After a flight from Dallas, TX to my home town Reno, NV, I stood up in the plane to leave when a lady sitting behind me said, “I know you.” I looked at her for a moment trying to place her in my mind and responded, “Aren’t you Saprina?”
In the late part of 2014, Steve and I started to become interested in non-performing notes. At first we wondered if we could buy non-performing notes in first position and turn them into Rent to Owns for our fund, ROI Strategies. It all started when I attended a very large convention in Orlando, FL, put on by a self-directed IRA company. There were multiple vendors, speakers, contacts, and networking opportunities at this event, all of which exposed me to new ideas. One of those ideas was buying non-performing notes.
Following that event, Steve and I went to some note conventions. One happened to be in Dallas and another was in Las Vegas. In Las Vegas, we met a person that had a company buying non-performing notes. The company was looking for people who were interested in learning how to buy notes and perform the workouts.
After spending a few hours with this person, we decided to join the group and pay the $5,000 fee it required. We travelled to San Diego to attend our first meeting and to learn everything we could. Well, to say the least, it was not very impressive. This company turned out to be full of neophytes in the notes industry and they were certainly not what they had previously represented to us. We went as far as getting a tape (a list of notes) from them, and we were ready to spend $300,000 of our own money and one investor’s money who agreed to be part of it. It was not going to happen. Not only did we not know enough to be successful but we had decided that our main business of Rent to Owns needed all of our attention. We also thought the group in San Diego was going to be a lot more experienced and be able to walk us through our first purchase, which just wasn’t the case.
However, that was not the end of notes. For the rest of the year, we continued to learn more and more about them, keeping the idea on the side burner while we ran our Rent to Own fund and made significant strides with the non-profit we work with. One of those accomplishments was being able to buy a family’s home through a short sale, rent it back to them so they could stay there, and then repurchase it in three years. We are very proud of that achievement and how it is such a win for those families.
While our Rent to Own business still occupies a great portion of our time, it is much more self-operational than ever before. That gave us additional time to research notes for a possible second fund.
During our time in San Diego, there was one shining star in the room. This person was a hired gun to help with the workouts of these notes and had done millions of dollars’ worth of them. In addition, she was very well respected within the industry as well as by us.
It just so happens that this was Saprina who was sitting behind me on the plane. I asked her, “What are you doing here in Reno?”
“I live here for two weeks out of every month,” she replied. What? She went on to explain that she no longer is consulting for the company in San Diego but working full time for another company here in Reno. She is helping to grow their successful existing business through the servicing and workouts of non-performing residential notes.
We made plans to get together again because we were still interested in buying notes but hadn’t found the right venue and partners to work with yet. We met a couple of days later with Saprina and the owner of the company, Ron Happe. Ron is a very successful yet humble business man, who has been buying and selling notes since the early 2000’s.
Fast forward a bit after hours and hours of meetings with Ron and his team. We are moving forward with our second fund, Assuravest, LLC, in the purchasing of second position non-performing residential real estate notes. We decided on seconds instead of firsts because that is where the returns are without adding the commensurate amount of risk.
You see, buying second non-performing notes is an exercise in statistics. If you buy one, two, or five it is like flipping a coin and hoping tails doesn’t come up too often. This is a bad move because tails could easily come up five times in a row. The diagram below roughly demonstrates my point for how notes distribute along a bell curve.
Some of these notes are going to be goose eggs. That is, a big flat zero or 100% loss. It just happens and is not preventable. Some are going to be home runs. We might purchase the note for $9,000 and get a $100,000 payoff. However, both of those are the outliers. You must consider everything in between the goose eggs and homeruns, so let me breakdown a typical second non-performing note that has been converted back into a re-performer. A re-performer is a note where the homeowner has agreed to new terms and is making a monthly payment.
A typical 2nd:
- Unpaid Principal Balance (UPB) – $76,400
- Arrearages – $33,000 (amount owed for penalties, interest, and late fees)
- Total Owed – $109,400
We purchase that note for $9,145.
After the workout, the note becomes re-performing and this is the typical outcome:
- They pay us $4,950 in arrears. The rest is forgiven at some point based on their future payment reliability.
