"Your investment is secured by California real estate. And you know how valuable that is."
These days, those words catch like alkaline dust in the throats of some of the hundreds of investors, ranging from the very well off to those of limited means, who have been left scrambling in the wake of the company's closure last month.
Through the media attention it has garnered, however, the company's demise has shined light on a little-understood segment of the development food chain that's based on the dual promises of double-digit returns for investors and few-questions-asked loans for developers.
The hard-money game
A "hard money" loan--some call it a trust deed loan--means there's something tangible backing it: land, in most cases. Because of the loans' very structure, the providers don't consider the buyer's ability to repay them. That simply isn't a factor. Rather, the idea is that, if the asset is foreclosed on, the investors should be able to recover all or most of their money.
That isn't always true, however. In some cases, the project remains unbuilt--funds may have been spent on permits and reviews, but not actual construction. In other cases, the project was begun and abandoned when the market turned and the numbers no longer worked out.
"Sticks in the air" is the term most of the people interviewed for
- PHOTO BY STEVE E. MILLER
- BUILDING TENSION : Investors have put an estimated $3 million into this Atascadero property and feel that they have little to show for it. 21st Century Mortgage Co. owner Linda Kennedy said that, even to get a property to this point requires a lot of money and effort.
Here's an example of how the process works--or, sometimes, doesn't.
Say a builder hopes to buy a $400,000 piece of property, spend $600,000 on construction, and sell a high-end home for $1.4 million.
The lender would appraise the property and then seek out investors to fund the $1 million it would take to complete the project. The builder might pay, say, 15 percent or $150,000 over a one-year period for the loan. The lender would pass on $120,000 to investors--a 12 percent return--and keep the rest in fees.
That's what would happen if the original estimate was correct, and in recent years, investors and developers alike have made big money as real estate values rose and the market was hot.
But there are myriad ways things can go wrong, especially in a bad market.
That same builder might, for example, find that the combination of slumping prices, the amount of time it would take to sell the property, and delays in permitting might leave it questionable that there'd be any profit left at the end of a project.
And, unless the developer has deep pockets--and many of those who resort to the high interest rates of hard-money loans do not--the incentive for the speculating developer is to walk away and allow the process to head to foreclosure.
Don Vaughn has been visiting plenty of 21st Century properties lately. Vaughn is president of All American Foreclosure service and someone who has been involved in the local hard-money lending business for decades.
Part of his job is to post notices on properties being foreclosed on. Too often recently, he said, he's found himself at 21st Century properties and found no building there to speak of.
"You don't expect to see an unfinished house or no house," he said. "That's a bad sign."
He said the company has been involved in perhaps 10 percent of the foreclosures he's worked on in recent months--far more than other hard-money lenders.
He said the key to success in the industry is how strictly lenders oversee the spending of their builder-borrowers.
"The dirty little secret of this industry is that builders don't have to put one penny of their own money into these projects," he said.
Overseeing builders is one area in which he believes 21st Century fell short.
"The big question for us is, what did they do with the money?" asked Paso Robles businesswoman Jean Cross.
- PHOTO BY STEVE E. MILLER
- SIGN OF TROUBLE: : This crumpled and discarded 21st Century Mortgage sign was in a trash pile at the site of BR302, a now-abandoned project in the middle of a Sycamore-lined Atascadero neighborhood.
# For the past two years, Cross has been making monthly trips to BR302. That's the shorthand 21st Century used to describe what was to be a project of six duplexes on three Atascadero city lots. Cross is one of about 40 investors who have sunk an estimated $3 million into the project.
But Cross said that in all that time she's seen almost no evidence of progress. The lots remain simply dirt, with electrical and plumbing fixtures sticking out of pipes in the ground--"pipes up" in the lingo of the trade.
Now BR302 is in the foreclosure process and Cross said she can't get the developer or 21st Century owner Linda Kennedy to return her calls. And Cross said she doesn't have access to the files that would presumably say where, exactly, the money went.
For her part, Cross suspects foul play and has filed a complaint with Paso Robles police. The matter has since been referred to county investigators, but the SLO County D.A.'s office couldn't comment on the state of it.
Whatever the result of that effort, Cross is also trying to organize her fellow investors to recoup at least part of their money. Under her contract, if investors who own 51 percent of the value of a project get together, they can take over control of a project. That's her intent. But what, exactly, are they supposed to do then?
Options would range from finding a new developer to take over construction of the project, to developing it themselves--a step that would include attaining permits, hiring subcontractors, and in all practical respects entering the contractor market themselves. They could also sell the property as is, likely at a significant loss.
"We don't even have all the permits we need," Cross sighed.
Cross is an experienced businesswoman and is careful with her words when it comes to what she thinks has happened to her project and 21st Century.
"Under the best of circumstances, it appears to be mismanaged," she said.
21st Century owner Linda Kennedy said that what happened to her business was a direct result of the broader downturn in the market rather than a reflection of any lax management on her part.
In a phone interview with her lawyer on the line, she said that
- PHOTO BY STEVE E. MILLER
- INTERESTED IN HALF A HOUSE? : Work has stopped on this half-finished Paso Robles house. It's one of dozens financed through 21st Century and other hard-money lenders that are now in the foreclosure process.
