Any investment under the sun carries with it some level of risk. Real estate is no different. The real question is what to do when a deal starts to go south. What you don’t do is fiddle while Rome burns. That’s where it pays to have a strong asset management team. It’s their job to make sure that these kinds of investments are profitable.
Whenever a lender acquires a new property, it’s an indication that the borrower ran into unanticipated costs or delays that they couldn’t overcome, and now you have to figure out how to correct the problem to make the project work. The prospect itself is like climbing a mountain, so how do we do it? There are various problems that can derail a construction project. Typically, they arise from unforeseen issues that weren’t apparent during the early planning stages, resulting in an insufficient budget or a protracted timeline, both of which cost the borrower money. That’s why action must be quick and decisive.
The first thing to do is assess the property to see how the progress compares to the approved budget. The next step is to conduct an appraisal and competitive market analysis to estimate the after-repair value of the home. This process will tell you if you can continue construction according to the original plan or if you need to course-correct to achieve profitability. There are four ways to handle the disposition of a given property depending on the above assessments: sell it as-is, complete construction and sell it, complete construction and rent it, or revise the scope of work and redevelop the property.
If you determine you can preserve the investment in the property in its current state, you should sell it as-is. This is the quickest exit, and it minimizes carrying costs like property taxes and utilities which can cannibalize potential profits down the road. The second most attractive option is to finish construction on the property then sell it. If you go that route, you need to decide if it makes sense to finish it according to the original plan or devise a new plan for the project. If the original plan doesn’t build the necessary value into the home, then you need to change course to ensure you can optimize what the home is worth. If the project has gone completely off a cliff and the initial investment can’t be recovered by fixing and selling the home, then fix it and rent it. Renting the property allows you to generate the regular interest payments expected by the investor and recover principle over time. Then once the property is right-side-up again, sell it and cash out.
Not every project like this is clear cut. There are any number of unknowns that you can encounter at any time, which means that you must be extremely agile. But, to put it simply, letting one of these investments fail is not an option. If the original borrower can’t make it work, then we do it ourselves because it’s our job to make sure we always come out on top.