JF1666: Loan Purchasing & Loan Servicing | Real Estate Note Investing with DeAnn O’Donovan
There are alot of note investors, both performing and non-performing. DeAnn is here to tell us more information on the strategy. We’ll hear what to look for both good and bad, and also how to know what the worst case scenario is. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!
Best Ever Tweet: “Don’t fall in love with your deal, every time I see someone do this, they make a mistake” – DeAnn O’Donovan
DeAnn O’Donovan Real Estate Background:
- President & CEO of AHP Servicing
- Has over 25 years of experience in real estate, financial services, asset management, mortgage lending, and residential loan servicing
- Based in Chicago, IL
- Say hi to her at https://ahpservicing.com/ or ceoATahpservicing.com
- Best Ever Book: The Alchemist
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Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I’m Joe Fairless, and this is the world’s longest-running daily real estate investing podcast. We only talk about the best advice ever, we don’t get into any of that fluffy stuff. With us today, Deann O’Donovan. How are you doing, Deann?
Deann O’Donovan: I’m great, Joe. Glad to be here with you and your Best Ever listeners.
Joe Fairless: Yeah, nice to have you on the show. A little bit about Deann – she is the president and CEO of AHP Servicing; she’s got over 25 years of experience in real estate, financial services, asset management, mortgage lending and residential loan servicing. Based in the Windy City, Illinois. With that being said, Deann, do you wanna give the Best Ever listeners a little bit more about your background and your current focus?
Deann O’Donovan: Absolutely. In terms of my background, I started out in acquisitions, working for a public real estate investment trust, so I got great experience early on in how to underwrite, and analyze, and close a deal. Then I also went to work in 2008 for a regional bank, and got some great workout experience there. A lot of experience running acquisition teams, as well as workout teams. I joined AHP Servicing about a year ago.
We are a socially-responsible investment company, so we’re crowd-funded. Somebody can invest in our fund, and the money that we raise we then use to buy non-performing notes. So it’s an alternative real estate play in this particular role. Then we work with the homeowners to try to reposition that debt and either settle the debt with them, or modify it.
Joe Fairless: And Jorge Newbery was the founder of AHP?
Deann O’Donovan: Jorge Newbery was the founder of American Homeowner Preservation (AHP), and that company was founded in 2008, at the height of the great recession. Last year he recruited me and moved into a chairman role, and then we started AHP Servicing to bring the servicing of our loans in-house. So we now have kind of two books of business, if you will. We’ve got the loan purchase and sale business, and then we’ve also just opened our doors to servicing for third-parties, as well as servicing our own loans.
Joe Fairless: Oh, okay. Got it. Well, Best Ever listeners, you can search “Jorge Newbery Joe Fairless” and you’ll hear Jorge on a couple episodes.
Deann, when you started in acquisitions, working for a REIT, and you said you learned how to underwrite, analyze and close a deal – what are some takeaways you got from that experience in terms of underwriting and analyzing deals?
Deann O’Donovan: That’s such a great question. What I would say is don’t fall in love with your deal. Every time I see somebody do this, they end up making mistakes, because they ignore warning signs, whether that’s the state of the market that we’re in, or the counterparties, or the financial numbers… So I think that’s really critical.
I would also say make sure you’re doing a sensitivity analysis on your proforma or financial underwriting, so that you give yourself some cushion in the deal. Everything doesn’t go right; it’s very easy to have the perfect deal on paper, it’s much harder to have the perfect deal in reality, so make sure that you give yourself that vacancy reserve, cap-ex reserve, and stress-test your own assumptions.
Joe Fairless: I’ve seen all sorts of sensitivity analysis… What are some main components – and you might have mentioned a couple already just now… But what are some main components that a sensitivity analysis should include?
Deann O’Donovan: I definitely think you need to build in a vacancy reserve, a cap-ex reserve… If I’m underwriting a commercial deal, I’m also gonna typically take it out three years and make assumptions on staffing costs, and operating expenses, and increases on the revenue side, and rents, ancillary income, so that I’m really seeing if things go well, what does it look like, and if things go bad, what does it look like… And making sure that I know what the operating margin is gonna be in all of the situations, and what my cushion is on my debt service coverage.
