Note investing isn’t always straightforward. Chris Seveney shares real-world case studies to illuminate the challenges investors face. Chris shares detailed scenarios, including strategies for dealing with uncooperative borrowers, assessing the true value of properties, and making informed decisions at foreclosure auctions. He also discusses the importance of understanding risk profiles, especially when evaluating high-return opportunities, and provides practical advice on vetting sponsors and avoiding pitfalls. Join Chris for an informative discussion on navigating the challenges and opportunities in note investing.

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Case Studies And Sponsor Vetting: What You Should Know

Case Study 1

I want to share a few more case studies with investors. I was talking about a loan that we had a borrower in a situation where they hadn’t paid in several years. This property was not their owner-occupied property. They were using the property as a rental. I made the comment that they were a professional borrower, meaning they knew how to game the system.

In this situation, we had gone on for several years with this borrower. The borrower filed multiple bankruptcies and went through multiple mediation. After never making a payment through any of these bankruptcies, it got tossed. The borrower went to file another bankruptcy. The court said, “Sorry, but you can file bankruptcy, but the property in question is no longer protected as part of the bankruptcy.”

After that occurred, we continued with our foreclosure. Here’s a strategy thing that a lot of people, when they go to note investing, are like, “It’s black and white.” Here’s the reality of this situation. We’ve never stepped foot inside this property. Depending on the condition, this property could be worth anywhere from $70,000 to $120,000. Using rough approximations, the borrower owed roughly $80,000 to $90,000 on the loan.

Here’s where you have to think. I bid $90,000 at foreclosure and took that property back. I bought that property for $90,000 because foreclosure is an auction. I don’t want to keep that property. I’m going to turn around and sell it. What would I need to do? One, file eviction and get that person out of the property. There are two things that would include or cause. It’s time and money. We’d have to evict them.

The next component is they have to turn around and sell this property. They have to get it cleaned out because I know it’s not going to be left in a nice broom-swept condition. Get that property cleaned out, change the locks, and have to get a real estate agent involved. We’re going to spend $5,000 cleaning out that property. I get an agent and pay rough numbers, 6% commissions. Other closing costs and everything else involved, it’s 8%.

The question is, what’s the magic number somebody should bid on at auction? If you do not want to take the property back, you have to realize that by letting it sell for auction at $70,000 or taking it back at $75,000, which one is better? In the long run, you’ll be much better off with $70,000. I’ll say the $75,000 as an example. Let’s use that $90,000. If I take it back for $90,000 and sell it for what I took it back for. Usually, it’s less because nobody would pay for that. The 8%, $7,200 plus $5,000 to clean it up, and $1,000 for eviction, $13,000-plus already spent. What’s that other factor that I mentioned early on time? Time is money.

You wanted 10% to analyze on your money, an extra $750 a month that this thing is churning. By the time you go through the eviction and everything else, you’re easily six months, which is another $5,000. These are the things that, as an investor, I want to share with those who want to be involved in note investing. As somebody who manages a portfolio, these are the things you have to think about. The $90,000 at foreclosure auction isn’t the same as $90,000 taking you back. The $90,000 at auction is far better.

$90,000 at a foreclosure auction isn't the same as $90,000 taking back. Share on X

I’ll give some ideas and insights. On this loan, it is going to use rough numbers for $35,000 to $40,000. It was going to be some money made on it. It’s a matter of how much. When it goes to auction, what I want to focus on is I did not want to take this property back. Knowing where that range of values could be, I started at the low end. I started our bid in the low $70,000s. Somebody bid and won the auction. I reverse-engineered it again to say, “Am I happy with that?” Yes, I was, because I no longer have to deal with the property. I’m going to get paid off at auction. I don’t have to evict. I don’t have to clean it out. I don’t have to do any of that. It’s done.

Case Study 2

Let’s talk about another asset in our portfolio previously, where this borrower had tons of equity. He has a $300,000 house. They owed $100,000 something. The property went to foreclosure. We bid full payoff. Somebody came in and bid well above that, which is great for us because in Michigan, which is where this was, there’s a redemption period. That person can’t do anything for six more months, but we get all our money. I wanted to share those.

We have another interesting situation where we had a loan. We were working on foreclosure. We’re trying to work what’s called a deed in lieu with the borrower. A deed in lieu with the borrower is, let’s cut to the chase. Do not do the foreclosure. You don’t want the property, which they don’t, in this instance, give us a title to the property. In order to do that, we have to be careful. We have to check that there are no other liens or encumbrances on that property because taking the deed is a quick claim to us, and we’d be responsible for all those.

Thankfully, we’ve done all that research and due diligence, and there are no other liens on the property. The challenge we’re running into is we have a borrower who is not receptive to giving a deed in lieu. The borrower has come back and has wanted tens of thousands of dollars from us for a deed in lieu. How do we evaluate the situation? If you’re a note investor, how do you evaluate this? Let me explain.

