What is gained can also be lost. Last time, we talked about earning money through note investing. Today, we look at the ways you can potentially lose money through it. Chris Seveney candidly discusses common mistakes he’s witnessed, emphasizing the pivotal role of education and the dangers of stubbornness. He stresses the need for due diligence and cautions against the pitfalls of following trends without a solid understanding. From internet sleuthing and assembling the right team to addressing challenges in specific areas, Chris wraps up with a passionate call to avoid being cheap in crucial aspects of the business. This is a must-listen for investors seeking to navigate the complexities of the market and avoid losing money. Tune in!

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How To Lose Money Through Note Investing with Chris Seveney

Welcome back, everybody, to another episode of the show. I’m going to follow up on a presentation I gave a few months ago at a great event called Cashflow Expo. I’m going to talk about how to lose money in note investing. A lot of these tips that I’m providing people can be used throughout any type of investing strategy. You’ll focus on note investing, but when we talk about due diligence, this can relate to any type of investing that you do.

This isn’t strictly for investors. This could be correlated across multifamily investors, short-term rental investors, you name it. This is information that is pertinent. This is also going to be from the experiences that I have had in the past and things that I’ve seen. I’ve been in real estate for over 25 years, so I’ve made a lot of mistakes. I’ve seen a lot of mistakes being made. This is overall from my wisdom. When you start with the types of mistakes that I see the most frequently, they come from two different avenues, education and stubbornness. Typically, the stubbornness is that people don’t want to be educated or ask for help. Let’s talk about those, and we’ll talk about other aspects of investing as well.

Know The People You’re Dealing With

One of the things I want to start by reiterating to people is that when you’re starting any type of investing, in this world with all the information that is available on the internet, especially if you’re going to be a passive investor as well, you need to be an internet sleuth. That information that is readily available will let you quickly and easily be able to learn more about the person you’re dealing with and the people involved. That is one of the biggest things people need to understand right out of the get-go is, “Who am I teaming with? Who am I doing business with?”

One of the biggest things people need to understand right from the get-go is who I am teaming with and who I am doing business with. Share on X

If you set it up and you’re with the wrong people from the start, that can have a significant impact on your business. I’ll give you a case in point when I started out at note investing. With the education I got from an individual, I came to find out that that individual took a wrong turn, was doing deals, and had a significant number of judgments against them to the tune of over $1.5 million. When I heard that and heard the stories and what was going on, I immediately disassociated with that investor. I see people associating with that individual.

If you’re somebody who’s going out there and trying to raise money from an investor, you want to be associated with people who have judgments against them because they never pay people back. A) You don’t want to be associated with them, but B) The affiliation or anything is so completely wrong. Stuff like that honestly blows my mind.

Continuous Education

Another thing people need to understand is your education or anything you do isn’t taught overnight. You don’t go to college for a weekend or a month. I’m going to nerd out a little bit here and talk about my degree, which was in Civil Engineering. I went and learned a lot about concrete structural engineering. After taking a concrete class, I knew a lot about concrete, but it doesn’t mean I could go design a foundation or a building.

When you get this education, it’s a good solid foundation, but you want to continue to gain more education. You’re far from being a master or getting started as part of your journey. For people getting started, remember that you get all hyped up by seeing something new and getting excited about it. There’s still so much more that needs to be learned. You’re scratching the surface. Those are some of the main things to get started that people have.

FOMO: Fear Of Missing Out

The other area where I see people making mistakes is the F word. It’s not the F word you’re thinking of, but FOMO. In real estate investing, there was so much FOMO out there a couple of years ago on short-term rentals. People are like, “Short-term rental. I got to have one.” What are the people who bought towards the middle or the end of that run doing who bought in ‘22 and ‘23? If you don’t know, I’ll tell you. Most of them are getting crushed now.

Multifamily syndications from pre-2020 are probably still doing okay, but everybody needs to be a multifamily investor because they’re seeing everyone else doing it. Every day, I see another multifamily syndicator handing over the keys or going under. Investors are getting upset. They should, but by the same token, they weren’t complaining when they were getting the 18% or 20% return and understanding that there is that risk of losing everything. People need to understand not only the FOMO but also rolling into the risk involved. The higher the return, typically the higher the risk.

