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).
I don't think that underwater is preferred, but it may allow for negotiating a better price for the loan purchase. If the asset is in an appreciating market, theoretically your loan balance equity will grow with the asset appreciation. You also have more latitude for negotiating with the borrower for a loan mod in terms of principal reduction and/or arrearage tactics, since your "true" equity is the current value of the home.
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.
@Scott Carson now I get it. Thanks for the explanation!
Yes sir @Bryan O. ! Anytime!