Note Buying - The Good, The Bad and The Ugly

[Jon A.]

I'm looking to buy my first note this coming year. There seems to be more than a few here who have invested in notes. If you would, please share some of your good, average (as if there is such a thing) and bad stories.

tia

jon

[Dion DePaoli]

I am with Bill. There is no real average. The good is easy, you didn't loose money. The bad is easy, you did loose money. All the other stuff simply goes with investing in notes in general.

I personally do not and could not prescribe a single line statement summary of the industry. It reminds me of a Taoism proverb, the student asked, "What are the teachings of a lifetime?" The master replied, "Exactly that.".

I don't understand the UPB references within the thread. Any reference to some sort of static price figure is simply speculation. A loan at 10% LTV will likely trade for more than 25% of UPB. Pricing is relative to the asset being priced not the class or sub-class of the asset being discussed. Not all NPN's are X% nor are all prime conventional loans trading at premium or par either. So you can not accurately make these types of statements without the input variables.

To quantify the 'good' I would point out is also somewhat relative. It is a fairly consistent rule that larger returns come from loans in deeper distress or files that carry more difficult defects. The opposite is also true, loans with less distress or risk have small returns. So sure, you got the loan for a lesser price and by dispositioning the loan well, you do well with return. Do not be fooled though, the line can be hard to see where risk increases and you only get one swing at bat. If you didn't see the curve ball, you may well not be able to hit the ball at all and then you have struck out with no more at bats.

Not trying to scare or be a pessimist but just a little sprinkle of realty. Whole loan investing has increased in the private sector considerably over the last couple years. Some of it is fueled by guru misconceptions about how to profit to some degree. Selling NPN's investment ideas as a circumvention of market price. You can get the NPN for cheaper than the REO, blah, blah. That is misleading hype to a large degree. In those ideas are many assumptions and false understandings of how all of it, and I mean all of it, comes together and works.

Continuing the NPN example, you are not guaranteed the deed nor are you guaranteed the amount of capital it will take to finish disposition to break even or profit. Costs of taxes, insurance, repairs, servicing, legal fees all add up pretty darn quick. Being off on exit value, expenses or even time immediately erode your profit margin.

The same is true for cash flowing loans. Sure you can hold out for loans that you can discount deeply to drive up your yield but just like with real property, while you hold out for a 20% return, there is a guy who will take a 15% and for the record, institutional capital will take an 8% for the same risk most want double digits for.

The more experienced investors will be more comfortable with risk the least experienced investors are not. That comfort or capacity to handle the risks are your barriers of entry into the asset. There is no duty to sell to you for any price. To that idea, it is the oxymoron of seal bid auctions of these types of assets, if you assume the highest bid wins. Being the highest might simply mean, you didn't see the risks and price the accordingly which may result in loss. On the other hand, it also might mean you are better at handling those which allows you to pay higher and execute better than the rest.

I would also add, being a note investor is not like being an REI guy which tends to have more of a linear approach to disposition and profit. REI tends to look to either fix and sell or hold. Note investors do not get as much of a choice as you might think or as some might try and say. Do we choose disposition strategies and then try and execute them? Sure, but it is a series of iterations, layers of event and action. While those can be chosen by the highest probability, that is not the same as certainty as mentioned above. Purchase an NPN to get a deed and the borrower reinstates. Purchase NPN to profit on REO sale, pay too much and asset trades at auction for small margin. Purchase PN for yield and borrower defaults. The list goes on and on, you get the point.

I realize the answers so far in the thread may not be the ones sought by the OP but they are the right ones. I will leave you with this conclusion to my post, the reason I personally pursue loans as a vehicle for investment is because I simply love the complexity and the amount of moving pieces that are involved. It is not something I do, it is my passion. If it was all good and easy or even all good with no bad to some extent, I am not sure I would enjoy it so much, it would become mundane and boring.