All Forum Posts by: Dion DePaoli

That doesn't make sense. You can not borrower your return.

You purchased the asset or $33k. You then pulled a loan with cash out and recieved $26k. Great! But you don't have that money back, you have that money borrowed. The $26k came from a loan, that needs to be paid back.

When you purchased the property for $33.5K and then pulled out $26k, you took on new debt. That debt cost you money in interest and the $26k is within the new principal balance of the loan. You would have to put the $26k to work and generate return that exceeds the interest rate in order for that to considered return.

While the future gain might be similar to the $26k, until the asset is liquidated you can't realize the gain. The money is not yours, it is the banks, you borrowed it. Another simple test for this rational is did you report the $26k as income (or plan to)? I suspect "No". Therefore, it is not your return.

You have a property with a loan at $102k. You now have $34k in equity. Previous to the refinance you had $64k in equity. You pulled out $26k through the refinance. But you have not 'realized' the $26k, you borrowed it. When you sell the house for $134k, you will realize the difference between the debt and RE Value, which will be your $34k. That is your gain on sale in the future, not now. If you took the $26k and made money from it, that money would also be income but not the $26k. It get's paid back. The bank doesn't give you $102k and only want $72k back. That would be income.

The post title is misleading and not proper accounting. We don't want newbies running around getting cash out loans thinking they are making money, when in fact they are not.

The the "note" is the contract for deed.

The sale structure would be you buy the real property which already has a contract for deed in place.

It is hard to tell if you confirmed the real property comes with the sale of the contract for deed or if the contract for deed is being sold as a stand alone asset, which is really just buying the cash flow from the contract.

In a Contract for Deed or Land Contract, essentially the borrower is more of a tenant than a borrower. They do not have title to the real property but have an interest which is created with the land contract similar to a tenant for use and enjoyment.

If there is a default on the CFD, then you can pursue eviction opposed to foreclosure which might be a little cheaper and faster depending on your state.

Not sure what legal action you think the tenant/borrower could take. Nothing here seems predatory or improper, just another way to finance real estate.

The description and calculation for yield above is not proper, there is no Present Value in yield calculations. Yield is the cash flow from an asset. Usually Net Cash Flow. Yield is not the same as return even though the return can be equal to the yield. Yield is a part of return. Yield is cash flow and Return is cash flow plus equitable gain. Equitable gain can be zero or less than zero or more than zero which will then leave the yield or portion of yield from the difference.

There is a standard formula used to calculate yield and it is used everyday in bonds.

Yield = Net Periodic Cash Flow / Total Capital Investment

Total Return = Yield (Periodic Cash Flow) + Gain on Sale (or loss)

Total Return is Internal Rate of Return (IRR) which takes into consideration the time value of money.

As in the description that Kenny left, it is true yield has affinity to the interest rate. The cash flow of a note is the payments made by the borrower based on the loan terms including loan amount, rate and amortization.

Return on Investment (ROI) is a commonly misused term and I don't agree with the definition above at all. ROI is the total amount of return divided by the total amount invested. Not the same as yield. ROI is really the same as "Cash on Cash" return. It is a sum of the money earned divided by the sum of the money spent. ROI does NOT include time in its calculation. (ROI = Profit / Total Cost) It is more of a summation of all the earnings and costs. So you can have a ROI of 200% and a yield of 10%. The ROI is large because the term of the investment might be long, say 20 years. (Again, ROI does not include time, it is a summation)

To understand Yield as a part of the total return as described above:

Recap:

Loan Balance = $10,000
Amortization/Term = 120 months
Rate = 10%
P&I = $132.15
Annual P&I = $1,585.81

Purchase Price = $6,000
Yield = 15.86%

(Yield = [Annual P&I] / [Purchase Price]) or
{15.86% = $1,585.81/$6,000}

Yield is the portion of the return that is returned to the investor annually, through periodic cash flow. Yield in only expressed as an annual number, that is its only relationship to time.

In order to get to the Total Return, it is important to include the time of the investment. In this case, let's hold it until maturity to calculate the numbers.