Joe Fairless: On the “if things go bad, what will it look like” how do you know how bad to make the scenario? Because clearly, if it’s an apartment building, for example, and it’s 100 units, if you make it 90%, then that’s bad, and the deal is not gonna work… So I imagine there’s a balance or a line that you walk where it’s like “Okay, this is how it would go bad, but that’s probably not gonna happen, so we still should proceed”, but… I know I have this bad scenario in the back of my mind, so how do you reconcile that?
Deann O’Donovan: You’re right, that is very specific on the asset class. If I was doing a multifamily deal, I would probably be looking at “Okay, what happened in the last recession? How long were things vacant for in my market, and what did I have to do to adjust the rents in order to fill those units?” Because I think that if you look back to that last recession, chances are we’re not gonna have one in our lifetime that’s worse than that, so that to me would be your absolute worst-case scenario.
Then from there I’d back off it a little bit and say “Okay, what do I actually think it’s gonna happen in the next 3-5 years?” The predictions are we’re gonna have a recession in 2020, but what do we think that’s gonna look like? What do I think interest rates are gonna be? How long is my debt? So then you can kind of back-fill what factors for my particular deal have variability that I need to understand that risk for, and make sure I’m comfortable taking that level of risk.
Joe Fairless: In 2008 you went to work for a regional bank, and you got, as you call it, “workout experience.” As someone who isn’t in the lending industry full-time – but I work with lenders, obviously – you’re talking about working out loans when people are behind, so you’re figuring out how do you work out the scenario so they don’t default and you don’t have to foreclose on them… Is that correct?
Deann O’Donovan: Yes and no. The company I worked for was Wintrust, they’re a regional bank – and they acquired a lot of other failed banks from the FDIC… So they hired me after they acquired the largest bank failure in Illinois history; it was a company called [unintelligible [00:08:10].10] It was a billion-dollar portfolio.
Joe Fairless: Wow.
Deann O’Donovan: And I’ll tell you, in the first 90 days on the job I wrote off probably 15 million dollars, or more.
Joe Fairless: What do you mean wrote off 15 million?
Deann O’Donovan: I’ll give you an example – there was one deal I was looking at where it had already defaulted, and when I took a look at the underlying security, that collateral for the loan, it was not a real estate deal; in this case the collateral was virtually worthless. It was worth maybe ten cents on the dollar… So then you really have to get creative.
Joe Fairless: Keeping whatever privacy you need to keep, but what could that be, that they initially used as collateral, that was perceived to be worth so much on a large loan, but then was worth ten cents on the dollar?
Deann O’Donovan: So in this particular deal that I’m thinking about it was a bundle of life insurance policies, and they had done an actuarial analysis basically, like the life insurance policies, the beneficiary benefit had been assigned to this company, and they had done an actuarial analysis on basically when are people supposed to die, and that actuarial analysis was incorrect, and there were a whole host of other things; they hadn’t collateralized it right… And the reason I think that’s such a great example is it was a very clear example of people closing on a deal where they did not understand the deal.
They didn’t have sufficient knowledge of the industry, they didn’t have sufficient understanding of what happens when that deal goes bad, how do you fix it, and what do I really have to collateralize that loan? I think that’s relevant to any industry, but it’s especially relevant to real estate; when people are moving into a new class, you’re dealing with different counterparties, or maybe a different lender for the first time – you really need to understand how that deal is put together and how that deal could unwind, and what you’re gonna do if something goes bad.
Joe Fairless: What an experience… First 90 days on te job. You started out quick. Did you know that was what you were getting into? It’s 2008, so I imagine you knew the sky was falling, so that’s probably what you were gonna be focused on when you got hired there…
Deann O’Donovan: I did. I did know that the sky was falling, and previously when I’d worked for a REIT, I had done large public company bankruptcy work and restructuring, so if we had a large tenant that went bankrupt, I would be the one working with our attorneys to figure out how do we restructure it, how do we rewrite the leases, what collateral do we need, what kind of margin do we want [unintelligible [00:10:42].13] or whatever it may be… So that was a very helpful experience. But taking on a massive portfolio of primarily defaulted or near-default, primarily commercial real estate, but also consumer debt and C&I deals… It was a lot of fun, I loved it, but it was a lot of balls in the air.
