Note buying?? Who is doing it?? What are your returns??
Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
Note buying?? Who is doing it?? What are your returns??
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Dion DePaoliPro Member
Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votesJoel,
The resale spreads are not large. Sellers, especially localized commercial note holders are not taking huge discounts. I think you have to decide how active of an investment you want this type of thing to be. Active investments are going to be situations where you have to work with the borrower to reinstate and stabilize the loan. Slowing paying or non-paying borrowers do require a fair amount of work and administration. Input value from you will have a barring on gain on sale size at liquidation.
While from time to time, you can find a diamond in the rough, generally speaking, there is not an innate arbitrage built in to most notes without some input of value add. In other words, your not going to easily and often, be able to find a note for X% and resell it for Y%, expecting the Y% difference to be a large windfall. With little to no value add, the spread will look more like a commission of a couple points rather than some home run and it can certainly hit zero and negative if you over pay or something happens to the loan when you liquidate which diminishes your value like a loan fading from delinquency to default.
Remember too, time is needed to improve value on these types of assets. Borrower's who are slow or spotty pays or defaulted non payers will need to be incubated before you will see a rise in value for their payments or continuity of payments. In general, quick time frames would be 3 to 6 months. Think about what it would take to get a non-paying borrower back on track. Property data and financials along with borrower financials to review to reestablish credit worthiness and the constant monitoring to ensure they make each period payment.
To some extent, commercial loans have a level of business acumen to them since the borrowers usually are operating some cash flowing property. This is both a blessing and plaque. Sometimes they are easier to work with than a residential borrower and sometimes they are not. A footnote to that concept, Seller's generally do not sell easy to work assets.
Trading the asset is no light work either. Once you find a note and do what ever you are going to do, now you need to sell it. This will require market exposure which is time consuming. You will need to show the loan to likely several different potential buyers and deal with their bids and questions. You know what this takes, it is similar to your commercial RE sales. Sharing files, fielding questions, chasing documents, same stuff. Moral of the story, I think folks get the impression that these asset trades are fairly light in workload and I would say they are not, they are more involved than real property because you have real property and the borrower/debt.
Certainly you can purchase more passive loans but remember this a better quality loan which will initially trade for a small or zero discount. Still a decent amount of work to run through the purchase cycle. The arbitrage here is really a simple difference between hurdle rates between you and the Seller and you and the Buyer. Seller willing to sell at 10% yield and a buyer willing to buy at 9.5% yield.
The yields and returns will depend on the quality of loan you purchase. In better CRE loans, institutional yields flirt around 7% to 8% for 'decent' stuff. Certainly higher yields are available through discounting but come with increased risk. Remember the originated and/or the modified rate is going to be pretty low in most cases 6% +/-, so getting to double digit yields takes sizable discounts or large amounts of negative equity. You might be able to target private loans which have a bit of a higher coupon like the HML rates mentioned above but not too much discounting in that market so you pay closer to par or even a premium.
Certainly you are capable of all of this but the time devotion caught my eye and stuck. Loan investments are being marketed as passive investments and to some extent this is very true but not all are. The 'passive' sales pitch is more of a longer term hold with smaller risk of default. A more passive nature can also come into play working with or through a competent broker or adviser and servicer who helps with the heavy lifting.
The "Velocity" trading model has been around for quite sometime and often gets look at by newbies as a good way to make good returns with controlled risk exposure. Problem is, the Velocity model has caused more failed investments than not. This is because the investor was never really in a position to actually work the asset and assumed there is always a perpetual upside bidder behind them. It is because of this that many folks still try and play this game by showing the potential purchase loan to an exit buyer hoping to create an arbitrage in a back to back trade. Most seller's don't want their loan passed around to unknown parties. Sophisticated Buyers will quickly vet out the fact you don't own the loan you are showing them. This model also promotes a lack of skill and knowledge on behalf of the intermediary party. Since you never plan to work the asset, learning and understanding how to do that does not get a top priority which puts the intermediary at risk for over bidding by not understand certain impacts of asset or trade.
