AIPIS 66 - Learn About Note Investing With Lee Arnold.

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It's my pleasure to welcome Lee Arnold to the show. He is CEO and chairman of the board of Secured Investment Group and he deals in notes, reo properties and different parts of the real estate business. Like that. And Lee, welcome. Are you coming to us from Coeur d'? Alene?

I am, Jason. Thanks for having me here.

Yeah, beautiful place. It's good to have you. So I want to talk mostly, if we can, about note investing today. And your company is a note brokerage. You offer individual note investments, one note, one investor, not commingling of funds or anything like that. And what are some of the things that people can do to be good at note investing?

Well, the end result of a bad note deal is you own property. So you go from being a passive note investor, being an active landlord or property manager or property rehabber.

Well, occasionally though that's the goal, isn't it? Loan tone?

Yeah, for. For some people it is. Our company is not interested necessarily in the in the real estate side, we'd much rather just lend money and have people send us a check every month. That's really more our model. Unfortunately, that doesn't always end up being the end result. So in that, in that instance, now we've got to go through and we got to foreclose out the asset, we've got to take back the management of it, and then we've got to clean it up and sell it or we got to liquidate or another strategy that I'm sure many of your listeners are familiar with and are interested in doing is buying the note either in a performing status or a defaulted status. So many people are familiar with discounted note buying to increase yield, but it all comes back to the value of the real estate. Now in today's market, one of the hurdles and pitfalls that people absolutely must be cautious of is that loan was originally underwritten. We're seeing a lot of people that are buying notes that originated in 2007, 2008, 2009, and this is pre alteration of the Frank Dodd act in 2010. So a lot of the loans pre 2010 are not in compliance in the present year. So you got to be real careful that whoever originated that note crossed their T's and dotted their I, because if they didn't and you buy that paper, you are now subject to the terms of the contract that was agreed to originally.

Okay, so that's a really good point that you make. So Dodd Frank and when, when was it revised Exactly. So, so investors could watch out.

2010.

Okay, so if they bought in probably what month, do you know what month.

I want to say it was? Third quarter of 2010.

Okay, so if you bought, if you buy a note that was originated before that, what can happen to you as the investor?

Well, well, prior to that, there wasn't a lot of stipulation for real estate investors, like much of your audience, to buy a property, fix it up and then sell it and carry back paper on behalf of the owner occupant. However, with the mortgage meltdown, it became now about regulations Reg Z and Respa and making sure that you are checking all the boxes, that you're providing proper disclosures to the buyer within three days of the contract. You know all of the now new rules that every mortgage lender in the land is subject to follow for loans written pre2010 by an investor to an owner occupant. What we're finding is that those loans were not written in compliance with today's market. So if it were me and somebody was.

Approaching me with a pre2010 loan. What I would require before I were to buy it is that that note be either modified or refinanced by that individual under the new post 2010 guidelines so that I can be assured that that loan is in compliance when I acquire it.

Okay, so how would an investor be sure that that's really happened?

You know, if you're familiar with the loan document process, when you buy a note, you're going to be handed essentially the entire loan file. And many private investors, and that's really where a lot of investors are going to from a note acquisition play is direct to the private investor that sold a home on contract and carried paper. That's typically where most people are going when you go to buy that note. You have the right to inspect the entire loan file. And the thing that you need to be looking for is the underwriting guidelines that were followed and or adhered to by that particular lender when they wrote the paper initially. So as you're going in there, ask to see, hey, did you provide the homeowner or the buyer of this property with all of the compliance regulations? Did you follow Reg Z? Did you file, did you, did you follow respa? Which are all now required documents for owner occupants. Now, the state of California has mandated that any investor that is doing more than five owner occupied seller carried back contracts that they be a licensed mlo. That's your mortgage loan origination designation. If you are an investor in California doing more than five of those a year, you now have to get your mortgage loan origination designation and you've got to follow all of the Reg Z and RESPA requirements.

Well, you know, it's always, you know, my home state, the Socialist Republic of California, it's always California that's got some damn special set of laws that, you know, just inhibit business and make everything harder. So does that apply to a California note or a California resident doing the deal or both?

