Aaron Norris is joined this week by Nema Daghbandan. The Norris Group is back this week after taking a break for I Survived Real Estate. Aaron thanked everyone who helped them raise over $70,000. Next year, they are going to hit the $1 million mark. September 18th, 2020 is when year 13 will happen and when they will raise a million bucks. Nema is in charge of the real estate finance group there, and he is a partner with the law firm. His practice entails all facets of lending matters across the country. He advises financial institutions on various lending matters, including licensing, usury and foreclosures, which he just helped Aaron with a couple of weeks ago. He is also an expert in default management and leads the firm’s non-judicial trustee group. He got his degree from Miami School of Law; and then before that, his undergrad was at UC Irvine in Political Science.
- What does it take to be a private lender today?
- How do regulations vary from state to state?
- How did the Jobs Act impact their industry?
- What are the primary reasons people are giving for wanting to leave California?
- How did he help squash regulations he knew were going to be bad for the industry?
- How difficult is it to get a license in states like Florida or California?
- What new regulation is happening in New York that would tax flippers?
Aaron actually received his MBA at the same school back in 2009, so Nema was happy to hear him say “Go anteaters.” Aaron thought it was a strange animal choice, although the rallying cry was even weirder. Aaron asked Nema how he went from political science into law, specifically his very interesting niche of law? Nema said the earlier part of his life was with him stumbling into things, and he felt like he had not lived a particularly intentional life. He graduated from UCI, and his older brother is a district attorney. It seemed like the natural progression of going to law school because he didn’t think that a career in arguing politics would get him very far. He applied to law school and grew up in Orange County for most of his life. He went to UCI for his undergrad and really wanted to try to venture outside his little 25-mile square niche for a little bit.
He went to the University of Miami, and as soon as he got to Miami, he realized he very much wanted to practice law and have his career back. At the time, he was reaching back out to his brother, told him he needed a job, and he would even work for free. He just needed a job back in California and asked him to talk to anybody he knew who practices. He happened to be playing poker with the man who would later become his business partner along with one of his other friends. He told them his brother was looking for an internship and asked the guys there if they were looking. His friend Anthony, now Nema’s business partner, told him to come work for him and he would pay him. At that time, Nema was a first-year law student, elated at the concept of making any money. He ended up working with Anthony during his very first summer in law school, and he was hooked. He had no idea what private lending was. He always had an interest in real estate and had taken the courses while he was in college, but he never went down that pathway. He always had an inclination and always really loved finance, so the merger between real estate and finance was awesome. He vividly remembered that first summer wanting to do it. When he graduated from law school, he went right back to Anthony and told him he would love to work with him. He has not looked back since then.
When Aaron started with his company back in 2005, it was right before the downturn. They were working on a report called the California Crash and warning all of their investors it was time to get out of dodge. They started winding down the number of loans that they were doing. Being very careful in the industry has just changed so much. Dodd-Frank came out several years later after the downturn. The fact that he covers private money, the private money space nationwide would seem to be very daunting because every state is very different here in California. They are regulated under the rules of the Department of Real Estate and have their California financial lenders license. They just don’t regulate themselves here under that. But in Florida, they are regulated under the MLO with the state of Florida.
Aaron and Nema had talked a couple weeks prior because they were actually overregulating ourselves. However, they did that on purpose initially because they thought that there was some legislation going through in the state of Florida. It didn’t matter what kind of loan you were doing, whether it be business purpose, like a real estate investment loan or a consumer loan, that you were going to have to have the same kind of regulation do both. They got to chat, and in 15 minutes Nema saved Aaron a lot of money.
Aaron asked Nema how he stays on top of everything nationwide since state-to-state is so different. He said it’s interesting to a great degree. The law firms always revolved around following their clients into where they’re going to take them. When he first started practicing, they were primarily representing people who are just solely California real estate brokers and California finance lenders who are making loans only here in California. That was great, especially from 2010 to 2013. The market was just on fire. There wasn’t a lot of competition, and the people that they were representing were doing extremely well and could can make a ton of money in the business. What ended up happening was yields started to really compress here in California. A lot of capital started chasing deals here in California. Those same clients were trying to continue to return high returns for their investors, and they didn’t want to increase the risk. They really started looking outside of the state of California as a reprieve. They also looked at things from a diversification perspective. One of his clients said if the big one comes, he did not want to have his portfolio not be worth anything.
