Turnaround Finance – Solution by Vultures or Angels?

An injection of turnaround finance involves saving a potentially insolvent company from irreversible insolvency and returning the company to a stable financial and operational position. The objective is to achieve this whilst maximising creditors’ interests and the interests of employees, managers and shareholders. Popularised by such media productions as Dragon’s Den (starting in Japan, now exported to the USA and UK), private wealth may be granted where the investor believes there is a future for the business. This article deals with turnaround finance for both under-performing businesses and businesses that are either insolvent or potentially insolvent.

The Progress Path

Turnarounds are achieved by a combination of financial, crisis management, restructuring and insolvency skills. The first step is to determine why the company is in the state it is. Realistically, is there anything that can be done to reverse the trend. Analysis is the key to really get into the problem. The analysis will resemble the three legged stool approach. The ‘legs’ vary, but essentially the analysis will get into these three areas: possibilities for restructure, viability and management

Restructure

Even a formal restructure involving insolvency doesn’t have to conclude the company. Many companies have found that this experience has forced a re-think of the company mission and a focus of action. But the majority of turnaround finance initiatives result in informal restructuring which is generally better for creditors, customers, employees, banks and shareholders. The restructure may necessitate job loss and lean arrangements with creditors. It may involve closing some facilities to reduce overhead or consolidating divisions to eliminate duplicate administrative functions. It might be necessary to sell off underperforming divisions of the company and outsource some functions to other parts of the world with less expensive labour rates. Viability This is the ‘leg’ that varies, sometimes it’s in the guise of the finance package. But whatever finance is required, whatever the state of the company and it’s creditors – is the company viable? Does it have a sustainable market? Does it have a future for it’s goods or services? If it’s a new business in something like internet technology, the answer to this question may not be straightforward and need significant analysis and business instinct. For older industries the past history of similar ideas will help greatly.

Management

Of all issues involved in the turnaround, the most difficult is getting the company to recognise deficiencies in management. Weaker members of the management team need to be replaced and this is very difficult for the board to be objective about. The management of any company do not want to know that their company is struggling because of the obvious implication of where decisions are made resulting in the problem. Many management teams won’t accept that they need help until the last moment – but the best help is the help administered early. The resulting action may have to be decisive and definite, a.k.a brutal. ConclusionThe most famous example of a turnaround success is Canary Wharf in London that had serious financial problems but is now one of the major world financial centres. Sadly this example involved formal restructuring which meant insolvency, then to rise from the ashes. Most companies can avoid this by excellent services of turnaround finance companies. These entities can rise to be major players in their market and can thank the time when they had to call in extra experience along with their turnaround finance.

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Annual Review of Football Finance Reveals Disturbing News

In an earlier article (Pssst, here’s £60m for your soccer team….. ) which I have posted in my blog, I alluded that the Beautiful Game is degenerating into something exclusive to people who have plenty of money to spare. An increasing number of Premiership clubs are being taken over by foreign hands: Manchester United are being owned by Americans, the same goes for both Liverpool and Aston Villa, West Ham United by Icelanders, Fulham by an Egyptian whose primary interests is in retail, Chelsea by a Russian with a personal fortune of £9 billion, who is obsessed with winning and can earn far more from his trade in oil and minerals. As of this writing, we even have the ex-Thai Prime Minister wanting a slice of the action by taking over the reins of Manchester City. Is the Premiership gradually becoming an expensive playground for the super-rich? I fear the answer is yes. And how true can this get, going by the latest annual review of soccer by one of the world’s top-four auditors Deloitte & Touche. The Deloitte Annual Review of Football Finance, released on 31 May 2007, revealed that the following startling financial facts:

1) The combined wages of the English Premier League is expected to surpass the £1billion mark for the first time ever since the competition was formally inaugurated in 1992 – 1993. The wages of the twenty teams rose to £854 million for season 2005 – 2006 compared to “merely” £168 million in 2005. Now isn’t it wonderful to be a soccer player instead of having a desk-bound job?

2) Wait, the rich pickings gets better for we can expect the first £200,000 a-week player in the EPL to emerge before 2010. Currently, the top earner in the Premiership is widely considered to be Ukrainian Andriy Shevchenko and German Michael Ballack (both Chelsea), whom each is believed to be banking at least £130,000 per week. I feel that even if you are proven players like them, you should only be getting a basic wage and the appropriate performance bonuses. Otherwise, soccer clubs will be forced to charge fans even higher ticket prices to keep up with the operating costs. This is the best measure to insulate the business when on-pitch results are not so rosy, and also help motivate and reward players and the management for winning.

