What Do Bon Jovi And Defaulted Bank Paper Have In Common?
An endless life span? You’re getting warmer…
Industry analysts tell us that 36% of all sales are now REO or short sale, and not likely to change. Additionally, approximately 3 million REO’s have been sold thus far, with about 5- 6 million more properties to go. So, as Bon Jovi would say,
Whooah, we’re half way there
Livin on a prayer
Take my hand and we’ll make it – I swear
Livin on a prayer
(Okay – for you math majors – we’re not quite half way, but you get the idea.)
I’ve previously commented that residential investing is getting very crowded. Lots of offers. Lots of people getting into the game again. So is there another way to buy a property without tripping over 50 other investors?
Instead of buying the property, you can buy the defaulted note from the bank. With 5-6 million properties left to go, that means there’s still plenty of opportunity for you to make money this way.
I’ve had many inquiries from people asking about whether this technique works, what it is, and how to get involved with it, so I decided to spend a few posts examining the world of defaulted paper. Let’s start with a little Q&A.
What is “defaulted paper?”
“Paper” is the term used in residential and commercial banking to describe promissory notes, along with the security instruments that secure the debt associated with those notes, including deeds of trust, mortgages, security deeds, etc.. “Default” simply means failure to perform a contractual obligation. So when an investor uses the term, “defaulted paper,” he or she is simply referring to when a borrower has failed to pay a note or mortgage back when due. Right now, as a result of the real estate collapse, there’s lots of defaulted paper.
Why would a bank sell defaulted paper?
The reasons a bank would sell a note rather than the property are a bit complex, and can vary from deal to deal, but generally banks recognize there is a huge cost, as well as some risk, to go all the way through a foreclosure process. These risks include delay and lawsuits, property management issues, title and insurance issues, etc.. Because of this, banks are more willing than ever to sell the bad paper, take a tax write-off, and move on.
When do banks sell defaulted paper?
Banks actually sell both performing notes and defaulted notes all the time. Many Wall Street-type institutions and large banks buy them. However, these institutions, like the banks, are not set up to manage properties. They only want “good,” or performing paper that is producing regular, consistent cash flow. This leaves a lot of opportunity for Average Joe to pick up the non-performing notes at a steep discount.
Why would you want to buy defaulted paper?
There are many reasons. I’ve already mentioned one – there are too many people on the property buy-side. Too much competition. Here are some other reasons:
– you can buy at a better discount than if you were to buy the property outright. Instead of buying at 50, 60 or 70 cents on the dollar, how about 10, 20, or 30 cents?
– banks are willing to sell notes even if the short sales can’t be approved.
– you can buy through your self-directed retirement account and all earnings can be tax free.
– there is virtually an endless supply of paper that you can purchase, so the business model will be viable for a long time to come.
Does this work with residential and commercial properties?
Yes. Many good commercial investors today are actually buying notes rather than buying the properties. It saves a lot of expenses normally associated with purchasing property.
What can you do with defaulted paper after you buy it?
There are many strategies you can implement once you own the note. Here are just a few:
– do a forbearance agreement with property owner to give him or her time to sell the property.
– offer a deed-in-lieu, maybe even with some “cash for keys.” The owner may be willing just to sign the deed to the house over to you. You can then sell the property on the open market at full retail or sell to a local investor.
– resell the note at a higher amount – a quick flip.
Is this an easy investment strategy?
Although the “process” of note-buying is easy, there’s also a lot of danger if you don’t know what you’re doing. I don’t recommend implementing this strategy without first having a full grasp on the risks associated with it, along with a good real estate attorney or mentor to help you through the process.
The Bon Jovi Defaulted Paper Tour continues next week, when we speak with real estate mentor Mike Warren, a note buyer, to understand how to tell a good note from a bad note, how to actually buy them, and how to get involved with note buying.
Til’ next time, Jeff