Ron Happe: Good day everyone. Thanks for coming. And today we're going to broaden our knowledge on pricing. We've got a number of requests and emails from people asking exactly what we buy and whether we buy first, whether we buy performers, whether we buy first non-performing, whether we buy seller financed. And yes, we do all of those things.
So, the questions kind of evolved into, "All right, so do you value those the same way that you valued the non-performing seconds that you buy?" Really, no. There's a little different valuation in each of the tranches that you're gonna be looking at. When we buy non-performing seconds, we're always, well I won't say always ... Occasionally, we'll do a one-off. But almost 100% of the time we're buying from a tape.
And when we're doing seller financed we're buying one-offs. So, we do a direct-mail campaign and into markets that we think that we would like to buy seller financed notes. And then we evaluate those a little bit differently on a one-off.
So, we're gonna go through how we value the seller financed tapes, excuse me, one-offs. Both performing and non-performing. And then we'll get into how do we value a first non-performing. And I will tell you that we do not buy first performing notes. We buy only non-performing firsts and they are just like the seconds that we buy. They are normally from a tape, although we do occasionally get some larger non-performing firsts that we would purchase as a one-off.
We're gonna cover those two areas extensively today, but before we get started I need to go ... I'm having trouble with my mouse here. Need to go through the disclaimer again in that we're not trying to sell you anything. This is for educational and instructional purposes only. And it needs to be used for just that.
The next thing that we wanna do, the pricing models that we talked about, the seller financed, both performing and non-performing. Then we'll get into the bank tapes on the first performing and non-performing. And like I said, we don't buy performing first typically, we will keep re-performing first, but we don't go out and buy performing first unless it happens to be from a lender who's looking to get rid of something in addition to a non-performing tape. We might do something then, and we would try to immediately resale it. The next thing is the bank tapes on the seconds, performing and non-performing again. So, these are the three categories that I wanna cover today.
The first one we're gonna try to get into is the seller financed notes. You might remember this little chart from the last time that we met of what really determines the price. We like to use the three Ps or P to the third power, the property, the paper and the people. And really, when you're evaluating a first or a second. These three Ps are in a different order. And so when we are going to talk about the pricing model of a seller financed performing note, the property is the collateral or the property is, in most cases, the most important product. And then we look real heavily at the paper. And I think you're gonna see why.
When we take a look at the property the most important thing is the fair market equity. What is the value of the house less the loan? And when we take a look at that property we wanna know what is the likely exit strategy that we're gonna utilize? Is it going to be foreclosed? Are we gonna try to do a short sale or are we gonna try to do a workout with the homeowner? And it depends on, first of all, if it's a performer, of course the homeowner's gonna stay in the house. If it's a non-performer, we need to find out from the seller of the note what they believe the intent of the homeowner is. And then, is that house vacant or is it occupied?
Let's talk about the first performing note. In most cases a seller financed note was seller financed because there's something wrong. It's either something wrong with the property, it doesn't conform to the neighborhood. Or it is a rundown property in a nice neighborhood where they seller can't sell it without offering some seller financing. Or there's something wrong with the buyer, that the buyer has poor credit, credit that's not approvable or, for some reason, can't qualify for the loan that is necessary to purchase the property so the seller needs to be involved in financing it. And that is almost ... In every case, there's some kind of reason that there was a seller financed note. In today's world it's become more popular to do seller financing because the banks are so tight with credit, and people that are self-employed or can't prove their income are being forced to purchase utilizing some seller financing.
The first thing that you wanna do with you get a seller of a note on the phone you wanna do some due diligence and you wanna find out what is the property worth. Just a real quick first blush, the places that you might wanna go Zillow, Trulia, Realtor.com, Epraissal.com, are places that you can go to get a quick assessment of what the property value is. We have a little software program that we had developed by an Elance person. I think that this particular person was from the Philippines that took Zillow, Trulia, Realtor.com and Eppraisal and when we put in address and a tape it automatically goes out, finds those values and averages them and that's what we use as a first blush for the valuation of the property.