The Total Return for this asset is 23.13%.

That Total Return consists of the Cash Flow ($1,585 annually over the term of the loan ) plus the discount ($4,000). The discount is returned to the investor over the duration of the investment through the borrower's payment. So the borrower has to pay back all of the $10k loan but in the loan the investor is only invested $6,000 not the full balance. Timing of repayment can be changed if the borrower was to refinance early or the investor sells the note, etc. So return can be manipulated by manipulating time of the investment. In loans, this relates to Prepayment Risk. If the borrower prepays the Return not Yield will be affected.

Another way to understand this is the borrower's first payment is $132.15. That payment consists of Interest portion ($83.33) and Principal portion ($48.82). The borrower's principal balance will be reduced by the principal portion of the payment ($48.82). The borrower will pay to zero over the course of 120 payments (amortization).

Now look at the investor, which we will assume amortized in sync with the loans maturity. The borrower will require all 120 payments to pay his balance to zero. Since the investor has a discount, the investor only requires around 46 borrower payments for the sum of those payments to be equal to the amount invested. This means payments 47 through 120 would all be profit or return for the investor.

Payment 1 to 46 = $6,078.93
Payment 47 to 120 = $9,779.15

So the numbers on this deal are as follows: (held to maturity)

Sum of all payments = $15,858.09
Profit = $9,858.09
ROI = 164.30%
IRR = 23.13%
Yield = 15.86%

The IRR can increase if you can decrease the investment term. That is, if you can realize the $4,000 discount sooner than over the course of 120 payments. The yield will not change unless the invested dollars changes.

Some insight into what I see here.

The loan is barely 7 months old. This is a hard money loan, unknown residency. The borrower put down 30%. The Lender offered a rate very close to market at 5.75%. From the looks, the borrower got a pretty good deal here, maybe even too good.

As Jon and Bill pointed out the post doesn't include any underwriting information related to borrower credit. I would be curious to understand why the borrower didn't get conventional finance. That down payment would have helped him a bit unless his credit is a real wreck.

I come up with a current UPB of $210,635 based on 7 payments. So the asking price is around 95.40% of the UPB and 63.49% of the RE Value. I come up with a yield at 5.72% (gross). (Jon, we may have used different numbers but he is not going to get a 0.50% boost to his coupon holding to maturity so he should be under the coupon)

New originations just hit 4.5% on a 30 year. That is an important benchmark as the rate on this loan puts the risk into a similar category as those 'vanilla' prime conventional loans. Granted we have some additional equity insulation but we do not have much of a payment history.

It is tough without more credit risk information to understand if the rate is warranted or under market. My guess is it is under market. That same 4.5% on a 30 year will get you good credit at 680+.

I agree with Bill, there seems to be a lot of newbies trying to finance notes. It also seems that the newbies tend to have little experience with purchasing whole loans. I think the OP here is a little confused on the matter.

Richard Lee, are you sure someone will provide you debt, secured by this mortgage, at 4.75%. It seems like you are trying to compare what sort of mortgage terms you will get if you finance an investment property with a mortgage to financing a note purchase. That is not the proper comparison here, really apples and oranges. At best, we are seeing 7.0% cost of capital to finance notes and the leverage is closer to 1:1 not 3:1. I don't know anyone with that type of leverage (3:1) at all right now at that type of low rate.

For similar hard money loans, rates are flirting around 9%. In comparison, this loan is a little light on the downpayment requirement for those loan types by around 5% to 10%.

If the finance terms given to put debt on the note are true, the OP would be looking at 18.72% rate of return. Again, great if true, but not likely this is the correct terms for debt with this type of collateral.

A little detail tidbit, in the sentence, "The property buyer ofc can pay off the equity any time."....as Jon pointed out this sounds like you mean there is no prepayment penalty. Fine. However, the OP terminology here is still wrong, a Borrower does not pay off their equity, they already have their equity, they pay off their debt. I hate to seem like I pick on details, but that says to me, the OP doesn't really understand the asset class all to well. (not picking on you, just an observation)

I didn't fully follow this statement in the thread from Richard, "Although the cash on cash rate of the note seems fine, the return on my opportunity cost for my credit is low, about 6%, I may want to consider the offer before I jump into it. "

Not positive that is being properly evaluated and could even be misleading. The CoC or [P&I] x 12 / [Sale Price] = 10.70%. Not a bad looking number.

