This guide covers buying real estate notes, in particular how to buy notes from banks.
The steps covered are applicable in buying notes generally but we focus on the banks
If that's what you're here for lets get started!
Begin with a Strategy for Buying Notes
There’s a good chance that you found this article because you want to buy notes from banks. But the fact is that banks aren’t the only ones selling notes and, moreover, where you buy notes should be determined by your strategy and banks might not be the right source for you.
For example if part of your strategy is to quickly flip or sell notes to other investors then buying from hedge or private equity funds is not a good option for you unless you’re buying large pools from them. Most of the margin that would make flipping possible is gone by the time you buy the note form a fund and your buyer is in even worse shape and will have very little meat on the bone.
Likewise buying notes from marketplaces and other retail outlets gives you very limited leverage or advantage if part of your plan is to broker, flip or otherwise resell the note because you’re paying a premium that the seller or broker has earned having sourced the deal.
Alternatively if you’re looking to invest personally in a single mortgage note or just a few real estate notes then calling on banks selling notes really isn’t the right avenue because banks are unlikely to sell you one single mortgage note and therefore paying the premium that comes with retail might be the right choice.
Which brings you to the most important question there is when you’re considering getting into the note business. Which is...
Why do you want to buy notes?
The answer to this question will dictate what kind of notes you buy, who you buy them from, the types of exit strategies you plan for and more. So ask yourself these questions
- Are you looking for cash-flow and you have your own money to invest?
- Are you looking to own the collateral (the property) at a discount?
- Are you raising private money?
- If you’ve raised money then what kinds of returns are your investors looking for?
- What kind of risks or assets are your investors comfortable with?
- If you haven’t yet raised money then how will your business plan define the notes that you’re looking for?
- Is there an asset type, location, or process where you have a depth of knowledge or an unfair advantage?
There are many more questions for you to answer for yourself. Make sure you ask and answer them. Like any business, the note business requires some thought, planning, training, and an interest and ability to keep up with the market as it changes.
Should I Buy Performing or Non-Performing Notes?
If you’re at the beginning of formulating your strategy then the one of the first things that you need to do is decide what kind of opportunities you’re going to pursue. The first step in that direction is to determine if you’re pursuing performing or non-performing notes or perhaps you’re raising private money and you want a mix of both to balance risk.
In any case, here’s a brief summary of the differences and some of the strategies around each.
Why Buy Performing Notes?
Performing notes are “cash-flow” or dividend opportunities. Performing notes offer reasonably reliable, secure returns with very limited effort on the part of the lender (that’s you) once you buy the note and servicing has begun. A mentor of mine refers to owning performing notes as “just clipping coupons”. Performing mortgage notes offer modest risk and a modest return. When you buy a performing note the goal is simply to continue to receive payments.
The three main opportunities with performing notes are:
- Brokering the note or selling it for a referral or finder's fee
- Holding the note for cash-flow
- Selling a portion of the cash-flow so you get a lump sum now and payments over time
Why Buy Non-Performing Notes?
The discount. The short answer is that when an investor is buying non-performing notes, it's for the discount. That’s not, however, the only reason to buy non-performing notes. Once a note is in default there are other opportunities that open up.
What kind of a discount? Depends on the note. You may find on highly desirable commercial notes that you’re paying 70 or 80 cents on the dollar or even “par”. For non-performing junior residential notes you might pay as little as 6 cents on the dollar.
If your strategy involves non-performers then buying notes from banks should be at least part of how you source your deals.
Non-performing notes are opportunistic investments that can provide significantly higher returns than performing notes but with a level of risk to match.
You can find a complete guide to non-performing notes here.
Buying a Note | Step-by-Step
The first thing to understand about buying notes is that there aren’t a lot of hard-and-fast rules about the process and how it’s done. As opposed to buying a home for example which is very standardized and something most consumers will do at some point in their lives buying notes is something that’s reserved for investors. Practices, procedures and regulations like there are in standard real estate transactions do not apply to buying the mortgage notes that underlie that real estate.
