One Way To Determine the Value of a Note

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

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

How to determine the value (“worth”) of a note… what should be the price?

This is the typical question asked from investors and sellers all the time. While there are many ways to determine the purchase price of buying a note, and many varieties of opinion, here is one method for your consideration.

First, purchasing a note has similarities to funding a hard money loan. The term Hard Money refers to the fact that the underwriting decision is focused primarily on the property being pledged rather than the individual.  Essentially, it is an “Asset” rather than a “Credit” (people) basis for the approval.

While credit is important, the asset being pledged is the focal point. It is that Asset that stands the test of time; it may fluctuate based on the economy, but never loses its entire value (never goes to zero value).

When considering the purchase of a note,

• First, look at the asset (property) being pledged. Examine the factors that may cause appreciation or devaluation.

Location, Location and Location…

Look at characteristics that may cause devaluation such as:

– Industrial property alongside a residential area.

– A waste site or nuclear power plant in a residential track.

– Region of county where there is high employment or plight.

– And in today’s climate, examine the local sex offenders list for residents in the area of your asset… in conclusion, these things may deplete from the value of the asset.

For Appreciation consider:

– A “gated community” to increase value.

– Low crime or vandalism

• Second, thoroughly examine the documents.

Consistency of individuals on the mortgage, note, title policy and the loan application. Look to see any variance, such as husband and wife and now only one left.

Term and conditions of the note. What are the specific terms of the note? If an ARM, on what index is it based. Look at a recent rate adjustment, to determine that the payment was calculated correctly and that the borrower was charged correctly.

• Third, examine the asset (property) itself:

– What is the AVM and on what basis calculated

– What are the current CMS (comparable market sales)

– Age and condition of asset (any function)

Once you have examined and are satisfied with the results of your review, you can begin determining the price you should bid for the note. The basis for determining the price is based upon knowing the UPB (unpaid principal balance), the AVM (average market value) and the CMS.

Determining factors for establishing a price:

#1: Establish what Cash on Cash return you want on your money. What percentage rate you expect as a return on your money investment.

#2: Determine what is the CORE basis for your computations: if the UPB is greater than the CMS, use the CMS to set your bid.

An illustration when UPB is greater than CMV

• A note has:

– UPB of $151,746 and a CMV: $145,000.

– Monthly payment of $1,220

• You expect a 15% Cash on Cash return.

How do you determine a purchase price?

Step 1: Take annualize (monthly payments times 12) the payments = $14,641

Step 2: Divide the annualized payment by COC percentage ($14,641/15.00%) = $97,606

PURCHASE PRICE WOULD BE $97,606 to meet you COC expectation.

The seller would have to give you a 32.69% discount on that note to achieve your target COC by selling the Note for $97,606

• if the CMS is greater than the UPB and the property has equity use the UPB to start set your bid Consider the paying history –
• Add if performing with on time payments (assume +5%)
• Add for high value retention areas (assume +3%)
• Subtract if in default or ongoing delinquency (assume -10%)
• Subtract for functional obsolescence
• Set an acceptable loan to value ratio

An illustration when CMV is greater than UPB

• A note has:

– UPB of $151,746 and a CMV: $165,000

– Monthly payment of $1,220 – current with ongoing payments

• You expect a 15% Cash on Cash return.
• You limit the LTV to be less than 75%

How do you determine a purchase price?

Repeat the same as Step 1 and Step 2: plus

Step 3: Add the premium of 5% for on time payments (5% of $97,606) = $8,250

PURCHASE PRICE WOULD BE $105,856 to meet you COC expectation PLUS

Loan to Value expectation is less than 65% ($105, 856 divided into $165,000) = 64.1 %

The seller would have to give you a 20% discount on that note to achieve your target COC and your LTV of less than 65%

In the final analysis purchasing note is a computation of the figures and the application of setting investment benchmarks.  Finally, notes are classified as either:

• Non performing indicating that the payments are delinquent and the loan is in some state of default and with possible foreclosure pending
• Performing notes in three sub categories:
  • Performing – never missing a payment nor having any of the terms and conditions changed.
  • Re-performing which indicates that sometime in the past payments were delinquent and now are current. Sometimes referred as a reinstated loan.
  • Sub performing notes are those where the terms, conditions or method of the payment have been changed and in three categories.
  • Modified loans – A change in any of the terms, rates and payments
  • Forbearance notes – An interim change in the payments only
  • Bankruptcy notes – change in any or all of the terms, rates, payments and structure of the notes

When considering purchasing a note, it is prudent to consider all of these factors before submitting an initial Mortgage Purchase Agreement. Purchasing notes are the combination of facts using formulas and applying good judgment; but the final skill of predicating future performance based upon the past track record.

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