They started talking about both diversification from potential risks, but also an opportunity to continue to earn higher yields because they were not seeing yield compression occur outside of California at the time. Their clients basically started saying they wanted to continue to work with him and asked him how they could do it. They asked how he could be their lead attorney knowing that he was in California and they wanted to make a loan in Texas. That really started their nationwide practice, and what they ended up doing was retaining law firms all throughout the country. As of right now, they have 40 law firms that they have on retainer. They started building a nationwide Rolodex, and it was just state-by-state. When they were in Texas, they would ask the same questions in every single state. He would walk into a new transaction and ask the Texas counsel if they need to be licensed to make a loan in the state or broker a loan there. He asked them to tell him how foreclosures work in their lending market as well as the specific concerns that he needs to be worried about, such as impermissible late charges.
During this process, they documented all of the things that they were learning from the counsel. In addition, they were also having their loan documents reviewed by those firms. That slowly started turning, particularly in 2014 and 2015 with the Jobs Act. That had the biggest impact on the industry. The Jobs Act was in regards to if you wanted to raise investment capital. The previous requirements was that if you’re going to do a private investment fund, you generally could not advertise that mortgage fund. Prior to the Jobs Act, whatever way you wanted to raise money, you were really restricted in advertising. The Jobs Act came around and basically permitted people to flood the airwaves. You could use Facebook and LinkedIn or email blasts or however you wanted to advertise, and you could advertise freely. That created this huge capitalization throughout the country. That also started in their industry with a concept called crowdfunding, similar to if you want to buy a Kickstarter with a margarita blender. That’s a form of crowdfunding.
What you started to see was people with single loans asked if they could put two hundred investors on a single loan. They asked if they could get people to invest as little as five hundred dollars into a loan. They started treating these very similar to how you go buy a stock in the stock market. This has completely revolutionized the private lending community because it made it much more easy to invest because, typically, this is an industry of really high net worth individuals. There may be someone with millions and millions of dollars who puts a single loan on a $3 million asset. That was how it worked before then. Instead, you started seeing companies that were going to be the source of deal flow and they were looking at that deal flow and saying they could place a ton of investors in the single loan transaction. These guys were passionate about building a scalable nationwide model.
They started working with a bunch of crowdfunding, crowdfunding clients, and they all wanted to go nationwide. Nema and Anthony were following the market. He usually tells Nema that their job is to see a need and to fill it. They look at whatever their clients are looking into and where they want to go, and they figure out together how to build the bridge for them. That’s how the nationwide practice started, and it has grown from there. It used to be this one-off basis. Oddly enough, as a law firm that’s just here in an Orange County, California, they probably have more out-of-state transactions than in-state transactions.
Aaron said a lot of people want to leave the state of California. Half of the people Aaron talks to say it is because they are worried about a recession. The other half is just politics. They’re like later, they want to keep their power. Nema said they are hearing this from both sides, especially with California’s continued push on the rent control side. They’re making it really difficult to make the real estate model pencil out. We’ll see where the economics pencil out on this issue, but to a great degree, people are saying that even though real estate prices seem to do very well here in California, it doesn’t seem to be a marketplace that we can trust and be able to navigate in the long term. Aaron doesn’t understand how individuals trying to raise money in the space right now do so if they don’t have great legal counsel or are not tied to their local mortgage association. He has belonged to the California Mortgage Association for a long time, and he makes sure to attend at least one time a year. Aaron and Nema are also both members of the American Association of Private Lenders. In fact, Anthony and Nema are part owners of AAPL. Anthony formed the organization back in 2009 with other partners, and they have always remained their general counsel since then. They do a great job on the government affairs side, and it’s necessary.