And then, of course, the second thing that we're gonna look at is how good is the paper. And here's where you kind of find some real poor support for the loan. Who wrote the note? Was an attorney or a title company or an escrow officer involved in writing the note or did the seller write the note? Is the note recorded? Believe it or not, we've seen firsts, so called firsts, on properties where the loan was never recorded. And can you look at the title, and does it have title insurance? Those are very important when you're buying a first. You don't need title insurance yourself, usually. You can get an endorsement after you buy it for a lot smaller fee but you do wanna run a preliminary title report to make sure that you are in first position, because if, for some reason, the seller did not record timely, or didn't record at all, somebody may have moved into first position and you might find yourself in a second. And we have actually bought seconds where we have found out that the recording was not done on the first and we moved into first position.
Paperwork is extremely important, as well as the support documents that the seller is able to provide you. Now, this is legitimate here. This is a, I think we looked at this in our last meeting too, but this is a documentation of the payments made on a commercial property in Southern California and this property was sold, originally, for over a million dollars. And this is the kind of record keeping that was made by the seller of this note, by the maker of the note. And I guess my question to you is would your attorney take this and take it to foreclosure versus having a professional software generated payment schedule? I would be very, very skeptical of buying a note with that kind of support.
I'm not saying I would not buy it, I'm saying I would be very skeptical and the pricing of that note would reflect the kind of support that I'm getting here. So, the paper and the actual collateral are very important when you're buying the first, and you're buying it performing.
Now, one of the most important things is that to know, and I can only speak from experience, and tell you what we do and how we value these things, and what we do on seller finance firsts that are performing, we bid a price that's almost always dictated by yield. What do we wanna make on a note? What kind of profit margin, or what kind of yield do we want when we buy one of these firsts? And if we were buying one that looked like the seller finance records that we saw on the yellow paper we certainly would want a much higher yield on that than we would take on one that was sterling.
Let's do an example here. Let's just take a look at an original, this home had an original note written on it for $150,000. The payments were at 8% for 30 years, fully amortized, there was no balloon on it. The payments were $1,100 a month, 40 payments have been made on it, and the balance on the note at that time, after 40 months, the principle balance was $145,403. We received a call from a seller and the seller said they wanted to sell this note. Now, this particular seller had never sold a note before and you're gonna find that to be most common also, these are usually a one time deal for the seller. They finance the sale of their house, they took back paper, they do it once in a lifetime and they're very unknowledgeable about the process so you have to walk them through.
On this deal here we wanted a 14% yield. I could run it through a calculator for you. Let's just do that so that you can get an idea of, again, a little practice on doing the calculator. This note, let me get this where I've got the numbers visible. I can do this fairly easily, write these down on paper. Right now the balance on that note is, excuse me, the payments on that note are $1,100 a month. So, 1,100 payments. And we want a 14% yield. After we buy it we expect to get a 14% yield.
What's going on here. Let me try this here. $1,100 a month is our payment. Got a problem with my calculator here. All right, let's try it again. We've got $1,100 a month. Well, I have time to screw with that today, so we're just going to ... You're gonna have to take my word for it. If you put these into the calculator you'll have that if you put in $1,100 a month, you put in the 320 months that are left on the payments, that's the 360 that it started out with minus the 40 that had already been paid. The buyer is going to get $1,100 a month for 320 months, and we want a 14% yield, so we would pay for that note $91,339.80.
There are some you're gonna buy like that. We bought notes from people that were well into their 80s and they knew they weren't going to be around for 320 months to get the payments and they were willing to take a discount like this in order to get cash. Maybe to settle their estate or whatever. In most cases, because these are people that only sale them once, they're going to be shocked when they take a look at this discount that they're taking on that note. They just don't understand the time value of money and that $1,100, 320 months from now, is nowhere near valued at what $1,100 a month is today.
