Skip to content

Note Brokering of Defaulted Mortgages and “Turnkey Investment Programs” – NOT?

Note Brokering of Defaulted Mortgages and Warning – this is a memo on the Art of Note Brokering. It was prompted by a note broker friend of mine who recently sent me a one-line update on what he had available for me: “Turnkey investment – Newly rehabbed middleclass homes (former REOs) with large equity positions, leased, and positive cash flow in a market beginning to rebound.” I think you achieve Jadedness levels of ’10’ when those kinds of deals make me go “hmmm, wonder what’s under the covers on this one.”

What was coincidental was that earlier the same day that I received this email, I’d just read a notice from someone else advertising an “amazing turnkey investment program”.

So, being the perennial tester, I decided to run some numbers to try to figure out what kinds of “deals” these could be. I cobbled together some logical assumptions in order to see if I could understand it.

Back-of-the-Envelope Calculations

$100,000 purchase 20% Down Payment 2% Closing Costs 22% or $22,000 – Down Payment plus Closing Costs

10% or $10,000 of Down Payment rebated at close (one common way to rebate this would be to have the purchase price “inflated” by $10,000, so now you have a $100,000 transaction, in which the seller accepts $90,000 and the remaining $10,000 is funneled to the buyer outside of escrow – often doesn’t show up on the HUD, which is questionable practice – there are other ways but this is a common one)

$12,000 Cash out-of-pocket

Reason for the FICO requirement is that obviously the “investor” is qualifying for a loan, most likely brokered by the “seller” or a company related to the seller (wonder how many points they charge out of curiosity).

Assume a 6.50% rate on an 80% 1st mortgage – it’s an $80,000 loan. Now, here’s the tricky part – what KIND of loan are these guys putting the buyer into – hopefully it’s full doc fixed rate financing (cautious and reasonable – look at default rates on fixed v variable rate financing and there’s more than a slight skew towards ARMs). Chances are it’s an ARM with an IO payment to minimize the financing cash flows. But let’s give everyone the benefit of the doubt and say that it’s fixed at 6.50%.

So now, what you’re looking at is a monthly of $514 (assuming 30-year amortization – though these guys probably push for 40), not including taxes and insurance (do they include T&I payments, and do they escrow for those when they’re setting you up as the buyer?). Taxes, let’s assume for simplicity, would be 1% of acquisition, so that’s $83/month, and insurance could be another $20 or so, so that’s about $617/month.

But wait. Since I’m not really managing my rent, there must be someone who’s being paid a property management fee, right? Well those fees can typically be 10% of the collected rents.

Now then, let’s define “positive cash flow”. The fact that this investment strategy is marketing “positive cash flow” rather than yield, the way an enlightened investor would think (I’m showing my bias here, and why understanding returns is crucial to your success as an investor in my opinion), means that this investment is most likely throwing off a few dollars, rather than a juicy spread.

So to be positively cash-flowing on this property, you need to be bringing in something north of $650 or so/month. So net of a property management fee of 10%, that would mean rents of $722.

But wait! Just to play it safe, since that’s the type of investment strategy being proposed here (a “safe” alternative to your market chaos), then we should probably build in a vacancy rate of maybe 1 month every 2 years. So that’s a 4.2% vacancy rate.

OK, so I discount my rent down by 4.2% – call it 4%, so that means I have to get rents of $752 / month. In certain markets I’m sure 1-bedrooms or 2-bedrooms can fetch that kind of money, easily. And in some others, I’m sure that that’s pretty tough to do. But this should be, by my very simplified calculations, what the rent should be in order to support a “positive cash flow” claim.

A Note on Rental Predictions

The challenges with these REO plays is that you’re not quite sure what the rental market is doing where Foreclosure volume’s pretty high. We’re seeing tenancy rates drop, leading to rental drops, in certain markets (completely counter-intuitive here), because some people move in with family, and because continued Foreclosure volumes lead to an increase in REO inventory whose only buyers are investors seeking what… rentals. Therefore, rents are staying soft in certain markets.

So the “guarantees” of cash flow in these investment strategies are iffy – the only way to make them “solid” is to actually have lease agreements already signed. Could well be, I’m just pointing out one risk to the cash-flow model.

