What is the note investor looking for when purchasing an owner-finance note

Question

I have a deal that I am working on. I am fairly new to OF deals. I own the SFR outright. I am selling the property for $125k. The buyers are putting $5k down and financing $120k. since I am fairly new to RE investing, I want to get my money (or the majority of it) out. How do I make the note attractive to investors that are buying notes? DO I need to try to get more down from the buyers to make the LTV more attractive? I haven't finalized the deal yet with the buyers but I was going to set the note for 30-year, no balloon, 7.5%. If they finance $120k and I offer it to an investor for $105k - $110k is that attractive? Any light you note buyers/sellers out there could shed on this would be helpful.

Scott Arpan · Answer

Stacy,

The price SF note investors will pay depends on many factors. These factors will help the investor determine their perceived risks regarding if the note will default and if the note defaults, what are the risks of at least being made whole if they foreclose and liquidate the property. I will give you some background to better explain my conclusion how note investors will receive your note.

Items that will help access these risks

• The credit capacity of the borrower- how have they treated other creditors? Are they living within their means?
• The borrowers’ ability to earn a steady income that is not likely to end in an industry or economic downturn. If they are laid off, are their skills transferable to other industries. If they jump from employer to employer I watch out.
• The amount of borrower’s equity- how much of a down payment and equity from paying down the note. I don’t count on appreciation but some might.
• Borrower’s pay history. The more documented on time payments tell me they can handle this debt. With new loan I have no idea if they have truly budgeted all the expenses for the property. Past due property taxes say a lot about borrower’s ability to manage the property and their finances.
• Is there any chance mortgage regulations were not done properly? This risk is high for RE investors using SF to liquidate multiple residential properties. I have seen many landlords selling off their portfolio of houses and 2-4 plexs using SF to maintain cash flow without tenants or toilets.  Most seem to have no clue about complying with Dodd Frank or other consumer mortgage regulations. That will kill the deal.
• Loan terms:

• Amortization: a 10 to 15 year amortization is much better than 30 where buyer is not gaining any equity from his payments at the start of the loan. Also, payments from years 15 to 30 are worth pennies on the dollar in present value terms so create a large discount.

Interest rate. If the buyer is willing to pay high rates, (9ish% and up) sets off alarm bells about possible default for residential notes. Most higher interest rate residential paper I have seen seams to end up in default. Some commercial property secured notes can justify higher interest rate if the cash flow is there and the venture is well managed just like a HML

Balloon payments- If it appears the borrower will not be able to refinance a balloon payment, most note investors will only by the payments leading up to the balloon or price as if the note continues to amortize out without the balloon.

• Property value must equal true/real market value. Some sellers try to inflate the sale price to receive a higher offer from a note buyer. If the loan is underwater in real market terms, there are no buyers unless you sell your note for pennies.
• Property type- If I take the property back, how quickly can I liquidate it with no or minor repairs? Is the roof leaking where that I need to address immediately with big bucks to prevent further damage?   Is there a lot of functional obsolescence in the property to fix before I can sell it at all? What are my legal and holding costs? I expect a rehabber or bottom fisher to be my likely buyer.
• Property location- is it close to major infrastructure and markets or out in the middle of nowhere? When available, I find the number and types of crimes being reported in the neighborhood. High crime areas get no offer unless it is industrial land.

As a rule of thumb, no SF note investor (I know of) will go beyond 70% ITV for any note right now unless it is gold plated. Yours being new with a small down payment would like only receive offers to purchase the next 48 to 120 payments where they could keep their investment blow $60K.  If you got 20% down on the property’s true market value, you could probably sell your entire note for 65 to 75 cents on the dollar for a 30 year amortization. A 15 year amortization could bring you 75 to 85 cents depending on the strength of the borrowers and property.

Hope this helps,

Scott Arpan

Brent Ecton · Answer

Yep, like Bill G. said.

10% down

20yr loan

try to sell first 15yrs and keep the last 5 for yourself

Bill Gulley · Answer

You need a broker to put a loan package together, process it, have verified documents, even if Dodd-Frank doesn't apply, the note will be worth more. I also suggest you set the note off to servicing at settlement, their accountings will be more believable than yours trying to sell the note, and lowers the servicing risks. And, 30 years will kill your profits.

10% down is more common too, that is a very weak loan.

Consider selling part of the note, you can guarantee the payments and you'll do much better. Good luck :)

Darren Eady · Answer

As a note buyer, I personally wouldn't be interested in a 7.5% yield.  The discount you're providing helps with the low rate of return, but, like you mentioned, there is not much skin in the game from the buyer to make up for the collateral, if it fails.  You haven't mentioned the value of the property.  If the value was significantly higher than the sales price of $120k, the deal could be more interesting.

What is the note investor looking for when purchasing an owner-finance note

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