3) The 20 clubs in the top division generated a total of £1.4 billion in turnover two seasons ago (2005 – 2006), a figure which is expected to go up to £1.8 billion for Season 2007 – 2008. I have reasons to suspect that the majority of these revenues came from the booming Asian economies, where the newly-rich are most willing to pay astronomical sums to catch their soccer heroes play “live” in off-season games.

4) Taking into account the money spent by teams in the lesser divisions in attempts to break into the Premiership, the total debts that have been taken on is an astonishing £2 billion. For next season, there will be in place a new 3-year TV deal worth £2.7 billion, which is widely to be a catalyst for wage inflation and for servicing such debts. The new TV revenue – including domestic and international rights – equates to about £300 million extra per season over the next 3 years. What I can see is it is going to be the turning of a vicious cycle: teams secure loans to enter the top division and earn more TV money, which is then used to service debts. And yet with reduced revenue, they will be forced to borrow heavily again.

Mark my words, the spiraling finances involved in the soccer scene will get out-of-hand one fine day. And the ones who will bear the brunt of the fall-out will be the fans themselves, as they are already being squeezed by soccer clubs to pay for higher ticket prices, more expensive jersey replicates, program sheets and even those who cannot afford a trip to the stadiums will not be spared – they are likely to be charged more for pay-per-view TV for “live” or even games which are broadcast delayed. Finally, I foresee that the ownership of more top-tier clubs will land into foreign hands. While these foreigners are generally super-rich and provide instant cash inflows, they may not represent the best interests of the soccer fraternity. After all, they are probably businessmen by nature. Who can guarantee that these clubs are not merely cash cows to be milked and the fans are not being taken for a nasty ride? It is obvious to me that the foreign owners have had considerable sporting success AS WELL AS financial gains. I feel that it is high time for the British government or even the highest governing body FIFA to step and start regulating such transactions before things get worse.

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Lending Guidelines Change – The Future of 100% Financing, Sub-prime, and First-Time Homebuyers

You have likely seen the television news reports or have read the newspaper and know something about the demise of the sub-prime mortgage business.

By now, you, or someone you know, thought they were getting a mortgage, and then suddenly, without warning, were turned down for that loan, because the bank no longer offered that program.

You may have even seen “The Mortgage Lender Implode-O-Meter” that many of my colleagues have sent me on the website mortgageimplode.com.

You also know that this is being caused primarily by a record number of foreclosures as well as the highest percentage of people who are late on their mortgage in nearly four years.

As a result, nearly every mortgage lender in the country has dramatically changed its lending guidelines in the last 30 days, especially the sub-prime banks that decided to stay in business.

Many banks have made the decision to close. According to the Implode-O-Meter, this number is now at 39 as of today.

New Century, the third largest sub-prime lender in the U.S, is no longer accepting loan applications. They are on the verge of bankruptcy or closure, depending on the reports you read. Their stock, which had been at 51 in the past year, hit a low below 4. It dropped nearly 70% in one day.

You have probably dealt with Fremont and Aurora as well. Fremont is the second-largest independent U.S. mortgage lender. They recently closed their sub-prime division.

Aurora recently eliminated a very popular sub-prime program they had.

You may have even had a deal fall out of escrow because of it. The buyer, who was a slam dunk loan a month ago, today can’t qualify.

Why are these guidelines changing like this and so rapidly?

The mortgage business works like a river with a downhill stream. All of the water ends up in the same pool at the end of the river.

Nearly all mortgage loans originated everywhere end up being purchased by a handful of companies. This handful of companies purchase nearly all of the mortgage notes made in the U.S. These are large, institutional, Wall Street investment companies.

These investment companies buy mortgage notes because they have been highly profitable in the past few years. They were profitable because the market was vibrant. People made their payments on time and when they didn’t, they simply sold their property at a profit before they lost the home to foreclosure. Mortgage notes were lucrative and came with little risk.

The rewards were tremendous and nearly every large Wall Street institution from Morgan Stanley to Lehman Brothers to Goldman Sachs to Credit Suisse got in the game. Even General Motors owns two mortgage companies.

