Be the Banker!

Being the banker offers significant advantages to being the property owner.  In previous newsletters we talked about private investing, which is just like being the bank but did you also know you can buy mortgages from banks?

Banks routinely sell Mortgage Notes (Notes).  These notes are promises to pay, backed up by a piece of real property such as a house, an apartment complex, a piece of land, etc. Banks routinely sell notes to raise more capital to loan or to clear their books.  These sales are often made to large institutional investors but banks will also sell them to individual investors.

As individual investors we are interested in either non-performing or distressed debt because the can be negotiated for the biggest discounts.  Non-performing notes are generally behind in payments whereas distressed notes may still be performing but the underlying value, collateral, may not be enough to secure the note anymore.  In either case, moving these notes off of the bank's books can be good for the bank.

Enter the investor with the right knowledge to evaluate the true value of the underlying property and purchase the note for a fraction of what is owed.  

When you buy the note you are not buying the property itself but the promise to pay.  The note is valuable in and of its self and offers a number of ways to make a profit.  Let's suppose we bought a note as follows:

• Total amount owed on the note: $10M (M= million)
• Value of the property:   $6.5M
• Price paid for the note: $4.5M

Now we are the banker and hold a promise to pay $10M secured by a piece of property.  We don't own the property but we own the note so how might we make money (exit) from this deal?

1. Sell the note to the original borrower: Once we own the note we can approach the borrower and see if they might be interested in buying the note for say $5,5M.  If they could do this, they keep the property, have a lower payment, we can make a quick $1M.
2. Sell the note to another investor: Another investor might be willing to pay $5M or more for this note resulting in a quick $500k profit for us.
3. Hold the note and collect the payments: If the note is performing, we can hold the note at the current terms or offer new terms to the borrower (such as lower interest rates or a longer time to pay to achieve lower payments) and collect the entire spread $10M -$4.5M = $5.5M plus interest over time.
4. Foreclose on the property: If the note is non-performing then this worst case option is available.  It is not difficult to foreclose on a property it just takes time.  Sometimes a borrower will deed the property over to the note holder to avoid foreclosure which can certainly speed up the process.  Once we have the deed we can sell the property or manage the property to increase its value.

If should be evident that being the banker offers less risk and more flexible exit strategies than being the property owner, especially if the note was bought for the right price.  In this case the right price means the revenue coming in from the property will cover the expenses and provide positive cash flow to the investors.

In addition, buying notes is conducted much quicker than buying properties.  Once a price has been agreed to the seller may expect to close within just 10 days versus the 60 - 90 day window you have to close on a major commercial property such as an apartment complex.   

It should be noted that this discussion is just an overview.  To properly execute this strategy you must be able to accurately estimate the true value of a property.     

The Demand Institute recently reported that the worst of the housing crash is over and a recovery is now underway in an article titled "The Shifting Nature of U.S. Housing Demand" . Key points from the article are:

• This recovery will be different than past recoveries because many people will be buying homes not to live in but to rent.

• Driven by young people and immigrants, demand for rental properties will continue to increase. This includes both multifamily properties and single family homes.

• This recovery will NOT be uniform across the country. (Remember we've mentioned before that all real estate markets are local.)

• The average size of the American home will shrink.

We remind our readers that all real estate markets are local and are generally driven by the availability of jobs.  For example, your tax dollars are hard at work and therefore the Washington, DC metro area market is in a solid recovery phase.  This is evidenced by the fact that in the neighborhood where our son Don lives, the average days on market is below 30 days.  Prices aren't rocketing up but there have been bidding competitions for some homes in the area which will eventually drive prices higher.

Laughs and Interesting Stuff 

Some Profound Ponderings:

1. Life is a sexually transmitted condition, and it's always fatal.
2. Never be afraid to try something new. Remember: Amateurs built the ark. Professionals built the Titanic.
3. Even if you are on the right track, you'll get run over if you just sit there.
4. An optimist thinks that this is the best possible world.   A pessimist fears that this is true.
5. There is always death and taxes however death doesn't get worse every year.
6. It's easier to fight for one's principles than to live up to them.
7. Make failure your teacher, not your undertaker.
8. It hurts to be on the cutting edge.
9. In just two days, tomorrow will be yesterday.
10. A day without sunshine is like night.
11. If marriage were outlawed, only outlaws would have in-laws.
12. You don't stop laughing because you grow old, you grow old because you stop laughing.

Different Ways of Looking at Things:   

"Me neither doc," said the husband. "But she's a great cook and really good with the kids."