Posted by David Butler on June 28, 2007 at 21:43:17:
Hello jtbar,
Just entering the term “throw-away seconds” in the search feature of this forum will give you clear explanation of a why a 2nd would be classified a “throw-way” in general… all has to do with equity, in respect to that end of buying 2nds.
Common thread in 2nds… first there are always “… ready sellers of this stuff out there…”! The problem is finding sellers holding viable 2nds.
Other common factors when working with 2nds - max 70% CITV for SFR, less for other types of notes. So, if senior note is 60% LTV to 69% LTV, not much there for buying the 2nd. And of course, if senior loan is 70% LTV or higher, there is nothing there for the seller of a 2nd.
As you correctly surmised, in a soft, and especially a declining market, the question of equity becomes of even more vital concern. A buyer will have to really do his homework, and know the market where the property is situated.
There is no such thing as a typical discount, but as for typical yield requirements, my own on 2nds range anywhere from 18% to 60%+, depending on note grade, and SIZE of note. But I’m not just buying for yield, especially when purchasing 2nds. I am buying for profit, operational cost, loss mitigation, and risk management.
If note is less than $10k for example, and pays out less than $150 per month, I would only pay somewhere around $3,000 to $5,000 for it, due to small size and payments, and low total dollar return on investment. At $5k, the yield is 30%. At $3k, the yield shoots to 52.5%. In each case however, that yield is also diluted by the reserve capital I have to hold in low yield, high liquidity bank accounts, in the event the senior goes into default.
It is further diluted by any time and effort the investor has to put in to manage the note. If investor gets lucky, and the payments just come like in clockwork… he does real well. But reality is that most won’t, particularly if the note has issues on the front end. So… the yield is set to account for safety requirements as well.
To gain some more understanding, follow the links in my reply Re: Discounted second? at:
http://www.creonline.com/cashflow/wwwboard3/messages/21595.html
That should get you on your way to ascertaining your comfort level for working with 2nds. Best wishes for your success, and
Have Fun For A Living!
David P. Butler