However, with foreclosure rates higher than ever and late payments also very high, these mortgages are no longer profitable for these Wall Street investors. In fact, they have become an albatross threatening to bring them down.

Sure, it’s great to own a $60,000 Note on a second mortgage where a guy pays you 11.000%. However, when he goes into default and you take back his home and he is upside down by $100,000 and you lose your entire $60,000 because you are in second position to the first mortgage note holder, it’s a first-class beating.

Some experts say these investors now potentially could lose billions of dollars. General Motors announced this week they are writing a $1 billion check to cover losses in their mortgage division. That’s billion with a “B.”

The biggest loser for these Wall Street investors has been sub-prime mortgage notes and second mortgage notes. Their research shows that these losses are mostly and directly related to first-time homebuyers and 100% financing.

So, these Wall Street investors have decided to fight back. They have collectively determined that second mortgage notes are the absolute riskiest and they are going to limit purchasing them. They have decided to only purchase the best notes. The ones with the least risk. The ones made to people who have some of their own money in the deal and/or only those with better credit.

They have determined that sub-prime notes are also not worth owning unless the borrower has a lot more of his own money in the property, so they are limiting buying those as well unless the borrower has a substantial down payment or a lot of equity on a refinance.

They have determined that notes for borrowers who state their income are far more likely to end up in foreclosure, so they are limiting those to only the better credit score borrowers.

They have determined that first-time homebuyers, without a down payment or a verifiable rental history or a very good credit score, are excessively risky, so they are limiting investing in those Notes as well.

So the mortgage companies that sell the Wall Street investors these Notes, including Countrywide, Option One, New Century, Fremont, Aurora, and nearly every other mortgage lender you or your broker deal with got put on notice from these Wall Street investors.

They were told, “Do business any way you deem necessary but just know that we no longer purchase risky notes, like those listed above.”

Without a place to sell these notes, these banks had to change their guidelines to only allow for notes they can sell and that’s where we are today.

OK, so what does this mean to you and me?

In the last few weeks, nearly all of the mortgage banks have eliminated stated income loan programs for credit scores under 660 that allow for 100% financing.

They want the buyers to have their own money in the deal as they believe that will make them less likely to be willing to lose their home.

If you do an 80/20 loan to cover 100% financing, the 20% second mortgage may be very difficult to obtain. It will be nearly impossible if your credit score is below 660 and you state your income.

If your credit score is less than 620, that makes you sub-prime to most lenders, so you will very likely need a minimum of a 5% down payment and probably more like 10-20%.

If you have to state your income, you should plan on at least a 5%-10% down payment if your credit score is not at least 660.

If you have to state your income, plan on a bank seriously considering your payment shock before approving you. Many new banking guidelines are limiting this to no more than two times your current payment. For example, if you pay $2000 today for your home or rental, it will be difficult, but not impossible, to find you a bank who will allow your new payment to be any higher than $4000.

If you are a first-time homebuyer, and you don’t rent from a professional management company, you should make sure you have cancelled checks to prove your last 12 month rental history and your credit score should be decent. If not, you are likely going to face a greater challenge and possibly a higher interest rate.

If your credit score is not at least 660, and you cannot fully disclose your income, you will find it very hard or very expensive to secure a 100% loan on a new home purchase or refinance.

When I say expensive, I mean if you are doing an 80/20 loan, and your credit score is not at least 660, and you have to state your income, plan on that last 20% costing you between 3-8% on that loan as a loan discount fee, if you can even find it.

If you buy a $300,000 house, and you are doing an 80/20, this means your first mortgage is $240,000 and your second mortgage is $60,000.

Based on these numbers, that second mortgage will cost you a discount fee between $1800 and $4800 just to get that second loan in additional closing costs.

Now this is still certainly less expensive than putting 5% down or $15,000 on this same home, but it does make it much more difficult for the first-time homebuyer and those with little to no money to put down.

Most banks limit seller contributions on 100% programs to 3% of the loan amount so those additional costs on the second mortgage will certainly mean you will need some cash out of pocket.

The sub-prime market, primarily for borrowers under 620 credit scores, is nearly dead today for higher loan to values. If you have between 5%-20% to put down, you should still be OK for now.

