Do I have enough capital to enter the area of Notebuying?

[Marcus Perkerson]

I have $70,000 in capital to invest in buying notes. Would that be enough to get into note buying? I recently retired and I like to augment the income I receive as a landlord. I don't want to purchase anymore tenant occupied properties. Thank you in advance for any information provided.

[Bill Gulley]

Hi, very good points above. As to the original posted question, yes 70K is enough to get into buying a note or several. I am assuming that you want to get "into the business" and not just as an investment for your own portfolio. If you are going to borrow funds to acquire notes, you'll need most of your cash on hand as reserves to carry the obligations you have vs. the income created from the notes (principal, interest, late fees and other assessments, if any). Here are some considerations/very simple guidelines I used in the business.

The yield spread between the cost of funds to the yield earned should be at least 25%, for example, if you are paying 8% on your money, you need at least 10%, more is much better. At such a low margin, fees should cover costs of adminstration and if fees can not be added (as with newly originated loans that will be purchased) such costs should be added to the yield requirement.

If borrowed funds are limited (to the extent that you have the capacity to manage a larger portfolio without additional costs) the accepted yield should be maximized within a risk tolerance generally accepted in line with secondary market guidelines, where the borrower is at a debt ratio of 36-40% and at a LTV (CLTV) of 80%. This can be accomplished when buying purchase money notes at closing or shortly thereafter, when borrower information can be obtained. Seasoned notes, where borrower qualifications are unknown, the LTV (CLTV) should be viewed almost as a purchase price with costs of acquistion being considered as well.

Additionally, when relying on purchased note income for your debt coverage, I suggest you use a debt coverage ratio of 130%. If your debt requirement is $1000.00, your note payments need to be at least $1300.00 for P+I. (No, a target yield requirement of 25% mentioned above is the minimum on one note and the cash flow from the notes purchased also includes the effects of the amortized period being shorter than your obligations since your assets need to exceed the offsetting liabilities at all times). That is basically from a cash flow basis. You also need to cover your debt service in the event of default of any one note purchased.

For a small portfolio (say less than 5 million) this reserve amount is difficult to ascertain especially when borrower qualifications are not known.

As to subordinate debts (seconds) some states allow for the assumption of underlying liens in the event of default of such obligations. The ability to assume these obligations from all sources of cash need to be considered and for a period of time necessary to dispose of the collateral. Knowing the local market is key in this consideration. Where you may be required to take out the underlying lien to protect your interests (and that of your investors/lenders) holding funds available for acquiting costs (foreclosure, attorney fees, title search and costs of disposition) should be viewed as a fixed contingent cost of one incident per five to six loans initially, and then allow this reserve to float to about five per cent of the number of loans in the portfolio.

As to buying out any underlying obligation, your ability to borrow is a key factor. This should be done with a letter of credit, not a personal assumption of your ability to acquire future funds! Without the availability of funds being assured, I suggest that small investors stay away from subordinate obligations if statutes do not allow for the assumption of underlying obligations.

As to yields on purchased notes, my average yield was, over a ten year period, about 35/36%, including fee income from late payments and insufficent funds charges. These were notes that were purchased at or shortly after settlement.

Consider this...a note made at 10% amortized for 240 months for 25K is 241.26. If this note is purchased after 10 years for roughly $7,100, you'll have a 36% yield on your investment. This can be done regularly and safely. Granted, to find such notes, you'll need to be creative, but if you find sources of notes where the seller is motivated, this is not hard to do. As an example; Divorce, estates, bankruptcies, buy-sell agreements between business partners and governmental issues such as IRS liens and medicare issues. Here is a little known fact and source for you.

There are many people who end up having to go to nurising homes for long term care. If they are uninsured (this is not a health care issue, it's a disability issue), it can wipe out almost anyone who thinks they are financially secure.
States require that a "client" receiving assistance have no more than $999.00. Having sold the farm and carrying back a note will likely keep them from qualifying for assistance. The mortgage payment of $300.00 per month does not come close to paying the expenses of the care required. The only option available is to sell the note and USE THE ENTIRE NOTE SALE PROCEEDS to pay for costs until that client reaches the $999.00 asset level! No one benefits from the sale of that note except the state. Arrangements can generally be made with the trustee or family of these persons at very low purchase amounts and time is of the essence in these situations. The state may not set a fair market value for these kinds of assets, there is no book value nor is there an appraisal of such instruments (at least not now because I no longer provide such appriasals)!

So, as to the original post (I know you thought I forgot about the topic) do you have sufficient funds? Yes, and you have sufficient funds to get into the business of buying notes as outlined. You also have sufficeint funds to simply buy some notes for your personal investment, but consider your reserves, I'd suggest you use 35 or 40K and keep the balance in another liquid investment (unless you have such reserves)

Sorry it's too long but it's the tip of the iceberg! Good luck, Bill