The State of the Note Industry

Around the country real estate markets have softened leaving a glut of inventory, decreasing values, and extended marketing times.  The result? More sellers are offering to finance a portion of the purchase price for the buyer in an effort to “Move that House”!

While sellers are motivated, lenders on the other hand are hunkering down or running scared.   In the face of the credit crunch and increasing foreclosures, lenders have tightened underwriting requirements.  Fewer loans are being originated and this also contributes to an increase of seller-financed private mortgages.

While the upside is increased private note inventory, the downside is fewer notes can be sold to investors.  While seller financing is an alternative to bank financing, note investors are not immune to what is happening in the lending arena, as evidenced by our recent post on Note Investor Registry Changes.

Many note investors were securitizing their product by pooling notes together and selling as mortgage backed securities to access Wall Street funds.  This helps provide liquidity and a lower cost of funds. Unfortunately, some of the investors using securitization as their sole source of funding are no longer buying notes due to the fallout of the sub prime debacle. 

So there are more notes but fewer resale options.  Where does that leave us? Undoubtedly there is opportunity from increased inventory in the current environment. After participating in the note industry for 20 years, it seems we are coming “full circle”.   Here are a few insights on successfully navigating your note business through the changing industry:

1) Realize note buying parameters have changed.  In order to minimize risk in a high default environment investors have tightened underwriting requirements. This means few private notes with less than 10% down or credit scores under 600 are being bought in today’s secondary market.

There is also a reduction in pricing for the notes being considered. This results from increased yields (more risk equals more reward) and decreased exposure or Investment to Value (ITV) limits.  If yields increase then the face rate of the note must also increase or the result is larger discounts.

2) Prepare for declining values. The ITV issue comes into play even further when property values are decreasing. For example, if an investor is comfortable at an 80% ITV on a property that sold for $175,000, the investment exposure would be $140,000 (depending on credit, yield, etc).  If that home now appraises for $160,000 and the investor still wants to limit their exposure to 80% ITV the maximum they would now invest decreases to $128,000.

3) Update structuring and negotiating skills. We once again must practice the “art of the deal” by learning more advanced structuring techniques such as partial purchases.  By purchasing a portion of the payment stream, a partial can create a win-win scenario by reducing the risk to the investor but still providing cash to the seller.

4) Be direct.  Now more than ever it is important for note brokers to be direct with the seller and the investor.  There is little room for multiple levels of note brokers diluting the profits, communication, and skill level.

5) Expand your base of note buyers. With fewer institutional type investors there is a need being filled by private investors and financial companies that can hold investments in their long-term portfolio.  These companies are looking for make sense deals that fall outside the stricter lending guidelines.

Consider looking to new sources of funds like pensions, IRAs, 401(k)s, and other retirement account vehicles.  Self-directed retirement accounts can be a welcome investment option.  For more information on this subject read “Utilizing Retirement Accounts to Buy Notes and Real Estate”. 

The inventory of notes that was depleted during the real estate boom is now being replenished.  While it will take time and ingenuity to deal with the investor issues, the markets will eventually balance. By adapting to change and increasing skill, note brokers can ultimately prosper from the current state of the note industry! 

About Tracy Z

Tracy combines her knowledge of cash flow notes with the power of marketing online to help grow your business! She can be reached at 1-888-999-7905 or at Exposure One Marketing.

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