All Forum Posts by: Mike Hartzog

Good questions @David Hite.  To answer your first question, there is no tax benefit to buying a late stage note vs early stage.  At the end of the day, you are investing to make a profit, and you will be taxed on that profit regardless of whether or not the profit comes as normal interest or return of discounted portion of principal balance.  

If you do the math on a loan which is amortized to return both principal and interest with each payment (normal mortgage loan amortization) you will find that each payment has the exact same investment yield with regard to the current principal balance. Later stage notes return principal faster, thus reducing the amount of your invested capital faster, but your yield remains constant.  It could be argued that an early stage note is preferable if you are looking for passive income because more of your capital remains invested longer, and it will therefor be a longer period of time before you will need to go find a new investment.

With regard to accounting for the "kicker", essentially you are tracking a thing called "Discount Earned", which is the amount of the principal returned with each payment that is not your invested capital. For example, if you buy a loan at 80% of UPB, 80% of the principal portion of a given payment will be a return of invested capital, and 20% will be Discount Earned, which is income in the same way as interest is. There are two methods of accounting for this. You can track it on a payment by payment basis, or you can run your capital account down to zero (call all principal payments return of capital), then beyond that all principal payments will be discount earned.

Hope that helps...

@Jay Hinrichs - I am guessing the bank would do this for first liens only, correct?

@John Underwood - In the defaulted notes investing space I have run into liens which were the result of lending to pay off delinquent taxes. I think it is a valid and useful service for folks who get into trouble with taxes. As I recall, there were some large companies doing it (Midland comes to mind), but the liens were not of DOT/Mortgage type. Perhaps UCC, but not sure.

@Jay Hinrichs - Not sure about the springer fishing this year. I typically wait for king season to open in mid July. 

@John Underwood I like your creative approach.  I suspect you find many of these properties with little or no equity.  Is that the case?

@Jay Hinrichs - Agree that land contracts can be problematic from legal and other perspectives as well. What is your view on using mortgage/DOT with a pre-confessed DIL? I suspect these would be frowned on by the courts in a consumer scenario as well but have never looked into it much. I have seen them used on commercial loans from time to time.

I think the scenario matters a lot here.  In Adams scenario, the mechanism of transfer was likely a quit claim deed done outside of escrow with no title insurance.  In that kind of scenario it is on the buyer to make sure they understand the lien situation.   In a standard real estate purchase and sale, the transaction is closed by a title company, a warranty deed is used, and the buyer would get a title insurance policy.  Title insurance is really the only way to fully protect yourself against liens that may not show up on title searches.

@Robert Huizar Likely the prior owner failed to pay both property taxes and HOA fees. HOA foreclosed, leaving the tax lien (and possible other municipal liens) which are senior. HOA may not have the capital to pay off the tax debt, but in an auction scenario they would receive any overage after tax liens are paid.

I don't think the situation is unclear if you bid and win. HOA had the opportunity to take out the tax lien and they chose not to, so they would have no reason to hold your winning the bid against you. You would simply resume paying the HOA fees and taxes. I would, however, recommend getting in touch with the HOA to determine if you can swing a deal ahead of the auction. I think the chances of getting a good deal via this route are greater than in the auction scenario. You would also avoid the clouded title issues related to the redemption period which come into play with tax deed purchases.

@Joseph Sangimino - You mentioned that you cannot underwrite based on NOI, and that tells me that you don't have a good idea of value, so that's that's the first thing to solve before looking at possible options for acquisition. I would contact the owner as a potential purchaser and gather the information you need to value it. Once that is done and you understand the value and equity situation, you can pursue the acquisition strategy which makes the most sense. If there is equity, you could look at purchasing directly from the owner (who is likely a distressed seller), or purchasing the note from the hedge fund and pursuing DIL or FCL yourself. If there is no equity, you might negotiate a short sale deal with the hedge fund and owner, or purchasing the note at the discount. As others have mentioned, I would not get hung up on what the hedge fund paid for the asset.

Note transactions are not a matter of public record in the same way RE transaction are. There is typically only an assignment of mortgage/DOT recorded and these do not include the purchase price. I think the price they paid is not really material here because at the end of the day, they own the asset now and will be looking to maximize profit and limit holding time. Understanding the current title situation (taxes and liens) will be key in determining the best way to pursue a deal.

I think the straightforward way to do this for performing notes is to report UPB as the FMV. Any P&I payments received can be disregarded because these payments go into the account as cash and are now a different asset in the account (cash) which is valued on its own merits, hopefully at face value :-). If the note is underwater, one would want to make some adjustments in FMV to take collateral value into consideration. NPNs could be valued based on cost basis + expenses.

Loans without tax and insurance escrows are not uncommon.  The servicer having an issue with it seems a bit strange to me.  No need to be worried though.  Transfer your loan to a servicer which caters more to small investors.  Madison management or FCI are good choices.