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Tips for Buying Mortgage Notes: My Favorite Note Deal

by Alan Noblitt on March 12, 2013 · 6 comments

  
Buying mortgage notes

Buying mortgage notes can be a funny business.  Like most sales jobs (I consider note buying to require even more sales skills than real estate or finance knowledge), there are lots of ups and downs in the business.  Some deals go fairly smoothly while others require tons of time and effort, only to blow up and not close at the end.   The latter frequently have missing documentation, unresponsive note holders, low property values, late property taxes, or some combination of several of those.  The bad deals are painful but are made up for over time by the good ones.

My Favorite Deal In Buying Mortgage Notes

When thinking back on the hundreds of deals that I have closed as either an investor or as a broker, one stands out as my favorite.  It was a high-end property in a town of about 20,000 people in Southern California.  In fact, this was the most expensive property in town, with an 8000 square foot house on nearly 15 acres that also included a large, separate RV garage and numerous amenities.  The seller was a personable and straight-forward guy who had all of the documents in perfect working order, a recent full appraisal, and a mortgagee title policy that was clear of any liens.  He was responsive to all of my questions and wanted to close quickly. 

The payers, one of whom was an orthopedic surgeon, had credit scores of over 700 and had put in a 30% down payment.  The only down side of the note was that only one payment had been received, but there was little doubt that this would be a performing note and an excellent investment for the investor that purchased it (because this was a high-priced note, I served as the broker).   

This note purchase closed in less than three weeks.  That is, from the time that the note holder sent to me a signed agreement until he had the promised funds in hand was only 14 working days.  Usually, a note purchase takes 3-5 weeks, and some notes and properties with “hair on them” can take even longer. 

This note had all of the properties of being clean and nearly perfectly done.  I wish that one of these would come along even more often, as they are highly profitable and relatively stress-free for the note investor or broker.

The Take Away

The lesson from this is that, if you are creating notes, try to mimic the fundamentals of the note described above.  Rarely will you get everything that you need due to the nature of the business, but try to get a large down payment, work with creditworthy buyers, ensure that the documentation is created by a competent attorney or title company, check that the sales price of the property is close to its actual appraised value, and build a good working relationship with your buyer.  If you decide to keep the note, you will be better protected and have a safer investment.  If you decide to sell the note to a note buyer, your transaction will close more quickly and you will get more money by having done things right the first time.

Photo: Dougtone

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{ 6 comments… read them below or add one }

Dave March 13, 2013 at 1:45 pm

Is this a private note or a note originated from a bank?

This sounds like a phenomenal deal, the only tough part is: how do you duplicate something like this? Did you market for this note?

– Dave

Reply

Alan Noblitt March 13, 2013 at 3:43 pm

Dave,
This was a private note. The lead came through my normal marketing programs and turned out to be a home run.

Alan

Reply

Ben Poole March 15, 2013 at 2:02 am

Alan,

From being a broker, I can understand you importance on the marketing side of notes. But, from an investor who as had great success with just a very few note purchases, do you see the discounts offered today as you would in yesteryear (say 10 years ago when interest rates where higher and 30% discounts typical for some properties)? From my very limited experience in notes, there is seller shock at the discount and then resolve assuming everything works out. I had a great ROI on mine and I held it from 20 yrs left down to 5 when they paid me off (I was hoping for a quicker payoff but they just stayed and paid).

A couple more questions: With interest rates so low in the market, what do you discount cash flow at for solid properties verses “some hair on it” as you say whether in title or more than likely condition and market value since property values have not recovered? How are you valuing your notes with greater than market rate since any maturity on a note would be at a higher face value than possible quick sale and interest rate at higher than market all other conditions being equal (no “hair”)?

Nice article but some numbers would have really helped! *hint

Reply

Alan Noblitt March 15, 2013 at 1:08 pm

Hello Ben,
Yes, the note landscape has changed over the last ten years, and especially during the last six years. Most investors had larger discounts in the early 2000’s, then got more aggressive with their pricing during the bubble years, and in recent years have gotten more conservative. Despite the low interest rates, most investors of any size are still requiring at least high single-digit yields on notes and low double-digit for riskier notes. An excellent note on a single-family home might get an 8% yield while a note on a property in poor condition or with poor payer credit might command a 10-12% yield. Either way, we also want at least a 10% equity buffer and prefer something much higher.

I intentionally don’t give exact figures in my articles on the off-chance that someone who lost out on buying that note might get their feathers ruffled. The property in the article sold for almost $2.5 million. Hope that helps.

Reply

Ben Poole March 15, 2013 at 3:29 pm

Thanks Alan,

I understand not disclosing as much on numbers for you do broker these after I reflected upon your answer. That most certainly is understandable. I was surprised that the risk premium has actually gone down. Perhaps most see little down side risk and want to lock in decent returns all of which beat what the banks are paying for no risk. That range reminds me of the 70’s and 80’s. The real risk is interest rates rising which appears limited in the next several years. Notes are to me one of the best investments even better than rental ownership if the note can be purchased at a good discount rate and moderate risk when priced for a quick discounted sale. Urgency of sale has its own discount and reward to the purchaser with the cash to take advantage of the opportunity There aren’t many that meet that criteria but with limited funds every investment decision counts! I look forward to reading more of your posts!

Reply

Alan Noblitt March 15, 2013 at 3:47 pm

Ben,
Investors are getting more competitive and everyone is chasing yield. You’re right that buying a note with a long time horizon and low rate is risky for when interest rates make their inevitable rise.

Alan

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