If you are in an industry that is sensitive to even the smallest market shifts, you would know that it is always wise to keep yourselves in the know of the latest movements. Here at 7e, Chris Seveney and Lauren Wells have you covered with this monthly webinar. Take a deep dive into what’s happening with the world of mortgage notes as they break down market updates. Learn why anyone would sell a performing note through 7e’s case studies. Finally, find answers to the questions that bother you as Chris and Lauren answer some of the pressing questions from investors. Jam-packed with information to add to your success toolbelt, this episode is one you won’t want to miss.

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Watch the episode here

 

Listen to the podcast here

 

7e Monthly Webinar: Mortgage Market Updates, Case Studies, And Pressing Investor Questions

Welcome to this episode, where we share market updates and case studies, and open up the floor to you guys to ask any questions you might have about us or our offering. A little bit of recap, if this is your first episode or first time joining us, welcome. We are 7eInvestments. Chris and I are cofounders here at 7e and we run a mortgage note fund that invests in first-position performing and nonperforming mortgage notes, which are secured by single-family homes throughout the US.

In short, if I could see your faces, I would probably ask you guys to tell me if you’ve ever owned a mortgage, had a mortgage before, or know what a mortgage is. If you have owned a mortgage, I would ask you, have you ever received a letter in the mail that said, “Now you’re going to make your mortgage payments. Instead of Chase Bank, you’re going to make them to Union Bank.”

If we are the people that are purchasing mortgages, the biggest difference is we are investing in both performing, meaning people who are consistently paying on time as expected for the terms of their loan agreement, and then nonperforming, meaning anyone who is 90-plus days delinquent for whatever reason. That’s at a high level of what we do. We have several other webinars on our website that you can reference that go into a deep dive into every aspect of the business, our acquisition process, due diligence, our fund, and how we got into this. Now, we want to keep it about this one case study and give a little bit of a market update. Chris, do you have anything to add before I go on?

You’ve said a lot about that. One of the things I want to reiterate is we do this every month, and we want to try and make them as educational and informational as possible. One of the things that we really focus on is that communication and outreach with our investors, our current investors, or potential investors and being able to answer the questions that they have that they bring forward to us.

Here at 7e, we have done over 500 deals and are raising capital for a Regulation A-plus offering has a minimum investment of $2,500 with bonus shares starting at $25,000 with 8% to 11% annually paid as monthly dividends. This is not our first rodeo. We have done previous offerings that have gone full cycle, and on those delivered average, we did IRR 14.5% to our investors. That’s a little bit about us, our track record, and our history. I want to pivot a little bit to questions that I’ve been fielding and I’m sure Chris has been fielding about bank failures, the state of the economy, and what is affecting this business. We are continuing to see bank failures starting with Silicon Valley Bank, Signature, and First Republic.

A common misconception that I’m hearing is that this is bad for our fund, asset class, and market, which is not the case. To break it down a little bit, when we will go to Silicon Valley because it’s where it all started, when banks have assets that are on their books that are at 3%, which is less valuable than a loan at 6%, what they’re doing is they’re losing money, so they’re writing down to market value those loans. They’re faced with two options, “Are we going to manage this asset through foreclosure?” Most people would think, “If I’m not paying or we’re going to go through foreclosure with this, the bank is going to take my home.” Contrary to popular belief, banks are not in the business of asset management.

They are in the business of creating debt. For them, that’s option number one. I can go through the disposition of taking this asset for my nonperforming loan through foreclosure. That would cost them a ton of legal fees as well as time. We’re looking at a minimum of 1 to 2 years plus. The other option is to sell these loans at a discount, and that is 1) Much quicker and 2) Allows them to take the money that they got from that sale and create new paper at 6%. What we’re seeing now is that the interest rates are continuing to rise. We’re going to see additional stress being put on these banks, which is going to continue to provide us with opportunities down the line for more inventory and better pricing. Chris, do you have anything to add there?

