Took the house back at month 9 and still came out around 12 percent

The 89 percent of as-is purchase price is the line that changed how I'm looking at this. Everyone quotes LTV against ARV, and at 61 percent that loan sounds conservative. At 89 percent of what the house was worth the day you funded, you had almost no cushion until the renovation actually created value, and the renovation is the part you don't control.

So what's your rule now? Do you cap total advance at some percentage of as-is, or do you just accept that the acquisition tranche is always thin and rely on the holdback to keep the rest safe?

Thirteen months for a twelve month note and you still got out cleanly. That's the part I'd want people to notice. Every timeline in this business is a floor.

A few things I don't understand well enough to argue about, so I'll just ask.

Why did he agree to the deed in lieu? He'd put in $27k of his own money plus whatever he'd spent, and signing it over means he got nothing. What was his alternative that was worse than that?

And did you release him from the debt as part of it, or does he still owe you the shortfall? I don't know if that's even a thing that can happen with a deed in lieu.

@anchor his alternative was a foreclosure on his record and probably a deficiency claim depending on the state, plus months of being tied up. Handing over the keys to end it is often the cheapest exit for a borrower who's decided he's done. Whether a deficiency survives, and whether a lender can even pursue one after taking a deed in lieu, is state law and there are states that restrict it hard.

@quarry the piece of your write up I'd want in a frame is only lending on work you could finish yourself. Every version of this that goes badly seems to involve a lender who takes back a project and can't do anything with it except dump it at a discount.

$22k to finish a house that had a half done kitchen at month 5 and then sat until month 13 seems low. Was anything stolen or was there water damage? Vacant houses mid renovation are magnets. I've walked into two where the copper was gone.

This works in an established suburb where $338k finds a buyer in a few weeks. Out where I look, the buyer pool for a finished $200k house is thin and for a half finished one it's basically zero, so taking a property back means owning it for a year. The lending math has to be different at that end of the market and I've never seen anyone lay out how much different.

Who did your draw inspections and what did each one cost? I'm looking at the service side of this and inspection on private construction loans keeps coming up as a thing lenders want and don't want to do themselves.

I want to argue with the return number, not the deal.

You called it about 11 percent annualized on $215k. But your capital outstanding wasn't $215k the whole time, it started at $170k and grew with draws, and after month 9 you weren't a lender at all, you were an owner with a renovation project. Those are two different risk profiles wearing one IRR.

More importantly, the $22k of work went in at cost with your own crew. If you'd paid a general contractor market rate for that scope with a lender's timeline and a vacant house, call it $32k to $35k. That's $10k to $13k off the $25,200, which puts you nearer 5 to 6 percent annualized over thirteen months. Fine, better than the savings account, well short of the 11 percent on the note.

So the real result is that your crew rescued a loan that had gone bad. That's a genuine edge and you should say so plainly, because a passive lender copying this structure without a crew ends this deal at break even or worse.

@ledger that's the calculation I came into this thread needing. I've been planning to lend precisely because I don't want to own or renovate anything, and this thread is telling me that the recovery scenario for a construction loan assumes capability I won't have.

Which pushes me toward loans on properties that are already habitable, where the bad outcome is selling a house rather than finishing one. Am I giving up much yield by refusing construction?

@tender in my experience you give up some, and the size of the gap moves with how much lender competition there is in your market. Bridge loans on rent ready properties price below heavy rehab construction paper because the work is easier and the risk of a stalled project is gone. Ask two or three lenders in your market what they're charging on each and get it in writing, since terms move around and anything you read here or in an article is already stale.

@quarry the item I'd have asked about before funding is the other two projects. You found out he had them when he chose to abandon yours. Did you ask for a schedule of his current deals and his debt on them up front? A borrower with three concurrent projects and thin cash is deciding which one to starve, and you want to know whether you're the strong one or the weak one in his portfolio.

The half funded draw is the most useful sentence in this post to me. Not the decision to hold money back, the decision to release part and hold part while telling the borrower exactly why. That keeps the job moving and puts him on notice at the same time. I would have either funded all of it to keep the peace or refused all of it and started a fight.

How did you get comfortable that the $62k rehab budget was real? That's the assumption underneath the $355k ARV, and if the budget was actually $85k the whole structure is different from day one. Did you price the scope yourself or take his numbers?

