Other Exit Strategies For NPN (First Lien) Besides Foreclosure?

29 Replies

   I'm looking at the FCI Exchange, just to give myself a sample of ideas as I look into notes. I can't seem to get my head around it. Another BP member mentioned to me that so far him and a partner have only gone for non-performing 1sts. You can get NP 2nds for about 20%, but what on average are you looking for in 1sts? Is your primary exit strategy to just foreclose and turn it in to a turn key rental or to attempt to get them re-performing? There doesn't seem to be much of a gap in the UPB and what you get it for to allow you room to work with them on reducing payments, balance, etc. 


Take these two notes for example:

  • Example 1
    • Purchase @ $26,000: 85% UPB
    • UPB = $30,000
    • This is only a $4,000 reduction on what they owe, how could you get this performing again and keep it profitable?
    • ARV @ $75,000
    • Makes more sense to foreclose and give them the choice to jump back on payments or no-go!
  • Example 2
    • Purchase @ $11,500: 40% UPB
    • UPB = $28,000
    • ARV @ $9,500
    • Is this just garbage?

    I'm not sure if there's something I'm missing, haven't read up on, a number I'm leaving out, or if I am just too slow to comprehend NP 1sts. 2nds seem much easier to understand when they are current on the first, as far as your options to get them re-performing, foreclose subject to first, etc. Thanks in advance!

  • Example 3:
    • As Is Value: $35,000
    • ARV: $65,000
    • Original Amount: $51,000
    • Principal Amount: $31,000
    • Status: In Foreclosure
    • Cost Of Acquisition: $15,000 + Fees
    • Rent $750-$800
    • Taxes: Current

This is something I feel somebody would jump all over. If you could acquire it with fees and all for $20,000 and even put $20,000 into repairs you're all in for $40,000. If you rented out at $750 you're still making the 2% rule! Then you can fill it with a tenant and sell it, or just sit on it and cash flow $750/month less expenses. I'd imagine you could get a construction loan or equity loan at that point to finance the construction. 

Granted, this is all hypothetical, but those are actual property examples. I just want to know if I'm missing something big or if I'm actually looking at these in the proper perspective. If someone could give me advice or opinions on how they'd look at these deals I'd appreciate it. 

Example 1 - Don't forget about the arrears.  When a borrower has not been making payments for some time those back payments stack up and add to amount owing, but they are not reflected as part of UPB.  If you bid on one of these FCI notes you will have access to these details for further DD.

Example 2 - Yup.  Most notes available on online exchanges are garbage.

Example 3 - It might be a good one, but chances are good that there is a problem.  Don't forget to check current taxes due (directly with the county), and consider this part of your investment because delinquent taxes are in a senior lien position to your note.  Also, check the level of crime in the area on Trulia.  Get your own value analyses as well before you pull the trigger.

For any note you buy you also need to make sure that ALL of the key paperwork is accounted for.  You need the original Note and Deed of Trust as well as all of the Assignments and Allonges.  I have had people on FCI try and sell me notes that were missing documents that would have made it very hard to FC if the borrower stopped paying.  Last time I checked a few weeks ago that note was still for sale on their website.

I'm an old fashioned private money equity lender. FCI happens to service a number of loans from several of my personal portfolios. We also use another company, service in-house the loss mit files and I own half a NPN hedge fund and part of another, neither of which I'm involved with day to day.

I was originally trained to look at the collateral from a worst-case scenario and not be reluctant to foreclose. Sometimes foreclosure can be tactically used as an attention or training device. What I don't care to become involved with is the unsecured or under secured paper that is becoming popular with some investors. It can be very profitable, but the rational is to buy and hold the paper and to be patient in get it re-performing. 

Check out Gordon Moss' book, 'Performance Anxiety' for a great introduction to the strategies that interest you. Several people offer training in how to buy and exploit these type loans profitably. In addition to Gordon, check out Dave Van Horn who occasionally posts here on BP. 