If you find people that are surprised at that big a discount then you need to take a look at the partials or the split, and we buy far more partials than we buy full notes. So let's take a look at that same note, the original note for $150, the payments at 8% for 30 years, again, are $1,100, and 40 payments leave a balance of $145,403. We want a 14% yield, and we're gonna buy it as a partial. We're just gonna buy 60 payments of $1,100 a month. And we're gonna pay $34,174.65. So, does everybody follow that? Instead of buying a full note for the time left of 320 payments, we're going to buy only 60 payments, or 5 years of that stream of income for $1,100 a month at a 14% yield, which means we have to pay $34,174.65 for those 60 months.
At the end of the 60 months the seller gets the note back and there's still a balance of $135,756.66. This is a far easier sale to make with that seller than discounting down to $91,000.
Now, typically, sometime during that 60 months period we will buy another partial. So, we may buy another 60 months, we may buy another 100 months, we may buy another 36 months, but always during that time the homeowner or the seller of the note wants more cash. And then you do this calculation all over again. But you would have to do it out into the future because, let's say, after 36 months the homeowner decided they wanted to get some more cash and they wanted you to give them 60 more payments, by 60 more payments from them, you gotta remember that the first payment you're gonna get on that purchase is out 24 months, so you're not gonna pay the same amount, $34,174, you're gonna pay quite a bit less because they payment is out into the future.
When you're taking a look at the seller financed non-performer, and this is where you can find some real deals, because most of the people that sell these things, like I said, are doing it one time and they get so frustrated when they don't get a payment. They don't know what to do. They're afraid to go to an attorney, they think that if they go to attorney, whatever they collect is going to be offset by how much they have to pay they attorney. They don't want to foreclose. They may have sold the house and moved to Phoenix. They may lived in Iowa. There's all kinds of complications that come about when a seller financed note goes into default.
It's kind of critical the way you value these notes, and honestly we have seen some really crazy valuations when we are either buying these from a bank, or in this case, seller financed if they've talked to somebody else. Some of the rates that people would pay are simply crazy and that tells you that the person buying them is not very knowledgeable in how to price these notes either.
So, when you're gonna talk about a non-performing, even if it's a seller financed, the first thing you need to do is you need to decide what is the amount that you can collect on the note. Exactly the same thing that we talked about when we discussed non-performing seconds. We wanna determine how much we think we can collect on that note. Is it gonna be a foreclosure? Is the property occupied or is the property vacant? If the property is vacant, how much is it gonna cost you to take care of that property? What's your overhead going to be?
By overhead I mean are you going to have to pay somebody to maintain the house? Are you gonna have to pay an attorney to foreclose? Are you going to have to pay a realer to give you a BPO? By the way, that's something that I wanna talk about just real quickly here, is that when you're trying to determine a price, or let's say that you're concerned that this house is vacant or occupied. If you're not using ActiveRain you might wanna consider that, it's free. Go to ActiveRain.com, sign up. And we do this quite often, we send out onto ActiveRain, a job post that says, "We are buying a note on 123 Main Street in Cincinnati, Ohio. The first person that gets back to us with pictures and a BPO on that property will get the listing if we have to foreclose or short sale."
And it never fails, within 24 hours you will have pictures and a BPO on that property. We ask for a 30 day quick sale price, how much, if you listed it, could you get if [inaudible 00:24:14] in 30 day? We'll get that price back from them and now we have a contact in Cincinnati, Ohio that not only will we use on this property but we'll use them again when we get other properties. So, ActiveRain.com is a good place to go.
If you think that you're gonna have to foreclose, what are you gonna do with the property after that? Are you going to sell it? If so, you need to have a relationship with a realtor in that area. Can you enforce the paper that you have? The yellow sheet, you might be hard pressed to find an attorney would even try to foreclose with that kind of paperwork. If that's the case then you better have priced that into your model when you decided that you were going to buy it.
