What happens when a major lender wants to unload hundreds of millions - or even billions - of dollars worth of delinquent mortgages, even at a price lower than the amount of money they are actually owed?
When that type of transaction is done with individual properties, it’s called a short sale. When it’s done with billion-dollar portfolios containing thousands of separate mortgages, it becomes the mega-money version of a short sale called “distressed debt funds”…
…and the formation of new investment funds for purchasing distressed debt suggests that the worst of the credit crisis is behind us, particularly when those investment funds are backed by major money managers like PIMCO, BlackRock and Third Avenue Value Management. Here’s why this is such a good sign:
When any market (real estate, in this case) faces a sharp and severe decline, the financial players in that market go into “shock mode”. As an example, see what’s going on right now at Fannie Mae, Freddie Mac, Countrywide, etc. And when this happens, those types of companies tend to be willing to sell off their underperforming (delinquent) assets at lower than face value in exchange for an immediate end to the “bleeding”.
That’s where the big-time money management firms I mentioned before come into the picture. Like vultures, they are flying high above the scene and watching as the major mortgage lenders are bleeding uncontrollably and are increasingly willing to do ANYTHING to lessen the pain…
…and sometimes that includes actions like selling BILLION-DOLLAR mortgage portfolios for far less than the face value of the securities.
As a practical example, imagine that some mortgage company holds a billion dollars in mortgages, and most of them are in or approaching foreclosure. You come along and offer this company $500 million to take the portfolio off of their hands. This mortgage company isn’t happy to “lose” $500 million on this deal, but as far as they know, the value of their portfolio could decline even further and be even less than what you’re offering.
So they sell the portfolio to you. Why is this a good deal for you? It’s simple, really. The math favors you. You’ve been watching the market carnage and you’ve been able to evaluate things rationally - and that’s a luxury that the mortgage company you just “scalped” hasn’t had.
Why would you make such an investment in “bad” debt? The only reason you’d do so is that there is a LOT of evidence that the bloodletting in the market is at or near the end, and you’re willing to risk your own money on the notion that your mortgage portfolio that has a “face value” of one BILLION dollars and for which you paid $500,000,000 will soon be shown to be worth something between those two. And when that happens, you make money. And probably a whole lot of it.
That’s exactly what’s going on right now. Distressed Debt Funds tend to spring up in the aftermath of market downturns, and are a very good sign that insiders watch for to determine when “smart money” is re-entering a market.
What is one of the signs that a turn in the real estate market is happening? Here’s one: The National Association Of Realtors announced that pending home sales were significantly higher than expected in June. A very positive sign indeed.
The time is now. Don’t let this opportunity pass you by!
Thanks for reading FreeRealEstateTraining.com.
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7 Comments So Far»
I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog.
Tim Ramsey
I’m not going to get technical, even though that would validate the thousands spent on my MBA(ha) so I’m going to pose a question. What does this action mean for those specializing in short sale property acquisition and/or processing? I believe from the post you are saying that the real estate market is settling down and now is the time to either: 1.take action 2. keep buying properties 3. ________? From what our company has seen nationwide and even locally here in York, PA, no matter what’s going on in the market, the buyers are out there - to attract those buyers your pricing has to be spot on in order to have those buyers run to you like moths to a light. Hopefully this rambling makes sense in some way.
You’re dead on the money Ed. The point of all of this is to get into the mix and buy some properties while they’re cheap, because sales don’t last forever. As for how the emergence of Distressed Debt Funds will effect short sales on individual properties - I don’t have an educated opinion about that. Hopefully some of my readers in the high finance business will step in with some analysis of that angle. Thanks so much for your comments! — Bryan Ellis
I heard that a company recently bought billions of dollars worth of non performnig notes for another big bank at a discount and the deal was funded using a loan they got from the bank. Talk about thinking outside the box.
I took a course from an “old hand” three years ago, who told me that he was getting ready to buy REOs in batches from the banks. That was 2005, a year before anyone would openly say the market would crash! Like the good book says, there’s “nothing new under the sun.”
You’re absolutely right - distressed debt funds are not new. In fact, they tend to appear around the beginning of the end of downward cycles in major financial markets. That’s why their emergence in the mortgage/real estate market is significant right now. Thank you for your comments! — Bryan Ellis
One of the ways that a short-sale investor can assist the home owner is to offer to buy the delinquent note from the lender (at a sharp discount of course), then the home owner deeds the property to the investor in exchange for surrendering the note. The benefit of this technique is that the lender cannot sue for deficiency or file an IRS cancellation of debt against the (former) home owner. The lender chose to sell an asset at a discount (happens at the time). No note means no deficiency.
Now the investor can repair, then rent or sell the property for a profit. In this “down market”, investors are buying properties on short-sales at a price that will cash flow, and “ride out” the market to wait for price appreciation.
Buying large portfolios of distressed debt may have a similar purpose. The portfolio buyer can offer to surrender the note to the debtor in a “deed in lieu of foreclosure” transaction. The benefits to the debtor are no deficiency judgment and no IRS cancellation of debt (phantom taxable income). Then aggressively market the property to recover the investment and a reasonable profit.
This may be a good opportunity to approach those “Distressed Debt Funds” companies to try to buy the underlying properties at large discounts. They have already done the hard work of closing the short-sale of the debt at 50% discount. Try offering them 55% to buy the property. They make a quick 10% profit on their investment and you get a property at a deep discount that can cash flow at current market rents.
two cents worth. your mileage may vary.
Just curious about how the \little guys\ such as my self can get good deals through these REO baskets. What happens to all these homes? Is there an opportunity for that savings to be passed on to the end buyer/investor who doesn’t have half a million?
Hi Kalimah,
you can still buy the note by going through the homeowner and getting an authorization to release as you would for a shortsale but instead of sending in a contract for sale, send the bank an offer to by the note itself.
The loss mitigator might not understand what you are trying to do but when you can try to explain as much as possible and if they still do not know what you are talking about ask to speak with a supervisor.
Another thing you can do is call the banks 800 number and ask the operator to direct you to the “Special Assets” dept. The also have other names for this dept too and it depends on the bank but if the loss mitigator does not understand you call the 800 number and have the operator connect you to the right department.
Try saying this “Hi my name is _____ and I am looking to buy non performing notes. I mean notes in which the borrower is in default because they are not currently paying the mortgage or the note is in foreclosure. Can you direct me to the the dept that handle this type of transaction”
Note: some back do not sell notes but in my view they will eventually because some that only sold REOs are now selling the notes, you just have to be patient and follow up
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