How To Price Real Estate Notes Pt.5

How To Price Real Estate Notes Pt.5

Livecast #


Take a deep dive into this 5 part series on how to price your offer to purchase distressed mortgage notes.

Ron Happe: Good morning everybody, or good afternoon, wherever you happen to be. Beautiful day here in California. Welcome to our livecast. Today we're going to do something a little different. Over the last couple of weeks we have received quite a few questions and comments and requests. And I want to do some review today and cover some of these questions because I think they're important. I think everybody need to get on the same page here. 

One of the big requests that we've had, and I think it's been kind of overwhelming for us, is that several, well more than several, a number of people have asked why and if we would do a live seminar or boot camp, and if not why not. Well, my basic philosophy has always been to avoid that. I don't want to be lumped in with what's considered to be the gurus out there who charge a fortune to attend a seminar and then try to step you up into a coaching program because almost all the questions that we receive are from people who have paid for those kind of coaching programs. We kind of sit back and we wonder why are they asking us if they paid up to $25,000 for a coaching program? Or they may be asking us to help them evaluate a pool or maybe just two or three notes that they have bought and they're dissatisfied with what they have received. And we just didn't want to get in that category. That's probably the first reason.

The second reason is that none of us really want to do that much traveling. In order to do a seminar bootcamp right you have to do it in different markets throughout the US. And I'm old. I don't like to travel that much anymore. [Chrissy 00:02:32] has a young family and a very busy husband. Traveling is a little bit difficult for her. And Tyler, in addition to being involved in our business, runs a law practice. So we've just decided hey, we would prefer to do it a different way.

But these requests have gotten to the point where we've pretty much decided, "Hey, we've got to do something," because number one, we want to create some very knowledgeable note investors that can be involved with us. And so I think that what we've decided to do is starting in January we are going to put together a bootcamp, a four day bootcamp. The first one will be easy for us because we'll have it in San Francisco. And then the second one we'll probably have in LA. Kevin [Corbitt 00:03:41] our person on the ground in souther California can put that together for us pretty easily down there. And those two will kind of guide us for the rest of the year. So I think what we're gonna try to do is do one every month, a four day seminar, a bootcamp. I'd like to discuss it a little bit today about what we think we're gonna get involved in. And I wish that you would comment, maybe put in some questions or areas that you feel need to be covered in this bootcamp. I'll kind of go through with what I think that we're going to do, how we're going to structure it.

So the first one I think we're gonna have in San Francisco in January, the second one we'll have in LA or San Diego in February. And then we'll have one in major markets each month for four days throughout the rest of the year. So I guess we'll just have to wait and see what kind of interest we have in it. 

Some of the good things about it is that first of all these are gonna be very thorough. We're not gonna offer any coaching program for 25, 15, 5,000, 9,000, whatever. We're gonna tell you everything we know in those four days. We won't hold anything back. 

Second, we are professional investors. We're not teachers, although my career started I was a high school teacher when I got out of college and coach for a couple of years before I got into the business world. But our main focus is definitely not teaching, our main focus is investing. And I think during the seminar we are going to give you what we do. And hopefully that will entice you to do business with us or alongside us. And we're gonna have in about another 30 days some very pertinent information to share with you about how you can get involved with us and whether you want to be totally passive, whether you want to be active, or whether you want to be somewhere in between, we're gonna give you that opportunity. But our workshop, our bootcamp is going to be very thorough. We're not gonna try to step you up into a coaching program, we are actually going to teach you exactly what we do in our business.

I think we'll start out with getting a background in miracle math as I like to call it where we can turn a 12 to 14% return on a note that we buy into a 35 to 50% return yield. That's very simple to do if you know how to do it. And then we'll progress from there. And then we're gonna spend one full day with Tyler, a licensed attorney, has very thorough knowledge and background and experience in SEC regulations and putting together the private placement memorandums in compliance issues, Dodd-Frank, how to operate in today's environment. We're gonna be spending a lot of time on the legislation that is now in place and what legislation is possibly going to take place in the next year or so, what you need to be aware of and how you need to be sure you keep yourself out of trouble. We'll cover all the licensing requirements and so on and so forth. So I think that we can put together over a four day period a very very thorough bootcamp that you'll walk away with knowledge enough that you feel comfortable in investing in notes. 

