What it takes for a private lender to recover cleanly when a rehab borrower stops paying mid-project

The 89 percent of as-is purchase price is the line that changes how a structure like this should be read. Everyone quotes LTV against ARV, and at 61 percent that loan sounds conservative. At 89 percent of what the house was worth the day it funded, there's almost no cushion until the renovation actually creates value, and the renovation is the part the lender doesn't control. A reasonable rule is to cap total advance at some percentage of as-is value, treating the acquisition tranche as inherently thin and relying on the holdback to keep the rest of the position safe.

Thirteen months for a twelve month note, and still getting out cleanly, is the part worth noticing. Every timeline in this business is a floor, not a ceiling.

A few things worth asking rather than arguing. Why would a borrower agree to a deed in lieu after putting in 27k of his own money plus whatever else was spent? Signing it over means walking away with nothing, so what alternative was worse than that? And does a deed in lieu release the borrower from the debt as part of the arrangement, or does he still owe the shortfall? That is not always the same across situations.

@ehernandez74 the alternative for a borrower in that position is a foreclosure on the 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 has decided he is 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. @carlos_nunez the piece worth framing is only lending on work you could finish yourself. Nearly every version of this that goes badly involves 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 a $338k house finds a buyer in a few weeks. In markets with a thinner buyer pool, a finished $200k house sells slowly and a half finished one is basically unsellable, so taking a property back can mean owning it for a year. The lending math has to look different at that end of the market, and few lenders 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.

The return number is worth arguing with, even though the structure itself holds up. The figure quoted is about 11 percent annualized on 215k. But the capital outstanding was not 215k the whole time. It started at 170k and grew with draws, and after month nine the position was no longer a loan at all, it was ownership of a renovation project. Those are two different risk profiles wearing one IRR. More importantly, take a scenario where 22k of work goes in at cost using an owner's own crew. Priced through a general contractor at market rate for that scope, with a lender's timeline and a vacant house, that work is closer to 32k to 35k. That is 10k to 13k off the 25,200 return, which puts the real result nearer 5 to 6 percent annualized over thirteen months. Fine, better than a savings account, well short of the 11 percent quoted on the note. So the honest read is that a crew rescued a loan that had gone bad. That is a genuine edge worth stating plainly, because a passive lender copying this structure without a crew behind them ends this deal at break even or worse.

@hannah_west29 that is the calculation this thread needed. A lender who comes to private lending precisely to avoid owning or renovating anything has to reckon with the fact that the recovery scenario on a construction loan assumes rehab capability that lender does not have. That pushes a passive lender toward loans on properties that are already habitable, where the bad outcome is selling a house rather than finishing one. The open question is how much yield that lender gives up by refusing construction.

@sonia_alvarez 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.

@carlos_nunez 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. The decision worth studying is releasing part and holding part while telling the borrower exactly why, which keeps the job moving and puts him on notice at the same time. Most first time lenders do one of two things instead, fund all of it to keep the peace or refuse all of it and start a fight, and both are worse.

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. Contractors see it from the other side, when the same borrower pays on time on one job and stops paying on another, and the lender on the starved job is usually the last to hear.

@carlos_nunez 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.

One basic mechanic is worth spelling out for anyone following this. When @carlos_nunez took the deed in lieu, what happened to the note? Does the debt simply vanish because he now owns the collateral, or is the note still a separate instrument he could in theory sell?

In the usual construction, @raj_mehta14, 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 is why @carlos_nunez's attorney was walking him through what he was accepting. The document worth seeing from this deal, @carlos_nunez, is the deed in lieu agreement itself. Two clauses matter most: 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.

The arithmetic from @hannah_west29 is right, and it goes a step further. Underwriting a construction loan means underwriting your own exit from an unfinished building, and almost nobody prices that in. The question to ask on every deal is what this collateral sells for today, in its current condition, to a buyer who wants a discount because it is distressed. That figure is neither the ARV nor an as is appraisal from an appraiser assuming a normal marketing period. On @carlos_nunez'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 is a real cushion, and it is the reason this deal was survivable before the crew ever showed up. The crew turned survivable into profitable. The question from @stephen_ok9 about the $62k budget is the other half. A rehab budget that is 30 percent light raises costs and, worse, drains the borrower's reserve, and a borrower with no reserve is the one who abandons a project. A lender underwrites the budget partly to judge whether the borrower can count.

The clause I'd want to see in the note, and @carlos_nunez mentions the default rate so maybe it's there, is who pays for the inspections and the title updates. It 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 the lender pays the taxes to protect the 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?

@ryanmck27 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 is what the inspection is for, and it is 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 says the borrower front loaded the visible work. Borrowers do that because visible work is what gets photographed, and photographs are what get draws funded. The roof and the mechanical, the work nobody photographs, come last if the money holds out and never come if it does not. On any stalled job, check what got skipped before you check what got done.

From the small end of private lending, a first loan of, say, 75k on a rent ready property with no holdback is a sensible place to start, precisely because managing draws is where inexperienced lenders get hurt. This thread confirms that instinct. The point from @hannah_west29 is the one to carry: the downside on a rent ready cottage is selling a cottage, and the downside on a rehab is being handed a job the lender cannot run.

Interesting that the wholesaler introduction worked out. That is usually a warning sign, 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.