And then, what really intrigued me in the email I received from this company selling the “Turnkey Investment Strategy” was something they termed a “guaranteed buy out” where you can get 1/2 the appreciation. Interesting. So the seller’s really selling a put option on the property. So it would be really interesting to read the language of that “guarantee” and what you’re being “guaranteed”. If I were to hazard a guess I’d say that there’s no strike price being locked in with that put, but rather a time frame (e. g. we’ll but it back in 24 months), and a notional cost to the option (and we’ll give you 1/2 the appreciation). So if there’s no appreciation (the forecast for price growth over the next three years according to Zandi over at Economy. com is flat over the next 3 years), then are they saying they’ll buy it back at cost? And if there is appreciation, then you’re essentially signing something now that costs the Seller nothing, and gives them 1/2 of some future “upside”. Wow. What a deal. For them. It’s only a deal for you if the future buyback price is actually defined now. More than likely, it’s some funky equation to the Seller’s benefit.

Me, skeptical?

What it sounds like to me is a deal to take market value of an REO ($90,000), inflate it by 10% and get a lender to finance that incremental price to facilitate a cash-back (potentially illegal) to buyer situation, with a claim that “rent will cover the mortgage payments” but perhaps on a loan that’s an Interest Only loan, and on a loan that doesn’t escrow for taxes and insurance.

That alone worries me.

The further claim of guaranteed buyback strikes me a great little scheme altogether. No one in their right minds guarantees anything – not in this market, not in any market. So what’s happening there is that you’re being invited to “part” with 1/2 of your future gain in some fashion, and potentially still be on the loan (or there’d be some other Credit Buyer Sucker lined up to take you out).

So my question to all Brokers out there: do you know exactly what you’re pitching? Have you seen the numbers?

Because if you don’t know the structure or the numbers inside and out, then you’re part of the problem rather than the solution.

THE BEST BROKERS HAVE ALL WALKED THEIR TALK. If it’s such a good deal, why wouldn’t you do up to 4 of these yourself?

You may know all of this, and I’m just preaching to my keyboard. And that’s fine.

But if you don’t, do yourself a favor and learn the intimate details of what you’re brokering so that you can inform and educate your buyers.

For a lesson on excellent note brokering:

We had Steve Cohen at Nautilus revealing his skills and his trade: We had a Question and Answer session with him as part of our Private Access Club Webinars.

Here is one of the main take-always from Steve, a top Note Broker:

A Good Note Broker sees Things that are Unrealistic in a Trade.

A good broker is like a good waiter or waitress. Imagine walking into a fine restaurant (you’re an investor looking for deals), and you are seated and given the menu. Your waiter comes up (“brokering” food to you – helping you to choose if you need help) and you ask him “What can you tell me about the duck?”

And your waiter looks at you dumbly and says: “Ummm, well I don’t know, sir, I’ve never tried it.”

Dumbwaiters are a relic from the past.

Help ensure that dumb note brokers become a thing of the past too.

So let me leave you with a parting note: even if you broker only a single note, you owe it to yourself to know what to look for in what you’re brokering.

If you haven’t invested in yourself and your own knowledge, how will you ever come across to your buyers as a trusted and knowledgeable Note Broker Source?

If people don’t take the time to educate themselves about notes, they’re bound to fail as a note broker.

I’ve seen many brokers fail.

The only ones that survive are those that really understand the business.

There are very few products out there teaching anyone what bank paper, let alone non-performing bank paper, actually is, and what to do with it.

And if you don’t take advantage of drawing on my knowledge of the business, organized into an easy-to-digest and comprehensive 16-hour Note Buying training course where I take you from Start to Finish on note deal after note deal, using “live” deals from my own portfolio, then you’re missing the point about the brokerage business altogether, and you’ll be one of the “Ugly” brokers out there.

You don’t want to be chasing buyers and sellers your whole life.

If you are a Note Broker, you want to close a trade.

For that, you want ‘sticky’ relationships, where sticky isn’t just defined as how many deals you do with someone, but rather, how much VALUE you bring to your Buyers and your Sellers.

The more you bring, the more you get paid.

It’s as simple as that.