The process will be largely determined by the participants in the transaction. In the end you’re going to want to end up with documents that transfer the rights of the lender to you but the paths that you take to get there will vary.
Step 1: Find Notes to Buy
Where to buy notes
Your business strategy determines where you should be buying notes. Since we focus primarily on brokering or buying notes directly from banks and credit unions at distressedpro.com that’s what we’re going to focus on for sources.
Buying Notes from Banks
For the purposes of this article we’re going to talk specifically about buying mortgage notes from banks although the process is largely the same whether you’re buying mortgage notes, business notes, or any other notes. The differences lie in the evaluation of the borrower and the collateral.
Buying notes from banks is more work than buying notes from brokers, hedge funds, or marketplaces but it also provides the best returns and the most flexibility in terms of strategy which means that you have the most options for how to profit.
If you’re looking to buy performing notes... banks probably aren’t your best bet unless your name is Fannie, Freddie, Goldman… Morgan… etc.
Occasionally banks will have performing commercial notes that are simply “out of covenant” which means that even though the borrower is paying they have broken another rule or stipulation in the note. There are also occasions where a note is still being paid but it no longer fits in the lender’s “box”, banks will sell these performing notes.
Sometimes banks hold “portfolio loans”, typically non-conforming loans that they went ahead and made anyway and they hold in their portfolio. You may find these for sale but making a whole business out of buying them would be tough.
Banks bundle and sell pools of performing notes in the secondary market or hold the notes on their books as whole/portfolio loans for interest income.
Non-performing notes, on the other hand, can weigh heavily on a bank's balance sheet. When banks have non-performing loans they have to set aside cash for future losses which cannot be used for investment.
Non-performing notes typically end up in a workout or special assets department or in much smaller banks with the originators. Workouts and default servicing takes manpower. The non-performers are a drag on the bank in every way.
We focus on buying notes directly from banks and credit unions and you can read in detail about the 4-step process here and elsewhere on this site. Here’s an overview of how to buy notes from banks:
2 Wrong Ways to Find Banks Selling Notes
1) Calling on the Big Banks - One of the questions I get from new note buyers is - “Can I buy notes direct from (Bank of America, Wells Fargo, Chase, Citibank, US Bank, PNC) [other BIG bank]?” The answer is “Probably not”. The problem is that your purchase doesn’t move the needle. Big banks sell big pools to big players for the most part. There’s no low level special assets person who is going to sell you borrower Dick Johnson’s mortgage.
Inevitably folks who pursue the big boys get frustrated and go over to the BiggerPockets forums and say “it doesn’t work, banks don’t sell notes” and then a bunch of other people who also have absolutely no idea what they’re talking about or how the business works chime in and agree. And that’s just fine for us, less competition ;)
2) The Bottom Up Approach to Buying Notes from Banks - One approach I see a lot is the investor will find a struggling homeowner and will try to parlé that find into a note purchase through the debtor’s lender. This isn’t a total fail if you happen to be working with a borrower who has a portfolio loan with a local, regional or community bank, but this won’t work with the big banks.
I’ve heard of people (who have heard of people) who say they know a guy…. And that they’ve been able to buy notes this way but I’ve not heard one single first-hand account of an independent buyer buying a single residential note from a Top 10 bank - not one. If you have personally had success with this approach we’d love to hear about it in the comments.
Buying Non-Performing Commercial Notes from the Big Banks
I do have experience and know others who have experience working with regional small balance commercial loan workout teams at the big banks. These commercial workout folks often have the ability to sell, even one-off, commercial notes. This is not the case for residential.
The Best Way to Buy Notes Direct from Banks
The best and most reliable way to buy notes direct from banks is to begin with the decision makers at your local, community and regional banks and credit unions.
