Tracy Z (00:10):
Today we're going to show you how to look and analyze the deal if you want to buy it, or you want to refer it on to another investor. In this situation, we're talking about notes that already exist,
Before we do that let’s start off with a disclaimer. Just letting you know that we are not attorneys, financial advisors, tax attorneys or accountants. And we definitely encourage you to seek the competent legal tax and financial advice.
Past performance doesn't always guarantee future performance. We've been doing this for a combined 50 years. We've seen a lot of things over the years, a lot of different economies. There are basics that you really want to be sure you're doing first when you're looking at buying a note or referring a note.
Fred Rewey (01:34):
We are going to start by going to go over due diligence. Let us introduce to you the 3P's.
Tracy Z (01:59):
The 3 Ps are the cornerstone of deal analysis, due diligence and note investing.
The first P is PEOPLE.
Some people call it the payors or the borrower. The person making the payments that's a key part of it. But people also include the seller that is selling you the note.
Fred Rewey (02:23):
The second P is PROPERTY.
Property is the asset. This is what the note is tied to. This can be the house, a single family residence or a multi-family.
Questions to take note of: What is the property as far as the value of the property? What's the condition of the property? How accessible are the essential amenities from this property? Such as, are there good schools nearby? Is it in a judicial versus nonjudicial state? As far as how easy or difficult a foreclose, if they stopped paying me to get that property back.
Tracy Z (02:55):
In the banker's terms they talk about the 3 Cs. Lots of collateral being one of them. Collateral, in this case is the property. The property is what you could take back if they did not pay the promissory note. That is a very important piece.
Another piece of the property, is it financeable through conventional means? We see a lot of seller financing on hard to finance properties. You might have a home with excessive acreage. You might have a mobile home and land. You might have just a mobile home. These are all the things you want to know about the collateral. Because that will make a big difference in how you perform your due diligence and also what price you want to pay.
Fred Rewey (03:41):
The 3rd P is PAPERWORK.
Tracy Z (03:43):
That's my specialty. I don't know if anybody loves paperwork, but it's certainly how I got started in the note business on the closing side. The paperwork is what gives you the ability to enforce your rights when you buy a note.
The paperwork is very important because you want to make sure it exists. It's been done correctly and it gets transferred correctly. This will give you the full ability to enforce just like the original holder of that note. It also is a way for you to verify some of the things that people tell you.
Fred Rewey (04:22):
I also look at paperwork as an ancillary on things like insurance. Is there insurance on the property? Are the taxes current? These things you will see on paperwork.
Tracy Z (04:33):
For paperwork this includes the copy of the closing statement. Some people call it the HUD one settlement statement. But it's that accounting of all the money, the sales price, the down payment and how things were handled.
Promissory notes are also very important. While the main piece of paperwork is the mortgage or the deed of trust. Some States have contracts for lien and then there's other types of paperwork too. We have a whole transaction checklist of all the standard pieces of paperwork.
When somebody says, ”yes”, you get them to sign an option agreement. Then we start performing that formal due diligence. Some of this due diligence you can perform without cost and some does incur a cost. It's important to stage it. Do the things first that don't occur a lot of costs when you're doing a deal analysis.
Now, we have here the Due Diligence Dozen. It's 12 questions that every note investor should answer about their transaction. You want to kick us off with the first?
Fred Rewey (05:58):
First one of these 12 questions.
How long has the buyer been making payments and are they current?
This one's pretty basic. Are they living in the property for two years, for two months or for 20 years? How long have they been making payments each and every month? Hopefully, they are current? Are they up to date on their payments? Did they fall behind? If they did, have they made it up?
This is particularly true in the last year. There were some people that fell behind during COVID. Surprisingly enough, the numbers don't show as many people as you would think necessarily in this environment. One of the things that they never ever want to lose is their home.
Tracy Z (06:52):
Another word we use a lot in our industry for that is seasoning. You hear somebody say, “Oh, how long has the note been seasoned?” In note investing seasoning makes it a more secure investment because it gives a chance for you to see that the buyer has been making those payments and hopefully we'll continue to make them.
A note that has one month payment made on it versus a note that has 12, obviously one that has 12 is going to be considered more valuable in my offset. Some other, maybe not so positives, but when we look at it we start adding them all together and in their due diligence.