Thanks, Lauren. Great explanation. First off, as you mentioned, with these banks, some are going out of the business sale of a store and where people who go buy that product, turn around, manage it, and sell it or keep it, and you’re buying it at a discount. One of the things I want to mention, as you talked about those banks that have already started to falter, is the banking industry in real estate is always a lagging indicator compared to the stock market. The stock market can be volatile on a daily basis. Something that happened yesterday can impact the market today. That’s not the case in real estate. A lot of people keep asking, “Is there a crash? What’s coming?” Nobody has a crystal ball or their magic eight ball to predict what is going to happen.

There are a lot of things coming out about commercial real estate that can have an impact on banks. I’m an engineer for people who don’t know. I like data and numbers, and Lauren knows this. We analyze a lot of the data that comes in and have seen already this quarter, which we’re in the second quarter of 2023, twice as much product for sale than we saw in either of the past two quarters. Another way is that we’ve seen so much in the first six weeks of this quarter as we saw in the past two quarters. For assets-to-sale, I’ll say the bid-to-ask spread, meaning what the sellers want versus what investors are looking to pay for, is, in some instances, off a little bit because of the added inventory.

Some of that pricing on the distressed product is coming down slightly. It’s not coming down significantly, but it’s starting to move the needle to go from a seller’s market to a buyer’s market. We’re starting to see some of the impacts already of what’s going on in the banking industry with credit tightening in the lending on our end. We are the frontline of this because most people in real estate might want to get a loan and see that they can or can’t. We’re the frontline because we’re buying that from the bank, so we usually have the most up-to-date information.

Chris and I know this is going to be a question we get. I saw it already dropped in there. While we’re here before we get into the case study, which is on a performing note, so it ties in well, why would a bank sell a performing mortgage?

We get that asked all the time. There are many different reasons. Whether it’s a bank, a hedge fund, or a whole loan trader, several don’t fit their portfolio. What I mean by that is most loans don’t trade a one-off loan. Most of them get sold in tranches of 10, 100, or 1,000 loans. The larger the tranche, the bigger the breakup of the firm that bought it will do. They’ll go because they’re forced to buy 1,000. They’re forced to buy a lot. They’ll take in tranches like, “Here are the ones we want to keep, and here’s what we can manage based on our staff.” There are additional tranches that they will then turn around and look to sell off to other investors. When you’re buying loans in bulk like that, you get a significant discount.

As you sell them downstream to investors, you can make profits because of buying at Costco versus buying at a 7-Eleven. You’re going to get it cheaper at Costco because of the bulk. That’s one. As I said, they bought in bulk. It might be a state that they’re not interested in. We bought a lot of performing loans from funds that are closing out. Especially towards the end of the year, we see significant inventory because funds want to close out. They want to get those off their books so a lot of those managers can get their fees or bonuses that they have at the end of the year based on how many loans they sold. Those are several of the reasons.

Flowing right into our case study, which is on performing, we talk a lot about nonperforming but we get questions a lot like, “Why would anyone ever sell a performing note?” We’re going to do a case study on a performing note and walk through this for you. On the right, you’ll see the stats, and I’ll let Chris go ahead and walk through this because this is a loan he worked on individually. Go ahead.

Thank you, Lauren. Back to answer why this one get sold, this was their closing out of the fund, and this fund was closing out and they had several loans left. This was one that we were able to cherry-pick and grab. The balance or UPB, Unpaid Principle Balance, was under $125,000. That’s how much they owed. The property itself was about $500,000 in value. Lauren can talk a little bit later about our investment strategy of the balance versus the value and principle and interest payment. Their monthly payment was a little bit under $600. The loan status is performing loan. We bought this loan at $80,000, roughly $0.67 on the dollar on the performing side.

One of the reasons why it was discounted is because of the interest rate on the loan to give it the yield that we target, which is in double digits, to ensure we have a coverage ratio to cover our costs and the investors. This is also a fund that they were looking to try and close ASAP. We have bought over 100 loans from this fund. I can’t emphasize the importance of relationships in this industry. Of the people who were on this webinar, many may not have even heard of note investing before us. It’s such a small niche market and there’s not a lot of people in the space. There are a lot of companies, but you need to build that relationship because it’s not something that everyone walks down the street and advertises that they do.

