There seems to be some confusion as to the nature of partials, and how both a NOTE BUYER and a note seller perceive them. A case in point is the story of a recent note seller who contacted me about selling her note.

The details are as follows: The house sold last year for $160,000 with $10,000 and the seller carried a note for $150,000 for 30 yrs at 7% interest. The payors had barely a 600 credit score. This does not make NOTE BUYERS feel warm and fuzzy.

The solution was to offer to purchase 72 months of payments from the seller for $47,195.70. The note seller said she would think about it. The next day she called back and said, "You are getting a 15% yield. This is a rip off". If yield is all you look at, perhaps you would think 15% would be a rip off. A closer look might give a different outlook; you tell me.

Let's examine several factors beginning with time value of money principles. For those who have taken my classes, or have followed my newsletters, you are aware that short pay periods require only a small discount to increase yields astronomically. You calculator junkies, ( I know you are out there, I get your email) can check my work; the rest can just follow along. While the note seller is correct that from the "calculator's" point of view purchasing 72 months of payments for $47,195.30 would produce a 15% yield, there are other factors which have to be considered besides yield.

Most of you are aware of the time value of money, but there is also the principle of the Money Value of Time. For example, say you could purchase a house with nothing down, and sell it in a month and make a $100 profit. Your return is infinite since you have no money in it, but what about your time and expense involved to make only $100? Is this worth it?

The same concept holds true with this note. Although purchasing 72 months of payments for $47,195.30 turns out to be 15%, the discount is only $11,339.12; and this is over a 6 year period. (Either check my figures or trust me)

Back to basics. When is yield realized? ANSWER: After you are paid off. With this in mind, what happens in the case of default? The NOTE BUYER will be forced to start the foreclosure process. This will take time and money. In judicial foreclosure states, it will take even more time and money. If nobody purchases the property at foreclosure, the NOTE BUYER then has to evict the prior owners, which is more time and money. Next the property will have to be marketed. More time and money. Who thinks the property will be in clean, pristine condition and ready to sell at top dollar. NOT REALISTIC. More time and money.

Make no mistake, the NOTE BUYER will eventually recoup all his/her investment, plus expenses when the property is sold, but is the time and trouble worth making $11,000 and some change? In this case, yes.

What if the NOTE BUYER received a 12% yield? In this case the NOTE BUYER's discount is only $3,850.42. This begs the question, "Who would want to go through all the foreclosure process and expense to make only $3,850.42 ?" NOT ME. Which brings us back to the Money Value of Time concept. In other words, I will take the risk if I can make $11,000, but not for a little less than $4,000. The risk, trouble and expense does not justify the reward.

Let's look at this note from the note seller's point of view. What does the note seller have in the $150,000 note? Does she have $150,000 cash? NO! All she has is a PROMISE TO BE PAID $997.95 a month for the next 348 months. A $150,000 note is not the same as a CD or cash. If you get nothing from this issue but the concept that a note is not the same as cash, this issue is worthwhile reading. The note seller has ignored that this note is merely a promise to pay from a person who has barely acceptable credit (low 600"s ) and put very little down (less than 10%). In today's market, if a NOTE BUYER were to make a full purchase offer on this below average quality note, the offer would justify approx 60% of the value of the property, or $96,000. This comes out to be a 12.09% yield, but a hefty discount. Why the hefty discount? Because of the high risk associated with a shaky borrower, and low down payment. Which brings us back to the Money Value of Time concept. With this in mind, I ask you, which is the better offer? $96,000 for the entire note, or $47,195.13 now for 72 payments, and at the end of 72 months, the note will have a balance of approx $136,000.

Note sellers very seldom think of what would happen if THEY had to foreclose. They completely ignore that it would then be up to THEM to pay for foreclosing on the property and any other expenses. Since the house is vacant, what is the risk of vandalism, especially in today's economy? Is the property going to be in any condition to resell or rent? Statistics say the average price to get a home in marketable condition is $12,000. It could be six months, more in judicial foreclosure state, before the house is ready to rent or sell. This is assuming the payors do not declare bankruptcy and prolong the foreclosure for even a longer period of time. Are you getting the picture? . A back issue of THE NOTE PROFESSOR NEWSLETTER gives a more in depth picture.

Conclusion: Although the yields of partials might seem "obscene", the reason is because the short time period makes the yield increase dramatically, even though the discount is not large. However, the money discount is not that high when you consider all risks involved. As a note seller, if you believe you can just foreclose without added expense, time, and frustration, you are not being realistic.

So if you have a shaky note, be prepared to take a partial or a hefty discount. And, yes, because of the nature of partials, the yield to the NOTE BUYER might appear to be high. That is unless the NOTE BUYER has to foreclose, then his/her time and frustration will greatly decrease the Note Buyer's yield. As a note seller you should be asking yourself, "Do I want lump sum cash now on this shaky note, or do I want to gamble the payor will continue to pay?"

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.

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Current ARCHIVES (end of 2009-2011)

I was to give a comparison of Ancient Rome and today's America in this issue, but several of you wanted me to comment on Obama's speech for the "Jobs Bill", which is nothing more than a stimulus package with another name. Suffice it to say we have discussed in detail in other issues of THE NOTE PROFESSOR NEWSLETTER how any "stimulus" bill is nothing more than taking money from those who produce, and transferring capital to other areas. One group benefits at the expense of another. This does not create wealth any more than my taking money from your pocket and spending it. It did not work for Hoover and FDR in the Great Depression, it did not work in 2010 and it will not work now. It is that simple.

