[Note: To follow is part 2 of an excerpt of a radio show interview conducted by Peter L. Mosca, host of Income Property Investment Talk dot com, with Scott Griffith, President, ERA Griffith Realty, Rob Verhaaren, Managing Director of Universal Equity Group, and Blaine Walker, President, RealSource. The guests explore the driving forces in today’s distressed market activity, the importance of conducting due diligence and ways to maximize profitability. To listen to the show archive or download an MP3, go to www.IncomePropertyInvestmentTalk.com/110409.]

Mosca: Rob, I know a lot of times when you are dealing with notes and purchasing notes that there is very limited time to review a lot of those files that are involved in those types of activities. Do you find that too?

Verhaaren: Timing is extremely short, everywhere from these large FDIC pools that are being auctioned, right down to individual homes that are selling on the courthouse steps. If you go to buy a home on the courthouse steps in some cases you are going to have 24, maybe 48 hours to go out, look at the property, check to see if there has been vandalism or what type of work might need to be done. You need to pull a title search. You want to make sure that what you are acquiring is real, what’s being sold is actually a first lien position so that you don’t end up buying a second position. There is a lot of work that has to be done before you show up at the courthouse steps. Then, you have to sort through a semi-chaotic scene with all of these bidders and properties being listed. Finally, if you are the successful bidder you have to close in 24 hours. You have 24 to 48 hours to do full due diligence including title search, property reviews, site inspection, and close the deal. That makes it a challenge for a lot of people who would have to go get financing but at the same if you have immediately available cash, you are in a very strong position. The same is true to a different degree on these large portfolios. Blaine referred to one pool that went out last year. It was $1.1 billion of unpaid principal balance. There were 1,200 loans in the pool representing 1,200 individual pieces of real estate. The FDIC gave the bidders 30 days to do due diligence on that extreme volume of properties, make a bid, and then close the deal. With the FDIC in that transaction if you are the winning bidder you had one week to close the deal so you had to close a $20,000,000-$50,000,000 deal in about one week's time having only had about 30 days to do the due diligence.

Griffith: It is a great time. In fact, essentially that is what we chose to do when we decided to form our Rescue Corporation where we go in and consult to the banks and ultimately also purchase these assets. You can form a business model, go in and execute it, and this is a great time to do it. When better to do it than in the times when things are in change? This is the best time to test your new business models and see if they will work and to make these investments.

Walker: I agree with Scott. There are a number of business models out there like the business model that we have in purchasing FDIC assets. Scott’s approach to go into the banks and help them look at all of their properties and give them advice as far as what approach they should take, as far as other business models that put together a small investment group to buy the assets as they become REOs, or to buy the notes. There are all kinds of opportunities out there.

Mosca: What about those brokers and agents who want to be in on this opportunity. Can they create a business model working with you guys?

Walker: Sure. They can get in contact with Rob or myself or Scott. Scott knows a lot of properties that have been stress tested and are now in the marketplace. We have our virtual deal room as I indicated and Rob has been working in the bankruptcy market quite extensively, in the Phoenix market as well as the FDIC and several other programs that he has been putting together. There is an opportunity for real estate brokers to joint venture with us or work with us on the assets that we’ve already proved up, that we have gone through that process on, and evaluating them and getting them at a price that is a great opportunity for short-term and long-term holds.

Griffith: A great strategy is to try to partner with somebody who has slugged through some of this and had some of the learning experiences so you don’t have to suffer some of the start and stop errors that are made. I think you have to decide where you want to position since there are so many opportunities. You have to stand back and consider yourself do I want to be in a position of at the end of it or am I going to be in the middle of it and then be able to stand back and say who are the people that are positioned to do that. As you hear here, a lot of the work being done here is to buy and get rid of it. Other people are buying to hold and so there are all different points at which you can enter this market and you have to identify where your comfort level is.

Verhaaren: We have a group of investors that support us, all of whom are accredited investors. We pool capital from people who otherwise have day jobs, and are off working in their professions. They rely on us knowing that we do this every day, all day long. They will invest with us. We then pursue the opportunities and generate the returns for the investors who have committed funds to us. That’s how we enable people who are interested to get into some of these larger FDIC transactions or even into these smaller courthouse step opportunities to invest, by creating a vehicle for them to invest and then returns we generate are sent back to them.

Mosca: Our audience has a great deal of knowledge in real estate and investing. Can they leverage that knowledge to work with companies like yourselves in building business models?

Walker: Absolutely. Remember, we have the virtual deal room where the properties are already there. They have an opportunity to go in and take a look at them. They can call us personally and talk to us about opportunities on the horizon. We are in the education business, and that’s what RealSource has done for the last 20 years, looking at markets throughout the country, emerging markets, and moving our clients to those markets. That is where working with the professional and working with those that have experience is a plus to any real estate broker or investor.

