Not a week goes by that I do not receive calls about how to structure notes that will be marketable. I am not going to address the terms of a note, like the interest rate, balloons etc. This is a topic for another time. In this issue, I am going to discuss changes in the last 4 years since the real estate melt down.

In the note buying industry, equity is king. This is especially true in today's market. While credit scores are equally important in that it is very difficult to sell notes with sub 600 scores, large equities will heal many ills in a note. Many consider the property value the most important element when purchasing a note. After all, in the final analysis, it is the property that gives the note its ultimate value because it is the collateral in case of default.

By this I mean, it makes no difference if you are getting 500% yield, if you have to foreclose and your collateral is not worth the amount of your investment. Likewise, although credit worthiness is very important, there are many credit worthy people who have lost their jobs, and are unable to continue making their mortgage payments. If the lenders did not have low LTV ratio (loan to value) in the property, they lost money. Note Buyers are not going to make the same mistakes. Note Buyers are aware that buying owner financed notes, especially in today's market, contains risks. One of the risks is deterioration or devaluation of collateral.

For this reason, Note Buyers have a different criteria than LTV for evaluating a note's value. Rather than LTV, note buyers go by ITV, or investment to value. ITV refers to the investment in the note relative to the market value of the property. As I say in all my newsletters, I am going to talk about "concepts", and not specifics. The market may change tomorrow, but the "concepts" will remain the same, whether you are reading this now or in 10 years.

Needless to say, the amount of down payment is very important, not only for valuing the note, but also how much money you will receive if you sell your note. For illustrative purposes, Note Buyers might want a minimum of approximately 80% ITV for "owner occupied" properties and 75% for "non owner occupied" properties. For example, if a house is valued at $100K, the Note Buyer would want to pay around $80K for O/O and $75K for NO/O. At this point the importance of a down payment should be clear. Let's say a home owner had a perfect 850 credit score, and purchased a $100,000 house for nothing down and you took back a note for the full $100,000. The Note Buyer might pay you $80,000 for that $100K note. However, if the home owner put $10K down, and you carried a note for $90,000, the Note Buyer would still pay you $80,000 for your $90,000 note. There is a $10,000 difference in the discount. In other words, the more money down, the more money in your pocket. Many Note Buyers will not even entertain valuing notes with less than 10% down. More importantly, Note Buyers are very reluctant to purchase notes in today's economy where the home buyer puts little to nothing down. The home buyer having "skin in the game" is very important to a Note Buyer.

Many investors tell me if they can get 10% down and a credit score of 600+, they can get FHA financing. This is undoubtedly true. In fact, I advise all that call me wanting to sell their property using owner financing that FHA should be their Plan A. Owner financing and selling the note should be Plan B. It is just prudent. By the same token, be sure to qualify all your buyers by having them fill out a loan application, and provide you with their credit reports. This will go a long way to weeding out those who do not meet your buying standards. If your real estate buyer cannot qualify for FHA, and does not have 10% down, do not overlook the option of selling "part of your note". This is becoming more and more the alternative to getting a note seller a lump sum of cash, while at the same time limiting the exposure a Note Buyer must take due to the risks in today's real estate market.

Another issue that catches many note sellers off guard are the taxes and insurance. Make sure your payors have their taxes and insurance paid up. Many Note Buyers will not purchase notes if the taxes are in arrears. In the past if taxes were in arrears, Note Buyers would merely pay the taxes out of the proceeds of the note sale. This is no longer the case. Note investors take the attitude if taxes are in arrears now, the payors do not have the income necessary to pay taxes in the future. Many note investors consider this to be a future administrative expense at best, and a future foreclosure at worst. Keep on top of when taxes are due, and make sure they are paid.

Another issue should be discussed; SEASONING. The days of an investor or rehabber flipping a property and getting 90% of the face value of the note at closing are gone. In today's market, Note Buyers are looking for either the note seller owning the property for at least a year, or the payor owning the property for at least a year, if the note seller had not. Even If the note seller had owned the property for a year, many Note Buyers still require three months seasoning to establish a payment history. Why? Because pre subprime meltdown scams and fraud were prevalent. Just as the lending industry was plagued with straw owners and fraudulent purchases, so too was the Note Buying industry. For this reason, verifiable payment history is important. Keep copies of checks or deposit slips.

Last, but not least, I always suggest you have an attorney and/or title company advise you when creating a note, however, DO NOT rely on title companies or attorneys to make sure your note is written correctly. Although the majority of the time attorneys and title companies do an excellent job in writing and structuring notes, just like you and me, they do make mistakes. This is why they put erasers on pencils. IT IS YOUR JOB TO CHECK YOUR NOTE for accuracy and correct form, no matter if you are buying or selling real estate. In my January/March 2006 issue of THE NOTE PROFESSOR NEWSLETTER , I discuss briefly An Anatomy of a Note. You would be surprised at the notes I receive that are sloppily written, vague, or sometimes no where near what the parties intended. Notes that are sloppily written can make your note less valuable, open the door legal action, or make your note virtually worthless.

I will be teaching a 90 minute workshop on Tuesday, July 26. on the proper way to write notes. This workshop will take Anatomy of a Note to a higher level, as we discuss in detail the proper way to write a note.

