Posted about 7 years ago

Elements of NPN Investment Evaluation

This post builds on information provided in Part 1 of the series and covers some basic information required in the analysis and evaluation of non-performing note investments.

Like traditional real estate investing, evaluation of a potential non-performing note investment is part art and part science. In a typical real-estate investment, we perform analysis to estimate as-is value, as-repaired value, rental rate, repair cost, management cost, insurance cost, etc., based on our knowledge of the market and our knowledge of the property itself. With all of this in hand we can apply some simple math to determine what we can afford to pay for the property based on criteria and desired exit strategy.

Evaluation of a non-performing note investment is similar with regard to the valuation of the collateral property. We still need to put a value on the property which represents collateral for the note.  We need to have a basic understanding of the market, including home prices, rental rate, crime rate, etc.  In addition, we need to look at taxes, title, the borrower, and the foreclosure laws of the state.

Collateral Valuation

While the end-goal of valuation of the collateral property is the same as it is for traditional real-estate investments, the information we are able to gather is generally less certain than it is for a property purchase due to the following factors:

  • Valuation at a Distance - Most of the non-performing notes available to individual investors are in the "low price band", which is defined as property values below 125K.  For many of us, that means we are looking at notes far outside of our home markets.
  • No Interior Inspection - Because the properties are owned by the borrower, we cannot enter them, even if they are vacant.  Interior condition, therefor, must be inferred.  For example, if the home is occupied, located in a low crime area, and the exterior and grounds appear well maintained, we can infer that the exterior condition probably represents the condition of the interior.  If the property is vacant, boarded, and in a high-crime area, we can infer that the interior may be trashed and the copper plumbing stolen.

We can use a combination of online tools and boots-on-the-ground to gather as much information as possible, but in the end the information we gather is imperfect, and this leads us to build in a buffer on our investment to account for these unknowns.

Taxes

Generally when people make the decision to stop paying their mortgage, they generally stop paying taxes as well.  Because delinquent property taxes represent a senior lien to any mortgage note, it is essential that we contact the county directly to understand the following:

  • Taxes Due - We count it as part of the initial investment because we end up paying them in all exit strategies other than loan modification.
  • Annual Tax Rate - Represents part of the holding cost for the investment.
  • Next Tax Deed Sale - Tax liens are one thing, but if the property is sold in a tax deed sale we lose our entire investment.

Title

We review title because unlike a standard real estate purchase, clear title is not provided to the purchaser.  We look at title reports to understand a number of important aspects of the investment, but primarily we want to understand:

  • Lien Position - What is the lien position of the subject mortgage?
  • Senior Liens -  These include all liens recorded prior to the subject mortgage.  We need the total value of all senior liens.  (This includes delinquent taxes but we are counting that separately.)
  • Junior Liens - These include any non-tax liens recorded after the subject mortgage, including additional mortgages, municipal code violations, contractors liens, judgments, etc.  The presence of junior liens does not kill our investment, but we need to know about them because they can limit our available exit strategies.

Check out my blog post on Tax and Title Due Diligence for a deeper discussion of these topics.

Borrower

For non-performing notes, we are primarily interested in bankruptcy history and status.  Has the borrower initiated a bankruptcy process? If so, when and what type? Is it completed yet or ongoing? If the borrower has an extensive history of bankruptcy filings, they are probably not a good candidate for a loan modification.  If a bankruptcy process is ongoing now, foreclosure must wait for it to complete.  If the borrower filed for chapter 7 bankruptcy after they took out the mortgage loan, they are no longer personally liable for repayment of the loan (although the loan still represents a valid lien on the property).

State Foreclosure Laws

When we purchase a non-performing note we need to be prepared for foreclose, even if that is not our desired exit strategy.  Different states have different foreclosure processes and timelines.   In addition, some states allow the borrower a period of time to redeem the property after foreclosure sale.  In some states there is no redemption period and in others it is over a year.  So, it is very important to know this information when evaluating a potential investment.

Summary

As you can see, there is much more of both art and science involved in evaluating non-performing notes than there is with a standard real estate investment.  This should help to shed some light on the reason why non-performing notes are discounted as much as they are.  Check out part 3 of the series where I cover how this information applies to evaluation of a potential investment with regard to each of the primary exit strategies. 


Comments (7)

  1. Hey Christopher.  Thanks for the comment. I agree that can be a great resource, and having relationships already established with good agents in your key markets is invaluable. I suspect that many of the BPOs we see are done by newbie agents.  The good ones who really know their markets are usually out there selling real estate, not doing BPOs for fifty bucks a pop. I like your restaurant.com gift card approach.


  2. HI Mike, great info here, thanks for sharing with us. On viewing the interior of a vacant property, the old trick of you heard a baby crying inside, and had to check it out always puts a smile on my face...

    We always confirm taxes owed & any potential tax sale by calling the county vs trusting what is on a tape or online.

    Todd Tracy, one thing I found might help is to go to activerain.com and find a local broker who will do a drive by and take some pics, tell you about the neighborhood, and pull some comps. I like to reward them with the MLS listing if we have to put it on the market, and I get a $50 restaurant.com card for $20 that I can email them for their time. A cheap drive-by BPO.


  3. Thanks Brent!


  4. Mike, this is a very valuable blog you've started, great information.  I thank you.


  5. Hi Todd - Yes, I always want to see fairly recent BPO as part of DD. Some sellers provide them and others don't.  For the ones that don't, the purchase process is usually set up so you can agree on price first then get a few days to complete your DD by getting BPO and O&E.  Considering the fact that the quality of the BPO is dependent on the agent that does it, I always scrutinize the comps and check secondary online sources.  Crime level in particular is something I look at closely and have found that the trulia crime map is a great free resource for this.

    Another approach to valuation which I think is better is to form relationships with agents in the markets where you are looking at notes, and toss those agents business when you sell acquired properties as compensation.  The boots on the ground network takes time to build up but well worth the effort IMO. 


  6. Hey, Mike!  Great series, thanks for writing this stuff down.

    Do you typically get a BPO prior to note purchase?  I started doing this during the crash and a lot of REO tapes would include burnouts, vacant lots, etc.  I've typically gotten one, but I'd like to see what other notes investors are doing.


  7. Great info! It's hard to find a good overview of note investing, thanks for sharing.