Before you go on, I’ll add to that point before you talk about the details of the case study. A lot of people will say, “This sounds great. Why can’t I do this on my own?” I will speak from personal experience. As Chris said, it is the relationships and you have to build out your team, systems, and processes. If you’re investing in more than one state, you need to have your attorneys in every state that you work with your vendors in every state. Having gone through that individual investor who built my own portfolio, I know you can be successful, but it’s not something that is for the faint of heart or considered mailbox money.

It’s interesting because the mortgage market is a $13 trillion industry with anywhere from $250 billion to $500 billion in distressed debt on residential. It is a huge industry that is out there, but a lot of people don’t know about it. Are you going to say something, Lauren?

 

No, I was looking to see if there were any questions that are coming in tied in.

When we were doing our due diligence on this asset after we got under the agreement, so we got to see what’s called the servicing notes, which are the conversations back and forth between the borrower and the seller. This loan, at one point in time, was nonperforming. The borrower did get it reperforming on this and had been paying for several years. In the notes, the borrower was a woman who was living by herself now. This is a 2,400-square-foot house. It’s got the deck and stuff, as you can see on the outside, but she had outgrown the home. She wanted to downsize the property. She went and renovated the property, which had been sitting on the market for a period of time from that standpoint.

When we acquired the loan, the loan was also listed for sale. If the borrower were to sell that property, and when you sell a property, the first thing that happens is you pay off your mortgage. We acquired this. When we ran our models, we typically hold loans for 2 to 3-year periods of time. This one, the target was for us. The worst case is if we don’t get paid off in four years, we could sell it and still have the coverage to pay investors and ourselves in that fashion. Lo and behold, the borrower paid off the loan. Since we had bought it, then $122,000 check came in.

At the end of the day, because it was performing, we had minimal costs. We only had $600 of additional cost in the loan, which a nonperforming loan can have $5,000 to $10,000 plus. On a performing loan, it’s minimal cost so there is a lower aspect of risk from that. At the end of the day, in that six-month period of time, this performing loan netted us close to $45,000 in profit from that strategy. One thing we like about performing loans is that the average time somebody lives in a house or refinances is under seven years.

One thing we like about performing loans is that the average time somebody lives in a house or refinances is under seven years. Click To Tweet

That number has fluctuated. It’s going to continue to fluctuate based on the rates, but historically, which is what we like to look at in periods of time, it’s seven years from that standpoint. It’s another avenue for performing loans. A lot of times, nobody stays in that property for 30 years, but in this one, we had modeled it even at four years. You can see that it’s not only nonperforming loans that can provide that incentive or that kicker. It also can happen on performing loans, which is what we wanted to focus on.

With that, I see some questions that have come in, so I’m going to start going through those. If you have any questions about who we are and what we do, I will leave the offering terms up here because a lot of the questions are around this. If you have any questions, drop them in the Q&A, and we will start going through them. You already answered the question about performing. How much will a downturn in bank consolidations affect selling performing mortgages?

We don’t typically sell our loans back to the banks. They usually will get sold off to hedge funds. Insurance companies are huge buyers of performing loans and will buy millions to billions of dollars in performing loans. We have a relationship with an insurance company that will buy starting at $500,000 of performing loans up to infinity. We’ve already built that relationship in the past. Knowing that we’re raising the money, we will want to get these nonperforming loans performing. That’s one avenue to sell to. Also, other investors. There are a lot of other investors out there who want to hold loans themselves, and they’ll buy performing loans as well.

I’ll add to that. There are other funds that only do performing.

Most funds only do performing.

