E342 | The Trap of Low-Rate Loans: Lessons in Pricing Non-Performing Notes

Welcome back everybody to another episode of the Paper Trail podcast.

I hope you're doing well.

As we mentioned previously, we are doing a multi segment episode of pricing non performing loans and mistakes that we see people make and making sure we share our stories, highlights and mistakes we made in the past.

So you have the ability to correct, you know, or let me say learn from the mistakes of others.

Which is one of the best ways to learn is by hearing the stories, hear what people go through and taking this information and just putting it in the back of your mind so again you don't make the same mistake we did.

It was a great quarter for our company overall.

We bought more assets than we've ever bought in any quarter, had some payoffs, some foreclosure sales, took some properties back.

Extremely busy.

Our portfolio has reached well over I think 100 assets.

We're nearing a thousand investors.

So great quarter and finished getting our information into the sec.

And now the fun part of next month will be getting close to starting our financial audit which if anyone has never been through an audit.

It's actually a very educational process to go through and understand valuations of loans, valuations of companies.

It's much more in depth than just taking some numbers and plugging them into a spreadsheet to say the least.

But I've also got my coffee ripple and ready to go.

Funny story, I was having a conversation with people about like type of coffee you drink and so forth and you know, do you use a Keurig or the kind of espresso one.

I forget the type we have as well, but I just make drip coffee every morning, nothing fancy.

Make some, you know, drip coffee and go from there.

One last thing I want to mention is for those who do follow and watch a podcast, be on the lookout for for some paper stack seminars.

Looking at potentially having some online seminars in the future talking about topics such as bookkeeping as we approach the end of the year, how to properly put your notes into your books.

That's always a common theme, common question.

Another is reviewing tapes, going through a tape and how to sort through a tape and lastly due diligence, throwing out some due diligence files so we can work together with people and understand how to walk through due diligence.

So stay on the lookout for that.

I haven't announced anything.

It's in the back of my mind of something that looking to to do to again share and grow the education programs out there.

I used to have a membership group which was paid membership and I actually disbanded it because a of time and trying to resources and I didn't feel like I could fully commit to it and wanted to try and step back from things which is kind of what I did.

And one of the ways of I still want to of course give back coming from you know, my family and that education background and one of the ways I think I can do this for people is once a month having a seminar.

People can come on, can learn and continue to grow, can network and all lead up to you know, future future in person conferences as well.

So I just want to give some insight on that and again stay tuned.

Lastly, for those who looking to Potentially invest with 7e, our Regulation A offering is closing in mid November.

So if you're interested in our Regulation A shares program, check it out@7e investments.com One last note and I apologize for the 5 minutes of abble I am speaking but one of the things we launched this past quarter I'm going to talk more about in the future is a private lending correspondent lending program and we'll talk more about that.

But we now can provide loans to real estate investors and this isn't hard money loans at 12, 14%.

These are DSCR loans in the 6 and 7 percents as well as some fix and flip loans between 9 and 11% depending on credit and amount of borrowed.

So extremely valuable for real estate investors who especially are paying those high interest rates.

We've got some partners who we can work with to get you better rates on loans.

So just another aspect of us trying to give back.

And the same token, yes, we do make a few bucks off of it.

And of course it's something that we wouldn't do if it cost us money.

But it also I think is something that's a win win for everybody involved.

Okay, enough of that.

Let's dive in today.

Talk about bidding on loans and understanding you just don't put the numbers into the spreadsheet.

You can review the property, the predicament and the person and all of that and everything looks good.

But let's talk about the loan itself in a mistake that I made way back in the day that basically highly recommend people try to avoid.

And what that is are loans that are not seriously delinquent and have a low interest rate.

Let me give you an example.

A $100,000 loan at 6% is $600 a month.

Let's say a borrower is six months behind on payments, 30 $600 six times 600.

