REtipster does not provide tax, investment, or financial advice. Always seek the help of a licensed financial professional before taking action.
Rob Hytha is a diversified investor who specializes in buying distressed mortgage notes. He was voted real estate investor the year in 2017 by Connected Investors and since starting in the industry over a decade ago, Rob has helped thousands of homeowners come to win-win resolutions on non-performing loans.
Rob has analyzed, acquired & liquidated over $500MM of debt and he has conducted research on several billion dollars of residential real estate nationwide securing more than 10,000 assets.
In this conversation, I’m talking with him about the niche of investing in distressed mortgage notes, who this type of business model is for, and why you might be interested in pursuing it.
Links and Resources
- FIXnotes.com (Rob’s Website)
- Where to Buy Mortgage Notes by Rob Hytha
- How to Invest in Mortgage Notes by Rob Hytha
- What Are “Comparables”?
- 078: Justin Bogard Explains 13 Things You May Not Have Known About Note Investing
- SN Trading, LLC
- RAMS Mortgage Capital
- Mission Capital
- Mountain View Investors
- Land and Home Financial Services
- Madison Management Services
- FixNotes YouTube Channel
- FixNotes Mortgage Note Mastermind
Episode 121 Transcription
Seth: Hey everybody, how's it going? This is Seth Williams, and you're listening to the REtipster podcast. Today I'm talking with Rob Hytha. Rob is a diversified investor who specializes in distressed mortgage notes, and he was voted the Real Estate Investor of the Year in 2017 by Connected Investors. Since starting in the industry over a decade ago, Rob has helped thousands of homeowners come to win-win resolutions on non-performing loans. That's what we're going to talk about today.
Rob has analyzed, acquired, and liquidated over $500MM of debt, and he has conducted research on several billion dollars of residential real estate nationwide, securing more than 10,000 assets. In this conversation, I'm going to talk with him about this niche of investing in distressed mortgage notes and how it can be kind of a lifestyle business in a way. And we're going to pick this apart a little bit, and I think you'll find it pretty interesting. Rob, welcome to the show. How are you doing?
Rob Hytha: Thank you so much, Seth. I've been following REtipster for a while. It's my honor to be on the show. This is awesome.
Seth: Yeah. I'm glad to have you here. Maybe you can just tell us your story. How did you get into real estate investing, and more specifically, how did you evolve into the note business?
Rob Hytha: I come from a real estate family, real estate and music. If you are watching the video, you can see a lot of instruments behind me here. My parents, they've been renovating and renting Victorian properties in the Philadelphia area for my entire life. I grew up around the hammer swinging really hard renovation type of work in real estate.
When I heard about mortgage notes, and specifically, I joined a company called U.S. Mortgage Resolution as their first employee, my junior year of college, I realized that this was the path for me. I'm savvier with the keyboard and the mouse rather than the hammer and the saw and found a really great niche for me personally, being able to use the computer to invest in real estate, which mortgage notes can be invested in nationwide using the tools that we have on the internet.
I do invest in rental properties as well. I purchased my first rental in 2010 and continue to buy about a property a year since then, but I've always found mortgage notes to better suit my skill set.
Seth: Yeah. That idea of investing in real estate with a computer, I think a lot of land investors out there can probably relate to that because that's a big part of how a lot of our businesses work. For those who are total novices, I'm just going to start from the kindergarten level here. What is a note exactly? What is happening when one party buys a note from another party?
Rob Hytha: When you buy a note, you become the bank. And a mortgage note is actually a multi-part instrument. You've got the note, the mortgage, the assignment, and the allonge.
The note is the promissory note with the terms about what's being paid, how much is owed, the interest rate, and the length of time. The mortgage secures that note to the property, the collateral. That's called the security instrument. And then we have the allonge and the assignment. The allonge endorses ownership of the note, the assignment transfers ownership of the mortgage.
The mortgage and the assignment are then recorded in the county record to evidence the transfers and the ownership of the debt secured by the property. And then, the note and the allonge are kept in the collateral file of the lender. That's really... this business is all based on paper. So, you're going to have folders full of very valuable documents in this business.
Seth: And are these notes typically just on single-family houses or multi-family or huge commercial? What types of properties are we talking about with regard to these notes?
Rob Hytha: Yeah, well, virtually any type of property can carry a note, and investors have all stripes used that to leverage and build portfolios. My personal specialty is in single-family residential. I've done a lot of vacant land notes as well, and some commercial notes, some secured by commercial properties, but also some secured by all sorts of different collateral chattel paper, and accounts receivable, and business assets. They call that the CNI type of paper, commercial and industrial. But generally, I think our conversation is going to be based on the residential side, primarily single-family residential.
Seth: This is something I remember back when I first got into banking my first year. I was just reeling in confusion all the time because it was so much banker lingo being thrown around like “chattel paper” and “assignments,” like ugh. It just took a ton of time just being around it and asking tons of questions to understand, like “What is everybody talking about?” If you're listening to this and you're getting confused by some of the terminologies, it's okay. I totally get it. Hopefully, we can reveal some of this as we get through it. Out of curiosity, what is chattel paper, by the way?
Rob Hytha: To be honest, I'm not an expert at all. They're partly accounts receivable, and I think they're like unsecured notes, really. I wouldn't consider chattel people real secured interest. But no, that's a great question. And I think that the lingo, the terminology is by design to keep this a protected niche. And when you look at the big picture, the banks and their lobbyists wrote these laws, like the lenders really have such an upper hand in the real estate equation. By becoming a note investor, you can get on the right side of that and really have an advantage in the real estate game. You're moving up the food chain by being a lender versus being a borrower or a landlord.
