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Real Estate or Residential Notes—What Makes a Good Deal?

by Dave Van Horn on March 6, 2014 · 12 comments

  
Finding good residential and real estate notes

I really can’t tell you how many times I’ve been asked the question: Is this a good note deal? So, first, let’s consider why people ask this question. I think it’s because they want to hear your response or opinion of what a good note deal actually is.  Although I’m honored that those who ask me value my opinion, I don’t want to do them a disservice by giving them a simple “yes” or “no” answer. Besides, what’s a good note deal for me isn’t necessarily a good note deal for someone else. When a real estate investor, who’s getting started in notes, asks me about a note deal, I try to explain my take on it by relating it to a real estate deal.

So, What Makes a Good Real Estate Deal?

At first, sometimes it is hard to tell, or to know, if you have a good deal until you get some experience. Let’s look at real estate, for example, there are several areas of a deal where you can make money:

  • The buy – When I first started in Real Estate, I paid close to retail like most people, who are just starting out. Today, I would usually only buy properties from motivated, or distressed, sellers. Another way to find a good deal on the buy, is finding a discrepancy in fair market value or a property in lesser conditions.
  • Rehabbing the property – Although heavy rehabs tend to be more profitable, sometimes you can find properties that don’t need as much done and that can be turned around quickly. If you have experience rehabbing, you may also have more knowledge of what everything costs. Another skill set that can give you an advantage, besides creativity and the ability to rehab a property, involves managing contractors.
  • Management –Were your estimates accurate? Did you come in under budget? Did you finish the rehab in a timely manner? If you’re using private money, the longer the deal takes, the more it will cost you.
  • Shopping for financing – The time and effort it takes to find financing, as well as the type of financing you find, can affect the profitability of your deal. For example, private money is usually cheaper than hard money. Also, people with good credit get better terms.
  • Foresight – Your level of foresight can go a long way. For example, there was a property I paid retail for ($65,000), but I saw potential to build a commercial garage on an adjacent lot. Now, the property is worth over $200,000.
  • Marketing – If you’re skilled at marketing, you will get the property rented or sold quicker than someone, who’s not skilled at marketing.

Any of these things can turn an okay deal into a really good deal.

I remember when my cousin and I were investing in similar types of properties; he always had to get a great deal on the buy side because he can’t change a light bulb. I, on the other hand, I had a few advantages. For one, I was a realtor and a property manager. On top of that, I owned a contracting company at the time. This was a huge overall advantage, because if the rehab was taking too long, my crew and I could jump in and finish the renovations. It was also easier for me to manage the deal because I had a more flexible job. So, if you’re in the investing business, it does make it easier to have yourself, your spouse, or someone close to you have a flexible schedule.

Related: How to Find Investors To Fund Your Real Estate Deals

And, What Makes a Good Note Deal?

Well, it’s the same way with notes, especially when their delinquent, because the money is made in the rehab. But first of all, what’s a satisfactory return, particularly when you’re just starting out and you don’t have experience yet rehabbing the note?  When I was new, I didn’t really focus on profit as much as learning the space.

Similar to a real estate, the following areas can affect the outcome of the note deal:

  • The buy – You can make money on the buy side just like with real estate, but all of the other components can certainly impact the deal as well. The quality of your past data can make you more efficient on the buy side, especially when you know the statistics for certain types of asset classes.  One of the reasons note buyers may get a great deal is if they have knowledge of the true value of the underlying asset (finding a property with a bad BPO).
  • Rehabbing the note – How good are you at negotiating and rehabbing bad paper, borrower management, creating workout plans, etc.?  Or, are you outsourcing these tasks to a servicer?
  • Note Management –The more efficiently you manage the administrative part of owning a note, the risk, the borrower, and your vendors, the more profitable the outcome.
  • Shopping for Financing – Do you have an affordable source of capital? Because it’s a finance driven business, you have to have affordable and available sources of capital to move on a good deal when you find it. Depending on your business model, you may also need to refinance or recapitalize quickly.
  • Foresight – Do you know your best exit strategy? Based on the type of asset or the borrower’s intent, choosing the right exit strategy can make or break the deal.
  • Marketing –If you’re skilled at marketing, you may be able to build a network of note buyers or note investors to sell your notes to after you get them re-performing.

All of these things can give you an edge or advantage to becoming more profitable.

Related: Tips for Buying Mortgage Notes: My Favorite Note Deal

What to do if You’re New…

It’s really the same as any new endeavor; it’s best to get educated and try to find someone to partner with you, or mentor you, until you get more experience. And lastly, try to build relationships with others, who are already doing the business. If you do these three things, your odds of success and getting some great deals will be much higher, once you’re ready to pull the trigger.

So, did you expect me to show you a one-off, great note deal that you should buy?

