Posted by Chris - AZ on June 15, 2007 at 14:25:58:
That helps alot! Thank you David for the detailed answers!
Interest rate on notes - Posted by Chris - AZ
Posted by Chris - AZ on June 10, 2007 at 14:30:47:
Hi,
I’ve been reading/listening to Mike’s unity of RE and paper and the new one Paper into Cash. I have three questions for any of the experts…
Assume good borrower (680 mid score, good income), good collatoral (SFR, clear title), and we are creating an owner carry note as a result of a purchase which we plan to sell in a simo transaction. Mike says he will buy the note with a minimal 5-7% discount, if the terms are 30 year fixed, 5% down, at 7.5%, no balloon, no prepay. With the discount taken into account, lets say the yield is 8%.
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How do investors like sunvest make money buying notes at 8%? Are they reselling or holding? I’ve got some money to invest in notes, but I can’t compete against that! I would want to get 10% or higher AND have a lower LTV!
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If the note above does have a 5 year balloon, but everything else is the same, can I still sell the note at 8%, or is this note riskier? How much should I add to the yield to be able to sell it? (I’m thinking of what Mike calls the “Balloon Split sale of paper”. In his example, the yield was 10.56%, but that may have been because of the payor.)
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Since a simo is a two step process, is the note normally structured as a wrap, or can it be a 1st trust deed right from the git-go?
Thanks a bunch!
chris in Tucson
Re: Market Forces! - Posted by David Butler
Posted by David Butler on June 15, 2007 at 12:11:48:
Hello Chris,
Some interesting questions you pose here. First thing to keep in mind… best price for note will generally run at 87% ITV in relation to property value.
As to your questions…
Q1) How do investors like sunvest make money buying notes at 8%?
A1) Because they are earning 8% on their funds. That means they enjoy the returns on their own funds, or they have a lower cost line of credit and are working on the spread to realize a profit.
Q2) Are they reselling or holding?
A2) Both. Holding some, reselling some when they need to replinish cash cash to purchase more notes, or to pay down calls on their credit line(s).
With regard to your observation “I’ve got some money to invest in notes, but I can’t compete against that! I would want to get 10% or higher AND have a lower LTV!”
My response: Exactly. The market is made of many forces, many notes, and many different buyers for those notes. The relative handful of larger buyers purchase roughly 25% of all RE notes sold in a given year; with thousands of smaller buyers all over the country purchasing the remainder. Even broader differences in business notes and MH chattel notes. With rare exception, these buyers have learned the trade, and can underwrite riskier paper, at deep discounts - or they are comfortable with parameters you are not comfortable with, and compete for those notes. (This includes the “deep pockets” factor. The more money you have to work with, the less discomfort you have in some respects, assuming individual risk tolerance levels otherwise being equal).
Q3) If the note above does have a 5 year balloon, but everything else is the same, can I still sell the note at 8%…
A3) That depends on the idividual buyer quoting on the note, at the time the quote is made.
Q4) …or is this note riskier?
A4) Assuming all information provided is accurate, the balloon is only considered riskier because the buyers competing in that range generally like to see at least 7 years before balloon payment. This is also partly due to fact that the investors want the investment to remain “in play” longer from a reinvestment perspective. In either respect, the note buyer may add an additional discount to offset these challenges if otherwise still inclined to purchase THAT note.
Q5) How much should I add to the yield to be able to sell it?
A5) Not sure what you are asking here? The buyers already have their yield parameters, and will apply those to the individual note situation, based on their underwriting of all factors related to that note; the Payor of that note; and the collateral for that note.
Beyond that, getting the best nominal rate you can get from the Payor is a matter of economic prudence, in that it enhances the note’s return if you keep it - and it works to reduce the discount if you sell it.
As to technique - the less of the note you sell for cash up front, the more you will receive on the back end. This is what makes partial purchases so popular to knowledgeable investors and/or dealers. Partial purchases can also include Balloon splits - a technique we often use in particular when purchasing land notes and MH chattel notes, due to the fact that refinancing out of those types of notes is frequently not an available option for the Payors.
Q6) Since a simo is a two step process, is the note normally structured as a wrap, or can it be a 1st trust deed right from the git-go?
A6) Depends on the position of the note being purchased at time of closing. If there is already an existing senior mortgage, and it is not being paid off at closing by way of property buyer’s cash into escrow, that lien will still be there after close of escrow. You’ll want to wrap that loan, so that note buyer coming in will be buying a wrap, and subject to his discretion - determining whether he wants to advance funds to pay off senior debt and come out moving note up in to senior position; or alternatively, purchasing only your equity in the wrap, and stepping in to your position subject to the underlying loan.
Most note buyers will want to pay-off first, and move into senior position, but every now and then it is advantageous not to do so, depending on the situation and circumstances of the property sale.
Hope this helps, and perhaps Mike will add his two cents when he has the opportunity.
Best wishes for your success regardless, and…
Have Fun For A Living
David P. Butler