Congrats, we’ve got a deal on our desk! This lesson will overview all the steps between receiving a data-tape and funding the deal. After completing this lesson, you’ll know how to decide whether an individual asset or pool of loans is a good fit for your portfolio.
Preemptive, Conservative Pricing Guidance
Under-promise on pricing! Don’t be afraid that you’ll lose a deal by low-balling when you communicate your initial pricing expectations to the seller. A much worse strategy is to over-promise and fail to close at the expected price – this will backfire and potentially leave you on the blacklist. By giving the seller the hard truth about the issues with their assets (and the necessary discounts to expect) early in the process, you will set yourself up for a smoother transaction at a more favorable valuation. If the deal dies before you even get into your due diligence, that’s OK! You saved the time & effort up front.
However, if you are starting to find every door is shut as soon as you tell a seller you pay “pennies on the dollar” then it would be a good idea to get some market intel & adjust your pricing guidance accordingly. For example, after every FIXnotes bi-monthly loan sale, Mortgage Note Mastermind members receive a breakdown of the loan-level sale prices of the assets in the portfolio so that they can hone in on market values.
Indicative Research & Rapid Response Feedback
What you do on the day you first receive the loan-data from a potential seller is critical – your goal is to provide immediate feedback based on the research you can conduct quickly using free resources and the seller-provided data. Here’s a quick process you can run to get a number on every asset in a portfolio ASAP:
- Confirm loans are secured (borrower = current property owner per county records)
- Gather or double check property values (recently sold comps via Zillow or discounted Zestimates)
- Review occupancy & property taxes (use county tax records for past due balance & owner mailing address)
- Calculate equity, request senior lien balances/statuses if necessary* (property value – taxes & senior liens)
- Apply loan-level pricing based on tax/sr status, occupancy status & equity position
- Price cash-flowing loans based on your desired yield** making sure pricing is less than UPB/available equity
*senior lien status & balance is crucial for 2nd lien acquisitions, if unavailable you will need recent credit reports to review 1st mortgage trade line
**a potential purchase price based on cash-on-cash yield can be quickly calculated with annualized payment minus servicing fees divided by your target yield ($12k per year / 15% = $80k note purchase price)
Designing your Decision Matrix
After completing your indicative review, you should have a good idea what kind of assets you’re dealing with, now you just need to figure out whether you’re going to be a buyer yourself or if a flip is the best move. There are several layers to your decision process, starting with what’s possible & ending with what’s most desirable:
- Level 1: do you have the capital?
If you are unable to fund the trade, we can stop here and move to flip. Make sure that you consider your working capital as well, you’ll probably want to set aside at least $10k per non-performing loan in available funds for servicing fees & legal costs (or more if you need to advance property taxes). It’s quite possible that you will be able to achieve a payoff or start a modification without spending more than a few months of servicing fees (typically ~$25 per month per asset) but it’s better to be on the safe side.
- Level 2: do you have the time?
In judicial states like NY or NJ, foreclosures can take a lot longer (several years) than non-judicial states like TX & AZ (several months). Again, you might reach the borrower and come to an agreement without a foreclosure but in order to plan for the worst – can you wait several years for a return on your investment? The time you can invest in actually manage your assets is another factor – cash-flowing loans are much less labor intensive than non-performing of course, but if you’re not a full-time note investor, can you put in the necessary time to track down your borrower, negotiate a deal & get a payoff or payment plan started? For a single asset, the time required is much more spent waiting for next steps than actually working but with a large enough portfolio (~100 NPL assets for a full time portfolio manager) your resources are important to consider.
- Level 3: do you have the skill?
A skill-deficiency is surmountable but if you’re already near your limits in regards to capital & time, it’s probably not a good idea to also jump in the deep end when you haven’t finished learning how to swim. A great example of this is buying NPLs in active litigation. If you’re buying loans from a bank that hasn’t attempted collections in a year or more, many borrower will respond to your Hello letter with interest in getting a deal done quickly. If collection work is ongoing but the legal process hasn’t been started, many borrower will respond to your attorney’s demand letter to reinstate their loan. On the other hand, if there is an ongoing legal process underway and you’re stepping into the shoes of the previous lender – do you know how to stay on track, what questions to ask their counsel and what issues may have arisen that caused the lender to consider a loan sale instead of completing their foreclosure?
- Level 3: do you have the interest?
You’ve probably already made up your mind whether you are buying performing or non-performing loans and perhaps what States you are most interested in targeting, but have you thought about what you will do with REO property, how to handle litigious or hostile borrowers and whether you have the necessary network or internal team in place to handle these contingencies? Due diligence is an especially important stage in the purchase process (you make your money when you buy in real estate) and when you complete your in-depth due diligence you’ll get a much better idea about the most likely outcomes (1st liens secured by vacant property = high likelihood of REO, serial bankruptcy filers = litigious borrower, difficult borrower might require door knocker, etc). Move forward with cautious optimism and make sure to consider worst case scenarios and how you will handle them.
Apply the above filters & frameworks as you complete your research and make 100% sure that you’re ready, willing & able to proceed as the note buyer. If not, you’ve still got a potential deal on the hook for a much easier flip – move onto the next lesson.
Your Letter of Intent (LOI)
Based on your indicative research and a successful screening through your decision matrix, the next step is to submit your LOI to the seller. This can be as informal as an email or as detailed as a PDF cover letter, proof of funds and pricing schedule table. Either way, the key here is to specify the loan-level prices, any contingencies or considerations, the proposed funding date and likely the requirement of an exclusive timeline to complete your research. The loan seller will review the terms & values and if agreeable they will sign-off on the exclusivity so you can spend the time & money to complete your comprehensive research.
- Seller has signed off on exclusivity: order title, BPO, credit, etc – get your vendors going ASAP
- Tighten up your property values, dig into county public records, check PACER for bankruptcy
- Review vendor reports as they come in, append your research spreadsheet with new information
- Make notes on any major misrepresentations (the only way you can “fade” pricing is if you have the evidence that the seller’s initial data was faulty)
- Communicate any issues early & often, don’t surprise the seller at the eleventh hour with bad news – make sure they are in the loop from the get go.
- Present final offer with back-up data if necessary and move forward with Loan Purchase Sale Agreement (LPSA), funding & servicing transfer