When it comes to investing in notes there’s typically only two ways to go about it: you either find them or you create them. Sure, with a background in real estate investing, you could create rehab loans for fellow contractors just like the hard money or private lender does. Now the biggest challenge with notes you create is that they tend to be short term, which can start to become a disadvantage especially when you get to the point where you have more money than deals.
You could also enter the “Seller Financed” world and crank up your marketing machine in hopes of the phone ringing, giving you the chance to buy a loan with all the perfect note criteria that you may be able to sell to a broker. I’ve gone down this path, and I’m not so sure it’s as easy as it used to be. The criteria is so strict, and the financing behind the broker has pretty much dried up, and when you throw the “Safe Act” into the mix, along with some seasoning requirements you now have the makings of a pretty tough business model. Even if you find the perfect deal with the perfect note, I’m not so sure you can repeat it very often. So, what else is there?
You could always go after pre-existing institutional notes from a trade desk, loan servicer, or broker. I know what you’re saying, Pre-existing what now? No, you don’t have to originate nor do you have to market or go to the courthouse to find some notes. It’s as simple as just picking up the phone or going on the computer to buy a note! You don’t have to face the problem of finding someone to lend to or not having enough notes to buy. You now enter a world where capital is your primary focus, instead of marketing. Although some trade desks only sell pools of notes, others allow you to cherry pick your assets with your tastes in mind: whether you base your decision on geography, risk tolerance, or desirable fair market value. With notes just a phone call or click away, you can now build a repeatable business model where you’re actually trading notes instead of searching for notes.
How Trading Works
Before I get into the different trading avenues, I should explain how the trading process works. After loans are originated, banks sell a portion of these loans for a multitude of reasons: to reduce their exposure in a particular asset class, because of capital constraints, or because of pressure from regulators. The major bank usually have a trade desk whose primary task is to sell notes to investors, some in fact have multiple trade desks that sell based on categories of notes. Usually these big banks aren’t really interested in selling notes on an individual basis, so they almost always sell notes to larger fund investors. Many of these very large fund investors then either service these loans in house or place them with a servicer, and if they choose to sell some notes they usually work through said servicer’s trade desk, through a broker, or through their own trading platform.
So, How Do You Get Started?
For investors starting out in the note business, the four best places to find product are banks, servicers, brokers, and trading platforms.
To narrow the field, a great resource to find smaller local banks and funds is a web service called Distressed Pro. For a nominal fee, not only do they provide contact information for asset managers and trade desks all across the country, but they also have data on who has what type of assets in their portfolios at any given time. Once you find a source that sells notes you’ll have to apply to gain access to product along with signing an NDA (non-disclosure agreement) or non-circumvent agreement prior to bidding. All of these options may sound overwhelming so let me simply the roles of each a little further:
Related: Cash Flow Notes: Step by Step How to Invest in Performing Notes
As described above, a trade desk is a department of a bank or fund that sells to investors. Most large banks do not sell individual notes to smaller investors looking to cherry pick. If you want to buy direct from banks and you’re just starting out, you may have more luck going to a smaller local bank. An even more promising route may be to buy from a fund – these outfits usually buy direct from the bank or from an even larger fund or servicer. Some examples of funds that sell directly to investors are Granite Loan Solutions, Kondaur Capital, and Gemini Capital. Distressed Pro also lists many more asset management companies and banks by region. They not only have the listings for all of these places, but they also organize contact information lists for the asset managers and trade desk workers at these outfits; so you’re not just calling bank tellers asking, “can I speak to the trade desk please?” If you’re starting out in the note business, this is by far the most effective route to go.
Brokers – Brokers can be found a number of ways, one of which that has surprisingly been successful for us was searching LinkedIn. The term “broker” has become a bit of a misnomer in the note industry, so when searching for these guys look for people with a title like Whole Loan Trader or Portfolio Manager. Keep in mind, brokers do charge a fee for finding you product but if you find the right one with the right contacts, the fee becomes a cost of doing business that’s easy to pay. Brokers are great for pool trading, so if you’re looking to buy one note a broker may not be your option just yet.
Note Online Trading Platform – Different than a traditional trade desk, an online trading platform allows you to see the product a broker, servicer, or fund sells online. Sites like FCI, NoteMLS, Auction.com do just that. It’s a great way to view notes on your computer that you may want to cherry pick and to also get an idea of market pricing.
Especially if you’re not dealing with a major bank, any transaction should be treated as “buyer beware,” My partner John always said, “There’s no such thing as a bad note, just a bad price”, so that can be determined by your due diligence and by having “reps and warrants” in place contractually, as well as other safeguards and buyback agreements. The best advice is to try contacting these companies to jump in and get your feet wet, start out small, and gain experience.
So at the end of the day what strategy would you rather have? A strategy where you hope someone calls in and gives you a deal from your marketing or a strategy where you contact an asset manager at a trade desk once or twice a month telling them that you have “X” amount of capital to deploy this month? I know which one I would rather have.
What’s your best way for finding notes?
Photo: Hans Splinter