Residential Real Estate — How To Build Wealth Using Distressed Bank Notes

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Hey, it's Mark Podolski, the land geek with your favorite niche real estate website, www.thelandgeek.com. and today's guest is a little bit different. Very cool, but different, which I'm super pumped about because I love learning about new models and new niches in order to build wealth. However, before we talk to our guests, I'd be remiss if I didn't properly introduce my co host. You know him, you love him. Scott Todd from Scott todd.net landmodo.com if you're not automating your craigslist and your Facebook postings, posting domination.com for learn anything about anything investor ninjas.com Scott Todd how are you?

Mark?

I'm great. How are you?

I'm great. Are you, Are you ready for this? This, this guest?

I can't wait. I want to learn something new.

I am too. I love learning something new. So our guest today is Bob Frazier from aspenfunds us. If you're not familiar with Aspen funds, Bob started it in 2012 to take advantage of a uni in residential real estate notes. So after experiencing the volatility of the stock market and seeing investors take large losses in their portfolios, Bob and his partner Jim were determined to design an investment fund that would provide excellent investor returns. Without the volatility of traditional investment options. So Jim spent 30 plus years career in real estate and in 2010 began looking into the mortgage note space. And through all his experience, real estate understood that the financing was always the key. Scott Todd, does that sound familiar? It does. Yep. And that through all the ups and downs of real estate investing, it was the banks who always seemed to survive and thrive. Bob Frazier, welcome to the podcast. How are you?

Awesome to be here with you.

So Bob, let's just rewind the tape a bit and kind of give us your background and why of all the real estate niches, you chose residential real estate, mortgage backed notes. Sure.

Well, you know, I'm really not a real estate guy. I was kind of, I was a tech guy. I am a computer scientist from Berkeley, was a programmer for many years, ended up starting a dot com back in the 90s, ended up raising $40 million in venture capital and growing this thing to 300 employees and then it blew up and I lost everything in the late 90s. And really after that did a hedge fund started a hedge fund, really got kind of what I call a finance degree, a street MBA. I say street MBAs, they're better than regular base, but they're way more expensive. And so, but again, when the crash of 2008 happened, I lost everything in this hedge fund. And so really at that point became a real estate guy. I want something that is a little more predictable, a little more controllable than a fat investment in the stock market. Meanwhile, my partner Jim is a real estate guy and he lost everything in the crash. So this is kind of our theme, right? You know, these massive cycles, economic cycles come and we want something that is, that is, you know, far less dependent on the cycles or something that is, that is countercyclical. Right. And so we found it with note investing. And so we buy these notes, you know, and partly too, I, you know, turn some passive income, bought a duplex and it was just such a horrible experience, you know, for computer scientists. You know, these fingers do magic and a keyboard, but boy, you know, try to fix a piece of drywall or toilet and I'm just lost. So it was way over my head and it was no fun at all. And, and so that's when I decided to get into this, the finance arena, which is really a lot more suitable to me. And real estate based finance is just so much cleaner, so much more scalable, so much more upside, so much more controllable in so many ways than any other thing I've ever touched.

Todd, I think all these benefits sound very familiar to you and me in our land investing model. But I just want to get your thoughts, Scott, on all of this.

No, I agree. I think that the thing is that it's not necessarily about, to me, it's not. Our business is not about necessarily owning the land. It's really about putting that land onto a note and converting that into paper.

Right.

I think the paper's worth much more than the real estate itself because the paper, the land, the land payments, it's what sustains us, you know, every month, like every month I don't have to wake up and worry about like, oh man, I gotta flip, flip two properties or three properties this month. It takes a lot of stress off. Even though you do get addicted to seeing the growth in your paper portfolio or the paper that you're generating ultimately. I was told a long time ago, paper is gold. That's what I was told a lot.

Yeah. So you turn your asset into cash flow. So we buy real estate based cash Flows primarily owner occupied residential real estate. We buy it at a discount almost entirely. So we buy, we don't do our own originations. So what you guys are doing with seller financing, you're originating a piece of paper. We don't, we buy distressed paper. And we typically buy at a discount. And so that has, is that we get enhanced yields because of the discount. Plus in a refinance or sale event, we have a cap gain in addition. So we get cash flow plus cap gain.

So let's unpack that a little bit for the listener because you really said a few things that our listeners may not be familiar with. The number one is origination. You're not doing that. So you're taking somebody, let's take Scott for example, who lives in his house and the bank has the first mortgage on his house. You are not buying that first mortgage. Correct.