If you calculate the cumulative interest payments to maturity, you will receive $99,039. The discount to UPB will bring you back another $9,632. So your total earning potential is around $108,671. That is a Return on Investment of 54.3%. Spread over 14 years.

However, you are only earning 5.72% as a Total Return for this loan held to maturity. Not sure if you are looking at the wrong number when you say the cash on cash rate of the note seems fine.

You mention you have a 6.0% opportunity cost. That would mean there is an alternative investment on your desk that you can use your credit to earn over 11%. Your opportunity cost is the difference between the primary and secondary investment choices. If you really have an opportunity cost of 6.0%, this deal should not be on your desk any longer. You should be looking for deals that are north of 11% return.

Most of the time you have open use of funds with a HELOC. Speak to your loan officer and they should be able to make sure the program doesn't exclude what you are trying to do. The BP nation would just be speculating as it is not our loan program.

What you are doing requires a license.

You are missing a critical step in the Wholesaler's world. You do not have an “equitable interest” in the property. That interest is usually created with a contract to sell between the owner and the Wholesale person.

What you are doing is advertising the sale of real property you don't own. You can't sell what you don't own. So therefore you are then broking. In order to broker real estate, you must have a license.

Simply goto the owners and have them give you a contract that you can work with maybe assignable or something and then you are fine.

No.

Each loan has its own qualifications. If you get more than one loan, those other loans will be loans for second homes or investment properties, you can only have one primary residence. Loans for a primary residence have less qualifying requirements such as down payment, reserves, etc.

Just the reserve alone would make it impossible to take a $400k loan and turn it into 4 loans. Loan 1 is primary. Loan 2 through 4 are NOO. So those four loans will require $100k (25% each) in down payment collectively. Those loans will also each require 6 months reserves of PITI.

Bill I like the idea of paying down the first and attaching a second lien but I believe that to be flawed and a little impractical.

The post does not detail what the value of the property is nor does it give us an idea of the payoff amount. We then have no solid idea of LTV.

The act of delivering a second lien proceeds to the buyer to pay down the first will function as a reinstatement for the borrower. So then removing or at least bringing to the table, the case to take less of a discount. In addition, we know there is no duty to accept those funds. Finally, we don't know how much negative equity there is, so the second lien may not have any equity to secure it. So while I think the strategy has some tactical precedent, it may muddy the deal up a little.

I don't want to get into legal advice on the matter of pooling investors and co-mingling funds. There is legality to that and the OP should discuss with an attorney. I don't agree with all the bullet point problems to the structures and Bill and I have not seen eye to eye on those matters before. That said, what Bill says should be understood and contemplated as they do apply and you could have liabilities. That is why you should speak with an attorney on the matter.

I am more concerned with the nuts and bolts of the deal.

Getting a deal into Chase is hard. You will struggle to get it in front of someone who can initiate a sale. I would imagine your offer will be submitted through the loan servicing department, likely the loss mitigation department. I personally don't give this much of a chance of going anywhere.

While generically the buyout of Chevy Chase by Capital One was around 25%, that is the generic percent of the balance owed. (I am commingling assets as I only have the macro numbers) So did Capital One get a good deal? Is it a "deep discount"?

We can't know, in order to determine just how practical that discount is or was, we would have to understand the value of the underlying collateral. I can tell you the bank buyout happened in the end of 2009. Since that time, we have seen some decline in real property value around the nation. So, 25% of UPB could be 65% of RE Value or in some cases 110% of RE Value. Many of the investments made around that time are still struggling to break even due to the large decrease in RE Values.