Seth: Now, why would somebody want to do this? Learn all this stuff about note investing and terminology and all this stuff. Why not just stick with houses or land or whatever else they're doing? Is it mainly because it's mostly on the computer, like you can do it all from behind your desk and it creates passive income and that kind of thing?
Rob Hytha: It's a great diversification. I don't think anyone who's already investing in real estate in another capacity should just totally pivot to notes. I personally hold rental properties. And I think that the advantage of a rental property versus a mortgage note is the depreciation, of course, and the appreciation of the property. Whereas mortgage notes get paid off, the unpaid principal balance is slowly paid off over time.
So, it's nice to have both in your portfolio because they do complement each other in that way. But I think you hit the nail on the head with regard to being able to invest with your computer. When you're investing in mortgage notes, you're using the internet, you're using the tools available to us through different vendors. And you're able to sit at your desk and do rehabs essentially on non-performing loans, just with your phone.
When you have a non-performing borrower, who you need to get back on track, you don't need to go in there with a crew and physically fix the property, but you do need to talk to that borrower to fix the situation, which personally is better suited for my skill set. And I think a lot of people who post and within the pandemic and hopefully post-COVID are going to have a lot more interest in this kind of “work from home” type of business. Not to say that driving to a property and managing (which I do myself, and that's very satisfying) isn't the right path, but it's nice to be able to spend more time with your family, with your own home to be able to make things happen, add value to an industry where otherwise there's a lot of troubles for these borrowers.
That's really the name of the game, and that's something I want to reiterate and hit home. This business is about helping borrowers' non-performing mortgage notes in general. And a lot of people think of that in the wrong terms. And they get into positions where they're fighting against the grain. And as a lender, as I said, you do have such a power position, but at the end of the day, you can't lose sight of the fact that these are borrowers whose lives can be drastically altered by decisions that you make as the lender, whether or not to file for foreclosure and enforce all of their past due interests and ar
You're winning because, with the bank, you're helping the bank unload bad debt that's otherwise clogging up their balance sheet. You're helping yourself and the investors make money on these loans. And you're helping the borrower by offering somewhat of a discount or a more affordable payment plan for them.
There's just so much good to be had in this industry, which I think some people really just think about obtaining properties through foreclosure when there's a better way, I believe.
Seth: What exactly is a non-performing loan? And also, when we say non-performing loan, non-performing note, non-performing mortgage, distressed mortgage, and all these things we're talking about the same thing. Does that all mean the same idea? Is that correct?
Rob Hytha: Yeah, absolutely. And it's pretty simple. It's just a loan that's no longer paying. It's a borrower who's not making their monthly payments. They're in default, oftentimes charged off, which is the bank's counting language for when they've decided a loan isn't worth pursuing anymore. They spend a lot of their resources trying to get non-performing loans performing again, but eventually, they throw their hands up and say, "We have to charge these loans off. They're no longer on this side of the balance sheet." And eventually, they're offered to sell to the secondary market.
Most of the loans that I see in the secondary market are charged off non-performing, particularly second position mortgage notes. That's my sweet spot, second loans secured by single-family residential properties. I bought a lot of first liens as well, but I believe that the risk to reward calculations and second liens are really the best you can get in this business.
Seth: Interesting. How is this different from a foreclosure?
Rob Hytha: It's a pre-foreclosure, so we haven't quite gotten to foreclosure yet.
Seth: And you're not buying the house. You're buying the note?
Rob Hytha: Correct. Yes.
Seth: It's going to be an attempt to try to not even let it go to foreclosure. Is that accurate?
Rob Hytha: Absolutely. Yeah, that's our goal, is to work with the borrower, generally to go toward the modification agreement. That's the easiest exit strategy, I think, for all parties. It allows the borrower to get back on track and bring their loan current. And it allows the investor to turn a non-performing loan into a cash-flowing asset very quickly. I think a good point to mention here is the crux of the conversation with the borrower really revolves around three questions. What happened? Where are you now? And what do you want to do?
And when we have those answers, we're able to craft a resolution for the borrower that really fits their needs. Some borrowers don't want to stay in the property anymore, and we can help them find a realtor, get that property listed, and either sell it for a full payoff or possibly a short sale. Other borrowers can afford a down payment and reinstate the loan and start paying on the original monthly terms.
Others can't afford the down payment. So, a modification is the way to go or a forbearance agreement. With situations where the borrower maybe is not able to be contacted, or they're maybe a bit hostile, they don't want to come to terms, eventually, your leverage is to pursue the foreclosure.
Although I would say that, and I'm not going to give you an actual percentage here. I'd have to look at the numbers. For us personally, my clients rarely foreclose. And on the accounts that we do foreclose, we often have a resolution, sometimes at the very last minute. Because these borrowers understand that at the end of the day, the lender has the upper hand in these engagements, and they really want to keep the property in most cases. And that's why I prefer second liens primarily over first liens, because in junior loans, you often have a borrower who wants to stay in the property, or you're able to determine in your due diligence process pretty quickly that that borrower wants to stay in the home.
Whereas in non-performing first position loans, those borrowers have often either kind of strategic-defaulted. Maybe it's not quite as strategic as we would imagine when we're looking at the spreadsheets, but they're often not interested in retaining the property. So, then you have to go through that OREO process and actually do some real estate type of work. Whereas in junior liens, I see way more modifications. And that's certainly a better approach for an investor who sits at their desk and doesn't have to get a turnkey property management company quoting you for repairs and getting a turnover completed.