Buying notes from banks is essentially a B2B sale. You are in business and they are in business. They have a problem and you have a solution. You need to find the right banks and then find decision makers.
Buying Notes Directly from Banks - The Short Version
Find local, community, and regional banks that have the types or notes you want to buy. Banks file reports each quarter that give us surprisingly deep insight into which banks are selling notes and which aren’t. We use these reports to find the real sellers and then we use a collection of other resources to find decision makers.
Call as high up in the bank as possible and have the decision makers direct you to the people who are responsible for selling notes. This person’s title or the department’s name will vary from bank to bank depending on the size and to some degree the locale. We have a complete list of titles in the Academy. The smaller the bank and bigger the credit (credit = bank-speak for note) the higher up the chain the decision will be made.
You need to get an understanding of their note selling process. Some banks will have a dedicated trading desk. Some really small banks will have the “line” (loan officers) handle their own workouts. Some banks will have direct involvement from top officers. You don’t know how any one particular bank handles their note sales and workouts until you call, speak to a decision maker, and ask.
If you’ve done this part right then at this point what you want is to ask the bank to send you what a lot of people in the industry will call a “tape”.
Tip: Banks do very little without legal counsel. Find out who the attorneys are in you area who do most of the bank work and get to know them.
Step 2: Note “Tapes” and Note Buying Due Diligence
A tape is simply a spreadsheet with the loan numbers and other pertinent information about the notes that the bank is going to sell.
Again I’m going to give you some broad strokes here so that you can gain a better understanding. At this point you’ve received a “tape” which is just a spreadsheet of notes with pertinent borrower and collateral information.
The types of due diligence you need to perform ties tightly in with the note buying strategy that you're pursuing.
Buying a multi-million dollar “loan to own” single small-balance commercial note on which you intend to foreclose as promptly as possible requires a very different due diligence process from evaluating 100 non-performing junior liens that you’re buying for 6 cents on the dollar that you intend to “Rehab” and modify.
One of the most often asked questions is “how much should I pay for a note”. This question cannot be answered with a number, only with more questions.
TIP: Banks tend to maintain regional customs, vernacular and procedures (probably due to the incestuousness of the the banking industry and the tendency of Americans not to move very far from home)
LASER - Loan Acquisition Suitability and Evaluation Rating
My friend and advisor, Pat Blount, a man who has been in the note business since the late 80s, who’s flown around the country to more than 2,000 banks, and who has sold many billions in non-performing notes put together the LASER system in response to an RFP from the FDIC for a system for evaluating notes..
LASER is the Loan Acquisition Suitability and Evaluation Rating system. There’s a reason it’s called that and not the “Loan Valuation System”.
What LASER does is helps you ask 25 or 30 questions about the note before you buy it. You take the numbers of your ratings and then you use that to decide if the the acquisition is appropriate for you or your client based on your desired returns and investment criteria.
In other words, you start with a strategy, then you ask a series of questions to evaluate how likely is it that the purchase of this note while help me achieve our investment objectives?
This is not the same as “what’s the value of this note”? Because that question cannot be answered except by a meeting of the minds between a buyer and seller.
When you buy notes you have 3 main components to evaluate and your strategy and the types of notes you’re buying will dictate the importance of each and the questions you ask. Here are slides from the LASER presentation outlining the loan, collateral, and seller criteria that you should evaluate.
Lender / Seller Criteria
When you’re buying low dollar deals at volume your due-diligence is going to be very different than when you’re buying one-off high dollar single commercial notes.
In all cases you'll want to see a title report.
Shortcut the due-diligence process.
The most highly paid and time part of this entire process is the actual finding of the note. Once you’ve secured a tape there are lots of ways to evaluate. One way to make short work of residential note evaluations is to contact our partner Craig Everett who will do it for you. You’re welcome.
