What I’m reading: King Larry: The Life and Ruins of a Billionaire Genius by James D. Scurlock. An entertaining book about DHL’s founder.
A couple of weeks ago we were set to lend $140,000 to a borrower on a fix and flip. We’d done a walk-through of the house, the title report checked out etc. It was in a B location within its town, but even discounting the location, the after-repair value would be $230,000.
The loan structure was to be typical: We’d lend $100,000 on a 6-month loan term, against his purchase price of $125,000 and hold back an additional $40,000 for repairs. Our all-in loan exposure would be just over 60% of the expected resale value of the house.
As previously discussed in my piece On the Banality of Lending, I use checklists to
confirm the “obvious.” 99% of the time, nothing comes of it. This deal was an exception. Of course, it’s not our job to conduct due diligence for our borrowers, we conduct it for ourselves and our co-investors, but if we find a deal killer we explain it to our borrowers.
This parcel fronts an arterial country road and had two small commercial buildings on each side of it. It backs up to a residential subdivision.
The seller represented to my borrower that the property was zoned residential. We checked on it anyway as part of our loan process. Nope. Turns out the property is zoned commercial. The nonconforming use was grandfathered in provided the property was not vacant for 180 or more days and provided it was not improved in excess of 25% of its assessed value.
I told my borrower. He was shocked but grateful that we looked into this. Why? Should the property lose its ability to be used for residential purposes, it would likely be worth ~$75,000 or less. He has gone back to renegotiate with the seller, but chances are the deal is dead.
Zoning is just one seemingly unimportant item on our checklist but every now and then, it makes or breaks a deal.