We buy npn 1sts with the intention to mod the loan and get it reperfroming. On underwater notes, I use the BPO as-is value for my pricing guideline, typically 30-50% of that value for my offer for properties in the southeast and midwest. West coast is higher and rustbelt lower. This way if I have to foreclose, I'm recouping my initial capital and expenses and perhaps making a few bucks when liquidated. 

For notes that are par or below BPO, then a percentage of UPB is my basis for the offer. Also, both Gordon Moss and Dave Van Horn are excellent resources but realize that they play in the NPN 2nd or junior lien space, and I'm assuming you are looking at 1st position notes.

@Jason Eyerly  

  too add to the incredible wisdom and experience of the above.. When your dealing with low value Notes like these  IE firsts in the 40 to 50k range.. VALUE of the asset must be established.. many of these homes if they become vacant and if they are in the mid west or rust belt only have a value to a WHOLESALER that will pay usually 5 to maybe 15k for these type of homes...

If your new to note investing my suggestion is just like owing rentals try to find a note close to your home so you can drive it, check it out and make darn sure its worth what you think its worth then establish a value if you have to fully foreclose on the borrower and your house is trashed when they leave..

Having funded hundred to really thousands of mid west Wholesale deals its rare that a house that goes through the process is in any kind of condition to sell or rent..

All the other issues like tax's foreclosure process arrearages proper docs etc etc. is something you can do from home for sure.. Just make darn sure you establish our value. And you know the foreclosure rules of the state.

There are a lot of pretty good performing notes out there for conservative cash flow investors that will do as well as buying rentals COC ... But I see the attraction of buying these at huge discount and making the delta.. But I suspect those that do well at it are very versed and cashed up.

Hate to be a small investor and you buy one or two with all your liquid funds and you pick poorly and lose.

Modification is my first choice exit as well.  Many notes are so far underwater with respect to value, you end up purchasing at a very low % of UPB and can therefore afford to reduce principal as part of the mod, helping the homeowner, and end up with a performing note at an excellent yield.  You can then sell that note at a more modest yield after some seasoning or just hold it in your portfolio. 

Deed in lieu and short sale are second choices, and quicker than foreclosure.  They can be feasible in cases where there are no junior liens in place and you can make contact with the borrower.

Foreclosure is the exit of last resort for me, due to the expense and long timeframe in many states.  However, it can be the only option if other exits are not feasible.  Because foreclosure has the greatest cost associated with it, it makes sense to use it as the primary yardstick for evaluating an investment, i.e., if the investment does not work under a foreclosure exit scenario, its not viable because you cannot rely on the feasibility of other exits.

@Rick H.  I'm not decided to go with 1sts or 2nds solely. Whichever presents me a lucrative opportunity, and which I can find, is what I will go with. I'm thinking seconds may be easier to start with for economical reasons, and they may be easier to get paid off, or re-performing to re-sell at a later point. They still offer the ability to FC, so providing the property is decent (I've seen many nice 2nd) then I would move in on them, and save the 1sts for when I have more capital or better yet, investor money! However acquiring properties at 30-50% of BPO as-is and going through FC sounds incredibly lucrative. What do you mean when you say notes that are "par"?

Thank you SO much to all of you who have provided me with so much information. I cannot thank you enough as this process starts to become more clear in my head, and something I believe I could pitch to a room of accredited investors!

Well, I've found Example 3 on Trulia. It was definitely to good to be true, I'd be selling this note while it's in FC as well! The estimate of $35,000 as is seems accurate enough, but I'm not sure where they came to get ARV of $65,000. I personally don't think I'd put the work into it. I broke it down as follows:

  • Pros:
    • Close to transit
    • Schools within 1 mile
    • Estimates at $35,000
  • Cons:
    • In A Medium Crime Area
    • Bordering High Crime
    • Schools Rated A 2!
    • Lots Of Arrests Locally (Even Recent)
    • 5/1 Townhome Seems Rare & Difficult To Sell

My summary of all that is that I would offer $8,000 to be generous, and leave myself room for PLENTY of renovations, just to get it to rental status, not even retail. Then I'd put a tenant in and try to sell it. Although all in all, I think it'd be better to just pass this up!