Seth: Interesting. So, where do you find these things? Are you calling banks and saying, “Hey, give me all your garbage loans so I can buy them from you?” And why do this? Is it because you can buy them for really cheap? Is that the angle as to why you're pursuing distressed non-performing loans?
Rob Hytha: Yeah. I think there's a couple of things to unpack there. First, the angle, like I said before, is primarily to help the borrowers, and these non-performing loans that are sitting on bank balance sheets are often charged off, those borrowers are in limbo and they're in a situation that they can't easily resolve. A lot of these borrowers that are charged off sit on the banks, charge off-balance-sheet for years, and years, and years. They try to call in; they try to get deals done. But since those loans aren't actively being serviced, they're not really able to get anywhere. There's a lien secured by their property, which limits the flexibility that they have to be able to sell the home, to get their credit worked out, to get things back on track.
By pursuing bank-owned law loans, we're able to get these loans out to that process into some type of resolution strategy, whether it's through, like I said, the modification process or potentially selling the home; we're able to help borrowers do that. And, of course, at a huge discount when you're buying from those institutional sources.
On the other hand, because your main question is where to find mortgage notes. And there are many ways to do that. I actually wrote an article pretty recently on my blog at fixnotes.com/blog. I'll actually pull up the article here because it's like 20 plus different ways to buy mortgage notes, where to find them.
So, you can use principal sellers like the clients that I work with. You can go right to the very top to the Freddie Mac standard pool offering. You can work with companies who broker loans, these secondary market sources that basically consolidate loans owned by other banks and hedge funds. You can also go to the mortgage note exchange platforms, paper, stack, and et cetera. And then finally, you can source your own loans. And you mentioned one of those ways, which is to go directly to the banks.
You can also use reverse inquiries to foreclosure attorneys and basically work with their clients to buy loans before they go through the foreclosure process. Another way is to market your services as a note buyer to seller finance private lenders.
A lot of people will sell a home and take back a loan on that property. I've actually bought two properties where I had the seller finance some of the purchase price. And oftentimes, those seller financers, they want to turn that monthly cash into a lump sum. So, you can buy private loans.
You can also research the assignments. As I mentioned, the assignment of mortgage is recorded in the county record. If you do a little bit of investigation on those public records in a specific county that you're interested in, you can find assignments that are being recorded and then reach out to the lenders, either the assignee or the assignor, the person who's receiving the loan or the person who's transferring the loan. Maybe they have more loans to transfer, and maybe the person who accepted that asset purchased it, maybe they'll be interested in selling some of their portfolio.
And then finally, there are a couple of ways you can do more of the networking side to find the decision-maker. And then, like you said, ask them for their distressed portfolios. So, you can do that through tools like Bankprospector from Distressed Pro. They basically aggregate the FDIC data of all of the defaulted portfolios at these big banks. So you can see who has the most defaulted loans and then approach them proactively, perhaps through LinkedIn, or I think maybe the most important as you find your way through this business is to network at conferences.
There are two separate tiers, I believe, in the conference world. One, is the note investor conferences like the Diversified Mortgage. They changed the name of it. I think it's called the Diversified Mortgage conference. And then there's also NoteExpo. Some other conferences are really geared toward note investors. And then there are the banker-centric conferences put on by mortgage bankers’ association, the Information Management Network IMN, or even National Mortgage News. They put on these conferences, which attract the institutional players where I think you'll have a much better chance of finding the big-time sellers who you can get the best prices from and the largest portfolios.
A whole bunch of information there. I would encourage you, if you don't mind to link that, where to buy mortgage notes for sale because there's a lot more detail and links to all these different sources.
Seth: I'm going to include a link to that article that Rob is talking about in the show notes for this episode, retipster.com/121. That alone sounds like a ton of value. Just understanding where to go about finding these things.
For the second position, I used to work in a job where we did SBA 504 loans, and the whole nature of SBA 504 loans is they come in and they support a bank that is doing a much larger loan. For example, if there's a $1 million project and the loan is maybe riskier than a bank would want to do on their own, the bank can finance 50% of that. And then SBA comes in in a second position and finances, 40% of that. And as a result, the bank is a lot safer because they've got 50% loan to value and first access to all the collateral if things go wrong with the deal. And also, the borrower is better off because they only have to put in 10%, whereas otherwise, they would put in 20% or 25% or 30%.
But the whole thing with that, part of why SBAs are doing this, it's a government program to encourage banks to do loans that they wouldn't otherwise do to help grow the economy and pump money into the economy. But as a result, when deals do go bad, SBA usually loses everything because they're in second position. If there's any collateral left, it's not much. And a lot of times, they just have to take a total loss on it. The fact that you go after second position loans, isn't that riskier?
Rob Hytha: Absolutely, it can be riskier, but it's all about your due diligence process. And in second position, I believe the biggest proxy for whether or not the borrower is going to pay is the status of the senior lien.
When you pull a credit report on a borrower that you're underwriting in a potential second position acquisition and you see that their senior lean tradeline is current and they're making their payments, you have a pretty good idea that they want to stay in the home.
A borrower who's not paying their first and not paying their second, your only hope is that there's enough equity to support both of those loans. And that's also an easy thing to do in your due diligence process, though my first step to valuing a property on a big portfolio of loans is to do my own recently sold comps.
