How to Buy and Structure Notes Dan Deppen

As an individual, you can essentially function as a bank.

Yes.

So you can go out and buy mortgages, land contracts, you know, on, on the market and hold them. And so any kind of have all the right, the same rights as the bank does, which is pretty powerful.

Welcome to the Next Level Income show where it's our goal to take your income, your investments and your life to the next level. I'm your host, Chris Larsen. If you haven't yet, get a copy of our book for free at our website, next level income.com that's www do next level income.com just click on the book link and I'll even send you a copy if you put your address in. On today's show, we have a fun episode with Dan Depen. He is the owner of Call the Underwriter where he helps real estate investors create compliant high value seller finance notes. After a decade in aerospace engineering and 12 years in tech companies like Oracle and AWS, Dan began investing in notes in 2017 and has scaled his portfolio using outside funding. He now specializes in mortgage underwriting and Dodd Frank compliance with a mission to make seller financing safer and, and more profitable. And a lot of you have heard me talk about the 18 and a half year real estate cycle. You can check out episode 100 if you want to go and do a deep dive into that. But right now in the real estate cycle, as rates have risen, real estate prices have risen. It's a great time to become the bank. And Dan's going to share how you can do that in your investing journey as well. Dan, welcome to the show.

Chris, thanks for having me.

Absolutely. Yeah, we were just talking, man. I'm a little, I'm a little envious. I love Colorado. You're out there in a beautiful area of the country just outside of Denver. And yeah, we, fortunately we live up here in the hills in the mountains of Asheville, North Carolina. So a little different than the Rocky Mountains.

It's not too bad either though. Yeah.

Oh no, it's great. I love this time of year. We're wrapping up summer here in Asheville and it's just, it was in the 60s this morning. It was just beautiful. But no, I'm excited for you to share a little bit more with the audience about what you're doing here. We're going to tap into an area that I was, one of the early areas that I started investing was in note investing. So we're going to talk a little bit about what you do there as well as how to originate note Stan. But before we do I'd love for you to share with the audience some more about your background and your business and call the Underwriter.

Yeah, so I'm on my third career now at this point. So I started as a mechanical engineer in the aerospace industry and so I did that for about 10 years which I really enjoyed. Did some cool stuff, kind of got to where I liked it, but I didn't want to do government contracting for like another 30 years or so. So after about 10 years doing that I left. I went to University of Colorado, did my mba, kind of took two years off, then went into product management in the high tech world. So like worked at Oracle for six years, worked for aws.

Yeah.

Most recently and, and did some, some startup stuff and then along the way in that I started getting involved in real estate investing and of started to scale that out and build it out and now focus on buying notes full time. And then also yeah we can get into a company called, called the Underwriter. So doing RMO work and underwriting and originating of seller finance loans now.

Yeah, terrific. Yeah, let's, let's take each of those separately here. Dan. So about 15 years ago I got into the note space. So I started buying notes with the partner. We were buying distressed debt.

Oh that at the time, that was a great time to do it. I wish it was. I started like eight years ago, but I wish I would have started then.

Oh yeah, you could get notes like 10, 20 cents on the dollar. And so for, for the audience that's, that's not familiar with that space, maybe you could share a little bit about, you know, kind of what the note space is. Talk about performing non performing notes, what the differences are.

Yeah, so, so some people don't even realize you can do this but you know, as an individual you can essentially function as a bank.

Yes.

So you can go out and buy mortgages, land contracts, you know, on, on the market and hold them. And so then you kind of have all the right, the same rights as the bank does, which is pretty powerful. So yeah, there's a million flavors of now like at a high level we kind of tend to put them in two buckets. Right. So it's like performing and non performing. Performing is what most people would, you know, think of. That's where borrowers making payments every month and you just sit and collect cash flow. Right. So it's just kind of like any other kind of cash flow investment. And then you can get into the non performing world which I've done a lot of those. It's not Always for the faint of heart. But you know, that's when you go out and buy a loan, they're actually the borrower isn't making payments or they're behind. And then you either like do a workout with the borrower or you know, you can take it through the foreclosure process. Those are real wild. So what's interesting, within the world, even though the world of notes is fairly small, when you dive into it, you can have like radically different business models. So if you're focusing on the performing notes, which I kind of recommend, especially if you're starting out, you know, it can be, depending on what you buy, it can be like super stable, steady cash flow income. And then as you get into different parts of non performing, it can really be the wild west with a wide range of outcomes.

