A topic that came up in a local REIA event I attended: Distressed mortgages

[Joshua Nudell]

Good evening all!

I was attending a local REI club meeting here in New York City and an interesting topic came up regarding distressed mortgages. I wanted to see if anyone on BP has had experience with these types of deals, and what your thoughts are.

Basically, some people at the meeting mentioned that one direction they were looking at in the real estate investment portfolios was distressed mortgages, where they buy a mortgage from a bank, credit union, etc for pennies on the dollar (or some other ridiculously low % of the actual value of the property).  At that point they had a choice:

1) Renegotiate with the current homeowner to start paying the mortgage again (possibly at a reduced value because it was the mortgage was purchased at a discount).

- OR -

2) Wait for the homeowner to miss one payment and foreclose on the property, thereby buying something for a deep discount if you don't mind going through the courts to eventually own the property.

Has anyone seen this type of negotiation/deal with lenders?

[Dion DePaoli]

@Joshua Nudell 

Distressed mortgage investing is known and here on BP there is a forum which covers many topics on the matter called "Tax Liens, Notes, Paper, & Cash Flows". Many folks use the layman term "Note" to talk about the set of instruments (Mortgage/Deed of Trust & Promissory Note).

There has been a lot of NY sales as of lately. Much having to do with the upward movement on real property price. NY carries the longest foreclosure time line in the union and around 3 years. As such, NY loans are deeply discounted to provide for the recovery of the advances needed to be made on the account such as taxes, insurance, property preservation and legal fees. Recently we have seen those prices push up about 10% above their mean from the last couple of years.

Talking about the discount on the unpaid principal balance of the loan with no reference to the underlying real property value on a non-performing loan is relatively pointless. Since many loans had negative LTV, where the total unpaid loan balance exceed the value of the property securing the loan that does cause those bids to be on the low side of the UPB (Unpaid Balance). However, that is only relative in relation to the value of the real estate since that is the collateral you use to recover your funds. In general, NY was trading for 45% of FMV (commonly documented by a BPO) lately that has pushed up to around 55%. If we assume the loan balance is par the level will match for both. If there is negative equity then the same dollars identified by that ratio will be a lower UPB percentage number. The more negative equity, the lower the level of UPB %. However, the opposite is also true. Most of the time, those folks who do not make the distinction and at the same time accent the "pennies on the dollar" either do not know what they are talking about or are trying to sell you something. The reason a loan is discounted is because it takes time and capital to resolve the issues.

As far as the simplicity of the two ideas. I would not consider that a legitimate picture of what happens. Addressing in reverse. A Mortgagee (the investor who owns the Mortgage and Note) can not issue a foreclosure process until AFTER 120 days past due. So, missing one payment doesn't work to initiate foreclosure, provided payments are due monthly. Further, a Borrower has rights to reinstate the loan and rights to redeem the property from the loan. A Mortgagee does NOT have an innate right to the real property itself only the debt secured by the property. A Mortgagee may end up with title to the real property if the bid level at foreclosure auction is not met but describing that as a way to get the property is a bit misleading since it is not always the outcome.

A Mortgagee can work with a Borrower to reinstate the loan. The are many things to consider when moving along that path as a Mortgagee. It is not uncommon for loans to be modified. It is also not uncommon for those modified loans to have some value issues in the secondary market. A Mortgagee can not work from both angles, providing relief to a Borrower and pursue foreclosure. I am sure you can also imagine the barrier that is likely present to simply make contact with the Borrower. It is fairly typical that a loan for sale has undergone some form of loss mitigation practice and failed or deemed unworthy. That said, things do change so neither side of the coin is uncommon. More than likely the elephant in the room pertaining to that idea is the rest of the strategy the investor has, usually some form of re-trading the asset.  Let's just say, that too, has more to it than is usually conveyed in the short conversations.  

The good news, yes, distressed mortgage/note investing is certainly a thing.  It is not new.  Many folks do such things.  Like any investing there are things to know.  With proper execution an investor can make nice returns.  I would not say they outrun real property as both assets can have some home runs.  Check the other forum out, lots of topics there.  Good luck.