Why to invest in Notes?

[Dion DePaoli]

I am not sure there is really a good thread here in BP which address this question.  I know there are many blogs but those do not provide expanded conversations around the idea, IMO.  

If you are a seasoned, new or potential loan investor regardless of performance, skill, knowledge or training chime in.  I know in advance, that this may be a tall request and many/some will not want to chime in, but I think it would do a good service to really start addressing the expectations that are flowing in the background and help put some light on realistic approaches and ideas to some of the core reasons folks consider jumping it, do jump in or stay away from investing in whole loans/notes.  

Some general questions:
What is attracting you to this asset class opposed to others?   

What are the expectations that you have, think you have or may have heard in regards to the amount or level of return one can expect?  

What is the amount of time a single investment will take or do you plan for?  Or your general investment horizon per asset.  Perhaps why that is your target as well.

What is the target amount of capital you believe you need or plan to work with or do work with?

How do you believe you will exit your asset investment specifically?  Perhaps a better way to say this is what is your most hopeful exist, highest best, as you know it.

How does that exit affect your return in your opinion?


I am not trying to sandbag anybody.  I really think this conversation needs to take place.  I hold this general conversation with many of the new investors I have talked with and some of those have been from here on BP.  

The fun and familiar motto is something to the effect of "Be the bank" - well, what does that really mean to you?  

The more open dialog, the better.

[Tiger M.]

@Dion DePaoli know that I read all yours posts, appreciate their value and your attempt to cover the questions posed. When I see folks talk about notes its almost like talking about old cars or a "box of chocolates" as Forest famously said. We talking 246 GT Dino Ferrari, 1939 Packard, 68 Pontiac Firebird or 1970 AMC Gremlin= owner carry, 1st position, 2nds, under water Vs. equity, performing Vs. default seniors, purchasing partials. They are incorrectly dumped into the generalized discussions. I don't think note investments are for greenhorns, especial NPN 2nds. Start with a simple OWC and work up.

1-Why=The past years of hard money lending have given an opportunity to compare both notes and REI. @Bill Gulley already mentioned the lack of toilets in notes. Rentals, whether commercial or residential, require active involvement Vs. little involvement in the notes(thanks to servicers). Availability of NPN 2nds over next 3-5 years is a factor because I can't compete with Oak Hill and buy $659 million from Freddie Mac at .76 UBP or Lone Star Funds-John Grayken, paid almost 66 cents per dollar of unpaid balance at the June HUD auction, winning bids on all 16 loan pools of NPN 1st's. I'm a minnow see.

2-Note returns= vary as well based on goals and product type. 15-20% yields for 1st's(its fine, boring but its mailbox money). Underwater 2nds can be a total loss to a 600% return. Our investors worst NPN 2nd pool was a 25% return to date.

3-Time=performing notes take about 15 minutes a month to account for each one at most. Pools need about 2 years on NPN 2nds to work through with servicer and take patience.

4-6 Investment amount and exits= It might help to answer the rest of the questions as a BEST CASE, hold for long term, cash flow, NPN no equity 2nd scenario. The other obvious exit to long term hold is a sale of 6 month seasoned reperformed notes at a 15-18 yield. Compare note potential to REI potential. Will have to generalize to make this work.

Assumptions NPN 2nds underwater based on past experience:

Price of notes: 20% of UPB (some are cheaper, some are more expensive so pick a blended number)

Face interest of note: 10%

Face value of note: $70,000

Percentage of complete loss of notes: 20%

Percentage of settled of notes: 20%

Percentage of settlement rate: 180%. i.e. 100k note, 20k purchase, 36k pay off

Percentage of re-performing notes: 60% at 7%

Terms of re-performing notes: 7% interest, principal paid off when property is re-financed or sold.

Term of performing note till property sold or refinanced: 15 years (historically 7-9 years but these may be less apt to sell due to value issue)

Example:

Buy 5 million face value of notes for 1 million.

20% are wiped out leaving 4 million of notes

20% pay off for 360k leaving 3 million of notes

Basis; 1 mill