Let's Talk Note Investing

[Chris Seveney]

If there was one feature of note investing you wish there was more information readily available on, what would it be?

[Chris Seveney]

@Don Konipol i purchase both performing and non performing. Right now SFR. Eventually will look to commercial

[Jim Goebel]

@Chris Seveney

I have some questions:

First: How many people buy notes with the intention of that being part of their buying strategy for operating under a buy and hold strategy?  What I'm wondering is if we get some properties with a really strong equity position, say, 1st position and non performing - with the intention of taking control of the property.  I understand at least here that the bank has to bid on the property during the County auction, so I guess in a sense that ensures there's no guarantee that the note investor would be the one taking control of the asset?  I'm just wondering how different the foreclosure process is by area and if anyone does this with the intent of using this to buy houses.

Second: Thanks for mentioning paperstac and Note MLS, I've been browsing those because I wasn't aware of where the actual 'marketplace' for these are - a few acronyms are not familiar to me: what's ITB and ITV stand for and what do they mean?

Third: In terms of buying in a Self Directed IRA; does the foreclosure process become extremely convoluted in working through a custodian on that? Or, is that navigable? I saw on paperstac they integrate with many Self Directed IRA custodians - and said 16% of volume was done this way. Wondering how this route is related to my first question.

Forth: How do you see this fitting in with an overall strategy - it seems Chris that you're doing this primarily but I'd wonder if you can comment on how you see this fitting into a landlord's portfolio?  Just some diversification?  Avoid properties too far away or does that not matter anymore?

[Logan Hassinger]

@Jim Goebel

Answers to your questions:

First: There a number of note investors you use the NPN as a way to pick up properties and add to their buy and hold portfolio. Now you stated that you would be looking for notes with a strong equity position. When a borrower has a good amount of equity, the likelihood of them not putting up a fight for that equity is very low. They could file for BK13 in some instances or use other stall tactics. Your going to have to be looking for an LTV greater than 75% or more IMO. When it comes time for the foreclosure, and you as the lender want the property you would simply set the starting bid amount at or above value pushing out any would be investors.

Second: I would think Paperstac is using ITB as Investment to Balance and ITV as Investment to value  

Third: Foreclosing on a note that is owned by an IRA wouldn't be convoluted. Just make sure the IRA has enough funds to pay for the FC costs and all other related expenses. No different than owning a rental and having to replace an A/C.

Forth: What do you mean how would this fit into your strategy of buying buy and holds?    

[Brett Burky]

@Logan Hassinger

Thanks for jumping in and providing the acronym meaning for ITB and ITV.

We might need to make that more clear. Noted and I will be bringing this up today as something to add for clarification.

[Tim S.]

@Jim Goebel  Can't say how many note investors buy notes with the intent to take the house back. I'd guess most would prefer to NOT get the house back.  It's usually more profitable to just get the note performing again, and collect the payments, and/or sell the note after it becomes reperforming, and is seasoned at least 12 months.  It's expensive and time consuming to go through the foreclosure process.  FYI - Note owners (the bank or investor) set the minimum auction price, if no bids over that price then ownership reverts to the note holder.  This may vary by jurisdiction.  

Some do look to get the house and sell it with owner financing.  This gets them out of the landlord role, and become a note holder again.  Note investors usually don't want to be responsible for the house, its maintenance, taxes, renters, etc.  Rather just deal with paper and collect an income stream. 

As Logan said, If your goal is to get the house back then it would be better if the borrower had no equity.  At that point they don't have skin in the game, and are more willing to leave without a fight.  A guy with lots of equity isn't likely to let the house go, they will fight to keep their equity.  

[Jim Goebel]

@Logan Hassinger

@Tim S.

Thanks for the input.  I've got some follow up questions, too.  Firstly, I'd like further clarification on the statements about an owner with significant equity.  I'm seeing some notes for sale with non performing firsts, with say an unpaid balance of 30% of the property's value.  I understand that the owner may know they have equity and won't willingly give up the property - but if the note is non performing, I'd like to better understand how this goes (please weigh in to confirm my understanding of 'ways' this goes').   More specifically, I don't understand the statement (used twice) that they will 'fight' - I guess, what I don't understand about that is that they signed a mortgage and are in default.  How can they fight?  If anything, perhaps they can stall?

