Should a Performing CFD be Priced The Same as A Mortgage & Note

Question

Recently I have been reviewing pricing of assets and I see many sellers pricing a CFD the same as a traditional mortgage and note. Am I crazy as I would never pay the same for a performing CFD as a performing note.

As a side note, I do see larger institutional investors buying up a lot of the performing notes but they will not touch a CFD with a ten foot pole (which is why I see a lot more CFD's currently for sale). I wonder if this is the reason why people are pricing them so high - thinking there is demand.

I typically sell my CFDs to investors at 13-15% returns and performing at 10-12% to give people an idea where I am at.

What are your thoughts?

Chris Seveney · Answer

@Ned Carey

Regarding the borrower:

1. Low credit and cannot get conventional financing.

2. Little to no down payment

3. Have no idea what they are signing

4. Unable to get insurance so must be through lender

Regarding the property

1. Typically in non liveable or poor condition

2. Sold at a price above market rate so negative equity

3. Jurisdictions more apt to levy penalties/ fines because they view it as out of state owner since borrower not on title - so any violations are sent to you since you home title.

Regarding collateral

1. Usually title issues as passed on by quit claim deeds

2. Typically have existing liens or back taxes

3. Paperwork not drafted by an attorney or using standard template state by state which leads to problems - for example a note is not required but some add it which creates confusion and legal issues for attorneys

4. Typically not recorded documents which lead to issues

John Sayers · Answer

CFD is often used when a buyer may not fully qualify for a conventional loan. That alone could  potentially add risk.Also, the property seller (or CFD holder/owner) still 
retains legal title to the property as far as I know. Ownership only passes to the 
buyer after the final payment is made. This makes the risk profile quite different. Unlike a reg mortg, the CFD owner can be on the hook to local muni's, taxing authorities etc.  Things a traditional lender is not liable for.

With liabilities and risks being different and higher to the lender, all other things being equal, I'd take the conventional notes if they all get priced the same.

EDIT: now saw Chris reply minutes ago, so what he said LOL

Jay Hinrichs · Answer

to Clarify these are new originations  not exiting notes  different sand box ..

Andy Mirza · Answer

We don't buy any CFD, only notes. Maybe one day I'll learn enough about them to understand the risks but I haven't got around to it yet. Not sure if there'll be a reason to. Too many notes to buy...

Jay Hinrichs · Answer

count me in on the CFD are not a wise investment at all with a ton of risk for most investors.   there is a reason the pro's dont buy them.

if I was to buy one the return would have to be north of 25 to 30%  not 15 or under you can find that or get close to that with fully insured recorded first mortgages  why take the risk..  ???   and of course beginners in the NOTE business really dont understand the risks ..

Jamie Bateman · Answer

With CFDs there is a higher chance of default and generally lower collateral value. More risk, more work, more liability = higher required yield for me. Yes, there are instances where the eviction/forfeiture process is less expensive and faster, and theoretically there can be more upside, but on the whole, those factors do not make up for the negatives. Pricing should reflect all of this and typically does from what I’ve seen.

Chris Seveney · Answer

@Jay Hinrichs

I recently saw some assets originated in last 24-36 months that were performing but the originator has class action lawsuits pending against them in the state for predatory lending. The seller wants to dump them (they have been bought and sold several times - geez I wonder why) and they have no origination docs and is selling them at 8-10% yield. Umm I think  I will pass. As you mentioned if the first number was not a 2 (as in 20% min) not worth the risk or my time. They can keep them.

Jay Hinrichs · Answer

YUP you have two bummers in one deal.. you have dead beat seller ( not always of course but if your talking these low value beat up homes in semi hood areas then yes) and you have the marginal borrower you described.. so since title stays with the dead beat original owner who knows what mayhem they could cause to the title and force you into a foreclosure or quiet title just to remove their crap.. in the right circumstance they are OK  know the owners well know the borrowers..   And I have sold on CFD quite a bit in my Land and Timber days.. I was not worried about me causing problems but it could have happened I could have had an upset and someone clouded title.

So it just adds another element that does not benefit the investor..  But for sure there are CFDs that have value.. and are good its not a blanket they are all bad..  But when your dealing in Sub prime defaulted  high risk paper it jsut adds an element

Randy Rodenhouse · Answer

@Chris Seveney

I agree that CFD are riskier and should be priced accordingly.  For a long time, I would only buy at 15%+.  I would now buy them at 12-13%+.

@Jay Hinrichs.

If you are buying in this market institution notes with 15%+ yields …God bless you.  I have not seen that kinda return in awhile.

Ned Carey · Answer

Why is a contact for deed riskier? Is it lower underwriting standards?

Should a Performing CFD be Priced The Same as A Mortgage & Note

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