And I'm sure you're very familiar with this, if you're listening to the show, you use Zillow to see what has sold recently (or any type of MLS service like Zillow), and then triangulate the value that you think that that property would be worth, then deduct the senior lean balance from that. And if there's some equity left over, then you've got a potential safer second lean.
The due diligence process is just so important. And if you want to take it to the next step, you can order a broker price opinion, a BPO, to get a stronger opinion of value from an industry professional, which will give you just a little bit more confidence that there is equity.
On one hand, yeah, if you buy negative equity, second liens behind non-performing senior liens, you're more likely going to be in a tough situation where you don't have that leverage with the borrower.
But I think that because we do all that due diligence upfront, you can mitigate those risks right off the bat and price assets accordingly. There's no such thing as a bad note, just a bad price.
And even some of these low-value, negative equity type of deals, we see something we call emotional equity where the borrower wants to stay in the property and they've fallen on hard times, but with a helpful lender, an entrepreneurial lender who can think outside of the box (unlike the bureaucracy that is the big bank resolution teams), we're often able to get modifications in place on loans that the numbers don't look good. The numbers don't look like we'd be able to come to a resolution, but we got a much better price on the deal because of those underlying characteristics. And then we get a cash flow started. The yield is so much greater on those deals.
But you really have to diversify across the board because, as you may imagine, non-performing seconds behind performing first liens with equity, that's the cream of the crop. That's what all the investors are looking to purchase. And the pricing is 60% of the unpaid principal balance. 70%. I've even seen some non-performing second liens suffer over 80% of the unpaid principal balance because all the other things were really positive. There's plenty of equity. The senior is current and that borrower is living in the property. That's another important characteristic. Owner-occupancy does lead to more resolutions as well.
And just to bring this back to first liens as well because some people who are listening, maybe their heart is set on first liens. They really do feel like the first liens are going to be safer for them. The proxy for a first lien being a potential modification is the property taxes. If the borrower is not paying their property taxes, then it's unlikely that they're going to be able to get started on a payment plan on your first position mortgage loan.
But if they're current on the taxes and they just have fallen behind on the first lien, oftentimes that's just because they haven't been able to get a hold of the lender. As I mentioned earlier, when these loans are charged off, they're sitting in this limbo where they're not able to get a plan started anymore and they're keeping their property taxes current, which is great. And now, when you finally reach out to them after the loan is acquired, they're often ready to go with the modification agreement.
And oftentimes have even some capital saved up at that point because they haven't been making their mortgage payment for years. So sometimes we'll get discounted settlement offers or even full payoffs as soon as the loans are finally transferred and they get their transfer documents, which maybe is a good time to talk about that too.
When a loan is purchased, there's a RESPA letter sent. RESPA is the Real Estate Settlements and Procedures Act. And your loan servicer will send that RESPA letter to the borrower. And the previous loan servicer will send a RESPA goodbye letter. The goodbye and the hello are both sent. The borrower is notified that within 15 days, the servicing is going to be transferred to the new company. And then a lot of lenders will follow that up with a welcome pack of sorts after the FDCPA letter goes out. And then, at that point, it's really about waiting for the borrower or pursuing the rest of your collection strategy.
A lot of times, we'll see the early successes right after those RESPA letters go out because these borrowers are just looking for how to pay, how to get things back on track. And we hear it time and time again, borrowers telling us they're good people. They never meant to go into default. They really want to get to paying again. It's just they haven't been able to either work with the bank properly or the bank's been unrealistic with what they needed to get the plan started. They wanted a full reinstatement or whatever.
But when we're able to work in that entrepreneur out-of-the-box type of operation, we can help so many more borrowers get back on track and really monetize a portfolio that's been undeserving for a long time for the bank previously. Because they really have been overwhelmed, especially after 2008. There were so many loans in default that the bank's resolution departments couldn't handle. I think generally, the default rate is like 2% or something. And then it went up to 9%, and then all of a sudden, these call centers are totally overwhelmed, and there's just not enough resources.
That's where entrepreneurs like us are able to come in and actually solve these problems that have been created, get borrowers back on track. And at the end of the day, help communities that otherwise would see more foreclosures and dilapidated properties that are being not kept up with.
This all trickles down, and I believe that being a note investor becoming a bank, this is really at the top of the food chain in the real estate world. And it can solve a lot of problems further down the line if you're able to be creative and entrepreneurial.
Seth: Now that blog post, that 20 different places you can buy notes, that kind of thing, of all those different places you can find them and buy them, where would you say you find and buy the majority of them? Is it from banks? Is it from individual seller finance deals? Is it from something else? Where would you go to do the 80/20 thing?
Rob Hytha: Yeah. My situation is a little bit different, just in my position in the marketplace. I mentioned this before we started the call, but there is somewhat of a conflict of interest for me to purchase loans directly from my portfolio management clients. There's a bit of an adverse selection bias. And if I was managing a portfolio that I could also cherry-pick from, you can see how the conflicts arise there.
The loans that I purchase are either from buyers who have bought loans from my clients non-performing and then resolved them, and then they have a reperforming loan. I'll buy a reperforming loan from them. And it's nice for me because I already saw the track record of that loan. I know that the paperwork is tight, and then if I'm working with that buyer, I know that they're a good counterparty. I trust that their modification to get that loan cash flow again is all buttoned up.
