How to price a performing 2nd?

[Laurena Davis]

Thank you all for the wonderful information in this forum!

Question: How do you appropriately price performing 2nds? Let's assume a nonjudicial state with seasoned pay history.

Do you price based on a certain IRR, maybe 10%-ish? (I calculate IRR as annual principal + interest divided by Note purchase price. Please let me know if that is the proper method!)

[Victor Ong]

Originally posted by @Andy Mirza:

@Laurena Davis The IRR calculation you mentioned is the yield. A lot of performing note investors are satisfied with 8-12% yields. For a second mortgage, I'd want a higher yield to make up for the risk of being in second position.

IRR is based off of cash flows. You can use a financial calculator or excel to calculate this for you. I prefer excel and you can research the "=irr" and "=xirr" functions. IRR is useful for taking into account the purchase price and liquidation price, as well as your cash flows, to come up with the most accurate, estimated, annualized return rate that you can use to gauge how well your investment is doing.

Because of the extra work and time involved, I don't use IRR even though it's the most accurate. I use Annualized ROI based on my total cost basis for my NONs. It's quick and gives me the info I need.

Wouldn't you factor DCR/CLTV/Term to price the premium on the spread? If the CLTV for both 1st and 2nd falls below 70% and within 1.25 DCR, then the performing 2nd shouldn't face that much risk at 2nd. In addition, we should also look at the duration mismatch between 1st and 2nd.

I personally think mezzanine is the most risky deal since you are responsible for both the 1st and 2nd. However, if done right, mezzanine could be rewarding.