You buy that loan and let's say, oh, you buy that loan at a non judicial state and let's say you buy that loan for, you know, $70,000.

Okay?

Thinking that I'm going to file for foreclosure, you know, go through the process and foreclose on this borrower.

Let's say a Property is worth $100,000.

Okay?

Thinking okay, I'll take it back, I'll be able to sell it, sell it for 90, paid 70.

I'm gonna make $20,000 in six months on this deal.

All is good.

Okay?

Remember, if you've watched my prior episode, we talk about common sense and what would you do in certain scenarios?

And sometimes what is common sense is not so common.

Let's say this borrower has been in this property for 20 years and the kids grew up there.

They may still or may have children.

Rent in the area is $1,200 a month.

Where are they going to go?

Okay, what if the person also lost a job or just got their job back, whatever the case may be.

You just looked at all the numbers based on a foreclosure and the numbers work.

If it was just based on a foreclosure, what if that borrower turned around and reinstated that loan and you know, you got the $3,600 and then they start making their payments of $600 a month.

Okay.

Now you still, when you net out servicing fees, other costs, other things involved, everything.

Let's just say it's $550.

Yeah.

Okay.

That is essentially $6,600 a year that you're getting in and you got that payment and the money's coming in the door.

Now in this instance, you're getting on your, you know, seventy thousand dollar investment minus the several thousand you got in a reinstatement, you're basically making 10% on the deal.

Okay.

If the borrower were to continue to pay on a consistent basis, but what happens is the borrower misses a month here, misses a month there, and you know, continues to back and forth a little bit, but never gets 90 days behind, but does get behind where your servicer starts charging you extra fees, that is going to dwindle down into your returns.

Okay.

And on $100,000 loan, 100K at 3%.

I'm actually looking this up right now.

Basically you are at, what is that magic number?

Four hundred and seventy seven dollars a month.

Okay, so if they're alone at 3% on a hundred thousand is 477.

And then after servicing everything else, we're just going to round up say 450.

Okay, it's $5,400 a year on best case.

And then at the 70,000, you know, you made a little money.

But whatever case may be, you're back in the 6 to 8% yield on a borrower who may have been behind, may have not been performing.

Of course they weren't because the loan was behind.

So here's a question I ask, are you better off originating a loan to somebody with 800 credit as a private lender loan at 8 or 9% or buying a six month behind non performing loan that's written at 3% and possibly foreclosing, but possibly then getting this borrower to reinstate and then getting 6 or 7%.

So this is where I know a lot of people talk about IRR and everything else.

You know, that's where IRR comes into play when you're valuing multiple exit strategies.

Multiple strategies.

But I just want people to be aware as this is reality when I look at loan tapes and if I wanted to buy that loan and target a 12 or 15% return, if it were to be reperforming, you might be at like 40 cents on the dollar.

So you'd be at 40, 40,000.

So why the while the numbers do work on when it's non performing, it doesn't work if the borrower reinstates.

Now that's something definitely, especially in non judicial states, something you definitely want to look into.

Because if you plug in to your calculators, something in a non judicial state that you're going to be in and out of that loan and save in a year and you wanted to make 20k on $100,000 loan, or you want to make 20%, you bid 70, 65 or 70,000.

The numbers are probably going to work or be very close.

But if that borrower turns around and reinstates that loan and you're collecting payments on 3, 4, 5% loan, it doesn't work.

Think back in the news also, oh, I don't know, a year or so ago, Silicon Valley bank kind of what happened to them was they held, which is not.

Companies should do this, that are that size as a bank.

They're holding a lot of these bonds that were only like 3% bonds and then interest rates shot up and people had a run on their money.

They went to go sell those bonds at 3%.

But today's rate is 5%.

So I can go get a new bond at 5%.

Why would I pay par or face value for a 3% loan?

They had to discount the living, you know what out of it.

It's no different than these mortgages.

These mortgages are written at 3, 4, 5%.

