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Background on the borrower
We began our relationship with the borrower
in early 2018. We had many meetings with the borrower regarding their
history in real estate development and their intended execution plan.
The borrower was operating a sizable operation, inclusive of
approximately 100 multi-family units. They had a track record of
completing work, multiple crews, standard materials, and refinancing
successfully.
Based on the provided plan, credit,
background, experience, valuations, and meetings with team members, Fund
That Flip made the determination to fund this and several other
projects for the borrower.
Timeline
The projects appeared to be progressing
well throughout 2018. At the beginning of 2019 we began to see late
payments across the portfolio. We also began to receive notices from
the city pertaining to code violations. The violations pre-dated the
borrower’s ownership period and our expectation was the renovations
would resolve them. At this time, construction continued to progress as
evidenced by the third-party inspection reports. We decided to halt
all new loans with the borrower until current projects were completed
and be repaid.
In April, we sent counsel to the first
hearing pertaining to code violations and began to learn of information
that was contrary to the third-party inspection reports. At this point,
monthly interest payments had also ceased while it had been reported to
us that construction had been completed.
Risk Mitigation
Our Asset Management Team began to analyze
and put into motion a risk mitigation strategy that sought to maximize
the preservation of principal. The options considered included:
- Forbearance & Refinance – We considered providing the
borrower with a forbearance to delay interest payments for six months
while keeping the loan in good standing. The goal here was to allow the
borrower to build-up cash reserves to get his operations stabilized and
the assets in a position to be refinanced. Ultimately, we had concerns
about the borrower’s ability to execute in a timely manner and we did
not want to delay the outcome an additional six months.
- Sell Note – We solicited offers for the notes via several channels. We were unable to secure offers within a reasonable price point.
- Foreclosure – While foreclosure is always an option, there are several significant drawbacks to this strategy:
- Cost. Attorney fees were estimated to be in excess of
$12,000 per property. If the borrower were to challenge the foreclosure
and draw out the process, these fees would continue to accrue.
- Timeline. Given the location of the properties, the process
was likely to take in excess of twelve months. During this time,
property taxes, water/sewer, city violations, etc. also continue to
accrue.
- Liens. The aforementioned fines, taxes and other liens
would not be satisfied through a foreclosure and would have become our
responsibility after foreclosure.
- Deed in Lieu – The other way to get possession of the
properties is to work with the borrower to have them deed the properties
back to us. Considering this is the outcome of a foreclosure, achieving
this strategy would compress the timeline and save on legal expenses.
The downside of this strategy is that the borrower has some leverage to
negotiate terms that benefit them in exchange for the Deed in Lieu.
Plan executed
Given that we had ruled out the first two
options, it became clear that we were going to end up taking these
properties back along with inheriting any accrued liability. As such, we
opted for the deed in lieu strategy in order to minimize cost and
uncertainty while speeding up the timeline.
We began working with the borrower to
negotiate terms of the deed in lieu. The main point we were required to
give up was the borrower’s personal guarantee (PG). While not ideal,
when weighing the additional costs and time of foreclosure, against the
likelihood of recovery from the PG, we determined it was more likely
we’d save expenses than we’d be able to collect on the PG. In other
words, the expense saving was rather certain but our chances of recovery
on the PG seemed slim.
We completed the deed in lieu over the
summer and began marketing the properties immediately. We received
multiple offers and while we are unsatisfied with the loss of principal,
we believe we received the best offer available.
Explanation of the Outcome
The percentage of loss on this project is atypical as are the circumstances that caused it.
As a way of background, we rely on
professional third-party inspection firms to visit each property and
report on the status of the renovation. These firms specialize in this
type of work, and as such, we rely on the information we receive from
them to make determinations on how much capital we advance for
improvements made to the property.
In this case, we believe the third-party
inspection company did not perform their duties. Leading up to the deed
in lieu, we performed our own site visits and the conditions we observed
do not align with the information in the inspection reports.
The result of this is that we advanced more
funds for renovations than we would have otherwise. This created a
situation where our loan amount was in excess of the value of the
properties. In other words, work and the quality of that work that we
believed to have been completed was in fact not completed.
We are committed to maximizing the recovery
of principal and as such, have retained counsel at our own expense to
hold the inspection company accountable. This process has just begun,
and it is unclear how long it may take to get to a resolution. We will
continue to keep you apprised as developments occur.
Below is a complete breakout of the recovered amounts, expenses, and net result:
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