All Forum Posts by: Scott Arpan

Jack,

The price you will receive for your note will mostly be a function of the down payment, strength of the borrower, interest rate and amortization. I will leave property type, location and condition out since those variables you can't really change but will impact an offer.

If the transaction is subject to Dodd-Frank use a RMLO to complete the transaction. If the note is serviced, have the buyer pay all the monthly fees. Any fee you pay out of your check will be discounted when you sell it unless your servicing is closed. Some investors will only use their own servicer.

Also the sale price needs to equal the true market value at time of sale. Inflating the sale price and giving your borrower less true equity will lower your offers. If you include a balloon payment, make certain it will be easy to refinance when it comes due.

To have much of any interest from note buyers at a good price you want 10% down and an rate north of 7% with an amortization of 10-15 years. If this is commercial property 20% down and bump the rate up to 9-10%; land notes will be tougher.  If your buyer and property qualify for bank financing, you are better off going that route.

Hope that starts you in the right direction. Good luck

Stacy,

The price SF note investors will pay depends on many factors. These factors will help the investor determine their perceived risks regarding if the note will default and if the note defaults, what are the risks of at least being made whole if they foreclose and liquidate the property. I will give you some background to better explain my conclusion how note investors will receive your note.

Items that will help access these risks

• The credit capacity of the borrower- how have they treated other creditors? Are they living within their means?
• The borrowers’ ability to earn a steady income that is not likely to end in an industry or economic downturn. If they are laid off, are their skills transferable to other industries. If they jump from employer to employer I watch out.
• The amount of borrower’s equity- how much of a down payment and equity from paying down the note. I don’t count on appreciation but some might.
• Borrower’s pay history. The more documented on time payments tell me they can handle this debt. With new loan I have no idea if they have truly budgeted all the expenses for the property. Past due property taxes say a lot about borrower’s ability to manage the property and their finances.
• Is there any chance mortgage regulations were not done properly? This risk is high for RE investors using SF to liquidate multiple residential properties. I have seen many landlords selling off their portfolio of houses and 2-4 plexs using SF to maintain cash flow without tenants or toilets.  Most seem to have no clue about complying with Dodd Frank or other consumer mortgage regulations. That will kill the deal.
• Loan terms:

1. Amortization: a 10 to 15 year amortization is much better than 30 where buyer is not gaining any equity from his payments at the start of the loan. Also, payments from years 15 to 30 are worth pennies on the dollar in present value terms so create a large discount.

Interest rate. If the buyer is willing to pay high rates, (9ish% and up) sets off alarm bells about possible default for residential notes. Most higher interest rate residential paper I have seen seams to end up in default. Some commercial property secured notes can justify higher interest rate if the cash flow is there and the venture is well managed just like a HML

Balloon payments- If it appears the borrower will not be able to refinance a balloon payment, most note investors will only by the payments leading up to the balloon or price as if the note continues to amortize out without the balloon.

• Property value must equal true/real market value. Some sellers try to inflate the sale price to receive a higher offer from a note buyer. If the loan is underwater in real market terms, there are no buyers unless you sell your note for pennies.
• Property type- If I take the property back, how quickly can I liquidate it with no or minor repairs? Is the roof leaking where that I need to address immediately with big bucks to prevent further damage? Is there a lot of functional obsolescence in the property to fix before I can sell it at all? What are my legal and holding costs? I expect a rehabber or bottom fisher to be my likely buyer.
• Property location- is it close to major infrastructure and markets or out in the middle of nowhere? When available, I find the number and types of crimes being reported in the neighborhood. High crime areas get no offer unless it is industrial land.

As a rule of thumb, no SF note investor (I know of) will go beyond 70% ITV for any note right now unless it is gold plated. Yours being new with a small down payment would like only receive offers to purchase the next 48 to 120 payments where they could keep their investment blow $60K. If you got 20% down on the property’s true market value, you could probably sell your entire note for 65 to 75 cents on the dollar for a 30 year amortization. A 15 year amortization could bring you 75 to 85 cents depending on the strength of the borrowers and property.

Hope this helps,

Scott Arpan

@Darren Eady@Darren Eady

Are you creating your own paper or buying existing SF or institutional type loans?

I could not agree more. I started 20 years ago and never could justify buying properties as the return for your time and risk are better IMO. 

The discounted yields on SF notes seem to range from 8% into the 20's and up.  Institutionally created notes have a different set if issues to contend with so I can't speak to them.

@Robert Breen

If the seller is not in the business of creating loans and is not defined as a builder i.e. “…has not constructed, or acted as a contractor for the construction of, a residence on the property in the ordinary course of business.." you should be okay. I would not feel comfortable table funding the note transaction but would want a payment to come in before finalizing the note purchase.