@Bob E.  

@Mike Hartzog  Could you provide an example (nothing specific, just numbers) on doing a loan mod in the scenario you mentioned? Just so I can see the numbers to make a better sense of the strategy? I was wondering how you'd calculate what the note would be worth if it became re-performing. I wouldn't want to hold a portfolio starting out, I just want to build cash, and recycle.

I can give you an example from a real note deal of mine.

  • Note Purchase Price: 27500
  • Property Value: 60K
  • 1st lien 180K + 100K in arrears
  • 2nd lien 40K (the owners kept this current for some reason)
  • Taxes due: 1500

In this case, the owners had been in the house for nearly 30 years and refinanced in 2006, putting a ton of debt on their property.  They could not afford the $1400 payment on the 1st so they didn't pay that but continued paying the 2nd which they could afford.  They very much want to keep the property.  I forgave the arrears and modified the 1st position loan to 75K at 9% over 30 years.  (I don't own the second.)   That provides a P&I payment of 603.47.  With my 27500 investment, that's a yield of 26.3%.

I plan to season this for a year or two before considering selling it to give it a payment history, thus improving the value of the note. When I do sell it, I would likely sell a partial to give the buyer a minimum 20% equity margin (80% LTV). So let's say I sell it at a yield of 12%. I could sell the front 110 payments (just over 9 years) for 40K, retaining the back payments. That would give my investor a 12.1% yield and a 67% LTV, which is quite comfortable, and I still own the back 250 payments.

Originally posted by @Mike Hartzog:

I can give you an example from a real note deal of mine.

  • Note Purchase Price: 27500
  • Property Value: 60K
  • 1st lien 180K + 100K in arrears
  • 2nd lien 40K (the owners kept this current for some reason)
  • Taxes due: 1500

In this case, the owners had been in the house for nearly 30 years and refinanced in 2006, putting a ton of debt on their property.  They could not afford the $1400 payment on the 1st so they didn't pay that but continued paying the 2nd which they could afford.  They very much want to keep the property.  I forgave the arrears and modified the 1st position loan to 75K at 9% over 30 years.  (I don't own the second.)   That provides a P&I payment of 603.47.  With my 27500 investment, that's a yield of 26.3%.

I plan to season this for a year or two before considering selling it to give it a payment history, thus improving the value of the note. When I do sell it, I would likely sell a partial to give the buyer a minimum 20% equity margin (80% LTV). So let's say I sell it at a yield of 12%. I could sell the front 110 payments (just over 9 years) for 40K, retaining the back payments. That would give my investor a 12.1% yield and a 67% LTV, which is quite comfortable, and I still own the back 250 payments.

That is an excellent deal! I'm genuinely impressed with the numbers here. I'm assuming that you didn't know they wanted to stay in the property so badly when you bought it, so what made you comfortable with the purchase at 50% of value? What was your initial strategy? If you were in my situation, not having a lot of cash, what would you do to get your initial $27,500 back ASAP to finance another purchase? 

Ignore that last question. If you sold the front 110 payments for $40k you already profited $12,500 and got your money back. And you gave yourself a potential cash flow in the future should they stay performing now. 

@Jason Eyerly  

I spent about 2-3 months in Jan-Mar of 2014 looking for performing notes to buy via FCI.  Some posters here on BP mentioned it had lots of cr*p but maybe a good note would come by every now and then.  Being the optimist, I decided to find it.  I finally gave up the search after finding a note I thought looked fairly good:

$55k FMV according to zillow, seller had $48k FMV. Nice pictures on google earth.

