Saturday, May 12, 2012

Non-Performing Notes (NPN's) - Where's the money?

After a rather long and successful trip to China, I am back in the saddle so to speak!  I'm glad to be back and wanted to cover a topic that seems to be problematic for people new to real estate investing.  First of all, non-performing notes (NPN's) are non-performing to the financial institution that owns the note.  They can become a star performer for you if you know what you're doing and know where to find good ones.

First off, let's define what a non-performing note is:  It is a note (in this case we are discussing only real property but it can apply to other asset classes such as credit cards, vehicles, other debt etc.) on real property that someone is either not paying according to the defined agreement with the lender and/or the value of the property is LOWER than the current unpaid balance (UPB) of the note.  If the value of the property is less than the UPB, and the property owner is paying as agreed, this is still considered a non-performing note to the lending institution.  

In many cases, in today's economic climate, the property value is lower than the current UPB.  Because lending institutions are hampered by the number of non-performing loans they have on their books, they are in various modes of motivation, interested in selling these notes to investors to "clean-up" their books and will sell for a discount in many cases, especially when they know that the property value is far below the UPB.  This is an excellent opportunity, but you need to understand the financial institution's level of motivation before placing an offer.  

Ideally, going direct to the source is the best option, but this requires extensive marketing, and relationship building.  Can you afford to do that?  Do you have or will you make the time to develop these relationships?  Regardless, you will need to develop relationships with individuals who can assist you in obtaining lists of non-performing notes in states and cities that you are interested in doing business.  These can be remote, or can be in your own backyard.  The financial institution doesn't care where you live, they only care if you have the cash to close.  You have to care whether you can make money on the deal, so do your homework and understand the market you're going into, the lien position of the note (ideally, first position), the underlying asset current market value, and depending on your exit strategy, understanding the background of the borrowers credit rating.  So make sure that you have your financial backing in place prior to jumping in these waters.

Identifying a good note for you requires as mentioned above, an understanding of your market, the neighborhood, and especially current comparable property value.  Do yourself a big favor and do NOT use BPO's (broker price opinions).  An opinion isn't worth the paper it's not written on. Get real comps based upon criteria YOU input.  Find a great source and use it.  That could mean using proprietary software and/or getting them straight from a broker / agent source that you've developed a relationships with.  It's up to you to make the decision on how to best get this information.

Once you have determined a motivated source for the purchase of non-performing notes, you do your comparable / financial analysis of the underlying asset, you now have an idea of how much the property is worth.  Clearly you want to buy the NPN for well below the property value.  You must know your exit strategy before buying.  How will you dispose of the note once your purchase it?  You have to know that going in, not afterwards.  You have choices of exit strategy.  If the current owner is paying as agreed with the bank but the situation is that their property is worth less than what they currently owe, you can make the note performing by negotiating with the existing property owner to reduce the loan amount to them....for example:

Current UPB:                          $150,000
Current Market Value of Home: $125,000
You buy the note for:             $  50,000

You negotiate with owner to agree to pay say $90,000 on a new note instead of the original $125,000.  Why?  Because this is a win-win....The owner of the property now has a performing loan on their property (as long as they pay as agreed).  You have done them a favor, right?  Yes you have, but you've also helped yourself.  You can then sell this note to another investor for $70,000 for example, and pocket the difference ($70k - $50k (amount you paid originally) = $20k).  You have sold a $90,000 note for $70,000 giving the buyer of your note a $20k equity kicker, plus they can now collect monthly P&I payments (principal and interest).  You win, the property owner wins and the investor who buys the note from you wins. Of course there is more due diligence involved, like understanding the condition of the property, the borrower's credit history etc., but you get the idea. 

This is just one way of exiting the deal.  There are other options that we will discuss at a later date.  There is no such thing as a loss of money, only a transfer of wealth....stand in it's path and collect your share.  Until then....carpe diem!


  1. Alex, I am curious what you think a reasonable time frame would be to do your due diligence on a note package of around 100 nonperforming notes if all the documents are in place for review?

    1. There is no right answer because it depends if you're talking all residential, all commercial, or a mix. Also, it depends on the geography because if they're scattered all over the country in different cities, due diligence is going to be a nightmare to verify physical inspections and true values. I know that's not the answer you were looking for but it really depends on your business's infrastructure in being able to do the due diligence correctly and the mix of asset types.

  2. I feel you are too good to write Genius!Thanks for posting, maybe we can see more on this.
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