Before then, she said she'd been in the hard money business nearly five years and owned the business for another five beyond that.
"My income stream tightened to the point where I could no longer meet my payroll," she said.
As for Cross' concerns, Kennedy said police haven't indicated they are investigating her, and said the dispute with Cross rose out of a dispute about a foreclosure.
She said BR302 was delayed repeatedly by city processes and allowed that "it may not look like much, but even to get to that point it does take a lot of money and effort."
Kennedy said that if she hasn't been returning calls, it's because she's been working to find a home for all of the loan files. And she said she's nearly finished doing so.
Finally, as to the idea that hard-money lending--without requiring money down--lends itself to letting builders walk away from projects, she said that can happen in any kind of lending.
She emphasized that lenders around the country are suffering from the effects of the down market and stressed that other hard-money lenders have as many foreclosures as she did.
Hundreds of others
In a way, the other investors on BR302 are lucky. In her own words, Cross has the "energy and commitment" to organize investors and try to recoup at least some of their money.
But 21st Century had about 100 projects running at the time of its closure, and not all of them have such a savior.
Many of the projects are being taken over by other hard-money lenders. Some have found leaders like Cross. Many, for now anyway, are leaderless.
But whatever is happening, it's clear many of the investors have little understanding of what's happening with their funds.
New Times talked to numerous investors in various 21st Century properties for this story, and many expressed confusion about what they're supposed to do now.
In some cases, they knew only that interest checks had stopped coming. In others, they knew that their particular project was in the foreclosure process but didn't know what that would mean for them. One told New Times that he'd invested money from a senior center in the project, and then asked that his name not be used in an article.
Jerry Holland is another one of those saviors working to pick up the pieces for other investors. The San Luis Obispo real estate agent has taken over control of four projects that he, his business partner, and his brother had invested money in. He was working on taking over a fifth.
Although he's heard plenty of rumors about 21st Century's troubles, he dismisses most of them.
"I don't think there was any embezzling so to speak of, but there could have been some mishandling or sloppy bookkeeping," he said. "They had a lot of money."
The way he sees things, there's blame to lay around all sides of the 21st Century closur--including on the investors themselves.
"Any stock broker will tell you: Don't put more in than you can afford to lose," he said.
By many accounts, some of the investors weren't following that advice. One man told Holland that he was so attracted by the promise of making 12 percent per year on his investment that he took out a second mortgage on his home, at above 6 percent, to invest more.
"When that guy told me that, I just got kind of sick to my stomach," Holland said.
In Holland's words, this type of investing is a "an awful big man's game," though it's clear that 21st Century and other hard-money lenders also routinely seek out smaller fish.
Radio ads and television ads by other lenders are less frequent today then they were months ago, but they're still prominent, encouraging the general public to enter the hard-money game with bombproof-sounding brochures and initial investments as low as $3,000.
They told us so
The troubles in the hard-money lending business are no different from those in the industry at large. Just as the boom was fueled in large part by no-interest loans and no-money-down loans that allowed people to buy homes they couldn't afford, the bust is being fueled by the aftermath.
Each market differs slightly, but across the county and statewide, foreclosures have spiked, home sales have slumped, and prices have fallen--particularly at the lower end of the market where sellers can't afford to wait out the slump.
Not unlike Statler and Waldorf's running critique of the Muppets' performance, the local market's downturn has been predicted and chronicled by a small but verbose group of anonymous commentators who frequent a blog called "The Central Coast Housing Bubble."
For perhaps six months before local media or experts were publicly acknowledging the troubled indicators that spelled bad times for the local market, the commentators were dissecting area MLS statistics and foreclosure numbers as if they were frames of the Zapruder film.
The leader of the group calls himself SLOBear. He doesn't want to be identified, but bills himself as "a hardworking professional" who "became sick of the gloating and fraud during the real estate boom." On the blog and in e-mails, SLOBear has periodically prodded and chastised local media for covering up, screwing up, or simply missing some of the tales of market troubles.
One of the most prominent plot twists in that storyline is last spring's closure of Alan Little Custom Homes.
Little was a well-known builder of high-end homes, many of them with ocean views. At some point, however, Little moved beyond building custom homes to building homes on spec, and for that he took out loans through 21st Century Mortgage.
When Little's business went under in a maze of lawsuits and foreclosures, 21st Century was left with a lot of unhappy investors who were no longer receiving interest payments on $11 million worth of loans. Kennedy said that didn't necessarily cause her company's downfall, but it was the first in a series of defaults that made it impossible to pay employees and investors.
She'd do it again
Shirley Moen is an investor in several projects that 21st Century put together.
Like others, she said she's concerned about the way her own projects were managed, noting "very unorthodox activities toward the end."
But she remains a stalwart defender of the industry--perhaps because she used to work for a different hard-money lender.
To her way of thinking, foreclosures happen and recessions come and go, but a well-run private lending business should be able to continue to operate. She said she won't stop investing in hard-money loans.
"It's a risky business or they wouldn't be paying that kind of interest," she emphasized. "The problem is if you get people who are totally dependant on this income, it can be devastating, because they don't realize that the payments could stop."
Managing Editor Patrick Howe can be reached at firstname.lastname@example.org.