There are two types of note sellers — institutional note sellers and private note sellers. Both are great sources for buying real estate mortgage notes but they operate and conduct business in very different ways. This article, along with A Primer on the Private Note Seller, will help you focus your marketing and relationship building efforts while avoiding missteps and wasting time.
What is an institutional note?
An institutional note is originated (or created) by banks, credit unions, non-bank lenders (like Quicken Loans or PennyMac) and other lending institutions. These institutions have rigorous quality standards, policies and procedures they follow that are often regulated or required by the federal government.
Once these loans are made, they are regularly sold in multi-million dollar packages (or pools) to hedge funds, investment companies and other investors on the secondary mortgage market. This process helps them generate profit, mitigate risk, create liquidity and allow further lending. Their buyers either bundle these notes into mortgage backed securities to create diversified investment opportunities or are held individually to achieve cash flow and investment return goals.
Traditionally, when someone refers to “institutional note sellers,” they are referring to the institutional lenders who originated these loans and their buyers in the secondary mortgage market. However, if you buy an institutional mortgage note and re-sell it to another note investor later, you too are an institutional note seller.
Buying mortgage notes from institutional note sellers
Institutional note sellers use a predictable process for mortgage note sales. With performing notes (where the borrower is making payments and following the other stipulations of the loan agreement), they sell their notes at prices as close to the unpaid principal balance of the loan as buyers will pay. This is referred to as selling at par. If the note is non-performing (full payment is not being made by the borrower or they are not following other covenants of the loan), the sale price will most likely be discounted to reflect the buyer’s risk of not receiving the full loan balance from the borrower.
Institutional note sellers have a defined, detailed sales process including timelines for due diligence, indicative bidding, and funding. Most will provide links to the collateral package online, title searches, valuations of the notes, or other pertinent loan information. Buyers need a streamlined process to verify the information provided by the seller as well as other important due diligence activities. Depending on the size of the sale, the buyer may have a few days or a few weeks to complete their file review.
Many institutional purchases are done in large pools — one sale could include hundreds of loans and a multimillion dollar sales price — so buyers planning to purchase notes from institutional note sellers must be well funded. If you aren’t able to purchase millions of dollars of loans at one time, you’ll need to purchase institutional loans from the larger hedge funds that purchase them directly from the bank or lending institution. These hedge funds have primary investment strategies that don’t necessarily fully align with the pool being sold. When that happens, they sell the notes that don’t fit their model to smaller investors.
Where to find institutional note sellers
The key to buying institutional notes directly from an institutional seller is to determine those that are currently selling notes and finding the right person at that institution.
While most banks sell mortgage notes, it is not a constant process. Buyers can avoid frustration by making sure the bank they are pursuing is a worthwhile target. Many metrics indicate which banks are likely to sell, including whether they’ve sold loans previously.
It’s also crucial you find the right contact at that institution. Depending on the institution, the department responsible for note sales is likely called one of the following:
- Special Assets
- Special Situations
- Secondary Marketing
- Loss Prevention
- Loss Mitigation
Regardless of the name of this department, it’s usually a small, fairly obscure division of the bank so it could be hard to track down. In addition, note investing is a relationship business so even when you reach the right contact, you have to establish and nurture this relationship before they become a consistent source of deals for you. And remember, they may not have anything to sell at this time, but it doesn’t mean they won’t in the future. You want them to think of you when they do!
Benefits of buying from institutional note sellers
Some note investors prefer to buy institutional notes over private seller-financed notes because of the professional quality of the underwriting and the structured due diligence and closing process. Loans created by institutional note sellers were written to meet current guidelines and regulations which often reduces liability and expense for the note buyer.
Institutional lenders also use third party loan servicing to manage payment collection and loan management. This involves detailed records of pay history and prior correspondence with the borrower and, if done properly, provides further security that the loan has been collected by a qualified debt collector.
Drawbacks of buying from institutional note sellers
The biggest drawback of buying from institutional note sellers is the capital investment. If you don’t have hundreds of thousands to millions of dollars to purchase at a given time, your list of potential institutional sellers narrows. Buyer competition in this space is fierce; those firms that have the least expensive funding can afford to purchase notes at cheaper prices. That locks smaller players out of current sales and pushes prices higher (and yields down) on future transactions.
Buying notes from institutional note sellers is not an easy task. It requires grit, perseverance, and strong communication, negotiation and relationship building skills. Investors who want to target institutional notes need a firm understanding of how to analyze notes, make offers, and conduct due diligence, all in an efficient manner and on a quick timeline.
The right seller for your business depends on the investing experience you currently have as well as the resources and capital you have available to you. So even if institutional sellers aren’t right for you today, the note sale process has been around for decades largely in the private market and could be a valuable source of product for you at a different point in your business.
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