Finding and Buying Performing and Non-Performing Notes
One of the most frequently asked questions I get from investors is, “Where do you and your fund find notes to buy?” The problem with this question is that most companies (including my own) aren’t exactly interested in telling other note buyers their sources of notes because it’s proprietary and in some cases it has taken years to develop these sources. But what I try to do when I get the question is find out a few things about the person asking questions such as:
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- What types of notes are you looking for?
- What is your experience?
- What is your level of risk tolerance?
- Are you a one-time, occasional buyer, or someone with a fund who can buy consistently?
“Or… Why Not Just Make Notes Yourself?”
Depending on the experience level of the person I’m talking to, I will usually tell them how I got started in the note business. I tell this story not because I think every person should start out this way but simply because it’s one of the most relatable examples of note investing to hard property Real Estate investors. When I first began, I started just like many Real Estate investors by originating my own notes. I did this utilizing some of my equity in my rental properties and money from my retirement accounts because I saw the returns my otherwise dormant money could make, and it was an investment tied to Real Estate without all the hassle of tenants.
The notes I would originate back then were first lien position rehab loans for fellow rehabbers. It was very similar to "hard money". If you think about it, all hard money lenders are in the notes business. I have a good friend in Philadelphia who has over 225 houses, and he's also a hard money lender. I think it's obvious whyâ¦It's much easier to do 1st mortgage rehab loans than it is to manage 225 houses.
Plus, these are safe deals to do when you’re new if you set them up correctly. You can create the notes through your title company or your attorney, but you just want to be sure your paperwork is in order, that you have a good value on the property, and that you know the borrower and his skill set and experience level (use a draw schedule if necessary). I would also be named insured and absolutely pull title on this type of deal.
Personally I only lend money to LLC’s and never to an individual (because of usury laws) or to owner occupants (in most cases it invalidates Deed In Lieu and you have to foreclose).
“But, Dave,” I hear you ask, “how many of these can you do in a year without being licensed in any particular state because of the SAFE Act? Good question. This was one of the reasons why many investors, myself included, started to prefer to buy existing loans, performing and/or non-performing.
“I Don’t Want to Make Notes. I Want to Buy Notes!”
So far we’ve been talking about residential first liens. Yes, of course, there are commercial notes, but much like traditional property investing, commercial notes usually demand more capital. They are typically sold to larger players directly from banks and servicers, but I have seen many brokers and note sellers use websites like LinkedIn (there are plenty of groups like Buyers and Sellers Commercial Property Loans) and Loan MLS. The product might not always be of the highest caliber for the price, especially when buying individual notes, but it’s certainly a start.
And when it comes to buying residential performing and non-performing notes, I think of two types: seller financed and institutional. Seller-financed brokers typically sell performing 1st mortgages although in the current market some of this brokering has slowed and selling “partials[SC1] ” are very popular in this environment. However, players in the partials space generally prefer lots of equity and security.
Where to Find Seller Financed Notes
So where do you find these seller-financed notes? You could market to out-of-state owners, people with older mortgages, or go to the courthouses, but you can also go directly to companies who do that for you and sell notes. When asked for seller-financed notes, since that’s not my specialty, I prefer to recommend people to seller-finance experts like Jeff Armstrong at Armstrong Capital or Ralph Marshal, the head of the Trade Desk at Colonial Funding.
As for the institutional note space, especially when you start out, you don’t always buy from where you think. We discovered early on that one of the hardest places to buy notes from actually is institutions! When we applied to a large bank that eventually became one of our best sources, we had to go through the vetting process that took upwards of two months. The information we had to give was quite extensive and included (but wasn’t limited to):
- Company history
- Background checks on both the company and the company partners
- Senior management member resumes
- The date our note funds started
- References of who you’ve traded with (usually bank references, ironic I know)
- A Certificate of Good Standing (this is a document produced by the state you’re incorporated in)
- Proof of funds
- Our anti-money laundering policy (documented proof that you have in place a policy that meets professional guides stating you don’t take money from suspicious parties)
- Company financials
- A minimum trade history (usually 2 years is what we’ve found to be the standard that banks like to see)
I know this might seem like a lot, but in a way it’s a good thing because this eliminates a lot of the buyers who truly aren’t serious or experienced enough to buy direct. I also know this list might sound discouraging, but we didn’t always qualify to buy direct and we had to start somewhere, too. In fact, it’s funny because the way we got into our first big bank was by accident – we were dealing with a smaller servicer’s trade desk and the person we were dealing with left there and went to one of the biggest banks in the U.S. And once you get into one bank it’s MUCH easier to get into others.
But remember, just like seller-financed, I’ve seen more specialty servicers who buy directly from banks that sell to the street. For first mortgages especially, I’ve never seen a busier time. If you have limited funds (this can be a capital-intensive business although you can use OPM – Other People’s Money) a smaller servicer or exchange such as Granite Loan Solutions or FCI may be your best choice to “cherry pick” individual loans. If you’re looking for pools of 1st liens you could try brokers and servicers, and of course, if you’re large enough and experienced enough, you could go directly to major financial institutions. There’s one major caveat though, this is a relationship-based business and you really need to know your note seller just as much as the notes you’re buying.
How to Get Started Buying Notes
So, as I and many others have previously advised, I recommend you start out small or get to know a reputable servicer or broker first because in this business, especially on the institutional side, you won’t receive your product at closing. It could take anywhere from 15 to 45 days on average depending on your contract. Also, just as critical to finding notes is your due diligence. Depending on what types of liens you’re buying (1sts, 2nds, commercial, secured, unsecured) and what category of lien, your due diligence will vary.
As always, questions and comments are welcomed below and please stay tuned for my next article on “Due Diligence when buying Notes”.