It's really mandated by a California note. Now Jason, this will drive you nuts, but I'm going to do it anyway. I'm not attorney, a CP or financial advisor, so everything I'm saying is my opinion and people should verify what I'm saying to be actual or factual. That said, my understanding and interpretation is that's for loans being originated in the state of California. If you are a California resident originating loans in another state, then that state's laws would mandate the requirements. Now you mentioned the Socialist Republic of California. I've heard it said that all good ideas Start in California and they're illegal by the time they get to Florida.

I love that. That's great.

So for everybody that's listening, if they're not in California, they need to understand that that legislation is going to continue to make its way east because most states are adopting this rule change to protect homeowners. So the onesie twosie investor, be aware, if you're originating paper more than five, you should absolutely check your state guidelines for licensing requirements.

Okay. But we're mostly talking not about originations. We're mostly talking about trading notes that have already been originated by somebody else. So. So that was good advice on the Dodd Frank issue.

What else? You know, I mean, this is such a. You know, even though you. By the way, before we even move on to what else, even though you do all that stuff that you mentioned, which is, you know, great advice, still, how do you know it really happened? How do you know it's really true? I mean, you really got to have a trusted source that you're buying from, right?

Yeah, it's. It's really important that you not only verify the information and the note that you're looking to acquire, but you also do background check checks on the parties that you're buying from. So who is the homeowner who signed on the dotted line for that loan? Was there credit pulled? Is there a credit document in the loan file itself? And I would encourage anybody that's buying paper, as long as the note seller allows this or is okay with it, is for you to contact the borrower and say, hey, how was your experience in getting this loan? Are you disgruntled in any way? Now, if you're buying defaulted paper, what you need to look at here are the loan docs written in compliance with the state guidelines. So did that investor adhere to the usury laws for owner occupancy in that state, or did they violate usury laws? Second to that, you've really got to do a strong determination of value. You know, if you're buying a note that was originated for 120 in 2007 and they're trying to sell you that same paper at 110 today, you may find through a simple value search on Zillow or Truly or any free valuation site that that property is now worth 60. So you got to make sure that you're basing the price of your paper acquisition on the actual value of the real estate.

What are your most popular states that you do business in? And what's your average deal size? And when I say deal Size, I'm referring to the purchase price of the note, not the face value or the unpaid balance, otherwise known as UPB or anything else, just the amount invested to buy the note.

Well, I'll tell you, Jason, we are not actually buying the notes. We are the originator of the notes. So we are the company that is writing paper for real estate investors for the acquisition of real property. Most of our clientele are buying that property to fix it, flip it and sell it and make a profit. So our loans typically range from 12 to 24 months. But then we turn around, we sell that note and we sell it at par. So we're not discounting it at all because we're transferring a yield to the investor. If I write the paper at 12 or 13, I'm selling it to an investor at 9 or 10. So they're getting a nice note. And the reason it's well secured for them is we only pay or we only originate at 65% of the purchase price of the appraised value, whichever is lower. So when you buy our paper at par, you are buying that note at 65% of the as is today value. So there's no wishy washy guesswork as to where is value today because all of our paper comes with a full blown appraisal less than 90 days old.

Right. And so when you originate that note, your profit is. You're probably keeping the points on the deal, right?

I'm keeping the points and we're also keeping a portion of the coupon and we're maintaining the servicing. So the reason a lot of investors that are looking for a passive experience are buying paper from us directly is because we're staying in the deal with them as well. So if I write a note for 100,000 and let's say, Jason, you buy it for 100 grand. If I wrote the note at 13 and I'm giving you 10, that means I'm still getting three, but I only collect my three. If that borrower continues to make their payment, I'm going to continue to service the loan so that I make sure I get paid. And if I'm getting paid, you can rest assured you're getting paid.

Yeah. And so Lee, is that the typical scenario that you're loaning those on? Those are like a hard money loan or maybe for a rehab or at 13, you're keeping 3 and the investors getting 10.

Correct.

That's the typical deal. Yeah. Okay. That model is a very common model around and it's great if you want just a passive Deal. And are there any other fees that you're taking off the top like servicing or anything, or do you absorb that in the deal?

No, the servicing fees are actually paid for by the borrower. In fact, all closing fees are paid for by the borrower. The only fees that anybody buying paper from us are going to pay are the transfer fees which range anywhere from 50 to $230.