Now the going rate on a mortgage now is 7%.

So you could go originate great credit to somebody at 7, 8.

I mean, if you do private money, you should be at 9 to 12%.

So why would you want to.

Now, again, you still may be able to foreclose in the numbers do work great if it goes down that foreclosure path.

Yes, you foreclose, you make your 20%.

Foreclosure provides significantly better economics.

It works, but if you don't.

And again, lesson I learned the hard way of this was back, oh, you know, I learned this before COVID So we weren't touching anything at 3, 4, 5%.

Oh, there was a loan that back in the day they did these 2% modifications.

I think this was before COVID or one was thrown in a pool and basically one was at 2% and Navarro was a year behind.

But the numbers still don't make sense even at a year behind at a 2% loan.

So we ran it as a foreclosure and basically took the risk, understanding, yeah, you know, if they re perform, but they're not going to perform, they're a year behind.

Oh, they borrowed money from a friend, got it reinstated, and then you're stuck with a performing loan at 2%.

You actually, when looking at these loans that are lower interest, you actually want them further behind because then it's going to be more likely that they can't reinstate.

But then the quandary comes.

The, you know, person and a spouse with two kids, they lost their job, they got their job back and they want to modify the loan or they want to give you some money.

They want trial payment plan, you say, no, I'm just going to foreclose on you because my numbers only work if I foreclose on you.

Some people will do that.

That's not something we typically tend to do as we typically want to work with the borrowers.

And this is why these types of loans we also typically shy away from because a, they're going to sell based off of more of the foreclosure number.

So you're not going to be able to work with them, or you can, but you're not going to get a desired return, which are, you know, I Also have a responsibility to my investors, which that wouldn't be fulfilling that responsibility.

And you're stuck in that quandary because if the borrower wants to get some type of trial payment plan or has something and you look and yeah, they can afford it, what do you do?

And again, you don't find any of this in any course that anybody teaches.

So you have to understand that, you know, kind of dynamics that go back and forth on these low interest rate loans.

And if the borrower wants to start working, paying again or not, the economics may not work.

So these low rate loans with minimal delinquencies, and I say minimal, it could be 18 months or less, can be a trap, especially if they reinstate, because if they do reinstate, there's nothing you can do.

Then you're stuck with a low coupon loan that's performing.

And what's that going to sell for?

You know, if somebody's buying it and wants 10 or 12%, that thing's going to sell.

Now we bid on some loans recently that are in that price range and I just told them like this is going to be the lowest bid you've ever seen because our numbers were like 25 and 30 cents on the dollar.

And it's home because I can go originate loans in double digits.

Why do I want to deal with a borrower on a 2% loan that if they miss a payment, Great, it's a 2% interest.

The discount has to be so absurd on those types of loans.

Now where it can be beneficial, and I'll just throw this out there is if you don't foreclose and they do on some of these, the spread is so wide.

If you get it at such a discount, sometimes might be worth going back to the borrower and saying, hey, I'll knock you out, refinance, I'll give you $10,000 or something.

We've done that in the past too.

Now on a 2% loan they're not going to do it because they want the 2%.

On a 5% loan, if rates are at 6, you might be able to convince them, who knows.

But I wanted to share this mistake we made in the past and want to share it with you.

Just again, when you're looking and evaluating the process of bidding on non performing loans, look at every exit scenario because again, like I mentioned on the other episode about assuming that fast foreclosure, now you're assuming foreclosure but you're not looking at some of the other avenues or options.

And some of those other avenues or options could put you at a significantly greater risk.

So that's all I have for today.

We will continue on this series in the future and more ways on non performing loans, looking at them, bidding on them, understanding what to look for and make sure again we're going to share our lessons learned, share some of the mistakes we have made to hopefully make you a better investor.

Want to thank you for listening or watching this episode of the Paper Trail podcast.

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I want to thank you, hope you enjoyed this episode and as always, I will catch you on the next one.