Coastline Capital Fund Management

Part 2 – Investing in Real Estate Notes from A-Z.

by Andy Mirza

Due Diligence

The seller will send a link via Dropbox or another file sharing app with the digital images of the scanned collateral file. These days, all loan documents are scanned and are easily transferrable.

Our checklist looks like this:

  1. Send copy of digital images to a third party due diligence company
  2. Do internal review of digital images
  3. Order BPO (Broker Price Opinion) – exterior, 5 day turnaround
  4. Order O&E title report
  5. Final Review

Due Diligence Company

For a few hundred bucks, a due diligence company will sort through the files you give them, inform you about what’s missing, and provide a detailed report on an excel spreadsheet with their findings.

The due diligence process generally takes 2-4 weeks. The due diligence report takes the most time to complete and is usually the last thing we are waiting on before completing the process.

The final report will list items that still remain missing because the seller was never able to locate a copy. It will list objective data as well as subjective interpretations of the quality of the borrower’s performance and likely outcome of loss mitigation efforts.

Internal Review

We independently do our own examination of the digitized documents as well. The due diligence company is an extra set of eyes looking at the same things.

Their reports save us time by organizing documents so it’s easier to track down missing items. It also alerts us to potential problems or exceptions that need to be cleared prior to finalizing our purchase.

Broker Price Opinion

An exterior BPO costs $100-$150 depending on how fast you want the report to come back. Unless we’re in a rush, we opt for the 5 day turnaround BPO. (We use Summit Valuations but you can try First Valuation or Clear Capital, too, to see which service you like best.)

BPOs are the industry standard for providing real estate values.

Real estate agents are contracted to complete BPOs, which are double checked for accuracy by in house evaluators at the BPO vendor. These are not full blown appraisals completed by licensed appraisers, which would cost $400-$600.

If the asset’s value comes in where you need it to, it passes this part of due diligence.

Seek to re-price when property value is lower than theirs

If your BPO returns a value that’s lower than what the seller has, it gives you a reason to seek to re-price the non performing loan. When the seller sends you a tape, the expectation is that you’re bidding on real estate notes that are consistent with that data, including the seller’s reported property value.

If anything is significantly different, then that justifies a request to the seller to fix the issue or re-price the loan. Ask the seller for a discount by providing a new bid.

Every BPO is different and of different quality. The seller might decide to believe that their value is accurate and yours is not.

If the seller doesn’t agree to a re-price, you need to make a decision based on how accurate you feel your BPO is and if the numbers still work for you. If the numbers don’t work, you pull the loan from the trade.

O&E Report (Ownership & Encumbrances)

These reports are offered by title companies and other title report companies such as ProTitleUSA. For less than $100 dollars, you’ll get a report and copies of the supporting recorded documents that pertain to ownership and encumbrances for a specific property.

The pertinent recorded documents are any property transfers using some type of deed, mortgages or deeds of trust, assignments of mortgage or deeds of trust, reconveyances, documents specific to foreclosure, judgements, and any other liens against the property such as municipal, contractor’s, or state and federal tax liens.

The O&E is very useful for verifying the information in the digital images provided to you by the seller. The O&E report compiles and organizes publicly available, recorded documents. If your digital images don’t match up with your O&E report then there’s a problem and you’ll have to track down the source.

Title Issues

Sometimes the O&E report has the wrong information. Other times, the O&E report points out missing documents or errors from the digital images.

When you identify a problem and have determined that the issue lies with the seller or the loan itself, you need to make the determination of whether it’s curable or incurable. Incurable means that there is a title issue with the loan that cannot be fixed.

Incurable Issues

If the title issue is incurable, you have to make a judgment call on how it affects the value of the loan. Some problems are minor and do not affect the value of the loan for your intents and purposes.

If the title problem is incurable and it severely impacts your ability to profit with the loan, notify the seller of the problem and pull the loan from the trade. This is a completely acceptable reason to pull a loan from a trade and won’t harm your trading relationship.