I have stayed out of the unseasoned note space because it is usually not an economically efficient model for the seller. In today’s market the seller may get 60 cents on the dollar for an unseasoned note. To get more they need to find a buyer willing to pay 10%+ interest but be credit worthy enough for some type of conventional financing. Real bad credit could be offset by 30% cash down but that buyer is scarce. The other options are to sell at a price far exceeding the true market value of the property or claim the property is totally repaired when in fact major problems were cosmetically covered up so they would not be found until the seller was long gone.

Not that you or your sellers would do this but that is my mindset on notes with little seasoning. Seasoned notes have far more value in my mind.

The only feasible option if you wanted at least some cash fairly quickly would be to sell 4 to 5 years of the note. This assumes there is not much debt on the property now.

Bill- Are there specific federal rules for seasoning before buying a note is note considered outside of table funding? Would the amount of seasoning matter if the note was being created with the intent to sell to the investor ASAP versus a mom and pop type seller who carried a note one time without the thought to sell it then decided they wanted to sell it a month after closing?

Thanks

Be very careful when you give your note buyer an option to buy more of the note at a later date. Every contract I have seen are always very one sided favoring the note buyer. There will be plenty of conditions that will give the note buyer a reason to opt out. Meanwhile you will likely give the note buyer an exclusive option to buy the remaining payments where you cannot shop around for better offer.

If there is a willing note buyer, you will be better off selling a partial without any commitment to future deliveries. If the note performs and the note buyer’s yield requirements and risk appetite are the same, they will still offer the same pricing for more payments, usually no more than 5-7 years into the future.

If interest rates jump up, the note buyer’s pricing to you will move down (be less) from what their pricing is today. They will likely hold all of the cards when you need to sell more payments down the road.

Another play on this are offers buy your entire note but to pay $X now and $Y dollars in the future, usually 7 to 10 years down the road. The odds of the note buyer being around in 7 to 10 years in the future have been pretty low. There are only a small handful of SF note buyers that have stayed in business for the last 7 years. If the note buyer dies or sells the note to an unsuspecting note investor, you will be looking at some nice attorney fees to recover the back end payments from your note.

In the 1990s a life insurance company was buying SF notes and offering staged payouts like above and described them as being like an annuity. They pointed to their “billion dollars of assets” financial strength and 50 years of being in business as guarantees they would deliver on their future commitment. They collapsed in 2003 or so leaving many note sellers with no recourse to collect promised future payments. I don’t know if any of the effected note sellers received anything when the company was liquidated.

 According to the data I collect to market note holders, the number of rehabbers creating notes jumped almost 50% from 2013 to 2014. This data analysis has some flaws but indicates a definite trend.

Back in the 2000’s there were fairly sophisticated investors who would warehouse these notes and hope to package and resell them before anything blew up in their face. By 2009 they all imploded.

This niche was rife with inflated property values, covered up structural defects, phony down payments and fictitious loan applications. To be fair, there are good operators out there and the OP may be one of them, but you need to be very careful.

This niche pretty much disappeared for awhile. I am afraid inexperienced investors mesmerized by high yields have replaced the old investors and holding this paper until it explodes.

Claudia,

Welcome to BP. I have been holding discounted notes in my SDIRA for 20 years. The Custodians will have the right forms for you to complete. Lots of potential upside when buying notes at a discount as explained and elsewhere in BP.

I will assume you are experienced in the mechanics of a real estate investment and focus on note specific issues.

I feel the toughest parts of investing in discounted notes is finding good, professional sources and making sure the note complies with state and federal lending regulations.

Be careful of discounted note investments being offered on Craig’s List or by “note brokers” that are certified through some school or program (ie guru). Always verify for yourself what a broker or seller tells you by using your own attorney/title company/appraiser/other professionals as needed.

I have been involved with direct mail for over 20 years albeit in a different part of REI.

My experience is a toll free number (800, 877 etc prefix) makes your operation appear more professional and large scale. A local number gives your company a more hometown and personal feeling. Some people feel safer working with "large" companies, others would rather work with someone local where the owner is directly involved with every step of the operation. 

Also, don't assume everyone you mail has a calling plan that allows them to make long distance calls as local. Many older and poorer (needing cash) prospect do not have these plans and respond better to a toll free number if they are out of your number's calling area.

Florencio,

An RMLO will have access to run credit checks on buyers and know the procedures. They will make your note buyer comfortable the note conforms to Dodd-Frank.

You can sell the note without much seasoning, however most note buyers are pretty cautious buying rehab paper in today’s market. I see notes similar to yours with 620ish credit being offered say $40K to $50K for X number of payments.

The X will depend on the amortization of your note. The shorter the amortization, the fewer payments need to be purchased. Just make certain you document the buyer can afford the payments. The $40K to $50K range will depend mainly on the strength of the buyer and condition/location of the property.

You might be able to get $10-15K more for the note after it has seasoned for a year. Your risk is the buyer misses payments or the investor’s appetite for your note disappears during that time.

You will want to run everything by the note investor to confirm what they can do before getting locked into the note.