The second question is related to the payment history.
Is there a servicer collecting those payments and validating the payments?
Tracy Z (07:43):
It's more common now to have a third party servicer that collects the payments from the buyer. Borrower keeps track of the interest in principal. Maybe they also do reserves for taxes and insurance, maybe not.
Sometimes though it's great when there is a third party service. We always suggest people use a third party service because they take away the headache. Kind of like a property manager for a landlord, a third party servicer is like a note manager for note investors.
One thing that we see a lot in seller financing is the seller sold to the buyer and they didn't have a servicer or a third-party to collect the payments. That buyer is making the payments direct to the seller. Now it gets a little bit more complicated to validate or verify the payment history for that.
Tracy Z (08:30):
That's where the paperwork comes in. If that's the case, we try to get the seller to give a proof of payment. It's a little easier now because everybody can go online. They can usually get copies of checks deposited into their account. They don't have to show everything in their account. But if they could just get copies of those deposits made from the buyer, that would be one way to validate a payment history. If a servicer is involved. The seller should get a copy of that payment history to make sure the buyer is paying. All right. Next one.
Fred Rewey (09:07):
Next question is, Do the documents match the terms presented for the sale?
Not a real long one here, not a real tough one to talk about. When someone says, “Hey, I have a note, the property sold for 125,000 and I carried back a hundred thousand dollars note. Then, I wrote the note at 10% with 30 year amortization. The payments are going to be $877.57.” We need to make sure that all those numbers match what's really in the document. Just because somebody told us that doesn't make it true. Just because someone gave us the address of the property or the legal description of the property necessarily doesn't make it true.
Fred Rewey (09:56):
When we look at the documents of a property that sold at a price that has a value of X and all the documents match, now they may have said the value is 125,000 and the value's gone up. The part of our due diligence is to make sure the value is at least what we think it is, which is what it's sold. If it went up great. If it went down, that's a problem but doesn't mean we still can't do the deal. It just means the value that we are presented is not the value today.
Basically we're just cross-checking what was set up front, with what the paperwork backs up. Because at the end of the day, only the paperwork matters. I don't care what anybody says.
Tracy Z (10:51):
Another piece of the documents that’s really important is terms. Because sometimes we see some really crazy stuff written into seller finance notes and they don't always use the boiler plate. It's very important to take a look at those documents. Read them, anything unusual will definitely stick out.
The normal things are the interest rate and the payment amount when the note is due.
If they wrote it as 0% interest rate or perhaps they wrote it at interest only payments. That's where I was going with this, interest only payments are payments that just cover interest. It doesn't advertise the cover principle, maybe they forgot to put an all due and payable date in there, which means those interest only payments would just go forever, right to eternity.
Tracy Z (11:42):
Now there would be a way to buy that note, but you would certainly want to know that upfront. Or perhaps it says in there that they gave the seller life estate so that they could continue living there. Or perhaps this buyer has the first right-to- refusal. If the seller decides to sell the note. Those are all deals that you can still do. You will just handle them differently and also price them differently. It is very important to read those documents because they are not always conforming to bank paper.
Next question, Are the real estate taxes paid current?
This is a basic question and easy to answer. You just go online to the tax assessor for the County where the property is located, this is something in almost all counties is available and now you can pull up and see whether taxes are current.
Tracy Z (12:32):
When you order a title this information will also tell you that, but don't wait around for the title. This is one of the very first due diligence steps that I do, even when somebody is just calling it for a quote. You want to talk about why it's so important to make sure real estate taxes are current?
Fred Rewey (12:48):
Because otherwise you're gonna have to pay them.
Tracy Z (12:50):
We always say taxes take lien priority over mortgages and deeds of trust. They get their money first. Real estate property tax is very important to know that those are being paid currently.
I know that there's extenuating circumstances and it can take a couple of years before they can go to tax, give a tax lien, go to tax sale and get a tax deed. You have time. But there are people who have lost their lien priority because of those taxes.
It also indicates the buyer's ability to pay. It's very important to know if there are escrows collected, reserves one 12 for taxes and insurance. The servicer should have been collecting those. A delinquent real estate taxes, it's time to start thinking about that. We also use that sometimes as a negotiating tool to the seller. If the seller doesn't realize that those taxes aren't current, you can explain that to them and maybe they can be deducted off.
