Investing In Seller Financed Notes

Investing In Seller Financed Notes

Livecast #


In this episode we cover the extraordinary potential of investing in seller financed real estate notes.

Ron Happe: Hey, everybody. Thanks for coming. As we talked about, today, we're going to discuss seller financed notes, the acquisition of seller financed notes. We're going to go through what we do and yes, we do buy seller financed notes. We buy both performing and non-performing. There are some companies that, that's all they buy are seller financed notes and we find that pretty difficult actually because they're just, you have to work pretty hard to find them where with buying institutional loans, we buy in tools and tapes so we get a number of loans at one time. With the seller financed notes, you are constantly looking and we do a very substantial direct mail campaign to find our seller financed notes and to be honest with you, sometimes we'll get a call from a note holder that we send a direct mail piece two years or more ago and they all of a sudden needed cash and they respond today. 

In fact, Crissy just had a call this morning on seller financed notes that it looks like we're going to purchase and the guy's been holding our letter for over 18 months so he finally decided that he wanted to cash out on it and we made him an offer and I'm pretty sure that it's going to go through. This happens to be one that is performing and normally, we don't hold those seller financed notes. We normally resell them to investors who are interested in a first mortgage, fairly secure for a 10% return and we have a number of people that are looking for those and we just turn them and the reason is, is that our capital can be deployed on non-performing and non-performing seconds and we can make a lot better return on those than we can holding firsts seller financed notes so we prefer to work the non-performing side however, we do aggressively look for seller financed that we can buy and then resell. 

We're going to go through that procedure that we use today and hopefully by the end of the session this morning, you will understand at least how we do it and at least have some kind of a basis for getting started in it and I know that a lot of you are looking for seller financed and first mortgages, very secure, just for let's say your IRA or a 10% return. Some of you will accept an eight. We have people that will accept an 8% return and they're just in it for the long term. We'll go through that today. I'll start out by just showing you, this is a file on a seller financed note that we purchased and we actually purchased a partial on this and it got paid off. The homeowners sold a house so this first got paid off in about eight months, but this is kind of what you can expect a file to look like. They can be pretty lengthy. 

We're going to go through what's in the file today, how to set the file up and what you need to do in order to get involved in this business of seller financed notes. Let's get started. Again, start out with our disclaimer. Presentations for information and educational purposes only. We're not making any offers to sell any memberships or interest or securities or whatever. This is just simply for educational purposes although we will tout our upcoming webinar or excuse me, seminar that we're going to hold in Los Angeles, the middle of March. We're finalizing details with the hotel right now and by next week, I think we'll have the thing nailed down. We'll be covering seller financed notes as well as our core business and that is the institution non-performing notes. I will say that on Tuesday of next week, our next meeting, we're going to go through some real enhancements. What's the math to really enhance these notes that you buy. 

What you can do just with your calculator to increase your return and we're going to go through some of these notes that we have purchased and show you just what we do with them after we own them to enhance our return, very nice way to go about making these notes more valuable so that'll be next Tuesday. Seller financed notes, so I think that in order to understand seller financed notes, we need to clear up some issues. Number one is that when a seller sells a house and carries back paper, it really is not a loan. It is an installment sale. The seller of the property is not giving anybody any money. They are simply trading their equity for payments. The brilliant government Congressman can't see that point and so they lumped in seller financed notes with the Dodd-Frank Law, there is a fairly substantial effort underway right now to get that changed, that seller financed notes would be listed as an installment sale and not a loan so that you didn't have to comply with these Dodd-Frank Laws, but right now you do. 

If you have a loan that was made or if you are a seller financed, if you are a seller that wants to seller finance after April 1st, 2014, after last April, you are able to do three notes a year and not have any problem with all of the laws that surround Dodd-Frank. I'm sorry, I've got a typo in my slide here, as of April 1st 2015, which is coming up very shortly, you will be allowed to do one per year and when that happens, if you do more than one, then you're going to be required to do the Dodd-Frank Law. You're going to have to comply with Dodd-Frank and you would have to have a broker write that note. Now I think right now and in the past, you should have had a broker write that note anyway, either a licensed mortgage broker or an attorney should be writing those notes because we have seen where some of them have become uncollectible because they were written by somebody that didn't have the authority to write them. 