Here are some of the other things you can expect to see:

· The lighter your documentation (stated income, stated assets, etc), the higher your down payment and higher your rate.

· The lower your credit score, the higher your down payment, the higher your rate.

· More intense scrutiny from underwriters. They are being told to take their time and be extra careful about every loan they make. Many of them have been fired as a scapegoat for today’s high rate of delinquency. As they land at new companies, you can expect their lesson to be learned.

· The acceptable documentation needed for your loan will likely be more substantial and will need stronger third-party verification like income, employment, previous rental history, reserves, down payment, credit history and depth of credit including more and longer trade-lines.

· All investment loans will likely require 6-12 months in reserves.

· Plan on all loans requiring more reserves and tougher asset seasoning guidelines.

· Option ARM’s will likely only be available with more equity or much more down payment.

· Plan on loans costing your borrowers more on the front end. Banks are dramatically cutting back the Yield Spread Premiums and Rebates paid to brokers and bankers and they will likely pass some of this onto the borrower.

If you have been reading this newsletter for some time, you know that I am an OPTIMIST!!!!

So, what’s the good news here?

The GREAT news is that we still live in one of the most vibrant, incredible real estate markets in the HISTORY OF THE WORLD!!!

People are still moving here in droves and they are going to for many years to come.

In 1989, at the age of 23, I bought my first house. It was in South Shore, on West Lake Mead, at the base of a giant desert that was rumored to soon be a development called Summerlin. I was a first-time homebuyer. I made about $6/hr. working for a television station after graduating from college.

My soon-to-be wife and I found a house we loved for $136,000. That seemed like it was all the money in the world. It was at the time.

I got an 80% loan because that was all I could qualify for and I got a generous gift from my parents to help with the down payment. My interest rate was 12.000% and it was not interest-only.

How I made that payment each month was once featured on a segment of television show called “Unsolved Mysteries.”

The point is we found a way. Las Vegas exploded during those years, as it does today, with people “finding a way.”

There weren’t any interest-only’s or hybrid ARM’s or Option ARM’s or 100% financing for borrowers “one day out of BK.” You had a down payment or you didn’t get a house. You had decent credit or you rented until you could improve. Many lenders did FHA loans and nothing else.

Yet our city exploded. More so than any city in American history.

In my opinion, creative financing did not create the real estate explosion. The real estate explosion created creative financing. Wall Street wanted in and they did so by creating “something for everyone.”

I can remember the days, not that long ago, when I would do tons of FHA loans, that required 3% down payment, and loans that required mortgage insurance, and loans that didn’t go to Wall Street but went straight to “the agencies” like Fannie Mae and Freddie Mac and guess what? Those days are back.

Sure, it will take some time getting used to it and we will have to say “no” a few more times than we did in the past few years. We will talk to a lot more people, try and pre-qualify them, and then we will have to make that call all lenders hate to make. We will deliver the bad news that their dream of homeownership is not today. However, with some good guidance and solid consultation that dream should remain alive as someday it will happen.

And, yes, the timing is horrible when factored against what is already going on in the market with inflated inventory and fewer buyers, so sales and values will likely drop even further from previous years as a result.

However, and this is the important thing to remember, there will still be thousands of home sales each month and more sales here than in most other cities.

I was talking about this subject to one of my reps at one of the biggest mortgage investors in the U.S. He told me his company went through the archives and the lending guidelines are now very similar today to how they were in 2000.

In 2000, a 30-year fixed rate mortgage averaged 7.75%, yet it was the third-best performing year for home sales in the previous 37, according to the U.S. Census Bureau, and Clark County saw its population grow over 300% from 1990. Even with higher interest rates than today and similar lending guidelines, people were buying houses and getting loans.

One more item of optimism for you. 100% financing still exists and likely will exist for borrowers with credit scores over 620 if they can prove their income and 660 for those who state their income.

Please look at the chart below. This is the “National Distribution of FICO Scores” table as found on myfico.com. This breaks down Americans by their credit scores.

800+………….. 13%

750-799………. 27%

700-749………. 18%

650-699………. 15%

600-649………. 12%

550-599………. 8%

500-549………. 5%

under 499…….. 2%

As you can see, nearly six out of 10 have a 700 score or higher and nearly three out of every four Americans have a score 650 or higher. It doesn’t take much work for a seasoned mortgage professional to consult with a 650 on credit clean-up issues to get them over the 660 mark.

