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Good, Bad and Ugly

Written by Jeffrey R. Armstrong – President/Owner of Armstrong Capital

Your favorite Master Note Buyer – Straightforward, Honest, Fair…

A veteran note pro and current practitioner tells you what you should know about the seller held real estate note business

There often comes a time in the life of a note business owner when the owner must decide if it’s better to continue to just be a note broker or to own a small piece of the pie. That’s because note brokering can only take you so far. When you’re lucky enough to reach the stage where you have a steady flow of transactions closing every month, a note business marketing plan that works for your business, and a support team that you have worked with for awhile and trust you start weighing your options.

To start the process of buying your first note you will have learned from the note buyers you have worked with over the years and your experience will allow you the luxury of not having to worry about the how much to pay  and focus on the due diligence. By this stage of your note business you should have already gained some experienced investors and/or Master Buyers who are on your side and can help you focus on the big picture and plan your growth strategy.  Let’s start with the good that is in the note business.

  1. Experience, advice, and mentoring. Whether you work in the tech world or the film world, the principles of building a business are the same. Those who have done it before can provide tremendous value. Master Buyers are usually current practitioners in the note business who have not only been successful on their own, but have also watched dozens of note businesses succeed and yes, fail. They can guide you through your journey.
  2. Objectivity. What drives the most successful entrepreneurs in the note business is their vision and their determination to succeed at all costs. It’s very easy to believe your own marketing and visions of success and lose objectivity. Having experienced partners there ready to throw cold water on you can provide a healthy balance.
  3. Networking. It’s always about who you know. People in the note business build and maintain extensive contacts with other note brokers and note buyers with whom they’ve done business with, worked with or networked with at industry events and workshops, and so on. Their contact lists are usually worth more than their weight in gold.
  4. Recruitment. It is hard to know what to look for when you’re interviewing for all the diverse positions you have to fill on your note business team. Not necessarily employees but independent contractors and other note business services. What do you ask when you’re interviewing a real estate attorney, for example? How can you tell if the servicing company representative is more adept at selling himself than they are at servicing your notes? A good team is usually a top priority of successful note businesses.
  5. Credibility/prestige. During the first couple of years of your note business, you’ll feel like adding “we’ve never heard of you either” to every conversation. Yet everything seems to change when you complete a few transactions with a particular note investor or buyer. It’s like joining a special club that gives you respectability. Even customers feel more assured when you tell them about your strong track record.  The note business is a small community and good news travels fast.
  6. Acceptable risk. Things will go wrong. The market will go up and down, deals will fall through, and key team members and customers will defect. Note Brokers and note buyers usually have built up reserves for the down times and for subsequent rounds of marketing and funding transactions.
  7. Big picture. It is very easy to be focused on your own note business and marketing and lose sight of the forest. With the thousands of notes that note buyers review every month, they develop a good feel for the trends in the areas of the country they buy notes in.
  8. Exit assistance. Nothing lasts forever. If things are going well, you will want to climb the next mountain. But the best strategy may be to cash out and start again. You and your team will watch for the best exit strategy. Broker the notes one by one, buy and hold notes to sell off in a package later on or buy and hold for the long term, etc.

All this seems too good to be true. What are some of the downsides of the note business?

  1. Mandatory exit. Institutional note buyers are in the note business for the extreme passive income. Most are not out to get to the property or do good for the world.  Their only priority is to buy notes at a reasonable discount, so that they can get the high returns they are looking for. In truth, in their world, the need to create high returns always triumphs over relationships.
  2. Loss of independence. You may still be working for yourself, be an independent contractor or even a one person operation, but when brokering a note to an investor you answer to them and you are not in control of the transaction anymore.
  3. They will have the right to cancel your transaction or even to not work with you at all. Should you operate your note business in an unethical, dishonest way or leave out pertinent information (lies of omission) you could find yourself without an investor to broker notes, or be ousted from the inner circle of the note business.
  4. Onerous conditions. Note Buyers usually ask for:
  • First Right of Refusal. If they buy a partial they have the right to purchase the remainder of the note or be paid off in full if someone else buys the note.
  • Yield. Combined with discount, note buyers have their own preferred rate of return on their note investment.
  • Liquidation preferences. Note buyers get their principal amount purchased before anyone else gets a penny.
  • Participation preferred. A note buyer may decide to sell all or part of their investment after the initial purchase and keep the remainder to themselves at their discretion.
  • Reps and warranties. The seller of the note may have to accept personal liability for representations they have made about key aspects of the note.

And what’s the ugly?

  1. Note Business conflicts. It’s a cutthroat world and note brokers and note buyers routinely compete with each other for deals. At the same time, they reduce their risk by having a list of other note buyers to sell notes to when a particular note doesn’t quite meet their criteria. The more note investors a note business has, the better its odds of success and the bigger the safety net. Yet differences in opinion usually emerge and personal interests often come into play. It can be a full-time job for a note broker to manage their note investor list.
  2. Ethical conflicts. As professionals in the note business conflicts can and do arise.  One of the ugliest is the bait and switch routine where a note broker or note buyer will give a note holder an unrealistically high price for their note all the while fully knowing that they can never close and fund at that price.  Then as the due diligence progresses and they get ready to close the price drops dramatically and the note seller is coerced into selling the note for a price much lower than expected.  This is different than lowering a price for poor credit, low appraisal or clouded title.
  3. Unfulfilled promises. Note buyers and brokers can only reach out to their contacts for a limited number of favors, and use their Rolodexes sparingly. They also have multiple investments to manage and their own funds to raise. So you don’t always get what’s promised.
  4. Egos. Disagreements about strategy often arise between the entrepreneur (new note broker, green note broker or newbie) who is on a mission to change the world, and the note buyer (investor) who can do no wrong. Like entrepreneurs, note buyers aren’t created equal and they often have varied and different experiences and backgrounds while the entrepreneur may have more details about the note, note seller needs and potential opportunity.

Bottom line: There are no easy choices here. The note business can be the best opportunity that was ever presented to you or your worst nightmare. Your challenges are to figure out whether or not the note business is for you, whether you want to stay small and just broker notes, or take the risk and eventually purchase notes for your own account. Just be aware that the note business is like any other business, it has its good, its bad and its ugly.

To sum up: treat your note sellers and note investors as you’d wish to be treated, and treat them in a way that will keep them as future referral sources or repeat customers. They, as your reputation builders, are your most valuable asset.

Remember, success demands action! Keep on marketing, it’s going to work! TWITA! (That’s What I’m Talking About!)

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