With regards to the main 'ways' a note can go (say for buying 1st position non performing) ; please confirm my understanding below:

First option would be they find another lender, source of funds, and pay off the whole balance - does this ever happen?  Is this a big pay day for someone buying that non performing loan at a steep discount?  Does this ever happen?

2nd would be they never pay.  I'd like to better understand the time horizon of how this might go.  Someone mentioned bankruptcy protection - I'm wondering best case, worst case-  does it depend a lot on the state as to working through the process?  I can't imagine a bankruptcy court not giving the asset (eventually) to the first position lien holder, right?  I mean, is there any risk of being wiped out as a 1st position lien holder and not getting control of the asset (or at least getting the option to take the asset to competitive bidding market?)

3rd would be they get back on a payment schedule, whether its a modified one or if it's getting back to whole.  

Of these three, for those investing primarily in 1st position non performing, what are your biggest money-makers, in terms of outcomes, what do you really try to avoid, and why?

Also, I'm picking up that most folks in this world aren't too picky about their geographic area.  Seems a little risky to me to not do detailed macro analysis on a market, to at least get a feel for the trajectory of the prices backing the assets.

Thanks for all the info.

[Logan Hassinger]

@Jim Goebel

No note is the same and requires it’s own due diligence so when I say the borrower my “fight” the foreclosure when there is significant equity, I use “fight” in a general sense. Also, I’d like to add that I purchase NPL’s with the intent of getting the borrower reperforming but have to be willing to ultimately own the property. I don’t buy NPL’s on properties I wouldn’t want to own. 

2 Scenarios

1st: UPB of 200k with Property Value of 600k

2nd: UPB of 20k with Property Value of 60k

In both scenarios, the borrower has a 30% LTV. However, let's take a look at the type of borrower in each case. Borrower 1 most likely has a 6 figure household income (or did before going into default). Borrower 2 likely has under a 6 figure household income. Borrower 1 likely has the means to pay for an attorney to review the all documents related to the FC. Borrower 2 simply thinks that they are in default and there's nothing to be done but lose their home. Borrower 1's attorney decides to initiate BK but never filed (this goes on for months to stall). Or Borrower 1's attorney finds that there is a missing AOM (assignment of mortgage) in the chain of mortgage ownership. Therefore the current lender has no right to begin the FC process. Now current lender has to rectify this issue.

A number of things can go wrong when a mortgage is traded numerous times like a break in chain of title, missing allonges, missing note, etc. 

My point is that depending on the situation, you just never know, which is why your due diligence on the note and property before purchase is essential. 

1st Question/Answer: Yes the borrower can find a way to refinance the current lender out and you as the NPL holder would be making the spread between what you purchased it at and the payoff.  It does happen but I wouldn’t build a strategy around this outcome.

2nd Question/Answer: Depending on the type of BK filed, 7 or 13, then this changes things. Chapter 7, in general, means you as the 1st position lien holder will eventually get control of the property (depending on the state). Chapter 13 is likely to drag on and the borrower wants to stay so they are now negotiating with their creditors for reduced payments, called a “Plan”.  If that borrower performs to the plan, then you don’t get the property. 

3rd Question/Answer: When it comes to my overall strategy, like I said before, I want the borrower to stay. But I'm also okay owning that property at the end of the day if we can't work out a plan. As far as the best money makers, for example, back in March I purchased an NPL on an investment property in Asheville NC where the borrower was 10 years behind (Prime example of a borrower stalling and other things going on). I purchased the note for 173k with a UPB of 254k and a legally collectible balance of 450k and a value of 260k. I had no intent of working with borrower given my review of the collateral and speaking with the seller and knowing the situation. This deal was no brained, even though it's not my core strategy. 6 months later the property went through the auction at a starting bid that I knew would allow ownership to come back to me. I then listed and sold it in August for 250k profiting 63k. By far this is my best deal and on average I'm looking to make around 10-15k/note with collection of payments and resale of the performing note 12 months later.

