"Discounted" Notes
EDITED: Can someone pls read may replies further down where I re-phrase this question (multiple times) and try to help me understand what I'm missing? Note that I fully understand what,how, and why to discount cashflows.
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When investors buy existing notes, what makes them "discounted"? I mean, with interest rates so low, any notes created when rates were higher should actually sell at a premium (all else being equal), correct? When rates go down, bond prices go up. right?
So with rates at 30+ year lows, who is selling notes at a "discount" and why?
What am I missing?
Thanks!
-J[ Edited by JonDoe on Date 02/04/2004 ]
They discount the principal.
Greetings JonDoe,
I’m no expert on note investing, but I can give you one example.
I bought a property for 72k and later listed it for 112k. A buyer offered me full price if I’d carry back a 20k second – I agreed, and sold the property. After a couple years of collecting payments on the note, I needed some cash and offered it at a 20% discount off the remaining note balance (approx. 19.5k). So I sold the note for roughly $15,600 cash. But the buyer of the note had the 19.5k plus interest coming to them.
So, in this case it really had little to do with the interest rate at the time. This is just one scenario. Hope it helps.
How would I go about finding someone that would buy a note?
Quote:
On 2004-02-02 18:13, antkojm1 wrote:
How would I go about finding someone that would buy a note?
If you have a note for sale you need to first get a quote on how much it is worth. I can help you out! Infact, I might buy your note. Please email me at **Please See My Profile** with all your note information.
The best note of all to buy at discount is ONE YOU OWE.
No one can dispute that.
Do you owe someone money? Try to get them to discount it.
Simple concept. Sometimes difficult in the execution.
Notes are discounted based on the RISK the investor is willing to take. Even FHA and VA mortgages are sold to Freddie Mac at a discount .
On the other hand seller financed notes are not originated under such strict underwrting guidelines as those of traditional or gov't backed lenders. Hence the higher risk. Notes are discounted from the principal balance and the discount is a direct funtion of the RISK an investor is willing to accept for a given ROI.
Either I don't understand or nobody is understanding my question.....
Ok, let's say I loan Mr Pink $100,000 for 10 years at 10% with monthly amitorized payments. This transaction would implies that the sum of all discounted cashflows, i.e. NPV or net present value (using prevailing interest rates + risk premium) is equal to the loan amount I'm handing him today (i.e. 100k).
Correct?
So, if I turn around a sell this note tomorrow, I should theoretically get about $100k again barring any liquidity issues, etc.
Correct?
But if tomorrow, interest rates, or the borrower's credit situation, or the security/property condition/valuation has changed, THEN it will effect my discounting and thus the price.
Correct?
So, now back to my original question in this post. If a loan was made a few years ago during higher interest rates and nothing effecting the RISK premium has changed since then, wouldn't the note actually sell at a premium due to lower current interest rates (thus less discounting of futures flows)?
thanks for your help!
-J
You must understand the Time value of money concept to understand why mortgages are discounted. Basicaly the concpet goes like this:The time value of money refers to the fact that a dollar in hand today is worth more than a dollar promised at some future time. But how can that be? A dollar is a dollar, isn't it? Yes, but a dollar in hand today can be invested in an interest-bearing account that would grow in value over time. This explains in part why the value of money is related to time. So in other words, the longer the investor that purchases your note has to wait for his return ,the gretaer the discount.
So basically if you take back a $100,000 note today, you WILL NOT get $100,000 tomorrow. Would you pay that much to get 10% interest on your money over 30 years(which you know will be refinanced)? Most people think theres a bit more risk, so then you look in detail at the buyer(credit, income, etc) to assess your risk. Someone would buy it at a discount, though. $80k for a $100k note, making 10% interest/year and then they refinance in 4 years and you getting $20k profit on top of your interest. Now thats worth the risk. You have to take into account also of late payments, foreclosure, them trashing it. It's like renting, really, except they're more likely to pay/keep it in good shape when they're buying the house.
I am fully aware of the time-value of money as well as yield curves, discount curves, forward curves, cashflow discounting, bond pricing, etc.
