Note Investing Rules of Thumb
Chicago, IL · Member since 2017 · 32 posts · 9 votes
Note Investing Rules of Thumb
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Wayne SnellPro Member
Londonderry NH & Miami, FL · Member since 2014 · 174 posts · 238 votesI will second Gail's comment. I keep hearing about how hard NPNs are and yet I was able to quit my full-time VP of Global Software Marketing job over a year ago, and somehow I am still eating. We have 300 notes. Are they work? Yes. Can you get burned? Yes if you don't know what you are doing. Should you avoid them? Yes - so I can buy more....
44 Replies
- 9yWayne SnellPro MemberLondonderry NH & Miami, FL · Member since 2014 · 174 posts · 238 votes
Hi there Micheal, I have a video I put together as a free pay-it-forward that covers a lot of what I do to evaluate notes, as well as what to do with them once you get one... Message me if you want the link...
- Rental Property Investor · Lindon, UT · Member since 2015 · 862 posts · 438 votes9y
I think the answer will be different for performing vs non-performing notes. Which are you considering purchasing? There are professionals in each arena on BP. I can speak to performing notes and @Bob Malecki and @Jay Hinrichs and others are pros on the non-performing side.
- 9yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
@Darren Eady Correction Darren I absolutely do not play in the NPN space I only do performing .. last thing I want is to work that hard for the little extra return LOL... give me performing or give me nothing Is my motto been there done that.
NPN is a job.. and not one I care for personally.
- Chicago, IL · Member since 2017 · 32 posts · 9 votes9y
@Darren Eady fair point! I think since I'm just starting out it may be smarter (safer) to get my feet wet with performing notes first. That being said, I would still be interested in rules of thumb for NPNs since I would like to be able to identify a "good" opportunity should one come along.
- Rental Property Investor · Lindon, UT · Member since 2015 · 862 posts · 438 votes9y
Sorry @Jay Hinrichs my bad. I knew you were in the performing space with me but I also know you know about the entire industry!
- 9yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
@Darren Eady NP.... I have over the years bought NPN but only for myself and not anything I recommend to beginners at all.. and or most investors.. its a niche.. and a tough one.. they are best off starting with some of the guys who have the little funds that do the heavy lifting then see how it goes.
- Specialist · Melrose Park, PA · Member since 2013 · 167 posts · 217 votes9y
@Michael Rosenson Last year, I jumped into NPNs from other types of real estate and I am absolutely loving it. I'm surprised people are urging so much caution. I only invest in 1sts so far. Your questions suggest you're looking at both 1sts and 2nds. I don't recommend that - learn one first (and I recommend it be 1sts) and then you can look at the other. If you're a good researcher and analyst - and it seems you are from the questions you're asking - I think you would love non-performing notes.
Cheers!
Gail
- 9yWayne SnellPro MemberLondonderry NH & Miami, FL · Member since 2014 · 174 posts · 238 votes
I will second Gail's comment. I keep hearing about how hard NPNs are and yet I was able to quit my full-time VP of Global Software Marketing job over a year ago, and somehow I am still eating. We have 300 notes. Are they work? Yes. Can you get burned? Yes if you don't know what you are doing. Should you avoid them? Yes - so I can buy more....
- Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes9y
Originally posted by @Wayne Snell:
I will second Gail's comment. I keep hearing about how hard NPNs are and yet I was able to quit my full-time VP of Global Software Marketing job over a year ago, and somehow I am still eating. We have 300 notes. Are they work? Yes. Can you get burned? Yes if you don't know what you are doing. Should you avoid them? Yes - so I can buy more....
I will take a stab at why the caution, and please let me know if you agree or disagree ... it seems to me that even among the NPNs there are different "flavors", but the main ones that come to mind that I think are pertinent to the discussion are:
1) Non-performing 1st with sufficient equity (from the LTV and/or discount you got) such that you can foreclose to recoup your investments plus make a decent return. You as an investor are still free to try to work with the borrower to try to get them back on track, but you know going in that the most likely outcome and the one you can still make a return with is to foreclose and take back the property (or sell at foreclosure auction).
2) Non-performing 2nds, or deeply underwater 1sts, where your main exit strategy is to try to negotiate them back to re-performing ... otherwise, if you can't do this you are likely to get wiped out in part or in whole. The business model seems to be buy more to build a portfolio and know going in that you will get wiped on a percentage of them.
I don't claim to be an expert, but it seems to me that this distinction is an important one and this second sort is the type that I think most (rightfully so IMO) would advise caution against. The statistics that I've heard on what percentage of non-performing mortgages actual get back to re-performing and stay that way vs. get foreclosed on would also seem to warrant caution for the second type. Thoughts?