 You nailed it, you absolutely need to know the market your going into. I’m in 5-6 markets across the country and I keep up them on a routine basis. 

[Tim S.]

Fight, yes they can stall the process significantly.  You'd have to pay legal fees to get things moving, could be several thousand dollars $4-8k is pretty standard.  Timeline, 6 months best case, 12-16 months is the middle of the range, some states are well over 2 years.  

They could file BK 13, which stops the foreclosure process.  If they fail to complete the BK plan, you can continue with foreclosure again. It's possible they can file for BK again, depends on the jurisdiction to some extent.  They could stall for a year or 3 with some payments coming in.

Pretty tough to find a lender if they are significantly behind on payments, who's going to give them a loan?  It is possible though. 

Getting them paying again is usually the most profitable, not always.  

What to avoid, people have different criteria, common ones are: long foreclosure states like NY, NJ.  Very low monthly payments.  War zones, very rural areas. 

In terms of geography, to some extent you have to take what's available. It's not like properties where you can find them everywhere on the MLS. The "good areas" are often purchased by the big players in large pools. What trickles down to us small fish are the dregs. Money can still be made, but usually you aren't going to have access to notes in desirable areas. Desirable being very relative. You have to re-calibrate what desirable means based on what assets you have a shot at bidding on.

I see Logan was typing his answer at the same time, his is better, but I'll leave this here anyway. 

[Jim Goebel]

@Tim S.

@Logan Hassinger

Thanks guys I really appreciate it.  I feel I've learned more from this topic/thread than from all the rest of my time put together trying to learn about this note investing stuff.

Still more questions, though...

So, firstly, what would be my best vehicle to search for notes that are specific to my area (currently central Iowa, Des Moines market)? Two platforms were mentioned: Notes MLS and paperstac earlier. Are there more? Is there a parallel analog to getting criteria set up on the MLS and getting notes sent over via a filter?

Second, I feel that I want to better understand that 'end' of the foreclosure process and how that affects ones' returns.  At least in Polk Co here my understanding is that the lender has to offer the property for auction, and sometimes takes control if they're the highest bidder.  So, just thinking out loud, let's say that the note that someone paid $60k on, has a house that maybe is worth $150k.  Let's say that note investor does their diligence and then decides (please confirm, do they decide?) to offer the property for $80k, which is a number that if someone bids higher, they're ok selling at, at which point they make that $20k of course minus costs up to that point.  If no one bids, the note investor takes the property - however what's still kind of confusing me is, does this mean the note investor has to pay the county the difference, or does what is usually paid to the county here go towards the lender to make them whole?

Also, I would be curious of how the above changes from location to location?  I'm mainly just sharing my anecdotal experience from Polk Co in buying stuff at auction. 

Interestingly I'm looking at this note investing as a possible avenue to get into the mix in acquiring properties, perhaps, and to diversify.  We're dedicated landlords and like our portfolio, and have no intention of wanting to move completely away from that.

I'm also wondering about the more dedicated outfits that do note investing, too.  

@Chris Seveney

Chris maybe this more applies to you, or others.  But I pick up the vibe that some note investors pool funds from others so that they can then invest in larger pools of notes, perhaps getting better deals?  I'm a little confused why this would be a fit for someone just starting with note investing, vs getting into the diligence and some of these platforms like paperstac, etc oneself?

Also, wouldn't that pooling funds from others make it an area ripe for fraud?  That's been one of my main concerns to date, but I really do appreciate sharing the info about platforms like paperstac, etc. as it allows me to see the market.

[Chris Seveney]

@Jim Goebel

1. Foreclosure process varies by state. As a note investor it is not my goal to get the property back but to protect my investment which in many cases is keep the borrower in the property and try and work out a loan modification. 

2. ITB and ITB were answered elsewhere.

3. The foreclosure process as noted above is not convoluted when working with your IRA funds. The source really does not matter you should treat a FC the same. Hire a lawyer and let them do the work.