You need to be aware of that when you're looking at a note to buy so when you're looking at a seller financed note to buy and you need to look very carefully at who wrote the note and make sure that it was written by a licensed authority, then you got to be aware of all the state specific laws too because when you buy one of these notes, you are buying the note as it stands and if there are flaws in it, you are buying those flaws and you may find yourself in a position that you cannot foreclose if necessary, if the borrower defaults or if the homeowner defaults. You also need to be aware of usury laws. Those usury laws are state specific and so when you are buying a note, let's say you're buying a note in Tennessee and you live in California, you need to be sure that you check the usury laws in Tennessee, that the note that you are buying does not violate usury laws. 

Usury laws by the way, if you don't know the term, usury is charging a higher interest rate than you're allowed by law to charge so in California, that'd be 10% if it's an owner occupied loan and then also know if there are exemptions to any of those laws. The thing that you need to first do when you are trying to decide if you want to buy and how much you're going to pay for a seller financed note is to determine that note's value and there's three things. We've discussed this before, but there are three things that determine value of a note, one being a qualification of a buyer. Two, the actual collateral or the property that supports the note and then the note itself. What's the downpayment? What's the loan to value? What's the term of the note? That is the interest rate. How long it's going to be? How was it paid? Is there a balloon, and by the way, if you're looking at Dodd-Frank now, watch out for balloons, very, very serious problem so if you've got a note that was written after January of last year, it's got a balloon.

You got a problem, and then how long has the loan be paying? That's called the seasoning and then also the loan paperwork itself and the payment schedule so those things are very important. Number one in seller financed notes will be the collateral. What is the value of the property that is securing the note and the loan to value of that collateral? What happens to you as the note owner if the borrower defaults? Do you have room in there to foreclose, to own the property, to work something out with the homeowner? The collateral of the house is going to be the most important. In order to determine the value of the house, there are certain places that we go to determine the value and to be somewhat sure that what we get is accurate. Clear Capital and Red Bell are two sources that you can go to, to get appraisals, actual desk appraisals of the property for what we consider to be a reasonable amount. 

You're going to be somewhere around $100 to $125 to get an appraisal from Clear Capital and Red Bell, but what you get, we'll show you an example in just a second, what you get is a real appraisal not just a Zillow estimate of value based upon square footage and that can be really not close to what the actual value may be so if we're not going to get a Clear Capital or a Red Bell and we are going to use the free sources, Zillow, Trulia, Realtor.com et cetera, we would normally get all three and then average them as opposed to just taking a Zillow or a Trulia. Better than that, if you're not going to get an appraisal from Clear Capital or Red Bel, you could call a local real estate agent and see if they would provide you comps from the MLS, a sold, try to get within a quarter mile and maybe 90 days. If you can't get at least three comps or four, then you might go out for the past six months and maybe a half mile or more if you have to. Just remember the closer you get, the better the comp and you want to do your darndest to get the best that you can. 

Then also get on Google Maps, take a look at the property. A lot of these properties that we buy are no where close to us in markets that we're not familiar with. We like to see the property and the nice thing about Clear Capital or Red Bell is that we can get pictures of them, that's part of the appraisal, but we use ActiveRain a lot too and if you're not familiar with ActiveRain, then go to activerain.com, get signed up and in that case, you can find a local real estate agent who will go by the property. We request that they give us a 30 day quick sale price that they would list the property for and take some pictures of it and send it in and we always get a really good response from ActiveRain. Here is an example of the Clear Capital. This file that I just showed you was an actual purchase of a mortgage or excuse me, it was a trust deed note in Las Vegas and we bought this note.

We actually bought a partial. We bought 60 months and we'll go through those next Tuesday. We'll go through partials. We'll go through how you put a partial together and why you would and what happens after the 60 months is over, and what happens if they buy, if the house like this one did sells during the 60 months, but here is what a Clear Capital appraisal looks like and what they do, they send a real estate agent out. That agent takes pictures of the house, makes the comments on the neighborhood and so and so forth, and sends it into an appraiser, a licensed appraiser and the appraiser makes a desk appraisal with the information that's supplied by the real estate agent. Now this is an eight page appraisal and as you can see down at the bottom, there are three columns, listing one, listing two, listing three. Those are sold comps in the market or current listings I'm sorry, in that market and it gives you an idea of what's going on in the marketplace. 