And in addition to that we're gonna try to figure out a way, I think we have figured out a way to make it a very affordable path for you that you can feel comfortable that you're getting the value for and actually get your money's worth. So please, you'll be made aware far advance of when and where. And please keep it in mind, if education is important to you, and it's important to us, we've been to just about every seminar that's out there. I think you'll find that what we're going to do is going to be very very worthwhile.

So now for the rest of this morning I would like to kind of go through some of the questions that we're receiving and try to give you our answer, our input to these questions. Some of them are elementary, some of them are I would say more advanced, but they're all questions that you, as a note investor, need to have answers for. 

And the first question that we have concerns the involvement that we have in all facets of notes. Seller financed, pools, tapes, and how we go about valuing the different kinds of products that we are looking at. And really there's two different kinds. First of all we have to realize that the two kinds of notes, the two categories that are going to be valued differently are performing and non-performing. It doesn't matter really if your performing note is a first or a second, it doesn't really matter if it's seller financed or part of a tape, you're going to value performing notes based upon a yield that you want. So keep in mind that if you're buying a seasoned note, whether it be a first or a second, or if you're buying a note that has never been delinquent. I'm sorry, if you're buying a reperformer that is seasoned, or if you're buying a note that may be seller financed that has never had a late payment, you're gonna be valuing both of those based upon the return that you want to receive.

So if you are going to receive, if your portfolio, your investment criteria is that you want to receive a 15% return, then you're gonna price that asset at a 15% yield. And that's part of the math, very easy to do. And in addition to that it's very easy to turn that 15% into 35% or more if you can get creative in selling partials and selling splits and so on, which you really need to learn how to do.

Now I'm not a math wizard, I'm pretty good with a calculator, I'm not a math wizard, but there are people out there that you can learn from who are real wizards with math. And over the course of these livecasts we'll share with you the names of people that we think are really spectacular. Some of them not teaching anymore, but we can give you some ideas of what they have come up with and how they work the field. But one thing to keep in mind then is if you're buying a performing note, doesn't matter if it's seller financed or if it's from a lender, a professional lender, is that you want to be sure that you are doing it for yield. 

So let me get a couple of things up here on the screen. I want to back up just a little bit. So one of the things that we, a big question that we received over the course of the last four or five weeks is, "Hey, can you break down the costs that we need to know about if we're buying a note?" And here's a list of the things that you need to consider when you're buying a note. A lot of people don't consider the costs of holding a note at all. So especially if they're buying a non-performing note and they don't take into consideration the legal costs that could be associated with that note such as foreclosure. And you need to do that.

So we always put in every note that we value, we put in a cost for the maintenance of these notes. And we retain a certain portion of our capital so that we can pay these fees. Now the first legal costs would have more to do with non-performing notes than performing, but the rest of these costs are associated with performing as well as non-performing. And so you got to keep in mind there are recording costs. A recording cost can run anywhere from let's say 15 to $17 in some counties to as much as $30 in some counties. And let me give you some advice right now, do not attempt to record yourself. You need to find somebody that is familiar with all the counties in the United States and what the recording requirements are. 

I'll give you an example. Let's say that in Sacramento County the document margins have to be one and one quarter inches. In Clark County, Nevada let's say that the margins need to one inch. And this is not, I'm not making this up, this is true. Now if you send in a recording to be recorded and the margins are incorrect they will send it back to you. That may take six weeks. So now you've had six weeks that your document is not recorded. Find somebody that will record them and pay the cost, all right?

In addition to that, let's say that you buy a note and something is missing from the file. There's document searches that need to take place and you need to pay for that. We don't have any paper in our office. We do everything electronically, so our notes, our collateral files are sent to a company that scans them for us. They do a document, they search that file, make sure everything is there. If anything's missing they go out and look for it, they get a new document. Let's say a trust deed is missing, they'll go out and get a new trust deed. They then send them to us electronically. In addition to that they store them for us. We don't want the paper here. They store them and there is a fee for that each month as an addition to the servicing of that account. Servicing [inaudible 00:16:47] from let's say $15 a month to $50 a month. And you need to account for that. If you have let's say 10 notes, that could be $500 a month that you need to have in reserve before these things start paying off. And then you are going to have accounting charges. So keep this in mind.

