Be The Bank

016 - It Depends!

August 10, 2022 Justin Bogard Season 4 Episode 16
Be The Bank
016 - It Depends!
Show Notes Transcript

Be The Bank S4 Ep16 - It Depends!

On episode 16 of season 4, Justin Bogard  breaks down valuing a loan and the post purchase items to be aware of!!

Key Takeaways:

  1. Grading Scale for Valuing a Loan
  2. Skin in the Game
  3. Don't forget about the Expenses

Resources and links discussed

About the Host

Justin Bogard – Note Investor specializing in performing Residential Real Estate Debt. He finds deals and acquires them for his own portfolio as well as educates investors while walking them through the process of owning a Real Estate Note!

Connect with the Host:

Narrator:

Interested in real estate. How about wealth? Well, they go hand in hand and here you'll learn all about it , about it. Welcome to be the bank, a podcast where we discuss and debate the topics centered around real estate. Investing your host, Justin Bogar shares insights into investing in real estate to create real wealth and passive income for you and your family. He'll share stories of real estate investments done, right? Walk you through the process of owning a real estate note. And most importantly, educate you so you can be the bank , your bank. This is be the bank brought to you by bright path notes. Now here's your host, Justin Bogar.

Justinn Bogard:

It is episode number 16 today, and we're gonna be recording our episode for you discussing the process of owning a real estate note, diving into specifics on kind of how I look at due diligence, how I bid on an asset and what happens after you purchase the asset and what are the processes and the steps that you have to go through . You may be surprised to find out it's a little bit more work than you stay tuned. This episodes brought to you by Welcome back. I'm your host, Justin Bogar today. And I am flying solo again today for episode number 16, brought to you by bright path notes. Like I said, in the opening package there, we're gonna be discussing the process of owning a real estate note. We haven't hit on this topic very often throughout, in many seasons we've had of this podcast. So let's just go ahead and get kind of granular with it. And every note investor has their own way of looking at a deal has their own way of underwriting a deal and has their own way of how they value a deal. There are very common traits between us as note investors, and we look at a deal to make its value to come up with a , with a magic number here, I'm using air quotes. For those of you that are listening to this podcast, I'm also streaming the video of this on our bright path notes, YouTube channel. So go , please subscribe, excuse me to our YouTube channel and go check that out. So I'm looking at a deal couple different ways. I could be buying a deal from a private individual, which we call a seller financer , and I could be buying that note from them. So they're more of an unsophisticated seller. I could be buying it from a sophisticated seller who would be kind of an institutional seller, like a hedge fund or a bank manager, or just a larger lending corporation that does this as a full-time business. And they may not have thousands of loans, but they may have, you know, 20 5,000 loans, couple hundred loans. And so those are the differences between the two types of sellers that we would go after. So we're going to talk about specifically a seller finance ear . This is an individual that tried to sell their home the traditional ways through real estate and they were unsuccessful. So they typically have sold their home via seller financing, and that's where they carry back a mortgage for the , the buyer that has bought the property from them. So they actually become the bank and they sell the property and they step back and I just have a lean on that property. So when I look at a deal like this, I'm obviously kind of vetting the seller, right? I'm discussing with them about the attributes of their note. I'm really diving into the specifics of the property, what they have put into it. If it has a new roof or a new HVAC system or air conditioning, water heaters, just talking about what kind of value have you put into this since you sold it to said borrower , and then really diving into the borrower . We asking questions like, do they have a full time job, right? Do they have a good credit history? Did you run credit when you sold this home with them ? Do you even have their social security number? Do you check, did you check their income to verify kind of what they have coming in and can they afford to make this payment more than likely the seller of the property? And it actually is state specific. We found that certain states people do a pretty good job of underwriting the borrower in general. And in some, in most states, they actually just kind of, it's almost like they fly by the night, right? They, they just find somebody off the street. They're like, yeah, this is kind of a buddy deal. I'll give you the zero down 0% rate. I mean , we've seen some pretty extreme notes like that. So we have to be careful. So my radar kind of goes up when I'm getting this story from the seller. When I'm hearing about the property, I'm just listening for details. I'm listening for things that may add value to the price, or may wanna decrease my bid on that property, on that loan, excuse me. So I'm talking with the seller, I'm gathering this information, I'm