Fred Rewey (13:47):
In most cases for the seller. When you tell them that they don't expect you to pay them unceremoniously, they usually take them out of their proceeds, which we've done at closing.
The next question is basically: Is the property insured for fire and other hazards?
These go hand in hand a little bit, because if someone is delinquent, if it's not service, if they become delinquent in their taxes, it's not uncommon for them to be delinquent in other things. The biggest one that’s next in line would be if they're insured the property.
Placing the property in insurance is important. We do have a story about property that burned down. When that property burns down, we're insured from the standpoint, it's our money on the line. And we want to get our money back out of it. So it's important that there's insurance on that property. We are the lien on that property. We will get what we're doing and then any remainders obviously for the person that owns the property. Definitely you need to make sure that you've got insurance on a property.
Tracy Z (14:42):
You definitely do. Look at the declaration page, it will show your buyer or borrower as the primary insured. Then it will show the lender, the lien holder as the mortgagee or, or lost payee. If there's more than one lien holder, they're on there as well.
Sometimes sellers on seller financing don't realize they need to do that. A lot of times you'll get the deck page and it doesn't show the mortgagee or the last payee. You need to get that added. After you close and you send over the paperwork, then you let the insurance company know that they need to change that to you, or add that to you. Whatever entity you used to buy the note. I'm shocked that so many people that are buying notes who don't check if the taxes and insurance are current. We, as Fred mentioned, have a story on that. It’s on our website at www.NoteInvestor.com.
Tracy Z (15:31):
Just look up “Burn to Learn”, you will see the whole story about it. We made a choice to close that note because the insurance was current but just lapsed because of the virus. It was supposed to get it right back on but it burned down over the weekend. That poor buyer lost their property. Of course, they're not motivated to make payments on a property. Normally they'd had insurance that would have paid off their loan, would have paid us off as the lien holder of the note investor, but it wasn't. There was a whole thing that we had to do to get through that process. But I'm telling you, it is a funny story now, in retrospect. Things like that do happen. So it’s important to insure your property.
Tracy Z (16:13):
All right, next up, Is there an updated title report?
You can get a title policy and then you can update it. If there's no title policy, you can get a new title commitment. You want to know that your buyer vested in title the lien and the mortgage deed of trust.
The person selling to you is the one that currently owns the lien. Because we've seen a lot of notes and mortgages transfer more than once. You want to make sure, just like the deed transfers title property, recorded assignments of deeds of trust or mortgage is transferred along with an endorsement of the note.
Please don't buy notes without getting an updated title report. I prefer title insurance. Some people are more comfortable just getting a report without the insurance, but definitely don't do deals without title reports. That's my opinion.
Fred Rewey (17:09):
Next one, keeping in line with titles, What is the lien position and what else is owed on the property?
This is very important for several reasons. If things go bad, it determines the order of which people are going to be paid back first. If there's a foreclosure, you want to be first in line because there's not going to be enough money at the end of the day. You want to get paid first.
Fred Rewey (17:48):
You don't have to worry from a recovering your money standpoint of the liens that are behind you, but you do need to worry from what's the status of this payer that liens are stacking up behind. Maybe they took out a second to improve the house. Hey, that's great. There's more equity. My first is sitting in a better position, but maybe there've been problems and people are starting to lien the property. That's just an indication that I could have a problem a little bit later, but you do want to make sure that you're getting the liens that you want. You hear a lot out there about people buying seconds, which means that they are behind the first.
Fred Rewey (18:29):
That means there's somebody in front of them. Take for example the 80, 10, 10, it means the payer got an 80% first mortgage. They had 10% to put down that left 10% in a second. Maybe the seller carried back a little 10% second. Well you have that, you can buy that, but you have an 80% first in front of you that has priority.
If something goes wrong on your note, or they stop paying, the only way to initiate a foreclosure, is to not jeopardize the note in front of you. Which means you have to pay that off. You have to take care of that. You have to make that note good or make payments on it if they allow that. You really have to take a look at that and understand what is the position you think you're buying? What does the paperwork show that you're buying or verify that you're buying? Then what do you want to do if there's other things going on?