As I said above, I assume the NPV at the time of the loan IS the amount of the loan (otherwise why would someone 'buy' or 'make' the original loan--unless there is a premium redemption which I doubt any notes have).
So, all other things being equal, if rates go down, the NPV should go UP, i.e. should be purchased at a premium.
Can anyone read my response(s) carefully and try to answer my question?
If you cannot understand my question, think of it another way..... I'm thinking of loans very similiar to bonds. Many bonds trade on the market above par (i.e. at a premium). Why? Well, either their (the issuing company's) credit went from bad to great and/or interest-rates took at dive since the bond was issued. So why would notes/loans be any different? In fact, many bonds also have 'call provisions' which allow the issuer to repay the debt early....which sounds very similiar to pre-payment / refinancing.
-J[ Edited by JonDoe on Date 02/04/2004 ]
Just a comment-
So basically, by selling a note that you carry, you are creating financing for your buyer? Do note buyers purchase bigger sized notes? Do they want to know the credit worthiness of the buyer of the property?
I have also been told you can find note buyers in the paper and yellow pages.
Another question about having two loans like that, does the buyer of the property make two separte payments (assuming the buyer got other financing for the rest of the purchase price)? If so, what if the buyer defaults on one of the loans? What recourse is there?
Ruman--
Explain to me WHY if I take back $100k today, I could not sell that same note tomorrow (or same-day if you want to be technical) for $100k with same terms assuming an 'efficient market' (i.e. theroetical perfectly liquid market) and no changes in the situation (i.e. credit, rates, etc). Why why why? Why why why why?
And I understand that you have to incorporate possible foreclosure costs, etc etc into your pricing, but didn't the original lender have to consider those things as well? Remember, I said we were assuming no changes in credit, etc.
-J[ Edited by JonDoe on Date 02/04/2004 ]
You could offer it for sale...but who's to say it will sell. If there is no demand for this type note then it won't sell. If someone wants additonal profit other than interest earned(i.e,discounting) then there is no demand for the note. So you can avail it to sale.....but will it? Supply + No Demand = Supply (no sale, note in your supply still)[ Edited by REI_SIMILAC on Date 02/04/2004 ]
John Doe,
The ideal and efficient market does not exist as you have referred to it. Notes on real property debt have too many other variables than bonds or traditional securities. The only way to balance out the lower interest rate world with a note held at higher rates is to refinance it.
I sense that you already know this and are looking to do this on a larger scale.
If so email me through this site and I'll give you some interesting ideas on how this could be done in a very profitable way. I use to purchase and sell an average of 3 million dollars a month of private notes in my distant past, so I know a little more that the average bear.
Thanks
Ivan
Dear John Doe,
You are most correct in your assumptions and there have been times in our long and snakey merchantile society when such events have occured.
In the middle 50's in California a firm called Southern California Mortgage Co.
placed a series of first mortgages at 50% of purchase price and the interest rates were 12%. Why? Good question the surface reasons were 1. commercial properties 2. No documentation on the Borrowers. 3. Because we could.
They needed the money for some large venture and we had the money and they agreed to put up the property as security. The appraisals confirmed the values of the properties and we lent the money. The lenders were a pool of private investors who had given us a requirement to make yields in excess of 8%. So we did. They got a yield of 10% steady on their money. We gave a full recourse to the investors. Why not at 50% of appraised value, the true yield on notes so secured in the common local market was about 7%.
Those notes were super prime. Any investor wanting his money out we gave it to them and merely brought in another (revolving lender) We the mortgage company were making a profit as we also participated and we serviced and the excess interest was profit to us.
What we were copying was what Banker Fugger did back in 1520 when he arranged to buy Charles the title of King of Rome from the Seven German Electors. Charley baby latter expanded this into the title of Emperor of the Holy Roman Empire. Good deal for Charles and even better deal for Mr. Fugger. He gathered the funds from his "private Investors". This loan was prime never to be discounted. Fugger latter excused dear Charles from having to pay it off. In exchange a small favor. Right on, The Permit to make money lending legal throughout the empire. Thus the beginning of the society which we enjoy today. The Mercantile Society.
Yes notes can be created at times of high interest and they are then super prime and they do not discount given all variable are constant. Do we see it often? Not very. Why cause nobody can make a buck except the lenders.
