My Latest Note Deal (June 2012)
I love creating win-win situations when buying notes, and that's exactly what happened on my last deal.
Note seller sold for $200,000 and took $48,000 (24%) down, carrying back a $152,000 note for 66 months at 3.75%. Monthly payment is $2552.27. Not exactly how I would have written it, but onto the deal.
Like most note sellers, he came into a situation where he needed the cash. In his case, he and his wife ran into some medical expenses that weren't covered by their insurance. They needed about $40,000 to get through their situation.
After 7 months of seasoning, the note had a current unpaid balance of $137,322.06. At a 14% yield, it is worth $108,416.49 to me. To him, that represents a 21% discount, which is a pretty steep discount for an otherwise very good note (his mistake was in only charging 3.75% interest).
Knowing that he only needed about $40,000, I scrambled the numbers, and made the following offer:
I would buy the next 20 payments for $43,000, and when those payments were made, I would have the option to purchase the next 20 payments for $43,000, and when those were made, I would then purchase the final 19 payments for $40,300. After thinking about it outloud, he happily accepted the offer.
To him, it represented $126,300 in money, or "just" an 8% discount.
To me, it represents:
N = 20
PMT = $2552.27
PV = -$43,000
Y = 20.3%
and
N = 19
PMT = $2552.27
PV = -$40,300
Y = 23.1%
In addition, I have 1st position in case of default, and my ITV (investment to value) ratio is a mere 21.5%.
A great "win-win". My only regret was that I did not have enough cash inside my Roth IRA to fund this deal at the time.
Comments (32)
Andre Green Don't mean to burst your bubble but I get about 2 solicitations a week from "note sellers" who are nothing but part of a daisy chain. If your NYC investor is a direct seller (he owns the notes in his name) then I'll be happy to talk to him. My contact information is public and readily available so if he's got a real deal, then I'm ready to listen.
Loc R., over 12 years ago
Loc R. Well I am not going to take your comment personal because I guess you are just going of your past experiences and we have never done any business for you to think otherwise. Hopefully that can change in the future. As for my inquiry I have worked on a deal before with the investor and his company is the direct seller as far as I know. I take great pride in my reputaiton and I hope that I can prove it to you Loc. I would like to chat offline or via email if you are open to it. I want to bring some value to BP and build solid relationships on here. My email is in my signature and I will look for yours Loc. Talk to you soon!
Andre Green, over 12 years ago
Hey Loc R. I have was trying to send you a PM but I am having alot of trouble with the new message system. I have sourced a local investor in my NYC area who is selling notes. I wanted to know if you knew of any BP members in my area that are looking to invest in those assests. Sorry again for crashing the blog. Great info as always!
Andre Green, over 12 years ago
Andre Green - You need to be colleagues with someone to send them a PM, or must have a PRO account to contact non-colleagues.
Joshua Dorkin, over 12 years ago
Joshua Dorkin I am colleagues but I not seeing any names in the "To" field when I am inputing the colleagues name. Any help is appreciated to get messages out Josh. Thanks
Andre Green, over 12 years ago
What happens when you start typing the name? If that isn't working (hopefully we can diagnose any issues and correct them shortly), try going to the user's profile or one of their forum posts and click the PM link. That will make it so you don't need to type it in.
Joshua Dorkin, over 12 years ago
Commercial. There are many different ways to think about the return. I simply do it the way everyone in the note business does it - off of a financial calcuator with the inputs "N", "I/Y", "PV", "FV", and "PMT."
Loc R., over 12 years ago
Loc, Thanks for sharing this nice illustration. This is great for potential new "Loan Lords". Seems your solution was a good way to get a higher yield and lower risk at the same time. Couple of questions. What type of property is underlying this note? In event of default, how does foreclosure process work in a partial note scenario? Lastly, do you use an attorney to review/draft your notes/documents?
Pat Lowry, over 12 years ago
Pat Lowry With partials, it is declared on the contract what the present value of the income stream I'm buying is worth. If there is a foreclosing, I'm 1st in line until I am "made whole" - once that occurs the rest of the balance goes to the original note holder. I only bought a partial, so I'm only entitled to a % of it. I use an attorney to review notes, and I use them to draft up paperwork. Since I've done a few of these now I simply re-use my old docs. The only time I really use an attorney on contracts now is to properly word creative structuring if that comes into play.