I had someone tell me something about how their business is providing loans. I couldn’t understand what they’re doing, but they’re providing loans and providing annualized 40% returns to investors 10% per quarter. I’m sitting here scratching my head because I have never seen any business ever be able to operate on 40% margins to its investors and still make money consistently over a period of time. Has it happened in a specific year or maybe a few years? Yes, but is that a sustainable model? Niche businesses maybe, but being on the lending side, I don’t know any type of lending that can produce that type of return without having incredible risk.

People get excited. That’s okay. I’m always excited. Don’t run into something because you feel like it’s the next big thing. That’s where I see a lot of people making mistakes too. They’ll go spend $5,000 on 1 thing, try it out, and they’re like, “This doesn’t work,” or, “This isn’t easy.” I can tell you whoever’s reading this, no matter what it is you’re going to do, it’s not going to be easy, especially if you’re not going to be passive. Even being passive, doing due diligence is not easy.

We talked a little bit earlier about being that internet sleuth and understanding who you want to affiliate yourself with. We will talk a little bit about note investing. Also, if you’re being active in any type of real estate, it is putting that team together and understanding that most real estate people need a realtor. We need a realtor. In mortgage loan investing, you need a servicing company. Understand the servicing company and what they do and will not do for you.

Also, understand the costs because 99% of note investors will only look at, “They charge me $20 a month for servicing.” They don’t look at, “Escrow is this much. I needed this type of letter or that type of letter. I need this. I need that.” The next thing you know, you look at the end of the year and it’s like, “This averages $75 a month.” That can have a significant impact on your returns. Also, if it goes delinquent, which we play in that delinquent space, what does that special servicer do for you? Certain ones don’t really do much. The borrower calls in and guess who gets a phone call? You might get that phone call.

Wrong Legal Representation

The area where I see a lot of people make mistakes is in their legal representation and hiring an attorney who does not fit their model. Finding an attorney is like any other type of individual that you need to find. They need to be specific to your needs. If you are a landlord, you need somebody who can do evictions. If you’re a note investor, you need somebody who can do foreclosures and evictions. You don’t need an attorney who does title and closing. Maybe if you do seller financing, you do.

Also, if you’re a smaller firm, you don’t need a big foreclosure mill that is processing thousands a month for large institutions because you’re a number. You’re not going to get the information where you pick up the phone and call somebody and try and get an answer from them. You’ll probably get pushed down the line. Understand who you want to work with because if you select the wrong team, that can have a significant impact and cause you to lose considerable money.

I’ll give an example situation I have. It’s an attorney, the only attorney I fired, and I fired them twice. I believe they overcharged me. You had to hold their hand and be like, “Did this get filed?” They’re like, “Yeah. That was filed.” I’m like, “I don’t see it.” The next day, it pops up as it appears it was filed. A) They’re lying to me flat out, which I’m going to call them out on, and charging me for every little thing. If they make a mistake, they still charge you for it. That’s something that people need to understand. They can cost you considerable money.

One thing I’ll mention is that can happen, but also, as an investor, it’s a business. You’re not friends with these people. Don’t feel bad if you have to fire them. If they’re screwing up and charging and you’re like, “I’ll pay it.” Push back. This is a business. You can’t treat it like friends and family and be like, “Maybe next time around, they’ll do me a favor.” Trust me. They won’t. Understand separate business from pleasure. When somebody’s doing something wrong, calm down. Work out the issue. Figure out if there’s something you can do to get it resolved, but make sure you have the business acumen to push back and move in different directions.

Financial Projections And Risks

Let’s shift topics a little bit. I’m trying to walk through some ways. We talked about education and the fear of missing out. We talked about putting your team together. An area where people make a ton of mistakes is financial projections and do not understand the risk involved with those projections, which I will call sensitivity analysis. People will get tunnel vision or blinders. They’re like, “I can get this at this price.”

Examples I’ve shared in the past are we will not buy loans typically that originated during COVID because those rates are going to be between 3% and 4%. Those loans are only a year behind. People are thinking, “This $200,000 loan that somebody refinanced on a $800,000 house, I’m going to foreclose. I’m going to get paid off now. This is going to be awesome.”