Aaron went back to DC earlier this year with ThinkRealty to talk to specific congressional members and committees that were in the real estate space or thinking about legislation around real estate. He really appreciated how ThinkRealty and AAPL have approached it from a very data-driven perspective because he thinks a lot of the times they’re just struggling to figure out how to deal with the affordable housing issue, but they’re not thinking long-term about the impact across the board. One of the reasons that they were overregulating themselves was because they really thought that they were going to be regulated the same way a consumer lender would. They were doing a full-blown financial audit every year, and it’s exhaustive. You don’t just ask what the $2.15 is. You ask what the process is and the procedures around it. It took a lot of their team off line for an extended period of time, and it’s very intense. However, Nema was one of the people who went down to Florida and basically fought against it and told them how they were about to shut down an entire industry.
Aaron next asked Nema about the process, how he found out about it, and how he was ultimately one of the people that helped decide to get that squashed. He said one of the things they were compiling in the background was a research library about mortgage licensing laws throughout the country. It’s oftentimes surprising for people in California, which is a very regulated marketplace. People are typically surprised to hear that the vast majority of the country does not regulate business purpose lending. If you’re going to be fix and flipping a property or purchasing a rental property, the financing side of that is generally unregulated throughout most of the country. They were building out this matrix over time. They had to be continually updated because laws were constantly changing in each state. Each year, over the summer they would refresh their research. It was always a very reactionary approach to this problem. They may have seen that Utah changed their laws a few years ago required you to have a license to make an investment loan. They would then report this to their clients.
After AAPL met with legislators in D.C., they realized firsthand that the legislative bodies simply do not really understand or know that this private lending space exists and they don’t realize what legislative effects they have on the private lending space. From that meeting, they said instead of being reactionary and just running annual surveys and reporting them back out, why don’t we actually start tracking these things so that when a legislative body is attempting to change these laws, we can actually go in and try to have a conversation with legislative bodies and help them understand the impact of the change. This happened, and the real first test of it was in March of this year in the state of Florida. He receives weekly updates from the different legislative bodies and saw that the state of Florida is amending their definitions for who is required to have a license to make a mortgage loan.
They talked with AAPL about how they can be very proactive and would let them know when something hit the legislative floor. They have a very short legislative session in Florida, about 60 days in total. They decided to go now if they wanted to make an impact. They started this campaign drive to try to get an informational campaign out to the legislative body out there. It was a Senate bill, and they tried to connect directly with the Senate bill sponsor out there and tell them they were private lenders and this effects their marketplace. They are private lenders and try to approach it from a data perspective. They had a bunch of mortgage lenders who are not currently licensed in the state of Florida, both people inside the state as well as people outside the state. They made X number of loans last year, and the aggregate loan amount is X dollars. Should you pass this licensing registration? He said he would go to the other states which don’t require a license to make a alone. In fact, there are 40 other states that he could go to and could simply cross the border over Georgia because it doesn’t make sense for him to obtain a license in your state.
They started this campaign with them, and they started realizing that the senator that proposed this was actually effectively doing a special interest benefit for a particular person in Florida who actually really wanted this to pass. This was not an education campaign anymore. They actually had to go in and really try to attempt to convince the remainder of the legislative body that this was actually bad legislation. He was able to fly down there a few different times and speak to the Senate there, and it was really interesting. They brought a whole group of people with them. They brought their private lenders who are in the state of Florida. They wanted to make sure that they had constituents speaking there.
On the ThinkRealty side, they started communicating with the local REIA groups out there and telling them if this passes, there’s going to be a lot less private lenders in your marketplace. They wanted access to capital as well. As they start showing up, others like the Florida Association of Mortgage Professional started showing up. They started getting this conglomeration effect where they really had a blanket. Not only would they go speak in front of the Senate committee rooms, but they were going door-to-door throughout the Senate halls for everyone. It was very interesting because they would say they were not the person you should talk to because this is about another committee next week. They would tell him to go talk to this senator and see what he thinks about this issue. They were getting bounced around throughout the Senate and Assembly there, and it was partly informative. They were educating them on the impact of this. The biggest arsenal that they had was telling them they were so far out of the marketplace by doing this. There were 40 other states, and in particular, they started talking about the East Coast states because it was relevant for them. They told them if you pass this, you’re more restrictive than New York, Connecticut, and Massachusetts. These are all states that he suspected are not looking to become more regulated than any of these environments. This was really what they started pushing in on, and thankfully, the huge effort was a win there.