Yeah. So why, I guess, you know, for the audience that are listening, like why would you, why would you want to buy a non performing node? Like people aren't making their payments, you know, why does that even make sense?

Yeah, so, so the reason you would buy them, right? Yeah. And intuitively it's like, why would I buy a cash flow thing that's not cash flowing? Well, number one, loans in general, even when they're performing, tend to sell at a discount. Right. And the actual amount of discount you can get varies widely. But let's say you buy a loan, it's not performing, but you've bought it at 50 cents on the dollar and maybe there's equity in the property. So the property is worth like even more than what the loan balance is now. You've got a lot of room to maneuver. Right. So if the borrower just never pays, you can take it through the foreclosure process, which you know, costs money, takes time, you're waiting but, but then you could eventually get made whole and get the whole hundred percent. Or if you can work something out, if the borrower is still owner occupied, the borrower's still interested in staying, depending on why they defaulted or if you can make contact with them, sometimes you can work out forbearance agreements with trial payment plans and loan mods to get them paying again. So if you can get that loan paying again, you've got a cash flowing loan if you season it. So that loan you bought for 50 cents on the dollar, maybe you, you know, you're holding it for some period of time and collecting payments, maybe as part of your agreement with the borrower to get performing again, they made a good faith down payment that you collected and now your Performing loan is worth your 90 cents on the dollar and you can turn around and resell it and do really great. So that's like the upside of them. But you know, you do get some there, it's not performing, you have to foreclose, you get it back and the property is just not what you were expected because.

Right.

One of the big risks, especially when you do non performing. Right.

Yeah.

Is you're, when you're buying a loan, it's very different than buying a property. Right. So if you buy a property, you're going to look at it inside and out, you know, probably get it inspected, do all this stuff. But if you're buying a loan, you can't do that. Right. You can go get photos outside, but you can't even see the inside. You can't contact the borrower. Like, like a lot of people listening. Right. Like you've probably had like the mortgage, your primary residence be bought and sold in the past. Like I know mine absolutely a number of times. Right. And, and when that happens, no one like comes in and inspects your house. So. Yeah. So you can sometimes be in for surprises after going through this long process.

So Dan, you mentioned some of the pitfalls of note investing. So let's talk about kind of like a worst case scenario. So you buy a non performing note at $0.50 on the dollar and the payments don't resume for some reason. What happens then at that point?

Yeah. So at that point you can't work out anything borrower. I've had ones where I was never able to make contact with the borrower.

Yeah.

They just like went to ground. So what? Well, one option you have is you can cut your losses and sell the note.

Yeah.

To somebody else. Right. And so you'll lose like.

Yes. If you bought a pool of notes at a discount. You know a lot of times with, with notes you can buy like a pool of notes. Right. Like, like a tape. You could buy, you know, 5, 10, 100 notes, which is what we were doing, we were buying as a group, you know, these notes and there was other stuff thrown in there, like other debt thrown in there. So yeah, you could recoup a portion of your capital, especially if you're doubling your money on another, another portion of the portfolio.

Right. Yeah, exactly. But you know what, I generally do or at least like let's take the case where I'm buying like a one off note.

Yeah.

And this is my model personally. Different people do it different ways. But I don't like to buy a note unless I'M willing to go all the way through the foreclosure and take the property because for me that like enforces a little bit of discipline on the front end, but basically. So if you failed in the loss mitigation, you know, at that point I'll start the legal process. Now how long that takes, what it costs kind of varies state by state. You know, if it's a non judicial state it might be a couple thousand dollars and maybe six plus months. If it's a judicial state, it might be five, six thousand dollars, maybe more and could be like over a year. And that's assuming the borrower doesn't fight you or you don't have any weird hiccups. But then basically once you go through the foreclosure process, you'll eventually get the property back. Now if it was owner occupied and the borrower didn't leave, you might have to do an eviction if you ended up with the property. Sometimes if it's gone through a sheriff's auction, someone else might buy it. So you might just get paid at that point. There's like a lot of ways those can go. But to get your question about the worst case scenario and I'll describe my, my worst deal in Muncie, Indiana. So I like never even able to make contact with the borrower. You know, took it through foreclosure, got the property back and the outside, you know, didn't awesome. It didn't look too bad. And this was one of my earlier non performing deals too. But once we got inside to find out like it was a full blown hoarder house, like literally wasted trash throughout the entire thing. And I think if I remember right, this is about like an 1800 ish square foot and I had to order four 40 yard dumpsters. Wow. To get all of the stuff out. So there was an expensive clean out. You know, the house was really messed up. So like at that point I couldn't sell it to, to a re. You know, to like a retail buyer without. I wanted to take on a rehab project which for me I buy notes. I don't have rehab teams on the ground. Right. So if you try to do big rehab as a one off from out of state, you're asking for, you know, you're asking for trouble. So basically when I got it back, that property was worth a lot less than what I had expected. So I ended up taking a pretty decent loss on, on that one ultimately.