4. I believe every investor should have a balanced portfolio that fits THEIR needs. A portfolio of a 30-year-old will be very different than one of a 70-year-old. What most people fail to take into consideration is risk. People only look at the numbers or the cash flow or returns without looking at the risk in the deal. This is where people get crushed. This is also why people should have a diversified portfolio. 

5. If you are a new note investor, I do not recommend you START a fund. My comment was to look at potentially investing in a fund. Why is that? If you intend to JV on a deal it is one deal and if it goes south then its a bad deal. If you invest with someone experienced who has a fund you're investing in every deal in the fund. Goes back to less risk. BUT whoever you choose to invest with (if you do) make sure you do a background check on them just like you would a tenant in one of your rentals. Also ask them for sample reports they provide and references. Some will say they will not provide references. That is a HUGE red flag. 

You can also go at it alone, nothing wrong with that, that is how I started. If you go at it alone, I recommend using your own funds before using someone elses.

[Jay Hinrichs]

@Jim Goebel  at least in all the states I have foreclosed our notes in ..  the max minimum bid for a property is determined by the note.. you can lower the credit bid but you cant raise it above what your owed vis a vi note terms and expenses.

Any money bid up above what your owed goes to the next in line if their are junior creditors.. Not to you as the note holder.

[Logan Hassinger]

@Jay Hinrichs  You beat me to it.
@Jim Goebel

Jay is absolutely right about the auction process. If the property really is worth 150k as-is (NOT ARV), and you want to cash in on the spread between what it's worth and your note purchase amount, then you would set the starting bid at or near the ARV to ward off any potential bidders.

You then take the property back and sell at your desired price. 

Does that make sense?

[Jay Hinrichs]

Originally posted by @Logan Hassinger:

@Jay Hinrichs  You beat me to it.
@Jim Goebel

Jay is absolutely right about the auction process. If the property really is worth 150k as-is (NOT ARV), and you want to cash in on the spread between what it's worth and your note purchase amount, then you would set the starting bid at or near the ARV to ward off any potential bidders.

You then take the property back and sell at your desired price. 

Does that make sense?

yes you can only set the Max bid at what your owed it has nothing to do with fair market or anything else. 

back in the GFC banks were lowering bids so they did not have to take in the inventory.. then you have step bids.

that's were the bank or lender will show an opening bid very low.. if anyone bids they step up the bid to their max credit or will bid up to the max credit.. frustrates the bejesus out of courthouse steps buyers..  

[Account Closed]

@Logan Hassinger Hi Logan! Great post. I was looking into notes as well, how do you find notes? Do you cold call banks or are there any reliable search systems? I've found a few but there doesn't seem to be anything thats used across the board by everyone. 

Is there any content out there that you can learn about the process of buying notes/etc? 

Thanks for a great read!

[Tim S.]

@Account Closed  As a newbie I think the hardest part of note investing is finding sources.  There are a few on-line sellers, mentioned already, the product there tends to be less than desirable (not always though).  

People that have been in the business a while develop sources, but aren't likely to tell you what those sources are, since it takes work to develop those relationships.  So newbies are often left with the not-so-great stuff that others have passed on. 

@Jim Goebel Yes there is fraud, see the recent revelations with Scott Carson. In addition to investing in funds, JV deals are common. An investor like yourself, puts up all the money for an asset, the experienced note person does all the work and the profits are split 50/50. As Chris mentioned you need to do a background check on people you give your money to. You're more likely to better learn about note investing this way, with the right person, but higher risk since all your eggs are in one note basket vs. a fund. I've been on both sides of the JV relationship, I don't want to be responsible for other people's money so I don't do it anymore. I find it too stressful, investing with my money is fine.

[Bradley Ritter]

@Chris Seveney can you get a heloc on a note???

[Bradley Ritter]

@Logan Hassinger can you get a heloc on a note

[Chris Seveney]

@Bradley Ritter

In the past banks may hypothecate (lend on a note). I am not aware of any lender for single family residential who will (commercial different animal).