And then, what kind of profit do you want? You're gonna have to know your cost. And what is your exit criteria? These are the main points that you're gonna have to use when you're looking at a seller financed non-performer. If the paperwork is good and you can get a decent BPO, a broker's price opinion, if you can get decent information on the property, if you can get some pictures. And these can be very, very attractive because the seller doesn't wanna deal with it. They would just assume be out from under this deal.
Now we wanna talk about buying these firsts from a bank on a tape, a tape similar to what we would get if we were talking about a non-performing second. And we'll get a spreadsheet, much like we covered in the last meeting, there'll be different things in there about the property, when the note was written, how many payments were made, when the last payment was made, maybe what the bank thinks that the property is worth. And sometimes they'll even have in there a number that they expect to get out of the note. What you need to do is you need to, first of all, find out what the collateral is worth.
Again, if you're buying one of these every now and then, you can use ActiveRain. If you are buying from a tape, and you're buying a number of these, you don't wanna go to 50 people on ActiveRain, you wanna do a quick assessment, again, using Zillow, Realtor.com, Trulia, etc. to estimate the value of the house. Please keep in mind that those are not very accurate, but they're close enough for you to make a judgment on whether or not you wanna buy this note.
Then you must determine, what are your costs? Is this a judicial versus a nonjudicial state? A judicial state, of course, requires a lawsuit to get the people out of the house, to get title back. Where nonjudicial state allows a trustee to sell the property. It's a lot faster. It can be, although it's not typically in these days, it can be as low as 21 days, it can be as high as 4 months. Today it's taking a little longer, of course. Judicial, however, can take two to three years. Are you going to be holding that property for two to three years? Can you locate the homeowner? What are your holding costs? Is the house vacant or occupied? If you were going to sell the house after you foreclosed on it, we always use a typical 80% of what we can determine to be fair market value.
If the fair market value we've determined of that house is 80%, excuse me, is $100,000. 80% of that is $80,000. That's what we will use to estimate we are going to be able to sell that property for after it's foreclosed on. How much could we sell if for in a short sale? Now, that's where you're gonna need a real estate agent in the market place to tell you. If you have an opportunity to sell it on a short sale, that's one thing. If the house is vacant and you can't find the homeowner, that's another problem.
And as I said, when you get a look at the property, you're concerned, of course, whether it's vacant or occupied. And also, whether it's been trashed or not. And if it is trashed, you're gonna need to have somebody clean it up. You're not gonna be able to keep that ... In Sacramento where I live, there's fines up to $1,000 a day for not maintaining property and they can add up very, very quickly.
We see, and have in just the recent past, if you look at taking a really educated approach at finding what value there is, we have seen some absolutely crazy pricing. People paying, I don't know where they're learning this stuff, but paying on a non-performer fist, unoccupied, weeds up to the windows, paying 80 to 85% of fair market value of the house.
You're gonna run into those when you see them, where they banks are becoming complacent in their pricing because they're getting some stupid offers on this stuff. So we kind of recommend that you treat this the same as a non-performing second. You're just gonna pay more because it's a first.
The information that you want on the spreadsheet that you get from the lender is, of course, if you can get what they consider to be a fair market value. If you can get a credit score. You want the first loan to value. If the taxes are current. What the original note was for, so that you can see how they paid it down. Is there a second? When's the next payment due? Is it vacant or occupied? Has the homeowner ever filed a bankruptcy or are they in bankruptcy now? What's the loan to value on the first versus the loan to value on the second? All of these things are important and you need to assess them before you make a purchase.
Let's take a look at a non-performing first. And let's say that this house has a fair market value that we're able to reasonably ascertain by doing our research. We come up with a market value of $135,000. The original note on the house was $255,000. The unpaid balance on that $255,000 note is $247,435. The first loan to value, LTV, 183%. The house is seriously under water. It also has delinquent taxes of $4,875 and a foreclosure cost with a holding time in this particular case, we estimate to be $4,850. That's to pay for the fees to file and the attorney fees and the time that you're gonna hold the property. We wanna sell this within 30 days of our foreclosure so we're gonna sell it, we're gonna list it, tell that realtor to mark it at $108, we wanna get rid of it.
