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How to Invest Effectively in Non-Performing Notes

Buying non-performing notes or loans is an excellent way to invest in real estate. Non-performing loans are the type of loans which the borrower is behind on or has ceased making payments.

Previously, banks would foreclosure on these kinds of loans and sell the property attached to the loan, but banks are currently selling these notes without foreclosing.

Whereas some years ago, banks would have been extremely inclined to foreclose on any non-performing commercial real estate property, they are now opting to sell the note.

Reason? Banks are always in the business of lending money, not only owning and operating real estate. By selling the notes rather than going through the costly and sometimes drawn out procedure of foreclosing, a bank remains out of the chain of title

The bank becomes unaccountable for the environmental conditions of the property and does not have to worry about the time and the expense of other property ownership and management issues.

Add in the effort and cost of marketing the property to all potential buyers after the foreclosure and the several existing properties that are already being carried on their books.

Now you can understand why banks were looking for an alternative to the foreclosures. Note selling has offered that alternative avenue.

For buyers, the primary benefit of buying a non-performing note is clear: great opportunity to get the loan and the underlying property at a steep discount from its initial cost. After buying the note, the buyer has choices: negotiate a new loan with the borrower, or even foreclose on the mortgage itself.

More often than not, the potential buyer—usually an experienced real estate investment firm or a developer who sees a real opportunity to turn the property around—needs to own the site and will eventually foreclose. There is high success for a buyer in this depressed market.

However, buyers be careful! Those looking to buy non-performing notes or loans need to consider the following things:

1. Foreclosure laws of the state

Ensure you know the foreclosure laws in a specific state in which the underlying asset is situated. In some states with its non-judicial foreclosures, the process of foreclosure is straightforward and can be finished very quickly.

On the other hand, in other states, the process can easily drag on for quite some time.

2. Full assessment of the asset

You must determine what proportion of the asset is being leased and, of such leases, what percentage of tenants are really paying their rent regularly.

A high proportion of the property may be leased, but a high fraction of those tenants may also be behind on payments. What are you actually getting for the money?

3. Sufficient enquiry

Try to acquire as much information as possible from the lender concerning the asset before investing your money on due-diligence investigations. The lenders usually have extensive files about every asset—you only need to push them to give you the materials.

4. The condition of the Improvements

The condition of improvements is usually more crucial than other property kinds since the turnover of leases is very frequent (i.e. each year) and potential new residential tenants will just look to an alternative apartment complex if the available property does not “look good.”

5. Obtain an Updated property condition report

If time allows, obtain an updated property condition report prior to buying the note, but possibly obtain such a report before finishing the foreclosure.

The property condition report is essential in determining any required capital improvements, and that amount will be used purposely to find out how aggressive a potential note buyer can be with the rental rates.