$35k UPB - 1st lien

minimum bid was selling for $29k, but I went ahead and bid $25k giving me a 16% COC. Seller accepted so quick! Red flags raised, and I contacted a real estate agent in the area to see what they thought. Turns out this particular house has been on the market for 2 years at $11k and recently dropped to $8.5k asking.

No thanks.  Better ways to part with my money.  It was then and there I knew if I wanted to be in that part of the note biz it would have to be with someone who knew what they were doing and could teach/guide me.  Be careful trying to find notes on an online exchange.

Originally posted by @Mark K.:

@Jason Eyerly 

I spent about 2-3 months in Jan-Mar of 2014 looking for performing notes to buy via FCI.  Some posters here on BP mentioned it had lots of cr*p but maybe a good note would come by every now and then.  Being the optimist, I decided to find it.  I finally gave up the search after finding a note I thought looked fairly good:

$55k FMV according to zillow, seller had $48k FMV. Nice pictures on google earth.

$35k UPB - 1st lien

minimum bid was selling for $29k, but I went ahead and bid $25k giving me a 16% COC. Seller accepted so quick! Red flags raised, and I contacted a real estate agent in the area to see what they thought. Turns out this particular house has been on the market for 2 years at $11k and recently dropped to $8.5k asking.

No thanks.  Better ways to part with my money.  It was then and there I knew if I wanted to be in that part of the note biz it would have to be with someone who knew what they were doing and could teach/guide me.  Be careful trying to find notes on an online exchange.

 That's interesting. Was it just torn to pieces on the interior? What would justify such a terrible price? I've been recommended to several places by other investors that aren't exchanges, but hedge funds who are the originators of the debt, or pool the debt together, and then sell it out. This seems like the best way to go. Exchanges seem like mostly investors trying to sell off their bad deals to some poor other guy.

Good job on the DD @Mark K.  Contacting boots-on-the-ground is essential.  I have looked at a few notes on FCI and other exchanges have had no luck with it. It seems that most sellers are looking for that greater fool.  IMO it is far better to establish relationships with larger sellers and review their offerings when they become available.  The quality of their notes is better, some provide BPO and O&E which helps with DD, and their pricing is generally more aligned with reality.

@Jason Eyerly  

My guess is it was a rental, went vacant, vandalized (HVAC stolen, inside stripped, etc.)  Once I heard the value (double checked to make sure the real estate agent had the right address) I didn't bother to probe further--waste of time.

@Mike Hartzog

That was my next step in the "wanting to get into the discounted notes business." I have established some relationship with a few firms out of NY who buy 1st lien NPN and get them reperforming. However, so far what they are selling is the dregs, so to speak and I wasn't impressed with the quality nor locations. My guess is they keep the best to try to exit these via refinance instead. They hold them for the length of time it takes for the original borrower to get their credit back in order then they help the borrower to refinance for better terms, payments, etc. Cash returns on that is far better than selling the RPN to an investor.

This is not a real property trade. After Repair Value does not apply - you do not have authority to repair a property you are not the deed owner to. You can preserve your interest and that is it. That's not the same as repairs. We will use FMV - AS IS Real Estate Value in the examples. We will assume the number given is the As Is Where Is value of the property. Assume these are all high level reviews for conversation sake but to add some additional price feedback from my eyes and experience:

Example 1:
UPB = $30,000
FMV = $75,000
- This asset has lots of equity. The LTV is 40%. As such the bid request is 85% of UPB. A reasonable bid level given the equity. NY can take up to 36 months to disposition. There could be some defects but assuming 'standard' distressed loan, the price would work. As you advance to pay for taxes, insurance and legal fees, those will increase the overall payoff amount and the arrears will also increase the claim. This asset would likely trade at auction and not revert back (assuming no other liens) due to the equity.

Example 2:  
UPB = $28,000
FMV = $9,500
- This will not work.  The bid is zero.  Costs to hold and foreclose would erode the FMV.

