My 3 Biggest Mistakes Buying Real Estate in the USA as a Foreigner
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I've personally purchased over 100+ rental properties in the US as a Non-Resident foreigner, but not every deal was a winner. I made some simple and often overlooked mistakes that cost me a lot of money, time, and stress. Here's what happened...
David Garner
Don’t Believe the Hype!
One of the biggest reasons private lending investments are so popular, is the fact that your investment is backed by physical real estate.
In most cases, a real estate investor seeking funding from a private lender will have a plan that involves some sort of renovation.
With that in mind, one of the most important aspects of a lender’s due diligence and underwriting process is the accurate assessment of the property valuation and the value-add plan (the rehab budget).
This can be quite the process…
Plenty to go Wrong
If well-planned and executed, this time-honoured ‘value-add’ (forced appreciation) investment approach makes sense in most markets, most of the time.
These investments can also prove lucrative for private lenders, often attracting annual interest rates into double digits.
That said, lending investments with a rehab element are inherently more ‘risky’ than simple bridge loans, or long-term DSCR mortgages.
For one thing, the value of the asset that secures your investment is likely to actually fall between the start of the renovation process and completion.
Further, if the RE investor encounters problems during the rehab process, the whole project could go belly-up. These include (but definitely not limited to):
- Unexpected capex/repairs
- Cost overruns for labour and/or materials
- Timeline overruns
- Issues with contractors
- Permitting issues
- Problems with city code enforcement
As a seasoned RE investor myself, I can attest to this. I have personally experienced each and every one of these problems more than once over the course of my 100+ RE investments.
As a lender, if you are forced to take back a property mid-construction, you might find yourself in a pickle!
Therefore, your very best defence as a lender is to identify potential issues ahead of time, and plan/lend accordingly.
This is where developing a robust and thorough due diligence and underwriting process comes in…
Due Diligence and Underwriting
First and foremost, you should take into account the track record and experience of your borrower.
For me, I am looking for evidence of a track record that demonstrates their capacity, capability, and competency.
Capacity – Their ability that exists at present, i.e. What can they do right now?
Capability – A higher level of ability that could be demonstrated under the right conditions, i.e. What could they do with access to my funding?
Competency – How functional or adequate one is in carrying out ones capability. or having sufficient skills and resources to deliver what is required, i.e. Have they demonstrated their ability to execute competently?
Essentially, you will want to see evidence that the borrower has successfully (and recently) completed similar projects, in similar markets.
There are plenty of tools and resources available to check the veracity of information provided by a borrower concerning their track record.
But this article is focussed on underwriting the rehab portion of a loan. So, I’ll revisit borrower due diligence in a separate article. make sue you subscribe to my email list for regular updates.
Right now, let’s get in to the meat of it. Here are my 3 top tips for assessing private lending rehab loan risk after assessing literally hundreds of private lending deals as both a lender and borrower…
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1. Obtain an Accurate After Repair Value (ARV)?
As I already mentioned… an accurate ARV is an essential component of your private lending risk assessment and underwriting.
The ARV is obviously contingent on the rehab being completed successfully. But, it is also important to correlate the level of rehab suggested with the ARV.
Question to Ask: Will completing the Scope of Work result in the suggested ARV?
First, there are varying levels of rehab. From a minimal lick of paint, through ‘rent-ready’, and ultimately high specification retail flips. It’s important to understand what level of rehab is appropriate for the project you are lending against.
In my markets (where I both lend and buy houses) much of the housing stock comprises rental properties. Some of those are Section 8, and some private market rentals.
In general, rents fall between $800/month and $1,500/month for single family homes, and property values fall between $60,000 and $150,000. I would describe these markets as ranging from C to B.
There are also a few good owner-occupier markets I participate in. Property values in those areas range from about $150,000 through $300,000, and the quality of the housing is probably around B+.
Of course, there are more expensive areas, but here I am compiling an overview of the areas and projects I am likely to lend on (or borrow).
With that in mind, here is my personal rehab scale that I apply to both my private lending investments, and to my personal real estate investments…
Basic Rehab
This is where the property will be sold on very quickly, probably to another investor.
The Scope of Work (SoW) will invariably involve some trash out, yard work, and perhaps some paint here or there.
It may also include any quick-win value-add items that can be completed quickly to add significant value (such as a new roof, sewer line, or foundation repairs).
with this kind of minimal rehab, I am essentially looking for any low cost opportunities to add quick value or ‘kerb appeal’.
Section 8 Rental Rehab
For my own section 8 or VA rentals, my rehab will – at a minimum – include repairs and/or replacement of the major mechanicals and CapEx. This could include; a roof, sewer line, electrics, plumbing, foundation work, dealing with water ingress, and/or repairing/replacing windows.
As such, I am looking for the same things as a lender…
Ideally, the borrower will have a property inspection in-hand. That will go a long way to highlighting expensive CapEx that a contractor walkthrough might have missed.
This level of rehab will also generally involve some cosmetic updates. This could include new flooring, drywall repairs, internal door repairs/replacements, and paintwork for walls, ceiling and trim.
A basic section 8 rehab will probably not include a new bathroom or kitchen if the existing hardware is functional. But, it will include repair and/or replacement of any worn out items as required.
