Rental Property Acquisition via Non-performing notes- Birm, AL study

Hi all!  Our primary business is buying (and sometimes selling) existing mortgage notes.  In general I think this is an investment every real estate investor should understand and consider as we routinely get 6-9% ROI to our investors on truly passive investments.  However, I know lots of you BPers are looking for real estate deals.  I want to share a recent deal we're thrilled with in Birmingham, AL.

We started this journey by buying a non-performing note (NPN) from Colonial in June, 2016 for $11,000.  The note selection/due diligence is an involved expert topic and while I'm happy to answer questions on those issues, this topic is about long-distance, remote landlording.   I am in Phoenix, and haven't been to Birmingham in 35 years.  The collateral was worth about $35,000 by BPO and online evaluation methods.  So we bought the note for about 30% of the value of the house-  good security.  The house was occupied and the borrower was about 2 years delinquent on his payments.  Whenever we enter a NPN deal our first steps are to try to get the note to re-perform.  This usually gets us returns in the 20% range, this note had 120 months remaining, so re-performing would have been a great ROI for 10 years.  Initially, the borrower was responsive, but after my servicer sent him a default notice, he stated he was moving out.  It took a couple months and $600 in legal fees, but we took possession of the house in late September, the lockout/property secure crew took pictures and the house wasn't trashed.  There was some cleanout necessary basically polishing of the apple.  

Unfortunately, while I was getting the contractors lined up for a December project, someone stole the a/c unit, so that needed to be replaced- this was my biggest expense and is apparently not that uncommon in the East Lake neighborhood of Birmingham.  I found a used unit and a very inexpensive installer and got the problem fixed and secured (big cage with locks and welded shields on the locks) for about $2400.  I have contact info for the AC guy if anyone's interested.

I identified my main boots-on-the-ground guy through Thumbtack.com.  Joel Burnett and several others walked the property, took pictures, suggested tasks and gave me bids.  Joel went the extra step of talking with the neighbors and getting me a pretty good feel for the property's history and neighborhood.  He was also the low bid and included materials in his bid.  We agreed on $2300 with payments 1/3, 1/3, 1/3 at satisfactory completion.  Joel completed his work promptly and well and confirmed completion by sending pictures.  The ability to get real-time pictures of progress and issues really lets us be there virtually.  The property was to be rent-ready- safe, secure with all systems working.  Cleaned, painted interiors, new blinds, repaired simple defects, pressure washed exterior.

After the house was rent-ready we posted hand-written for sale and for rent signs in the front yard.  For sale text-  For Sale by owner to deserving buyer with large down payment.  Call (my local number from phone.com).  We got a number of potential buyers on this sign but haven't received any completed loan applications.  For rental marketing used sign, craigslist and gosection8.com.

Our typical sale terms would be substantial down payment-(not $500, want $5000), balance financed over 10-15 years. We push the interest rate and get the payment to a comfort point for the buyer.  Like the interest at 9.9%.  Sale price in this mode would be 45k resulting in a 40k note that we would age for a year and sell as a performing note or partial.  We would sell a 72 month partial on a performing note like this for 23k and the investor would earn 9% as mailbox money.  I would have all my investment back (about 16k) and a profit at this point of about 12k.  I would also be entitled to monthly payments after my partial investor had gotten all his money out (that would be another 60-90 months at a monthly payment of $416 (25k to 50k).  

But, good things happened before I found a retail seller-financing buyer.  Got tenant application from two middle-aged guys to rent the house for $550/month.  The tenant screening process was done through Houserie.com.  Coming to grips with the tenant quality reasonable for a property like this took some discussion with my partners and colleagues but these guys worked out.  Automated the payment process through Surepay at their bank (Wells Fargo) and am holding first months rent plus deposit- $1100.  Score!  I'm sure you guys know the landlording pitfalls better than I do, but if things work we're looking at $6600 gross on our investment of about 16k!  After 2.5 years collecting rent my CCR goes to infinity!  Joel has agreed to be my boots-on-the ground fix-it guy on this property so I will self-manage for a while.

If these guys prove to be stable tenants I will put the management to a local company, get a good paper trail on the financials for a year or two, raise the rent to $600 in year two and market the property as a turnkey rental to an investor.  Assuming reasonable expenses and management costs I model an annual NOI of 4k.  At a 11 cap rate to the investor, my sale price is $36k.

We finance these turnkey deals on a 50/50 model.  The investor gets a standardized seasoned turnkey rental for 50% down and the balance paid by the rental income over a short term- typically 5-7 years.  We get loan payments equal to the NOI at a reasonable investor interest rate (6% currently) and the investor has a free and clear turnkey rental property after 5-7 years.  Typically a happy outcome.

At this point I would be happy with a number of exit strategies-

• Long term rental- Cap rate of 10+, with IRR of 62% with sale after 20 years
• Turnkey rental sale-  about 10k of net rental income, 17k down in two years, $4k/yr for another 5-7 years.  IRR of 51%
• Rent-to-own- push rent to $650, credit $100/mo to down for 36 months, finance sale to seasoned tenant- push price to 45k, payments of 480/mo for 12 years (sell 72 month partial).  IRR of 48%

The key to these yields is buying the property through a NPN for 30 cents on the dollar of collateral value.