The sales cost, in my area, sales costs right around 10%, this one I would do a little less because we're gonna make a deal with the realtor, instead of a 6%, we'll pay 5 and we'll give them more work. We're gonna net, after paying taxes, the sales costs and the foreclosure cost, we're gonna net $88,555.
Now again, you have to decide what kind of a return do you want. If you want a 25% return on your investment then the most you can pay for that note is $66,416. Now personally, I would not buy a note that was non-performing that paid 25%, that I could project a 25% return, I simply wouldn't do it.
But if you take a look at the price here. I'm sorry, that slide is incorrect. It's 49% of the fair market value. So, not original note, or unpaid balance. I don't really care what the unpaid balance is because that's not gonna do us any good at all, unless we can work something out with the homeowner. But in this case, we're gonna sell it. And depending upon how I evaluate this note, in most cases we determine in our evaluation that we're gonna sell it. That we're gonna have to foreclose and sell the property.
If we're gonna make a 25% return on an a non-performing first note, and we have to buy it for $66,416 or less, and that represents 49% of the fair market value. You will see pricing where the lender has priced it at a percentage of the unpaid loan balance, unpaid principle balance. That means absolutely nothing in your valuation. You can only count on what the fair market value of the home is, unless you consider that you're gonna hold this property for five years, and see market appreciation. In our estimation, this is the absolute top of what we would pay for a delinquent first.
In this case we have a second. I just wanted to go through here with you and show you just a little bit of difference in how we would determine the price of the second versus the time of the first. They're very, very close. So, in this case we have an unpaid principle balance of $85,000, the homeowner's in arrear $20,000. And we work out a payment with them that if they'll give us $5,000 of that $20,000 in arrears, the workout payment that we would allow them to make is $450 a month. Now, keep in mind that the $450 a month is probably a number that the homeowner came up with that they thought they could afford. And after us evaluating their financials, we would agree to $450. If we looked at their financials and thought, "No way, they can't afford $450 a month." We would reduce it. Let's say we go down to $350 a month, because the last thing we want is that homeowner defaulting again.
So, the combination of examining their financials, see their pay stubs, seeing their tax returns, and collecting $5,000. They now have some skin in the game. It's unlikely that they're going to default again. So, they have 24 monthly payments of that $450 a month is $10,800. We're gonna sell this to an investor for a 17% yield after a 24 month seasoning.
A 17% yield to return $450 a month, the investor would have to pay $30,366. So, over this 30 month period of time that we've held this note we now collected $46,166. That is the $30,366 plus the $10,800 plus the $5,000. And if we wanted to get a 200% return plus our capital back, we would use a divisor of 300% or 3, come up with a price of $15,388, and we're gonna make an offer of 20% less. And we're gonna offer for that note $12,310. That's a little bit of difference between the first and the second, because in most seconds we're gonna try to work out a ... Our number one goal in a second, if the homeowner is in the house, is to work out a payment schedule with that homeowner and not foreclose. Simply because we're in second position.
That is kind of the difference between the first and the second. I hope that this was some help and answered some questions from people who were very concerned or interested in doing something other than delinquent non-performing seconds. There is a market in the non-performing firsts, either from bank tapes or from sellers. And in our operation there is a good market for seller financed notes that are performing for people that need cash. I will tell you that they're hard to find.
We have a fairly large budget of direct mail that we do each month and we just don't get that much response from our direct mail and we have it set up on a six month schedule where we send out those post cards every six months to the same people. We'll do that three times, and if they don't respond after three times we take them off the list.
This is a wonderful business. You can decide which tranche you want. We have some exciting things happening at our company right now and opening up another office. We'll be talking more about that in the near future.
Thank you for coming. Please, if you have questions or comments, we'd love to hear from you. Just send us an email. If you want to see something that we haven't covered and if we know anything about it we'd be happy to try to accommodate you. So, again, thank you and [inaudible 00:41:57].