Ron Happe:Okay, good morning everybody. Thanks for joining us today. Welcome back. It's been awhile since we've had the live cast because we had a boot camp in Los Angeles and we needed to prepare for that. I am so excited. It was an absolute blast. We had a great time and believe me, it was very successful. We had … There were 42 people in attendance and it was great to be able to spend some time with other note investors to learn what they're doing and to help them possibly in their business. I think everybody had a great time. But we are excited to be back.
So, I'm glad that you joined us today. I'm going to go over some things that we found out at the boot camp. we're going to go over some things of questions that people had that I think that will be very timely for the people that are watching today, in addition to that very pertinent to other people that may have the same question.
So first that I'll bring up to speed on the boot camp a little bit. As I said, there were 42 people in attendance. We had a very intense four days. Now, we found that four days might be one day too long. By that fourth day people were wore out. We are having a boot camp in Florida. We're cutting it to three days. It still will be an intense three days. We'll go past the quitting time that we had in this boot camp because we still want to cover all of the information that we could. Believe me, this was information filled. It was strictly educational.
There was absolutely no selling. We don't have anything to sell. It's a teaching and instructional environment that includes me. I spent a day. [Saprina 00:02:34] spent a day with Ingrid. Tyler spent a day on the legal and legislative aspect of the business and licensing and so on. Very well received. Then Chrissy spent a day on the tools that we use inside our business that you’re probably going to have to get too.
So, today to get started, what I'd like to do is kind of share the feedback from the attendees. If you're really interested in seeing what some of them had to say you can go to the website, notemogul.com. N-O-T-E-M-O-G-U-L dot com, which is our boot camp training website. There are some testimonials of people who were in actual attendance at the boot camp and telling you what they thought of the experience. We really had a good time. So I met a lot of new friends and learned a lot about their business.
The attendees really liked the fact that we had lunch together every day. So the networking, and I know that there are some people that met at the boot camp that are actually going to be doing deals together. A big portion of that was because Tyler spent so much time talking about raising capital and how to do it right way. I think it planted some ideas in some people's minds about how they can get involved with each other. So, just in that respect, the networking opportunity was really good.
So, the first thing is that the comments and questions that they had I think that everybody that's watching today will have a very good, clear understanding that these are important questions that everybody has. So, the first one came in from Judy more and Judy from Portland Oregon her question was I'd like more information on evaluating a note for purchase. How do you determine the quality of a note? I'm also interested in more information on the particulars of raising capital. Well, thanks Judy. It was a pleasure to see you at the boot camp and to have such a knowledgeable person there. Judy is an attorney, a note investor, very knowledgeable and always wanting to learn more.
So, in our business, we have a matrix that we use to evaluate the notes. We have a pricing desk. Larry Canfield operates that pricing desk and tape is pretty much entered into a spreadsheet. The tape is imported into our spreadsheet and our spreadsheet does several things. Now, keep in mind that we're primarily second note investors, although we do do first. I'm going to show you a couple of things here this morning, one on seconds and one on first. But primarily we’re second invest note investors and you can use the same due diligence for pricing and determining the quality a note on a first or second.
But the first thing that we look at is if it's a second we're looking at the buyer. Has the buyer made payments on time? How long have they been in the house? What is their …We like to name it emotional equity? You’ve probably all heard about that. People do not want to leave their home. They'll make payments even though the house is under water. What we take a look at is the neighborhood. if the neighborhood is a decent neighborhood where people will want to stay then we rate that higher than a neighborhood that's let's say the hood where people can easily just walk away from it if they have no interest in staying whatsoever, so we use that.
In addition to that, we use the note itself. How long did they pay on it before they went delinquent? How much are the arrears? One thing that I need to make clear is that when you look at a note on paper if you're comparing two notes it's very difficult to decide or even know which one's going to be a performer and which one is not. Even ones that have equity in front of them often people just walk away from it. When you would expect that they had been paying on their first they might keep paying. It's just totally unpredictable. So, we find that a note with no equity in a pool a note with no equity is just as likely to perform as one with equity.
So, what we do is we determine how much do we think that we can collect on a note and that is based upon our history. So, we have an experience with notes and we can take a look at it, determine which state it's in. is it New York, which is a judicial state or is it California or Arizona which is a non-judicial state? We rate that accordingly because of the exposure to expense in foreclosure and the time delay that's required to foreclose in judicial states. So, we take a look at that and through our experience we take a look at the note we decide at what point do we think … How much do we think we can actually collect on that note.