What are the chances that the borrower is going to let you foreclose? I can tell you it’s 0%, not even 0.1%. This isn’t dumb and dumber, that 0.1% there’s a chance type of thing. It’s zero. They’re going to either file bankruptcy or a way. That’s the reality of what they’re going to do. They’re not going to let you foreclose. Why? Where are they going to go to? The rent is shot up. They can’t buy a house. Their mortgage payment is probably still lower than rent. What are they going to do if they file bankruptcy?

Let’s say they’re a year behind on a $200,000 loan. What’s their payment? $2,000 a month? They’re $24,000 behind. You’re going to get an extra $400 a month for 5 years. You bought yourself a 3% loan. You can go put a treasury at 5%. Maybe you’re making 4% on that loan 4%. The person will be like, “It’s reperforming. I can go sell this at $0.90 on the dollar because,” back to education, “my guru told me I could sell this at $0.90 on the dollar.” You can’t because the interest rate is at 3%. Nobody’s going to give you that. You’re lucky if you get $0.70 on a dollar for loans that low. That would be from an institution that’s probably trying to pull about an 8% yield.

People are not understanding the projections and the outcomes that are going to prevail. What would you do in that situation? You’ve lived in a house for twenty years. You’ve got three kids. You’re married and you’re best friends with your neighbor who you’re barbecuing with every weekend during the summer. You’re going to the pool parties. You’re going to let somebody foreclose so you can go live in an apartment? What do you think?

I’m going to dive a little bit more into some more specifics in regards to pulling back on everything that I   talked about in regard to these ways that I’ve seen people lose money. Here are the ways that are plain flat-out flipping stupid that I see people do and then wonder why, “I can’t believe I lost money on this deal.” To give an example, it is due diligence in note investing. This relates to using a term in real estate investing as well.

In note investing, you have to get eyes on the property. Drive by and look at it. People don’t do that. It’s like buying blind. It’s like you buying a house without looking at it or buying a house without even doing an inspection on it and paying full market value for it. People do that as well. They then come back and say, “I found out they issued an issue for $30,000. Can I go back and sue anybody?” Are you going to win? No.

Here’s an example. There was a pool of loans that came out a few years ago. I bought 80 of them. Originally, we were going to buy about 120, but 40 of them, we threw back. One I remember vividly was the house was vacant, which we typically do not like, but in the servicing loan comments. When you buy notes, the conversations that the borrower has with the servicer who’s a company that collects those payments are all documented.

In this one, they had somebody go out and say, “In pulling an inspection, there was an icicle chandelier hanging from the ceiling as the home was not winterized.” The asset came back on another tape and they put what the pricing was on that. The person owed $100,000 on this property and they’re selling it for $0.15 on a dollar. Someone’s like, “I’m buying these for $0.15 on a dollar. I’m getting a killer deal.” They paid $15,000 for this. This property also had taxes owed on it. The property wasn’t worth $100 because of the taxes and everything you did. It was a knockdown. You’re buying a vacant piece of land that owed taxes.

Understand people. Create standard operating procedures and follow them. It’s common sense. If you’re going to buy something, go look at it or send somebody to look at it. How many of you go shopping and go to the store to buy sneakers and you’re like, “I want to go look at these. I want to try them on.” It could be jeans, a shirt, or a car. Are you willy-nilly and do not look at it or see a picture and order it? Maybe a sweatshirt and stuff, but most people still want to try stuff on.

The other component that I’ll mix into play with that is the expectations on when you do go send somebody out to look at the property. What is that valuation worth? I have this battle with sellers all the time. I had this one with a property. I really like the property and thought it was a good asset, but when I sent somebody out there, it’s got a hole in the roof and no flooring inside the property. When you peek through the windows, you can see daylight through areas of the house. They valued it at $300,000. I’m like, “A house right next door sold for $300,000 completely renovated.”

When you’re pulling comps, the valuation team is living in this fictitious world of, “This borrower who hasn’t paid in three years is going to have a completely updated and renovated house.” You can get a house where they even trash it out for you and you can spend less than $1,000 or $2,500 if you take it back. To me, that’s a win. Understand that these properties should be valued as REO properties, not as brand-new construction homes. I see a lot of people make those mistakes as well.