How long that these houses have been on the market? How big they are? How they compare with your property and so on, so you get a pretty good estimate of the value of this property. If I were buying a sizable note and I guess by sizable, I would say anything over $75,000, I would spend the money, once the homeowner or excuse me, the seller agreed to sell the note, once they agree to sell it and we had a purchase agreement for that, gives me some time to do my due diligence, then I would go ahead and pay for this appraisal. I would invest $100 to be sure that my loan to value was in line. If you're buying a seller financed note and it's the first, you're also going to need to check title. You need to get a preliminary title report from a title company in town. Those are easy to get. Most of the big title company, Chicago, First American, Fidelity and so on, have offices just about every major city and any place that you're going to be buying, and they can give you preliminary title report. 

You're going to need to get that. You're going to need to make sure you are a first and that there's nothing ahead of you and make sure that there's no judgements, tax liens or whatever. Then in addition to that, you're going to want to see if the title company that has written the title policy before, if you can get a title commitment on the policy that was already written. In most cases, you can and won't need to buy another title policy. It would automatically go to you if you bought the note. Then you want to find out if there's any taxes due, make sure the taxes are current. Netronline.com is a site that you can go to and get on every county recorders office or county assessors office in the country and determine whether or note the taxes are current because you may have to bring those taxes current if they're not so that's very important. You want to know about the title and you also want to know about the taxes, property taxes, very, very important. 

The next, when you made the decision that you want to purchase and you're going to negotiate the price, now all of the notes that we buy, that are seller financed are priced, we priced them according to a yield that we expect so we don't price them to discount. For example, if the note is 100,000, we don't say, "Well, we normally pay 92% of the unpaid principle balance. Everything that we do is based upon the yield that we expect and a lot of the yield that we expect is determined by how much the homeowner has put down and what the LTV is, the loan to value because we want some coverage and if we don't, the more coverage we have, the less yield expected. It's kind of inversely proportional so if there's a 20% downpayment so that the LTV, loan to value, is 80%, we'll accept a yield of let's say 10%. If the loan to value is 90%, we probably would expect a yield of 12%. Now these are higher numbers and I'm just throwing them out. 

You'd have to decide what kind of yield you expect, but the riskier the loan, the higher the yield that we would expect and we're going to go through and determine all these prices next week. We'll show you exactly what we do. This is our document checklist. We have made an agreement with the seller to purchase their note and we tell the seller, in order for us to close, these are the documents that we need. By the way, if you would like a copy of this, just email me. My email is right down there at the bottom, at mscpinc.com. Email me and I'll send our copy out so that you can just make copies and have it in your file, but in order for us to prepare the purchase or the purchase agreement, we need the following. We need a copy of the signed promissory note. Now we do not need the original at this point. We need a copy. We need a copy of the recorded, original recorded trust deed. We need a copy of the HUD, the closing statement when this note was written. We need a copy of the title insurance policy and a copy of the hazard and fire insurance policy because you are going to want to be named as an additional insured if you own the first.

You need a copy of the grant or warranty deed that was deeded when the property was sold, and here's one that gets sticky. The next two get a little sticky. You need a copy of the payment record. Very rarely will you find sophisticated records kept by seller financed sellers. They don't have any software programs. If you're lucky, they will have kept maybe an Excel spreadsheet. We're going to show you what this person did and what we insisted that they do because they did not have a copy of a payment record. The other thing that they're not going to have often is social security number of the mortgager. You need to have the social security number. The person who wrote the note may not have an obligation to send the 1098 to these homeowners at the end of the year so that they can take their mortgage interest deduction. You or your servicer is going to have that requirement. You cannot do a 1098 unless you have a social security number so you must get a social security number. If the seller doesn't have it, you need to find a source to get it. You need the complete address of the property and that includes the legal description.