What’s your average cost of expenses once you’ve bought the discount loan from the bank to create the note? We’re not creating or originating notes. Chris, you mentioned this. The cost for a nonperforming can be $5,000 to $10,000. Now, that spread is dependent on, or it could be less as well on how long it is before we get them reperforming. If we go to foreclosure, those costs are greater on the higher end of that scale, and then how much time it takes.

Again, it’s how much time and what the exit strategy is. If it’s something where the borrower comes to the table and says, “This is what happened. This is what I can pay,” we work something out rather quickly. That’s very different from someone from a property that ends up being vacant and we have to go through the full foreclosure process.

It varies state by state because each state has different costs, different laws, and different hold times. When we model everything, it’s modeled based on each state.

That’s an important note. When we’re going through our due diligence process in order to bid on assets or give indicative bids, we are looking at and adding those costs into it. It varies state by state, which we take into account and different exit strategies. We model it in ten different ways before we make a solid indicative bid on something.

Speaking of indicative bid, Jeffrey asked a question about offering below the asking price and bid price. You want to give people a little bit of a rundown of how the process works of indicative bids. Talk through this to answer that question.

Essentially, it’s not something where we receive what’s called a tape, which is a glorified Excel spreadsheet of assets with all the information from the seller. We bid, and it’s like, “That’s what you’re bidding. Let’s close. Here’s the wire. Wire me the funds.” It is a tape that will go out. If it goes out on Monday, they will say, “You have until Friday or the following Friday.” It takes anywhere from 1 to 2 weeks to make your indicative bid. That is taking the information that the seller has given you on this tape the values, where it is in the legal process, how many days delinquent, and all the information on the borrower. It is taking their word on it and saying, “Which ones fit my portfolio? Here’s what I would offer on these.”

The seller then reviews their bids. They say, “We’re going to accept your bid. We’re going to counter.” It’s similar to buying a house in the escrow period. Say they accept your bid and you enter into a due diligence, which is the escrow period, where you are able to then go and do your own research to validate everything that they’ve given you. Is the title clean, or is the stated value correct? This is where those vendors and relationships come into play. It is having attorneys in each state or more than one, in our case, who can review the title or having people set up to go check on the property to make sure that it is, in fact, the picture that they presented in the tape and not the house next door that doesn’t look nearly as nice.

We do a lot of validation and due diligence there. Once we do all of that, if everything lines up and there’s nothing where a first position is a third position or the loan is nonperforming and it’s actually nonperforming, we will continue and close. If there are things that we find that we’re not able to fix or are completely off the value that is big or if the value is significantly lower, then we will lower our bid or pull that bid from that specific loan and continue through to close with the rest. It’s definitely a process. It’s not something that is done overnight. The due diligence period is anywhere from 3 to 4 weeks.

Somebody asked a question about writing a book about this whole process that you’d have to go through and the team and stuff. The problem is, for me to write a book, it would be about 7,000 pages because I can’t shut up and I get too detailed on things. The more would kill me if I took the time to write a book.

There are many books out there. Having started in this industry as someone who built their own portfolio, none of the books do justice, telling you all the nitty-gritty things and detailed things that go into it. As Chris said, it probably would have to be a 500-page book because there are so many aspects that are not covered. Everything is high level. What I explained to you is very high level in terms of the actual due diligence process.

We have about 150 episodes on our show, Creating Wealth Simplified. Originally, we started as The Good Deeds Note Investing Podcasts, which, at the time, was my journey into note investing where I was sharing the case studies, the stories, and the lessons learned. As Lauren said, all the books out there are real high-level of what note investing is. There’s a very big difference between knowing what it is and how to do it.

If you read a book on the NBA, it doesn’t qualify you. I like to use an analogy because many of us are golfers. You can watch somebody or read a book on how to hit off the tee, but the moment you get up there and swing that club, it is a completely different animal. It’s like playing golf. After that first swing, you take that next one and continue to adjust your swing in your game. That’s an analogy we’ve used a lot in the past.