Watching a borrower decide which project to starve is the whole business. I've been the contractor who stopped getting paid on one job while the same guy paid me on time on another.

@quarry reading this right after posting my own version of it. Mine went the other direction and the difference is almost entirely the title update before I released money, which you did and I didn't. Your $9,400 contractor claim is the same animal that cost me $27k, you just found it before you were in it.

The part I'd add for anyone following along: your claim was recorded and negotiable at month 9. Unrecorded claims for work already performed are the ones that surprise you, and how far back they can reach into your priority is a state statute question.

Something basic still has me fuzzy after a couple of months of reading about notes. When @quarry took the deed in lieu, what happened to the note? Does the debt just vanish because he now owns the collateral, or is the note still a separate thing he could theoretically sell?

@vellum in the usual construction, taking title extinguishes the practical purpose of the note because you can't collect from yourself against your own property, and the security instrument gets released. Whether any personal obligation of the borrower survives depends on what the deed in lieu agreement says and what the state permits, and those agreements vary enormously in how much they release. That's why @quarry's attorney was walking him through what he was accepting.

@quarry the document I'd want to see from this deal is the deed in lieu agreement itself. Two clauses I always look for: an acknowledgment that the conveyance is voluntary and for fair consideration, which matters if the borrower later files bankruptcy and someone argues the transfer was preferential, and a representation listing every lien and unpaid claim the borrower knows about. The second one gives you something to point at if a $15k claim shows up in month 11. Neither clause makes you bulletproof, and how a bankruptcy trustee treats a transfer like that is a question for counsel.

@ledger is right on the arithmetic and I'd take it a step further. Underwriting a construction loan means underwriting your own exit from an unfinished building, and almost nobody prices that in. The question I ask on every deal now is what this collateral sells for today, in its current condition, to a buyer who wants a discount because it's distressed. Not ARV. Not as-is appraisal from an appraiser assuming a normal marketing period.

On @quarry's numbers, a half renovated house in an established suburb with an ARV of $355k probably clears $240k to $260k to an investor buyer in a week. Against $182k outstanding at month 7 plus taxes and legal, that's a real cushion, and it's the reason this deal was survivable before the crew ever showed up. The crew turned survivable into profitable.

@meridian's question about the $62k budget is the other half. A rehab budget that's 30 percent light doesn't just raise costs, it drains the borrower's reserve, and a borrower with no reserve is the one who abandons a project. I underwrite the budget partly to judge whether the borrower can count.

The clause I'd want to see in the note, and @quarry mentions the default rate so maybe it's there, is who pays for the inspections and the title updates. Sounds small. On a four draw loan with a title update each time, it's a few thousand dollars, and if the note is silent the lender eats it. Same with the cost of protective advances when you pay the taxes to protect your position. Say in writing that those get added to principal and accrue at the note rate.

$4,100 of unpaid taxes at month 9 means they went unpaid at least a cycle. Is there a way to get notified, or do you just check the county site every quarter?

@halyard some servicers offer tax monitoring as an add on and the counties themselves are inconsistent about notifying lienholders, which varies by state and sometimes by county. Cheapest version is a calendar reminder and the assessor's website.

The inspector's percentage complete coming in below the borrower's claim at draw three is the single moment this deal turned. That's what the inspection is for and it's why paying a few hundred dollars is not optional on a rehab loan.

One construction note: a half done kitchen at month 5 on a $62k scope tells you he front loaded the visible work. Borrowers do that because visible work is what gets photographed and photographs get draws funded. The mechanical, the roof, the things behind the wall, those come last if the money holds out and they never come if it doesn't. When I'm looking at a stalled job I check what got skipped before I check what got done.

Coming from the small end of this, my whole first loan was $75k with no holdback because managing draws terrified me. This thread confirms that instinct. @ledger's point is the one I'll carry: my downside on a rent ready cottage is selling a cottage, and my downside on a rehab is being handed a job I can't run.

Interesting that the wholesaler introduction worked out. That's usually a warning sign for me, because the person making the introduction gets paid on the deal happening and has no exposure to whether it performs. Did you diligence the borrower independently or did the referral do some of that work for you?

I've spent six months researching without closing anything, and what I keep coming back to is that most of the value is in the two or three documents and one inspection that cost a few thousand dollars total. That's the part I can actually prepare for now, before I have money out.