TIP: A pool of non-performing juniors in Ohio is different from a gas station in Massachusetts, is different from a pool of 1st position residential notes in California and your due diligence should be driven by your strategy and the types of notes that you’re buying as a result.
Step 3: Making an Offer to Buy Notes from a Bank
Arguably due-diligence should be part of the “Making an Offer” section. Sometimes you will get a tape first and be able to evaluate it and then make an offer on it. Sometimes you will have to make an offer and then do your due-diligence, often it’s both.
Before we go further you should know that you should always have an attorney involved in your note purchase. I am not an attorney and I am not qualified to offer you legal advice and that’s not what I’m doing - ok?
The bank will 99.9% of the time have an attorney involved in their note sales process. If you find yourself involved in a transaction where there isn’t a bank attorney involved I’d be willing to bet that it's because you will be buying the note(s) with a contract written and approved by the bank’s attorney for which there is no negotiation.
The workout, or special assets, or secondary marketing manager that you’re working with is representing an organization that is worth at a minimum 10s-of-millions and much more likely 100s of millions or maybe even billions. When you represent an organization like that you’re not shooting from the hip on legally binding contracts.
How to Make an Offer to Buy Notes
- Offer: How the offer is made will more than likely depend on the seller’s own process and could involve a variety of methods.
- Bidding – Open or Sealed Bids: Banks that regularly sell notes to individual investors might employ structured bid processes. In this case the forms, timeline, contingencies, and deposits will generally be thoroughly spelled out and non-negotiable so that any bidders are on a level playing field and the bank can maintain a firm expectation of when they’ll close and on what terms with the only question being for how much.
- Letter Of Intent: An LOI or Letter Of Intent lays out your the terms, timelines and contingencies for your purchase and may or may not include with it a binder. An LOI usually just gets the conversation started. You might use an LOI on a commercial note or notes.
- Indicative Bid: In an indicative bid process you will have a good idea of what the collateral is but you will not have all the details until you make an “indicative bid”, which is just an offer, and that bid is accepted at which point you’ll typically receive all of the documents related to the notes that the bank has on file which you will take possession of (typically) under an NDA. An indicative bid says “I’m willing to pay X provided what I see in due diligence meets my expectations. This is pretty common when you’re buying notes from banks.
- Offer to Purchase Leading to Purchase and Sale: A variation of the process mentioned above you will first submit an offer (or LOI or Indicative Bid) which likely includes a binder and which also outlines a due-diligence period and details about the more thorough Purchase and Sale Agreement that you’ll complete which will lead you to the close.
- Binder: A binder can have other names but it’s the money that you put down upfront to prove that you’re serious. You’re binder is typically only at risk if you violate one of the terms of purchase and sale agreement.
The required binder amount can vary but it’s not uncommon to see 10% of the purchase price for a binder. A binder isn’t always required. Sometimes you’ll get a free look for a short period and then be expected to go immediately to close without any offer or binder so…
- Due diligence: Discussed already above but I’ll just say here that the due-diligence period for buying notes is typically MUCH shorter than that of, say, a home purchase. I’ve seen note deals close in as little as 5 days with very little in the way of paperwork and I’ve see large commercial note deals drag out much longer than anyone wanted (usually due to suspect paperwork, title issues etc) but you can expect somewhere between 7 and 30 days max. If you’re not able to perform in that kind of time frame then this might not be the business for you.
- Escrow: Whenever possible your binder or deposit should be held in escrow if there is such a period in your process and contract. Reputable sellers will not ask you to blindly give them cash or a wire. A reputable seller understands that all the parties in the transaction need to get what they came for and be comfortable with the process. Typically the seller’s attorney or agent will hold escrow. There are times that you will make an offer to purchase notes and then immediately close with no escrow or binder.
After all that you’re ready to close which brings us to the next step.
Step 4: Closing on Your Note
You’ve found notes to buy, evaluated them and decided to make an offer and now your offer has been accepted and it's time to close and take possession of the note. After you close on the note you’ll need to begin servicing which is not something I’m going to go into in this article.
