There are two primary sources of funding for purchasing notes to keep for your own portfolio. The first would be institutional sources. Many are quite successful working with institutions and we will talk more about them in a later issue. The second source is “private” investors. This ranges from individuals to small companies and pension funds. There are several nice aspects of using private investors and some caveats we'll talk about also.
Here's what's good:
- Quick funding
- Collateral qualification
Properly trained and cultivated private investors with liquid funds (I insist this is the case) can write a check on the spot. This means you can have the ability like a frog in the pond with a big tongue to snap out and capture a good note before it flies away. Quick funding can give you the keenest edge and advantage over your competition. Some of my very best notes come in this manner.
Private investors can weigh individual situations and deviate from set standards and procedures when it makes sense. For example, what if you have a note where you need to move quick but getting an appraisal would take too long. Yet, it is simple to run some “comps” and know that it is a safe note. A private investor may look at this, fund the note and wait for the appraisal to come in after the purchase. Some of my investors like creative deals where they would love to get the collateral back or where a problem or delinquent note needs to be straightened out.
Private investors tend to look at the collateral for their decision to loan against a note. An institution may want to personally qualify you to pay back the note if the payor didn't pay you. A private investor is more likely to look at the payor and the ultimate recourse – the collateral.
Few things are as frustrating as establishing a relationship with someone at an institution and having them transferred to another branch or position where the relationship does you no good. Private investors don't change their policies as readily as institutions.
Institutions will seldom give you referrals, but private investors that you treat right can be your greatest fund raisers.
Working With Private Investors
First I'm going to talk about how to work with private investors properly, because some of this information has a bearing on how to find the investors. We'll discuss finding them next.
Here are the important points:
- Protection for them
- Protection for you
- Full disclosure
- Share the wealth
A friend told me one time how he had a “stable” of over a hundred investors but wasn't getting any notes placed. In my view, he didn't have investors, he had a mailing list. Potential investors, “wanna be's” and “looky loo's” waste time and frustrate many note buyers. Take it one step further and qualify the note buyer. Verify their funds, parameters, speed and desire. I ask investors the following questions:
Have you purchased or loaned against notes before?
What education or experience have you had related to real estate or mortgage loans?
How much money do you have to invest?
Where are these funds and how long would it take you to get at them?
If I presented you with a note funding opportunity today, how long would it take you to make a decision?
Would anyone else need to be involved in the decision making process?
What would you consider to be a good “safe rate” rate of return for your money?
What types of notes would you be comfortable owning or lending against?
What types of notes would you not buy or lend against?
Those are a sample of the type of questions that you would ask an investor. Even after blunt questions, you may only know the seriousness of an investor when you put a deal in his or her hands. I use a technique that helps me do this.
The “Unavailable Available Note”.
Even if I believe I have a firm funding commitment from another investor, I may run a note past investors that I am trying to qualify. I'll preface it with “I have other investors interested in the note, so you'll have to move quick if you want this one.”
One of several scenarios take place. They may squirm, make excuses or admit that their funds are not liquid or are coming from a banker, etc. They step up to the pump and give you a back up offer if your other funding doesn't pan out. When an investor misses a note, they become more anxious. They know the deal was good, because the demand was strong.
I have investors that I even tease gently about this with statements like “you snooze, you loose” or “you don't steal in slow motion.” They know they must move quicker next time or get closer to the front of the line by lowering their cost of funds.
There are some other things involved in the qualification process.
He Who Names a Number First Loses
The last thing you want to do is to violate an investors “too good to be true theory”. They may believe a risk versus rate of return theory that says a lower rate of return is safer. You could scare them with 18% when they would be thrilled with 14% on the very same investment. You should also be much happier with paying the lower rate. So, ask the investor what they feel a good rate of return would be and negotiate from there.
I'll give the investor as much education as they want about the safety, terms, discounting or qualification of notes. I draw the line when it comes to teaching them how to find notes or any other abilities that could cause me a “commission-dectomy”.