Example 3:
** Do not use ARV. This is not a real property investment.
UPB = $31,000
FMV = $35,000
- Not clear what state this is in, so TVM can't be judged.  In general assets below $50k get pushed down quickly.  It's not worth 50% or $15k.  More like half that number even in a quick foreclosure state.  So at best - $7,500 +/-.  If a longer state - closer to half that number so more like $3k.  

In general, the value of a NPN secured by real property at or below $20k - is zero. You will not stand to recoup the advances needed to be made. Most stuff in the $30k range trades for around 10% to 15% of RE Value provided taxes and other liens are not too large.

Example 4 (Mike's Mod) 
UPB = $75,000
Rate = 9%
FMV = $60k
2nd Lien = $40k
-Re-performing sale - It's romantic to think that the sale would simply be about yield. Perhaps to some that might fly, however the trade value in the example does not seem to properly convey the risk involved. Not going to address this as a partial. As a whole loan trade assuming 12 payments on time you might see $40k. The asset has a CLTV of 130%. That price would depend on the underwriting of the MOD and can drop quickly. If the Borrower late pays or slow pays, that will drop that price to.

Example 4 (Mark K FCI Bid) - some comments
UPB = $35k
FMV = $48k
Bid = $25k (52% FMV / 71% UPB)
COC = 16% ($4,000)
- The COC is realistic but the bid level dollars is too high.  The LTV as displayed is 75%.  Disposition by true sale, there is equity - that was the red flag that should have jumped out at you.  In general when we look at $50k, the best pricing will be in the 25% of FMV.  Additional liens or defects would lower that number.  The FMV was from Zillow - not the best place to get values without crunching numbers on real comps or getting a BPO.  See my note above about sub $20k - zero is the right number.

OP (Jason) - a Mortgagee usually does not get interior condition information out side of just guessing/approximating.  That also speaks to the sort of common error in understanding these.  You do not have a right to make repairs.  It's not your property and you are not entitled to the property.  

In most cases NPN to re-performing to refinance exit takes more time than most probably expect.  Not as much of a legitimate exit strategy as I think may believe it is.

Thanks for giving me something to do with my insomnia to all.  



This post has been removed.

@Dion DePaoli  

  GREAT points on low value notes... From my world were we do the mezz financing for those that end of buying these lower value deals... zero to 10k is all anyone can expect to get out of these notes and or if they take the property after expending a lot of time and energy.  And if an investor is going to take the property to sale and think they are going to sell 3p  they need to really understand the wholesale values.. And this is where the 2% rule jumps into the mix  those that buy these want 2% or far better and work their numbers backwards.. Other wise those that buy these homes for a living will just let them go through the system let the foreclosure clean up title then buy them from the asset manager or whoever with clean title.. And again usually at 10k or under. As most of these will require pretty extensive rehab.  And there are little demand for home owner ship in these price points.. these price points through out the mid west and south have become rental assets by and large...

I have never personally modified a mortgage on a owner occ so I don't have first hand experience at that but I did prior to the laws changing bought quite a few owner occ that were in default and worked with the owner to lower their payment give them some cash etc etc so they could get back on their feet and buy the home back or live there for years to come.  I did well over 100 of these..same scenario though of doing a loan mod.. And these were in Oregon and Washington so average values were 200 to 400k per home... Of all those deals I did I had exactly 2 buy the home back.. One got relatives to pay it off the other worked for a company that had a esop and when they sold they got a big check and paid us off... The rest made it anywhere from 3 months to maybe 3 years before they were right back to the same bad habits of when they stopped paying in the first place..