Do you remember when Treasury issued the 15% notes? Yip, I bought them and so did every other thinking human in the world. So much gold came out of the mattress of France they had to import new feather beds from the Balkans. Most of old time Serbia was sleeping on bare wood. Some guy by the name of Alex made a small fortune stripping feathers out of Geeese.
Of course the Treasury suddenly had a burst of common sense and recalled the issue. But it was fun for a short while. What was real fun when they seperated the interest return from the notes. The notes discounted to yield the 15% and the world of Mortgage Investment turned into the Tower of Babble. Some of the reasons given by our learned friends in high places at Treasury were so funny they should have been issued in book form labeled "Joe Millers Jokes, The New Treasury Edition!!"
I think you are thinking like Fugger, you want to create a steady value note. Hold it in portfolio and attract investor to it. You probably expect your profits to come from fees, service expenses and the usual BS. Your thinking is correct.
I hate to sound like a Text Book, I am really not trying to put you to sleep with some dry old fashion'd stuff, but it has been done before. Like to see it done again. You Sir, or Madam, are acting like most John Does, you are Thinking. Please continue.
On the sidelines Lucius
JonDoe,
People have answered your question, it's just not the answer that you wanted.
You're trying to get much too technical and lingo on this (you're thinking too much).
Putting aside the credit of the buyer, seasoning of the loan, etc, as you say (which when looking at a real deal you can't do), As a note buyer you still have to consider profit.
IF you created a $100K today, sold it to an investor for $100K tomorrow, and the payee paid it off the same day, then the investor made nothing (no interest buildup). In it's simplest form, that is why notes are discounted. It's also why they'd likely never be sold at a premium, or above principle amount, too much risk of losing money.
Current interest rates, stock market, etc. All that you're trying to figure into the equation, really doesn't matter.
Just so you know though, banks do do what you're suggesting daily. If you've had any mortgages you'll know that they get sold alot. On lender will fund the deal, collect his fees, and "sell" the note to another lender the next day at face value or near. This lender rides the interest for a time and may after awhile choose to sell it as well, though much more likely at a discount.
Simple reason, the longer the note has been paid, the greater the chance of it being refinanced, especially in a low interest market. Most home loans have a 5-7 year life span. In that time, they are either paid off or foreclosed.
Roger
I'm trying to understand this market.
rajwarrior---
IF you created a $100K today, sold it to an investor for $100K tomorrow, and the payee paid it off the same day, then the investor made nothin
Yes, just like the lender would make nothing if the payee paid the loan off next-day--well, maybe he'd make some fees/points. But that's what an investor should expect, no? For any investment that is held 1 day.
So what I am gathering--assuming no change in the fundamental credit situation--is that the 'discount' in my 'same-day-resale' example is not a [difference] in cashflow discounting but is a discount priced in due to extreme market illiquidity and inefficiencies???
Lufos-- I think I understand what you're saying. It sounds to me that what happens in this market, is that the inefficiencies effect prices much more than interest-rates typically do. And often, more than the 'credit spread' does too.
thanks again for your efferts in trying to educate me =))
-J[ Edited by JonDoe on Date 02/04/2004 ]
Jon,
Keep in mind that some notes created by real estate transactions do not have a very wide market. Often note prices are driven by the immediate need of the note holder which can create interesting opportunities.
Here are two personal examples.
I bought several notes from a builder who was in a financial bind. He carried back the notes on properties he built and sold. I bought them at a deep discount and gave him an option to buy them back. He called me later and abandoned his option position because he was still in a bind.
A lady took back a third ($20K)on a condo she sold and rented from the new owner. When she tried to sell the third she did not like the discount offers. I asked her what she needed and she said $3500 to send her child to Catholic school. I offered her $3500 for the note and gave her an option to buy it back at around $4000 two years later. She took the offer.
Both of these situations were driven by owner needs and a limited market for their notes.
Regards,
Ed
You said
Quote:
So, now back to my original question in this post. If a loan was made a few years ago during higher interest rates and nothing effecting the RISK premium has changed since then, wouldn't the note actually sell at a premium due to lower current interest rates (thus less discounting of futures flows)?