One of the things that we like to do when pricing a note is we want to retain 5% of the value that we're gonna pay for that note as a retention to pay these fees until the note starts paying. So please keep that in mind. A lot of people were shocked that they had this kind of expense after they buy a note.

I need some help here Mark. Okay, so another of the questions that we get is, and I think we've covered this fairly thoroughly, but we still get questions on it. What is, if you're going to be buying seller financed notes, and a lot of people do, a lot of people look to those primarily, if you're going to be buying seller financed notes you need to be looking at the collateral. You need to look most importantly at the value of the house. What is the fair market equity? And when you buy it, what is your likely exit strategy? Now we know that there are some people out there who buy with the intent to foreclose and then resell the property. If that is your model then be sure you have your legal fees for the state that you are purchasing in nailed down. And the timeframe that it's gonna take you.

Now we are seeing people pay what we consider to be exorbitant prices for these first non-performing firsts without taking into consideration how much it's gonna cost them and how long it's gonna be before they able to sell that property. So with a performing note you are looking at the yield, but your yield is going to be determined by the quality of the collateral. And the thing that most people forget is that on a seller financed note it was seller financed usually because there's something wrong with. There's either something wrong with the borrower or there's something wrong with the property that caused the property to be sold with seller financing. So either the buyer had bad credit and couldn't qualify for a loan, or didn't have a down payment, so therefore the loan to value is high. Some reason it was a seller financed note. If there is problems there are you going to decrease what you'll pay for it or increase the yield that you want because there's something wrong with the collateral or with the buyer? 

And then third, and we showed you an example in one of our livecasts, we showed you two examples. One of a very sophisticated software showing the payment schedule, the trust deed, the county recording and so on, the title insurance. And then we showed you one that was written on yellow legal paper. Again, I might buy that poor written poorly executed note. I probably wouldn't buy unless I knew the title was good and that I was in first position, but if I had some weak paperwork I probably would still buy it, but my yield would have to be considerably higher on something like that. And then I would try to correct all that when I had it. So that's very important if you're buying seller financed notes from ...

So again, we want to talk about the difference between performing and non-performing. So when we talk about the performing we're going to be looking primarily to a yield that we expect, we're going to be looking at the collateral and the qualification of the buyer. Was there a down payment? So on and so forth. On a non-performing note we are most concerned about how much do we think we can collect on that note. Now we're still getting comments and questions from people who are asking ... They're talking in terms of how many cents did I pay on the dollar? Like, "Holy cow, you paid 15 cents on the dollar for that note," or, "You paid 20 cents on the dollar," or, "You paid," in the case of a first, "55 cents on the dollar." On non-performing notes it doesn't matter what you pay. Well, within reason. You're not gonna pay 100 cents on the dollar for a non-performing note. But the point is you need to concentrate more on how much are you going to make?

First, how much is it going to cost to maintain and collect that note over a period of let's say six, nine, 12 months to work that note out or to foreclose or whatever you're going to do. Unfortunately if you haven't got a big history of buying notes you are going to have a very difficult time determining how much do you think you can collect on a note because you don't have a history. That's why we always say this business is a learn by doing business. You need to do it enough that you develop a track record or that you're working with somebody that has a track record that can give you an idea of what might transpire over the period of time of how much you might collect on this note.

So it's not so much how much you pay for it, it is how much you're going to collect. So this pie chart here we used in one of our livecasts that give you an idea of some of the percentages that you might see historically. Now you could use this when you're trying to determine how much you're going to collect on a ... If you're buying a one off non-performing second for example, and again, you want to know how much do I think I can collect on this note. And I'm gonna translate that into how much I'm gonna pay for it. I'm gonna translate that into how much I'm gonna pay for it by first determining how much is it going to cost me to maintain that note both initially and as an ongoing monthly charge. 

And then I'm gonna say, "Okay, this note looks to me like I'm going ... My mode of business model is to work out and hold this for cash. And that is going to provide me with a X percent return after paying my expenses. And what return is it that I want?" It's not hard to take a reperforming second and make 30 to 40% annualized on your workout. Especially if you collect some arrears, and that's something that we try to do on every one because we want the borrower to come up with some cash to have some skin in the game so that they don't default again.