What I wanted to discuss in this issue is the myth of Obama's example of government's funding of the transcontinental railroad through a "stimulus" package in the mid 1800s. For Obama, the transcontinental railroad is a monument to how government subsidies create wealth and prosperity. I agree the transcontinental railroads should be held up as a prime example of what happens when entrepreneurship is based on political connections and government funding, and not market forces. A good reference today is the Solyndra Inc. scandal.

Because of space and time, I am going to give you "in the nutshell" version of the transcontinental railroad. In 1862 Congress passed the Pacific Railroad Act. From this act the Union Pacific (UP) and Central Pacific (CP) railroads were established. Like all government entities, these companies were created not because of market forces or ability, but by political connections. The plan was for CP to start building rail from Sacramento, CA. and the UP to start building rail from Omaha, NE. Besides land subsidies, which totaled millions of acres on either side of the railway, the UP and CP would be paid from $16,000 to $48,000 per mile of track laid depending on the terrain.

Being political entrepreneurs and not market entrepreneurs, the executives of the UP and CP saw immediately how to take advantage of situation. Instead of finding the straightest and best routes for the railways, they would lay track in winding and sometimes almost circling patterns to take advantage of the miles per track subsidy, not efficiency. In other words if they laid a mile track straight, they would be paid only $16,000. However, if they made the track wind for an extra quarter of a mile, they would be paid $20,000. Since creating a profitable business was not the objective, but merely collecting a subsidy for laying track, the quality of track was not of any importance either. Why? Because government would pay them by the mile, no matter the quality of the track. The railroads did not care what type of wood they used as long as track was laid. In fact, farmers and land owners along the route would have to put armed guards overlooking their land to keep the railroad workers from cutting down their trees, any trees, to use as cross ties. As a result, cross ties were created out of inferior wood that would not withstand the weight of trains.

If using inferior materials were not enough to assure a poor quality railway, cross ties and rails would often be laid in the winter on top of ice and snow. When the spring thaw came, the tracks were inoperable because the ties and track had shifted. Why would a company waste time and resources on inferior goods? Because the UP and CP were not using their own money, and the profit was in laying tack and collecting subsidies, not in creating a railroad whose profits would be made from having efficient tracks to haul goods and passengers.

Oh, but it gets better. The Pacific Railroad Act was amended to allow UP and CP to be paid subsidies of up to 300 miles ahead of where track was laid ( I promise I will lay the track tomorrow, if you pay me now). It gets more ridiculous. In Utah there is still evidence of the corruption of government "stimulus" in the building of the transcontinental railroad. At one point you can plainly see the tracks of the UP and the tracks of the CP only 50 yards apart running parallel for approximately 250 miles. This was approximately a years work. Since the railroads were being paid wherever they laid track, even next to each other, it was obvious there was no intention of connecting and completing the project, but merely collecting as much subsidy as they could.

Finally, some bureaucrat discovered what was happening. Congress demanded the tracks meet. Like today, politicians do not like it known how much money they waste. So with much fan fare and publicity, the link at Promontory Point, Utah was "completed". We have all seen the picture of the golden spike being driven, and the appearance of much celebration. We are led to believe that trains immediately started running and carrying passengers and goods. The impression was the government "stimulus" was a success, and without a "stimulus", there would have been no transcontinental railroad. What is left out is the track from both lines not only had to be torn up and rebuilt, but often relocated because of the shoddy way the track was laid. It took five more years and millions of dollars more for the rail way to be completed.

When politicians are using other people's money, of course there is the usual graft and corruption. The transcontinental railway is no exception. Executives from both UP and CP siphoned funds from their own companies to profit personally. For example, UP executives created a coal company and mined coal for $2 a ton, then sold it to their OWN railroads for $6 a ton. Nice profit for them, but their shareholders did not fare well, nor did the railroad customers.

Before concluding, as a side note, it was these political entrepreneurs who gave rise to the "robber barons". Not only did these political entrepreneurs bilk tax payers, but their stockholders, as well as the public. These political entrepreneurs, who were nothing more than political con men, were interlaced with true market entrepreneurs. The result has been you think of a Rockefeller, a market entrepreneur in the same light as you do the CP and UP executives, who were "political entrepreneurs. But this is a story for a different issue.

In conclusion, I would like to agree with President Obama that the building of the transcontinental railway is the epitome of the outcome of government stimulus packages, and government "investment". However, let's be clear on the results. The tax payers paid for inferior, unusable, unnecessary and even non existent track, while political entrepreneurs made millions at the expense of others. This is the nature of all government projects where profit is not the guideline, where tax payers front the bill, and investors have nothing to loose, because it is government money being spent. History is filled with these examples. So if anyone tries to use the transcontinental railroad as an example of how great government sponsored "investments" are, remind them of the true history of the transcontinental railroads. For current events, we have only to look at the Solyndra Inc. scandal. Same song, different time.

For those who say that only government can afford to take on projects like railroads or dams, I will refer them to the accomplishments of J.J. Hill and the Northern Pacific Railroad, or to Henry Huntington and the Big Creek Hydroelectric Pant, which was built not just on a river, but high in the Sierra Mountains. Suffice it to say these market entrepreneurs created wealth from private funding because of their abilities. On the other hand, political entrepreneurs' only capital was their political connections. Is it any wonder that a market entrepreneur like George Westinghouse gave us AC/DC current to power our homes and businesses, while George Kaiser gave us the Solyndra Inc. scandal? You tell me which system is better.

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

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