Notes are discounted more heavily now than in the past. But this begs the question why are notes discounted in the first place? The most prevalent answer you will receive from novices and "gurus" will be because of the time value of money. Well, sort of, but this is not anywhere near the correct answer. While the time value of money scenario plays a part in discounting notes, in today's market it is incorrect to use the time value of money as the only consideration for discounting notes. However, many gurus and note buyers will keep repeating "the time value of money" when trying to explain a discount. In defense of these people, most are perpetrating these sleight of hand explanations out of ignorance. As a result, the note seller will often be confused at best, or think he/she is being taken at worst.

The most common error note buyers or gurus use to try to convince you to take a huge discount is the example, "Which would you rather have, a $100 today or a $100 a year from now." WOW! How can you argue with this? The sleight of hand is they are not taking into consideration interest and are therefore not asking the right question. A simple example: if your note is carrying 10% simple interest, the correct question would be "Which would you rather have, $100 today, or $110 a year from now."

Adding interest to the equation puts a different perspective on the transaction, does it not? If you want to have fun with a note buyer, ask him/her why your note is being discounted? If the answer is "the time value of money", reply, with "Great. Since my note is 10% or above, there should be no discount, and you should pay me full price for my note". Wait for the answer. It can get amusing.

Mistaking the time value of money as the only criteria in valuing notes is not an uncommon scenario. This error is commited by both Note Buyers and note sellers alike. For example, I am often told by note sellers that since they have a 30 year, $100,000 note paying 10%, I will receive over $300,000 in the life time of the note, and therefore I should pay full value for the note. This note seller is as much under an illusion about the concept of the time value of money as are the Note Buyers and gurus. Often this type of note seller will comment about Note Buyers being bandits or some other derogatory remark when the note seller is not offered anywhere near the price he/she thinks the note is worth.

The confusion lies in the time value of money is only one element of discounting notes. There are many other factors which determine the discount of a note. In January 2009 issue of THE NOTE PROFESSOR NEWSLETTER, I explained other risks in purchasing notes and carrying notes These risks include interest rate risk, deterioration or devaluation of collateral risk, credit risk, liquidity risk, and risk adjusted discount rate. Rather than go over these risks again I invite you to revisit the January 2009 issue for more detailed discussion.

When examining the risks a note buyer undertakes in purchasing notes, especially in today's market, where real estate prices are declining, it is easy to see the time value of money is only one factor in determining the value of a note. In my advanced notes course, I teach the solutions to the risks of investing or creating notes, but this will be discussed in another issue.

The purpose of this issue to point out another factor in discounting notes which is paramount to why notes are discounted so heavily now, as compared to three years ago. That element is the supply of Note Buyers. The supply of institutional Note Buyers has declined enormously in the past several years. This is the same as saying the demand for owner financed notes has declined. What happens to the price of any commodity when demand declines? The price goes down, or the buyers become "more picky". Both can be applied to selling your note to a Note Buyer in today's market.

At least three times a month I receive calls from note sellers, reminding me that they once sold notes in volume to The Associates, Metropolitan, NoteOne, or Bayview for 90% of the face value of their notes, and are expecting the same price now. The fact of the matter is NoteOne is no longer around, and The Associates, Metropolitan and Bayview are no longer purchasing owner financed notes. What is left are the "old line" conservative institutions who do not buy notes at closing, demand 10% down, and demand decent credit scores. Moreover, many of these funders have gotten "real picky", and require 20% "hard equity", 680 credit, and six months of seasoning. Other Note Buyers are not that stringent, but offer to purchase only partials if there is less than 10% down, but still demand a 600 credit score.

When note sellers are informed of the new criteria, the most common reply I receive is "If the buyer has a 600+ credit score, and has put 10% or more down, they can get FHA or conventional financing". The answer to this is "probably". But this is falling on deaf ears of the institutional Note Buyers who are facing rapid decline in property values, along with job lay offs, and an uncertain economy in general. Remember, with FHA or other conventional financing the loans are insured to a large extent. While this insurance eliminates credit risks, and collateral devaluation on FHA or other financing, seller financed notes have no such insurance. As a result, banks and pension funds which are purchasing seller financed notes have only the equity in the property as their protection. The fact that these institutions are currently purchasing notes in volume, indicates there are notes out there meeting their stringent criteria. Because institutional Note Buyers are purchasing Notes 'hand over fist', they can be more "picky" in their selection.

To put it another way, if you have a mediocre note, meaning marginal credit, marginal down payment, and marginal property value, you are NOT going to get 90% of the face value for your note, as you did prior to the real estate meltdown. At worst be prepared to accept a low offer. At best be prepared to accept a "partial offer", where the Note Buyer will purchase so many years of payments, at the end of this time the note reverts to you. While you might not like a partial offer, the other option is to keep the note. This is a reality in today's market.

In summary, I want to point out the time value of money is not the only factor a Note Buyer uses in determining the value of a note. Secondly, the supply of institutional Note Buyers has decreased, which also decreases demand for seller financed notes. These Institutional Note Buyers have tightened their criteria for purchasing notes because of the other risks discussed in the January 2009 issue. You have heard the Golden Rule: He Who Owns the Gold Makes the Rules. Here is TOM'S GOLDEN RULE: When You Got the Dough, You Run the Show.

