Bidding on Notes: How to Buy Right for YOUR Business Model
“How much” to bid on notes is probably one of the most commonly asked questions, especially coming from newer note investors.
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There are three main questions, in reference to buying nonperforming notes, which really come to mind:
1.) How much to pay for a note, or pool of notes?
2.) How long will it take?
3.) How much will I make?
Not to sound like an attorney, but the real answer to all of these questions is it depends. Realizing that it’s not the answer most folks want to hear, especially those thinking about jumping into the note business, or those contemplating the move into nonperforming notes, it really does depend on multiple factors. You also have to understand that there’s some trial and error involved, as well as a lot of common sense. But, that being said, I’ll try to break them down to explain a little further.
How Much to Pay?
Since the note business, in general, and not just bidding on notes, is a “learn by doing business,” it’s very hard in the beginning (I know I’ve been there), when you don’t have any data or a track record to go on. It’s also a business where you learn things by trial and error. The best advice here is to be sure to track your data and performance for future reference to assist you with future bids.
Due Diligence is a big factor as well. Of course you will look at generic criteria—depending on the asset class your bidding on (for example: commercial notes, first liens, or second liens)—such as fair market value, loan status, occupancy, etc. But as you improve your due diligence over time, your bidding will become more precise, and you will soon realize, like the more experienced note buyers, that your internal numbers are the most important factor to you or your organization.
Targeted Revenue is another difficult concept to determine when you’re new, since you have very little data to go on. My best advice is to make a dart throw until, over time, your own data becomes more accurate. Another way to start would be to track your data on an equity deal. I know for my company, we never used 100% as a figure for targeted revenue, regardless of equity, because every non-performing note has some degree of risk. And, you never know what could happen later, like increased expenses, falling market value, or that you might want to discount the payoff to exit the deal sooner.
How Long Will it Take?
This just leads me to another question which is, to do what? How long will it take to get the loan re-performing to hold in your portfolio? Or to just recapitalize, by selling the note, selling a partial of the note, or borrowing against the note (a.k.a. Collateral Assignment)? The length of time it takes to generate revenue will also depend on your asset class (for example: equity notes, REO’s, first liens, second liens, etc.).
Another important factor will be your experience level. When I was new, it took me longer to do everything, largely due to the fact that I was still learning. Efficiency of your collection process and note administration is another overlooked variable.
How Much Will I Make?
Previously, we touched on how due diligence, and your proficiency at it, can affect purchase price when getting ready to bid, but there are many other factors as well (for example, the quality of your workout process with the borrower). Efficiency of your model and the asset classes you’re buying come into play again. But, I think two other important factors enter the equation: Cost of Overhead and Cost of Capital.
Cost of Overhead is pretty obvious, when it comes to office and desk space. There’s a certain level of administrative expenses per note, but the biggest expense for us is usually legal. Both of these numbers have dropped dramatically over time as we become more efficient.
Cost of Capital is probably a bigger factor in my mind and really lends itself to, what type of business model do you have? Are you small buy-and-hold shop? Or, are you more of a velocity shop? How much capital and what type (OPM, IRA, institutional vs. private), also plays a big role in how much availability of product and what type deal flow you would need.
Oftentimes, folks, who are just starting out, ask me for my proprietary, corporate data, and even if I did tell them what it was, in most cases, it’s irrelevant to them and their model. If I’m a velocity shop with expensive capital, I’m forced to make decisions based on my costs and operating expenses, which aren’t as much of a factor for a smaller-scale buy-and-hold investor, who is working out of his house.
So, like I said earlier, when it comes to bidding on notes, it’s a “learn by doing business,” with lots of trial and error, but be sure to track your performance and due diligence data. And at some point, you may have to be like PPR was in 2007, and just take the plunge.