- Chicago, IL · Member since 2017 · 32 posts · 9 votes9y
I definitely hear the caution bit. I think having multiple exit strategies mitigates this risk to an extent, but I agree that starting off with 1st liens before thinking about 2nds is probably a good move.
So what are some thoughts on rules of thumb then? For example, @David Faulkner what would you classify as "sufficient equity"?
- 9yWayne SnellPro MemberLondonderry NH & Miami, FL · Member since 2014 · 174 posts · 238 votes
We get nearly 50% of our NPNs to re-perform. The actual number is 47.8%. Our model is only to purchase occupied 1st NPNs and contract for deeds. That increases our odds of a re-perform. We typically offer a trial loan mod (or forbearance) and show them that their payment is less than the rent for their location. We never talk to borrowers ourselves - always use licensed loss mitigation personnel so that we remain compliant with CFPB/Dodd-Frank/RESPA. But As you can see, 52.2% do not re-perform. We have our attorneys foreclose in these cases (with an occasional DIL). We keep the re-performers for cashflow, and then after 12 months of seasoning we will sell them as re-performing notes if the yields are worthwhile. Otherwise we keep them. For the FCs we either sell the property as is to an investor, or we will rehab it and then sell it under an owner-financed note, or as a turnkey rental property.
- Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes9y
Originally posted by @Michael Rosenson:
I definitely hear the caution bit. I think having multiple exit strategies mitigates this risk to an extent, but I agree that starting off with 1st liens before thinking about 2nds is probably a good move.
So what are some thoughts on rules of thumb then? For example, @David Faulkner what would you classify as "sufficient equity"?
As a rule of thumb, I ignore rules of thumb as I find that most of the time they are a poor substitute in an attempt to shortcut around actual thought and analysis, and the results are mixed at best to put it kindly. I have plenty of operational philosophies that guide me, but no rules of thumb.
I'm not an expert in the note space, so grain of salt ... however, I'd back into what "sufficient equity" is ... for the state the property that the note is in, how long will it take you and how much will it cost you to foreclose and sell the property and at what price will you be able to realistically and conservatively be able to sell? So, you then have your time, you have your costs, and you have your exit price ... what sort of ROI would you expect is fair for the risk you are taking with the note and the amount of work you are putting in? ... with that last piece of data, you should be able to back out how much equity you need in the deal to realistically come out with that ROI. That will vary greatly with the type of property, the geographical state it is in, the physical shape it is in, the price point, etc ... that requires real analysis, there won't be any rule of thumb that will tell you if you have sufficient margin or not.
- Chicago, IL · Member since 2017 · 32 posts · 9 votes9y
Touche!
Originally posted by @David Faulkner:
I'm not an expert in the note space, so grain of salt ... however, I'd back into what "sufficient equity" is ... for the state the property that the note is in, how long will it take you and how much will it cost you to foreclose and sell the property and at what price will you be able to realistically and conservatively be able to sell? So, you then have your time, you have your costs, and you have your exit price ... what sort of ROI would you expect is fair for the risk you are taking with the note and the amount of work you are putting in? ... with that last piece of data, you should be able to back out how much equity you need in the deal to realistically come out with that ROI. That will vary greatly with the type of property, the geographical state it is in, the physical shape it is in, the price point, etc ... that requires real analysis, there won't be any rule of thumb that will tell you if you have sufficient margin or not.
I totally get what you're saying in terms of your evaluation steps, and I think that those are important steps to perform when seriously considering an investment. However, I was thinking of rules of thumb as a "top-down" approach to narrow my scope a bit. There are thousands of investments out there and I don't have the time (unfortunately) to do a deep analytical dive on each of them. The way I'm thinking about it is that a rule of thumb is the first step to get you from thousands to hundreds or even tens of possible deals, and then to use a method such as the one you describe above as the second step once I've gotten it down to a manageable number. The rule of thumb is purely intended to be a (very) basic first step to make the real analysis actually doable from a time perspective. Thoughts?
- Note Investor · Austin, TX · Member since 2012 · 602 posts · 357 votes9y
What I would recommend after the thousands of deals that I've done over the past ten years is this. Only focus on 1st liens. I love NPN's, but you have to manage your vendors (especially if you are working full-time as I'm sure @Wayne Snell will attest to). Vacant assets will always need work so if you aren't comfortable or knowledgeable with rehabbing, stick to the occupied assets. You'll still have to foreclose around 50% of the time anyway but at least most will have AC and electrical and not be that vandalized like a vacant property will see. ALWAYS put eyes on the asset! NEVER trust a seller's BPO. ALWAYS call to check on taxes. ALWAYS pull an O&E Report (we love ProTitle USA)! Stick to your numbers! Some sellers are extremely proud of their NPN's and sometimes the best deals are the ones you walk away from! Run your deals by someone who is closing deals on a regular basis and not someone just writing about it! Don't cut corners or the pennies you save will end up costing you thousands of dollars.
- Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes9y
Originally posted by @Michael Rosenson:
Touche!
Originally posted by @David Faulkner:
I'm not an expert in the note space, so grain of salt ... however, I'd back into what "sufficient equity" is ... for the state the property that the note is in, how long will it take you and how much will it cost you to foreclose and sell the property and at what price will you be able to realistically and conservatively be able to sell? So, you then have your time, you have your costs, and you have your exit price ... what sort of ROI would you expect is fair for the risk you are taking with the note and the amount of work you are putting in? ... with that last piece of data, you should be able to back out how much equity you need in the deal to realistically come out with that ROI. That will vary greatly with the type of property, the geographical state it is in, the physical shape it is in, the price point, etc ... that requires real analysis, there won't be any rule of thumb that will tell you if you have sufficient margin or not.
I totally get what you're saying in terms of your evaluation steps, and I think that those are important steps to perform when seriously considering an investment. However, I was thinking of rules of thumb as a "top-down" approach to narrow my scope a bit. There are thousands of investments out there and I don't have the time (unfortunately) to do a deep analytical dive on each of them. The way I'm thinking about it is that a rule of thumb is the first step to get you from thousands to hundreds or even tens of possible deals, and then to use a method such as the one you describe above as the second step once I've gotten it down to a manageable number. The rule of thumb is purely intended to be a (very) basic first step to make the real analysis actually doable from a time perspective. Thoughts?
Technology is a wonderful thing ... you can build your investment model into excel or other such tool to automatically do the analysis to back into the numbers you care about. Then you can fill in the parameters that the model uses for the specific investment(s) you are considering and have the computer do the heavy lifting to give your answer in seconds (or less). Not only does such a method have the convenience of rules of thumb, but I always find it very helpful and enlightening to my understanding to identify the key parameters and actually go through the initial legwork to code the model with excel formulas. Of course, I still cross check everything before pulling the trigger, but this should give you the quick analysis you seek without bypassing the analytical rigor that most rules of thumb tend to do ...
- Investor · Fort Worth, TX · Member since 2016 · 41 posts · 48 votes9y
If your in the 1st NPN space listen to @Scott Carson and @Wayne Snell
I can answer your question because of their mentorship
Rules of thumb and standards are interchangeable. Standards are a good thing for systemization, processes and to separate the wheat from the chaff. When I get a list of 200 assets I need rules of thumb to drill down to what meets my criteria. After the drill down then the art of pricing kicks in. Without standards/rules of thumb your VC's will not have clear process to follow and you will be inconsistent in your buy criteria. #notecamp
1) Borrower's credit score is meaningless in 1st position NPN's. #notecamp #VNBFD #notebuyingblueprint
2) Borrower's equity in the property: I avoid assets with equity. Especially on higher values assets because they will fight with an expensive contested foreclosure (I also learned to vet lawyers that cap contested FC to $5K just incase). I want little equity on occupied assets for emotional equity. On CFD with 25% equity some states require foreclosure. #notecamp #VNBFD
3) Interest rate. The lower the interest rate the larger the discount you need to make a yield. Interest rate on 4% needs a lot more purchase price discount that an 8% rate loan. Take the monthly P&I x 12 months / purchase price to get a basic yield. If i'm are in teens I need a different deal or a bigger discount on the NPN. #notecamp #VNBFD
4) Senior status needing to be current (if 2nd lien): Wait long enough the 2nd can become a 1st. #VNBFD
@Wayne Snell5) Needs to earn over XX% of a returns (IRR, ROI, etc) Projected returns on paper rarely go up but they can easily go down. If I cannot get 20% on three exit strategies on paper then I bounce to the next deal. #notebuyingblueprint
- Chicago, IL · Member since 2017 · 32 posts · 9 votes9y
Originally posted by @Brady Durr:
If your in the 1st NPN space listen to @Scott Carson and @Wayne Snell
I can answer your question because of their mentorship
Rules of thumb and standards are interchangeable. Standards are a good thing for systemization, processes and to separate the wheat from the chaff. When I get a list of 200 assets I need rules of thumb to drill down to what meets my criteria. After the drill down then the art of pricing kicks in. Without standards/rules of thumb your VC's will not have clear process to follow and you will be inconsistent in your buy criteria. #notecamp
1) Borrower's credit score is meaningless in 1st position NPN's. #notecamp #VNBFD #notebuyingblueprint
2) Borrower's equity in the property: I avoid assets with equity. Especially on higher values assets because they will fight with an expensive contested foreclosure (I also learned to vet lawyers that cap contested FC to $5K just incase). I want little equity on occupied assets for emotional equity. On CFD with 25% equity some states require foreclosure. #notecamp #VNBFD
3) Interest rate. The lower the interest rate the larger the discount you need to make a yield. Interest rate on 4% needs a lot more purchase price discount that an 8% rate loan. Take the monthly P&I x 12 months / purchase price to get a basic yield. If i'm are in teens I need a different deal or a bigger discount on the NPN. #notecamp #VNBFD
4) Senior status needing to be current (if 2nd lien): Wait long enough the 2nd can become a 1st. #VNBFD
@Wayne Snell5) Needs to earn over XX% of a returns (IRR, ROI, etc) Projected returns on paper rarely go up but they can easily go down. If I cannot get 20% on three exit strategies on paper then I bounce to the next deal. #notebuyingblueprint
This is all great! Just the kind of stuff I was looking for. Obviously there are always exceptions to the "rules," but the pieces you mentioned about drilling down a large asset list and having a clear process/consistent buying criteria definitely resonate with me. There is only so much time in the day!
