Dear Daily Crux reader,
This week's installment of our World's Greatest Investment Ideas series is a little different.
It's with James Woodford, a multi-millionaire entrepreneur and private investor. And while you'll never hear his name mentioned in the press, he's one of the smartest, most successful investors we know.
He's made a fortune for himself and his investors in various industries… from banking to industrial liquidations (selling used equipment) to real estate development.
James is a "hands on" investor. He takes advantage of contrarian market opportunities in the private sector… which allows him to earn far higher returns than folks earn in publicly traded stocks. For one of his most successful ideas, read on…
Regards,
Justin Brill
Managing Editor, The Daily Crux
www.thedailycrux.com ––––––––––––––––––––––––––––––––––––––––––
The Daily Crux: James… you've made a lot of money in a lot of different industries. And now, toward the end of your career as an entrepreneur and an investor, you've become a "real estate pawnbroker."
You're sort of a legal loan shark who earns very high interest rates on his money. And real estate is your preferred collateral.
Could you explain what you do and why it can be such an extraordinary wealth-building strategy?
James Woodford: Sure. I've spent much of my life buying, developing, and selling real estate. It's been very good to me. And even though I don't need to make more money at this point, I love looking for deals and finding value. I have a good idea of the value of most every piece of real estate in my area.
After the great real estate and credit bust of 2007-2008, I noticed a lot of people in my area were desperate for short-term loans. However, the entire American banking industry was seized up. Credit, which was flowing like water in 2005, completely dried up. Even quality borrowers couldn't get money.
Many banks suffered huge losses during the real estate bust… so even if quality borrowers approached them for a loan, they had to turn them away. The banks were trying to repair themselves, rather than focusing on new business.
And since I had a lot of money in the bank, many people came to me for loans. Even some of my banker friends encouraged folks to give me a call. My banker friends would say things like, "James… this is a high-quality buyer with great collateral. I'd make this loan in a second, but headquarters won't let me."
So I started making loans… And my phone started ringing off the hook.
Crux: You're a private investor who didn't take a bath in the real estate drop, you had a cash-rich balance sheet, and you had quality borrowers who couldn't get loans elsewhere… So we imagine you were able to dictate some pretty good terms…
Woodford: You're darn right I was able to get good terms!
One of the keys to being a contrarian investor – or a loan shark or pawnbroker or whatever you want to call me – is to make sure you have cash when others do not.
When you have cash and others do not, you are able to do some amazing deals. That's when you set the terms.
Crux: So what were the terms?
Woodford: Well first of all, I will only accept real estate as collateral. Real estate is what I know. Real estate always has a market. And a good piece of real estate is valuable enough to make it worth my time.
If the potential borrower is a reasonable credit risk and has a piece of real estate to put up for collateral, I'll consider making a loan.
When I consider doing the loan, I've got two numbers on my mind at all times: One and 60.
Crux: OK… how about explaining "one" first.
Woodford: If I do the loan, I make sure I'm No. 1 in line for that property if the borrower defaults. I make sure there are no legal rights to the property that are ahead of mine. This is called getting into the "first position."
Now, I don't want folks to default… But I have to protect myself by being in the first position if they do default.
Crux: OK… let's cover "60."
Woodford: Sixty is my next layer of protection. I'll only loan 60% of my appraised, lowball estimate of the property's value. This is called the "loan-to-value" ratio.
I never, ever loan 100% of my appraised value. By using a 60% loan-to-value ratio, I can cover my expenses and still turn a small profit if the borrower defaults. For example, if I think a property is worth $100,000, I'll loan $60,000.If I think a property is worth $500,000, I'll loan $300,000.
Crux: That sounds just like what pawnbrokers do.
Woodford: Yes, it is. If you bring a $1,000 necklace to a pawnbroker, you're likely to walk away with $600 or less. I'm doing pretty much the same thing as the pawnbroker… I'm just doing it with real estate.
Crux: So as the "lender of last resort" in your area, what kind of interest rates do you get?
Woodford: Generally, I look to get the prime rate plus 6%.
The prime rate is a benchmark rate used by the banking industry to set consumer borrowing rates for things like credit cards and car loans.
For example, during most of 2011, the prime rate was around 3.25%. So I'd get an annual interest rate of around 9% or 10%.
I also often charge 1% of the total value of the loan as a fee. If I'm loaning out $200,000, I'm going to charge $2,000 as an origination fee. Most loans last one or two years.
Crux: Those are super-high rates in a low-interest rate world. On a one-year loan of $200,000, you'd earn $22,000, assuming a 10% rate and a 1% fee.
Woodford: It beats the heck out of CDs.
Crux: And people are willing to accept those terms?
Woodford: I know it sounds crazy… But when banks seize up because of a crisis, people who want to borrow money don't have many options. Like I say, lots and lots of people are willing to accept these terms. Again, if you have cash when others don't, you can dictate great terms.
Crux: It sounds like a great business for folks with money and an eye for value. Any parting thoughts?
Woodford: Well, it's not a party all the time. You have to deal with late payments… contracts… and other small hassles.
But at least 99% of the loans I've made have been paid back, and I get great rates of interest, but not so high that it suffocates the borrowers.
Ultimately, anyone who makes these types of loans needs to remember that they absolutely have to protect themselves by getting "first in line" – by getting into the first position – for the rights of the property.
Also, make sure you have an excellent assessment of the collateral's value… and consider loaning much less than that value. That's another layer of safety.
But the ultimate layer of safety is if the deal looks even a little shaky, pass on it. There's always another one coming by.
Crux: Thanks James.
Woodford: You're welcome.
Sunday, 15 April 2012
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