- Monthly payment of $475 at a 4.75% interest rate with 215 payments remaining.
- Once that note is re-performing, it becomes much more valuable as an asset. It can then be resold on what we would consider the retail market to an investor for a 15% yield, or $35,371.
We get asked all the time: Why would they start paying again on the note they haven’t paid on for years? The answer is “emotional equity” and for some they haven’t had the opportunity to do so. They still want to live in their home and we have the right to foreclose on them if they do not start paying on the note again. However, a foreclosure is really just a strategic move to get them to start a conversation with us on how we can work the note out.
We have a secret weapon to get the conversation started that no other note holder can provide. That secret weapon is our Short Sale Repurchase program with our Rent to Own fund. We can immediately start the conversation in a way that will help them stay in their home. We purchase their home through a short sale and they can buy it back in the future.
They are not used to the note holder saying, “Let’s look at your financial situation and work something out that will be acceptable for the both of us and will keep you in your home.” Once we get that conversation started, there is a substantial amount we can do to help them stay in their home and start re-performing on the note. In the traditional world of notes and mortgages, the lenders are not interested in working these out. That is why they sold them off, which makes it a huge win for us!
Remember, we purchased this typical second for $9,145 and they owe $109,400. There is quite a bit of room to make it work for them and our investors.
So what is “emotional equity”? It is the family that has been in their home, taken care of it, loved it, is attending church down the street, has kids that are going to schools nearby, and likely kept their neighbors and family in the dark about being behind on their payments. They want to stay in their home any way possible. Perhaps one of them previously lost their job and went through a trying time, but now they are back at it with a new job and ready to move forward.
Whatever the reasons and however they arrived at this place in life, they want to stay in their home. Now remember, I told you that this was an exercise in statistics. You cannot just buy five notes and hope one is a homerun, one is a dud, and three are typical. Statistics do not work that way. You could flip the coin five times and get five tails in a row. The way you protect yourself is to buy millions of dollars’ worth of notes so the odds work in your favor. For every million dollars, it buys approximately 109 second non-performing notes. At that point you have some volume working for you.
I don’t want you to think that all notes are duds, homeruns, or re-performers either. They are not. In fact, the easiest way to explain the breakdown of what happens in general is by the chart below. History has shown that the portfolio breaks out in this manner.
- 36% Sale of Re-Performing Notes: We have worked out a payment plan on these notes and they have been seasoned anywhere from 3 to 24 months, proving they are re-performing before being sold off. While we are waiting for them to be fully seasoned, we are collecting the monthly payments, thus increasing our return on those notes.
- 11% Discounted Settlement: When a borrower offers to pay something for the note to pay it off. In general and on the conservative side, we will receive a 30% premium on what we paid for the note. What we accept depends on the situation and the time frame we have held the note.
- 15% Sale of Non-Performing Notes: Occurs when we will sell some of the notes we purchased directly to others for about a 20% profit without working on them.
- 8% REO (real estate owned): We have foreclosed or assumed possession of the home. We may be able to rent it out or sell it.
- 9% Short Sale: When the borrower asked us essentially for a discounted settlement but usually they are not staying in the home. On those we receive an average of a 50% premium.
- 3% Homeruns: When the borrower wants to sell their home and move on, usually paying all or a majority of the total owed in order to do so.
That leaves 18% that are not worth anything (or at least not right now). We call these the ones “we put in a draw.” A great majority of them will never be worth much or possibly anything. However, we put them in a draw because, while we are not working them, they are still a lien on a piece of property. Someway, somehow, some of those will come back to pay-off in the future. Not all is lost.
Be aware of the difficulty of breaking down all of the scenarios into one number or average. Many things take place along the way that affect the outcomes, but now you have a general idea.
What does this all mean for you, the investor? We have another opportunity for you to part of. This fund will officially open in February of 2016. We have a special offer for our existing investors within ROI Strategies, our Rent to Own fund, and they will get the first rights to invest. After that period of time we will open it up to other accredited investors.
If you are interested in finding out more, please contact us at Investing@HughesCapital.com or call (775) 297-4977.