Joe Fairless: Oh yeah, I bet that was an intense job.
Deann O’Donovan: Yeah. And I would say you learn so much more by working at somebody else’s bad deal than you’re ever gonna learn doing a deal yourself on the front-end… Because you see everybody’s mistakes. I used to tell the guys on the team that were younger “You’re gonna be an amazing underwriting, and you’re gonna be amazing at putting new deals together when the market turns, because you’ve learned from all of these mistakes that these other lenders made over the last ten years.” That’s amazing experience.
Joe Fairless: What are some mistakes you’ve seen that you’ve taken lesson from, that you can share with us?
Deann O’Donovan: Well, I was thinking about that in advance of this podcast, because I think you ask really probing questions, which I very much appreciated… And one of the things that I think I’ve learned is the more you can figure out for yourself what your drivers are, the more you’re gonna figure out why you like the real estate business, and why do you like it part-time or why do you like it full-time.
For me, the reason I love it is I’m a builder; I love putting deals together, I love building teams, I love doing new business, I’ve launched a lot of new product lines, moved companies into new lending areas… And one of the appeals for me about AHP Servicing was, frankly, taking a company that had a small book of business on the loan trading side, and then this new business that they were starting up on the servicing side… For me, that’s a blast. But for a lot of people, the knowledge that they’re gonna be working 60 or 80 hours a week and there are all these systems to put in place is overwhelming and disheartening, but for me that’s what gets me up in the morning. So the more you can figure out what gets you up in the morning and how does that relate to what you do professionally, and how do you want it to relate to what you do professionally, then it becomes play that you get paid for. Not that you’re not working hard, because I work very hard, but you’re passionate about it, and that makes all the difference. So I think that’s one thing.
Then I think the other thing is being intentional about who you’re doing business with, and making sure that you’re doing business with people that you can trust and people that you respect.
Joe Fairless: Any tips on qualifying those individuals in advance of doing business with them?
Deann O’Donovan: I’m a big believer in references and test drives. So if I’m looking at a new vendor, for example, we have a really robust due diligence process, especially for critical vendors. That includes talking with references and other clients, because you learn so much more in a five-minute conversation than you’re gonna learn by going through their annual report and their [unintelligible [00:13:41].02] Not that you don’t need to do that, but you do need to also talk to people who have done business with them, so that you make sure that you’ve got that DNA alignment between the organizations. And I’ll tell you, that served me incredibly well in my career.
As I’ve moved jobs, I’ve had co-workers and employees that have worked for me who have said “I wanna go where you’re going”, and I’ve also had attorneys and other vendors that when I know I need somebody, that’s the person I’m gonna call, because I’ve got that 5-year, 10-year, 15-year trusting relationship with, and I know they’re gonna give me a straight answer.
Joe Fairless: What’s been the main challenge as CEO of AHP Servicing?
Deann O’Donovan: I would say the main challenge was doing everything all at once. In my first 90 days at the job I had four different systems implementations or conversions I was working on, I was hiring a management team, I was closing out a fund, I was putting systems in place, and understanding the processes, and taking the reins over from Jorge, and picking up the relationships that he had developed over a decade… So when I would put my company project list together, I kid you not, it was five pages long.
So prioritizing those things and making sure that they’re all not just getting done, but getting done well, and being done in a way that’s going to create the infrastructure to take the company from 5 to 10 million, to 15 million, to 100 million, makes a really big difference… Because once you’ve got that infrastructure and that scale, and people understand how the company runs and you’ve defined that company culture, it will be much easier to take this company from 15 million to 500 million.
Joe Fairless: When you have that five pages long list of things and you’re going about prioritizing them, what type of thought process or system do you use to do that prioritization?
Deann O’Donovan: What’s the most critical, what order do things need to happen in? Then once they’ve happened, what do we need to go back and back-test? What kind of people do I need to hire that I can delegate some of these things to, and trust that they’re gonna keep them running? How much autonomy do I give them, and then how do I check back in a way that feels good for them, rather than them feeling like I’m checking their work, where it’s truly collaborative? I think that’s incredibly important as well. I’m a big believer in collaborative companies. So I’d say those are some of the key things.