Are there any legal ramifications against the seller for providing deceitful or erroneous information, or is it buyer everywhere? I’m assuming you’re talking about the tape before the due diligence process. It’s not necessarily something that is done in a deceitful way. It could be that the data is a few months old because the things that we would find would be something like we order a new title report. When we go into that due diligence period, maybe their last one was a few months ago or they didn’t find what our attorney found. It’s not necessarily a deceitful way of doing it. It is just more dated information. As you can imagine, with housing values, we want the most current value when we’re making our bid as that is a heavily weighted factor.

There are two things I’ll mention to that. One, trust but verify. We take the information we’re given, and that’s how we determine our number, but we also verify that other information. The second component to that is we have a very tight locked contract with the seller. If there was something deceitful, like they had a backdoor deal, they didn’t own the asset, or something along those lines, we are protected through the contract in many things that are happening. If there was a document that had already been signed knocking $10,000 off the balance of the loan and was not provided to us, that would be remediated through the contract to get resolved. We’ve bought over 500 to 600 of these assets, and we’ve never had to litigate anything based on a contract dispute.

I love this question, “If the housing market takes a hit, how much downside protection is there in the fund?” There’s loan-to-value, and then there’s investment-to-value. The loan-to-value is the UPB. Here is $123,000 over the asset value of $500,000. There’s that loan-to-value, which is something we look at when we are making our bids. It’s why verifying the values of the home is so important, but the investment-to-value is the investor’s coverage. You’re looking at the acquisition cost of $80,000 to the asset value of $500,000. For this to become an issue where investors didn’t have protection, you can see that value would have to drop.

If that value dropped, it’s probably something much more catastrophic happening in the world. It’s not out of the realm of possibility. You don’t know what you don’t know until it happens, but now, our portfolio has an investment-to-value of 18%, and our loan-to-value of our entire portfolio is 23%. This is to give you an idea of the coverage we have and protection for our investors and the assets.

I’ll add to that. A few things are do’s and don’ts. Essentially, our don’ts are we don’t originate new loans based on values nowadays or even post-COVID values. I don’t think we have bought any loans on first-position residential mortgages that originated post-COVID. Most of the loans that we buy originated in 2000, 2006, 2010, and 2012.

Back in those times, if somebody was getting a loan on a $200,000 property, say they put 10% down, which is $20,180, they paid some of that mortgage down but also got the appreciation value of the home during that time. A very important thing that we focus on is making sure the loans have some seasoning or they’re older loans because they’ll get that equity bump on them. As Lauren said, our investment or loan-to-value is very low. We like to try and keep that number below 30% or 40% to protect the investor’s funds.

A very important thing that we focus on is making sure the loans have some seasoning or they're older loans because they'll get that equity bump on them. Click To Tweet

There are two questions. I want to answer this one because it’s pretty short, “Whenever you use the word seller, you are referring to a bank, broker, or whole loan trader, correct?”

Yes. They’re selling us the loan.

Regarding the bonus structure, someone asked about this, and this is important. It’s always something when people ask me, “Am I missing something? This is something I am not asking.” The bonus structure is calculated on an individual investment basis. It’s not cumulative, meaning those bonus shares start at $25,000. If you invested $15,000 now and $10,000 next month, you would not be eligible for bonus shares. It is on an individual investment that those are awarded. Will the bonus distribution be a rarity in your estimation? Is the 8% to 11% return a conservative number?

We do have certain targets that we hit for the portfolio. If we exceed those targets, there’s potential for additional bonus distribution. It’s not something that we are going to commit that every quarter, there will be a bonus distribution. It depends on the performance of the portfolio in that given quarter.

As I said, we’ve been through five different funds. Some with different structures. Based on this, we’re having to go through the SEC. We have certain compliance and regulations on what we provide. If there’s the opportunity to provide additional distributions to investors, that’s something we’ve done in the past and prior funds as well as this fund. It’s not out of that realm of possibility.

In this environment, is your fund more or less profitable? Given interest rates are much higher than when you started the fund, would you consider increasing your payout rate?

