“Notes/Paper” by Bob Leonetti

Have you ever wondered why the banks have the big tall buildings downtown with their name plastered all over the top?  The answer is simple:  they make real estate sized profits without ever owning the property.  Another way to put it is, he who controls the equity, controls the property.

Put another way, if a lender loans $100K on a $150K property and for some reason, the payer stops paying, then the bank can repossess the property through foreclosure, and they now control not only what is owed them but also the $50K in equity!  Pretty sweet!  Ahh…but there’s a catch.

Banks got greedy in the early 2000s.  (This author knows, because he was once a CEO of a publicly traded mortgage bank, and speaks from experience!).  They took risks they should never have taken, including making high-risk loans to high-risk borrowers.  And when the real estate market collapsed, they were left holding the bag.  Now, because they loaned more than the properties are currently worth, they are faced with TREMENDOUS losses, with more and more properties going into foreclosure every day.

How does this affect you, the real estate investor?  And what does it have to do with notes?

The answer is pretty simple, keeping in mind two things:

1. When a person stops paying on their mortgage, the note becomes non-performing.
2. Banks/lenders sell non-performing mortgages every day, at a loss, to private individuals and other institutions.

There is a LOT of money made every day in the trade of mortgages, both performing and non-performing.  And that’s what a “note” is:  the promise to pay back the lender.  It’s the I.O.U, the evidence of the debt.  And in real estate, it is all secured by a lien against the property called a mortgage or deed of trust, depending on the state you live in.  This document gives the lender the right to take back the property if the payer stops paying.  A very easy way to describe this document is:  you don’t pay…you don’t stay. And when one talks about paper, it is the trading/selling/buying of both the note and the deed of trust.

Let’s look at FIVE examples of how people make money with paper:

Pretty Paper: Sometimes when properties sell, the owner has to offer seller-financing because the buyer couldn’t qualify at a lending institution.  This gives the seller a note (receivable), which is an asset, because someone owes him money.  And just like any other note holder, he hangs on to the I.O.U. and records the accompanying mortgage at the county recorder’s office.  Here’s the cool part:  he can sell that asset, getting cash in turn for assigning the cash flow to someone else.  All you need to do is find these note holders through public records, gather some information about the note and the transaction, and sell that note to an institutional investor, who may be found online.  They pay one price; you offer a lower price to the seller and you keep the spread.

Short Paper: You’ve most likely heard of a short sale, where the bank takes less than what it is owed when the property sells.  In other words, if the bank is owed $100K and the property only sells for $80K, then the bank reserves the right to take +/- $80K to satisfy the debt.  And while short sales are very popular in today’s economy, they are saddled with regulations and onerous delays, often taking as long as six-months or a year to complete.

Now imagine that instead of dealing with a short sale, you buy the note directly from the bank.  YOU become the new banker!  YOU give the short payoff!  YOU pay less for the note than the payoff you give to the new buyer! And this means that you get a huge profit without ever owning the property!

Ugly Paper: Have you ever wanted to go away from the crowd and create your own business?  What about creating your own REOs without any competition? It’s pretty simple, actually.  Because the banks have a lot of non-performing or bad debt, they would rather sell it off than complete the foreclosure process and end up with a property on their books.  You step in and buy the non-performing note.  You also get, as a condition of closing, a deed-in-lieu-of-foreclosure.  There is no competition for the note, and when the dust settles, you now own the property for literally pennies on the dollar.

Creating Paper: The market is fairly slow right now, hindered by many buyers’ inability to get a traditional loan because of tightened banking guidelines.  Wouldn’t it be great if, when you sold the property, you could offer seller financing and then…sell the note and still get cash??? One of the little known secrets of paper is its use in the real estate investing market.  And this techniques helps you buy properties with owner financing (and still getting the seller cash) as well as sets your property above all the others when you sell it, because you’re able to work with the buyers when others can’t.

Investing with Paper: One of the great things about the seller-financed paper game is that you can buy a portion of the note, rather than the whole thing.  For instance, if you want, you can buy just the next 12 payments on a note, and only pay ten (10) times the payment amount.  This generates a yield to you of 35.07%!!  And the amazing thing is that by only investing a small amount, you lowered your risk, because you’re in 1^st lien position for the 12 months that you own the note.  Wow!  Higher yield…lower risk.

Here’s to the Power of Paper!