What are the options or outcomes? That’s how I always look at things. You know, what are the outcomes that could occur? We can foreclose. We are confident we’ll take this property back because the valuation is close to the total payoff. There are some benefits we believe in taking this property back to put it back on the market and get some surplus from it.

The first thing is, how long is that foreclosure going to take? This is in a non-judicial state, which means you don’t have to go through the courts. It’s going to take about 60 days, but we could foreclose in 60 days. It’s going to cost us $5,000. It’s rough numbers of foreclose. We can try to get the property back. What’s that property worth? How much should we give this person? Do we give them $5,000 that we give the attorneys? Do you give them a little bit more? If he came back and said, “I want $50,000,” do you want to give him $50,000, or do you wait two months of time?

Those are the questions that you have to evaluate and understand. As a note investor, I had this early on, and it doesn’t even phase me anymore. Early on, you look at it as there is no way I’m going to give somebody who’s not paying their mortgage money to walk away. They should be giving me money. It is the way you think about it and the way you look at it.

Unfortunately, it’s not reality. It’s not how the business works. You have to take all your differences, separate everything, and focus on what the best outcome for my company and me is. In this instance, giving him $50,000 is not the best outcome. Pushing it through to foreclosure is a better outcome because of what it will cost us in that time. If this was a two-year foreclosure process and the costs were $20,000 to foreclose, that would be a much different conversation or analysis.

What we have in front of us is definitive and defined. The borrower we know is not going to file bankruptcy. The borrowers passed away in this instance. The estate is not going to file for bankruptcy. They could, but we would still push to try and get the property sold because they’ve already said they want no interest in this property.

What is the magic number? This is the question that people have to think about in the gray areas, as I always mention, we do in note investing. What’s the best to provide or to get to secure the property, which is one thing that we want to do? We want to take control of this property because we want to make sure it stays vacant. We don’t want squatters in there. We want to make sure utilities and things are on. We don’t have floods, leaks, or fires.

Another thing to focus on is eventually, we’re going to take this property back. Let’s try to get it sooner rather than later because if we can get it back sooner, we can get it on the market, but we can turn it over. It’s another potential outcome that people have to look at and try and resolve. There are a lot of people out there who will show you black and white of note investing, but there’s so much in between in the grays that this needs to be understood and resolved.

 

I believe we will come to some settlement or agreement with the borrower. We’re not being overly aggressive with them, emailing them back and forth. We’re reviewing to see what works for us, get back to them, and review the numbers because time is more on our side than it is on their side. It’ll be an interesting outcome that we can share in the future once it gets resolved. It’s something that is still ongoing and something we are still evaluating, looking at, and trying to see where it goes.

High-Return Investments

Those are 2 case studies or 2 active loans. The third thing I want to talk about is a recent loan that came across our desk that we turned down. One of the things that, as a sponsor of a fund as well as an investor in other funds, people need to pay attention to and be aware of sticker excitement. What do I mean by sticker excitement? Look at the potential of an opportunity on Facebook. That is an awesome return. We had an opportunity. Someone was to acquire a loan that was paying 20%. It was newly originated. We would be able to collect some points on it and 15% interest on this loan. It’s 20%.

We looked at it and went through a thorough due diligence process. One of the first things that kicked it out for us was that it was a highly leveraged second-position loan. Do we have some second center portfolio? We do. It’s not what our main focus is. We always evaluate and underscore the risk in these loans. It was leveraged up to about 90%. We looked at it and said, “No.” They asked us if we knew anybody else. There are other people who will lend on this and who are happy to take on this type of risk.

I’m active on BiggerPockets. I’m seeing post after post of people investing in syndications that were promising 15%, 20%, to 25% plus returns. The reality is somebody took a poll and showed how many people invested in this opportunity. The majority of them invested when the returns went from 12% to investors and 20% to investors. The first question I’d ask is, what change as part of your business model allows for that type of return? What is my risk profile? What am I looking at? What are you investing in?

Unfortunately, many people have ruined six figures of income with no idea what they’re investing in. The sponsor freezes distributions and stops paying. People are shocked. They’re like, “I’ll get all my money back. The reality is that there could be nothing left because when somebody is trying to target such a high return and bring all that money, it is a high-risk investment.

That’s not to say there could be some low-return investments that aren’t high-risk. Every investment has significant risk, but if somebody is trying to target a return that is significantly higher than the marketplace, you have to understand that your risk premium is going to be significantly higher. Your standard deviation, which is where that fund could finalize and perform, could perform well and give you that, but it could also perform down to zero because of that type of opportunity.

Every investment has significant risk in it. Share on X

Other things people need to focus on and consider as part of investing in this space is not getting excited by this person’s offering or that percent return because that’s not guaranteed or promised. That is a target. That’s what they’re aiming for. The question should be, what needs to go right to get there? What could potentially go wrong? What is this risk profile?

Closing

I hope everyone enjoyed this episode. Make sure to leave us a review. If you want more information about the company, head over to 7EInvestments.com. Thanks for reading. Take care. Enjoy the rest of your day, and we’ll continue to keep you updated on these case studies and more about how to invest in mortgage notes.