To Aaron’s point, he said earlier that one of the arguments they posited was what the problem was with getting a license and why do they care. A license is not a big deal, so shouldn’t everyone have a license? People have a license for nominal things, so why wouldn’t you want a license? They weren’t necessarily even opposing the aspect of becoming licensed. The biggest aspect was it’s a pain to get a license in the state of Florida because it’s very expensive and it’s a huge amount of oversight. One of the requirements is you need audited financials, and the senators had no idea how much this cost. You go to most accounting firms, that’s forty thousand dollars every year. It doesn’t matter how many loans you do. That’s a big thing. If you’re not busy doing massive volume, it’s not going to financially make sense for you to be in it at all. It would effectively shut down a lot of smaller private lenders, and it would’ve been across the board. It wouldn’t matter if you’re doing one or two. It would have just been a blanket of you’re getting a license, and this is what it will look like.
What’s frustrating is that every state is so different. When Dodd-Frank came out, they said that’s not enough. In 2013, Senate Bill 578 overlaid a bunch of different things on top of it, and we have had a series of updates. It’s an extremely regulated environment. Aaron loves doing hard money loans, but he knows at some point people outgrow them and they think they want to start raising capital on their own, which is a business altogether. Aaron asked what point California requires you to have a license. Nema said California is really interesting. It’s probably the second most regulated state. Oddly enough, Nevada tends to be more regulated than California. But in California, effectively you cannot make a loan at all in the state of California, whether it’s for consumer or business purposes, without some form of license. The way this manifests is if you read the definition of a California finance lender, the definition basically says a finance lender is a person who makes a loan in the state of California. There’s a single exception to that rule which says that you can make one business purpose loan per year without being licensed, so there’s a one off exception. There’s a second exception, which is how real estate brokers operate in the state of California, which is any loan which is arranged by a licensed real estate broker is exempt from the California Finance Lenders law. Outside of that, you’re either a California finance lender or you’re a real estate broker or the loans are coming arranged through licensed real estate brokers. The fact is you really couldn’t do this on your own, and a lot of people are unaware of this, and the penalty is fairly severe in this situation.
You have regulatory issues, obviously, that the state regulators come after you. Another concern is usury. In California, if you make one of these unlicensed loans, either that wasn’t made through a California finance lender or arranged by a real estate broker, the maximum rate of interest is 10 percent. Most private lending deals exceed a 10 percent APR. When you have a usurious loan, the penalty is zero interest. If it’s a knowing violation, three times the amount of interest that was ever paid or earned during the life of that loan, you could actually lose principal in a deal as well. There’s a really interesting case in California where the original transaction of a loan was arranged by a licensed real estate broker. No usury problem; there’s an exemption there. But, that investor started extending, modifying, and changing the character of this loan over a series of years. Those changes were never done through a real estate broker, so that exemption he initially held was gone.
We’re now 10-15 years down the line, and he goes to enforce this and tries to foreclose. The court unwinds all these records. What ends up happening is not only does the the the lender not get any of its principal back, they end up stroking a check back to the borrower because they’ve been collecting interest payments for 12 years. They actually end up owing more than anything that was ever due to them. That’s how crazy California can be from a regulatory perspective, particularly when it comes to not using licensed professionals either to make the loans, arrange loans, or even modify and extend all these things. Oftentimes people fail to take into consideration that California wants professionals involved when it comes to the lending business. It’s just a state of our marketplace.
Everything’s been going well in the market. It’s during the downturn that things get really mucky. The digital tools are such as they will hunt and find you, and it’s just not fun to get caught. If things go sour, if anybody starts complaining and gets the attorneys and parties involved, that’s when you know you just need to do things the right way. He always tells people if you’re planning on raising any kind of money, you better be talking to an attorney that knows what they’re talking about. He got told last year by an attorney in Florida that he knew more about this than him, and that’s the problem.