NO- the discount would however be less.
Kelly
[quote]
On 2004-02-02 19:00, defreeze wrote:
Quote:
On 2004-02-02 18:13, antkojm1 wrote:
How would I go about finding someone that would buy a note?
<
Well your in the right place. To find someone to buy a note you would do best to go to a note sales marketplace. There are a few online. A good place to start is http://www.bcpl.net/~ibcnet/american-note-network.html
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Quote:
On 2004-02-04 16:47, JonDoe wrote:
I'm trying to understand this market.
rajwarrior---
IF you created a $100K today, sold it to an investor for $100K tomorrow, and the payee paid it off the same day, then the investor made nothin
Yes, just like the lender would make nothing if the payee paid the loan off next-day--well, maybe he'd make some fees/points. But that's what an investor should expect, no? For any investment that is held 1 day.
So what I am gathering--assuming no change in the fundamental credit situation--is that the 'discount' in my 'same-day-resale' example is not a [difference] in cashflow discounting but is a discount priced in due to extreme market illiquidity and inefficiencies???
Lufos-- I think I understand what you're saying. It sounds to me that what happens in this market, is that the inefficiencies effect prices much more than interest-rates typically do. And often, more than the 'credit spread' does too.
thanks again for your efferts in trying to educate me =))
-J
<font size=-1>[ Edited by JonDoe on Date 02/04/2004 ]</font>
JonDoe,
Right on ya got it. That is it exact.
"In every pattern no matter how perfect in concept and design, there is present a flaw. It is there by virtue of the human condition." Volt----.
Lucius
JohnDoe,
The reason is that note are usually discounted in real estate for different reasons than they are discounted in the bond market.
In the bond market it is primarily rate which determines whether a note is trading at discount or premuim. But real estate notes mostly are discounted to reflect risk. Specifically when the borrower is deliquent and facing foreclosure.
So while your example is perfectly true allow me to give you a different case.
Lets say Mr. Pink 's $100,000 note is secured by a second mortgage on his house which is worth $500,000 there is a first mortgage which is in the amount of $350,000. So between the first and the second Pink has borrowed 90% of the value of the house.
So Mr. Pink falls on hard times, the company for which he was a middle manager closes its doors and he's out of work. Whats worse, since the company was the largest employer in the town the entire economy of the area is affected and suddenly houses which prevously traded at $500,000 are only worth $400,000. Whats worse Pink, in an attempt to cut his gas bills trying to make ends meet on his new, smaller salary as the manager of the local Wal-mart turns the heat down so low that the pipes freeze and burst and do $10,000 worth of water damage which Pink has no money to repair before he markets the house.
So, clearly the value of the security underlying Pink's note is less than $100,000 in fact it may be nearly worthless.
So Pinks note holder, realizing that his note may be made worthless at any moment if Pink stops paying the first and they foreclose decides to take an offer of $25,000 and sells his note to Mr. Red, who is an investor. Red has also gone to the first mortgage holder and convinced them to take a discount as well. But they are only discounting their note $50,000 because, being in first position they are more secure than the second mortgage holder. Meanwhile Red, who also owns a contracting company figures that he can repair the damage for $5,000 so he's now got $330,000 in a house worth $400,000, slightlly more than a 15% discount to market value and so not a great deal but manageable.
So, you see. The relatively minor change in the value of Pink's note due to an interest rate change is less important than the risk change due to the change in value of the underlying collateral.
This is why RE notes can trade at a discount even in a low-interest market.
If, on the otherhand everything is going swimingly with Mr. Pink then after a year or two of propmt payments the risk analysis of the deal looks much better than when the note was new. (We say that the paper is seasoned) and therfore, especially when coupled with a fall in rates the note could well trade at a premium.
Hope that helps.
As an interesting exercise you could see the post about structuring a note elsewhere in this forum. You will note that the note buyers interested in buying have disagreed on the desireablity of a balloon or not and even over whether the rate is excessive. But every one has asked about the value of the underlying security and whether the paper will be seasoned prior to sale. Clearly these are the most important factors they consider in valuing the note.