Tracy Z (19:22):
Also you're looking at how much does that buyer or borrower have encumbered against the property. We talk about loan- to- value LTV. There's also something called CLTV, which is cumulative loan to value or combined loan to value. That's all the debts that the buyer owes against the property compared to what the property is worth. Because if people get underwater, meaning they owe more than what the property is worth. They don't have as many options because they don't have much equity and they're much less likely to continue paying if they hit financial hard times. Very important to know lear lien position and other liens on the property. It also affects you. If you're going to take a deed in lieu of foreclosure, even if liens are behind you, if you're in first position, that will also affect you. If you're going to take a deed in lieu foreclosure, you may still have to foreclose those out. All of that should work into understanding your purchase. Now we'd like to buy performing notes and we hope none of that ever happens, but you always have to prepare for the worst case scenario and know what your outs are. You need to have exit strategies. I recently did a presentation on 15 different exit strategies. Have all these different exit strategies and knowing your lien position is one step towards knowing which exit strategy is the best.
Tracy Z (20:40):
All right, next question. Who is the current holder or seller of the note being purchased?
We talk about the buyer, the payer, and knowing your payer, who's making payments. Are they gainfully employed? But another piece of that is who are you buying the note from? There are a lot of sellers who are great sellers and you buy notes from them maybe once or multiple times. And they are wonderful people. There are also sellers that are pretty savvy and they will not always reveal all the things that they should, which is why you perform your diligence. Or you might find out there was a contract for a deed seller that was unscrupulous and actually got in trouble with several States for taking advantage of buyers and not doing full disclosures. That doesn't happen very often, but it's one of those situations.
Tracy Z (21:35):
You should Google the name of your seller and just see if they have any litigation or outstanding problems that might carry over to you. Now, a title report can tell you that related to this piece of property, that security for your note. However, you might want to look at that seller if they are creating multiple notes in general. Just so you know, your seller and you know your buyer borrower. That is something that we didn't think about so much in the past, but now as people have gotten more savvy, that sort of thing is a very important piece of your due diligence to do a little bit of research on your seller.
Fred Rewey (22:13):
There is a question from the viewer. Karen just typed in Facebook, “when a note turns to non-performing (NP) and this probably across the country from you, how do you handle disposing of the property after foreclosure?”
It's a great question, Karen. Usually my first call is to a local realtor and depending on strategy on how much you have in it and what it's worth. But you sound like you've completed after the foreclosure aspect. I'm going to look for what a quick sale.
Fred Rewey (22:57):
Meaning, if this is a hundred thousand dollar property, but if you sell it for 80,000. Can I live with that 80? Yes, I can. Great. Let's do that. Otherwise, maybe I play for the longer strategy, which is maybe let’s fix a few things, try to get the 110k, 120k for the property, or maybe I listed for sale. I carry back another note if I like the property, but if I'm not scared from it overall, and I think, Hey, this is still a pretty good property. I got it back. I'm in at the right price. That may be your best strategy, you bought as a note originally maybe hoping to make it work out, maybe hoping that they would get their payments. They didn't, you took the property back. So unless there's something new that came up about the area or new that came up about the property, it might be a good idea. You know what, let's just take this opportunity to offer this for sale by the owner, get a realtor, help you there since you are at a distance. And just go with that.
Tracy Z (23:49):
One thing also, that's important about that question is when a note turns non-performing, then the first thing you've got to do is work with your servicer. If you have a servicing company and they will normally hire an attorney to start the foreclosure process. We like to try to do a deed in lieu of foreclosure, whenever possible. Some kind of cash for keys, and either you get it back through that means, or through an actual foreclosure. Which can take some time and energy and expense. That's why we like the deed in lieu of foreclosure. All that has to happen before you can start worrying about disposing of the property.
Fred and I just recently listed a property and we did the flat fee so we could get on the MLS. It was just a flat $299 fee. We offered to pay a buyer's agent, two and a half percent and well that we had access to them the less. It was a fantastic response without having quite as big of expense. We've also used Facebook marketplace to dispose of advertised properties, Craigslist was used to great, but now we see more action from Facebook marketplace. But if you're worried about the real estate agents commission, that flat fee can be good. I still think if you're long distance, a full service real estate agent is what we refer to.
