REO Strategies

When to Hold ‘em – When to Fold ‘em By Grant Jones There are three things in cards and loan collateral/property management that must never be ignored if you are to avoid the pitfalls of holding on to, or getting rid of, cards or properties at the wrong time: market value [what are my [or their] cards, or assets, worth – now and later?], break even projection [what will it cost me [or them]to play the hand profitably?], and burn rate [can one afford to stay in the game?]. Keeping track of these essentials, will make your decisions about when to hold [or accept as loan collateral], or sell off, assets, more predictable, and, therefore, less fraught with anxiety. In other words, you’ll keep all your “play” within the envelope of profitability, even when you lose a few hands. MARKET VALUE: Market value fluctuates, depending on lots of things, including time, and what the other guy has. It’s true that many properties can be made profitable with enough injections of time, energy, and other resources. It’s also true that properties can become “black holes”, sucking up everything you throw at them. The key is to know, really know, what you’ve got, and what it’s worth – when to hold your ground, and when to cut your losses. The time to evaluate whether the property is worth more resources, is before you become the owner. In the equity lending business, it’s before you let your clients get further in over their heads with your money. Remember, your “hard money” client drained THEIR resources on the project before they came to you. Unless you impose it, nothing will change but time. Unless more than money is brought into the equation, your client is not going to be any smarter after the cash infusion than before. Unless you love the agony of defeat more than the thrill of victory, look before you lend. So, the first rule in playing cards and buying an interest in property is: know what your “stuff” is worth to the savvy cash buyer BEFORE you up the ante. BREAK EVEN PROJECTION: Now, how do you “break even” with a bad property, or a good one in a bad location. Some things can be changed, like management and advertising. Some things can’t, like location or timing. Let’s say you’re stuck with a bad hand, but the raises [loans and overhead] have been modest, you’ve had a winning streak, and you’re tempted to “stay in” just to see the next turn of the cards. When it comes to property, that kind of curiosity can be costly, and occasionally deadly. Treat every deal seriously, evaluate your hand carefully, and, over time, the odds will reward you. Don’t be impulsive, and don’t acquire an ego investment. Even after all that, there are the problematic costs: training, maintenance, theft, more government fees and assessments, and stuff that just happens. Break even is when you become marginally better off for being in business, than you were before; therefore, making an accurate assessment of how much, and how long it’s going to take, is crucial. The best measure of whether the numbers being used to determine “break-even” are accurate, is to apply them to the property in question. If you can’t use a linear extension of the track record to reach profitability on time, be very conservative with your assumptions. The second rule to adhere to is: before you send good money after bad, make a realistic budget for likely completion, maintenance, and marketing costs to bring the property to profitability if your client [or your cards] do not live up to expectations. BURN RATE: Burn rate is the rate at which you [or they] spend more than is taken in. When you’ve spent your last dime, and can’t borrow more, you’re finished – no matter how good the property is otherwise. On a practical level, then, one must consider whether one can “stay in business” long enough to “turn the corner”, and whether it’s worth it. People who didn’t think about that eventuality either sell at a loss, or become equity funding clients. Equity funding brokers who don’t think far enough ahead either, take a “write off” or plow more resources into the project to “turn it around”. Well and good if the project just needed a little more time, or a push; but, what if it was just a good looking “black hole” to begin with, or the time-line to break-even is so long that we need an actuarial table? The time to evaluate these things is before, not after [and yes, that means some impatient souls will go elsewhere, but console yourself, they won’t go with your money, and there will always be another deal]. To avoid the specter of having to sell off prior to reaching maximum profitability [because you’ve run out of ideas, or money, or both], do a “worst case” projection of your balance sheet BEFORE you commit your funds, and see if it still makes sense. No matter how hard you squeeze your cards, they don’t change value. The third essential is to keep one eye on the rate of closure to meet the budgetary expectations of “break-even”, and the other on the rate of “burn”. If the burn rate exceeds the acceptable closure rate after a trial of, say 6 months, seriously consider cutting your losses. One of the reasons professionals usually win at whatever they do, is because they come to the table prepared, they pay attention to the details, including the players, and they’ve learned what works, and what doesn’t. Too often, as equity funding brokers, we take the tack that all we have to look at is the appraisal and balance sheet. In some environments, almost anything works, but times are getting tighter; bankruptcies, repossessions, and foreclosures are on the rise, and the value of a failed business in a depressed market is a lot less than when everything and everybody was in an expansive mood. Unless you have “a card or two up your sleeve”, don’t buck the odds by discounting the basics. Other factors: Don’t get emotional, do the math, consider tax benees, sell off gradually, consider fundamental shifts, and forget what you paid [be objective from point to point]. * * * Grant Jones is Director of Property Management with Equity Funding, a Division of Centrum Financial Services, Inc., in Seattle. He is an attorney, in addition to holding professional credentials in a broad range of fields, and has authored many articles on property management issues. He can be reached for comment at [206]269-0628, or gjones@centrumfinancial.com. The author retains his copyrights, but license is granted for limited personal use copying.