In order to close on your note you’ll need to deliver the rest of the funds. This typically happens by wire.
In order to close you should have physical possession of the following documents including but perhaps not limited to:
- The mortgage or deed of trust, a copy, which is the same as that which is recorded with the county or municipality
- The promissory note originally signed by the borrower - this document is the note that you’re buying! The “note” lays out all the terms of the debt and each party’s rights.
- The assignment - sometimes done within the note itself or else done as a standalone document, this is the document that says that you are now the lender. The docs should have borrower’s and seller’s signatures. If the document is attached it’s referred to as an allonge.
- The file - This isn’t a requirement, and frankly you probably won’t get it, but it is nice to have and occasionally provided to some degree or another on commercial note transactions. The file is just that, it contains documents and communication related to the debt and the borrower. Don’t count on getting this. Do ask for it.
That’s it, now you’ve purchased a mortgage note!
More Thoughts on How to Buy Notes
Maintain your integrity in the note buying business
Getting yourself into broker chains where you are simply hoping for a greater fool is a terrible way to live and to run a business and I highly discourage this.
If part of your strategy is selling notes to others then you need to either be buying sizable pools from the hedge and private equity funds, buying notes from private mortgage holders or buying notes directly from banks, credit unions, and servicers.
I can’t stress enough how important it is to retain some integrity in the business. It is not a huge market. If you become known for passing off crappy notes or representing that you are brokering notes when you don’t actually have any authority to do so then you are not going to last very long and you’re not going to make any real money.
If you have real money and you’re simply looking to put some of it to work then buying from the brokers and funds could workout for you just fine just don’t expect that brokering or flipping will be part of your business.
FAQs About Buying Notes
Can I Buy Notes with No Money?
I hear from a lot of people who say they want to buy mortgage notes but in fact what they mean is that they want to broker notes. If you don’t have your own cash to invest then you’re going to need someone else’s buying notes is not “no money down” real estate investing.
If you’re actually going to be buying notes (as opposed to brokering or bird dogging) then you need to raise money from private investors or you can do double closings (like a flip) but that's another article.
The bank isn’t going to finance you buying their notes. While banks can finance your purchase of their REO (even up to 100% of it) and get it off their books they can’t finance your purchase of their non-performing notes. There’s no cash or balance sheet benefit to them giving you notes with… a note on the note…. See what I mean.
Buying notes is cash intensive and it happens fast. That means you need capital ready to be deployed usually within 15-30 days once you’ve found a deal. You should not be expecting to find any financing you will need capital, “dry powder”, your own or raised, ready to go.
Do I need a POF (Proof of Funds)?
I’m not sure when the Internet fad of “Proof of Funds” came about but I believe it to be just that. I’ve sold hundreds of assets for banks, my friend Pat Blount has sold billions, my friend Mike Ruscica has bought hundreds of notes…. None of us has ever come across, used, or had required of us or our clients a “Proof of Funds”.
The proof, my friend, is in the pudding. Will you make your deposit on time? Can you send the wire? Do you close? If you don’t you will not get another at-bat with that lender. So decide before you begin that you’re going to be for real and you’re going to fund and close when you say that you will.
What other ways are there to make money with notes?
Having a strategy doesn’t have to mean that you have to walk away from all the other opportunities. Once you’ve started making contacts with banks selling notes, if you do it right, you’ll hear from the bank about all kinds of opportunities that don’t fit into your “box”.
Learn how to position yourself to profit, at least through referrals, with what comes your way. I cover some of this at the end of this article.
Are You Going to Buy Notes?
Now that you’ve got a thorough overview of the business and the process of buying notes what are you going to do? What other questions do you have about notes or about working with banks? Let us know in the comments.
If you liked this article give us a tweet or better yet post it to FaceBook or LInkedIn. Thanks and best of luck in the note business.