Joe Fairless: Just as a refresher for Best Ever listeners on AHP – will you just give everyone a refresher on what you all do? I know you’ve briefly mentioned it earlier, but it’s a very cool concept, that I think is a win/win for everyone. I’d just love to talk about that a little bit.
Deann O’Donovan: We actually internally have crafted a business model that I refer to as a win/win/win/win…
Joe Fairless: Oh, okay. There’s an Office episode on that, where Michael Scott resolves conflict between two co-workers and he tries to get win/win/win/win scenarios…
Deann O’Donovan: Oh my gosh, I just saw that a few weeks ago! That was pretty funny.
Joe Fairless: Yeah, yeah… [laughs]
Deann O’Donovan: So to answer your first question, what we do is we do a series of funds – we have a current fund open right now, and it’s open to both accredited and non-accredited investors. They can invest in our offering for as little as $100. We then use the money that we get from that offering to go out and purchase defaulted loans. Then we work with the borrower to try to come up with a cooperative solution to their past due payment status. If they’d like to keep the loan, we’ll modify it, reduce the principal, reduce their monthly payments, and make it affordable for them, so that they can stay in their home.
If they’ve already vacated the property or they would like to get out from under the debt, if the title is relatively clean, we’ll take a deed in lieu of foreclosure, we’ll bring that underlying collateral into our portfolio as real estate owned, and then we’ll sell it. We underwrite those loans on the frontend, so that we have a pretty good idea of if we have to take that asset back, what it’s worth and what we’ll be able to sell it for.
Then the win/win/win that I was talking about, our philosophy is we are socially responsible, so we’re trying to create funds that are good for our investors, so our investors get a return of up to 10%. We’re trying to create solutions that are good for our borrowers, where they get to modify or settle their debt, and hopefully go on to rebuild their credit and have a good life. We’re trying to do something that’s good for our communities, because nobody wants a vacant, moldering, decaying property sitting next door while it’s going through a two-year foreclosure process, right? That’s terrible for the community. It invites drugs, it invites vandalism… It’s just awful.
And then finally, we’re trying to create a company culture that’s good for our employees, who really come to work knowing that what they do matters in somebody else’s life.
Joe Fairless: Yeah, I was waiting for the employees to be part of it, and if they weren’t, I was gonna add another win to your win/win/win/win… But you got it covered, so… Four wins.
What is your best real estate investing advice ever?
Deann O’Donovan: I think my best real estate investing advice gets back to what we were talking about earlier, which is be deliberate and don’t fall in love with your deal. Sometimes the best deal is the one that you never do.
What I say to folks here is you have got to be willing to walk away from the deal if it no longer makes sense. We just had a situation at the end of the year where we did that. Somebody tried to cram us down literally on December 31st, and I was like “Not gonna happen. Sorry, guys. If you change your minds, let me know.”
Joe Fairless: What were some specifics on that that you can share?
Deann O’Donovan: They wanted to capture the upside after we completed our due diligence, without crediting us for the downside, where some of the loans were significantly less than they had indicated that they were worth… So they sort of wanted to have their cake and eat it too, and we said “That’s not how we underwrite, that’s not how anybody underwrites in this business. If you can get your deals done that way – God bless, go do it, but we’re not gonna close and we’re not gonna be pressured to make that deal at year end.” They ended up coming back a week later; we just closed it, and I think we got to a place that was good for them and good for us… But you have to be willing to say no.
We had spent probably 40k or 50k in due diligence, so…
Joe Fairless: Wow!
Deann O’Donovan: But I’d rather not do a deal and eat that cost than do a bad deal that I spend 18 months regretting after I close.
Joe Fairless: Right. Where does that cost go, that 40k-50k in due diligence prior to making the transaction happen?
Deann O’Donovan: When we’re buying a loan, we’re ordering basically three pieces of due diligence from third parties. One is a broker’s price opinion (BPO). That lets us value the underlying collateral, and we need to do that to make sure that we’re buying the debt at the right level, so that we’ve got a cushion there.
Then we order a title report and we take a very forensic look at the title to make sure that if there are any gaps in title, we can complete that curative work… Because the last thing you wanna do is buy a loan and then find out that you can’t foreclose or you can’t take a deed, or you can’t modify it because somewhere there was a break in the title, so you can’t prove clean ownership.
