The criteria an investor establishes for the different types of loans they’re willing to acquire is what you refer to as a “buy box.” A buy box helps the seller or even a broker match the loans that you typically buy with the loans they may have to sell. Now being able to answer this question comprehensively can be the difference between starting a relationship or not.
A seller will often determine whether there is an opportunity to do business with you simply by the way you answer the question about what’s in your buy box.
Experienced note investors tend to put a matrix together outlining their purchase criteria. It makes it easy for all parties involved once you put this matrix together. One of the critical characteristics to define when describing your purchase criteria for a performing loan is the property value or what some refer to as the value band, which represents the range of property values you’re comfortable with when buying a note. For many investors, the minimum property value they’ll typically get comfortable with is somewhere between $50,000-$80,000.
Now the loan to value often referred to as the LTV is another essential characteristic. An LTV indicates whether the property has equity or is underwater. Some buyers are okay with borrowers being underwater and even prefer it because a higher LTV for a performing loan can sometimes translate into a higher yield. This is because an underwater loan is sold based on the value of the property as opposed to the loan balance or UPB, and when your purchase price is low relative to the loan balance, the yield can be desirable. Speaking of investment yield, as a note buyer, you want to be able to discuss your hurdle or minimum return requirement when asked.
Different investors have a different cost of capital, and this has an effect on the minimum return they can accept. 6-14% is currently the range in which most performing loans are trading in the secondary market. The lower end of that range, which represents more aggressive pricing, would typically be for very clean loans, and the buyer at that 6-8% yield would usually be a bank or a fund with a meager cost of capital. They could also be an individual investor, perhaps buying a loan for their self directed IRA. Quite often, you’ll see performing and reperforming loans sold between 9-12% yield.
We’re going to shift gears to talk about payment history and credit score because those are also critical components to the Buy Box discussion. Now when discussing an acceptable payment history with a note seller, you want to be very specific. You want to say whether it’s okay for the borrower to have ever been late or if you require you to know 12 straight months of on-time payments. This means the borrower has never been more than 30 days late past the due date in the last twelve months. And the industry jargon for this is you might hear a clean 12×12 or 0 times 30 the past 12. Or it could be called a perfect pay or no later. There’s a lot of language to the note business, and that’ll help you speak with a note seller in a style that they understand. All those describe a payment history with no hiccups. When discussing the borrower’s credit, you’re going to want to specify the minimum acceptable fico score. A bank buyer will often want to see at least a 580 score or higher, and some investors will, in fact, want to see at least a six twenty fico. Another piece to a thorough buy box discussion will spell out whether it’s okay for the borrower to have been modified or have a loan modification as well as any bankruptcies. Most note investors will be okay with one adjustment. But some investors want to see a borrower if they have been modified, make sure that they’ve at least paid for 12 months under that modification. So there’s some history of them reperforming. And the same tends to apply for a bankruptcy file. You know some investors will require that the borrower has made consistent payments on the B.K. plan for a minimum of six to 12 months.
Let’s shift gears and discuss the Buy Box in the context of non-performing loans. We’ve covered performing loans and many of the same considerations apply as performing loans. Some aspects differ, and sometimes they’re the same, but they are just varying degrees of importance. For example when you’re establishing a Buy Box for non-performing loans (NPL), it’s critical to determine the geography. So these are the states that you’re comfortable buying in some states are creditor friendly, and others are debtor-friendly. Texas, for example, is a very creditor-friendly state. It’s effortless to foreclose in most cases in Texas. But contrast that with New York, which is a very debtor-friendly state. If you compare those timelines between the two and you find it takes on average about 246 days to foreclose in Texas and it could take 5x that long to foreclose in New York.
It’s not just the foreclosure that needs to be considered with non-performing notes. Once you foreclose you’re also sometimes dealing with an eviction process. That’s a key point as well. This is another reason it’s important to determine the minimum property value when determining your buy box with non-performing loans. When a borrower hasn’t paid in many years, the interior condition of the home can be really rough and for that reason some investors will specify the degree of delinquency that they’re comfortable with. In other words, one investor might be okay if the borrower hasn’t paid in a year but not okay if it’s been 3-5 years since they’ve made a payment. And when you consider all the fixed costs involved, for example, foreclosure fees, it can be very tough to make the numbers work from a return perspective on a low-value note because of these fixed costs. Occupancy status is another key consideration with non-performing notes. Some investors want the home to be occupied, and others prefer it vacant.
One reason for wanting the borrower to be in the home is to get them paying again, and you may do a loan modification—additionally, vacant homes in colder parts of the country where it will freeze need to be winterized.
The big idea in this lesson is to establish a thoughtful and deliberate Buy Box, make it easy for sellers to do business with you, and understand the key loan criteria for buying performing and non-performing loans.