You know, we are buying that first mortgage.

You are buying that first mortgage.

Okay, so you don't originate means we don't create the paper, we simply purchase the paper.

Okay, so the bank already has the paper. They already have. So Scott's paying the bank.

Yes.

However, now let's go, let's, let's define distress. So what does that look like? Why do you get this at a discount?

Typically these are, these are notes that were not being paid for a period of time and they may be, they were modified. So if you don't pay your mortgage, sometimes you can talk to your bank and they will modify the loan. And once modified it's called a troubled debt restructure from a bank. And once a troubled debt restructure, always a troubled debt restructure. Doesn't matter if that borrower's FICO credit score goes back up to 800. Doesn't matter if they're making a million dollars a year, doesn't matter if they're paying on time. It is still a garbage loan. It's a troubled debt restructure. It's a black eye. So these things get sold. So the banks end up selling them off to clean their books. A lot of times they sell bad loans, the loans that are non performing because banks don't know what to do with them. They're bought by specialty funds and hedge funds and other investors who re perform the loans or take possession of the property and create seller financing. Once they do those things, they have a piece of paper that they no longer want. It's simply a cash flowing, boring piece of paper and they want to get their money out so they sell it. So we buy in the Secondary market performing notes, basically.

Okay, so, but they are performing once you get to them, but because they've been troubled, you get them at a discount and your yield is way higher. Can we define when we say higher yield, what would a traditional note look like compared to your note?

All right, here's an example. It's a little New York, upstate New York house, little tiny house. It's $100,000 house. He has $100,000 loan on this. He gets a 6% interest rate on this loan. He's paying $579 a month. Okay, we bought that loan for $50,000. So Larry, he owes us $100,000. His house is worth $100,000. He doesn't know that we paid 50,000 for that note. So instead of a 6% yield, so the note is a 6%. He's paying 6% per year. But because we paid 50 cents for that, we're getting a 12% yield because we only paid 50 cents on the dollar. And then what's more, so he's paying us every month $566 a month or whatever it is. And when he refinances or sells that house, he pays us off. He pays our note off. The new buyer will satisfy the previous debt. And so we'll get how much? Well, we're not going to get 50. We're going to get 100. So we end up making a 12% yield on that paper until we earn a hundred percent cap gain.

Like this, Scott. Ty. Exactly.

We do, too.

Your thoughts?

I mean, I think it's great. I mean, you know, like anything that, you know, drives the yield higher is definitely a good deal.

So, Bob, I would assume this is a due diligence model where when you're looking at this tranche of notes of distress, notes from your, your, your bank, let's say, do you get a chance to pick and choose which notes you, you want and which notes you don't?

It depends on the seller. We have tons of sources, but we generally underwrite every note individually. You have to do that. And generally we do have a right to put back loans and exclude them from the pool, saying, this doesn't meet our criteria. But yeah, it's definitely an underwriting process. We're very sophisticated underwriters. Using discounted cash flow models. We look at every possible scenario, every possible outcome for this note, including default scenarios, and we build a cash flow for each one. And based on our experience, we assign a probability, each one, and that becomes a cap, a price that we pay for that Note. And there's really no such thing as a bad note to us. It's just a bad price.

There's no such thing as a bad note. It's just a bad price. And you are very comfortable with the asset being a residential home because what's the worst case scenario for you?

And the worst case scenario, we probably had it right where property Prices declined by 35% across the nation. So you definitely want equity in these things. We look at a key metric we call investment to value, meaning our cost basis relative to the value of the home. And we include, we buy a lot of second mortgages. We actually prefer second mortgages. Yes, you heard that right and I'll tell you why. But we look at total investment, total debt on this property measured by our cost basis and a senior note relative to the price of the property. And we like to keep that at 65% or less so that we can weather a downturn. And you know, the borrower may have, you know, their watch their equity get, you know, decreased, but we're, we're safe as the lender. So, you know, we love seconds. People, people are terrified of seconds, and I'm so glad they are because it creates huge inefficiencies in the market. So second mortgage, So a typical first mortgage is maybe around 4% coupon rate, interest rate, second mortgage is typically double that. So maybe a 4% rate. But are they any riskier? It's really not. It really depends on the property and the debt stack. So if it's a $300,000 property, there's $100,000 first at 4% and $100,000 second at 8%. Which one would you rather have? Well, I'll take the second all day long, especially since the first, I probably can't get a discount on that first mortgage. On the second, I may get a 50% discount. So I'll buy a hundred thousand dollar loan which is at 8% and I'll get it for, you know, 50, 60, 70 cents on the dollar. So I love seconds. And then what happens when there's, when there's a sale or a refinancing? We get a capital gain. So we far prefer seconds. But we do have, in our portfolios, we typically have quite a bit of firsts just for the safety factor of having firsts where there's really nothing that can happen to these loans.