Loc R., over 12 years ago
Thanks Loc. I am speaking with a few attorneys now as part of getting started. Was this a commercial or residential property? Lots of discussion on the yield details. Seems to me like it is just the IRR on cash flows based on price paid up front and payments embedded in the note, correct?
Pat Lowry, over 12 years ago
Hi, you'll have a day of math if you're buying discounted notes without a financial calculator. You can look in the instruction of your calculator on the return of a discounted bond, it's the same thing. The note buyer uses the purchase price of the note with the required note payment over the term and solve for i the interest rate for the yield or the APR. The amount of the discount, that amount between the par value or face amount of principal remaining and the purchase is recognized as interest as it is received over the amortized period. The note buyer ignores the note rate except for the computation of the note terms, it is irrelevant to the note holder as to the investment made. The purchase price is entered as the PV, the required payments are entered as PMT and the principal balance is the FV then solve for the interest rate. Now, when you have a balloon payment, I do two computations, one for the payment and the other as the FV of that portion of the principal amount % as represented by the purchase price. If I pay 50% of the remaining amounts due and the balloon payment is 70% of the total amount due I assign 50% of the 70% as the present value, the balloon payment as the future value and enter the term and solve for the interest gives me my yield for that amount, the remaineder is computed as above as payments on that 30% being paid. Then you will need to weight the interest for the weighted average rate of return to get a better picture of the entire investment. Good luck with that...lol....but what I usually did was simply said, it's a great return, you'll see that in your deposits at the bank, that's what counts.
Bill Gulley, over 12 years ago
"I'll take being a LOANLORD any day over being a LANDLORD." Truer words were never said, Loc. I'm absolutely stealing that one from you. Thanks. Jeff
Jeff S., over 12 years ago
Clear as water. Thank you.
T Davis, over 12 years ago
@ronald: Sorry, but I don't understand what you are asking. T Davis The calculations are based on what I bought, which was the remaining 59 payments. You should always start with the original terms to calculate "back" to the current UPB just to double check.
Loc R., over 12 years ago
Loc, good post and I appreciate you sharing the info. Just wondering why the calculations were based on the original amount and term i/o the current seasoning amount and term. Thanks. TA
T Davis, over 12 years ago
nice deal I understand the numbers and how you did the deal with low interest and monthly payments and the seller carried a lot of the money for a certain period of time. Do you know any investors that will front money to buy and sell contracts. What do you say to people to get them to open up like that. I have a note business but I find its hard to get people to open up to why their selling or what debts they owe.
ronald weinert, over 12 years ago
Ping, You should always have an appraisal done. You don't want to buy a $100k loan on a property that's only worth $50k. Make sense? As for books, I always tell people to start with "Investing in Debt" by Jim Napier.
Loc R., over 12 years ago
Loc, thanks! I'll need to buy a financial calculator then. I am very interested in notes too (don't have time for rental) like you. I'm also a Chinese. Could you kindly suggest some educational material or link so I can gain more knowledge? Do you physically inspect the property or evaluate the market value of the property before you purchase any note? Or do you just buy if the discount is good enough?
Ping Liu, over 12 years ago
thanks! I ordered one copy from Amazon.com
Ping Liu, over 12 years ago
Al Williamson: You're giving me too much credit. You only need to know how to punch in the "inputs" into a financial calculator - pretty easy stuff.
Loc R., over 12 years ago
Loc R. thanks for sharing and transparency. Love what you're doing. It would be huge if you would show your calcs in smaller chucks for those of us who only have public school educations.
Al Williamson, over 12 years ago
Mike, yes, you are correct. I updated the post to reflect the #s. I have been so busy trying to close and fund these deals that the details got jumbled up in my brain. And yes, notes are great. I'll take being a LOANLORD any day over being a LANDLORD.
Loc R., over 12 years ago
Hi Loc, Just so you are aware, you updated the amount to $2552.27 in the first paragraph, but in your two breakdowns below you still show "PMT = $2522.27": N = 20 PMT = $2522.27 PV = -$43,000 Y = 20.3% and N = 19 PMT = $2522.27 PV = -$40,300 Y = 23.1% Thanks for the great post and also your recommendation for "Invest in Debt" in one of your other recent posts. I bought the book and it arrived today!