Fred Rewey (25:04):
You're gonna want somebody to manage it for you. Great question, Karen. Thank you.
Next on due diligence dozen. Where is the original note and will it be delivered at closing?
This is really simple. The note is key. It's an original note. It was signed, it's not just a copy. It's not a Xerox. It's not a fax, it's not an email. The note is just as powerful as a check. It’s going to be an actual income. We've done the spit test where you kind of put your spit on there and make sure that it actually smears that it's not a copy, especially as copiers got better and better over the years.
Fred Rewey (25:46):
When I'm dealing with the seller, I asked if they have the original note? Is it in a safe place? It should be in their safe deposit box. Some people have it their attorney keeps it for them or it's an important file on their desk, wherever it is, they should have that. Will it have the ability to be delivered at closing? If it's not, then we can do a loss now note, affidavit. Where we have to ask everybody to sign a new note saying, “Hey, we all recognize the note got lost, but we all agree on what the terms are. And we're deciding on another copy.” They're going to endorse that note over to us. Then we're going to keep it and we're going to have that. You want to make sure that they have the original note and they are able to deliver it at closing.
Tracy Z (26:28):
This is another one of those things that I've found new note investors just don't even think about. You need the original because promissory notes are negotiable instruments. Original notes are very important. We're not saying you can never buy a note if it's lost but there are different steps that you need to go through.
This is one of those things. I'm really surprised people haven't keyed on more. I think now that it's becoming more common to have to present a note. If you have to go for foreclosure or something like that, that people are becoming more aware of it now. Sometimes you have to play the where in the world is the note game, especially with these sellers. We have a whole process of how we do that.
Fred Rewey (27:35):
We have a bonus question more on housekeeping. Christopher asked you, do you have these 30 dozen in a document? I could download some more or should I have been taking notes? I got two things for you. Christopher one is since you're on YouTube, if you skip forward to all those little blue bars that have been popping up, those have all the questions. Or in the next couple of days, what we'll do is time code this video, if you will look at the video description, you'll see them all right in there as well.
Tracy Z (28:04):
They will also become part of a blog at www.NoteInvestor.com/101, where we post all of these series.
Fred Rewey (28:11):
There is another question from the viewer, if the original note is lost and the buyer refuses to sign a replacement note affidavit. How do you resolve this?
Tracy Z (28:18):
Great question Christopher. The first course of action I would like to do if the original note is lost is get a replacement. Know about the borrower and get a lost note affidavit from both parties. If they don't, then I suggest that you talk with an attorney and find out in that state how tough it is to foreclose without the original note. Or if you know that seller, perhaps they can do some kind of indemnification as part of their affidavit. If you ever have a problem that they would buy it back. I don't normally like to rely on those. I like to know that we would be able to take care of the situation if we needed to. Some people do buy with just a loss note affidavit signed by the seller without a replacement note.
Tracy Z (29:07):
But it really does depend on the state. Whether you think you're going to have to foreclose or not. I mean, obviously it's a much bigger problem on a non-performing note than a performing note as well. That would be a case-by-case scenario.
The next question on due diligence dozen is, What is the current value of the property?
That's your collateral. What is the current value property? It's so important. When we talk about people, property, paperwork, what's the value of the property? Has it gone up? Has it gone down? Right now everybody seems to be going up and that's wonderful, but we lived through 2008. When we bought deals at 50% investment to value. And then they were a hundred percent investment to value because of falling value. Knowing the current value of the property, most of us will do some kind of analysis online.
Tracy Z (29:54):
Then most of us will order either a BPO, a broker's price opinion or a drive by appraisal to get a third-party validation. Now, if it's not local to you, you can't drive by it. That's why we use these third parties. There's all kinds of third parties that provide that service. They're not all created equal. You definitely want to do some of your own little research on comps as well. But get a reliable, local real estate agent or appraiser to give you an opinion of value. A lot of that depends too, how much you're investing. How much equity the buyer has.
Fred Rewey (30:26):
Next question is, How much equity does the buyer/payer have?
The more equity they have in the property, whether that occurred because the property value went up or it occurred because they've been living there a long time making payments for a long time. There's a lot of seasoning as we said earlier, however that equity has occurred, the more equity there is, the less likely you are going to have to foreclose on the property. Because in the event that they get into a situation where they can't afford the property, or they need to move, they're going to sell that property to gain some of the equity back themselves and cash and leave. The more equity equals a safer investment.
