Note buying?? Who is doing it?? What are your returns??

[Joel Owens]

Okay so my commercial real estate brokerage business is great. While I want to make investments what I do not have a lot of is time to devote for a return because that is a JOB.

I do not like hard money loans for lending as that can tie the money up for a very long time. I also do not like rehabbing with fix and flip as that is very time intensive and ties up capital before you get it back.

I have heard of others buying notes at a discount and some hold for the income stream and others to flip. I am more interested in buying first position notes at a discount through my contacts and selling them back off for a profit. This seems like an ideal way to keep churning my money and stay relatively liquid between my large commercial deals closing. In Georgia foreclosing is a relatively simple and quick process if it needs to be done. If the owner started paying again with penalties and interest I could still sell it off at a spread to someone else.

Wanted to get feedback from others who are doing these types of deals. I know some who buy the notes and hold but I want to churn the notes for a spread instead.

[Dion DePaoli]

Joel,

The resale spreads are not large. Sellers, especially localized commercial note holders are not taking huge discounts. I think you have to decide how active of an investment you want this type of thing to be. Active investments are going to be situations where you have to work with the borrower to reinstate and stabilize the loan. Slowing paying or non-paying borrowers do require a fair amount of work and administration. Input value from you will have a barring on gain on sale size at liquidation.

While from time to time, you can find a diamond in the rough, generally speaking, there is not an innate arbitrage built in to most notes without some input of value add. In other words, your not going to easily and often, be able to find a note for X% and resell it for Y%, expecting the Y% difference to be a large windfall. With little to no value add, the spread will look more like a commission of a couple points rather than some home run and it can certainly hit zero and negative if you over pay or something happens to the loan when you liquidate which diminishes your value like a loan fading from delinquency to default.

Remember too, time is needed to improve value on these types of assets. Borrower's who are slow or spotty pays or defaulted non payers will need to be incubated before you will see a rise in value for their payments or continuity of payments. In general, quick time frames would be 3 to 6 months. Think about what it would take to get a non-paying borrower back on track. Property data and financials along with borrower financials to review to reestablish credit worthiness and the constant monitoring to ensure they make each period payment.

To some extent, commercial loans have a level of business acumen to them since the borrowers usually are operating some cash flowing property. This is both a blessing and plaque. Sometimes they are easier to work with than a residential borrower and sometimes they are not. A footnote to that concept, Seller's generally do not sell easy to work assets.

Trading the asset is no light work either. Once you find a note and do what ever you are going to do, now you need to sell it. This will require market exposure which is time consuming. You will need to show the loan to likely several different potential buyers and deal with their bids and questions. You know what this takes, it is similar to your commercial RE sales. Sharing files, fielding questions, chasing documents, same stuff. Moral of the story, I think folks get the impression that these asset trades are fairly light in workload and I would say they are not, they are more involved than real property because you have real property and the borrower/debt.

Certainly you can purchase more passive loans but remember this a better quality loan which will initially trade for a small or zero discount. Still a decent amount of work to run through the purchase cycle. The arbitrage here is really a simple difference between hurdle rates between you and the Seller and you and the Buyer. Seller willing to sell at 10% yield and a buyer willing to buy at 9.5% yield.

The yields and returns will depend on the quality of loan you purchase. In better CRE loans, institutional yields flirt around 7% to 8% for 'decent' stuff. Certainly higher yields are available through discounting but come with increased risk. Remember the originated and/or the modified rate is going to be pretty low in most cases 6% +/-, so getting to double digit yields takes sizable discounts or large amounts of negative equity. You might be able to target private loans which have a bit of a higher coupon like the HML rates mentioned above but not too much discounting in that market so you pay closer to par or even a premium.

Certainly you are capable of all of this but the time devotion caught my eye and stuck. Loan investments are being marketed as passive investments and to some extent this is very true but not all are. The 'passive' sales pitch is more of a longer term hold with smaller risk of default. A more passive nature can also come into play working with or through a competent broker or adviser and servicer who helps with the heavy lifting.

The "Velocity" trading model has been around for quite sometime and often gets look at by newbies as a good way to make good returns with controlled risk exposure. Problem is, the Velocity model has caused more failed investments than not. This is because the investor was never really in a position to actually work the asset and assumed there is always a perpetual upside bidder behind them. It is because of this that many folks still try and play this game by showing the potential purchase loan to an exit buyer hoping to create an arbitrage in a back to back trade. Most seller's don't want their loan passed around to unknown parties. Sophisticated Buyers will quickly vet out the fact you don't own the loan you are showing them. This model also promotes a lack of skill and knowledge on behalf of the intermediary party. Since you never plan to work the asset, learning and understanding how to do that does not get a top priority which puts the intermediary at risk for over bidding by not understand certain impacts of asset or trade.

Don't mean to be a 'Debbie Downer' but wanted to make sure you got a little bit of a realistic insight to the amount of work it really takes to make this sort of thing productive.