That's one way that I purchase loans. But if we go up the food chain to my clients, yeah, they're buying directly from the banks. Recently, I got a call from a small bank in the Pennsylvania area who found one of my clients, U.S. Mortgage Resolution, in a distressed debt receivables collection type, and I could probably look it up. But basically, they found us on a list as part of an association and they wanted to unload some of their loans. So, they reached out proactively because it's a one-man operation managing their whole distress portfolio, and he wanted to find a better way to monetize those loans so that they could work on other more profitable avenues for their department.
I think that there are two angles here. There's one, which is proactively reaching out. And one which I absolutely prescribe to, which is putting content out to then attract the right type of people. Because I think cold calling is probably the worst use of your time if you're trying to find a bank to sell loans, just to make a call to these portfolio managers without any sort of background on you, isn't really going to get you anywhere. That's why I mentioned in the article to go to these banker-centric conferences because then you can actually make an impression and you can talk to somebody face-to-face and you can be in a much better position to take that relationship to actually doing business together.
Whereas if you're just calling them, you're not going to get anywhere. But by putting out content, that makes sense for them. For example, this guy who's a portfolio manager, it's a small portfolio. He's about $3 million of non-performing first liens, $300,000 of non-performing seconds, which is actually way smaller than the typical portfolio that my clients will take on. But to build a relationship, we would absolutely want to do that.
The best type of content I would see for him would be to create some, and I guess this is tough if you don't have any experience to start, but this is something I'm thinking about, writing some posts about how to manage an overwhelming amount of non-performing loans. That's something that I do on a day-to-day basis, and I can show a potential seller of loans all of the steps. And there's a huge benefit there for them if they actually choose to follow the steps, but they can also see what's involved with managing non-performing loans and decide, “Well, maybe I do want to sell off these loans.”
By putting things out there to invite some serendipity by creating blog posts, for example, or YouTube videos or things that meet that person's need, then you're going to be able to find people who are pre-qualified leads because they're coming to you because they were able to get to know you through the content online, which I know you're very familiar with that, Seth. I'm sure you see all sorts of opportunities through the content that you put out. That's my way to go, I think, with the more passive approach. It takes longer, but I think it scales in a much easier way in the long term.
Seth: If a person doesn't want to do content or isn't willing to, I guess it sounds like conferences are probably the next best way.
Rob Hytha: Conferences are great. And then I also say on this list, note brokers and mortgage note exchange platforms would be the best way to go if you're not looking to do a full-time business.
I would say one broker on this list that I actually bought a loan from earlier this year, SN Trading, David Pollio puts out a lot of paper. He runs the trade desk for a loan servicer. What's really great about working with Dave is he will send out a list of assets from one of his clients or one of someone in his network. And then if you're interested and reach out, he'll connect you directly with that specific seller, and then you can take it from there. And he goes on the honor system and I close a deal with a bank.
It's a crazy story, actually. My hometown bank, the very first bank account that I have ever opened. I've approached them before about mortgage notes but never was able to get anywhere to buy distressed debt.
David introduced me to their portfolio manager and I closed a deal with them. And now I'm their guy because I'm born and raised in this town. And I was able to deliver on what I said I would do with buying the one loan we purchased. They don't have a lot of distressed paper, but I'm their first call because I built that relationship. That's what I really liked about working with Dave. He made the introductions so that you can sort of take it from there. And if you build that relationship directly, you're able to continue to do business with that person.
And then I sent David a check for $500, went by the honor system just to, “once the deal is closed, pay me my fee,” and that was absolutely reasonable on the deal. I think that David Pollio would be great to get on his list. You'll see a lot of paper from RAMS Mortgage Capital if you reach out to Tad Dahlke. Go to their website, you can get on their list.
This company First Financial Network has a pretty interesting model where they will aggregate a list of assets from a bunch of different sellers in the business and put them out in these quarterly loan sale events. You can cherry-pick loans from their portfolio and close deals through their network.
Two at the top, in the note brokers section of this article, Mission Capital, and Mountain View, they're a little larger and they're generally selling to bulk buyers. For purposes of this part of the conversation, I think maybe they would be worth looking into as you scale up, but not a first purchase.
And then the mortgage note exchange platforms can be a good place to start, but I would be a little bit hesitant with your initial due diligence on the seller. There's a lot of due diligence to do on the specific asset, of course, but there's a whole another phase of research on the counterpart that you're working with.
And sometimes, the unsavory folks will list an asset on an exchange to distance themselves a little bit from it. Actually, one of my mastermind members, he closed a couple deals with me and had a lot of success. And then he expanded and started trying to buy some loans from these exchanges and ended up buying an unsecured loan and bought it for secured pricing, which unsecured just means that there's no collateral anymore. He can't foreclose on it. The borrower really doesn't have much of an incentive to pay the loan unless he goes through a lengthy legal process to seek a judgment and then potentially garnish wages. There's a whole another angle in the unsecured side of the business, but because he bought this through an exchange, he had a much more difficult time since he didn't have a real relationship with the seller.
That can be the one sort of tricky situation when dealing with these exchanges, which you definitely want to consider when you're doing your due diligence in the beginning.
Who's actually selling the loan? Check the assignment of mortgage and make sure that they're recorded and then look into the BBB on that specific company, Google them, see if there are any lawsuits out there outstanding against that company. There's a lot of things you can do with the power of the internet to make sure you're dealing with good people. And that's going to be more important when dealing with these exchanges.
Seth: How often do you come across land notes? And if so, can you buy those at a big discount just because it's land?