 Professional Borrower

The last thing I’ll talk about specific to notes is the borrower’s situation. We like to use a term we paint a three-dimensional picture of the property as well as the person in the predicament, like that one with the icicle chandelier. In those notes, we can see what happened. I see it’s a mother with five kids whose husband suddenly passed away. That’s not a loan I want to deal with because it’s probably not going to end in a win-win solution. In other instances, I have seen borrowers who have filed for bankruptcy. The record is seven times. I’ve also seen borrowers who have a spouse and they alternate filing back and forth.

Similar to people who own real estate and have tenants who are professional tenants, there are professional borrowers who know how to game the system. They know how to milk the clock per se and do not have to pay their mortgage and keep going. We’ve seen it. I’ve got one in a situation from one of my prior funds who’s using it as a rental and has filed for bankruptcy three times. She is a professional borrower of collecting rent on a property and milking it.

 

Unfortunately, what she doesn’t realize is if we foreclose on this property, because it is an investment, she still has liability for any shortage on what is owed if there is any. That’s one of the benefits of foreclosure that you have in those situations. To digress a little bit there, it is understanding that in those situations, is that one you want to get yourself into? If I’m buying a rental property that the person hasn’t paid in three months or they’re a spotty payer on a rental property, are you going to pay full price for that? Those are things to be careful of.

I have one last thing that I do want to mention specifically to notes as well. The other thing on the property is understanding the title defects. Do not pretend you’re an attorney. This one drives me nuts because you are going to eff up. Usually, you screw up the contrary where you think you got everything and you’re missing something. When you think you’re missing something, you don’t have anything. Y ou’re pissing off the seller.

These people who play attorney, this is probably one of my favorites. I stayed at the Holiday Inn. I can’t tell you how many times I see sellers who play attorney. Why do they play attorney? Let’s go back to another mistake that people make. They are cheap. You’re going to spend $20,000, $30,000, $40,000, or $100,000 on an asset and you won’t spend $100 for a title report or $250 for an attorney to review or you won’t send somebody out to take a look at the property. If you’re going to be that cheap, then get out of the business. I’m being frank. Many people start being cheap.

Those are the main areas where I see people. I could go a deeper dive into people trying to manage your loans who don’t manage your loans. They think, “The servicer’s going to manage a loan. The servicer’s going to work on the loan modification. Tell me what the numbers should be.” That doesn’t work. You need to manage your loans, and that goes back to education. There are the attorneys and the servicing companies. Realize that every consultant or vendor you use needs to be managed. Your servicer does not get paid as much as your attorney. A lot of times, your attorney may need more handholding than your servicer. It’s the reality.

 

Buying Overpriced Properties On Seller Financing

Those are the main ways I want to talk about in this episode. Those are ways that you can significantly lose money.  A lot of them are common sense. As we wrap up, the last thing I’ll talk about is outside of note investing, certain things I see people doing that I feel are going to get crushed later on down the line. I can come back in three years, read this, and pat myself on the back or say, “I was wrong. I’ve got no consequence, so it doesn’t matter.”

Areas I see people who scare the heck out of me are buying overpriced properties on seller financing because they’re not putting any money down. They’re like, “I’m not putting any money down. This person will finance it for me for an extra $30,000.” They’re going to find out very soon that they can’t exit that deal and it’s not going to cashflow, and they’re going to get in trouble.

There are people who buy loans that are nonrecoverable thinking that they can recover them. There are people who are not keeping money in reserves in any asset class you invest in. In notes, real estate, you name it, you need money. You need that cash on the side. There are people who are doing things the wrong way. I see so many people not playing by the rules that it blows my mind. Every day, we see more people going down either financially or being investigated because they’re doing things wrong.

I hope you found some information or content that’s valuable from this episode. I’m happy to share more information. Please visit our website. We have webinars where we talk a lot about the risk involved in investing not only as an active investor but a passive investor. That website is 7EInvestments.com. For the webinars, you can go to 7EInvestment.com/Webinars. Thanks for tuning in. I can’t wait to record another episode. I’ll catch you later. Thanks, everyone.

 

Important Links

• https://7einvestments.com/Webinars/
• https://www.LinkedIn.com/in/ChristopherSeveney/