Trickle-Down Distress: How Mom-and-Pop Investors are Tackling a Long Tail of Bubble-Era Loans

The following is an extended excerpt from the February 2016 edition of RealtyTrac’s Housing News Report, named best newsletter in 2015 by the National Association of Real Estate Editors. For full access to the newsletter, subscribe here.

Robert Woods learned about the world of non-performing loans when he answered a phone call in 2011 from an investor who had purchased Woods’ strategically defaulted loan and was foreclosing.

“We signed a deed-in-lieu (of foreclosure) and the house was gone. The place had stainless steel appliances, we left it clean,” Woods said of the Florida condo he had purchased in 2006 with buddy while in college using a stated-income loan and $2,000 down. “We were part of that. Even with a finance degree from college, (we were) truly uneducated about an adjustable rate mortgage.”

That phone call put Woods on a path toward eventually buying defaulted (non-performing) loans himself. Now he is on the other side of the phone calls to “deadbeat borrowers.”

Read more about how Woods works with “deadbeat borrowers.”

NPL Sales Gaining Steam

Woods, who is based in Orlando, jumped on the loan-buying train in 2012 just as it was gaining steam.

RealtyTrac loan assignment data — including sales of both performing and non-performing loans — shows that loan sales peaked at more than 687,000 in the second quarter of 2012, up 57 percent year-over-year and up 341 percent from the third quarter of 2010.

The third quarter of 2010 was a significant milestone in the world of non-performing loans because it was when the U.S. Federal Housing Administration (FHA), kicked off its Distressed Asset Stabilization Program (DASP) — selling non-performing loans insured by the government agency.

Read more about trends in NPL sales.

The NPL Waterfall

Longtime loan buyer Eddie Speed said the flood of NPL sales over the last few years is beginning to waterfall down from large institutional investors — who purchased the loans by the thousands in the initial auction — to mid-sized buyers like his company, Colonial Funding Group — which purchases loans by the hundreds — and eventually trickling down to mom-and-pop investors who purchase by the tens.

“The waterfall of selling these non-performing notes started a year ago to any measurable degree,” said Speed, who also runs NoteSchool, a company that trains investors how to find, research, buy and service loans. “We might buy 100 loans, but we are not Carrington and we are not going to buy 10,000 at a time.

“We have seen more assets in the last six months than we saw in the previous 24 months,” continued Speed, adding that while he is always in the business of buying performing loans, there are only certain windows where he buys non-performing loans. “We think the calendar for the next five years will be one of the biggest windows for that.”

Read more about how NPLs are trickling down to mom-and-pop investors.

“You’re My One Foreclosure This Month”

As more non-performing loans waterfall down from the big banks to large institutional investors to mid-size note brokers and finally to mom-and-pop investors, the borrowers of those loans may be in for a surprise, according to Chase Thompson, who co-hosts the NoteMBA podcast with Woods.

“Many people are used to a Bank of America or Wells or Chase who just drag their feet on foreclosure because they have thousands of them,” said Thompson, who is based in San Antonio but buys notes in many markets across the country. “They aren’t used to someone who is saying ‘you’re my one foreclosure this month.'”

Thompson jumped into the world of NPLs in 2014 after he was laid off from his day job as a mortgage banker.

“I had gotten involved in real estate investing while I was working, and the world of notes was the least populated,” he said, explaining his real estate investing strategy was to “go where there is less fish.”

Read more about Thompson’s NPL investing strategy.

High Risk, High Reward Second Loans

Phillip Silver buys non-performing loans from a third-party broker website, but he buys second position loans, which are inherently more risky and therefore come with a bigger built-in discount.

Silver said he started buying NPLs three years ago after he was priced out of buying residential properties in Southern California, where he lives. He said that properties in the “Inland Empire’s” Riverside County that he previously was able to purchase for $100,000 had risen to the $150,000 price point.

“The yields on it just weren’t making sense to me, at the price point,” said Silver, whose day job is in commercial real estate. “With $150,000 you can buy 10 to 15 second notes, and those are going to be all over the country.”

Read more about Silver’s NPL investing strategy.

Foreclosure Process Matters

Michelle Hill, another mom-and-pop NPL investor, said she pays careful attention to the state foreclosure process when buying loans because her exit strategy involves foreclosing about 60 percent of the time.

“I’m not afraid of the judicial side of it,” she said, referring to a foreclosure process that goes through the court system and is used in about half of all states, typically taking longer than the non-judicial process used in the other half of states. “But I want to know where we are in the process. Are we looking at a six- to 12-month process or are we looking at a 12- to 24-month process?”

“I won’t touch anything in New Jersey or New York,” added Hill, who lives in Austin, Texas, explaining those two states have extremely protracted foreclosure processes. “I’m going to prefer a non-judicial state, but I’m not opposed to a judicial state depending on what those state laws are.”

Read more about Hill’s NPL investing strategy.

NPL Buying Pitfalls

All the note buyers interviewed for this article emphasized that not every note purchase ends in a win.

“The truth is there are deals you are not going to make money on,” said Woods, adding that there are three primary items that need to be researched as part of an investor’s due diligence before buying a non-performing loan: property value, property title, and property taxes.

“Even if you have a first lien, which is all I buy, real estate taxes are the one thing that is going to go in front and could completely wipe out your mortgage,” he said, providing an example of a recent loan he purchased where it looked initially like the unpaid property taxes were $8,000 but turned out to be $18,000. “That mortgage is gone. It’s now worth zero. Whoever bought that property at tax auction owns a property free and clear.”

Read about more NPL investing pitfalls.

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