This ties a little bit to what you started a little earlier about where the market is. The interest rate environment hasn’t had an impact. As I mentioned, it’s a very lagging indicator, so it hasn’t had a significant impact yet on our business. We are starting to see more products come on the market. That bid-to-ask thread is starting to move towards a buyer side, but it hasn’t fully gotten there yet. There are so many other factors besides interest rates on a macro scale that can impact a fund and its performance from housing values and many other factors. That one item doesn’t determine whether or not our fund would be more or less profitable from that standpoint. We have to look at everything holistically.

Are there bigger purchase discounts near the end of a month, quarter, or year? Are sellers more motivated to sell to get off the books?

Typically the end of the year. The slowest time is right around tax season for companies to try and get their taxes done. For us, we had audits. In the summertime, it flows down a little bit because of vacations. Post-Labor Day, it’s a marathon towards the end of the year, and the last 60 days are a sprint to the finish.

Can you talk about what we saw in the first quarter with inventory? You talked about this a little bit, but maybe go into a little bit more detail. What we saw with inventory in the first quarter compared to now is how many bids we’ve placed in the last week and months. I know I’m putting you on the spot here, but we do have all the data.

Typically, we see around $300 million to $400 million a quarter in loan sales. So far, this quarter, we’ve seen about $800 million come through the door. What we’re seeing a lot of are loans that are what we’re going to call scratch and dent. A little bit of understanding of how the process works with a lot of lenders and banks is they originate a loan, they collect a fee for originating that loan, and then they turn around and sell it to Fannie Mae or Freddie Mac, which are called GSEs, Government Sponsored Entities. They get their money back and issue another loan so they keep collecting those fees. Scratch and dent loans are loans where borrowers have incorrect information, falsified information, or didn’t qualify based on the government.

 

Previously, a lot of those banks would hold onto those assets. As Lauren said, these are ones that originated in 2022 at 3%. They don’t know what to do with them, but now they’re pushing them out to the market and already starting to trade those. As an example, in 2022, we were trading at about $0.85 on the dollar. Now they’re below $0.80 on the dollar for those who are trading. We’re seeing a lot of loans like that. There are a lot of second loans for people who took out equity lines. We’re still seeing significant aspects of nonperforming loans as well. We’ve received over $100 million come through the door on nonperforming loans from people we’ve bought from in the past. We’re starting to continue to reiterate and see an uptick in the inventory in the market.

The biggest thing there is supply and demand. The more inventory we’re seeing, the more the pricing is going to soften in our favor and turn out to be a buyer’s market. We’re already starting to see that, but even more so, I anticipate that will continue to happen. I got another question. Can I invest in your fund through my broker, and if so, do I get the same benefits? The answer to that is you can, and you get the same benefits as someone investing directly online. We got through them all.

There’s another one. Tom asked a question. It’s more real estate related but I can’t help myself answer real estate questions, “I own a couple of single-family rentals. Is there a way to get notes on these properties and stop renting them?” Tom, there’s something you could do where you could do what’s called seller financing. You could find a buyer for those properties, act as a bank, and issue a loan to that buyer. That is something that we hear the phrase a lot. Tired landlords are people who have owned rentals for a period of time and get worn out by tenants and maintaining them or complaints and rather be leanlord versus landlord.

When the toilet breaks at 2:00 in the morning on a Sunday or is flooded, you don’t get the call as the lender. They call the owner of the property. That’s one thing. If you want, hit me up offline. I’m happy to give you some direction where you can find information on that.

We are raising capital for our Regulation A-plus offering. It’s open to accredited and non-accredited investors alike. The minimum investment is $2,500. Those bonus shares start at $25,000, and it’s 8% pay annually. I’m giving in bonus shares and paid monthly as dividends. If you have any questions, feel free to reach out. If you go to the next page, it will have our contact information. You can reach out to Invest@7eInvestments.com. There is my direct line as well, or find us on our website at 7eInvestments.com. Thank you all so much for joining us. Reach out if you have any questions.

Thank you all.

 

Important Link

• Invest@7eInvestments.com