How to use OPM for performing notes.

Question

I have been looking at performing notes recently for cash flow purposes.  Wanted to know if anyone has structured deals to take down pools of performing notes using other peoples money. The reason I ask is because I have heard of someone who uses OPM to purchase performing 2nd's and is making great money. I never got the name of the person so I can't ask for myself.

Example of a 1st position performing note.

Purchase: $10,000.  Monthly payment is 582.46 with 20 payments left.

If I purchase this asset with my own cash than I would be looking at 18% yield.

In order to scale this up I would like to bring on investors and give them a 10% return in order to fund the project 100%.

However, this brings their monthly payments to 544.90 which leaves 37.56 for me....this does not even include servicing fees or due diligence fees.

I want to be in the deal from the front end to the back end...I don't want to sell a front end partial to recoup my money and wait months/years to get passive income.

Any help would be appreciated.

Rick H. · Answer

@Mike Carr I'm a pretty seasoned note investor so I'll chime in.

What you have to determine is if you are using the note seller's asset to fund your deal or if you are using 3rd party qualified investor money.

If the former, there are any number of models. I'm doing two right now with an investor, whereby he has assigned his notes to my based on a contract for sale of note. Think if it as "a note for a note".

What you may be trying to do is merely to purchase a note or note(s) with investor money, which is typically considered a broker activity requiring a license, at minimum. The model you propose is to give investors a level return while you capture the excess.

Here are  just some the challenges that you'll need to work out:

1) Licensing - in my state, a real estate brokers license is required by entity corporate officer

2) Qualified investors - there are very specific rules to protect little ol' ladies and such

3) Servicing - you'd be well advised to use a licensed NMLS servicer to stay compliant

4) Documentation - Find a good attorney who specializes in lender matters

5) Formation of Entity - you'll need an attorney to form an entity such as a mortgage pool to remain compliant with SEC laws concerning Private Placement Memorandum offers.

My friend and mentee Gerald Lemoine has done just that. Perhaps you'll search for him and see how he has done this.

Chase Thompson · Answer

Love the explanation Rick H..

Really like the "note for a note" analogy.

What if instead of setting up the transaction as a broker, the contract is written as a JV deal?

OPM for acquiring the note, any overage comes out of OP's pocket.

Dion DePaoli · Answer

Chase has some good questions there but let us take that one step further.  What will you do when the loan or loans completely default and make zero payments for the next 150 days.  Do you have enough capital to enforce the security instrument?  While that is contemplated.  Your math is off.  There is no 18% return here.  If the Borrower's payment is $582.46 and they only have 20 periods left then your total collection is $11,649.20.  So that is $1,649.20 in total above the $10k investment capital.  Take $380 off that number for servicing so now we have $1,269.20 in total potential.  So we have an ROI of around 12.69% which if we shave 4 months off we will get a little boost due to time but it will not be all that meaningful.  It looks like this trades pretty close to par.If the capital invested is paid 10% that will mean a periodic payment around $544.90 which means you have about $22.56 each month in spread.  So the investor would make their 10% or $10,897.98 and you would make $451.22.  Bare in mind now, my initial question or that of Chase.  What happens if the loan falls into delinquency or default?  Have you ever deal with such matters?In general, this investment at around 13.88% is probably not all that good for a second lien but may be slightly better looking if there is some decent equity protection in the real property.  We could back off, to some degree, concerns of delinquency and default perhaps.  However, bare in mind we have done zero due diligence which will cost a couple hundred bucks.  So the return potential diminishes further closer to 11.54% IRR with a ROI of 10.69%.  Which may or may not bring us to the next issue.  The loan matures in 20 periods, does it balloon or pay to zero?  If it pays to zero, then the above applies.  If it balloons, well we have a whole other set of concerns now.

Rick H. · Answer

Spend the time, money and resources to perform real due diligence.

You can structure many ways, but talk is cheap and dreams are futile unless followed by well-thought out action.

Joshua Andrews · Answer

I echo the questions and thoughts of Mike Carr. Much like him I have been seeking a way to scale up my business with performing notes.

My initial thinking was along the lines of giving the investor a fixed yield and me pocketing the difference in payment each month. Essentially I would own a partial if my thinking is correct. In my contract with the investor I would handle foreclosure and legal fees should the borrower default, but would recover them upon resolution of the default, be it foreclosure, sale or just a workout where we have a resolution. Fees associated with these items do not worry me, as I have dealt with them before and have the resources to handle them. Due diligence would also be handled by me, as this is a critical part of the transaction prior to purchase. In fact I would not want to be a part of any purchase that has not undergone careful due diligence.

I would be interested to hear how others are actively using other peoples money to purchase performing notes.

Rick, could you elaborate on the "note for a note" idea? I am not sure I fully understand how it works or value is generated.

Josh

Chase Gochnauer · Answer

To be up front I'm a note newbie, but I'd think you need to calculate servicing costs in your return. I'm only familiar with FCI and I think they were $15/mo. Not much but when you're looking at $37 leftover for you, that's not much.

Also, how would you guarantee this to investors? What would happen if in month 3, the person stops paying their note? Do you have funds to provide a guarantee of 10% or are they going to stop receiving money if the note stops paying?

Wayne Brooks · Answer

My bad, yeah your yield is probably right.  I was just thinking you're only getting 16%, and it's over 20 months.....but you're getting principal back as you go, so yeah the APR is probably there.

Mike Carr · Answer

Just started using a financial calculator a few days ago. It keeps spitting out 18% for 20 months with those exact numbers.

Wayne Brooks · Answer

Don't have a calculator with me, but your math is off.  In your example your yield is about 16% over 20 mo.s, about 10% annual, not 18%.  Not sure on the reg.s for raising money like you're thinking.

How to use OPM for performing notes.

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