How to start investing in discount notes?

[Nick B.]

Hello there!

I am considering investing in discounted notes and I need some advice and directions.

I got inspired by several articles written by Jeff Brown (AKA The Bawld Guy) where he explained in great details how notes are supposed to work while glossing over the most important topic: where to find them.

Hence my question to the notes investors out there: where do you get them from?

What I am looking for is a note with 50-60% LTV that pays 12% or more based on the price I would pay for it. For example, if the property has a FMV of 200K and outstanding loan of 200K at 6% APR, I'd like to buy it for 100K. This would satisfy my LTV requirement as well as interest rate (6% on 200K is 12% on 100K).

Is this example realistic? If not, what is a realistic one?

I signed up with the PPR Notes company hoping that they have a few notes to choose from but found out they sell 2nd position notes with almost no equity in them.

Thanks

Nick

[Dion DePaoli]

A loan that trades for a discount has a discount for a reason. The discount sets off some characteristic of the loan such as paperwork defects or borrower performance defects or underlying collateral defects.

If the loan you want to target has a current LTV of 60% a performing loan may not have much to discount for. The equity already affords a mortgagee the ability to enforce the mortgage and collect what is owed. There are caveats to that but we will set that aside.

If your yield requirement is your driving force at 12%, you could be fine simply finding a loan written for 12% that has a current LTV of 60%. No discount needed. In a situation like that, there should be minimal defects.

A loan written at 12% has some inherent risks in it already though. Since the prevailing market rate is closer to 5%. So the borrower agreed to take on 12% instead of getting a better rate. That could be a Seller financed deal. Equity may not be as much in such a situation, where the borrower puts down very little unless the loan is seasoned for a long time.

Some hard money or private money lenders will achieve that type of rate and obtain equity close to what you are looking for. In some of those cases, the loan is based more heavily on the underlying collateral and less on the borrower. They also tend to be shorter term loans.

Trying to find more of a conventional loan can be done but the defects will be present and you will have to deal with them. A seller of a loan has no duty to sell you nor take a haircut. The deeper that discount is the more of a defect. What you end up with here is really the reality check of the idea of return that the investor wants. Just because you want a 12% return doesn't mean you will get into a trade since someone else is happier with 8%. Now, put that idea in contrast with where prime conventional loans trade which is around 4.5% in today's market. I know many guru teachers like to say you can just pick your yield and viola, but that is not reality. Competition in the market place, just like in real property puts downward presumes on those return ideas.

So can you get a 12% return? Sure. But you have to reconcile how active you want to be and how much risk you want to take. Neither of those are meant to push you into super high risk investments but there is a relatioship that must be recognized.