It’s like Bigfoot, people claim it exists on single family but no one I know in the past 3 years I have been in business has provided the name of a lender who does

Your best bet would be to sell a partial.

[Logan Hassinger]

@Account Closed

I appreciate the positive feedback. From a new note investor’s perspective (which I was 18 months ago) I get the feeling of lack of info on deal sourcing, due diligence, and pit falls, as this business is a small niche in the grand Real Estate arena. 

When it comes to sourcing notes, I cold call/email banks and hedge funds and a number of other related parties. Like it was mentioned above, it takes time to build the relationship with direct sellers. So unfortunately I won’t be sharing my sources lol. 

Potential sources can come from institutional, large l and small private lenders and even a local investor who creates their own owner financed paper. 

[Andy Mirza]

@Jim Goebel It's important to remember that note investing and real estate have some very important differences. Going from real estate to note investing requires a significant shift in thinking. It's a mistake to go into note investing with the sole intent of getting control of the property. It can be your main intent if you'd like but you have to be ok with holding or working the note if the borrower reinstates or re-performs. When you buy the note, you are buying the rights of the lender as outlined in your contract. You're not buying a straight path to owning the property. 

As to developing contacts for institutional notes, you should consider going to one of the many conferences for investors in the secondary loan market. I prefer the IMN conferences. If you do some digging here, you'll find the other conferences that guys go to.

[Jim Goebel]

@Andy Mirza

@Logan Hassinger

I was having a conversation with a friend and investor the other day, and he stated that there was some risk of getting 'wiped out' in a bankruptcy situation.  Is there any risk whatsoever of losing the entirity of one's principal investment in notes?

I'm not talking about fraud in investing with someone else, but rather, buying a note, and then - basically my question is what is the absolute worst case scenario?

[Don Konipol]

@Jim Goebel

First, let me to address the question of foreclosing to own the property. If there is significant equity in the property (REAL equity), then there will probably be numerous bids. If you as the lien holder foreclosing bid say $100,000 to pre empt other bidders, and you are owed say $50,000, the $50,000 overage goes to lien holders in inferior position, than what’s left goes to the borrower. So, you’ve arguably bought yourself a property at “auction market” value.

Now, the question of being “wiped out” absent fraud. For my own portfolio, and the portfolios of the funds I run, I have originated or purchased over 500 notes, 85% commercial. In three instances we lost a significant percentage of our investment. In one, the apartment complex burnt down, arson investigators accused the property owner, and hence insurance refused to pay us. In the second case, the parties filed multiple bankruptcies,showed the courts proof of insurance, and when the property burnt down we found out that the insurance proof provided the court was forged. Interestingly, this was 10 years ago, the party accused worked a plea agreement to avoid jail time, and we just received the FIRST payment under the agreement. At this rate I would have to live another 455 years to be paid in full! Third instance, borrower dies, probate tie up in Dallas County for 2 years, property deteriorates, county levels property. So rare, but can happen.

[Sean Mcintire]

@Chris Seveney "... getting assets at very good pricing."

what do you consider very good pricing and if it'e below 40% then how do you get it?  Decent quality assets?  bulk purchases?

THanks.

[Chris Seveney]

@Sean Mcintire - 

Two ways

1. Bulk purchases

2. Taking on stuff that has some hair. An example is buying a loan that has some cloud on a title but can be resolved by some additional research and work or hunt down a signature. Most people fall into two categories- 1. Lazy and 2. Too big to deal with minutia like I mention and will let someone else take care of it and sell it discounted because it’s not worth their time and effort.

If you fit into 3. Work hard to solve problems you can find assets at lower cost and put in the sweat equity 

[Jim Goebel]

@Don Konipol

So if I'm to understand, the most you could get out of that auction process would be the property, perhaps at a discount IF you don't get outbid.

However, if someone else outbids your initial bid, that extra money (relative to the balance) in no way goes to the note investor.  It would go to pay off the note investors balance (say if it was in first position), then it goes to junior lien holders, then finally, to the borrower?

Personally I'm confused why that extra money would go to the borrower.