I point this out because I hear many newbies somehow want to equate the idea of some deep discount that a procuring bank or large investment fund received as being able to flow downstream into the street level investor. Far from true. The fact that I as a fund or institutional investor received a discount does not translate into a similar discount in re-trade downstream. When you own an asset, the idea is to get maximum recovery value from said asset that coincides with the goals of the portfolio.

My intentions with my post was to point out the flaws in the proposal of this acquisition and the structure of the capital. It seems like we are spending a bunch of time trying to delineate how to structure this with a debt and equity guy. Number 1, it is likely the offer goes nowhere at all and the bank won't sell. Number 2, the 'real' debt structure has not been addressed and I think is a large barrier to getting anything done.

Debt has interest. How will you pay for this interest. Forget legal for a moment and just deal with the simplicity of debt service. If the loan is non-performing, there is no cash flow to service debt from. If the debt provider wants periodic cash flow, you will have to capitalize that from the equity investor. This diminishes equity return. The security of the equity is also at stake. Just like any other note, there will likely be a demand feature. Again, diluting the equity and security in the asset. If you buy this loan and the borrower is in a BK plan, you may not see any cash from the BK plan or trustee for several months. If the BK is chapter 13, the plan could extend for years. All of these are barriers to working with the debt guy to adhere to the debt maturity and interest accrual.

Additionally, I don't see any plan on the on-going costs to service the mortgage. If the loan is non-performing, the loan is going to REQUIRE on-going outlays of capital beyond the purchase price. BK defense, FCL attorney, advances for property taxes and insurance. The holding costs of a NPN are large. These fees can not be itemized into a total purchase prices structure right now since you don't even know what they are yet. In a typical equity structure, the equity guy ponies up all this capital. The debt guy does not issue new capital for these costs. So then, the equity guy diminishes again.

I guess the other way to say this, it seems that lack of an acute understanding of the asset class could create some bad plans here. Stacking equity and debt sounds ideal but without understanding the asset and how it will work, which may not be anything like the current underlying assumption can turn this into a very bad mess. I am not positive the OP should use any type of debt in the deal at all. For the sake of all parties involved. I am just not seeing enough of a understanding of this asset class by the OP nor the general plan to make this seem like a good idea.

If everyone jumps in with equity, then you have them ride the investment out all at the same time. No distributions until final disposition.

So I think the main issue here is execution on all levels. The two investors do not sound like they know the asset class. The OP seemingly doesn't have a firm grasp on the asset class or capital structure and ramifications of the same. Because of these and also believing that folks can figure some stuff out as they go, I don't think you should use debt in this deal in any manner at all. I think the debt will make your life and this deal very hard. Learn with equity, maybe find a smaller note. You are taking your inexperience with the asset class and mixing in your inexperience with stacking capital and even LLC/LP operation and formation. The three main concepts to this deal, the OP has zero experience with. I don't think that is a plan, I think it is a wish. I wish that could turn out to be a pretty big headache and possible nightmare.

One comment on Tom's question on structure. To some degree hiring a third party manager will work, PROVIDED, you use a full service mortgage servicer. That manager then functions as Servicing Surveillance and Investor Reporting and can not interact with the borrower if they are not a licensed loan officer. The communication must pass through the servicer in full, since they would be the licensed entity. Not all servicers are made the same in this regard, providing that service without higher per period fees, etc.

The best way is to have an ownership interest in the company that owns the note from an efficiency standpoint and avoid legal liability.

I am always a fan of more detail than less, with a little more information we could help you determine if you have a competitive over and situation. Many things will go into whether the Mortgagee accepts an offer to sell.

A couple of ad hoc hunches, the BK is not grounds to severely discount the note. If the borrower reaffirmed the debt in BK, then the Mortgagee might be getting payments from the BK Trustee or Borrower, depending on the BK plan and chapter.

I am inclined to think this deal is coming from the borrower or the borrower found you guys. If not, no biggie. If so, be careful not to strike a deal with this borrower, even subject to your deal, as you may have some problems with your price level and subsequent dealings with the borrower. In my experience, over involvement from the borrower is not good and the borrower gains a sense of entitlement.