writing it down, I'm compiling it together and I'm just evaluating it , right. I'm looking at the property value of what I perceive the value is based on local comps that I see in the area. If I have a realtor run them for me, or most likely I'm going online and just kind of looking at several different websites and looking at what the account assessor says, the tax value is of the property and getting a good idea of what possibly the , the selling value is on it. There are some good resources out there like realtor.com. And if you do have a real estate license, you can get on the RPR website. And that way you can find out an automation value, as opposed to just a, a standard value online, like a Zillow, it's gonna be totally different. So if you can see some comps out there, you can get a good idea of what a property's worth, especially if you've been in real estate for a while . What we like to do is on these lower price point properties, let's say they are lower than, I don't know , $125,000 in home value. We're not gonna find a lot of comparables with conventional financing in that area. So comp will be a little hard to find if we use a traditional, we also realtor let's say to go after and look at at different properties, more than likely those properties are bought by investors with cash and not a lot of conventional financing. So what's hard for us as a note investor sometimes to evaluate the value. But what we do have on our side is that there should be a lot of rentals within a radius of that maybe a mile or two that can give us a good indicator as to the square foot , uh, per rent price there that we can come up with kind of what we think a net operating income is. And then we can back into a number to find out what could we sell the property for based on a net operating income, and also understanding the capitalization rate of that specific area. So we can get pretty scientific with it if you will, but all in all, it's kind of a gut feeling. And if you've invested in the Midwest and these lower price band properties, south of $125,000 , you kind of get an idea of what they're worth in certain areas. If you go to Jackson, Mississippi, for example, you're probably not gonna find very high values , um, for properties there versus going to a Midwest area, but maybe a little higher valued in the Midwest. And, oh , I don't know what's to say , uh, somewhere on the east coast where the properties look the same as they do, maybe in Jackson , Mississippi, but the price points are a little bit different. So maybe a $40,000 property in Ja Jackson, Mississippi, sorry, I'm picking on you, Jackson, Mississippi, and maybe a place in New York is probably worth, you know, another a hundred grand more, but it looks like exactly the same. It just kind of depends on where you're at. So you kind of gotta know the area where you're investing. So we invest kind of all over the us . There are certain states that we kind of stay away from just because we know the foreclosure time period is a lot longer than when we want. So if we have our money out for an investment, especially a performing loan, and it goes south on us, we kind of don't wanna have to wait two or three years to go through foreclosure, unless we're just getting a heck of a deal. Now we will buy non-performing loans in those certain states, but the deals gotta be really sweet because if we're gonna have our money out there for a very long period of time, man , if we're not getting cash flow on it, I'm gonna get pretty impatient right. To, to not see a return for a couple years. So it better be a pretty sweet return over that time period. So needless to say, we kind of shop in the Midwest areas in the Southern states and we do go out west a little bit. We've shopped in California, we've done an Arizona. We've done Oklahoma and Texas, obviously. Um, so, so gimme get back to the story about the seller. So we're gathering all this information from the seller and we come up with the value, right? So I said the property value is one thing that we look at, we look at what is the borrower skin in the game ? Did they put down a S sizeable down payment? Did they do a , was this a least option to where maybe they paid rent for a year or two to help with that down payment? And then they bought the property with solar financing. Do they have equity built into it? Was the house worth a lot more than what they have a loan for, which would mean they put a dime good down payment. If they didn't put a sizable down payment down there, do they have a long pay history? Now a long pay history to me would be probably 24 to 36 months would be a sizeable , uh, pay history if it's less than 24 months. And they have a very low down payment, you have to consider that deal a little bit risky because the borrower doesn't have a lot of skin in the game just yet. But if they put down a sizeable down payment and they have a little bit of a pay history , well, then that, that mitigates some of the risk rep there. So that, that, isn't a very important factor of that. And also, how is that pay history being paid? Is it being paid on time? Meaning are they going to not go past their grace period every month? Are they going to skip payments? Are they going to catch back up after 60 days and then do it all over again? Like what is their habitual routine as they pay? Because sometimes we're okay with they pay late if it's due on the first of the month and they pay