Yeah. Yeah. And that's, I mean I think that's part of it is understanding what that is. And you know, we have, we have a debt fund where we're financing fix and flips and we know that sometimes we've had a handful of those loans default and we know we have to take those homes back and we either sell them to another investor that's going to rehab it and we recoup our capital or we have to take it over ourselves and do it. So I think either understanding, you know, the, the, the pathways that you have there or having a partner or a group of people that, that you can work with if you have to get rid of a property like that, if you're buying the note can make a lot of sense.

Yeah. And the thing to keep in mind, like, well, just about anything, but especially like if you're doing non performing notes, it's really a numbers game, right. It's like I've got a model I've used a lot, works pretty well. And so most of the time you.

Are an engineer, so.

I am, yeah. I'll have like a pretty solid return, you know, kind of base hits. But if you do enough, you will get a couple that go super sideways like the I described. But then you also get a couple like super home runs. Like I've had ones with just like fantastic, you know, returns where like you double your money and the whole was just super easy and all of that. So if you do enough of them, it works out if you have the right model. But, but any given one could be a horror show. So you just have to like.

Yeah, no, I think it's great. Well, let's, you know, we kind of started with, with the worst case scenario here. Let's talk about the performing notes, you know.

Right.

So let's talk about like what a performing note looks like, you know, specifically on real estate because there's all kinds of different, you know, you can buy, you can buy pools of debt, you know, credit card debt and all kinds of different things as well. Let's talk about like you know, your, your bread and butter performing residential note. Like what is that? What does that look like?

So, so those are what I like to buy for my self directed ira.

Yes. Yeah.

And you know, so basically what those look like, they could come from a variety of places, right. So sometimes I'll buy them from individuals in my network that do things similar to what I do. Maybe they have an investor that wants to cash out. There's like small funds you can buy from. There are some online exchanges like paper stack. The one thing that really won't work, that is everyone's first instinct and it makes sense why it would be. But you're not going to walk down to your local bank and ask them what loans they have for sale. Right. So it's like big bank loans, they, they kind of, you know, the banks either holding them or they're going to. Larger hedge funds are not necessarily going to sell you like a one off individual one. Or if you do, the pricing is probably not going to work for you because their cost of capital is so low. And the other thing I'm often buying are a lot of seller finance loans. Seller finance loans people create that can be on a variety of different things.

Yeah.

Oh, you know what that looks like is usually it's. For me, I buy a lot of notes on properties that are Maybe either like $700,000 properties in the Midwest or you know, maybe up to a couple hundred thousand dollars properties. And a lot of these seller finance loans, you know, they're written at 9, 10% interest rates. You're often buying a little bit of a discount. So you can buy pretty stable.

Yeah.

Loans where borrowers are making payments, you know, regularly that are yielding, you know, north of percent. And so that's nice because then basically, you know, you go through that process, you buy the note. What you'll do is you'll use a loan servicer. So there's a host of regulations obviously involved in mortgage. And so as a loan servicer, like you're never going to comply with that on your own. There are people who do it, but yeah, good luck. But what you do is you just use a loan servicer. It's boarded there. The loan servicer is going to send the payments to your borrower. They're going to collect payments from them. They're going to track, you know, the amortization schedule and the balances and the payoff amount and all that stuff for you. You buy a good one with a good borrower, you should be able to just sit back and collect cash flow. Now, you know, if the loan does default, you may have to go through the foreclosure process. And you know, even good loans can default. Like I had one where the borrower passed away, he was paying reliably. Yeah, we've had that way and then you didn't really have it. I mean we got it worked out, you know, it's fine. But you know, even on a very stable loan, like, you know, stuff, stuff does happen. So you kind of have to be prepared. But if you're buying them too, where there's a lot of equity. Right. So buy loans like I like buying loans that were originated, you know, 5, 10, 15 years ago. Prices on those homes have gone up a lot and they've paid them down. So have a lot of loans where there might be like an 80k loan balance, but the property is worth north of 200. So it's kind of like really nice. Yeah, they're going to pay every month and I paid or I've got tons of room for, for fallback plans if they don't. So they can be really nice stable investments.

