Will, I haven't read all the posts, didn't read the other one. I read yours because I know you here and have, I feel, a good sense of how you operate in lending areas. I'm not arguing with your popularity on BP, I never expect you to take any of my compliance suggestions, I'm not concerned with you getting out of compliance I just point things out for others who may weigh the risks before they act. The same thing applies to the other post as well. :)
Tiger, I'm seeing your valuation process as perhaps a conventional bond approach, financially logical but IMO flawed if you're assessing from the point of view of an IRR to some degree as in notes, having a valid opportunity cost of like investments is difficult to arrive at. Risk is missing.
I appraised notes, and assessing loan quality is a risk assessment, not primarily a financial assessment. Risk is assessed through underwriting the borrower, the collateral, past performance, amounts at risk and probability of a note being paid as agreed.
I can teach a 5th grader to punch a financial calculator as to the annuity value at a required return to find the present value, that isn't "valuing" a note, that is basically setting an amount one might be willing to pay for a note and comparing present values (to them) between other options.
I'd have to bet that small note investors, portfolios of less than 5 million, simply make assumptions. Thinking that the originator of a note was accomplished by a lending institution and therefor underwritten properly and in compliance is acceptable, if you accept that 10% of those will be improperly underwritten or not compliant, I'd say 15% as you can have both issues. A decent bank will have 2 to 3% of compliance issues but can run much higher if errors were following through the operation on a consistent basis. Making a mistake over and over again.
Most note buyers seem to come from RE, adapting skill sets from that point of view is rather flawed, especially those thinking they will acquire the property as if they bought it. RE is only a collateral matter, Ill mention this aspect to Bill B.
I haven't specialized in NPNs, to say looking for them, they came to me regardless of what I did as people looked for solutions. Banks I dealt with in NPN portfolio were generally looking for a solution that was usually dumping them one way or another. I was doing short sales before Realtors had the term, buying the note is another way to go.
Don't forget to assess the costs of foreclosure, protecting the collateral, holding period, costs of sale and the proceeds from a sale paying the note off. At some point, if you do enough notes (but for the lucky few, it could be your first note deal) consider death and holding during an estate settlement, bankruptcy, law suits, title issues found on your watch, insured losses and settlements and God just saying this isn't going to work as you thought. All is part of your risk assessment and impacts valuation.
In pools, much of this has been done, if other institutions are involved in bidding or negotiation, the asking price may reflect the actual value, these are sophisticated buyers, they have the expertise and staff to value what THEY are looking for. This will be close too in larger loans that investors here will never be involved in, so why go there!?!
The greatest profit potential in notes is not institutional notes of any kind, but privately originated notes or contracts. The originators screwed up, if they are non-performing 90% of the mistake can be traced back to poor origination, the other 10% arise out of the same circumstances that effect all loans, things happen.
Gotta move on, this is a forum post, not a book.
Bill B. no need for decades of experience in RE. Notes are not an RE activity, it's finance and RE is only the collateral. You do need a market value to assess the level of collateral, so you need to know RE, valuation is critical, but what you need to know can be learned in, lets say the time required in a college semester, or, if the cash reserves allow and the discount is deep enough, you can hire out the RE aspects, appraisers, BPO, attorney, contractor, inspectors, title folks and a good Realtor can probably cover the bases for you. Most note investors don't want to spend 2 to 5K on top of the price of a note and small notes won't allow you to get in that deep. So, it pays to know.
Sorry for length.
Jay has a good point, it's an NPN craze and it is purely driven by brokers marketing, guruized programs and misconceptions of great returns.
As to exits, it's selling the property after foreclosure, taking a deed in lieu of FC, modifying the note to a better performance level if it has issues and then refinancing or, if it's a clean note refinance it or pawn the thing off to another investor. Your other option is holding to maturity. However, there are other uses for a note too, assignments, pledges, trading and splitting these areas up in whole or in part. Consideration should be given too, that dealing in any NPN, that asset has already crossed the threshold of the note getting pawned off to another investor, think about that, is the buyer better versed in finance and notes than the seller? Usually not. Buying a NPN is much like buying a wrecked car, can you really fix it, buying from a broker where the note is reinstated and performing is buying a wrecked car that has been rebuilt to pass inspection. Both are still wrecks, the value of both are less, the mentality of the borrower has already been tainted and in a different mindset than a more credit worthy borrower. You can make money fixing wrecks and selling rebuilt cars, you may be better off just starting out selling used cars that haven't been wrecked.
The highest yield possible, bar none of any strategy, is to buy a note at a discount and refinance it days latter receiving the UPB or close to it, they yield skyrockets! The longer you hold a note the closer you will be to receiving the discounted yield.
BTW, Will, you probably haven't read all this, but my minimum was 15%, if you can't pull 15% from a discounted note you're wasting time being in notes. And the more dealers there are in line on a note the less you'll get of that pie. Buying from private note holders you're looking at 20%+.
@Dion DePaoli hope this is the kind of stuff you were looking for, we are beyond your original questions, if not, I'll pass going further. :)