If you have a note to sell, or know of someone who wants to sell a note, CONTACT ME Remember, I pay referral fees.

Be sure to contact THE PROFESSOR with questions or comments. This is where I get my topics.

As usual, consult a CPA and attorney before dealing in notes.

Copyright © H&P Capital Investments LLC All rights reserved

If you have not attended a Note Professor "How To Get Rich with Notes" class, be sure and purchase the Note Professor Note Book manual to enhance your knowledge of creative real estate financing and note buying and selling.

"I got your news letter. It was great, purchased your (Notebook) and it was awesome. I used your renter technique and it worked also. I am getting 41% return thanks to your expert advice. I have spent hundreds and not able to do any thing thru other gurus" Gary W. Garland, TX

"It blew me away what a powerful tool notes can be. Lots of great information, worth every penny! Highly recommended."
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"Your manual is short and straight to the point, it's rare to buy something today that gives you your money's worth. Thank you" Stephan B. Phoenix, AZ

You will learn at least one new usable concept to increase your profit in buying or selling notes and real estate.
Tom Henderson, author

By popular demand, THE NOTE PROFESSOR NOTEBOOK is now available in easy, downloadable E- book form for a the low, affordable price of $39.95. Other products are also available, including HOW TO MAKE OBSCENE PROFITS with SMALL MONEY, and GUIDE FOR SECOND LIENS. There is also a FREE download of CHECK LIST FOR OWNER FINANCING. Simply go to the NOTE BUYERS STORE. I can think of nowhere that you can find such information packed products at such incredibly low prices. We are still working out the bugs, so if you have any problems, be sure to contact me.

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Current ARCHIVES (end of 2009-2011)

Last week on the TV political talk shows I heard "experts" continue to perpetuate three economic myths. I say "experts" because one was an ex Secretary of Labor and another an ex Secretary of Treasury, and another was just an expert on being an expert. We have covered two of the three economic myths. First there is the assertion that rich people are not spending their money, and therefore hurting the economy. In other words, saving money is bad. (Ask these "experts" if they spend ALL the money they make each month) Jeeze. We covered this topic in the February 2011 of THE NOTE PROFESSOR NEWSLETTER. Next was the ole standby that government spending during WWII got us out of the depression. In other words, WWII created prosperity and raised the standard of living. Tell that to the men and women who had to endure it. We also covered this fallacy in the September 2010 issue.

The new talking point is what is being called Winner Take All. What they are referring to is the "income inequality" of lower wage earners as compared to the top 1% of earners. This old tactic has been used for years to try to discredit free markets, and justify wealth redistribution. Their contention is there is a huge inequality from lower income wages and those in the top 1%. Now, they exclaim, it is the largest discrepancy since 1928. They will then go on to describe how CEOs receive over 400 times the salary of the lowest worker. This, they say is a Winner Take All. And, of course, the only way to rectify the situation is to tax the upper 1% ($395,000 yearly and up)

I feel like the mosquito in a nudist camp. I know what I am supposed to do; I just do not know where to start. Let's begin by the implication of "winner take all". Those who attack the "winner take all" scenario do not address the major fallacy of the term itself. This phrase implies that a free market economy is a zero sum game; meaning if one person wins, another must loose. This is one, if not the major distortion of free markets; individuals get rich at the expense of others. In fact, it is just the opposite. Only in economies that adapt policies contrary to free market principles does one group benefit at the expense of another. For example, all wealth redistribution programs, which includes everything from corporate welfare, to price supports, to protective tariffs, to paying farmers not to produce, to government spending and bailouts benefits one group at the expense of another. Is there any doubt that a government policy to take money from tax payers to transfer to corporations, individuals or even foreign countries benefits those receiving the transfer of wealth at the expense of those who produced the wealth. Is not one group becoming richer at the expense of another group, or in other words, "winner take all".

Contrast the above scenario with purchasing an iPhone. If you buy an iPhone, who is "richer" because of this transaction; you for voluntarily purchasing an innovative means of communication, or Steve Jobs for accepting your money? Notice I said "voluntarily purchasing", rather than being forced, which is basis of all wealth redistribution programs. More importantly, did not both you and Steve Jobs benefit from this transaction? Steve Jobs is definitely in the top 1%, not because of your lone purchase, but because several million individuals also voluntarily purchased an iPhone. Should his compensation be tied to that of a janitor? Yet by the measurement of many, Steve Jobs was enriched at your expense or the janitor's expense, and therefore should have his wealth confiscated to make everyone's income equal. Do you see the difference between a free market transaction which is voluntary, as opposed to wealth redistribution which is coerced by force of government.

