In more than thirty years of buying real estate and notes, I have found that the best chances to buy notes at huge discounts come when lenders themselves are in distress.
Owners of real estate are not the only ones who get into trouble in a weak market. Lenders, both private parties and institutions, hold notes secured by mortgages and trust deeds that are non-performing. By non-performing, I mean the borrowers have quit making their payments.
Why lenders in a weak market will sell
In normal times, when loan defaults are few and optimism about property appreciation abounds, lenders often try to profit from defaulted notes. They foreclose and try to resell at a profit, often successfully.
In a weak market the climate is different. Most institutional lenders are scrambling to make a profit and already own an inventory of real estate they have foreclosed on. That real estate produces no income, unlike the loan they used to hold, which paid them interest. Likewise, many private investors are not receiving the payments they counted on.
Most foreclosures are not opportunities
Many foreclosures are properties you would not want to own, no matter how cheap they are. I talked with a lender who made many high-interest-rate loans on houses in older downtown areas. Making high-rate loans to people who cannot afford to repay them is bad business in my book, but that’s another subject.
Eventually he foreclosed, and he has been unable to sell the properties at any price. They are now boarded up and condemned by the city, and he will probably lose everything because of past-due property taxes he is not willing to pay. That’s an expensive seminar.
I only look at houses, or notes secured by houses in neighborhoods I know and like. If I buy a note or a house, I need to know the real value and know that I can resell it or rent it at a profit.
Don’t let greed override your common sense. Don’t buy a note at a ninety percent discount if it is secured by something you don’t want to own. It is far better to make a smaller but sure profit than to take an expensive “seminar.”
How the lender sees a default
If you plan to take advantage of opportunities from lenders, you need to understand how the lender views his situation.
As both a buyer and holder of a number of notes secured by houses in my town, and a buyer of distressed paper and property, I have experience on both sides. In fact, I have more experience as a mortgagee (noteholder) than I need. Even when you understand what is happening, it is not a comfortable experience when a borrower stops making payments.
It is unlike being a landlord. A landlord’s remedies are faster and more certain, and the tenant has less to lose. Losing a security deposit on a rental home is not the same as losing the equity in your home.
The courts and our legal system also give homeowners more time and protection. A bankruptcy filing further extends the time a borrower has to repay the debt or give up the security.
Foreclosure is more expensive, too, in out-of-pocket costs and in time. First-time investors in small notes are often wiped out when they cannot afford the costs of foreclosure plus the payments on the underlying mortgages on the property that secures their note.
When you invest in paper, keep a cash reserve at all times that would let you make the payments on any loans senior to yours (recorded before your note), plus attorney’s fees, trustee’s fees and court costs. If you do not, you will be in a weak position when a borrower fails to pay you.
Two rules for buying notes on houses
The first rule I follow as a buyer of notes secured by houses:
Never buy a note secured by a house unless you would like to own that house.
If you hold a note secured by a property you don’t want to own, you will make costly concessions instead of taking title. When you don’t mind taking title, you will not give up any of your profit.
The second rule:
Never loan more against a house than you are willing to pay for the house.
Many lenders are left holding the real estate they accepted as collateral instead of payments. In effect, they bought the real estate for the amount of the loan plus their cost of recovering the collateral. Often this was not a good buy, and they will be forced to sell for less than they have “invested” in the property.
Which lenders will sell at a discount
Not all lenders are in weak positions, and you only want to make offers to those who are. A common mistake real estate buyers make is making offers to the wrong people. Most of my offers are accepted (after some negotiation) because I only make offers to sellers who really need to sell.
From the points above, you can build a profile of a lender who would be anxious to sell to you at a discount. Before you contact lenders or advertise for them, know what you are looking for:
- Lenders who have loaned too much money against a property.
- Lenders who have loaned against property they are afraid of owning.
- Lenders who cannot afford to foreclose.
- Lenders who do not want to foreclose because of public perception or a personal relationship with the borrower.
- Lenders who are desperate for cash and willing to sell loans they own to get it.
- Lenders who have foreclosed and don’t want the property.
You can deal successfully with a lender in any of these positions:
- You can buy performing loans (payments are current) at a discount when the lender needs cash or discovers that many of his loans are going bad.
- Once a loan is in default, you can buy loans the lender does not want to foreclose on, because of the relationship with the borrower or the financial considerations.
- After a lender has foreclosed, you can buy the property directly from the lender.
In the first two cases you are not buying the property but the debt secured by the property. You step into the lender’s shoes.
Locating lenders who want to do business
If your town has a weak real estate market, it’s fair to assume most local lenders would make you a good deal on their problem loans and REO (real estate owned) properties. You can simply call the bank and make an appointment with the officer in charge of the REO department.
I have found it is better to find one property they own and approach them with an offer or inquiry on that one. You have more credibility than if you just walk in off the street. After you discuss that property, you can ask about other similar properties they might have.
Most lenders list their properties with local real estate brokers. Search the MLS for properties owned by an institution, or simply ask a broker whether he has any bank-owned property listed, and you can find your first one.
Another way I find houses is by looking for abandoned properties in neighborhoods where I already own property. Years ago my friend Warren Harding taught me one of his trade secrets: never drive the same streets to work, or anywhere. Drive down a new street every day and sometimes you will see something you have never seen before, like an abandoned house. That advice has found me many abandoned houses. Thanks, Warren!
When you find an abandoned house, you need to find the owner or the lender. Often the owner is nowhere to be found and the lender is the one to see. Don’t look in the mailbox for mail, such as past-due loan notices addressed to the owner. That may be against the law.
Do talk to the neighbors. Find one even if you have to walk several houses down the street. They will usually have a story to tell and may be able to give you leads. Neighbors have a personal interest in seeing the house repaired and occupied, because an empty house attracts the wrong people.
Finding the lender when there are no clues
When all you have is a house address, it’s still not hard to track down a lender. Go to your local tax assessor’s office with the address, and you should be able to find the legal description of the property. Don’t be shy about asking for help, but do be nice.
Once you have identified the owner, look up the owner and the property in the public records, where all deeds, mortgages and trust deeds are recorded. You will find the deed by which the owner took title, which gives you the owners’ names. Typically recorded next is the mortgage or trust deed.
You can usually find other debts against the property, and judgments against the owner, by doing a name search. Most public records can be searched by name and by legal description. If you don’t understand how deeds and debt instruments are recorded and searched in your town, take an afternoon and go to the courthouse. Ask for help, and research your own name (or a friend’s) to see how the system works.
