At first I got excited about 14% return and equity backing the note ($178K-$138K=$40K but the price of the note is $23K, hence $17K equity) but then I did some calculations and found out that the actual ROI is slightly over 5% compounded over ~30 years. In essence, this note has the same payoff as a hypothetical 30yr bond with 5% coupon bought at par value. Not much considering that the interest rates may rise in the next 30 years.
Granted, this note may get refinanced or paid off a lot sooner than 30 years and I heard of average time being ~10 years. That brings expected ROI to 7.8%/year. Still waiting for 10 years until a payoff is a long time.
Another thing I did not like about this note is the property state. It is a judicial state and it takes 12-15 months to foreclose there.
So, here are the questions to the notes investors out there:
What do you think about this note?
Would you buy it or not and why?
Is this note priced too high, too low, or just right?
Is the note term (30 years in this case) an important or minor factor to decide if a note is a good investment?
I like the way you calculate returns but what if a note was purchased as a source of income? Then spending it all would leave us with no capital and no note. I guess only interest portion of a payment may be spent and principal may be reinvested.
That whole reinvestment thing only makes sense if it is possible to buy another note with similar characteristics for $280 or so. If no such note is available, one will have to wait until all initial investment is returned (6-7 years) and only then look for another note. An alternative is to buy 100 notes at once and then use monthly income ($28000) to buy 101st note and so forth. Not many people have such resources.
Now, back to the note. If another one like that comes along, would it be a good investment or not so? My main concern is 30 years term. I'd rather see a note with 5 years of payments left but all other parameters being equal.
Do such notes exist?
Nick, I am not sure what other reason you would purchase a note for if not for a source of income/return. They do not make good lawn furniture.
What portion of capital that get's allocated to reinvestment is at the hands of the owner of said capital making the investments. I think what you are asking is what if a portion of the return was needed as some type of personal income to live on. Well, as I mentioned then, the investor can allocate any portion their heart desires between 0% and 100% of the return for such things.
However, the quantification of such things only has meaning to the actual investor and is not so related to the asset. The asset delivers a 14.57% return, what you do with it is your business, in that sense.
The investor capital schedule and the borrower principal and interest schedules only align if the loan is invested in at Par. Any discount or premium applied offsets the investor from the borrower. With discounts, portion of the loan principal becomes return and with premiums portions of the loan interest becomes invested capital in terms of repayment.
Again, at the end of each year, we have $3,336 that is no longer earning return. Is it practical to find investment opportunities with that low of a capital amount around the same return rate as the primary investment? I suppose that is more a function of risk assessment. For instance a second position mortgage might trade for that type of money. Other micro finance opportunities are also out there, you just have to find them. In addition, a linear idea to return is not always practical either. You may only invest the $3,336 in a bank CD and add the entire amount each year earning say 2% until you have done so for 5 years at which time you might be able to invest the $16,680 into a higher return investment which makes up for the time the return was small.
I don't understand the another note question you are asking. A mortgagee does not have to hold the mortgage to maturity. Just as the mortgage was purchased after origination here, so too can the loan be sold prior to maturity. During the term of ownership, you still received return at 14.57% annually. When you 'cash out' will not change that idea.
Are there loans with shorter time to maturity? Yes. Some loans have been written for shorter terms which may or may not have a balloon feature. In addition, as you mention you can simply seek loans with are more seasoned in their total term and closer to the maturity to accomplish the same thing.
Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes
12y
Thank you, @Dion DePaoli , this was a good explanation.
So, just following through with it, in 7 (or so) years, once I made my initial investment back, I may then sell the remaining note and that sales price will be my overall gain on the note or I may continue for hold it till maturity, or default, or refinance by the borrower. Either way it becomes risk-free at that point.
Ok, then I only have to worry about borrower's default in the 7 years preceding the return of original investment.
Now, since the note is warranted, all I can lose in the case of default is the interest in the preceding years. My original principal should still be whole. So, my only risk here is loss of principal purchasing power due to inflation.
Thank you, @Dion DePaoli , this was a good explanation.
So, just following through with it, in 7 (or so) years, once I made my initial investment back, I may then sell the remaining note and that sales price will be my overall gain on the note or I may continue for hold it till maturity, or default, or refinance by the borrower. Either way it becomes risk-free at that point.
Ok, then I only have to worry about borrower's default in the 7 years preceding the return of original investment.
Now, since the note is warranted, all I can lose in the case of default is the interest in the preceding years. My original principal should still be whole. So, my only risk here is loss of principal purchasing power due to inflation.
Correct?
Yep, that is the gist of it.
Remember, how the actual formal accounting takes place will influence these ideas in regards to what is a realized gain or not. For that sort of planning, see a CPA to understand the tax implications.
