Upside Down 1sts Preferred?

[Bryan O.]

I have been looking at investing in non-performing 1st notes. It seems many look for notes that the UPB is higher than the FMV (i.e. underwater). Is there a reason that is preferred? It would seem to make exits harder (owner sell or auction).

[Scott Carson]

What you have to realize is that when you buy a note, you are buying the mortgage that controls the asset or home.  Why I like buying notes is that I'm buying that debt at a fraction of what is owed, but the borrower still owes the full amount.  If I can't work to create a win-win with the borrower on a reinstatement, trial payment plan, or loan modification, then I have to look at deed in lieu of foreclosure or potentially end up foreclosing on the property.  If the borrower owes $200K on a $150K property, there is no equity and the borrower has less reason to fight me to stay.  I may pick that note up for 50-60% of value or at $75K, which gives me plenty of room to make a profit.  Now, if the property is worth $200K and they only owe $150K, the note seller is going to want to sell that note close to the full payoff.  If I have to foreclose and the asset gets bid up beyond what I am owed, that difference doesn't come to me, it goes to the borrower or any lien holders behind my first lien.  So let's say it goes for 80% of the value at the auction, which is $160K.  That's not a good use of my funds to only make $10K on a drawn out foreclosure where the borrower is fighting me to protect $50k in equity.  Now, if I could get the borrower to sign over the property via DIL or a cash for keys situation, great!  But often times, most sellers with equity are going to fight you for that.  

So in recap, I like buying notes where the UPB is more than the value as I get better pricing, along with being able to better control the exit strategies of the deal. I hope that helps. I know it's different if you are coming from a "traditional" real estate investment where investors look for equity, but it's a different game with notes.