The 5 Best Ways to Lose Money in the Note Business

 

Intro

 

#5 - Investing Your Last Dollar

Twofold -- you have to keep money on hand for holding costs and workout expenses. If you have $50k to invest, you better not buy a $50k deal or you are going to stuck holding that deal forever. Your servicer’s kids need to eat too, you know.

 

You also do not want to invest the last of someone’s savings. These will be the investors that constantly want to check in and see how things are going. They need to know their last pennies are OK so they need to hear — repeatedly — that all is well. You want the guy with enough invested overall that by the time he gets around to checking in with you, you’ve already emailed him an update. Then once he’s sure you’ve got it together, he brings you more $$.

 

#4 - Sloppy Due Diligence

We all know where to start -- beds, baths, square footage, sale comps… But there are things you could be overlooking that might not be a big deal if you budget for them or might make your deal a total loss:

 

Do you CALL on the taxes? County websites are not great, even if some are better than others. You cannot be sure that looming tax certificate or tax deed sales are posted. You also cannot be sure that the county website details what city taxes, school taxes or even local sewer charges might be delinquent. You have to call and you have to ask the right questions.

Do you call code enforcement to see if fines are accumulating? I’m not sure everyone understands how quickly these charges can get out of control. We are currently foreclosing on a FL condo that has had a torn screen on the patio for years. Her outstanding town lien is over $600k. (We’ve been assured that since the town has not had to actually spend money on the issue, it will be wiped out with the foreclosure. I’m choosing to believe that until proven otherwise.) Other issues — like forcing the town to come mow the lawn — are easy fixed even though you don’t yet own the house. I’d much rather pay $100 a month during foreclosure to have the lawn mowed than get a $5000, earning more interest every day, bill from the city.

When you check condition on Google, do you zoom out to see if there is something unsavory near the house that will negatively affect its value? Do you know how hard it is to sell an REO close to a sewage treatment plant? Do you want to worry about what the heck is in that weird green pool of something down the street? It's no news that foreclosure happens and you want to take back an asset you can actually sell.

Have you checked to make sure the borrower name matches the current owner’s name? If it doesn’t, it might have gone to tax sale. Or the HOA might have already foreclosed. If the new owner is a beneficiary of the original owner, there could still be some probate issues. No one needs a distant cousin 700 times removed to put a cloud on title.

If it’s a condo, have you checked to see if there is a rental or age restriction? This will make it harder to sell the asset if you take it back.

Do you check Pacer no matter what the tape says about their bankruptcy status? Even if they actually aren’t in BK now, if they filed previously, the case information will be available and you can get great insight into their life at that time vs. now. It’s a great window into why they aren’t paying.

Do you check county records to see if the borrower owns any other properties? This is where a deficiency judgement might be a great play. There are different opinions in our space about filing for deficiency judgements so this may not apply to you. If the borrower works with me, there is no way I would even consider a judgement. But hostility, lying, forcing me to evict you? I’ll do it if I can collect.  If they own other properties — their own home or other rentals — there’s my money, assuming that state allows me to file a judgement.

Do you have your attorney review the collateral file BEFORE you purchase the loan? Collateral custodians do not understand the legal nuances that each state enjoys. Even if they find a gap in your assignment chain, they can’t recommend a fix for it other than using their expensive, pay even if we are unsuccessful document management process. Not only can your attorney find issues, find cures for those issues, and tell you how big a problem any unresolved issue might be, they are going to recognize issues that are unique in their particular state. Without question, you will pay more money for an attorney’s file review. But if an extra $100 keeps you from throwing your money away on an uncollectable deal, it’ll be the best $100 you ever spend.

A quick example. I was reviewing a deal in Ohio -- a first on a typical 3/2, 1500 sq ft single family home. A husband and wife were on the deed but only the husband was on the mortgage. For the newbies in the room, that’s not a deal breaker as long as the non-borrower spouse grants permission for their ownership interest in the home to be used as collateral. The wife had signed to give her permission so I checked that off the list and moved on. Everything else was fine -- the assignment chain, the note and allonges, servicing history, even the entire loan app with all it’s disclosures and documentation. I was ready to close and had my funding set up. All that was left was sending the wire.

And then I got the call. The language that was used when the wife approved the mortgage was incomplete. Apparently, in Ohio, spouses (both men and women) have something called a dower interest -- beginning forever ago when a wife came into a marriage with a dowery. And apparently, the approval has to specifically address the dower interest and this one did not. Worst case scenario, I wouldn’t have been able to take full ownership of the house. I’m not sure exactly what you do with 95% of a house. My attorney saved me from a huge headache that a collateral custodian would have never found.