on the 28th of the month every time, but they hit it like clockwork. That's okay with me. We'll buy those loans. That's okay. As long as I see some consistency and that pay history tells me the story of how they are paying. So that's kind of crucial for me cause we got the property value. We got their skin in the game. We've got how they pay and their pay history. We also wanna look at the terms of the deal. So is it a very low interest rate loan, like a 0% ? Is it a high interest rate loan , like maybe a 10% interest rate that'll affect weigh in on my calculation? Is it written on a land contract or what we also call a contract for deed to where it's an installment sale or is it on a promissory note and mortgage, a promissory note deed of trust, depending on what state you're in, what type of instrument and did they actually create the document themselves, the seller that is, or are they using a title company with in-house counsel or did they use an attorney that is real estate specific to draft that document? Oftentimes we look at these documents and they're like a one page document for the mortgage. We're like, there is no way that you can fit all the language in there that you need to on a mortgage. It's actually really simple to go to the Fannie Mae website or Freddie Mac , and you can actually download their templates and be state specific for a note in mortgage or a note indeed of trust . And they also have assignment of rent clauses, and they have , um, for just about any state out there, they can do different types of arms or different types of amateurization or, or when they , when they skip interest rates and they, they have step interest rates. I'm sorry. I mean, there's lots of different things that you can do as a seller. So that's kind of where we come up with the value of this loan per se, when I price it. So maybe the under the, excuse me, the unpaid principal balance might be $50,000 on this loan that I'm looking at today and the value of the house . Let's just say it's probably worth $80,000 today , but I'm looking at all those factors. So I might be willing to pay closer to $50,000. If some of those factors are really strong, like they had a sizable down payment and they had a great pay history showing consistency and the interest rate was kind of high and the term was shorter and it was written on a good instrument and it closed at a title company. Like all those things say, yes, this is a strong, really good loan . And if they underwrote the borrower and they got specific financials and just really ran their credit and looked at the ability to pay all those things will say, yes, I'm willing to pay more for this loan because it's less risky for me in the long run to have this performing loan. And I feel confident that it's going to perform in the future and really not have any problems. So if any of those factors are what scare , 'em on a scale of an a to F and if any of them are an F, sometimes you can get away with a really bad , uh, value and one attribute of that loan. But if the rest of them are BS and A's, that can mitigate some of that. So there's about five, six, seven, eight factors. You can call them in a note that you can value it. And that's kind of the scale that we use when we look at a note. So people often ask me, so what Justin , what will you, what range will you buy this note at? And be like, it depends, right? The famous answer. It depends. It really does depend. There's a lot of things that go into it. So it isn't really a boiler plate answer or a range that we can buy loans at. And it also depends on your cost of capital, is this in your retirement account where you can set it and forget it and just put it on the shelf. And you don't have to worry about making a monster return as a note investor. Is this something to where your cost of capital meaning the lo money that you have to buy this long one ? How much is it costing you? Is it your own money? Is it borrowed from somebody else? Is it borrowed from a bank? Is it on a Helo ? Like what, what is that cost to capital? So all those things will also weigh into your calculation. Long-winded answer, right? I know, but these are all the things that note investors have to think about. Once you start buying, a lot of these loans is you really have to get granular on the expense of owning a note. The expenses can be your loan servicing fees. That'll be a monthly expense that you have just to be having the loan being serviced. There could be an escrow charge on top of that from a loan servicer. So it could not, there could only be a monthly fee. And then also an escrow fee, there's also set up fees with it. There's also due diligence that cost you money. Meaning you're gonna have to get a title report somehow, whether it's from a title company or whether you're ordering a title search from a national company, like what we do from pro title . And you can look up, I think it's, ProTitle usa.com I believe is the website. So that's a cost right there. There's a cost to have somebody drive by and take photographs of the property . Because if it isn't in your backyard, you need to see that property and get your eyes on it. Whether it's through the lens of somebody's camera or you physically get there to look at it, you need to be looking at the condition of it to make sure that it is actually the address of the property that you have the security with the loan that you're buying. There are times where