Rob Hytha: Yeah, certainly. We see a handful of land loans in every portfolio we buy. Most of the time, they were always land. They aren't properties that were knocked down. Some of them are, but most of the time, a borrower took out a construction loan to eventually develop that lot and was not able to fulfill that dream. And then oftentimes, these loans are hugely underwater because they took out a lot more to actually build the home.
In those deals, it's interesting because you're going to be pricing them as a percentage of the value of the underlying property, not necessarily the unpaid principal balance. That's where you can really get into some really good deals discount-wise because you're not going to pay more than $5,000 for a lot that's worth $5,000. Whether or not the borrower wrote $50,000 or $100,000 on that, you're really capped at your potential value there.
There are some land lots that, like I said, I'll see all the time in these portfolios. I think I should have some loans available from my primary clients in January of next year. And I'll let you know if there are any land lots. Do you buy nationwide, Seth?
Seth: Yes, I do. It's interesting because that whole thing of somebody taking out a construction loan. Does that mean they could feasibly maybe have the excavation work done, but they never actually built anything? Like it's altered, but it's still vacant. Has some improvement been made?
Rob Hytha: Yeah, totally, totally. I closed the deal last year where they've gotten as far as putting in the kitchen cabinetry, but they never got their occupancy permit and it just fell to the wayside. There's anywhere in the spectrum from just doing the foundations all the way up to almost finished and didn't quite get there.
I generally think, though, we're seeing more just raw land and oftentimes, you already know this, but when we look at the Google Earth satellite, if we see that there's a lot of vacant land in that neighborhood, then we're immediately discounting that really significantly.
But if it's only one of the last vacant lots in a really developed spot, then that almost trades closer to single-family residential type of discounts because we know there's a demand there. And then, you can back into the price based on the ARV, which in this case is the after-built value and then work your way with some builders in the area. And it's a whole another niche there, for sure.
Seth: You mentioned earlier, you can typically buy a non-performing second mortgage for like 60% of its balance. Is that right? Can you ever do less, like 50% or 40%?
Rob Hytha: Yeah, certainly. When you get into 10 and even single digits, you're talking about much lower quality loans. And when I say quality, I mean there's negative equity. The senior lien is non-performing, the property may be vacant. Those still certainly exist. I think that pricing has increased pretty significantly in 2021, and there are some underlying market forces there. And that's why I think 60% for a higher quality loan is like a really good deal now, whereas in 2020, that was the top of the market for non-performing seconds behind performing firsts with equity.
And just to mention those underlying forces. In the Cares Act, when the pandemic started, there were two accounting reliefs in place for banks, TDR and CESL, which is Current Expected Credit Losses, and TDR, Troubled Debt Relief.
And these basically allowed the banks to kick the can down the road. Instead of reporting their bad debt, they were able to have it in this opaque bucket of assets that then didn't affect the rest of their balance sheet. Those provisions are due to expire, the beginning of next year, which means that a lot of bad debt that was otherwise underreported and just sitting there is going to have to be sold to clean up these balance sheets.
That really created a lack of supply this year, which drove up prices on both the underlying collateral. The real estate values were all-time highs this year, but then also the mortgage notes that are being traded on those properties.
I think next year the market as a whole will cool down. Property values should come down when there's more inventory brought to the market. And then note value will be brought down as more inventory's been brought to the market. Hopefully, we'll have a really good year in 2022 for note investors.
Seth: What are some of the big risks in this kind of thing? Say you find a non-performing second mortgage loan and you think everything's fine so you get into it. How often does it happen where that falls apart? It doesn't actually ever get resolved. Do you lose your money? Or do you have to then do much work to get your equity out of it? What happens in the nightmare scenario, and how often does that happen?
Rob Hytha: I think the number one risk, which we already alluded to, is counterparty risk. And the worst-case scenario is you buy a loan, you sign a contract, you wire the funds, and you never get your collateral file. Either the seller just outright scammed you and they never had anything to sell, or they delayed and delayed and delayed, and they just don't have the documents together. And we see that even from reputable sources where they don't have their assignment of mortgage complete, and they're just waiting for the docs to be in place to be able to ship them out. Sometimes it can take six months or longer.
That situation counterparty risk is the first thing to look out for. After counterparty risk is the due diligence of the specific asset. And the thing that can bite you in the back the most, if you have everything else worked out, if you have your credit report, and it looks good, if you've got your property value, and it looks good, you've got equity. The documentation is going to be critical.
And most of the time for the institutionally originated loans, we see pretty tight documentation, and the relationships that my clients have with the bank sellers are very good. When we have trouble with a missing note, we have a loss note affidavit signed. If we're missing an allonge, they'll prepare that allonge, the endorsement of the note. If there's a breach in the assignment chain, which happens more often than you think, where little stuff like the instrument number wasn't written down correctly, or the origination date was off by a day or two, those things can cause a blight cloud and title on the chain, but they can be corrected. And a corrective assignment of the mortgage can be recorded with the correct information. By having good counterparties, you can correct most issues with the documentation.
I think there are some risks when buying private loans that maybe have not been originated properly. And that's why your previous guest who was speaking on notes, Justin Bogard, would be great to work with because they're professional note originators, so they know what they're doing there.
But then after that, I think the main way you can mitigate your risk for the worst-case scenario when you own the loan, the worst-case scenario, assuming everything else is in order, would be going all the way to the foreclosure process. And by working with a local attorney as part of your due diligence to review the collateral file, to make sure that it looks enforceable and they're not going to see any issues later on it, that can really save you a lot of trouble. Especially if it's a loan that you expect to go through that foreclosure process, it's worth spending some money upfront to have counsel actually look over, and not just any counsel, the specific attorneys that are going to be pursuing that foreclosure directly, because they're not going to pull any punches. If they see an issue, they don't want to have that issue later on. So, they're going to make sure things are tight from the beginning. I think that's really important.