#3 -- Accounting

Accounting in the note space can be such a torture. We’ve all dealt with that deer in the headlights look when explaining note investing to a potential funding partner. We shouldn’t have to deal with it from a professional.

Grasping the concept doesn’t seem to be a matter of intelligence or education but rather being able to put aside what you currently know about real estate investing long enough to see a new path. And accountants, either by birth or by training, aren’t great at putting anything aside. As a client, you really have to walk them through a few deals before they get it. And take it from me — unless you personally know a note investor that has used this accountant, don’t believe them when they tell you they have experience with note investing. They certainly don’t all lie but putting a one off seller finance note that has never missed a payment into the system is a lot different than trying to book 100s of semi performing, went BK, paid every third month for a year, finally foreclosed but now have to evict kind of deals. Exaggeration affects all professions.

If you need an accountant, there is a guy who presents at different note conferences you might consider. He’s not particularly good at answering questions from the audience but he could be a fantastic accountant. His firm is large and there is nothing necessarily wrong with with staff accountants but the head guy’s understanding of the notes space does not necessarily transfer to his staff. You have no idea if the junior accountant you’ll be assigned to is any good let alone trained or trainable. If you are interested in talking to them, I’ll be happy to give you their information off stage. But you have to promise me that you are going to press them to make sure the staff member assigned to you either knows note investing or is willing to be trained on it.

Another headache is the fact that when someone has a great accountant, they really have to keep that on the down low. I’m currently still testing the one I’m using but let’s say I was comfortable enough to recommend him. What if every investor at DME suddenly calls him during tax time? Would my returns ever get done? And done efficiently and in a timely fashion? Until there are more hours in a day, passing this particular resource along to everyone does make your life more difficult.  

That’s why I think your best option for finding a good accountant lies in your network. With almost everything notes related, you need a group of people you can count on for advice and good recommendations. If my guy turns out to be good, I’m certain he can handle

#2 Tunnel Vision/Inflexibility

This issue can affect your business in many ways.

When you decide you will only invest in one market or only invest in one type of deal, you always limit your deal flow. Currently, there is a remarkable number of tapes flying around but prices are pretty high and quality is kinda low, making it tougher than usual to find a good, solid deal you know will make your investors happy. If you have a really narrow focus, you might find yourself out of deals. You need to explore different note deals (1sts, 2nds, contract for deeds — performing, non-performing), different markets (judicial really isn’t so bad if you have patient investors and holding costs built into your model), different real estate deals (you end up with an REO from time to time so how about starting with one? You usually note yourself into a deal — how about noting yourself OUT this time?) or different asset classes (have you checked out commercial?). You can also try finding new deal sources (if you’ve always bought from hedge funds, have you tried calling banks? Current investors? Looked online?). When deal flow changes, you have to change with it or it won’t be pretty.

Another inflexibility we see amongst note investors is a hard focus on purchase price. Don’t get me wrong — you’ve gotta know your numbers. But you have to make sure you are hard and fast on the RIGHT numbers and flexible on the others. I confess — this was a big one for us. First, the prices some sellers are looking for — and unfortunately, some of the newer investors are willing to pay — have gotten crazy. There’s not enough room in a note deal to pay almost 80% of value because you really have no idea what the inside of that house is going to look like. You need that buffer. But how do you find your absolute highest % of value you’ll pay? Well, it’s not like I did at one point and pull it out of the air. “I absolutely, positively will not pay over X% of value!” Is a statement that can get you stuck. Because ultimately its not about price. It's about your ROI. Let’s say your seller counters at 60% of value. If you have decided that 60% is just nuts — with a few rounds of “that seller is out of his freaking mind!” — you may be walking away from a good deal. Did you run your counter through your ROI calculator? Is your return still at or above your target return? Then why would you walk away? No one wants to overpay obviously but prices are what they are. Deal flow is what it is. You pay what you have to pay to get the results you need. What’s your alternative? Sit around waiting for lower prices while your investors put their money in other deals? Do that for too long and you’ll be out of a job.

Taking that a step further, what if that new price lowers your expected ROI to just under your usual target. I’m talking 2% off, maybe 5% off — not cutting it in half. Do you immediately say no? Or do you take a beat before you decide?