Note Brokers do not like the decrease in Note Buyers and more stringent parameters any more than do note sellers. However, we are going to have to adjust to what institutional Note Buyers are willing to pay for notes, just as the seller of houses are having to adjust what buyers of real estate are willing to pay for houses. We must deal with reality, not with "what was".

There are ways to make your note more valuable, no matter if you intend to hold them or sell them to a Note Buyer.

Hope this helps.

Please CONTACT ME.
if you have a topic you want me to discuss. It is from your feed back that I get my topics. I look forward to hearing from you.

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Let me emphasize this issue is not an endorsement nor condemnation of any illegal immigration law, but rather only an observation of the effects the immigration law, such as the one in Arizona will have from an economic standpoint.

For those who have attended my workshops or talked with me personally about the immigration issue know I point out the unintended economic consequences that different laws will have on local communities in general and real estate in particular. For example, if all the illegals were suddenly rounded up and deported back to their home country, what effect would this have on the real estate values?

Using Dallas, Tx as model, there are certain areas which are widely known to be predominantly populated by illegal aliens. What would be the economic consequences on real estate if all of a sudden a great number of illegals were either deported or left voluntarily? From a real estate standpoint, is there any doubt there will be a deluge of unrented houses and apartments as the demand for housing decreases because of overnight vacancies? Will this not also add to possible foreclosures because investors will not be able to make their mortgage payments on the SFRs or apartment buildings. The snowball effect will continue because the glut of real estate inventory will rise, causing a downward pressure on real estate prices. Add to this the small businesses, from grocery stores to clothing stores, which cater to the illegal population will go out of business because there are no longer customers to buy their products. This, in turn, will lead vacancies in shopping centers in these areas, which in turn makes it difficult, if not impossible for the investor to make his/her mortgage payments. Other businesses from gas stations to even the larger shopping malls will see a decline in revenues. For those businesses living on the margin, this loss of revenue will be the turning point of their going out of business, which will lead to more vacancies, and possibly more commercial foreclosures.

On the other hand,many local government enterprises like hospitals, food stamps, city schools, county and city jails and courts will see a decrease in services to be rendered. The over crowded county hospital emergency rooms, which were used for primary medical care for many illegals, will see a large decrease in patients, which will grant much needed relief on the county's already inflated budget. Likewise, the local schools will see a decline in the size of classes, which will relieve the schools from the pressure of hiring more teachers, providing lunches etc. Governmental services like ambulance service will also see a drop in calls, and therefore costs. Local and State government budgets will shrink with the departure of illegals.

At the same time, local merchants and manufacturers who rely on illegal labor will experience a disruption of service. For example restaurants and landscape companies will no longer have the labor necessary to provide their services. By the same token, manufacturers will no longer have the labor necessary to produce their products. How they handle this situation is anybody's guess. By this I mean can they offer enough raise in pay to make it attractive for others to replace the lower pay of illegal aliens, while at the same time not having to raise their prices to the point their product or service is not affordable to many.

Another point of view is that since we are in a recession, where jobs are scarce, it will not be difficult to replace this labor at a price where the employer can still make a profit. There are other factors to this issue, which is too lengthy to discuss here. The purpose of this issue is merely to point out the economic ramifications of the illegal immigration laws.

The reason I chose this topic is because I read an article where illegals are already fleeing Arizona before the new immigration law takes affect. My mind naturally started thinking of the economic ramifications. The article goes on to mention many of the illegals are moving to Pennsylvania and other "sanctuary" states and cities. If the article is true and illegals are exodusing Arizona in masses, look for real estate in Arizona to decline in value, and foreclosures to rise as described above, while at the same time Arizona's local government and schools will see their budgets decline.

On the other hand, if these illegals migrate to Pennsylvania, while real estate rentals might rise in value or hold their own, look for a bloat of demand for county and local government services at a time when Pennsylvania cannot pay their bills now.

From a Note Buyer's view point, notes generated in Arizona will be looked at with even more scrutiny. A property in Arizona worth $100k a couple of years ago, will certainly go down in value if there is indeed a mass migration of illegals out of the state. We shall see.

I was asked if I had a solution, and the answer is YES. Return to a free market system and the immigration problem from an economic standpoint would be moot. I will discuss in more detail in another issue. Again, the purpose of this issue is to point out the economic ramifications of immigration laws.

As I teach in my Advanced Notes Workshop, my advice is to purchase property at discount prices using all cash, so you will own the property free and clear, or with owner financing so you will have control of the terms of the note. Both strategies will allow you to adjust to the reality of the moment, and not have to rely or be pressured by the regulations and policies of lending institutions.

Summary: The migration of illegals out of Arizona will have a downward pressure on real estate and the local economy, while at the same time providing relief to the over burdened budgets of the schools and local governments.

If you have a question or comment, please CONTACT ME. It is from your feedback that I get my topics.

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