Account Closed, over 12 years ago
Travis Haigler I updated the post - thanks. Too many 5s and 2s in the numbers, and apparently I'm dyslexic. Glad you enjoyed the post. Hopefully I'll have a few more good deals to write about.
Loc R., over 12 years ago
Wow, notes are amazing things. However, I calculated that the monthly payments should have been $2,552.27, which is $30 more than you indicated. Is that not the case? If it IS the case, your returns are even better.
Mike G., over 12 years ago
Ping, I think you are calculating simple interest. I get my #s with a financial calculator.
Loc R., over 12 years ago
Great tip! However could you show me how your calculation is done? I'm brand new and still try to get to the basics. "the note had a current unpaid balance of $137,322.06. At a 14% yield, it is worth $108,416.49 to me." -- how did you get the $108416.49? Is there some kind of spread sheet out there? "N = 20 PMT = $2522.27 PV = -$43,000 Y = 18.9%" how come my calculation of the return is 2522.27x20 = 50445.4, return 50445.4-43000 =7445.4, return 7445.4/43000/1.6(year) = 10.8? What did I do wrong?
Ping Liu, over 12 years ago
You bring up a good point, Ping. The interest rate calculated with the financial calculator gives you the equivalent interest rate that the borrower is paying on the loan of that amount, but apparently not the rate of return on the investment for the note-buyer. Why is that? I think it is because the interest paid by the borrower each month is based on the remaining principal (balance left on the loan). Each month, the principal gets paid off a bit, so the amount of interest paid month after month is reduced. Let's look at a specific example. In the case identified by Loc above, the loan amount (from Loc's perspective) is $43,000, the monthly payment is $2,552.27, the term is 20 months, and the interest rate is 20.3%. If you calculate 20.3% of $43,000, this gives you $8,729. This is the yearly interest that would be paid on the loan if the principal was not reduced each month. Divide this by 12 to get $727.42. So, if the principal is not reduced each month, then every month $727.42 in interest is paid. This means that at the end of a year, $8,729 would have been paid in interest. Right? In that case, the lender (note holder) would in fact be getting a 20.3% return. However, the principal IS going down each month. And each month, the interest is recalculated based on the new principal amount. So, in the first month, the borrower pays $727.42 in interest. In each subsequent month, the amount of interest paid is reduced. After the first payment has been made, the remaining principal is $41,175.27. Calculating 20.3% interest on that and dividing by 12 months gives you $696.55. This is the amount of interest that will be paid in month 2. By the 12th month, the amount of interest paid is only $357.64. This is much less than the $727.42 that was paid in the first month. This means that the actual annual return for the note-buyer is also less. As you were getting at, if you take $2,552.27 and multiply it by 20 months, you get $51,045.40. This is the total amount paid back to the note-buyer on his $43,000 investment. $51,045.40 - $43,000 = $8,045.40 in profit. Taking $8,045.40 and dividing by $51,045.40 yields a 15.8% return over those 20 months, which is not only less than 20% per year, it's not even 20% over the 20 months. It is, in fact, only an 11.2% annual return. Right? Loc, I hope I'm missing something, because now all of a sudden this note buying thing looks a lot less interesting to me.
Mike G., over 12 years ago
That's very interesting. I think without the interest componding, it makes the annual return a lot less. So should we calculate how mcuh we want to pay for the note base on how much anual return we desire?
Ping Liu, over 12 years ago
Mike G. Sorry for the late reply - I was trying to figure out how to best word my response. Thanks to Bill Gulley for chiming in. In addition to the discount being amortized over the "term" I buy, you forgot the original interest of the note. When you combine the interest of the original note, and the discount itself (which is calculated as interest), that is where the 20% figures come from.
Loc R., over 12 years ago
Loc R., I don't see Bill Gulley's response, so I'm not sure if you are referring to (or expanding on) his comment in your reply. In any case, my basic question is this: For the $43,000 you are paying for the note, are you getting any money besides the twenty monthly payments of $2,552.27? If the answer is No, then you are simply not getting a 20.3% return on your money, you're just loaning at an equivalent rate of 20.3%.
Mike G., over 12 years ago
Great Post. Thank you for sharing your strategy
Brandin Johnson, over 12 years ago