With more and more everyday Americans signing up to invest with GROUNDFLOOR, we thought it prudent to resurface an older post from January 2017 which discussed the Asset Management process we employ with our borrowers. The case examples at the end of that article and the metrics quoted have been updated to reflect our operations up to August 30th, 2018.
You may read the original post here.
As with any investment, GROUNDFLOOR loans aren’t risk-free. Instead, exposure to risk must be approached thoughtfully and managed carefully. That’s a shared responsibility -- for us as an issuer of securities and for our investors as well. For those of you new to GROUNDFLOOR, I’d like to introduce myself. My name is Rich Pulido and I’m the senior vice president of lending, capital markets, and risk management at GROUNDFLOOR. My 30-year real estate career includes leading the Special Servicing group of Prudential Mortgage Capital Company during the Great Recession of 2008-2010.
As a professional who’s had a front-row seat to several up cycles and down cycles in real estate, I’ve observed first-hand how important asset management is to controlling risk. With fix-and-flip loans for acquisition and renovation such as those we offer here at GROUNDFLOOR, there are two aspects of risk to consider: the extent of loan repayment and the timing of it. At GROUNDFLOOR, our highest priority is maximizing the repayment of principal and interest. Minimizing the time to achieve repayment runs a close second.
How have we done? Our most recent vintage analysis is promising. The substantial overhaul and upgrade of our underwriting, risk, and asset management processes that we undertook in 2016 are making a big difference for our GROUNDFLOOR investors. Despite more than doubling the rate of originations, on-time repayment was up 26% from our first round of loans. Even more significantly, despite significant growth in origination unit volume, our asset management team has returned capital on 252 loans from our newest vintage with only one loan realizing a loss of principal.
While we strive to avoid any loss, the realized loss was limited to approximately 5% of the principal and represented just seven basis points (0.07%) of total principal in the vintage. To put that in dollar terms, our losses realized are equivalent to less than $1 out of $1,000. Under the circumstances for the type of lending we do, we’re proud of this record.
For an inside look into how we’ve accomplished this, here’s a step-by-step, detailed walkthrough of our underwriting and asset management practices.
Step 1: Underwriting
The term “underwriting” refers to the assessment of risk in relation to certain criteria.
GROUNDFLOOR employs a team of professionals who apply decades of real estate investing and lending experience to this task. Our underwriting team carefully screens borrowers, quantifies the value of loan collateral presented, and assesses the feasibility of completing proposed project tasks. We established and maintain a grading algorithm to price the risk identified through the underwriting process. The algorithm, based on property, borrower and market data analyzed by our underwriters, assigns a grade. That grade then defines a range of rates that would properly price the risk.
As an underwriting team, we utilize even more data, tools and policies to support our underwriting process than we did when this article was originally published in January 2017. For example, we continue to adhere to more robust appraisal standards, but require full interior inspections during every project. We also employ more extensive sources of valuation data and analytical tools, adding more sources as we find and vet them. All loans are subjected to rigorous business case analysis and stress testing, and GROUNDFLOOR’s closing documentation incorporates stronger, industry standard lender protections.
Step 2: Monitoring
Once we make a loan, GROUNDFLOOR employs proactive asset management practices to protect your investments. We monitor progress against the borrower/principal’s stated plan and budget, as well as compliance with loan requirements. This helps us to identify or anticipate problems sooner and more reliably than we could without that monitoring. Once a deviation from plan or another concern becomes apparent or is detected, we promptly contact the borrower to understand the situation.
Most of our loans fund renovation work to prepare a property for sale or lease-up. The borrower typically pays for the renovation work and then requests a draw for reimbursement. We contract with local, independent, experienced professionals to assess the quality and scope of the work completed against all reimbursement requests to assure reasonableness.
In addition to tracking a budget, we measure the project against the original schedule. Any significant deviation from schedule prompts a phone call from our asset management team to discuss project progress. GROUNDFLOOR’s loan documents require the borrower to maintain sufficient insurance coverage, remain current on all real estate tax obligations, and keep the property free of any liens (other than GROUNDFLOOR’s first lien). We diligently monitor all these conditions. Problems meeting these requirements may indicate financial stress or insufficient focus.
