How much to bid on commercial NPNs (past maturity)

[Jean G.]

Hello, I have been seeing increasing opportunities recently to bid on non performing notes on commercial properties that banks are trying to offload.

These notes usually have the following characteristics:

The note has reached maturity several months ago. Sometimes a year or two ago. Presumably the borrower is unable to refinance at current rates.

The borrower may or may not be making payments on the note, even though it is past maturity (is it a problem to foreclose if they are making payments?)

The notes are all on commercial properties (office, warehouse, shopping center, mixed use or sometimes multifamily)

The properties are either vacant or occupied by tenants, not owner occupied

The property value is usually higher than both the UPB and the legal balance, sometimes significantly higher than the

Now it is important to mention that I have very little experience with issuing notes and buying performing notes. No experience with non performing notes.

My idea is to buy these notes with the primary goal of accessing the property through foreclosure, knowing that there are several other possible outcomes. This is what I think I know:

- The borrower can choose to pay off the note at any time (by selling the property or just paying off the loan with other funds), so it is important that the legal balance covers my investment and some profit

- The borrower could file bankruptcy (can someone confirm that this will only cause delay, but not jeopardize ultimately collecting the legal balance of the note)

- Most of these DOTs will have a rent assignment clause, so I could try to enforce that and collect rents from tenants (essentially manage the property) while I am holding the note and trying to foreclose. Does anyone have any input on why this may not work, as it seems to not be a common thing for the banks to enforce.

- I could be successful with foreclosure and end up owning the property

- Since the note has reached maturity, it cannot be made to perform again by the borrower where I am stuck with it for years. There will be a resolution, one way or another, say within 6 to 24 months

Please feel free to comment on anything above that does not make sense.

Now my main question is: how are such notes valued? What is the seller typically expecting to sell these for, considering that the UPB and legal balance are lower than the property value?

In one instance I was told that the seller was expecting 92 to 94% of UPB, which was in that scenario equivalent to a 85% LTV, and I thought this was too high for the amount of risk and unknown involved.

I would love to be buying these around 50 to 60% LTV but don t know if that s realistic currently?

If the legal balance is already at 60% LTV for example, would a seller expect a higher amount than the legal balance possibly? Which would mean you loose money of the borrower immediately pays off, so not good at all. Just trying to understand what sellers expectations are.

Thank you for any pointers including things I may be missing.

[Don Konipol]

Quote from @Jean G.:

Hello, I have been seeing increasing opportunities recently to bid on non performing notes on commercial properties that banks are trying to offload.

These notes usually have the following characteristics:

The note has reached maturity several months ago. Sometimes a year or two ago. Presumably the borrower is unable to refinance at current rates.

The borrower may or may not be making payments on the note, even though it is past maturity (is it a problem to foreclose if they are making payments?)

The notes are all on commercial properties (office, warehouse, shopping center, mixed use or sometimes multifamily)

The properties are either vacant or occupied by tenants, not owner occupied

The property value is usually higher than both the UPB and the legal balance, sometimes significantly higher than the

Now it is important to mention that I have very little experience with issuing notes and buying performing notes. No experience with non performing notes.

My idea is to buy these notes with the primary goal of accessing the property through foreclosure, knowing that there are several other possible outcomes. This is what I think I know:

- The borrower can choose to pay off the note at any time (by selling the property or just paying off the loan with other funds), so it is important that the legal balance covers my investment and some profit

- The borrower could file bankruptcy (can someone confirm that this will only cause delay, but not jeopardize ultimately collecting the legal balance of the note)

- Most of these DOTs will have a rent assignment clause, so I could try to enforce that and collect rents from tenants (essentially manage the property) while I am holding the note and trying to foreclose. Does anyone have any input on why this may not work, as it seems to not be a common thing for the banks to enforce.

- I could be successful with foreclosure and end up owning the property

- Since the note has reached maturity, it cannot be made to perform again by the borrower where I am stuck with it for years. There will be a resolution, one way or another, say within 6 to 24 months

Please feel free to comment on anything above that does not make sense.

Now my main question is: how are such notes valued? What is the seller typically expecting to sell these for, considering that the UPB and legal balance are lower than the property value?

In one instance I was told that the seller was expecting 92 to 94% of UPB, which was in that scenario equivalent to a 85% LTV, and I thought this was too high for the amount of risk and unknown involved.

I would love to be buying these around 50 to 60% LTV but don t know if that s realistic currently?

If the legal balance is already at 60% LTV for example, would a seller expect a higher amount than the legal balance possibly? Which would mean you loose money of the borrower immediately pays off, so not good at all. Just trying to understand what sellers expectations are.

Thank you for any pointers including things I may be missing.

I gathered from your insightful questions that you’re an experienced commercial property investor.  I’ll try to answer some of your questions

once a note has matured the note holder has the legal right to call the note due - with proper notification to the debtor.  Proper notification and time line is dependent on state law.  Should the debtor be unwilling or unable to pay within the described time allotted, the note holder can foreclosure.
Depending on state law foreclosure can be judicial or non judicial.  Judicial foreclosure requires a petition to the courts, and a court trial ending in an order by the presiding judge allowing a foreclosure auction to take place.  Because it can take 6 months - 2 years to obtain a court date, judicial foreclosures in general take longer than non judicial foreclosures.  Additionally, because of court time, requirements, etc. they result in  higher legal fees. 
Non judicial foreclosures do not require court participation; they occur mostly through deeds of trust rather than mortgage instruments.  Once a default has occurred - be it missed monthly payment, note maturity, etc, the note holder or their representative send a letter to the debtor notifying them of the default and providing the statutory timeline for corrective action. Assuming this is a matured note, and the debtor does not pay, the trustee of the property (assuming deed of trust) will be instructed by note holder to foreclose.  Timeline ranges from 22 days in Texas to almost 12 months in some other states. 

” The borrower could file bankruptcy (can someone confirm that this will only cause delay, but not jeopardize ultimately collecting the legal balance of the note)”

I wish I can confirm that, but it isn’t true.  BK is a WILD CARD.  Here’s an instance where the note holder will lose part of their investment.  The property may be deteriorating as the debtor delays and as his attorney stretches out initial court hearing (in BK court) for 6 months.  When the courts finally hear of the debtors plan, 9 - 12 months after initial BK filing, the debtor claims subject property is worth less than the amount owed.  The debtor and creditor would each hire an appraiser to appraise current value, and of the values vary greatly the court may have another appraisal done.  By this time 18 months have passed and the property through neglect, no maintenance, loss of tenants, etc. may appraise for significantly less than amount owed.  The court would typically write down the secured note amount to no higher than the appraised value, with the balance of the amount owed being placed in the unsecured creditor status.  Since typically unsecured creditors get on average 10% of their claim, the note holder can suffer significant loss.  This is known as a CRAM DOWN.  

Further, the court is empowered to do just about anything it wants or perceives as “fair”.  All the usual creditor protections are thrown out the window depending on which BK court has jurisdiction.  So, for instance the court can decide that the note holder of the matured note will receive a new note in exchange for his interest - with the new note amortized over 20 years and bearing a 6% interest rate.  

@Chris Seveney is much better informed about the current state of note sales than I am since 80% of my business is originating high yield notes and only 20% is the purchase of existing notes.  But from what I’ve seen the general price level of notes for sale is way too high for the risk involved.  This doesn’t mean that one can’t SELECTIVELY find “deals” that make sense.  Especially since your goal is to own the property.  But any analysis needs to consider the points above. 

@Chris Seveneyundefined