Don't mean to be a 'Debbie Downer' but wanted to make sure you got a little bit of a realistic insight to the amount of work it really takes to make this sort of thing productive.
15 Replies
- Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes13y
Joel, first check with you state dept of finance, as to brokerage requirements, stress that you are using your own money and they will be commercial loans/notes. :)
- Real Estate Broker · Naples, FL · Member since 2013 · 9k+ posts · 6k+ votes13y
I am also interested in possibly buying notes. I have been led to believe there is a great profit to be made in non-performing notes as well. The question is where to start looking for notes and also what the typical discounts are. Thanks!
- Lender · Los Angeles, CA · Member since 2009 · 1k+ posts · 2k+ votes13y
Originally posted by Joel Owens:
I do not like hard money loans for lending as that can tie the money up for a very long time.What's a "very long time?" We've found a typical HML will be in the 6 to 8 month ballpark and I bet that's true close to nationwide, or at least in the warm weather states. If your LTV is low enough and you loan to experienced rehabbers, these are very safe investments when held to maturity, in my view. They're also the least time intensive. (Interesting that everyone always want to focus on returns, like in the title of this thread, but its always time that's as or more important.) Total hours per loan should be in the single digits. Total annualized return will be in the high teens.
Alternately, there are a few threads here that discuss hypothecating your loans. Here, you make a loan to say a rehabber and use the note as the collateral on a personal loan someone makes to you at a lower interest rate. Loan at maybe 12% plus points and borrow at 8% with no points, or whatever your local market will bear. You keep the spread. More work, lower return, but don’t need as much money to get started.
In both cases above, you originate the loan (or have someone originate it for you depending upon state law).
If you have the reliable contacts you mentioned, you could buy non-performing notes at a discount and restructure them to re-perform, then re-sell. In this case, your buyer will want to see a track record of payments so these could take a long time to work out and develop that track record. There’s also the higher risk of foreclosure.
If you really want in, look at buying high equity or non-performing seconds at cents on the dollar. Some of this begins to become work, however.
For my money, rehab loans are the simplest, safest, and most time efficient approach for the return.
Jeff
- 13yDon KonipolBusiness MemberInvestor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votes
Hard Money Loans will yield anywhere from 12 - 24% depending on the size, type, risk level, etc. We lend 40-60% LTV in Texas and Arizona and obtain 15-18% plus 4-6 points for one year.
I also purchase performing hard money loans and sometimes restructure them as 5 - 10 year amoritized notes. Yields are 14-18% per annum.
Performing notes purchased at a discount will yield less return to maturity, in the 8 - 12% range. Of course your return will be increased by early payoff.
- West, MI · Member since 2012 · 674 posts · 182 votes13y
This is also the direction I am turning. With values up on income properties, the numbers/returns are not stellar like they were. For a strong return on cash I can put up with the bs/problems with rentals.
But with the returns on new properties now after running the numbers it makes more sense to turn to the note buisness.
- Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes13y
Originally posted by Jeff S:
...If you have the reliable contacts you mentioned, you could buy non-performing notes at a discount and restructure them to re-perform, then re-sell. In this case, your buyer will want to see a track record of payments so these could take a long time to work out and develop that track record. There’s also the higher risk of foreclosure.
If you really want in, look at buying high equity or non-performing seconds at cents on the dollar. Some of this begins to become work, however.
...
If you are interested in looking into what Jeff S wrote in that quoted piece, then Dave Van Horn is the person to look up.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes13y
Just jumping in I probably wouldn't want to mess with seconds. I know a few note buying companies and most stay away from anything except first positions.
The 2nds have to have so much equity in the property that you will still get cashed out in foreclosure. I wouldn't be making these investments to put a bunch of time in and break even.
I make a great income of my commercial real estate brokerage business so I can wait for the right ones for buying the notes and I am not rushed to do something.