If you can get the seller to give you pictures of the property, that would be great. If not the appraisal, Clear Capital and Red Bell will provide pictures with their appraisal and if you can get an active rain agent to go out, he'll take pictures or he or she will take pictures too. If it's a mobile home, you need the title and you need a copy of any superior mortgages if you're buying something that's not a first, so we just send this out to them. We either email it or fax them and they send it back, send all this back to us either via fax or email. 

Here is our receivable purchase and sale agreement, and this just identifies at the top there, you can see that's our address and under that is what we are paying. In this case, we are paying $73,240 for 118 monthly payments of $1,062.10, and it's got all the information about the note itself on it for our benefit. Once we have made the deal, then we need the collateral file. We need all of the documents that the seller has for this note or else, we do not buy it. We would require the original signature promissory note. We have a copy. We got the copy when we were making out but before we would do our purchase and sale agreement to make sure that it was available on that checklist. Once we have consummated a deal, we require the original signature promissory note. If there is none, we do not close on the transaction.

Simple, if they try to give us an affidavit of loss promissory note or some other indication that they don't have the note but that's all right, no. With us, and I would suggest with you that you just do not buy it. You're asking for problems so you want the promissory note. You want it fully executed and you want the original signature. 

Then you're going to get an allonge to the note. This is now, two things will happen. When you get the promissory note, the promissory note could be signed just like a check endorsed on the back of the note. We get that endorsement that says pay to the order of Main Street Capital Partners, signed by the seller. In addition to that, we get an allonge to the note and that goes into the file. In addition, we get a trust deed or in a mortgage state, we get the mortgage. Again, we want the original signature trust deed.

Now, that would be only the recorded trust deed when you, when the seller took back this installment sale, that was recorded and you want the recorded document that comes from the county. You can see up in the right hand corner here, that's the recording of the document and also, that's the copy that you want. Now if this is a partial, you're going to keep this file and you're going to return it to the seller once the partial has elapsed. In addition to the trust deed, you are going to get an assignment of the trust deed, so this is the collateral for the note was the trust deed and that assignment that you're getting now takes title from or takes the note and trust deed and its collateral from the seller and gives it to you. 

Now in our case, we have this sent to a third party who holds these notes for us, stores them for us and then at the end of the partial period, we'll return those notes to the seller if we don't buy another partial from them, but the assignment of the trust deed again is a recorded document. Now you'll notice the allonge was not recorded because promissory notes are not recorded but the trust deed or the mortgage is recorded, and therefore the assignment of the trust deed or mortgage is recorded and you must have a copy of it. Now if this note has been sold before you bought it and you're buying it from someone else, you must have the chain of assignments in there so every assignment that was made, you must have in the file. Again, if they are not there, we simply do not buy it. Again, you're asking for trouble.

I mentioned that in this case, this lady did not have a record that she kept of the payment that these people made. What we required was for her to send us her checking account statements or a bank statement showing the deposits that were made of that amount of note payment, so you can see that the two arrows that I've marked there show $1,062 in payments for those two months and we required for the entire time that this note was in force to show those payments. If you don't have some kind of proof of how they have paid, you could be buying a note that is in arrears by quite some amount and you think that it's current, so be sure you require either some proof that payments have been made and that they have been made on time.

How do you find these notes? Well, direct mail is one way. You can purchase a list. The people we purchase from is Vanzant. You can go to vanzant.com. There are other people that sell them. If you're interested in buying them, only around where you live, you can go to the county recorder's office and just research notes or research properties and find out who holds the note on it and the ones that appear to be private owners, not institutions, you can create a list. You can hire somebody to go do that. You research your own list. You can ask realtors. For some time, we would write notes at the closing table for seller financed and we would buy them right then. We'll say that usually when there's a seller financed note, there's something wrong with either the property or the borrower. Either it's a property that has some significant situation with it, it might have a weird floor plan or it might be in a weird location. It might be rural or there's something with the buyer. Today, it could be as simple as the buyer being self employed. He could be a doctor, a dentist, a lawyer who has a great income but the way lenders are today after the fiasco that took place, they may not be able to get a loan because they're self employed, so one way to do it is just seller finance.