Any other "rules" that I didn't specifically mention in my original post that you think are worth considering?
- Specialist · Dallas, TX · Member since 2014 · 900 posts · 392 votes9y
@Michael Rosenson, you need to narrow it down, there are performing and non-perfroming, and senior and junior and each has its own rule of thumb, though I love the comment by @David Faulkner ignoring rules of thumb.
- Chicago, IL · Member since 2017 · 32 posts · 9 votes9y
@Christopher Winkler I just updated the original post to specify. Although I'm interested in rules of thumb for all note types, let's start with 1st (senior) lien NPNs and work from there.
- Specialist · Dallas, TX · Member since 2014 · 900 posts · 392 votes9y
Great, because with a 1st, its more about the property, and with juniors, its more about the homeowner. As Scott mentions above, you have to run a current occupant title report, or O&E report (Occupancy and Encumberance), have to look at taxes, and city fines & fees. You need to buy 1sts like you buy the property, avoid ghetto, 2 bdr due to hard to sell if you foreclose, busy streets, railroad tracks, and its absolutly critical to get eyes on the property, and pictures. I try to find a local realtor to do a drive by BPO in exchange for listing it when we get title. You might have to call a few realtors , as the newer ones are more inclined to help you. Looking for damage to home or what needs fixing. Is the AC unit still outside? How is the roof? Broken or boarded windows, full of junk, or kept up?
If you agree on a price, and its not a phiranna feeding frency, you get it for a fair price, transfer the servicing, and have the collateral files sent to a company that scrubs them for defects, records anything that needs recording, creates anything missing, and stores them for you.
Then the fun begins; if its occupied, you or your servicer will reach out to try to get them repaying and sometimes they won't, so you have to foreclose. Depending on the state, it can be months or years. After foreclosure you typically have a worn out home that you can sell for +/- what you are in it for. Now we plan to rehab it to get top dollar.
There is so many moving parts. This is just the most basic of it. Please let any of us know if we can be of any other help, lots of good people in this thread who know what they are doing...
- Investor · California, CA · Member since 2016 · 367 posts · 375 votes9y
Location: judicial or non-judicial state? Affects how long it takes and cost to foreclose. Location, is it in the middle of nowhere? Will you be able to find a handy man to fix it up? Will you be able to sell it or rent it in a town of 5000 people?
http://www.realtytrac.com/real-estate-guides/foreclosure-laws/
Have they been paying their property taxes? Indicates if they want to stay or not? How much are their principal and interest payments vs. prevailing rents in the area? Is it cheaper for them to keep paying, or rent somewhere else?
- Real Estate Agent · Belmar, NJ · Member since 2017 · 370 posts · 200 votes9y
Originally posted by @Wayne Snell:
Hi there Micheal, I have a video I put together as a free pay-it-forward that covers a lot of what I do to evaluate notes, as well as what to do with them once you get one... Message me if you want the link...
Wayne, would you mind passing along if I reach out?
Thanks in advance, and for all the helpful insight along the way!
- 9yWayne SnellPro MemberLondonderry NH & Miami, FL · Member since 2014 · 174 posts · 238 votes
@Cody Z. Happy to - I will send you a PM.
- 9yDan DeppenBusiness MemberErie, CO · Member since 2017 · 274 posts · 267 votes
Originally posted by @Brady Durr:
@Wayne Snell5) Needs to earn over XX% of a returns (IRR, ROI, etc) Projected returns on paper rarely go up but they can easily go down. If I cannot get 20% on three exit strategies on paper then I bounce to the next deal. #notebuyingblueprint
Can you get 20% IRR on performing notes? I realize the actual average return will be lower because some notes will go bad. If I make bids on performing notes targeting this IRR how often will they get accepted? I am new to notes and haven't tried to buy any yet, still in the process of putting my strategy together....
- Note Investor · Austin, TX · Member since 2012 · 602 posts · 357 votes9y
Most performing notes are being sold at a 12-15% yield...
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