Okay. And so average deal size.

Right now our average deal size is $56,000.

Okay, 56,000. And most popular states, that would be where the property is located.

Of course, Midwestern states and southeastern states for our company are by far the most popular simply because the price points of that real estate is lower and more investors can enter those markets with less cash. Which is why we're seeing so much activity in those regions versus being in Southern California where the average flix and flip deal is going to put you out 380 grand. You can actually get into properties in the Midwest for 38,000. You know, we've got some people buying houses at tax auction for 500 bucks. So because of those price points and what's gone on in those markets, we're seeing very, very low price points and a lot of activity.

And so your customer, your borrower, is it always a rehabber where they're just doing the rehab fix and flip stuff?

It's always a real estate investor. We actually do not do any loans to owner occupants simply to avoid the Frank Dodd reg and respa.

Yeah, when Dodd Frank gets involved, that just limits financing options for borrowers. So good job government.

Yeah, and what Frank Dodd did is they essentially eliminated every independent broker on the planet and moved it all internal into banks. So if banks want to play in the owner occupied low interest rate mortgage space, great. I'm going to let them keep that side of the business. I don't want to deal with the regulation.

Yeah, yeah, that's very understandable. Okay, good. Well, so tell us about the rest of your business. Oh, but before we go on to that, I want to ask you one more question. You said the average, the average loan amount was 56,000. How are you underwriting? Talk a little bit about underwriting that deal. So for example, what does that property need to be worth for you to loan that average of 56,000. What's that LTV on the, you know, on the acquisition value and then the.

After repair or ARV value on that deal at 56. I'm going to be sitting at 65% of the value, which I didn't run the Numbers previously to this, Jason, but it's going to put me somewhere in the 85 to $90,000 range on an acquisition.

Okay, so it's going to be 65% of the acquisition price.

Correct.

Okay.

So the borrower is going to either have to come to the closing table with their own cash, which we prefer because it puts skin in the game, which reduces our risk and our end lend risk, or they can also have the seller carry back a subordinate second to our first. We always have to be in first position.

Yeah. Gosh. Okay. And then what's the. Or do you even care about the ARV value? Do you even consider that in your underwriting?

Yeah, we do consider arv because again, if that borrower doesn't pay, that property becomes our responsibility. So we want to know what is the expense that will be incurred to bring it up to snuff and once we do, what is that end value? So on an 85 to 90 acquisition, we want to see value ARV value in the 140 to 160 range based on a 90 acquisition today.

So I mean, those are pretty secure loans. You're not offering a very high LTV. I mean 65% LTV on the buy for a 13% loan to a rehabber is. I mean, they can, you know, they can get better deals than that. You know, they can get more liberal lenders, but your investors probably love it. My question is, do you have enough deal flow? Do you have enough rehab that want to borrow like that? They don't go out and get better terms? I'm kind of surprised.

You know, that's what's interesting is that we have more deal flow typically than we can absorb because there are many companies rising up now that are coming in and they're doing that second position on the ARV rehab side. And we're seeing a lot of local lenders that want to come alongside our first and be in the second position because their boots on the ground, I mean that house is across the street from them. So they're much more apt to want to take that riskier position. Now, for some of our better borrowers, we certainly have more aggressive guidelines which allow us to do some higher LTVs and we even have some properties and investors that we do do ARV lending for, but not until we've established a relationship with that individual and we've got a working relationship to know what kind of work they do. Do they make their payments on time? Do they do good work?

We are a relationship lender. We're not trying to be the highest LTV lender or the lowest rate lender. That's not what we do. We want to work with good investors, give them good fair rates and allow them to get in and out of a lot of properties.

Yeah, yeah, good stuff. And Lee, the terms are 24 months. That's pretty long for a rehabber. Really? You said 24 months before, right?