Specialist · Westlake Village, CA · Member since 2010 · 1k+ posts · 781 votes
12y
Originally posted by @Nick B.:
Originally posted by @Ellis San Jose:
@Nick B.
If you are purchasing notes for the purpose of predictable monthly income, non-performing 2nd's with high CLTV% are probably not the most suitable investment.
Ellis,
The note I posted here was performing (or re-performed to be precise). Where did you get non-performing reference?
As for my calculations, I was just trying to see what kind of rate should I get on a CD (compounded annually) to match total return of a given note at the same maximum period of time (29.75 years).
Obviously notes and CDs are different but if we start with the same initial investment and arrive at the same ROI in the same period of time, the rate of return is the same, isn't it?
14% on a note is non-compounded. Try to compound it over 30 years and see what the payoff would be :-)
@Nick B
I incorrectly assumed it was a NPN because it was thru PPR, my mistake.
I would still be cautious of the high LTV% if this was the only note you were planning on investing in & you were relying on the monthly income.
Any reinvestment rate assumption on monthly income has an inherent flaw in that you aren't 100% certain what you will be able to reinvest into.
Although, I would certainly hope you could surpass a current paltry CD rate.( You could pay off a bill early for a 10% discount for example).
Great quote by Dion Depaoli "The asset returns 14.57% to maturity, what is done with those proceeds once received is up to the investor. The manners in which it can be treated are pretty numerous." ...I couldn't have said it better.
If the borrower pays as agreed 14.57% is a return that banks, stock & bond brokers would salivate over.
Also, your equity cushion would be affected by how fast the 1st mortgage is amortizing, among other things.
14%+ compounded is a nice juicy return over a long periods of time , which is why I love "note tails & zero coupons" for IRA & 401k accounts. :-)
Specialist · Tucson, AZ · Member since 2009 · 108 posts · 24 votes
12y
Really great replies on here, thank you guys very much! Considerate and informative replies that didn't talk down to or degrade the OP unlike some responses can be. This is the kind of interaction and information that makes Bigger Pockets great!
Thank you again guys!
Investor · Perth Amboy, NJ · Member since 2013 · 110 posts · 21 votes
12y
Great thread. When I grow up I want to be as well versed as @Dion DePaoli
Not sure you would agree here but ..... Amortization is a beautiful thing. If you buy a re-performing note the early payments are mostly just interest. The principle is barely touched. When you sell a note, UPB is most of what dictates the sale price. When you collect 7 years of payments then sell the note, you are maximixing the cash cycle (I made that term up).
small second behind a large first is the most risky note you can buy.. 10% equity is not nearly enough to cover you in a FCL situation you will take a financial loss if this occurs... Warranting a notes performance is only as good as who is giving the warranty and I suspect there are very definite securities issues related with such a warranty. For a fact you could not warrant a CA OR or WA note without running afoul of the Securities rules. This gives an investor a VERY false sense of security.. IE hey I will make this less than safe investment because if it goes pear shaped the company 7 years from now will replace it with another note. That I think is wishful thinking. If a company is warranting or guaranteeing performance then I am sure the combined wisdom here on BP would think that there would need to be a full blown security offering. And said security offering would have to have Notes and or substantial cash reserves to back this up.
I mean really with a warranty like that why would anyone buy anything else than a Not from PRR .
@Dion DePaoli I think you explained IRR better than I would've, and I'm glad to see that type of valuable info in a BP forum. It may already be evident in your calculations, but just to verify, when my partner calculates IRR for the notes we sell, it's a P&I payment over 12 months with the FCI servicing fee ($15/month) calculated in.
@Jay Hinrichs In regard to your comment, I’m trying to have my Securities Attorney, Craig Zappetti, chime in on this thread, because I’m sure he can explain this much better.
That being said, a note buyer purchasing from PPR would be buying an actual note and mortgage (not a security), and he/she would be taking ownership of this note. The warranty we offer on Performing Notes is essentially a re-service and re-purchase agreement. It states that if the note were to go into default, one of our asset managers will service the note in an effort to get it re-performing, and if the asset manager is unable to get the note re-performing within 4-6 months (depending on the State), then PPR will buy this note back for the amount of the note buyer’s initial investment principal less any payments received from the borrower during his/her time of ownership.
I suppose every state will have a different take on this.. I can't say I am 100% certain but I am 98% certain this would not fly in Oregon or to an Oregon resident. Been there done that with the state regulators any form of buy back guarantee etc would require some sort of securities offering. In Oregon its called a Real Estate Paper offering.. And its a Minnie reg D filing. Not that what your marketing cant be done but the state of Oregon wants full disclosure to their citizens.
So the question becomes. And if I may take the liberty to play devils advocate here.