Pro Tip: Check for any outstanding code violations with the city code inspector and make sure they are included in the SoW.
Private Market Rental Rehab
My private market rental rehabs are generally fairly similar to Section 8 rehabs as far as major CapEx and mechanicals are concerned. Additional work at this level will mostly be cosmetic.
That might include better quality materials for things like flooring, doors and windows. It might also include higher quality finishing touches such as better quality lighting, electrical outlets and switches, doors, and windows.
This rehab level may also include bigger jobs like a new kitchen/bathroom, exterior paint, and/or new siding.
With this kind of project, the RE investor should be looking to maximize future rents and ARV so as to max out of cashflow potential and the ability to refinance as much as possible.
Pro Tip: Check out local rental listings and measure up the SoW against currently available properties.
Retail Flip Rehab
This is the highest level of rehab in my personal scale – both for private lending investments and for real estate I purchase to resell.
In my market, I don’t buy luxury houses. The value range of ‘flippable’ properties for me is between $150,000 and $300,000.
For these rehabs, I go all in, and would expect the same of my borrower if I am lending money.
I look for use of the best possible materials. I will also use the best possible contractor that can deliver a high quality finish.
Look for complete remodels. New kitchens, bathroom, fitted closets. Maybe even restructuring the internal layout.
You are looking for a Scope of Work that delivers in a highly desirable property at the right price for the local market.
Pro Tip: Look for similarly priced (ARV) properties for sale and sold listings, and compare the images to the SoW. Also look for evidence of previously project completed by the specific contractor and assess the quality.
Putting it all Together
Once you’ve identified the level of rehab that your borrower intends on carrying out, you’ll be well-positioned to analyse the accuracy of the ARV…
The most important point here is to ensure that the ARV is reflective of the finished product. In other words, make sure the price comparables used represent a comparable rehab level to the proposed SoW.
I have encountered this many times when underwriting potential lending deals. I have seen borrowers use comparable of high end retail properties to value a section 8 rental. This may not have been intentional, but the difference in value can be significant.
There are a number of tools and resources to help you do this, including;
- Research of local rental and sale listings
- Acquiring a Brokers Price Opinion
- Acquiring an appraisal
- Using an online valuation tool such as RicherValues or ClearAVM
For reference, here’s an example
In this private lending investment case study, from the Garnaco Private Lending Program, you’ll see that the initial loan was originated for $45,500.
This was supposed to reflect around 65% of an ARV of around $70,000.
As part of the due diligence process, the lender was able to compare the SoW with current and sold local listings.
They were also able to review previously completed investments of a similar nature in the same market.
Finally, they were able to review examples of similar work completed by the same contractor.
The borrower also provided a Brokers Price Opinion indicating an ARV of $69,580 (see below).
Ultimately, the property ultimately sold for $86,000 around 23 months later!
This is a great example of how a solid due diligence process produced a great result for the lender.
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2. Check the Budget is Sufficient?
Now you have checked off the accuracy (or otherwise) of the ARV, you should also dig down in to the rehab budget itself.
The question you are asking here is; Has the borrower allocated sufficient budget for the rehab?
There are lots of moving parts to consider here…
Perhaps the borrower is also the contractor, and they are providing the labour free of charge, and the materials at cost price.
That looks great on paper, and I’ve seen that work out well many times. But as a lender, you have to also understand what it might cost you to complete the project if you have to take the property back.
After all, it’s not likely you’re going to want to carry out all the labour yourself, right?? With that said, it’s also unlikely you’ll find another contractor to work for free, or find materials at cost price.
You should account for this when deciding how much you would lend on a project to leave yourself some leeway for a worst case scenario.
What you are trying to do here is assess the accuracy of the budget. For example, if the the borrower has budget $2,000 to paint the entire house, chances are they’re going to come up way short.
The little things can add up, too. Mispricing doors and windows by couple hundred bucks a piece can soon add up!
If you don’t have the experience or expertise to analyse the SoW, there are some tools and resources that can help, such as a Renovation Analysis reports from RicherValues.
Of course, there is always risk involved in any constructions project. I don’t think I’ve ever had one come in exactly on budget in over 100 renovations.
The idea here is to ensure the accuracy of the budget as well as you possibly can with the tools, resources and expertise you have available.
3. Check the Budget/Plan is not too Excessive?
IF you are dealing with a prolific borrower who has multiple project on the go, this step becomes even more important.
I have seen prospective borrowers provide inflated budgets in order to use funds from one project to pay for shortfalls on another.
Unfortunately, I have also seen borrowers provide a rehab budget and just take the money and never complete the work.
While a seemingly inflated rehab budget is not a definite signal of potential fraud, it does warrant further investigation.
After all, if your borrower’s budget seems wildly inaccurate, that is a red flag in and of itself.
Most private lenders I know will ultimately pass on a project with comes with an inflated budget. Erring on the side of caution is probably the right idea!
Conclusion
So, there you have it… my 3 top tips for evaluating the rehab element of a private lending investment…
- Obtain an accurate ARV
- Check the rehab budget is sufficient
- Be wary of over inflated rehab budgets
Remember, there will always be some risk attached to any private lending investment, that just the nature of the beast.
After all, you wouldn’t be able to earn double figure interest if there were no risk…. this isn’t the 1980’s.