When dealing with nonperforming notes, it’s much more statistical than that, and it could depend on many variables.  The reason I can’t tell on an individual note is because I’m just not that smart. This is largely due to not knowing the borrower’s intent, market fluctuations, and unknown events that could happen in the future. This happens in real estate as well. For example I have a duplex I’ve owned for 10 years that I bought at a great price, did a nice renovation on it, got a nice appraisal at the time I refinanced, and now I just discovered, years later, that I have a serious termite infestation.

But, even though I can’t predict everything, including the future, the outcome will depend more on how I react and handle the problem, than on the actual problem itself. And, I wouldn’t have changed a thing in my real estate or note investing career. So, go ahead and get started!

If you’re an active real estate or note investor, are there any other areas, or aspects, of your deals that have impacted the outcome or the profit level? I’m always curious to hear some stories from Bigger Pockets folks!

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{ 12 comments… read them below or add one }

Graham Mink March 6, 2014 at 1:23 pm

Hi Dave,

Great article, very informative for someone unfamiliar with Note Investing such as myself. Obviously the more capital you have available the better, but for someone who wants to start investing in notes how much capital is ideal to get started?

Thanks so much!

Graham

Reply

Dave Van Horn March 7, 2014 at 2:48 pm

Graham
Hi Graham, thanks for the positive feedback! Well, it does depend on what type of notes you’re getting started in. Although I can’t speak for other note companies, there are three ways people get started with us. One is investing in a note fund, and the minimum for ours is $10,000 (5K a share). If you’re investing in re-performing residential notes, most of our 2nds sell for 10-30K, and most of our 1sts sell for 20-60K. If you’re investing in non-performing notes, these sell for roughly a third of the re-performing price, but that is a very general statement. If you’re investing in unsecured notes (which we don’t offer), they sell for even less. So, it does depend on your level of risk tolerance. Hopefully this gives you an idea/range for thinking about how much capital you would need in residential notes.
Let me know if you have any additional questions!
Best,
Dave

Reply

Nick March 11, 2014 at 10:31 am

Hi Dave,

Could you please elaborate on the note fund? I don’t see any references to in on PPR site.
How is it structured and how does it work?

Thanks
Nick

Reply

Dave Van Horn March 11, 2014 at 2:20 pm

Hi Nick,
It’s actually a private placement, which is an LLC, and it pools money to buy distressed debt from banks in large pools. Because it’s a private offering, we don’t market to accredited investors on a public forum, such as the web, since that would be a violation of Securities Law. For more specific information on how it works, I will directly message you the contact information for our Investor’s Relations Department.
Best,
Dave

Nick March 11, 2014 at 2:37 pm

Hi Dave,

If this fund is for accredited investors only, I do not qualify.

Thank you
Nick

Martin Cortez March 7, 2014 at 9:06 am

Dave – very thorough article on notes. I am very familiar with the actual creation of notes using owner-financing, but not so much on the investing side. I have worked very closely with an investor who created, then sold these notes before the real estate fallout started in 2007.

Would you say the market has come back to the point where it may be possible to sell a well performing note for 70-80 cents on the dollar? These are the rates we were getting back then.

Reply

Dave Van Horn March 7, 2014 at 2:49 pm

Hi Martin, thanks!
Yes, I don’t believe that the rates have fallen below that. Most seller financing note brokers would be happy to give you the metrics on what they buy, but I do think that’s possible, especially as equity starts to creep back into the market.
Best,
Dave

Reply

Shaun March 10, 2014 at 7:10 am

Great checklist on things to think about.
I also like how you related it back to buying an actual property. I think most of us that aren’t doing notes (Yet!) can wrap our heads around that kind of analogy better.

Reply

Dave Van Horn March 10, 2014 at 9:44 am

Hi Shaun, thanks for the positive feedback!

Reply

Jason R March 10, 2014 at 9:27 am

Very timely article for me!

I’m looking at a package deal. A lady needs to sell a SFR and a note on another property where she financed the buyer. I understand how to value the house. The note valuation is new to me. Where can I find a market value for the note?

Here are some details: The note was written in 2010. The maturity date is 2025 with a 5% fixed rate. Payments are current and have all been paid timely as far as I know. What price do I need to put in my offer?

I don’t want the note, just the house. I would be looking to resell the note immediately, so I need to know the price to pay. Any help is appreciated.

Reply

Dave Van Horn March 10, 2014 at 9:44 am

Hi Jason,
Although we don’t do seller-finance notes, you just need to contact a seller-finance broker and ask for a quote on the note. There’s many out there, and they’ll certainly give you the information you’re looking for. I hope this helps!
Best,
Dave

Reply

Jason R March 10, 2014 at 1:30 pm

Thank you, sir.

I will look around.

Reply

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