Now we would actually prepare a note and probably would have had had Tyler prepare the note. At the closing table, the seller would take back the note for the sale of the property, and then we would buy that note at a discount immediately, thereby making the seller have cash available for the sale. We do this quite often and then we would resell that note to a list of investors that we have, and that's another way that you can get, if you were to make acquaintances with realtors and tell them what you're willing to do and to buy those for discounts and I'd say that typically, a seller financed note could be written for let's say 7.5% and then you discounted that to 10% or 11%. You bought it at the closing table. The seller would walk away with cash, so that's another way to do it with realtors to let realtors know that you are a note buyer. They may have clients that have notes that want to sell.

Then of course there is the networking that you can do with [inaudible 00:37:46] groups, meetups, all that kind of thing where you actually go out and let people know that you're interested in buying seller financed notes and give them an idea of how much you'd be willing to pay and what you're looking for and that is a good way to get notes in your own neighborhood. If you're going to buy on a region or a national basis, I think that you should probably look seriously into direct mail and don't expect direct mail to work immediately. It's going to take some time. You may get a call right away and out of five calls, you might make one deal. Just keep that in mind. You're going to have to explain seller financing to the noteholder. They don't understand typically discounts and why you would pay, why you wouldn't pay the face value of the note. They don't understand risk and they don't understand the time value of money and you're going to have to explain that to them, so be ready to do that. Then make sure that you get an offer to them quickly.

Now if you are buying non-performing seller financed notes and these can be the very best because the seller of these notes doesn't usually want to have anything to do with trying to collect their note, so they often will sell at a substantial discount just to avoid all of the pain that they have to go through to collect or to deal with an attorney to start foreclosure or to deal with a homeowner and hear all the sob stories. We love to buy the non-performing seller financed notes and we can get some really nice returns, but when you do, you must consider the cost of the exit. What are you going to do with that note? If you're going to have to foreclose and this is the way we always figure it out, if we are going to pay X for a note, how much are we going to be able to sell that property if we have to foreclose? 

Normally, will get an active rain agent to give us a 30-day quick sale price, tell them that if it goes to foreclosure and we ended up owning it, we want to sell it at 80% of market value. What is market value? What's 80% of that and take then the cost of foreclosure and the holding costs, deduct them from that price and that gives you what you're going to net and then you need to decide what kind of profit dollars do you want from that in order to determine what kind of price you're going to pay, because they're not paying so you can't use yield because there's nothing, no payment coming in for you to figure that on.

We'll go over that next week too when we go over the prices of how do you determine or how do we determine the price that we would pay for a non-performing seller financed notes and even a first that's from an institution. 

That's it for today. We've covered the primer on seller financed notes and then next week, we'll do performing and non-performing valuations. How do we determine the price? Once we have purchased it, what do we do with it? How can we enhance the value of a note we bought? How can you get a homeowner to pay you more by giving them some super consideration so that you have a more valuable note to sell? We're going to cover all of that, so have your calculators out and we'll be on the whiteboard. We'll be showing you how we go about it and hope that our experience will add a lot of value to how you go about valuing and buying these notes and it won't just apply to seller financed. There's things that you can do once you get a performing note of one that you have purchased from an institution. 

That we'll cover, again I want to let you know that we are going to be having our seminar in Los Angeles the middle of March. I think it starts on the 19th. We'll be announcing the name of the hotel I think next week. It will be near the airport. We're negotiating with two different ones right now. It will be a four-day full seminar where we're going to cover everything from soup to nuts, from sourcing to valuing to raising capital to doing a private placement memorandum. Tyler's going to spend a whole day on Regulation D, on limited partnerships, on joint ventures, how to keep yourself legal, how to go about raising money so that you can buy notes and we'll discuss all of the legislation, Dodd-Frank, state laws and introduce to you the servicing and workout part of the business that we can do for you. We're excited about meeting you face to face and I think that you'll need that four days with outstanding background so that you can go home and get involved in this great, great business.

Thanks for attending today and we look forward to seeing you next Tuesday at 10 o'clock again Pacific time and we'll go over the mathematics of turning these things into more valuable notes. Thank you. Have a great week. See you next week. Bye.

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