But generally, when you're buying equity loans, especially seniors, current juniors or taxes, current seniors, most of the time those borrowers want to get back on track. Oftentimes you'll never even get to the point where the documentation is disputed. I've seen plenty of deals where technically something might not have been perfect, but that borrower wants to get paying again. They never intended on defaulting on the loan and they're not trying to find a way out of it. They want to pay the money that they owe and it doesn't even become an issue. I think that there's maybe a major thing to do in the beginning of your due diligence, especially when buying from these secondary market sources, that'll save you a ton of trouble down the line, which is to look at your servicing records.
If a loan is still non-performing after it's been in the secondary market for a number of years, there's a reason why that loan is still non-performing. And by looking at the servicing records, you can see exactly what was going on. And if the loan has been non-performing for all this time and different lenders may have been trying to collect on it. And the next step really is to do foreclosure on this loan to pursue that foreclosure process. Why haven't any of those lenders pursued it? That's where I would really want to spend the money on working with an attorney.
When you're buying a loan directly from a bank source and that loan is charged off and is not being collected, that's a different situation. Those borrowers are often just looking for a place to pay, but if the borrower has been pursued and has not started a payment plan, you really got to cover your basis for the worst-case going through that foreclosure process.
And that is one reason why I don't want to make this like an outright pitch, but in our Mortgage Note Mastermind, I'm currently doing a case study of a portfolio that I'm actively managing. And when we get to selling these loans, which in January, we're going to sell the loans that haven't been resolved yet.
I've been every step of the way explaining the portfolio management process so the people who eventually buy the non-performing loans that are still left in this portfolio understand exactly what has happened, exactly what the next steps should be. And there aren’t any surprises there.
And just to provide a little bit more clarity around that, my clients, who I do portfolio management for, generally approach this business in a velocity model where they want to really focus on the transaction. They're taking down a large portfolio of loans, they are service transferring those loans to their servicer, sending out those RESPA letters, and sending out the FDCPA letter in one collection letter. And there's a lot of low-hanging fruit that comes out of those initial letters.
We're starting modification agreements, we're selling properties, we're collecting, or we're helping the borrower sell properties. We're collecting discounted and full payoffs. And then by the time we would decide whether or not we're going to foreclose or take some other escalated approach, we're just looking to sell the non-performing loan to an investor that's local to that specific market, or more better suited to go through the process in that area, and then use that recapitalization to buy more loans and go through that process again.
By being transparent with the entire servicing history, investors who are buying these loans aren't going to be wasting time with the next steps in the process and they know exactly what's happened. Whereas sometimes you can buy a loan and really not realize the whole history, which could save you a whole bunch of time if you were aware of that from the beginning.
Seth: Yeah. We talked about some of the ways that things can go wrong and what to do and that kind of thing. But what are the biggest upsides about getting into this kind of business? Who is this for? What kind of person should be exploring this? Is it people who are mostly concerned about the biggest ROI or cash flow or a lifestyle business? There are different types of investors out there. There are the hunters and the farmers. Some people are chasing down huge deals. They're going to make massive paychecks relatively fast. Others are more about the farmer mentality of just investing money and letting the profit drip, drip, drip, back to you and having to be more of a passive type thing. Would you say it's more for the latter, that kind of person?
Rob Hytha: It's cool because it can be for everyone based on your strategy. There's a whole microcosm of different niches within the mortgage notes sphere, just like in real estate, in general. You can fix and flip, you can buy and hold. There are all these different models, which can have their corollaries in the mortgage note business. Some investors who you'd call hunters, who want the big lump sums, may be looking to source assets and connect them with the buyers who can take down those loans and make a broker fee.
Other investors, the farmers, I think are very well served in this business to buy reperforming loans or to buy non-performing loans and get the cash flowing again because of that mailbox money every single month. And it's easier than the rental income mailbox money, for sure. When you own a rental property, I'm dealing with a couple turnovers right now, you've really got to put in the work. Whereas in the mortgage note world, if there's a problem with the property, it's the homeowner's responsibility. You never call your mortgage lender because your toilet isn't working or anything in that sense.
Seth: I have, but they don't really respond to that.
Rob Hytha: Right. Right. The only reason you call your mortgage lender is for some type of insurance claims, but at the end of the day for passive income, the note business is ideal. And as you know, most loans refinance within 7 to 10 years or so. Eventually, you will get a full payoff on these loans. Very rarely does a loan pay all the way to maturity. And most note investors, especially if you buy a loan in your self-directed IRA, they just want to get that cash flow. They don't want the lump sum. I actually have a loan in my IRA that just paid off and that money is just sitting there. It was earning, getting those monthly payments and now I got to redeploy it. I think for farmers, it's a great business, and I actually never really referred to note investors as hunters and farmers, but I like that.
Seth: Yeah. Actually, just logistically, once you have a note and you start getting payments, how do the mechanics of that work? Is there some loan servicing company you use for that? Or are they literally paying you? What service do you use to manage all that?
Rob Hytha: You definitely want to have a loan servicer. It'll save you many headaches in the long run. Your loan servicer will send monthly statements. They'll collect the monthly payments. They'll amortize the loan and account for all your principal and interest payments. They'll send the 1098 I at the end of the year, the interest statement to the borrower for their taxes. It makes life so much easier to have a loan servicer in place.