I like that. So you mentioned you're buying some of These notes at 9 and 10% interest rates from people that have originated these loans. Give us an example of, of that. And I know you help, you help investors do that as well and teach people.

Yeah, so there's a whole industry of folks who originate notes and there's like a lot of different business model that, that people use. But and so the reason that exists on you know, say like single family residential. Right. Is so everybody remembers the, the financial crisis where banks were doing, you know, crazy stuff and not even underwriting at all. And they put in all these regulations like namely like Dodd Frank that says hey, if you're going to make a loan to somebody on their primary residence, you have to validate that the borrower has the ability to make payments. So they kind of set this like minimum bar for lending standards. But in the years since, for a variety of reasons, banks have on their own their standards way, way up. Right. So there are a lot of borrowers who you can create a compliant loan for, but they're not going to meet the bank standards. That could be because they're an ITIN borrower. Banks often tend to frown on self employed folks, you know, different things. So there are a lot of really good borrower credit that have good incomes that for various reasons aren't going to be able to get financed through a bank. And so a lot of times that's seller finance comes in. So your typical seller finance deal, the terms are all over the map. But I would say kind of like the average is the borrower's making about a 10% down payment, you've got about a 9 or 10% interest rate and then it's set up over 30 years and then you know, there's a million flavors, you know, in between.

Yeah. And you also help investors do this as well, right? If they want to do that.

So yeah, I do. So, so with call the underwriter, where it's called an RMLO or residential Mortgage loan originator. So what we do is help investors with all the computer compliance. Well, there's two phases to it. Some of it is dealing with compliance and regulations. Right. So you have to comply with Frank. There's this other thing called TRID where you have to send out, you know, loan estimates and closing disclosures and kind of similar to the loan servicing. Once you have a system set up to do it, it's not that hard. But if you were trying to do it as yourself, as a one off, like no fun, there'd be a lot of brain damage. So. So part of it's the compliance, which is real important and then the other part is just the underwriting. Right. Like if you're selling a property and you're holding a loan, you want to know what kind of borrower you have and you want to know that this thing is going to cash flow steadily over time. Now a lot of times people create these and their intent is just to hold, that's fine. But the other thing too is a lot of people who get into creative finance and seller finance, they're typically into all kinds of stuff and, and they do other kinds of real estate. So one of the nice things too about holding a loan, if you got a quality one can be really liquid, right. You have the option like you could sell if you have a good loan, you could sell it if you want to free up the cash for something else. And then you know, not, not to rabbit hole on it, but you can also sell like what are called partials, like let's say I hold this loan for 30 years, I want some cash for something and I might sell you three years payments but then I'm keeping the back end. So you, you can do all kinds of cool stuff with them. Yeah, yeah.

One of my favorite strategies was you could, you could buy a loan, you could work it out, you know, like a non performing known loan. Work it out, sell a portion of the payments on the front end so that you recoup your capital and then stick the tail in like your self directed Iraq or something like that.

Yeah, yeah. Especially when you're buying at those low, low prices.

Yeah, right.

You probably refinance yourself out.

Yeah.

The other thing that people will do. So as far as like where people get properties to sell or finance, there's like a million models, some of them, you know, a lot of the folks that do this are like homevestors, franchisees and you know, cash buyers. Almost like a variation on a fix and flip strategy. And they may not even fix Depending on what the condition of the home is. But, but one thing people do, if they can get a property for a lower price, let's say to make a cash offer, they then turn around, sell the property on owner finance. But instead of creating one loan, they'll create two. So they might collect the 10% down payment and create an 80% first position mortgage and a second, a 10% second position mortgage. And they'll do a similar thing, I think, to what you might have been doing where if you buy right and you structure it right, they'll sell the first and now they basically finance themselves out. And also this 10 down payment and then they have this 10 second, they're holding free and clear.

Yeah.

And then they can just kind of pile those up.

Yeah.

Over time.

That's beautiful. And it's, you know, it's a way you can stack these strategies and do that. I mean, who's your, so who's your ideal client, Dan? Let's talk about that. Like who do you work with? Who do you really help out with your business? Call the underwriter.

Yeah, so there's a bunch of different profiles. So one of them are like the cash buyers, homevestors, franchisees that are doing a lot. There's a lot of people doing subject to deals and wraps. Because as part of that you're creating another note.