This has been an issue Chase and I have dealt with frequently. If I’m going 50/50 with my funding partner, an ROI of 20% is hard to sell, especially as a one off and especially to investors in this room. But if keep turning down all of my counters, I lose credibility with both note sellers and my investors. I need both to keep coming to me, not looking around this room for other investors who might be able to close. That means I have to consider changing the deal split. If I take less so that my investor gets a great return and then brings me more money, have I really lost anything? In this 20% example, say I go 14/6. My seller is happy. My investor is happy. And it’s not like I’m out on the street. I’ve just made an investment in both relationships and still got paid a return on funds I didn’t even have in the deal. Note investing is a numbers game so if my return on 1 or 2 deals out of 20 dips a bit but my business overall is stronger, it’s a definite win.

Honorable mentions -- vetting, education

Vetting

Not vetting your investment partners. This holds true for both the active and the passive side of the transaction. I know you want the money for your next deal but do you really know the person you are taking it from? I’m not talking about the investor questionnaire and the 5 touches you need to do to keep the SEC happy, although those are obviously important. I’m talking about what it’s going to be like to have this particular personality in a deal with you. Are they going to call every day to see what’s up? Will they respect your knowledge and experience when it’s decision time or will there be a lot of second guessing and repetitive questions? Likewise, are they going to be so hands off that you can’t get a hold of them to make sure you are both on the same page? If this person seems annoying before funding, they aren’t going to get much better after funding. Obviously, you won’t become BFFs with every investor but the reality is, a bad investor can make even the most profitable deal torture. Hard as it is to imagine, you could actually turn someones money down.

On the flip side, for our more passive investors and the newbies who want to learn by partnering on their first deal, what kind of vetting are you doing on the guy you are giving your money to? Charisma won’t keep your money safe. Excitement and energy are not synonyms for effectiveness or focus or even character. A wonderfully detailed story about how a great a deal went could be just that — a fantastic story. Could have been someone else’s deal or it might be total fiction. Your due diligence cannot stop at the deal itself. The best ways to vet your asset manager finding someone who has actually done a deal with this person and see how it went. Go online and look for reviews. They are harder to find than reviews for an Instapot but they are there. Start by searching Google with the term “I invested with” and his or her name and see what pops up. You can do the same on Bigger Pockets. You can also pick the largest counties in the state the investor lives in and see if any liens or judgements have been filed. In general, we do more research before purchasing a television set than we do before handing over our savings. Don’t let that be you!

Education — While note investing is a lot harder than some people make it sound, you probably could learn it all by yourself. Lots of us write books and articles, maintain a blog, record a few videos — put out a lot of content that could help someone start from scratch. But that takes an incredible amount of time and energy. And it’s isolating — you don’t meet anyone who is learning alongside you compare notes and bounce ideas off of. Wouldn’t it be much easier to dive into a formal note education and speed up your learning curve? Yes, it will cost you but so will taking a bath on deals you bought before you knew better. And your network? With many programs, your access to other investors explodes and you can watch, listen and learn from so many more people faster than you ever imagined. And there are many options out there — choose the one that fits your learning style and pocketbook best. Time really is money so if you shorten the learning curve, you’re investing sooner and better than the rest.

#1 Not acting like you are running a real business

While some people are operations and systems focused and others find that painful, you really do need to have a system in place to manage your note investments. There is a lot of detail and paperwork in every deal and if you can’t keep on top of it, you’re going to lose money. In the beginning, your workouts will simply take longer because you won’t have the information you need on hand to make decisions quickly. As you progress, you’re going to miss nuances in the data that you can use to make sure you don’t leave money on the table.

Of course, your systems are going to evolve over time. The spreadsheet you use for your first 2 notes is going to look a lot different than the software you are using by your 100th deal. But you have to keep the business part of your note business in mind as you grow to avoid chaos. Because as you add another deal here, 2 more there, maybe another 5 a little while later, you feel the need to keep it all organized looming. Are you going to manage that need thoughtfully as you go along or are you going to keep putting it out of your mind until it blows up and all your deals are in limbo for a bit while you try to dig yourself out of the chaos?

This also applies to processes. Some elements of the note business are pretty repetitive. Reviewing a collateral file. Boarding a loan. Vetting an investor. Adding force placed insurance. All important tasks but things you eventually could do in your sleep. And what happens with repetitive tasks after a while? We get sloppy. We get busy and don’t focus like we should. And then we miss things.

What if you documented the process and then followed a checklist every time? If you’ve got 10 things to check off while reviewing a file, are you just going to ignore step 6?

And what about when you finally hire an assistant? Training — and trust — are tough. How much easier will it be on you if you can look over their completed checklist to see that they covered it all? A thoughtful management system — with appropriate checks and balances — will help you function as a real business and not just a hobby.

Aol email addresses

Not putting your face on LinkedIn

Using FB for business but having your cat as your profile picture

Not managing your relationships