And, finally there are still those agency loans like FHA (loan limit now $304,000 in Clark County) and some very exciting Fannie Mae-backed loans that allow for 100% financing for borrowers with less than perfect credit and lower income and the rates are fantastic!

I just got a single mom, school teacher approved this week on 100% financing with a 626 credit score and a debt to income ratio of 55% with an interest rate of 6.000% for a 30 year fixed.

No, it’s not interest-only, and yes, she has to pay mortgage insurance, but last week she was an innocent victim of a Wall Street-backed bank that decided she was too risky. In the next two weeks she will be a proud first-time buyer with a home to raise her kids.

My incredible English professor, Mr. Harrington at Clark High School, once told me to always avoid clichés when writing.

But you know what? Where there’s a will, there’s a way. And, we, real estate professionals, will “will” our way through this, like we always do.

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How To Finance Multiple Investment Properties

Financing multiple properties

We have all heard phrases like; “Buy land, they are not making any more of it.” Own land, my son and you will never be poor.” “No man feels more of a man in the world if he has a bit of ground that he can call his own.”

These and many similar sayings are weaved into the character of every real estate investor inspiring each to go forth and nobly create a substantial portfolio of properties. Too over the top? OK, maybe you just want the income real estate can provide and realize that building a real estate portfolio can help you reach your financial goals.

As a real estate investor, I have seen firsthand the effects the new mortgage qualification rules set down by the banks are having on both the individual home buyer as well as the investor. Many lenders have further tightened their own guidelines, in turn making it extremely difficult for many investors to successfully grow their portfolios. (Many lenders have eliminated their rental property “products” while others have closed their doors altogether)

So what are the current financing options, what lenders are available and how do we “present” ourselves to potential lenders to get favorable results in order to buy our first rental property or add to our portfolios?

First, let’s address the lender presentation. When we can present ourselves (and our portfolios) professionally, we stand a better chance of getting more mortgage approvals. Many real estate investors do not have a proper “financing binder” and consequently have a tougher time with financing. You want to show any potential lender that you know how to run a legit real estate business.

A professional financing binder should include the following:

1. A copy of a recent credit bureau. You must know your credit score and you “standing” with your creditors before the lender does. Almost 50% of people who have not seen their credit bureau discover errors. These errors are usually from poor reporting on credit cards, loans or car lease accounts. In many cases the client has completed and fully paid an account (perhaps years prior) but the account has not been documented as a closed account. These issues are easily repaired by contacting the credit bureaus as well as the creditor. In the meantime that “open account” can be adversely affecting your credit score.

Go to Equifax or Transunion to “pull” your bureau. These companies provide your credit score at low cost (or free) and provide an historic outline with your creditors. There is no negative impact on your credit score if you pull your bureau 2 or 3 times a year (which I personally recommend).

Speaking of credit, it is wise when mortgage qualifying to reduce or better yet, eliminate credit card, line of credit and other debts. High credit card balances, leases, loans or credit lines can impede the qualifying process, as these debts are part of your overall debt service calculations.

2. Your last 2 years of Tax Returns). If you have existing income properties, make sure your accountant is properly reporting your rental income and expenses in the “Statement of Business Activities” section of the return. This gives a lender a realistic view of your business and indicates the income, expenses and write offs you are taking.

3. Your last 2 years of Notice of Assessments. (NOAs) It indicates whether there are still taxes owing to CRA and provides your (net) taxable income amount, which appears on line 150, both which are key to any lender.

Regarding your line 150… The result of a higher line 150 means we pay more tax, but it is better in terms of receiving more mortgage approvals, so this is clearly a double edged sword situation.

4. If you are self-employed, include a business registration or business license as a sole proprietor or Articles of Incorporation if a Provincial or federally incorporated company. If you T4 yourself from your company, include your recent T4s.

5. For salaried individuals, include your most recent paystubs and a Letter of Employment which includes your length of time with the company, your position and your annual salary.

6. Include statements for any non- real estate investments such as registered funds, stocks, mutual funds or insurance policies.

7. Include the latest mortgage statements from all the properties you own including your principal residence. These statements should include the current balance, interest rate, monthly payment and maturity date. It is also helpful for the lender to know the original purchase and original mortgage amount.