Granted I know a little about the note business but definitely not an expert in it.
- Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes13y
Joel, I see Canton is a two zip code town, about 25,000 and has grown 199% from 2000 to 2010. 38,000 median income and 197k average home price.
Being a commercial broker you're aware of various markets in business. The note business as far as supply will be driven by your local market. You can sell on a national market, but usually you can find better buyers locally with private investors, institutional buyers or brokers should be your exit strategy more than your model.
Consider your market as you receive suggestions as to what you should do, you need to think about the opportunities compared to those in some city or MSA of a million. Trying to build a note niche is market driven like any other business. When I began my market area was about ten times where your's is now.
I also farmed Branson and surronding areas, about the same growth rate. Most of the lending activity is purchase money, residential and commercial. You may have some rehabs going on, but that's not the lion's share.
What I found with rehabers is that the good ones, or contractors, use the bank not HMLs. There is a reason a contractor is willing to pay more for money, so these guys are usually not slam dunk borrowers. Doing rehabs with higher risk types means you better have a rehab crew on call that can come in a finish a job quickly.
I suggest you act as a partner in rehabs more than a lender.
As an RE Broker, you probably have many opportunities to get involved in 1st and 2nd mtgs. You'll also have opportunities to get into inventory financing, another ball game but returns I had were 20% plus, so it is profitable and more common than RE deals.
Buying RE notes are and were a minimum of 30%, after it wa all said an done with issues, some would dip down a few points, but twice the yields mentioned in lending. It's all in the discount and term that the note needs to be held. Buy low and refi and your yields will skyrocket, look at a 100K note with a 30% discount and refi within 90 days and your calculator will go nuts, even after paying closing costs. Short holding periods are really the goal and the best use of a limited supply of money. I say limited as I don't know of any broker or HML/investor borrowing from the federal reserve.
I also suggest you get a servicing company involved if a note is going beyond a year. You can do a few short term notes yourself, you can prove the payment history. Servicing commercial or residential carries liabilities. Foreclosure or refiancing is much easier with a servicer involved.
When you modify a note that was initially an equity note you change the complexion of the debt since you paid and advanced cash, take great care in your modifications paying the equity first then your basis as your basis can fall under deficiency judgments, equity is not.
Get up on the tax issues too as a modification can be a new loan and selling the note is obviously income.If you can get borrower information (processing issues) you can certainly take the road of HMLs and look at the LTV. You'll be dealing with lower LTVs and while you may be better secured, you may be missing 10-15% more in earning on more of your money, as I would go to 80% on firsts and 90% with seconds. BTW, Dave, who deals in seconds may be a good source of info for you. You can usually foreclose the second paying off the first, however if the first takes it to the steps you may be required to buy them out. Now, I know Dave says he doesn't, but being a MB or institutional dealer makes a big difference, it's different in some areas of a regulated entity and some guy off the street, you're not going to carry as much water and a bank may just move forward with a private note holder. State laws will cover the rights of junior lien holders so if you buy seconds, know the laws.
Again, being a RE Broker, you can easily carry back commissions as a second and if you're half careful, you do fine, even if you sell the note all you did was take less in commissions. :)
- 13yDion DePaoliPro MemberReal Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
Joel,
The resale spreads are not large. Sellers, especially localized commercial note holders are not taking huge discounts. I think you have to decide how active of an investment you want this type of thing to be. Active investments are going to be situations where you have to work with the borrower to reinstate and stabilize the loan. Slowing paying or non-paying borrowers do require a fair amount of work and administration. Input value from you will have a barring on gain on sale size at liquidation.
While from time to time, you can find a diamond in the rough, generally speaking, there is not an innate arbitrage built in to most notes without some input of value add. In other words, your not going to easily and often, be able to find a note for X% and resell it for Y%, expecting the Y% difference to be a large windfall. With little to no value add, the spread will look more like a commission of a couple points rather than some home run and it can certainly hit zero and negative if you over pay or something happens to the loan when you liquidate which diminishes your value like a loan fading from delinquency to default.