Then we also order a tax report, so that we can see if there are any due taxes, because those are typically credited against your purchase price when you close.
Joe Fairless: Okay.
Deann O’Donovan: So if you’ve got a big deal – let’s say that’s $300 a loan, all-in (I’m rounding up there), if you’re doing that for every loan and it’s a big enough deal, those dollars add up.
Joe Fairless: Got it. We’re gonna do a lightning round. Are you ready for the Best Ever Lightning Round?
Deann O’Donovan: I am ready!
Joe Fairless: Alright, then let’s do it. First, a quick word from our Best Ever partners.
Joe Fairless: Okay, best ever book you’ve recently read?
Deann O’Donovan: I would say The Alchemist, by Paulo Coelho. I go back and read that every couple of years.
Joe Fairless: Why every couple of years?
Deann O’Donovan: Because I think you get different things out of it. It’s a very simple story, it’s a quick read, but it’s kind of a classic hero’s quest story about finding your destiny… So it’s something that not only have I come back to, but I’ve given that book to more people as gifts over the years than probably any other book.
Joe Fairless: Best ever transaction you’ve been a part of?
Deann O’Donovan: Well, I would say maybe the deal that we just closed that I was referencing… Not because it’s the best deal that I’ve ever done, but I think it was — I’m training a couple of new traders right now, and I think it was the best deal that they’re going to see in terms of the discipline and the other things that we’ve been talking about.
Joe Fairless: Yeah, a case study in real life, and they’re working through it.
Deann O’Donovan: Exactly.
Joe Fairless: What’s a mistake you’ve made on a transaction?
Deann O’Donovan: A mistake on a transaction… Well, I think getting pretty far down the line on a deal with a new counterparty, and then discovering that they’re just not reputable in terms of how they do their deals. One of the things that I feel very strongly about is I do not retrade my deals. If I tell you I’m going to buy something from you, I am going to buy something under the terms that I agreed to… So for me that’s a really big pet peeve when somebody–
Joe Fairless: [laughs] Do you invest personally in real estate?
Deann O’Donovan: I do, but in a small way. I’ve got some single-family rentals, but they’re all passive. I’m so busy with my day job… I would love to have time to do some multifamily or other asset classes, but right now…
Joe Fairless: You’ve got your hands full. The reason why I ask that is in your personal investments when you agree to buy it for X, I’m sure during due diligence something comes up. Something must come up, where it’s like “Wait a second…” They weren’t being dishonest, it’s just due diligence, inspector reports, something comes up… So in that scenario, did you just say “Hey, I’m gonna agree on the initial price, all good” or did you go back and say “Let’s knock it down a little bit” or did you just say “I’m not buying it.”
Deann O’Donovan: If there’s something material that comes up on due diligence – absolutely; I think it’s appropriate to go back to the table. When I say “retrade”, I’m really talking about somebody who when it gets to the finish line there’s no communication along the way, and then suddenly they’re like “Well, I’m not gonna close unless I get X and Y in addition to what we agreed on”, or they try to knock the price down without having a justifiable reason for doing that.
Joe Fairless: Okay.
Deann O’Donovan: I view that as distinct. The whole reason you do your due diligence is to see “Did I price it right?”
Joe Fairless: Best ever way you like to give back?
Deann O’Donovan: Really through AHP Servicing. I love the business model, it’s one of the reasons I joined the company, and it feels amazing to go to work knowing that you’re doing a good thing.
Joe Fairless: How can the Best Ever listeners learn more about what you all are up to?
Deann O’Donovan: They can connect to me directly at firstname.lastname@example.org. They can check us out online on our website at www.ahpservicing.com, or they can give us a call at 866-ahp-team.
Joe Fairless: Well, thank you so much for being on the show, Deann. I really enjoyed our conversation, from the lessons you learned starting out, working for a REIT on underwriting and analyzing deals, to the regional bank that you worked at, and the example of when you talked about the first 90 days, and you wrote off 15 million dollars or more, and discussing that… As well as, obviously, what you and your team are doing now at AHP. Certainly a win/win/win/win scenario with your business model.
I really enjoyed our conversation, great catching up. I hope you have a best ever day, and we’ll talk to you soon.
Deann O’Donovan: Thanks so much, Joe. I enjoyed it as well.