isn't paying his subs or he's paying them in cash with no records, and both mean liens are coming.

On the cause: @cairn is right that condition drove the sale price, and you're right that relation back cost you the $27k. I'd say the actual root is that you funded a project with existing unpaid labor on it and had no idea who was owed what. That's the sworn statement you named at the end, and on a job that's already been started it's the single document I'd refuse to fund without. Some states also let you record a notice of commencement or a similar filing that affects lien priority, but the rules and the deadlines are state specific and that's an attorney question before you close, not after.

One more: mid demo shells are the worst collateral in residential. If you're going to lend on one, underwrite to as-is value and treat the ARV as a story about the future.

4 replies

2renee_dubois Get yours

The relation back thing is real and I don't think most people funding their first construction loan know it exists. But I'd push on the ARV. You underwrote 58 percent of $245,000 finished, and the property never got finished, so that ratio never described your actual risk on any day of the loan. Your real exposure was against a partially demolished shell with a tiny buyer pool, and $203k on a $245k ARV in that condition suggests the appraisal was fine and the condition was the whole problem.

What was the as-is value the day you funded? If it was $150k, you were at 95 percent of what you could actually sell that afternoon, and the liens only made a bad position worse.

3aliyah_bAU2APRO6

Nineteen months of dead capital hurts more than the $24k in my head. That's the part I underestimate when I run these scenarios.

1paulgrant17PassivePRO5

The borrower profile is what I keep circling. Someone who bought with cash, gutted the place, and ran out of money before finishing is already telling you he can't estimate a budget. Then you refinanced him out of a private loan and cleared his back taxes, which means the first dollar of your money went to problems rather than to work.

I don't know enough about draws to argue with @cairn on the appraisal. But I'd have wanted to know why the previous private lender wanted out.

Released four draws on photos and texts, then two subs' liens beat my deed of trust

4 replies