Then, we decide, all right, if we can collect X number of dollars on that note, how much are we willing to pay based upon a rate of return that we want? So let's say that we're going to evaluate this note over a two-year period that we're going to get, we're going to buy it and then it's going to take us two years to have some kind of an outcome be it a foreclosure or a workout with a homeowner. The homeowner agrees to a workout and so we know just over the course of that two-year period how much do we want to collect and what kind of profit percentage do we want.
So let's say that we decide that we can collect $30,000 on a $100,000 note and we're looking for a 300%. Why 300? Well, we want 100% return to get our capital back and then we want 200% return over that two-year period. So, we're going to pay $10,000 for that note that we think we can collect $30,000 on. So that $30,000 note probably has a unpaid principal balance of let's say $75,000 to $100,000. So we're paying $10,000 for a $75,000 note and we're intending to collect $30,000.
Now, one of the things that you have to consider is that some of these notes are not going to pay off in two years and so therefore that 300% percent return is not going to be true across the board, but it's how we determine how much we're going to pay for it. The next question was from Ken Martinez and Ken is an experienced real estate investor. His question was is there a way to forecast for every $100 you spend today on defaulted seconds? How much money do you have first year, second year, third year from now and the same thing for defaulted firsts.
That's really a really tough question to answer because a note buyer’s experience plays a great deal, has a large influence on how successful that note buyer is going to be in getting a note to perform. But, I would like to just go through some numbers with you and I think that by the time we're finished with the exercise you're going to see why we are more interested in purchasing seconds than first although we do both. But up to 70% of our portfolio is in seconds. I'd like to just … I wanted to do a PowerPoint presentation for you with this.
I'd be happy to email you this PowerPoint but for some reason we had technical difficulties this morning, PowerPoint didn't show up. So you are going to have to follow me. I thought I could use the whiteboard but the glare is so bad that you can't see it. So what I'm going to do is I'm going to read this. Let me try something here. Mark is that … Can … Nope, that shows it backwards. Yeah. Okay. I'm going to give you these numbers in hopes that you will write them down as we go. All right?
So, let's say that you as an investor have $100,000 to invest. We would recommend that you retain 10% of that $100,000 for the expenses of administering the notes over the period of, let's say, six months to a year before you start receiving any income from that pool. So you don't have to come up with any additional capital, retain 10% of your investment fund for expenses. So, that leaves us with $90,000 to invest. If we invest $90,000 into some non-performing seconds and that would allow us to purchase eight notes at $11,250 each. So, we're going to purchase eight notes with that $90,000. Those eighth notes each have an unpaid principal balance, or excuse me, they were originally notes for $85,000 at 8% for 25 years or 300 months.
So, an $85,000 loan for 25 years at 8% gave a payment to the homeowner of $656 per month. We did a lot of this work at the boot camp using the calculator to determine these kinds of yields and so on. But I'm sorry you just have to follow along with me and write it down as we go. So we have … So let's say that this homeowner paid for 36 months and then stopped paying and they did not pay again for 24 months when we bought the note. So that we bought the note 24 months after it had gone delinquent which gave us a $656 a month times 24, 24 months that they haven't paid so they have arrears of 15,744 and there would be also some penalty on top of that. But let's just say in payments they're in a rear $15,744. So we contact the homeowner and we determined that the homeowner wants to stay in their house.
At the boot camp we discussed that if a homeowner wants to stay in the house there is every opportunity for you to make that happen because you're buying these notes at such a discount. So, the homeowner through examining their financials and talking to them they agree that they can pay $375 per month in a new payment. We're going to say look if you will pay us $5,000 in arrears and pay us $375 a month we will reduce your interest rate from the 8% original down to 4%. The homeowner agrees to do that and sends us a payment of $5,000 for the arrears. Now remember we paid $11,250 for the note. So after one year we've cut … Let's say after … If they make 12 monthly payments of $375 after one year they're going to have paid us $4,500. All right?
So, they're going to pay us for that period of time one month or one year for $375 4% when they started paying the balance on the note because they had paid down for three years the note now an $85,000 note had a balance of $81,377. So what we need to do is determine at 4%, how long would it take the homeowner to pay off $81,377 at 4% percent with a payment of $375. What it is is it turns out they would have to pay us 386 months at that level. So, they go for a whole year they pay us that 375 times 12 is $4,500. Now remember that we purchased this note for 11,250 we collected $4,500, excuse me, we collected $5,000, so we have a balance of $6,250 that we actually have paid for the note. That’s how much we now have invested. So $6,250 and we've collected 4,500, 72%.
