RE residential Notes . . .quality of properties and forrates

[Jay Gill]

I know of a few people that are investing in real estate notes that are working with a third party individual. I noticed that the properties they are invested in are far away from any urban centers(tertiary markets), the comps for these home come out to 30-50k. The argument given is that these homes offer a better discount when purchasing the note.    However I feel these notes are risky in terms of the payor defaulting on the note when doing a loan mod. 

Also when it comes time to foreclosure, is it difficult to sell the property? Also what are your experiences in foreclosing on these types of homes and flipping them? Is there any type of ROI? What kind of %'s is to be expected?

[Dion DePaoli]

@Darren Eady is it possible for you to make a post which is not a sales pitch?  Your post doesn't address anything asked by the OP.  The forums are not for advertising.  

@Jay Gill that is a good question that I don't think has made it's way to the boards.  The first thing we have to do is build some understanding of ideas.  The urban property still has a real property value, what ever that may be.  That value should be a number which represents what a buyer will buy for and a seller will see for in an open market arm's length transaction.  Generally the value represents a price which will cause the sale to occur within 120 days of being on market.  As we get into more rural locations the universe of potential buyers shrinks.  We would expect to increase the marketing time.  It takes longer to tap into a smaller group of folks.  Each rural area is going to have different characteristics.  A township with 500 people might take longer than a township with 5,000 people.  Depends on what the economies and potential sources of income are.  The key is to ascertain the correct comparable and sales characteristics to place a value on the real property.  The point here is the property has a value and that value is a function of these influences.  We need to start there.  Knowing that number will also mean knowing the time it takes to market.  In some rural markets you could see marketing times of a 6 months or a year.  Each area will be slightly different due to the characteristics.  

Discounts on notes are driven by the amount of time and capital it takes to fully disposition the asset. Short term disposition have higher prices and longer term have lower prices. Holding the loan and then the REO to sell costs money. So when pegging the value it is important to peg the time to complete. We would expect to see deeper discounts on rural property compared to urban assets that are similar as best they can be. So, is the discount greater? Yes. Is that "better"? Not really. The discount is driven by the capital it takes to hold and disposition the asset. So the real comparison of whether the rural property is actually a better deal should extend into the total price, advances and expenses it takes to disposition the asset in full. We can't necessarily rely on purchase price as that lead indicator, we will be mislead. By their nature, they should be less than urban loans of the same characteristics.

In regards to higher risk of default.  That is going to depend.  Rural borrowers may have a harder time finding replacement work if something was to happen to their primary occupation or source of income.  That issue is a function of simply being farther away from urban centers which typically have more employment opportunities than rural locations.  Does that put rural loans at a higher risk of default than urban loans?  It probably depends on what the source of income is and how prevalent a potential replacement source of income is for the borrower if something does happen.  In a farming town a farming replacement job, even though the number or residents is low, may very well be fine to support a quick replacement.  Whereas a factory job in a small town where the factory shuts down may be much more difficult to replace if the next urban center is 100 miles away.  

There is a level of complexity in these understandings when it comes to urban versus rural assets.  The USDA has a couple loan programs which targets rural area properties.  They do have some more relaxed guidelines on sub-prime borrowers which may allow for an earlier refinance opportunity than that of an urban loan.  In addition, the loan to be purchased may be a loan which provides further incentive for a mortgagee to purchase the loan with guarantees to the Mortgagee.  The point of those features in those loan programs is to encourage mortgagee participation in those markets.  

I probably would consider any rural loan a potential flip.  They will not move quickly and just like the universe of potential real property buyers is small the universe of potential loan buyers will also be small.  It will be easier to get through an urban loan than a rural loan in most cases.  

In regards to returns on rural versus urban.  You can make some decent returns on any asset if you purchase it correctly.  That includes taking into consideration the time and capital you will need to deploy into the asset to disposition it.  There is certainly a case to make that a rural loan should bring back a return higher return than that of urban loan but I think it is relative.  If we seek 20% returns on a urban loan a rural loan may be 25% or 30%.  I would not let that be an indicator of one deal being better than the other because one deal has the potential to bring back a higher return.  The risk is greater and thus we seek a higher return.  I am not sure higher risk, even with higher potential return, defines anything being better than the other.  

Can you purchase rural loans and make money?  Yes.  Is it a little harder than urban loans as close to the same rural asset?  Yes.  There is not a lot of competition in those assets so that speaks to something if the investor can do a good job of working the loans out.  You will be involved in the loan on average longer than that of an urban comparable.  As such, you will spend more money on it.  Just the same, you may also experience easier opportunities to get the property surrendered.  Do to being far away from alternative housing solutions you may also experience less property deterioration and abandonment issues.  

So there are both pros and cons.  The key is always, on any note, to purchase the loan correctly in a conservative manner to allow for the needed time and advances to take place to disposition the loan.   In that we can, in theory, put a value on any loan anywhere which provides for returns relative to the risks.