people have been swindled into buying a loan and looking at the property and the property is the wrong property that someone gave the pictures of. So you always do an address verification when you do this , uh, property, we call it exterior inspection. We have somebody drive by , take pictures, look at it, say, there's any damage in there. They'll isolate a picture specifically to that. So we can take a look at it and see like, yeah, we can deal with that. Or, oh no, that's gonna be a problem. We better, we better mitigate that risk in our price. So all those expenses are going to weigh in my calculation as well, that that's not gonna be a , a thousand dollars in expenses, right? But it's safe to say you could have a couple hundred dollars in expenses, maybe up to $500 . In our case for being a larger note investor, if you will, we're gonna have expenses to hold the collateral of this document. We're gonna have expenses for somebody to audit our collateral file, to record the documents, to fix any errors on those documents and then resubmit them to counties and have the mailing charges for all that. So, so we have an idea of what that expense is. And so we calculate that into our number. When we're happy with the number we want, then we, then we also subtract out those expenses so that when we actually purchase the loan, our net net , as we call it, our net return is exactly what we want to be. And so our portfolio will show us exactly what we should be making. So when we're doing our accounting, we take out those expenses. So we can look at that stuff. So I got pretty granular with you on that, but I think you have an idea of why you have to be very careful and why you want to know your numbers. As my previous cohost, super E would always say, you need to know your numbers. Well , when you get in a note business and you buy several loans, you need to know your numbers as well and understand are you really making the money that you think that you're making? And oftentimes that you're not, cuz you're not considering all the expense of it. Now with that in mind, after you buy a loan, there are things that you need to be aware of and there's things that you need to monitor. And there's things that you need to keep track of. And we U utilize a lot of vendors to help us with that because quite frankly, there's a lot of things with the loan. If you want to be , uh, very cut and dry with it and make sure that you are on top of the entire penny, that you're going to be receiving in profit there's things that go into it. So we have people that help us monitor for taxes, because once you have several loans in different states, you may not remember that in Indiana, we have taxes due on May 10th and November 10th, right? Some states you have taxes that come up three times a year. There could be a village tax. There could be a summer and a winter tax. There could be a municipality, certain municipality tax. Um, there's just different states have different things. Sometimes it's one time a year. Sometimes it's multiple times a year. Sometimes a township has their own tax. It's just, you need to know those things. And we just use a vendor in order to do that. And most of the time, our servicer is our vendor. That kind of monitors that for us, there's an expense too . The insurance is something that's often overlooked, but note investors after you buy a loan is that you need to make sure that the endorsement or the mortgage E on the insurance policy is changed to your new entity's name, whether it's in your retirement account , uh, hopefully you're not doing it in your personal name. You can, but we recommend that you always shelter this stuff inside of an LLC or something like that, just to give yourself some protection and your name's not really gonna be out there on public record . So that endorsement change on the insurance policy really needs to be updated as quickly as you can. So that God forbid, if something happens to the home and they need to pay off the mortgage on it, then you wanna make sure that that check comes to you or your servicer. So when you're working with your servicer, you , you wanna know , uh, exactly how do they want that endorsement language to look like? Typically, it's gonna say your company name and then care of your servicer with your servicers mailing address. Some servicers want just their name on it. Some servicers say, just put your name on it and your address. And some servicers want a blend of that as well. All of it is fine and you're guaranteed to get that money. It's just up to your servicer, how they want to handle it. And again, sometimes our vendor on tracking the insurance is our servicer as well. We just pay a little extra for it so they can track that and they can monitor it. And then if the loan does , um, miss it , or I'm sorry, if the borrower misses paying on the insurance, cuz sometimes our loans are not escrow. Then we wanna make sure that boom instantly we're getting a force place policy on there. So we're not even losing a day of downtime as far as the property not being insured, cuz it doesn't happen very often at all. But there have been cases and out there that note investors have mentioned about, you know, the property just got destroyed and I realize that the insurance lapses on it and there's nothing I can do about it. You don't want that case to be you . So you wanna have a good process in place. So this is why I'm drilling down today