Our average loan is 12 months. For those that think they can pay it off sooner, that's fine. We actually don't write in a prepayment penalty into any of our loans. So if you want to pay it off in 30 days, you can do that. But you know, I've been a real estate investor for a long time myself and you know the old adage, if something can go wrong, it will go wrong and the minute you tear down that wall, you're going to identify another $5,000 in problems you didn't know were there. So we don't want to write loans that are specifically going to get that investor in trouble because we don't want to foreclose, we don't want the property back. We want them to have a great experience, we want them to make a profit and we want them to come back and borrow again and again and again. So the last thing we want to do is foreclose. So we're going to write paper that is comfortable for the investor. We will modify and give extensions if that's what is needed to help them get the project completed. And we'll refinance at the end of two years for another two year term if they want to hold it as a rental. We are the investor's lender because as the CEO, I cut my teeth in this business by buying, fixing and flipping real estate. So we know exactly what the investor is looking for and we try to be as accommodating to those needs as we can.

Sure. And in those deals, are they just interest only balloon at the end or do you require payments in the interim?

We do require payments, but the payments are only interest. So there's actually no principal buy down at any time during the loan.

So just monthly interest payments.

You got it?

Yeah. Okay, good, good stuff. Okay, well, so you don't deal in the discounted note side at all then, huh?

You know, we have. I've acquired discounted paper. I've sold discounted paper, but it's not our space per se. There are several other great sites out there that offer the discounted note buying stuff. It's not something that we specialize in. Though.

Yeah, I'm just kind of curious. Is there a reason you've shied away from that business? I mean, I know you've dabbled in it, it sounds like, but you don't do it as a business. It's not what your company's focus is. So I'm kind of curious.

I wouldn't say that we've shied away from it, but because of my background as a real estate investor, I've actually found more value in recovering the asset and either reselling it to another rehabber and writing new paper for an origination or taking it back, fixing it up and selling it at a retail price. So my experience with a lot of people that are discounting notes and trying to load them is because they don't have the infrastructure that is necessary to succeed in defaulted paper. It really is a specialized skill set. And if you don't have the capital backing you to absorb the cost of foreclosure, the cost of eviction, you know, I've had legal fees in the, in the $100,000 range on some foreclosures, in some judicial markets. So our experience has been most people that are taking these steep, steep discounts, it's because they'd rather just take the loss now and cash and let somebody else take the ride than do it themselves. Our experience has been we'd rather take the ride.

So Lee, how do you decide? You say that you, you sell loans off one by one to investors, but then you also offer funds. How do you decide which goes where and how does an investor decide which way to invest with your company?

Well, we actually have two private equity funds. These are reg C funds, 506 C funds for general solicitation that we use essentially as our funding line. Others would refer to it as a warehouse line where we actually originate the paper. We fund those loans internally with our, with our high yield funds which is made up of accredited investors. Those loans funded then create the inventory that we now sell to one off investors, many of whom are buying these notes through their self directed IRAs or other retirement accounts. Because these are great annuity type income for the retiree that's, that's looking for more of a passive play that are well secured. Their service, it's kind of a one stop shop. We do everything and there's nothing that we hold internally, not for sale. So every loan we originate, we actually put it on our website. People can go there and see what notes are available and then they can let us know that they want to buy this note or that note, some buy one, some buy two, some buy five. And because our loan, our max or our minimum loan is only $15,000 and we do a lot of business in the Midwest, we have loans in the 15 to 30 thousand dollars range. So for those that are full time employees, they've maybe just recently opened a roth or a 401k so there's not a lot of money in it. It's a great way for them to get involved in the note buying space without having hundreds of thousands of dollars.

And when they do the fund, what's the minimum there probably 25,000.

Minimum investment is the fund is $50,000 and they would need to meet criteria for an accredited investor. So we would need. Yeah, we would need a letter because it's general solicitation. We would need a letter from their CPA or their tax advisor or tax return showing that they meet the qualification.

Accredited investors only for that. Good stuff. Well Lee, give out your website, tell people where they can learn more.

Tell check me out securedinvestmentcorp.com www.securedinvestmentcorp.com if you are interested in buying any of our notes you can just simply go to Loan or Deals our deal site. There you will see both notes that we have for sale as well as REO properties that we have foreclosed and we are now reselling. That's@securedinvestmentcorp.com and you are a real estate investor that needs to borrow money and would like us to look at your file and possibly getting you some acquisition cash or even some cash out refinance. If you own properties that are free and clear. Check us out at www.cogocapital. that's C O G O cogocapital.com Good stuff.

Lee Arnold, thank you so much for joining us today.

Thank you Jason. Appreciate it.

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