Griffith: When setting up your model for how you want to participate, be careful to evaluate it well, too. You need to look at the depth of the pool and look at the dynamics of the market. In our own consulting business, one of the things we underestimated was the pressure even the banks were under to retain their money and their capital and the difficulty in the fact that they valued the service that we provide but had a hard time finding a way to write the check to pay for it. The same is true when it comes to these investments. The market has changed a lot.

Mosca: Are you help our audience learn from the miscues or missteps that happened along the way of you creating this business strategy in and around distressed assets?

Walker: We’ve found that when you get a package the size of a $1.1 billion, there are a lot of unknowns. You have a short time frame to conduct a lot of due diligence such as analyze all those properties, all of the assets, the individual loans, the quality of the borrower, the capacity of the borrower, what the current state of all the loans is, are there any outstanding portions of those loans that have not been funded, and other considerations. You have to build in reserves for the legal issues that arise as far as questions on title and to go through the REO process. You have to be very careful when you are bidding on these packages. It may sound great that you bought a package for 25 or $.30 on the dollar but as I said before sometimes you can buy a house for $5,000 and maybe pay $20,000 too much because of the extenuating circumstances. The same thing occurs in buying a pool. That's what we found -- you have to do due diligence to the very best you can and then there's still going to be some hidden things in there that you may have missed. Those are the pitfalls. We do the best we can to find those.

Verhaaren: One important pitfall can be avoided by being willing to walk away from a deal specifically at auctions, closed bid auctions or open bid auctions. You go, you have a price that you will pay, you might bid and you lose a couple, your competitive spirit might kick in. I start to get the urge to win the next one. Then you find yourself bidding too high. I see people do that all the time and I see a lot of these auctions going for prices that are just too high. As you go into these things you need to be prepared just to stick to your guns, stick to what you think is the proper pricing, and walk away. That is a pitfall that will keep you out of a lot of trouble. You’re going to make your money in the distressed market if you buy right, so resist the urge in these auctions to overpay because I see it happening all the time.

Walker: I agree with that 100 percent. Go back to the fundamentals we talked about. If you get away from the fundamentals and you get too anxious to get involved in the deal, there is a good potential that you can get damaged or hurt or your investors could be hurt. I have a partner and I used to tell him that he’s never seen a piece of property he didn't like. Sometimes you have to say that piece of property will not work for whatever reason and be willing to walk away as Rob said.

Griffith: That is great advice. The whole secret on the auctions is exactly that, knowing what the price is, doing a projection of what your success is on it, and not going above it and not getting caught up in the moment. It seems that every auction that we have been either at or participated in, we’ve seen that exact same scenario where people are caught up in the moment and they just didn't get anything and they felt their model was wrong rather than looking at the fundamental concepts. When you go to the more open auctions, which are the residential properties, you basically have two kind of people there, you have your investors and you have your end users. The price the end-user will pay traditionally is more than the investor and people don't separate fees as they are looking at the property and they get caught up and they end up trying to compete with the end user when they should just stay in the investor mode and walk away if it’s not going to happen.

Mosca: What is your golden nugget?

Verhaaren: We are finding some footing in the residential side. We are in a great buying opportunity. On the commercial side we are only at about the fifth or maybe sixth inning in terms of decline in value so commercial has a long way to go but I do think on the residential side if you are careful and buy right it's a good time to find some opportunities.

Griffith: I believe there is going to continue to be an escalation of the commercial foreclosure market even with the attempts of the government at this point to try to buffer it. It’s well documented that there is going to be a lot of loans coming due. Tenants are bragging about beating up their landlord and getting their rent reduced. If that occurs across the whole investment property and cash flow is no longer worth what it once was and the bank is going to be compelled to try to do something to try to cover their security that means a lot more money from the owner when they don’t have it.

Walker: There is still a downturn that is going to occur in the commercial market. We know that there is somewhere in the neighborhood of 1 1/2 trillion dollar loans coming due over the next three years and while a lot of those will be rolled over, the capital requirements of banks have gone from eight to 12% at a 25% increase. When you get that type of a requirement for reserves, it makes it more difficult to loan money and the banks are in a Catch-22. They need the loan money to make money but they have to maintain certain capital reserve, which puts a lot of pressure on them.

Published: December 10, 2009

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Peter L. Mosca is president and founder of BAK Communications, Inc. He has over 22 years of communications and media consulting experience, serving a variety of nonprofit organizations, including the CCIM Institute and the REALTOR Association on all three levels – national, state and local. He is the Spokesperson Trainer for the CCIM's Jay Levine Academy and trains hundreds of residential REALTORS nationwide to be effective industry spokespeople. He is consistently ranked as "excellent" by about 90% of those who attend his presentations. While his principal consulting focuses are public speaking and media relations development and content delivery and management, Peter is also the host of the Voice America Network's weekly radio program, "Income Property Investment Talk," a one-hour program that brings the powerhouses of commercial and residential real estate to property investors every Wednesday at 11 a.m. EST. Peter is married 17 years to his wife Barbara. They have two children: Ashley, 15 and Kelli, 12. Hence, the name BAK Communications, Inc.