Also, dealing with this borrower before you become an owner and if you do not have a Mortgage Broker license is acting without a license. This could bite you in the rear if the borrower gets mad and wants to report you. In order to negotiate with a borrower, you need to be the owner of the asset or a licensed MLO.

As far as the capitalization of the deal goes. You have two investors who need to be pooled so you can purchase. If one investor has agreed to be a debt investor and the other equity, that is fine. However, in your post I think you jumped the gun to owning the deed. First thing first, regardless of the future disposition, you need to purchase and own a loan. The equity guy gets equity, the debt guy get's debt but will likely want some form of collateral to his loan. So you can not jump him into a DOT as you can not record a DOT on a DOT (you can't mortgage a mortgage). When you buy the loan, you don't own the real property, so you can't perfect an instrument against the subject property in this structure.

The debt guy would be a note inside the LLC or LP or company, etc. The equity investor forms a company with any other party and the company delivers a Promissory Note back to the debt investor for his capital contribution. The debt would be collateralized by a UCC filing in most cases from the company over the note.

This may not be what your investor is comfortable with. You are his borrower and the Mortgagor is company's borrower. It is not clear how you plan to debt service said debt. If the borrower is not paying, and you can not get your borrower to pay, all your money comes from the sale of the asset either as REO or a re-traded note. So, you need to think on how you will make payments to the debt guy if he wants them opposed to a deferred interest type of loan with everything due at maturity or final disposition.

The next issue you will have, depending on these two investors is, the equity guy now becomes first loss. Since the debt guy will want to hold a Senior lien against the asset, the debt guy get's his money first and the equity guy get's his money last. This may make your equity guy a little concerned as you dilute his collateral with the debt. The investors are not on equal footing. If the deal doesn't bring back the anticipated return, the equity guy could see his return drop or even become a loss and the debt guy could end up getting a decent return because of the interest demand from his note.

Creating a debt stack to capitalize notes is done everyday. The debt provider usually understands the asset class pretty well. Many street level investors do not carry this knowledge. That might be a barrier for this structure. The folks who have done this and do it, know exactly how they want their debt secured and they will drive the car to that extent. I am not overly keen on DIY here.

I also get a sense the OP doesn't understand how a DOT and Note is conveyed. It is mentioned in the post the conveyance of the DOT will be by Trust Deed or DIL. That is real property not a mortgage or deed of trust.

The seller will sell the note and an Assignment of Lien will be recorded which assigns the Seller's interest in the DOT to the Buyer. The borrower still owns the house and in on the deed and in title. The interest in the note will be delivered by an endorsement from the seller as well but that is not recorded.

As Bill described there are several ways to skin the cat. You can join the investor(s) in a LLC or LP and the company becomes the buyer. Or you can name each interested party. (I personally am not crazy about that and prefer LLC/LP to hold the asset). If you do the individual interest in the DOT and Note, the debt stack becomes more complex as all parties named have to subordinate their interest to the debt guy. So more than one name instead of one name with a LLC/LP.

One other comment on the separate interest part. You then need to create a document which all parties agree to on how control and discretion is practiced over the asset. How will you handle conflicting ideas amongst the investors? So fundamentally, you still end up doing all the same work and similar paperwork as if you were setting up an LLC/LP and having the members governed by the operating agreement. Again, I just think that is cleaner and easier inside a company.

I would venture to say your best bet here is a straight equity setup with all the investors. Say the OP is the manager and gets 20%. So then each investor get's a share of the 80% based on the amount of capital they put in or in proration. Simple, effective and easy to work with, IMO.

Wayne mentioned there will likely be some barriers with the reverse inquiry for one loan. Very true. A one off reverse inquiry is tough. it will depend on the owner of the loan currently. The loan could be owned in a security right now and your chances will diminish to essentially zero of getting anything done here. Might have some luck with a local or regional bank. The bigger investment banks will be difficult. The mortgage servicing department do not have authority to trade the loan. At an investment bank, a portfolio manager has this loan on his P&L and makes the final decision on trade. These folks are use to bigger pool trades and it is hard to get them excited about trading one loan.