Now let's say that, oh excuse me, we have $4,500 in income, we paid $90,000 for our total portfolio. So we have $90,000 that we out laid. We take in $5,000 in arrears, so now we have $85,000 dollars out invested and we collect $4,500. All right, we collect $4,500 in payment on $85,000 expense. That is a return of 5.29%. If only one note out of eight performs at this level, and this is certainly not a home run, if only one note performs at $4,500 on that $85,000 investment our return each and every year is 5.29%. The point being that even the fact that we would only collect on one note out of this portfolio returns us more than you're going to get in a CD.
So, it's very hard to say where we’re going to be after one year, after two years, after three years. But in this case, if we collect on one note we have 376 months of $375 payments and what is the likelihood of the loan going 376 payments almost nil. I think everybody realizes that the average note pays off … The average mortgage last about seven years. So in seven years you're going to get your entire $81,377 whatever the balance is on your new amortization schedule you're going to get total paid off probably in seven to 10 years or sooner.
So, there's what you need to be looking at. Not where will you be one year, two years, three years but what is kind of a worst case scenario. Well worst case scenario on this thing is you invest 85,000 you get back $4,500 a year until the note pays off you get 5.29% and that's with only one note out of the portfolio performing. That's why we like seconds. You’ll develop a history where you'll find that you collect six out of eight, five out of eight, one of them would be a discounted payoff you get a big lump sum and so on. So, look at it in that vein, not the vein of where will I be in a year or two years, three years.
The next one is let's do one where Ken ask about on a first. So, we typically pay 40 to 45% for, let's say, up to 50% for a delinquent first. So, we pay 50% of the fair market value, not based upon unpaid principal balance but based upon the fair market value of the house. All right? So let's assume this house in Florida, let's say, has a value of $215,000 that we've determined by a legitimate BPO. We had a broker price opinion, a local real estate agent went out, took a look at the house, sent us some pictures and they say this house is worth 215 on a quick sale. All right?
So, when we're looking at a first it's a lot easier to make a prediction because everything that we do is based upon a foreclosure. That what kind of a return are we going to get if we have to foreclose, that's how we would value the first. So, let's say that this house had a fair market value of $215,000 and we're going to pay we say between 40 and 50, let's use 42.5%. We're going to pay 42.5% of the fair market value. That's our $90,000 investment. So we have $90,000 that we pay for a house that's worth 215. Okay?
So, what do we determine now? This house is in Florida which we know is a judicial state and the judicial state is going to require a two-year period to foreclose. The costs are going to be somewhere in the neighborhood of $5,000. So, first thing we have to do is consider our expenses. Well $5,000 for a foreclosure. We go to foreclosure sale now we own the house and we are going to have to sell it. So our instructions to our remote agent, we're in California that agent is in Florida, is we want to get this thing sold today if possible but definitely we want this thing sold in 90, excuse me, 30 days.
So, in order to sell this house in 30 days we may have to take a discount we're prepared to do that so we're going to figure in our pricing a discount. We're going to say that we're going to sell this house at 80% of market value. So if it's worth 215 we're going to sell it at 80% of market value we're going to get $172,000 for this house.
Now, we now own the house and we've sold the house and we have some sales costs involved. So first of all we have the $5,000 foreclosure costs, we have a sales commission, which we've negotiated down to 5%. So that's $8,600 on this $172,000 sale. We have sales costs which include title insurance and all of that. That is estimated at 3,500. We have holding costs. Remember we've held this house for a year. So, there are maintenance costs in that. We have to mow the lawn, we have to take care of it, it can't deteriorate. I don't know what it's like in your city but in Sacramento here if you don't maintain a house the fines can be up to $1,000 a day. So we have to figure holding costs and that's we figure at estimated at $2,200 over the course of that period of time.
So when we deduct those costs we have a net off the sale 152,700. So we sold it for 172, we subtract our costs we net 152,700, which is a profit of $62,700. Remember, we have 152,700 minus the 90,000 that we invested leaves us a profit of 62,700 or an ROI of 70%. This was over 24 months so we have an annualized return of 35%. So Ken I hope that helps you in determining if you purchase first where are you going to be lot more predictable than if you purchase a second. If you purchase a second even if things go terribly wrong the return is still better than what you're going to get on a CD and the note doesn't go away. Even though you didn't collect it in two years, it could still be out there and you collect in three years or the fourth year or the house sells or they refinance or whatever happens. But, the worst case scenario that we painted here was that you collected only one note and still had a 5-1/2% annualized return.
So, please go to the website, notemogul.com, and listen, watch some of the testimonials of the people that were in Los Angeles. We look forward to seeing you next Tuesday, this is something we're going to now be doing regularly except on the week that we travel to the boot camps. Thanks for coming back to the live cast and we look forward to seeing you next week. If you have any questions whatsoever please email them and we'll design this live cast around what you want to see and what you want to learn. Thanks again and have a great day.