So if you're paying let's say $15,000 for a $100,000 note and you do a workout at let's say $400 a month, that's $4,800 a year on a $15,000 investment less, let's say $5,000 that you received from a arrears payment. You've got a $10,000 now into that note for a $4,800 return. That's a 48% annualized return year after year after year after year if that is your business model. So you determine how much your overhead is, determine the kind of yield that you want, and that's how you price the note. You don't price it at, "I'm gonna pay 15 cents. I'm gonna pay 12 cents. I won't pay any more than 20 cents." For the right note if you can pay 20 cents and sell it for 80 cents, who in their right mind wouldn't pay 20 cents? Don't get caught up in that, "How much am I going to pay as a percentage of the unpaid balance."

Now that's the key there in the non-performing is you're going to pay based upon the, in a second, you're going to pay based upon the unpaid principal balance, not based upon the value of the property. You want to pay based upon the unpaid principal balance and you want to pay as low as you can based upon that unpaid principal balance. The reason is is that most of the time when you're buying seconds these days you're buying property that's underwater. And it doesn't really matter what the property is worth, what matters is how much you can get out of the note once you get it worked out. So please keep that in mind. Do not forget to calculate what it's going to cost you to hold that property, all right?

Now the issue then becomes whether you're going to be buying one offs or whether you're going to be buying one offs or whether you're going to be determining pools. If you're going to be buying one offs, if they're non-performing you're gonna develop a model that says, "It's gonna cost me X number of dollars to hold this. I'm going to historically do workouts that result in payments. Or my focus is going to be on discounted payoffs where I take a lump sum payment to satisfy the note. Or I'm going to do foreclosures and sell the property. Or I'm going to do a short sale." You have to determine what your exit strategy is, what your expenses are going to be, and what kind of a return are you looking for. That's the way you would price a non-performing second.

When you're pricing a non-performing first, again, you need to take these costs, this maintenance into consideration, and you price based upon the property fair market value. You could care less what the balance of the note is at the point of trying to determine what you're gonna pay for the note because the only thing that you can count on is the fair market value of the property. So you're gonna base your price that you're willing to pay for that first on the value of the property and whatever percentage. Let's say I'm gonna pay 50% of the fair market value of the collateral in the event that I have to foreclose. I'm gonna add all these costs to my note cost. And that's how I'm gonna figure out what I'm willing to pay for it and what my profit margin is going to be. So I think in every instance when you're buying a first, non-performing first, you need to calculate what you are willing to accept on a profit margin on that first. Because if you don't, these costs are going to add up rapidly, especially the legal costs if you're going to foreclose.

And then depending upon of course where the property is located is going to indicate further how much it costs to foreclose and how much you're going to have to pay to hold this thing. It certainly takes a lot more money to hold for 18 months as it does for six months. And in some cases you may have to hold for two or three years. In addition to that, is the house vacant? Is it occupied? Can you deal with the owner? If it's unoccupied you're going to have to maintain that property for the period of time it takes you to foreclose. And in order to foreclose you might want to skip trace the owner, you might want to try to make a deal with the homeowner who obviously doesn't care to have the property anymore. So you need to keep all those things in mind. And just to come up with, "Well I pay 65% of the fair market value." That doesn't work and I don't want you to get into that habit because you're not taking into consideration all of the things that can attribute to the cost of holding that note. 

So if I were you I would develop a matrix. It would be easy for you to develop a matrix that just, Excel Spreadsheet. I think next well I'll share one with you that we can assign a value to each category. For example, is it a judicial or non-judicial state? A judicial state is worth one point, a non-judicial state is worth three. Is it occupied? That's worth three. Is it unoccupied? That's worth one. And we come up with an easy way to identify these so that you get a clear picture of what you are buying, and you're just not buying a non-performing first, you're buying a non-performing first with these attributes.

So again, I think what we'd like to do is we want to get you educated. I think in the next couple of weeks we'll have some exciting news for you about some of the things that we're involved in right now that will only be beneficial to you. In addition the education and we really look forward to these things on Tuesday mornings that we can spend a half hour to 40 minutes together and maybe get you to the point where you're really comfortable in this business because once you become comfortable, the sky's the limit. This is a wonderful wonderful business to be involved in. So thank you and we'll see you next week.

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