8. A current property tax statement or tax assessment is important to have for all properties.

9. If you hold any condo style properties, all up to date condo/strata documents such as minutes from the most recent Annual General Meeting (AGM), maintenance and engineering reports should be included.

10. A recent appraisal on your properties gives the lender an idea of the equity amount of your portfolio.

11. A net worth statement should give the lender a cross section of all income, assets, liabilities and expenses. Your assets may also include vehicles, precious metals as well as jewelry, furniture and art (providing it has real value… I’m not referring to your synthetic diamond earrings, Ikea couch or your black velvet Elvis painting… not that there’s anything wrong with these!)

12. Finally, you’ll need a section which outlines your properties. This should include pictures, all current leases, a list of repairs, a breakdown of chattels (if applicable) and a DCR or debt coverage ratio spreadsheet.

DCR is a calculation which equals a ratio that lenders consider (especially if you have multiple properties) for the purposes of understanding if your property or portfolio is “carrying” itself. Basically lenders want to see the ratio at 1.2% or higher (although some lenders only require 1.1%). What this means is the property is generating enough income to carry itself without the owner having to go into their own pocket to service the mortgage.

Once you have a well put together financing binder you increase your options as to the lenders you can go to and your chances for approval. That said, adding another mortgage to an already significant portfolio, even with a slick financing binder can still be challenging. It is entirely possible to exhaust the traditional ‘A’ lender’s risk tolerance, forcing investors to utilize alternative lending sources.

Most alternative lenders are less concerned with your personal financial situation and more concerned with their equity position in the property, often resulting in lower LTVs. You should be prepared for slightly higher rates, possible fees and shorter loan terms… usually 1 year. They are also concerned with the marketability of the property should they have to foreclose, so “geography” and current market activity are major factors in the approval process.

Loan of this nature can be accessed through mortgage brokers who have relationships with “Alt A” or “B” lenders, private individuals/estates and Mortgage Investment Corporations (MICs). Let’s break these lending sources down for clarity.

An “Alt A” or “B” lender can be owned or a subsidiary company of an “A” lender (although as of this writing, many of the A lenders have closed these divisions). Other alternative sources are trust companies and credit unions. Many of these institutions have both A and B lending divisions. Because many of these lenders are regionally based, they are often more favorable to purchases in smaller communities where many national “A” lenders are hesitant.

Private individuals or estates which are often represented by a lawyer can be excellent sources for financing. These sources often lend their own money or pooled money from a few investors. They each have their own guidelines as to the loan amounts, types of properties and geographical areas they are comfortable with. Some of these sources advertise locally but are commonly known to well-connected mortgage brokers.

The other alternative source which I am quite familiar with is Mortgage Investment Corporations (MICs). These entities are relatively unknown to many mortgage brokers and investors alike depending on where in Canada you are located. MICs came on the lending scene in the 80s but have gained significant momentum as of late, making their presence known initially in single/multi-residential properties, with some MICs lending to development projects and commercial properties.

MICs are governed by the Income Tax Act (Section 130.1: Salient Rules) and must operate in a fashion which is similar to a bank. In a nutshell, MICs get their mortgage funds through a pooled source of investors; the MIC then carefully lends the money out on first and/or second mortgages. The investors/shareholders make a return on their investment and mitigate their risk by being invested into many mortgages. MICs may also own properties like single for multifamily homes, apartments, commercial buildings and even hotels. All of the net income is returned to the investor/shareholders often on a quarterly or annual basis. MICs can also use leverage similar to a bank. (For more info on MICs, refer to my article entitled “Optimizing MICs” in the March 2011 issue of this magazine)

As stated previously, many of the above institutions may only lend 65% or 75% loan to value which can often fall short of the required amount needed. This is where you can enlist a combination of lenders. Using an “A” lender or any other lender for a 1st mortgage and getting a 2nd with another lender at a higher LTV is possible. Some lenders will offer both a 1st and a 2nd with different rates.

Other financing challenges may stem from the property itself. Lenders have become increasingly more concerned with the property’s age, condition and usage. Lenders want to make sure your properties are well maintained and the units are safe.

Remember, lenders are always concerned about the implications of resale should they have to foreclose, so a well maintained and well located the property is easier to finance and to market… which is good for the investor as well.

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