Scott and I are what you would call ambitiously lazy and we certainly aren't going to go outside of our, our own niche, even though we might love this model. So what could we expect as investors investing in Aspen funds as far as a return?

Gotcha. Well, it's a pretty cool fund. We've made a passive income fund because a lot of people, most people want the passive income. And you know, it is difficult to do. You know, our industry is heavily regulated. You know, we're lenders. So you do have to know what you're doing with laws and licenses, et cetera. So we manage all that, we do all the due diligence. We have, you know, of course, lots of sources. And we typically pay 8.5% cash return on an annual basis. Paid monthly, Monthly basis. So it's real nice, you know, it's mailbox money and it's. Here's the other really cool thing. This is huge differentiator for from us versus most of the real estate funds which you have a lockup. Typical real estate funds, you've got a, you know, I mean I've seen them at 10 year lockups. You literally cannot get your money for 10 years. Well, who wants that? You know, we have 100% liquidity on any, at any quarter. We actually price our notes, our portfolio every quarter we come up with a net asset value price of the fund. It's a per share price. And you can put more money in at that price. You can take money out at that price. And how do we do? We've literally been operating for seven years now, have never failed to meet a liquidity need for an investor. How do we do that? Well, we have three hundred and fifty loans in our portfolio right now. Eight percent of them will refinance or sell every year. And when that happens, we get cash coming in. It's because we have so many notes. There's always a liquidity event. So every quarter people want to get their money back, they just send me a note saying I want X bucks back at the end of the quarter. I just reserve that much cash as it comes in and we're able to pay our investors. So it's kind of a, you know, you can have your cake and eat it too, you know. So we give pretty much unlimited liquidity, quarterly liquidity. We do require a one year lockup is all. But then after that it's unlimited liquidity and a 8 and a half percent return, 100% passive. So, so it's, you know, honestly this, this asset class really lends itself to a really attractive income product.

That's how. What are your thoughts?

Okay, so here, here's my question mark. And I invest in raw land, just the land no house.

Scary, scary nothing.

Okay. Like raw land. I take this land and I put it on a note, okay. Like, I don't run credit on my buyer, right? Okay. It's a low down payment to the, to the total purchase price. I've got this note. Will you buy it?

I probably wouldn't buy it because there's no underlying cash flow on that, on that property. So there's nothing to support the value. Right. Except there's no cash flow to support the value, if you will.

And you see, like, my point behind that is this, like, what's. It's really for the not. Look, I'm not dissing you. I'm just, I want the audience to listen to this piece, right? Like, therein lies the opportunity. Like, Bob talked about the second mortgages and being an inefficient market. Right. Like, and how he's benefiting from the inefficient market. Mark and I and the other land investors in this community, we are beneficiating from the inefficient market. And if Bob won't buy your paper, I will buy your paper. Because I understand it. Like Bob understands his world and that's cool. I understand our world. You need money, come talk to me. I'll do it. I know Mark will buy paper too. So like, you see, you got to find people. There's value in the assets, as I said, and you got to find the people that understand that component of it. And you know, a lot of times, I know when I started, I went to people like Bob, like, will you do this? And the response I got like, I kidding you 100 times, was exactly what Bob said. And I, and I argued, not disrespectfully, but I would say, like Bob, there is cash flow coming from these. Because I sold it once on the note, it's there. The cash flow is there and the yield is there to support it. And the Bob's were like, no, because you see, they're accustomed to their niche and that's cool. And I really think.

And you're right, I mean, traditional lenders are, you know, you look at, you want to have income to pay to pay, you know, on real estate, you want to have income to pay that, to pay the debt service. So on land, right? There really isn't that. So you're creating paper, but it doesn't have an underlying income on. Doesn't fit our model. But right.

And see, that's the thing.

It's like not to say that I wouldn't start a fund, an income fund to do that because we like all cash flows. But in our fund we will not buy those. But we have five different funds so that have different metrics. There's certainly a model that would work on that. I totally.

But see, like. Yeah, go ahead, Scott.

