How to Evaluate Real Estate Notes for Today's Market

The first step in buying real estate notes, in any market, is to determine the value of the underlying collateral, which is the real estate that secures the note.
Here’s the problem. In today’s rapidly fluctuating real estate market, no one really knows what a property is worth.
And that’s exactly why the lending institutions are so difficult to deal with in this market.
In many markets, the loans are way beyond the current comps. The property is upside down, and the market value is less than the remaining amount of the loan. Comps and appraisals are either dramatically low or all over the board. And the lending community is trying to play it safe.
Whether you are buying real estate notes to flip or to obtain the underlying collateral, you need to have a good idea of the value of that collateral and structure a note purchase price that will keep you safe.

Buying Real Estate Notes – It’s All About the “Cash Flow”

What is this note really worth?


When you’re looking for real estate notes to purchase, forget about the current market comps or sales price when evaluating the collateral.
What? That’s right. Since real estate values in most markets are still fluctuating, market value or comparable sales price is only a very rough number. It is a guide to get you close, nothing to rely on.
The more important number is the current rental rate in the area. What will the property rent for, what is the payment on the note you are considering, and how do they compare?
Think about it. Since the whole point in buying real estate notes is cash flow (income stream), this makes perfect sense.

Buy the Real Estate Note to Own the Property

Look at this example:

Property Note Balance: $185,000
Payment: $1109.17
Term: 360
Interest: 6%
Property Rough Value: $100,000
Average Area Rent: $750

Now if I’d like to own the property and rent it out and gross $100 per month, I know what I have to work with. (Realize I’m just using this $100 figure to teach you the concept.) I go to my Hard Money guy and ask for the amount he’d loan on that note.
I use a note calculator to figure how much money a $650 payment will support. If the cost of the hard money is 12%, here’s how it works out:

Payment: $650
Interest: 12%
Term: 15 Year Amortization
5 year call (balloon)
Solve for Present Value: $54,159.08

This becomes my target price for the note, which equals roughly a 54% LTV (loan-to-value ratio). Since hard money lenders will loan up to 65% of LTV, it should be easy to get this loan.
However, if you can use Private CD money at 6%, rather than 12% hard money, you could raise your price to $77,027.28 to get the same $100 cash flow. So now you can see how you can construct different scenarios based on the interest rate.

“Flip” the Real Estate Note for Quick Cash

This way it is a “no money down deal.”
If I’m only trying to “flip” the note, then I look at the deal differently. I want to accomplish two things with my analysis:

  1. What is the yield my note buyer needs?
  2. What is the LTV he requires at that price?

Let’s say I have a private investor who is looking for yields of 15% for a first, but he doesn’t want an LTV higher than 75% because he (or she) is not sure of the current market value. Sound familiar?
Okay, if we solve for a 15% yield (assuming there are still 360 payments remaining), that would make the current present value  $87,719.98
If our investor is comfortable with that LTV exposure with a 15% yield, we now know what number we want to be below. We need to buy the note at $65K or $70K or 75K to make a nice profit.
If the investor wants to be no more than 75% current LTV, we know our note purchase price should be no more than $60K to $65K to flip the note and make our target profit figure of $10,000.
If the note is performing, we use an LTV our investor is comfortable with (% of rough current market) as a guide for our highest figure. If the note is non-performing, we use the current rental market number to start with and back out the value and price.
Always remember, this is a people game and everything is negotiable. Some of the best deals will be those the local bank wants to unload. You can then “flip” to an investor, while never having to put up a dime.
The following Success Story is a good example of negotiating to sell before you buy a note or group of notes: How I Cashed In on Mobile Home Notes.
I’m always looking for notes to buy, especially from banks, and I’m happy to pay a percentage of the deal to anyone who brings me real estate notes. Email me at tlv@creonline.com
Good hunting!
Terry Vaughan
tlv@creonline.com