Now that the true "winner take all" system has been identified, let's examine the assertion that the income disparity between the lower paid workers and the top 1% are more than they have been since 1928. Of course, the only way to "equalize" the wealth is to tax the rich. The proponents of "winner take all" go on to tout that many corporation heads ran their companies into the ground and received golden parachutes in the millions. While others who attack the "winner take all" premise will remind everyone the top 1% pay 37% of the taxes, or that the uneducated, lower level employees automatically will make income disparity larger. These argument, although true, do not really address the underlying reality of business cycles. You might be surprised to learn I agree the income disparity has risen, but there is a different explanation. I will take a different approach to attacking the "winner take all" concept by addressing that economic bubble we are experiencing, is no different from any economic bubble. Like many false economic assertions, often the cause and effect of an event are reversed. So it is with the income disparity. A deeper examination of the current economic bubble will reveal that growing income disparity is a normal result when bubbles form.

Let's review what has gotten us to this point. The Federal Reserve Board created money out of thin air, and then artificially set interest rates well below market value. This distortion in the price of money resulted in lenders' lending money, and borrowers, both individual and corporate, borrowing money they never could have afforded if interest rates were not artificially low. This resulted in borrowers not only going to banks, but also using their credit cards, and even their homes as ATMs. Therefore, not only did real estate sales rise, but also the sale of consumer goods, ranging from new cars to new appliances. Because of the increase in sales, those in upper level management of many industries were consider to be "geniuses", and of course demanded top pay. From financial institutions to automobile manufactures, top level executives were in demand, and therefore received "obscene" pay. Like all bubbles, when the supply of money is artificially increased, and/or interest rates are set artificially low, at first there is the illusion of prosperity. This bubble is no different. And, YES, income disparity from the lower level worker to the top CEO did increase, but this increase was a result of the bubble, not the cause. It is also true that many became the top 1% (households of income of $395,00) because of the real estate bubble, as investors and home owners alike, took advantage of the bubble, and rode the wave to riches. It should be noted here, that historically lower wage earners do not invest; hence they never became part of the 1%.

This scenario is similar to the events leading up to the Great Depression. The Federal Reserve triggered a bubble by increasing the supply of money in the 1920s to pay for WWI. Like all bubbles, this easy money policy created the illusion of prosperity. This led to the bubble in the stock market, which like real estate prices of today, stock were inflated because of easy credit. Because of easy money, many with any assets whatsoever, were "getting rich" by riding the wave of the stock market. Similar to our real estate bubble, lower income employees did not enter the stock market to "get rich quick", therefore the "income disparity" seemed to grow as one group followed the illusion and invested in the bubble, while the lower income individuals could not invest. Moreover, individuals who profited from the early bubble formation, purchased consumer goods which benefited large retail chains, as well as local merchants. Like today, many merchants and corporate executives experienced their incomes rising while low income individuals stayed at their same level. Is it becoming obvious that when bubbles form, the illusions of prosperity brought on by easy money policies creates an environment where many surge to the upper income levels because of the bubble? The bubble causes the surge in wealth, not the other way around.

What the "winner take all" advocates conveniently omit is what happened after bubbles burst. Notice they will tout the date 1928. Do they mention 1933, or do they mention 2011? Why? Because if they did, they would have to show that many of the top 1% of earners lost their entire portfolio when the bubble burst in 1929, just as many of the top 1% lost their fortunes in today's real estate crash. Likewise, companies that were thriving when the stock market bubble was forming were suddenly in financial difficulties. So it is today. Companies like General Motors and Country Wide, which were very profitable during the bubble formation, are now targets of scorn. Yet their top executives, which only a few years ago were financial heroes, are now examples of how CEOs "ran their companies into the ground" and walked away with golden parachutes. Could not the same be said for the CEOs of Fannie Mae and Freddie Mac, which had government oversight, or government bureaucrats whose salaries increased to the point that they are paid higher than the private sector? But this is a different topic.

Summary: Free markets are not Winner Take All propositions, but rather a voluntary exchanges of values, such a purchasing an iPhone. This is the most important idea to take with you from this article. Moreover, when bubbles form, companies, individuals, and even industries will appear to prosper, only to take a nose dive when the bubbles burst. Comparisons of income and wealth of lower income individuals to the top 1% when the bubbles are forming is in itself useless, because as with all bubbles, lower income individuals do not invest. Just as in 1928 when the wealth seemed to go to the 1%, we found out the wealth was only an illusion, as their financial gains were destroyed by Nature returning to reality when the stock market declined to seek its real price level. Likewise, our real estate bubble of today surged many into the top 1% with illusions of equity in property, as well as companies and small businesses prospered from the easy money of credit cards and home equity loans to purchase consumer goods. Top executives were compensated well during the bubble formation, and were called heroes. However, when the bubble burst, these same executives are now open to ridicule and scorn, as their companies also fell victims of the inevitable crash. Likewise, many investors who were elevated to the top 1% are now filing bankruptcy as real estate prices decline to seek their true level, as did stocks in the Great Depression. So when you hear of the income disparity between top earners and the lower income, realize that the disparity of wealth increases when bubbles form. It is the nature of bubbles. In other words, the surge in the disparity of income and wealth is the effect of bubbles, not the cause. The economic predicament we are experiencing is due to the abandonment of free market principles, not because the rich are not taxed enough.

Food for Thought: How does taxing the rich decrease the discrepancy of wealth, unless you believe in wealth redistribution? What is the "proper" relationship of compensation from the owner or CEO of business and a janitor?

If you have questions, CONTACT ME. I will address them in future issues.

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