Editor W. J. “Bill” Mencarow once wrote an article called “The 60-Second Screen,” which explained how to screen a note quickly in the first phone call with a note holder. Dana Barnes, one of the most experienced and successful note brokers and investors in New England (possibly the toughest market in the country), disagreed. Here is his reply, step by step, followed by the exchange it started.
Why a quick screen can cost you deals
Dear Bill,
I enjoy your insight on many of the issues and strategies facing our industry, but I must take issue with your article “The 60-Second Screen,” published in January 2000. By trying to simplify the first interview, you have sabotaged the very essence of this business: spotting and capitalizing on the many opportunities that come to us every business day.
Your seven-step process for quickly culling incoming calls is designed to make people experts at screening notes. What it really does is push everyone toward the bread-and-butter deals that everyone else is chasing, instead of making people experts in notes. There is far more opportunity in the deals that don’t fit the vanilla framework. Let’s go through your list and see what else could be done.
Step 1: Are you receiving payments? A good start. I was getting ready to pat you on the back.
Defaulted notes are opportunities, not dead ends
Step 2: Are all of the payments current? If the mortgage is in default, your advice is to pass quickly, because it is probably a real estate investment rather than a marketable note. I disagree. There are all kinds of opportunities here.
In one recent deal, we modified the note. We lowered the payment to fit the payor’s budget, extended the balloon, and added the overdue payments and back taxes to the balance. That created a marketable note we could sell. The end investor knew the whole situation from the estoppel and the modification agreement, and now had a semi-vanilla note to buy. How much competition do you think I had on that deal?
In another deal, we sold a note in serious default to a buyer who advertises for that kind of paper. Again, how much competition did I have? None.
In a third recent transaction, we decided the only way to close was to end up with the real estate. So what? We got the note under contract, got the payor to agree to a deed in lieu of foreclosure and closed. We ended up with a single-family house in a desirable area, worth about $90,000, for about $35,000. It is being fixed up now for resale.
I would have missed all of these deals if I had followed your step 2.
Unusual property, new notes and odd balances
Step 3: What kind of property secures the note? Your advice is to pass if the note is secured by something unusual. I disagree. Even some major note buyers will buy notes secured by taverns, churches and the like. If people won’t take the time to study the directories of note investors, what are they doing in this business? If they do take the time to become professional note buyers, they’ll find less competition on these deals. They’ll also learn that people holding these notes are much more open to creative purchases.
Step 4: What was the sale price, and when was it sold? Your advice is to pass if the property is worth less than $50,000, and you say that new or “green” notes are worth less. Some smaller notes are ideal for your own portfolio and can be bought at bigger discounts because of the limits you describe. As a professional note buyer in a market, you should know what real estate is worth there and where values are going. A property worth less than $50,000 might not scare you at all.
As for green notes, some major companies consider a note seasoned at six months, or even three. You could price a note today that closed last week and structure it to fit those seasoning guidelines. If not, you can ask the end buyer to make an exception, and they just might.
Step 5: What is the balance of the note? You say notes over 85% loan-to-value are tough to market, third liens and notes under $10,000 are impossible to sell, and notes over $500,000 are very hard to sell too. Up to this point I thought you were having a bad day and was giving you the benefit of the doubt. Do you still think this way after reading my answers above? I hope not.
Low down payments and short balloons
Step 6: How much cash did the buyer put down? Your advice is to pass if there was very little. But suppose you dig further and find that the property sold for $100,000. The seller held a first for $80,000 and a second for $20,000 (the down payment). The second was paid at $1,000 per month, without interest, for 20 months, and the sale happened two years ago. Not a bad note now! You would have had to ask a few more questions to learn all this.
Or suppose the buyer put no cash down but gave the seller a 20% down payment in the form of a mortgage on another property. Now this note looks pretty good.
Step 7: Is there a balloon, and if so, when is it due? Your advice is to end the call if the balloon is due in less than a year. Wrong. Perhaps the payor has tried to refinance and can’t. The payor knows they need help from the seller, and the seller knows they need help from you.
Perhaps you can extend the balloon a few years, raise the interest rate and buy the note at a larger discount. Will the payor be happy? They’ll be ecstatic, and they’ll gladly sign estoppels, modifications and whatever else is needed. Will the note seller be happy, even with a slightly bigger discount? At least they won’t have to spend all that money to foreclose. They’ll take your check and thank you all the way to the bank. Again, how much competition would you have on a deal like that?
Should beginners take the hard calls?
I can only guess that your article was meant to give pointers to people just starting out. If so, I think they must spend time on these calls, because that is how they will learn to make a living in this business. They’ll learn the difference between good and bad notes, and what to do with both. So what if they spend the time and don’t close any of them in the first couple of years? After that, they’ll welcome those calls, because they’ll be able to spot all of those opportunities.
Dana Barnes was president of New World Capital Funding, Inc., a note brokerage and investment company in East Hampton, Connecticut.
The exchange that followed
Bill replied, and Dana answered back:
Bill: You make some valid objections, and I would agree with you, to a point, if my advice had been meant for experienced brokers and investors. It was not, and I should have made that clear. I think if beginners don’t stick with bread-and-butter notes, they will be in way over their heads, spinning their wheels on notes that need restructuring they aren’t trained to do.
Dana: I think even beginners can learn from being in over their heads. The most important thing they’ll learn is whether they have the fortitude to work through all of those deals, easy and difficult, and what it takes to succeed in this business. Very few people really succeed doing only vanilla deals. After some trial and error, they’ll learn what is a waste of time and what is not, whether or not it is a vanilla deal.
Bill: I have to disagree. I’ve heard from far too many beginners crying for help over the years, then giving up. Many of them are already in over their heads just trying to broker plain vanilla mortgages. If they are told to go ahead and find investors for delinquent notes, low or zero down, balloons due next month, notes on H-bomb test sites and so on, and then, if they find an investor, convince the seller to take the massive discount such paper requires, they will quit in disgust. They’ll get plenty of experience starting with the easy ones. I just don’t see the point of a baptism by fire they won’t survive.
Bill: Maybe your approach is a good way to quickly weed out those who won’t make it in the business, though. I’ll have to think about that. Thank you for having the moxie to speak your mind. I respect your opinions, since they come from years in the trenches.