Fred Rewey (31:11):
This is also true when you start looking at products that fluctuate in price a lot. How much equity you want to see in something on a single family residence versus how much equity you want to see if it's a piece of raw land. You want to see a greater commitment. If I'm going to buy a note on raw land, I want to see a really big down payment, to know that they are committed to this land. That they're not going to walk away. Also, land prices can fluctuate a lot faster than a single family residence. Especially when we're looking at it in an economy that could go down. They don't go up twice as fast, but they do come down twice as fast. You’re just going to look and see how much equity is. One of those indicators is one of the things we talked about as far as credit and all the other stuff, but it's one indicator of what's going on in the property.
Tracy Z (31:59):
Well, that is what brings us to our last question in the dozen. And that is, What is the credit worthiness of the buyer. And are there any bankruptcy filings?
How do you check bankruptcy filings? Well, you can go to pacer.gov, and you can sign up to have a free account. They charge 10 cents a page for the data. That's one way you can see if they have bankruptcy filings for the credit worthiness of the buyer. Depending on the seller, they might have a copy of the buyer's credit report. They may not. You may have to do your own research as well if you're creating the note. It's a little easier, get a copy of the buyer's credit report because the buyer's involved and they can give that to you.
Tracy Z (32:43):
If you're working with institutional investors that you're referring the note to, you don't have to worry about this part because they will take care of that for you. When they are ready, they will do a soft poll on that payer's credit and check that as well. If you are buying for your own investment, then you're going to need to network with someone that has the ability to get this information legally as well.
According to the fair credit reporting act, the buyer's credit, how they paid their bills in the past is a very good indicator of how they will pay their bills in the future. Now, sometimes buyers get into a little trouble because of life circumstances but then they get themselves out.
Tracy Z (33:43):
Somebody only has good credit. But they've had some problems with medical bills, those sort of life-changing situations. That's why all of this comes together. When you're looking at these 12 questions, one question out of the 12, isn't a deal breaker. It's a balancing of the scales. If not a big down payment and that's a negative. Oh, but they've been paying 24 months. That's a positive. Maybe the credit's not perfect, but they put a nice 20% down payment. You're constantly balancing the scales because you're buying notes that may have already fallen out of some thinkers box guidelines. You're looking for the value where other people might not have seen it, but you still want it to be an investment that you can recoup if something does happen.
Tracy Z (34:26):
I always call it balancing scales. Just think about the pros and cons list. When I'm doing a deal and we will present it back and forth to each other, what are the pros and what are the cons? Do the pros outweigh the cons. Do they have offsetting factors? Because if you look at the list and it's all a con or negative then you get that's not a deal you want to do. You definitely have to understand what your outs are? What are your exit strategies and how you're going to make the deal profitable and what you're going to do.
Fred Rewey (35:01):
It's what I love about this business. We went over 12 things and let's just assume that all 12 of those things on a traditional conventional loan if one of those 12 does not hit whatever benchmark then it's done. I don't care if there's 40% equity in the property. You didn't hit this mark, so you don't get to do it.
That's why we're able to buy notes. That's why this industry exists. That's why roughly between 6 and 8% of all of all real estate notes or if you see me 6% of real estate transactions involved owner carryback financing. It's just what it ends up being. A lot of stuff falls through the cracks. There are good people that might have good credit, but they're self-employed, or just started their own self-employment. But they've got this big down payment. The banker is like, well, I don't care. There's no track record here. You haven't been employed long enough. That's what's great about this industry, all the offsets.
Tracy Z (35:52):
We love the note investing world. We're glad that you joined us here today. We'd like to encourage you to do a couple of things. If you want to learn more, you can go to www.NoteInvestor.com.
If you go to www.NoteInvestor.com/101, you can enjoy the Note Investing 101 series. You can also sign up to get notifications. We have a blog, a newsletter, a bookstore on all kinds of great information, over 300 articles. We have lots of good stuff. Of course we ask you to like, or share here on Facebook or YouTube. Hit the bell so you get notified when we go live.
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Happy Note Investing!
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