Yeah. So let's pause on that. So yeah, talk about what a subject, I know what that is. Like a subject to deal or a wrap or how that works. And you know, why, like right now, you know, a lot of listeners have heard me talk about the real estate cycle and why now's a great time to be the bank. And we're seeing some of these strategies that worked, you know, 10 and 20 years ago. Come back in right now.

Yeah, so. So right now, right. There's a lot of existing mortgages that are written at, you know, three, four, two and a half percent. So what people will do is they'll go and find a property for sale. Maybe it's one where the, you know, the seller was trying to be too aggressive, the listing expired or the listing stale, or maybe they just don't have a lot of equity and they, you know, they need like a certain price because they can't get out of it without putting in cash. Well then, you know, what you can do is roll in and say, hey, no problem, I'll buy your property for what you want, but I'm going to assume you're 2.5% mortgage. So you buy this property and now You've got, you know, like super low financing that you've assumed. And then what we'll do is, you know, you can turn around and take it a step further, sell the property on owner finance and now create maybe like a 7 or 8% loan. And now you're creating big spread and you can also structure it to where like you actually get cash out of the deal up front. And then you're creating this big monthly spread and then, you know, your new loan is hopefully bigger than the loan now. That's like highly technical and the devil's in the details. Oh yeah, I haven't actually done one of those myself, but I'm going to doing that next year. So I've been going down those rabbit holes like, because it's, it's one of those things that can be a good strategy. There's a lot of confusion over it. If you do it right, it's, it can be fantastic. If you do it wrong, you can create some nightmares.

So yeah, you go sideways quickly.

Yeah. If you go there. But those are the right. And that's increasingly popular mainly because, you know, interest rates have gone up. But then there are all these low interest rate loans. In fact, in the 80s there was a ton of this that went on. It's actually not a new thing. Some people think it's new.

Oh no, no, no. This is one of the first strategies I learned about in the late 90s. Yeah. And George, George Allen. And I'm trying to remember who else was doing the. Was it, was it, who was the guy that was the big subject to Guy?

Well, I mean, Pace Morbi's the more.

B, is the guy now, but no, this, this is now. There was a guy way back in the early 90s, like on infomercials and stuff like that, so.

Oh, I know who you mean. I, I, I can't think of it. But I know the person that, yeah, I gotta look.

He's all flashy and he looks. Was it Ron or something like that?

Yeah, yeah, yeah. But then, so that's another one. And then the other one that, the other kind of model that's increasingly popular is people with rental portfolios no longer want to deal with, you know, property management. Maybe they're retired or getting near retirement or, you know, their costs have gone up over time. Like one of the things people are doing a lot is they'll take a rental property, sell it. And historically, you know, people might be hesitant because if you've owned this for a long time, if you own it free and Clear. Right. You're going to get nailed with taxes. But yeah, what, what people are doing is they'll sell the property, will do owner finance, create a loan. So now they've still got cash flow. They're not on the hook for property management. They're not on the hook for fixes and capital repairs. And then I'm not a tax guy, but because they sold it as a loan, they collected a down payment. They're. They're spreading the money they receive from that over time. So it's more of an installment sale. So they're not getting hit with all the taxes, like, up front.

Yeah.

When they do it. So that one's been increasingly popular.

Yeah.

No, I love it.

And if you know you're listening, you have a property that you have, you're an investor and you want to do this, you can reach out to Dan, check him out@calltheunderwriter.com and it was Carlton Sheets that I was thinking of.

Okay.

Way back, yeah, that was way back in the day. I had a box of all this different stuff. He was one of the things I had in there. So, yeah, it's really cool as you look at these strategies and I think if you understand where we are in the real estate cycle, you can layer these in. So, Dan, thanks for sharing a lot about this strategy here today. How people can not only use notes to invest in, but also use notes to help supplement their strategy. And, you know, I mentioned your website called theunderwriter.com. what's the best way for people to get in touch with you? They want to learn more.

Yeah, there's a form there. They can send me a note there. Or you can always email me directly at dan@calltheunderwriter.com as well.

Awesome. Well, Dan, thank you so much for your time today. I appreciate you sharing your wisdom with our audience.

All right, thanks for having me on. I enjoyed it.

Hey, Chris, here again. I hope you found this episode valuable. Now I have one more thing to give to you. We have a page for my coaching clients where you can get a free copy of my book as well as much more from previous guests on the show. Just check out nextlevelincome.com coaching to get a free copy of my book, audiobook and much more. I'll send you a copy of my book and cover all the shipping costs as a thank you for listening to the podcast. Also, please like share and take just 90 seconds to give us a rating on Apple podcasts.