BiggerPockets

Hi, an offer is made and if it is accepted, an assignment is made and the note is endorsed over to the new holder. There is no closing requirement as there is for real estate. Assessing the value use to be a hip pocket deal, what ever a buyer thought they could steal it for. Now, buyers are much more sophisticated, they look at the property and collateral value, payments histories, credit reports, and perhaps even re-verify information concerning the borrower. Then they will perform a little present value calculation at the yield they desire and see if they can steal if for that amount! I guess it really hasn't changed, LOL! There can be a wide spread in values offered. I bought notes and other contracts as well and appraised instruments for the government in assessing assets. Not much has changed and it's a pretty simple transaction. Bill

HI, let's go a little deeper. There is a basic economic concept referred to as an "opportunity cost". If you have have two (or more) opportunities to invest, the difference bewteen the two (or more) investments in selecting the investment with the lower return is the "cost" of selecting that lower return investment. Now, why might an investor choose a lower return on any investment? There may be many reasons, but two main considerations are the degree of risk and the use of funds. Private notes are rarely underwritten by any consistant guideline. A farmer who sells 50 acres to his neighbor usually makes the deal out of marketing and personal considerations, not from a risk management analysis. While the farmer may know his neighbor, his decission to finance the deal could be purely subjective. Investors don't know the borrower and therefore must use more objective and calculated analysis to assess the risk involved. SInce money, for everyone is a limited commodity an investor will also choose an investment that provides the highest return or the best use of their funds. Books have been written on both of these aspects.
A balance between acceptable risk and the highest return can be a daunting decission. I would have to say that most individuals, based on my personal experience in dealing in the paper business for over 15 years, lack the knowledge required to assess a fair value of a privatley originated note. Further, even if they do have a knowledge of real estate and finance, and after trying to assess a fair market value, they will soon find that a generalized rule of thumb usually meets their personal investment goals. What ever they then determine to be the highest yield requirement usually becomes their target yield on any note. Going at it from this simplified approach, with perhaps a quick check of the property and limited due diligence, becomes their standard assessment and basis for making an offer.

Institutional investors, companys that leverage or borrow money to purchase privately held notes are much more sophisticated in their analysis. Considerations include actual underwriting guielines and requirements which must be met due to the requirements made on them by their lenders or investors. Again, since most privately held notes or debt contracts have been made on a subjective basis, the task at hand for the institutional investor is to underwrite the deal under these guidelines. Even at this level of a more sophisticated financial assessment, a target yield will be identified. Interest rate risk for a large institutional investor is a consideration. A move in interest rates will effect their cost of borrowing money to acquire notes in the future. Inflationary periods are really of a lesser concern than for a bank since privately originated obligations are for shorter terms. Most notes require a balloon payment in five years or less. Since institutional investors deal in a volume of these obligations, they "block" loans or consolidate many loans in groups based on a maturity distribution (when a note becomes due) providing a weighted average yield. I won't go beyond that, but again, all of this will effect the expected return and therefore the present value of an obligation to them.

As with anything, the market will dictate a price as well, if someone has a note for sale, where do they go to sell it. You can't go to your local bank and do this deal with the teller. In the scope of things, buyers are really limited for these obligations. They are more marketable these days than they were say 15 years ago as more investors enter the paper market and most deals are leveraged as opposed to simply being purchased by an individual from his bank account. So, if you have a limited secondary market for anything the price will be lower for a seller and profit higher for any buyer. Simply a suppl and demand function. It's a buyer's market. In the beginning of the private real estate note market, there were only private investors. When the word gets out about potential money to be made in any market others (and larger entities) enter the market. Historically yields have been high for investors in this market due to these factors. As more have entered the market more competiton for a quality note has been seen and "prices" have decreased for the buyer, but not to a level of conventional loans. While there are billions in the private papaer market it is still a small portion of the financial sector.

When I purchased and brokered these obligations I always suggested that the seller search the market. I was usually offering the best deal for properties that I could reach out and touch and expecially where I could assess financial aspects. When I appraised for the market values of privately held financial contracts for state government, I found many notes that were so poorly written or constructed that they simply were not marketable, especially notes made between related parties.

Privataely originated notes are almost viwed as collateral loans, like auto title loans. A buyer of such an obligation may not be able to obtain a credit report since no authorization to do so was ever given. So, the price for a note is what the market will bear under these conditions. It arises from economic, financial and market conditions at the time the obligation is presented into the market. I'm sorry this is so long, but hope you have a better understanding of the paper game now. Good Luck, Bill

I second that Dustin. Well written Bill and I hope a lot of folks read this post. I prefer to work with private investors vs the institutions because they are able to look outside of the box when it comes to investing in areas they are comfortable with. This allows us to create more competition in this tight market and to get our note holders a better price. There is also more of a relationship factor in working with private buyers and smaller firms than with the institutions.

Awesome post Bill. Voted up!

Bill, What is your success rate when working to purchase a default note from a loan servicer since they are not the owners of the note. The servicer of the note makes more money holding the default note then being motivated to sell it. On the other hand the pool or owner of the note may be sitting with a portfolio with from 15% to 24% of defaulting notes which they would be happy to sell to increase profitability for the portfolio.
So my question is if you are offering to purchase a default note from a loan servicer is there a sure or legal proceedure to make sure the offer is going directly to the note owner. Thank you for your input.

Hi, just found this back up! Thanks for the votes everyone.

A servicer only gets paid for servicing and effecting the transaction through loss mitigation. A note sale may not be in their realm and therefore not motivated to respond.

However, if the note purchase is presented initially as an offer in compromise for the payment due, a servicer will probably realize that if there is an offer in-lieu-of-payment to pay the obligation, the servicer better present that to the note holder. If such an offer were made and the property goes to foreclosure, and the an injunction is sought in favor of a judicial foreclosure and the offer is presented, the question would then be why did the lender take this to foreclosure when there was an offer to cure the default?

You might point this out to the clerks that answer the phone.

After an initial presentation is made as to the proposed transaction and the note holder has favorably responded with an interest to your method, then would be the time to negoiate price.
Those justifications used for a short sale are applicable. Since lenders get a little back on the deal from the government, a discount will not be as heafty as a short sale, but may be worth the difference. IMO

My purchases were from portfolioed lenders with servicing retained so I did not purchase through a servicer, but as I pointed out, even though they are not motivated, it will be difficult justify not acting in the best interest of the holder.

Good Luck, Bill

There usually aren't any local customs or laws pertaining to this business, the transaction of an assignment is pretty simple. No license is required if you are buying notes with your money for your portfolio, but there are many requirements if you are acting as a broker.