I give them a special edition of my newsletter titled “Wake Up World” that talks about the basics of paper. I'll also give my book “Discounting as Easy as 1,2,3” to investors that want to learn more about the time value of money and calculate their own yields. My focus is on educating the investor to the point where they are very comfortable telling good notes from bad notes and making qualified decisions. In this sense, I am always working to make them more independent of me.
Document your calls, conversations, meetings, agreements, notes presented for their review, etc. Investors are human and forget agreements, how hard you've worked, what you've told them, etc.
Notes of meetings kept in your daily planner are now even being admitted into court cases as evidence.
My concern isn't winning in the rare case of a severe mis-understanding with an investor, but more along the lines of preventing a misunderstanding from ever happening. I had a case where an investor saw me making a $2,000 commission on a small note. The look they had was like “what did you do to earn that much?” and I wish at that time, I had documentation of the dozen or so other notes they had turned down and the meetings, time and cost that went into them.
Protection For Them
Be “hyper-vigilant” in protecting your investor. Don't sell an unsophisticated investor a note you wouldn't buy. They will appreciate the protection and your long term reputation and image will be rewarded far more than a quick commission on a questionable note.
Make sure every detail is handled – even if they are the ones who should be doing it. We had a case where an investor seemed to know what he was doing and his bank drafted the paper work for the purchase. As I signed the papers the bank prepared, I noticed they had not drafted an “Assignment of Trust Deed”. I was in a little shock since my entire office had fried in a fire a few days earlier and didn't pay much attention to it.
I didn't even have a computer to draft the document and was in a daze from the fire anyway. I assumed they would contact us later. Well, later came – almost a year. By that time the note buyer was feeling frustrated and mis-treated over one simple document that his bank escrow officer should have prepared. Yet supposedly he knew what he was doing.
If something isn't done quickly, properly or at all, you'll take the heat for it, even if it was real clear that someone else was supposed to do it, so make sure it is done right – always! Even if you lost tens of thousands of dollars and a large piece of your life in a fire a few days before.
Protection For You
In light of what I've just said above, make sure you always protect yourself with documentation, agreements, disclosure and careful examination of the work and efforts of others. Have a signed statement as to the details of the transaction with the note buyer. Detail out any potential risks, quirks of the particular note, responsibilities, guarantees (or the lack), etc. Put some time into drafting a disclosure statement that covers that particular note and general risks of all notes.
With each note and each investor, I go through a Ben Franklin “T – Form” that shows the pros and cons of a transaction. For example, maybe they are looking at a higher than normal LTV ratio (con) in exchange for an attractive yield (pro). In another case, maybe the buyer has questionable credit (con) and a slow payment history (con) but the LTV ratio is real low (pro). There are trade-offs some times.
We had one case where we backed out of a transaction and left a potential $20,000 commission on the table rather than be involved with a note that we learned could be a problem for the investor. We just told the investor our concerns and backed out of the transaction leaving him to close if he wanted.
Share The Wealth
When things go well, we like to bonus the investor. Cash or some kind of “spiff” like a trip to Hawaii can go a long way. The little things can make a big difference sometimes.
Selling To Private Investors
Up to this point, I have made little distinction between selling to private investors and borrowing from them. It is vital that you read this section that I would consider the most important of the entire article.
I do not like to sell to private investors. There is a liability any time you are dealing with an unsophisticated investor. Notes can have problems that a beginner investor may not deal with properly. For example, a note may go delinquent and the investor is timid, slow or inexperienced in solving the problem. The problem gets bigger and what may have been a great note turns into a lemon.
An institution probably would not let this happen and wouldn't turn to blame you if it did. Unsophisticated private investors can turn to you when they don't do their job properly and even experienced orsophisticated investors may claim you took some unfair advantage.
I prefer to borrow against the notes, be in control, collect the payments, guarantee the cash flow and make sure the note is treated professionally. What I don't like is “liability without control”, so if there is any liability, I want the control to minimize it.
I prefer to borrow for many other reasons too. It is the most profitable approach to note investing. You'll love it when you see it and won't want to do it any other way.