and talking to you about, you know, how we price a property. I'm sorry, how we price loan . Right? And then also when you're taking care of the loan afterwards, there are some things that you want to keep, keep in check. So like I said, the servicer can be, you're saving grace and they can take care of a lot of those headaches for you and manage that process. But sometimes you kind of wanna do it yourself depending on how many loans you have. So let's talk about that for a second. So the cost of a servicer sometimes can outweigh really what the principle interest payment coming in is. For example, if you have a $200 payment coming in monthly for a Newton mortgage or a land contract that you have purchased and your servicing cost is $50 a month just to service alone . Well , wow, your net price coming in is $150. That's a big chunk of change, right? That's a big hit onto your return based on that. Now, if the principle and interest payment monthly coming in is a thousand dollars and you're paying $50 in loan servicing fees a month, that's not that big of a hit, right? It doesn't make that big of a dent in your return. So the lower the payment is the more aware you have to be of your costs because it can chew into your profit a lot heavier and a lot quicker. So when we look at loans, sometimes we overlook loans that are really less than 200 $5,300 because our servicer cost may be so much that it doesn't make sense to really get that loan. Or we have to buy the loan at such a big discount to mitigate that servicing fee that's coming in. And oftentimes we can't get the deal because of it. Now we do have different servicers that cost a little bit differently. We have 'em from anywhere from 18 to $50 a month, different servicers and different programs that they have. So we can mitigate some of that and push something to a cheaper servicer to offset that. And we do do that at times cuz we, we do get payments coming in as low as $250 a month , uh, in the rare cases. But we have to keep that stuff in mind, right? And then when a loan becomes, non-performing obviously they're going to have a higher servicing cost more than likely. There is one servicer we have that doesn't really change their non-performing price, but most servicers they will, they will charge you more because honestly they had more time into the deal. They're gonna have to contact the borrower a lot more. They're gonna have to stay on top of the regulations on when they can to contact them. They're gonna be sending them out late notices and late letters and demand letters. And then foreclosure letters, lost mitigation letters. Like they have a whole set of procedures and processes that they have to follow in place and make sure their timeline is not too early. Cuz the borrower has the right to get time to get their stuff together, to respond back to that. Uh , what's call it kind of a , a light litigation if you will . So that's kind of the process of owning a real estate note. This podcast today is not meant to deter you from doing it. It's just meant to be realistic. So if you're trying to be a note investor and being full time in this and run your own business and also if you have a lot of money and you wanna invest in notes, these are just things you want to be aware of. Now you probably figured out about the expenses and you probably are understand how to analyze that already. But some people just don't UN realize that until it's kind of too late and be like, oh yeah, I bought that loan. I forgot about the servicing expense. I forgot about the due diligence cost and, and they kind of wanna make it as simple as I wanna make a 10% yield on this. And so whatever my calculator says is a 10% yield. Well, that's what my price is gonna be. Well then they're gonna be really sorry. When they find out that they spent a couple hundred dollars in due diligence, they spent a couple , maybe a hundred dollars in recording fees afterwards and maybe they have a $30 servicing cost every month with a hundred dollars boarding fee that they didn't calculate. So they could have three, $400 tied up in that asset pretty quickly. And if it was an asset that was less than $30,000, well that's really gonna chew into their profit and that 10% yield they thought I had, maybe it comes down to a 7% yield. So we just wanted you to be aware of that. We want you to keep that in mind when you're out there investing, I'm happy to discuss this with you. You can always reach out to me. You guys know you can get ahold of me@justinatbrightpathnotes.com . And this episode number 16 is brought to you by bright path notes. Do not forget to check us out on the bright path notes , YouTube channel and subscribe to our YouTube channel. We really wanna get those numbers up and you can see a ton of great videos on there. Videos just like this podcast and all the podcasts we've done before this as well as our monthly broadcast as well. So again guys, I'm Justin Bogar a company is bright path notes. This episode is brought to you bright, bright path notes, and we will see you on the next episode.

Narrator:

Thanks for listening to feed the bank. We hope you learned something from today's show. If you enjoyed this episode, please rate and review us. Plus check out our bright path notes channel on YouTube and follow us on Facebook and Twitter at be the bank and on Instagram at be the bank podcast. Be the bank is sponsored by bright path notes . Thanks again for listening.