The Asset Management team also requires that borrowers provide monthly updates on project progress for the GROUNDFLOOR investors in those projects. Making sure investors are well informed of the health of their investments is of utmost importance to our team.
A key element of proper loan management is focusing the borrower on upcoming loan maturity. We contact the borrower 90, 60 and 30 days prior to maturity to remind them of the upcoming maturity and to understand how they plan to pay off the loan. These discussions allow us to prepare a payoff statement, coordinate with the closing agent or new lender, etc. These communications allow us to get ahead of a situation that may result in a payoff occurring later than the stated maturity date.
If the situation warrants it, we or a designated third party may meet with the borrower at the project and conduct a property inspection. It is critical to mitigating risk and minimizing loss to understand the property’s condition and hear directly from the borrower what the plan is to ensure any problems are resolved promptly and with minimal impact to GROUNDFLOOR.
Step 3: Recovery
In some situations, rigorous underwriting and proactive asset management are not enough. That’s where the real art of asset management comes into play: recovery. The real measure of how effective we are at protecting your investment is the loss ratio on loans that have experienced trouble. While we have certainly had loans that paid off later than anticipated, realized cost overruns or even faced foreclosure, we’ve successfully recovered and repaid all principal and interest due on 98.5% of the 314 GROUNDFLOOR loans repaid to date.
As a lender secured by a first mortgage, we always have the right to foreclose on a troubled loan. However, we seek to resolve problem loans in a manner that is quicker, more cost effective and ultimately economically better than a foreclosure.
Here are two actual case examples of our recovery efforts since the original article was posted in January 2017:
Example 1: GROUNDFLOOR recently resolved a loan that had significant title problems. The borrower stopped construction on the project leaving the collateral as a simple shell. However, due to title issues caused by a title insurer’s error, the property could not be foreclosed, sold or refinanced until clear title was achieved. Fortunately, our original underwriting properly assessed the strength of the market and even as a shell, the property was in demand by both investors and end-buyers. Further, our Asset Management team recognized the problems early and ceased funding construction draws, leaving sufficient proceeds available to fund taxes and protective advances during the pendency of the resolution process. In order to achieve resolution, GROUNDFLOOR had to pursue action against the title company, satisfy another claim on title and effectuate a sale of the property. Our newest Asset Manager, Brianne Cunnion, a licensed real estate lawyer, was perfectly positioned to step in and manage myriad legal and title insurance issues to clear the path to a profitable sale of the property. While the resolution occurred 31 months beyond the original maturity date, investors did receive a full return of principal plus interest over the total term of the loan.
Example 2: GROUNDFLOOR takes great pride in its underwriting and asset management capabilities. Those skills recently influenced the outcome for a loan headed toward foreclosure. The borrower had substantially completed the project but was distracted by other business problems and was unable to sell the property by the loan maturity date. GROUNDFLOOR promptly commenced foreclosure proceedings while simultaneously exploring alternative resolution options with the borrower. Fortunately, GROUNDFLOOR never paused the foreclosure action as it became clear foreclosure would be the only viable resolution option. At the foreclosure auction multiple bidders were present and GROUNDFLOOR was outbid by approximately $20,000. By losing the foreclosure auction, we were able to provide our investors with a full principal and interest recovery much sooner than if we had foreclosed and sold the property. Sound underwriting resulted in controlling our leverage sufficiently enough to withstand a distress situation. Further, proactive asset management ensured resolution was achieved in an expeditious manner.
At GROUNDFLOOR, we take great care to do everything we can to protect the interests of our customers, whether that’s guiding a borrower to achieve a successful outcome or resolving the problems that customarily arise in real estate investing. We hope this has given you a clearer idea of how we manage all of our loans from start to finish. As always, please feel free to reach out to us at email@example.com with any further questions, or drop us a line in the comments.