For this reason I never really got excited about trying to buy notes and do mods I think its just sub prime paper as a whole  ( obviously some will work)  working in and around the mid west and south were these low value assets are I think trying to get a borrower who already defaulted on a sub 500 month payment will be challenging at best over the long haul

@Jay Hinrichs when we model a NPN loan trade we typically use a 20% Target Return. In general, the most conservative approach is plan to take the asset all the way through foreclose, auction and an REO sale. That is the longest and most expensive disposition, anything less is better - like DIL or Short Sale. We do not model for those unless it is uncovered as a likelihood in due diligence. Before the crash and many years initially after, $20k and down was $0 and folks literally could not give them away. Mainly due to the potential liability that will follow. Detroit is the greatest example of such things, where they tried to go after the Mortgagees. In regards to our approached to rehab in the event the asset reverts back to us. In the low value band, the dollars spent do not amplify value generally. In other words, spending $3k in a $30k house generally doesn't help the house become $36k. So, those dollars not so much value add - as much as value stop loss. As such, I always like to say, I am not HGTV. I would rather sell the REO to an REI and let him do all that stuff than put more money in trying to make the nicest low level asset on the block.

Interestingly, I do think if there was a way to really 'free up' those lower value assets it would be beneficial for all.  Most of the purchases would be investors looking to rent since you have a financing barrier for primary borrowers.  The issue of course is the surrounding area is generally run down so one asset improvement has little impact.  It needs to be a pretty big project as we all know.  Taking on neighborhoods is no small task.

Modifications are interesting beasts.  The general re-default rate for a modified mortgage is around 35% to 40%.  That is a "default" rate.  The delinquency rate is higher than that even.  So in other words, many completed mods will slow pay (pay late each month) and slip into delinquency as they go down.  Did not mean to pick on Mike.  We love loan modifications.  Some of the best yield in the market.  The point is, the incubation period is longer than many newer investors plan and the risk profile is still higher than most new folks give credit to.  The concept get's simplified to the notion of 12 consecutive month payments - that is not entirely right.  Buying any cash flowing loan, it is always about the predictability, continuity and consistency of future payments.  12 consecutive periodic payments is a contributing factor to a higher valuation, the point is do not assume it is the only factor.  1 year is not really that much time, it's only 12 'things' (payments) which is also not a lot in comparison or 1/30 of the entire plan still to come, 29/30 has some inherent risks still.  But like I said, we are pretty fond of them.

Jay, you are correct - it is sub-prime paper.  It is not worthless and has a risk reward ratio to keep the game playable and interesting.  To your subtle point, let's not assume it went from Sub-Prime to Prime with a little lipstick and redressing.  As long as we keep that idea, we will be grounded investors in that segment of this asset class.

@Dion DePaoli  

Dion all great points and I think we are of like mind when it comes to NPN.

Agree about Mich and parts of Ohio.. Institutional note buyers would not buy in those states for any price. 

Many of these Notes as you state have no value .  Not sure where the banks go with these if no one will buy the worthless note and then the bank does not want to spend money foreclosing.. I suspect we will see a huge surged in Tax sales as the banks just let them go and hope to make some overage's.

I have a friend that works for a company in I think its Jacksonville and they do computer modeling for banks that is very cutting edge to take their portfolios and give data on how many will default over time so the banks and servicers can get ahead and know which loans are at risk and move them out of the portfolio..

Great discussion that came about here. What I gather from all this is that notes are a lucrative way to invest, provided you know what you are doing and what you should be paying.

@Jay Hinrichs   @Dion DePaoli    What is the quickest way to get at least your minimum investment back to use towards another deal? Selling the re-performing note, selling the front-end payments, etc?

 @Mike Hartzog  

@Bob E.  I know you are relatively new in the note space, but have you had any late payments or defaults after you've complete a mod?

It seems like with 1st NPN there are a lot of complexities and issues that may be avoided by going with the cheaper 2nd NP behind a 1st performing. Perhaps this is why some prefer the 2nd?

Join the Largest Real Estate Investing Community

Basic membership is free, forever.

By signing up, you indicate that you agree to the BiggerPockets Terms & Conditions.