Remember too, time is needed to improve value on these types of assets. Borrower's who are slow or spotty pays or defaulted non payers will need to be incubated before you will see a rise in value for their payments or continuity of payments. In general, quick time frames would be 3 to 6 months. Think about what it would take to get a non-paying borrower back on track. Property data and financials along with borrower financials to review to reestablish credit worthiness and the constant monitoring to ensure they make each period payment.
To some extent, commercial loans have a level of business acumen to them since the borrowers usually are operating some cash flowing property. This is both a blessing and plaque. Sometimes they are easier to work with than a residential borrower and sometimes they are not. A footnote to that concept, Seller's generally do not sell easy to work assets.
Trading the asset is no light work either. Once you find a note and do what ever you are going to do, now you need to sell it. This will require market exposure which is time consuming. You will need to show the loan to likely several different potential buyers and deal with their bids and questions. You know what this takes, it is similar to your commercial RE sales. Sharing files, fielding questions, chasing documents, same stuff. Moral of the story, I think folks get the impression that these asset trades are fairly light in workload and I would say they are not, they are more involved than real property because you have real property and the borrower/debt.
Certainly you can purchase more passive loans but remember this a better quality loan which will initially trade for a small or zero discount. Still a decent amount of work to run through the purchase cycle. The arbitrage here is really a simple difference between hurdle rates between you and the Seller and you and the Buyer. Seller willing to sell at 10% yield and a buyer willing to buy at 9.5% yield.
The yields and returns will depend on the quality of loan you purchase. In better CRE loans, institutional yields flirt around 7% to 8% for 'decent' stuff. Certainly higher yields are available through discounting but come with increased risk. Remember the originated and/or the modified rate is going to be pretty low in most cases 6% +/-, so getting to double digit yields takes sizable discounts or large amounts of negative equity. You might be able to target private loans which have a bit of a higher coupon like the HML rates mentioned above but not too much discounting in that market so you pay closer to par or even a premium.
Certainly you are capable of all of this but the time devotion caught my eye and stuck. Loan investments are being marketed as passive investments and to some extent this is very true but not all are. The 'passive' sales pitch is more of a longer term hold with smaller risk of default. A more passive nature can also come into play working with or through a competent broker or adviser and servicer who helps with the heavy lifting.
The "Velocity" trading model has been around for quite sometime and often gets look at by newbies as a good way to make good returns with controlled risk exposure. Problem is, the Velocity model has caused more failed investments than not. This is because the investor was never really in a position to actually work the asset and assumed there is always a perpetual upside bidder behind them. It is because of this that many folks still try and play this game by showing the potential purchase loan to an exit buyer hoping to create an arbitrage in a back to back trade. Most seller's don't want their loan passed around to unknown parties. Sophisticated Buyers will quickly vet out the fact you don't own the loan you are showing them. This model also promotes a lack of skill and knowledge on behalf of the intermediary party. Since you never plan to work the asset, learning and understanding how to do that does not get a top priority which puts the intermediary at risk for over bidding by not understand certain impacts of asset or trade.
Don't mean to be a 'Debbie Downer' but wanted to make sure you got a little bit of a realistic insight to the amount of work it really takes to make this sort of thing productive.
- Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes13y
I agree with Dion and just to clarify, those seasoned notes I was speaking of before were not notes purchased at the closing table usually, once in a great while a seller will be willing to take such a hit.
The velocity Dion mentioned is not new, but to do these as a conduit or middle man would be seasoned notes with those borrowers who then qualify, no work outs necessary. While you could work with a broker or originator to get those done I was the one who originated the new loans placing most into the secondary, not everyone wanting to get into notes will be in that position.
I agree with Dion as well about notes requiring to be modified are a PITA and you really need a financial background to rewrite notes that will perform and hold hands over a longer term. I'd say that if that is not your full time business, it can be a full time job.