But no, I was just going to wrap up. See like, I'm not trying to like argue at one way. I just want to, I just want everybody to see like it's, it's all about perspective, right? Like Bob knows this piece. And like what Bob said was there's no income, underlying income from the land. And like for me, I could easily say that, look, when that, when that house is empty, there's no underlying income from that house either until it gets resold again.

True.

That's the piece. And so all I'm saying is like everybody, you got to understand, like there's investments that we all make. And once you understand, once you understand it, see, Bob's not saying no because he doesn't like land. Bob's saying no because he doesn't understand what we do. That's really the ultimate piece of.

It's totally right. And it goes to really what you guys do. And what we do, it's taking advantage of inefficient markets and finding niches that are very profitable ditches in what we do. You know, we have another business, another strategy where we buy non performing debt and that just terrifies the heck out of people. But we so understand that market, our margins are incredibly high and we make a lot of money on those, on those things. But again, it's one of those things that people, people just do not know how to go after this. And we're buying debt for as little as $0.10, $0.15 on the dollar. That has a lot of value, may not have cash flow, but it has value. So we totally understand that. And there's so much money to be made in so many different models.

Yeah, absolutely. But that reminds me that today's podcast is sponsored by TL Folio tlfolio.com if you have a performing note and you need cash, you can sell 12 to 18 months of that cash flow, take that money, redeploy it, put on a new note and really get exponential returns for yourself. And then you get another bite of the apple after the note, 12 to 18 months, you get that passive income reverts back to you. So you get the cash and then you get the passive over there and we can walk you through the numbers. So tlfolio.com for your land notes. All right, Bob Frazier, we're at that point now in the podcast where your mentorship has been phenomenal. And thank you so much for educating us and our audience on your model and your fund. But now we're going to ask you for one more tip. A website, a resource, a book, something actionable for the art of passive income listeners to go improve their businesses, improve their lives. What have you got?

Okay. Are you ready to have your life completely changed for 2020?

Absolutely.

There's a tool I use, it's called Microsoft Power BI Power Business Intelligence. And I just can't recommend this tool highly enough. It's basically lets you create data dashboards for any data, including finance data, spreadsheet data, and it lets you slice and dice this data in a live way. We do analytics on every one of our portfolios. I can tell you everything about my portfolios and I can slice that data and dice it in seconds and minutes. It is one of the coolest tools and it's free to get started.

Very cool. Scott Todd, this is super geeky.

Exactly.

I love it. I love it. Powerbi.Microsoft.com Very cool. We'll have a link to that in the notes. Scott Todd, what's your tip of the week?

Mark, my tip is just for you and others, but really I thought of you when I found this one. Check out the book The Daily Stoic. 366 Meditations on Wisdom, Preservation and the Art of Living on Amazon.

I love stoicism and I believe that's Ryan Holiday who wrote Ego is the Enemy. Yeah. Okay, done. I'm going to get it. That's how I'm going to start 2020 with my stoic practice. Thank you so much. Now my tip of the week. This is going to be a one that's going to actually get you wealthy slowly and increase your passive income. Go to Aspenfunds Us. I'll have a link to it. Aspen Funds us and learn more about how you can just invest your money and make 8.5% on real estate backed mortgage investments. The risk reward ratio seems very, very appealing. And if you have qualified retirement money, you have self directed IRA money and it's just sitting there. This is a great place to start getting that larger yield with. It sounds like very, very little risk. Is that right, Bob?

I would say so.

All right, well, Bob Frazier, are we good?

Yeah. Pleasure to be here with you guys.

Thank you so much. Scott Todd, are we good?

Yeah, Mark, we're good.

All right. I want to thank the listeners. Just remind you the only way, the only way we're going to get quality of guests like Bob Frazier from Aspenfunds us is if you do three little things. You've got to subscribe, you've got a rate, you've got to review the podcast. Send us a screenshot of that review to supportlandgeek.com we are going to send you for free the $97 passive income launch kit as well as the new wholetailing course how to double youe money 30 days or less. All right, Scott, are you ready to do this?

We are, Mark.

One, two, three, let freedom, freedom ring. Bob's like, if I knew you guys are going to end like that, I don't know if I would have been on the podcast. All right, thanks everybody.

Thanks for listening to the Art of Passive Income Podcast. Start your journey on at www.thelandgate.com and www.scotttod.net. rate and review the podcast and email supporthelandgeek.com your screenshot for a free Passive Income launch kit.