And I really don't know anything about your business other than I think your selling non performing second trust deeds or mortgages and by your post your offering to service them or replace them if they go bad. I suspect you buy them in bulk for pennies on the dollar then re assign them and make a profit selling them ( does not take a rocket scientist to figure that one out).
So from an investors stand point. And we already know this is high risk defaulted paper in second position.. So the most risky notes you can buy ( except for 3rds)
So we know these are going to default and probably default at a pretty high rate I would suspect 50% or better ( do you provide this information to your buyers IE how many have defaulted).
So I am a buyer of a 2nd it craters and now your going to step in your not going to give me my money back just replace the note.. What if I don't like the note your replacing me with.. How do you handle that.. Does the investor just have to take one that match's monetarily or do you send them 10 and tell them to take their pick.
What happens if there is a run on the bank.. How many of these do you have in reserve to use as substitute collateral. And or do you have any data on how successful your buyers are over time getting these things up and running and keeping them running. How do these investors handle the senior liens if the second is non performing the first usually is these people usually pay the second and not the first because its a smaller payment and no one said the US borrower is that versed in RE and credit.
Back in the day in California we sold notes all the time with an endorsement on the back "with recourse" this meant if it went bad we had to cash them out. and take over the position..
Just seems like warranting a second that is NPN is just highly risky from your perspective.. And what happens if a note default 7 years from now and your no longer in bizz your retired what is an investor going to do then.. Or is there a sunset IE if the note holder pays 24 months the warranty is over. that would make sense.
Anyway look forward to hearing how you handle this.
Last comment if you are selling these notes for 1k to 5k then forget everything I just said other than the legalities of a warranty. too little of money to worry about if they go TU
Investor · Philadelphia, PA · Member since 2014 · 6 posts · 9 votes
12y
The first issue to consider in any securities analysis is whether or not the item in question is in fact a security. If it is not, then it is not subject to the securities laws. A single note secured by a mortgage is essentially a real estate interest and generally not a security as there is an actual asset underlying the purchase. The purchaser is in essence is acquiring a real estate asset and the warranty covers a portion of the loss if the quality of that asset turns out to be deficient. This really should be no different than any warranty that a seller provides in a contract to sell a house. It is a contractual matter that is regulated by real estate and general contract laws.
This doesn't mean that regulators in some states won't try to push the issue. I just think that securities regulators would have this first hurdle to pass. The other issue is that, to expend enforcement resources, the buyer would need to have experienced losses. If the buyer receives some payments from the borrower and the seller covers the remaining unpaid amounts through the warranty, there shouldn't be any losses to justify any real enforcement action.
This analysis changes if the seller assembles a pool of notes and sells fractional interests in that pool OR raises a pool of money by selling equity or debt for use in purchasing a pool of notes. In either of those scenarios, there would be a sale of a security and regulators in all states and at the SEC would regulate those offerings. This is just not the case in these deals.
well I went at it with state of Oregon on these issues and it really comes down to picking your battles. And if they disagree with you its big money fighting city hall as it were...
for the general public then the due diligence is hey will this company be there in the long run how do I know they have the wherewithal to cure.. what happens when there are no more 2nds to be bought at these huge discounts. what happens when they have made gazzillions and have retired and there is no company left to warranty... the notes down the line. what happens if I don't like the replacement note how does that work.. so those are just basic questions when your buying something with a warranty be it a car a toaster ( or my favorite Windows) Windows have 10 year guarantee ( window company folded) your windows have leaks nothing you can do.
Its just like sellers of property giving rental guarantees they are only as good as the strength of the people giving the guarantee
Although we rep and warrant that all the liens we sell are valid liens are in the lien position as advertized, that is not to be confused with the warranty we offer on performing notes. Just to clarify, we sell both non-performing notes and performing notes, and the warranty referenced in this tread is only offered on Performing Notes, not on non-performing notes.
*The warranty we offer on Performing Notes is essentially a re-service and re-purchase agreement. It states that if the note were to go into default, one of our asset managers will service the note in an effort to get it re-performing, and if the asset manager is unable to get the note re-performing within 4-6 months (depending on the State), then PPR will buy this note back for the amount of the note buyer’s initial purchase price less any payments received from the borrower during his/her time of ownership.*
The length of seasoning we require for a particular note is based on the amount of arrears paid by the borrower. We have an experienced team of asset managers, and we’re confident in our workout process, as it is a trust and verify situation. Also, we have a charge-back to the asset manager (salary + commission) if we have to buy it back, so they have a vested interest in creating a sustainable workout to begin with. If it hiccups, they also have a vested interest in getting it back on track, since they know that if we have to buy the note back, they’ll lose money.
I hope this helps to clarify some of the confusion surrounding the warranty on Performing Notes.