He talked recently with a crowdfunding attorney on this. If you’re going to leverage anything in the Jobs Act, you just really need to look at the activity you’re doing and how you’re raising money. There’s a false sense of security and you need to be careful with some of these platforms that are offering the Reg D offering. He doesn’t get the sense that a lot of these platforms are in the business of offering good, solid legal advice because they just want to be a platform. They’re not vetting the deals, so there’s a sense of security from someone looking to lend money and make a return. There is also the investors leveraging those platforms. You just have to be very careful in the years ahead, especially if we hit a recession, that’s when things typically get a little wonky and difficult to get out of and people looking for money, especially since a lot of these things are happening with self-directed IRAs.
Nema said of the things that that is really interesting, in particular with the proliferation of online crowdfunding platforms is that when you actually read through and understand it, there is no security involved in this transaction. What the crowdfunding platform is offering you is an unsecured note, and there’s a derivative sitting behind it saying based on the performance of its underlying theme, we will pay you money. But, at the end of the day, if they don’t pay you, you don’t get the underlying alone. There is no security for your loan, which is crazy from a real estate perspective. It takes the entire premise of real estate investing on the lender side completely out of whack. Their business was built upon having great security sitting behind the loan, and they stripped that out. People really failed to realize that most crowdfunding platforms in the real estate space simply have no security behind them.
It’s very scary when you read the fine print further and you find out that there’s language like if there’s a default that occurs, we may not exist anymore. So the platform itself isn’t saying that they’re going to help you get your money back either. If they’re not making any money, you might have one person answering phones. That’s it. You’re in bed with a bunch of people you don’t know trying to get your money back. Aaron said that actually happened to him when he first started the business. He is part of the California Mortgage Association and was trying to hunt down some contacts. Nema would call private lenders that were very aggressive right before the downturn. Iit was just a voice message saying they were closed and to leave a message. We just get really spoiled in a good market and don’t think that it can go the other way and some of the ramifications that come with it. Be very careful whether you’re on the lending side or are a real estate investor looking to raise money and do these kind of things. You just really have to do it right, and you better be working with legal counsel that understands the state laws because it changes drastically.
One thing Aaron will be promoting this week is in New York, but it’s really important. At the conference in Las Vegas for AAPL last week, he learned New York has this great idea of charging flippers 25 percent tax if a property is bought and sold within a year. In actuality, in the first year, it is 20 percent and 15 percent if sold in the second year. Aaron asked if this is a tax on the net proceeds from the flip, but Nema said it is actually on gross sales price. This makes it even worse. This is interesting because this would completely damage iBuyers if this goes through and why we all have to care about this as the state of Georgia is already looking to New York and saying this is specifically an affordable housing play and a gentrification play. Those are the two key terms that are getting thrown around a lot. You just have to know it exists. Just because you don’t live in the state doesn’t mean that you can’t sign the petition. If you want to go to the link to voice your concern, go to www.aaplonline.com, and it should be right there on the main page where you can sign petitions or otherwise. Nema recorded a little video on New York; and to Aaron’s point a lot of people will wonder why we care what goes on in New York. However, this one has scary legs to it to the degree that if New York passes this, you will start seeing this in a lot of other states because they are very interested in additional revenue sources and stopping the dramatic increase, particularly of low valued units. He sees this as being a pretty strong response nationwide. This is definitely something where people across the country really have to be careful about it.
If you go to www.aaplonline.com, there’s an engagement section where you can sign up under the engagement tab. There’s a government relations section, and you’ll find out more about it. It’s New York’s state Senate Bill S3060E. Aaron highly recommends signing the petition that’s on their website. You can put a little information on there on how you think it would impact. Aaron thinks about all the trades and construction, especially since it’s 20 percent of the gross. That would effectively squash fix and flip for the foreseeable future. The margins are so tight right now that this just seems incredibly impossible.
The Norris Group originates and services loans in California and Florida under California DRE License 01219911, Florida Mortgage Lender License 1577, and NMLS License 1623669. For more information on hard money lending, go www.thenorrisgroup.com and click the Hard Money tab.
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