Now, there are some barriers to entry with loan servicing. For the loan service that I prefer to use with my clients, Land Home Financial Services, the minimum monthly fee was $250. And I think it's $500 or more now. If you don't have more than 20 assets at $25 a month, it can get to be cost-prohibitive. $25 a month is a pretty standard rate for client-managed servicing, which essentially means that they'll collect the payments, but they're not going to do any outreach. Closer to $100 a month is more reasonable for active management where they're actually making calls to try to get the borrower back on the hook.
I generally don't see a lot of success with that type of servicing model. I work with third-party collection companies or just wait for the inbound calls from the borrower to get our loans performing and keep the client-managed approach with my servicer. If you want to work with a servicer that can manage smaller portfolios, there are many options, Madison Management, Allied Financial Corporation. I mentioned Security National, David Pollio. They're a loan servicer as well. FCI Lender Services. There's a whole bunch of them. On my website, I have a free course, how to invest in mortgage notes, and there's a whole bunch more information about servicing there.
But logistically, you can expect to pay around $20, $25, maybe $30 a month for a small portfolio. You can negotiate that down even as well as $15 a month for a larger portfolio. And that's really your only fee once the loan is performing.
You're collecting the monthly payments. The servicers are doing all the work. If the loan redefaults, if they stop making payments, then you do need to figure it out and potentially get an attorney involved, send a demand letter if necessary. But for loans that are happily performing, there's not much work once it's paying and you have a servicer in place.
Seth: No, that's really helpful. Yeah, I'm going to be sure to link to a lot of those that Rob just mentioned along with his free course in the show notes. Again, retipster.com/121. This is episode 121.
Rob, as we wrap this up, are there any other closing thoughts or advice or recommendations? Say if somebody is curious, looking at this from the outside, as “Maybe I do want to invest in some mortgage notes,” that kind of thing. How should they proceed? How should they find out more and not get burned on anything? Should they work with a specific person, or should they start with a teeny tiny deal to test the waters and then go from there? Any thoughts on that?
Rob Hytha: Yeah. I would say to start with just absorbing all the information you can find. There is so much free content out there. I'm up to 40-plus hours on my YouTube channel of my monthly show. We go through case studies every episode and a whole bunch of features around different aspects of the due diligence and collection process. You can also read the blog and the free course. Fixed Notes alone have tons of free content, which you can start with.
Now, most investors I hear from will say, “Well, I really learned by actually doing.” And you're right, getting a small deal under your belt you're going to learn so much more than just going through the motions with all this reading and watching. It is kind of tricky to find a seller who will just sell you one small deal, but that's not unheard of. That's definitely a way you can start getting into this business.
And this is another soft pitch for the Mastermind group. The Mastermind group has a lot of great investors who are willing to work with an up-and-coming investor who does have single assets available for sale. We've got 14 loans on the market from different sellers who are members as part of the Mastermind right now. We have an aggregated trade desk where members exchange loans with each other. You can buy some loans there, buy a single asset if you want.
I wouldn't recommend starting with one asset, though, with high hopes. You can definitely learn a lot, but without diversifying, it's pretty difficult to just pick a winner out of a hat with a good price. Of course, if you buy a non-performing second or a non-performing first behind current taxes or a current senior with equity, like we talked about, it's pretty sure that you're going to get a deal done, but you're going to be paying up for that asset.
Personally, I would rather diversify into a mixed bag of different quality loans rather than spend all my money on one high-quality loan. Especially if you get started because you're going to learn so much more by going through different processes through these different types of situations that you'll be exposed to by buying a mixed bag of quality.
Just learn as much as you can before you jump in. And then, when you jump in, make sure you're working with good people. And I think this business has so many benefits to other areas of your real estate career.
When I bought my second rental property, I was able to negotiate a seller finance type of deal. It's actually a lease option with some seller financing as well, which made such a difference because I was really aware of this lending side of the business. I was able to take down this property with just much savvy understanding.
Whatever aspect of real estate you're involved with, this will augment and supplement that, not only with monthly income or lumps on payoffs from non-performing loans but also just with your leveling up your skill and being able to think more creatively. I'd highly recommend checking out mortgage notes. It's such an exciting industry and a lot of good to be done as well. So, do it.
Seth: Yeah. Well, Rob, I appreciate you coming to the show. And again, if you're listening to this and you are interested in this type of business, I would implore you to check out fixnotes.com. Granted, I haven't looked a lot into this niche of real estate, but I don't know of any other blogs or websites out there that have so much information about this particular topic.
If you guys check it out, I think you'll find a lot of help there. And also, Rob's YouTube channel as well. And I think most of your videos are long-form. Is it a live stream? Is that what you're doing?
Rob Hytha: Yeah. All my videos are live and they are longer, but I do put chapter markers. If you want to just skip to the case studies, you use the scrubber bar at the bottom and click that part of the timestamp. You can definitely skim and get a lot of information without reviewing the whole thing. I personally love the live approach because I don't have to do any editing. You go up, you do your show, and it is what it is, but definitely, it takes some watching. If you go through the whole thing, there are 40 plus hours now.
Seth: Awesome. I'm going to include links to a lot of the stuff that Rob talked about in the show notes, retipster.com/121. Rob, thanks again for coming on.
Rob Hytha: Thank you so much, Seth. Yeah, this is very exciting and I'm happy to be a part of your podcast and I'll keep listening in the meantime.
Seth: Sounds good, man. Thanks again.
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