All the notes you find aren't going to be a deal for many reasons. I'd never really get involved buying notes at par or even at a sliver of a discount for the sake of servicing it. Just as in RE, to get the better deals you must know how to find motivated sellers who for one reason or another can't take thier note to market. The respondents here I'm sure would never take a 30/40% even 50% discount on thier loans, but Joe who sold a farm 8 years ago can and does. A guy who sold a casket vault company 4 years ago does, but as Dion indicated, lenders don't trade there and neither do most brokers or servicers. :)
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes13y
Maybe buying properties cheaply and whole tailing them to buyers for cash might be better than messing with the loan avenue.
I will have to think on it some more.
I look at everything in a context of how liquid will my cash be (how fast can I get it back), and how hard I have to work for the anticipated returns. Most of my time is devoted to my commercial RE business so other income streams have to go without a huge direct involvement or creating another JOB.
Any income stream will have some work to create it.
Case in point I go eat at Jersey Mike's subs frequently. I knew the previous owner and they retired and sold it to another gentlemen in his 50's that bought it with his retirement funds. That guy is great but now is working constantly at that restaurant to make it go and keep on top of employees and now is dreading the decision he made to invest in this.
Only way I would buy any restaurant is if the managers and assistant manager is paid for on the books and it still produces 6 digit profit returns every year. With the Jersey Mike's he might be lucky clearing 40k or so working the business all year. I would have to pay a manager to take the owner operators place and be at almost zero profit in that model.
Other investors that have been doing things a very long time I have learned how they have processes and systems in place to make them hands off day to day for the income streams they produce. That is my goal but at the same time keep some funds liquid.
- 13yDave Van HornPro MemberFund Manager · Wayne, PA · Member since 2009 · 1k+ posts · 1k+ votes
Joel Owens I and my company both buy and sell notes, and buy and hold notes. There are pros/cons to both, which is why I do both.
As far as 2nds go, I thought the same thing about equity for almost half my note investing career but I've found it to be a misconception. Now my model's not for everyone but I'll tell you this - I work in the 2nd space because of the higher yield and to mitigate my risk, not to lose money haha. I also invest in 1st mortgages and other types of debt as well, and there's nothing wrong with diversification.
If you want to learn more about notes and how to get started (no matter what type of notes you're looking to get into) message me and maybe we can set up a call so I could help point in the right direction.........same goes for John Thedford and Ryan M.
- Investor · Southeast, MI · Member since 2012 · 2k+ posts · 1k+ votes13y
I purchased a first position note about three years ago. It had 23 years left on it and was paying 11% interest. I was able to buy it for about 50 cents on the dollar. Two years ago, I secured a private loan against that note for the amount that I paid at 7% interest. I'm currently only making a little bit each month, but the private loan will be paid off in three more years. After that, I will have a nice monthly check for 17 years.
This deal fell into my lap, but I would like to find more like it.
- 13yDave Van HornPro MemberFund Manager · Wayne, PA · Member since 2009 · 1k+ posts · 1k+ votes
Hey guys,
I know there was a lot of talk on this forum recently about getting started in the note business.
I just did a podcast here on BP that should give you guys a good overview of the business that some of you might be interested in: http://www.biggerpockets.com/renewsblog/2013/07/25/podcast-dave-van-horn-note-investing-private-money/
Would love to know what you guys think!
Best,
Dave - Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes13y
Dave, I'll need to get to another computer for that, pry it away from the kid.
Also wanted to clarify something too, my results won't be yours in most cases. As Dion and Dave I'm sure too would attest, being in the market with brokers and lenders will limit yields to the going rates of the market in time. You won't be getting deep discounts there, you must establish a local niche where note holders of even questionable deals are willing or must sell, often restructure them and add value as Dion mentioned. The trick is knowing what can be pulled out of the fire and refinanced, it's easy to get stung. Since I was doing refis, I knew what would fly. If a note investor followed this avenue they better be working with a great broker or lender. :)
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