If it’s incurable but won’t affect your plans, you should consider an attempt to re-price the loan with the seller. Every title issue has the potential to negatively affect the value of a loan just like any particular ding on a used car can affect its value.

For the seller, it might be better to give you a discount instead of having to deal with the problem himself or the chance that another future buyer might ask for the same thing. Ask for the discount by submitting a new bid.

The seller may re-price the loan or pull the loan from the trade rather than take a loss. It’s up to you to accept or counter the re-price until you both agree on a new price or pull the loan from the trade.

Curable Issues

For curable issues, you need to make the same judgment call on how serious the issue is, how much time, money, and effort it will take to cure it, and how much this affects the plans you have for the note.

For curable issues, notify the seller of the problem first and let them respond. For some issues, such as missing documentation, the seller might be able to locate the document in question or have someone execute a new document that solves the problem.

If the seller can’t or doesn’t want to fix the issue, then discuss a re-price. The same calculation goes into play as with incurable title issues:

The seller may re-price the loan or pull the loan from the trade rather than take a loss. It’s up to you to accept or counter the re-price until you both agree on a new price or pull the loan from the trade.

Go to contracts

At the end of due diligence:

  1. You have accepted loans “as is” or subject to trailing documents after you close.
  2. You and the seller have accepted a re-price for loans with title issues or because of property value fades.
  3. You or the seller have pulled loans from the trade.

Now, it’s time to complete the trade and this process goes quickly, 48-72 hours.

Complete the trade!

Time is of the essence and no one appreciates the other party dragging its feet. At this point, your seller will expect you to complete the transaction.

If you back out of the trade or fail to fund it, you will most likely get blacklisted and not do a trade with the seller again. Worse, the seller may let others know not to do business with you.

Buyer and seller complete a Mortgage Loan Purchase Agreement (“MLPA”). This document consists of about a dozen pages and is similar to a real estate purchase agreement.

Some important things to highlight are the Representations & Warranties (“reps & warrants” for short) and Interim Servicing sections.

(If you’re not familiar with these contracts, have your attorney look it over and give you their advice. The information I present here is not legal advice and is for informational purposes only.)

Reps & Warrants

“Representations & Warranties” refers to what the seller is guaranteeing to the buyer and the critical piece is the amount of time you have post-sale to remedy any defects of the loan that you discover. No one’s perfect and some things can slip past the due diligence process or not be uncovered until after the loan transfer has been completed.

The reps and warrants section protects you post-sale by keeping the seller on the hook for being responsible to fix any defects.

A reasonable reps and warrants period is 3-6 months post-sale. The longer the better for you as a buyer.

(Luckily for us, we have great relationships with our main sellers and we get help from them even after the reps and warrants period expires.)

If you don’t have a relationship with the seller, this section of the MLPA is even more critical as you have a limited time window to bring the seller back into the picture if there is a problem.

Interim Servicing

The interim servicing period occurs after you purchase the loan. It starts when you buy the loan and lasts until servicing is transferred to your designated servicer.

Loan servicing is heavily regulated by state and federal agencies and must comply with rules on how it communicates and sends documents to borrowers.

Some sellers use a separate contract for interim servicing while others include interim servicing in the MLPA.

Interim servicing periods are typically three weeks to two months. The MLPA will spell out the cut off, closing, and servicing transfer dates.

“Cut off” date is used to determine whether the buyer or seller is entitled to income or responsible for making payments to vendors.

“Closing date” is the date the purchase is completed and you become the new owner of the loan.

“Servicing transfer date” is when the servicing of the note transfers to your servicer.

Interim servicing is a kind of limbo. You own the loan as of the closing date but the loan is still serviced by the seller’s servicer. The seller’s servicer takes direction only from the seller and not from you.

The interim servicing agreement spells out what actions the servicer can make on behalf of the new lender (you).

Read this section carefully and make sure that you’re in agreement with what the servicer can and cannot do during interim servicing. For example, you might not want the servicer to engage in any loss mitigation efforts without your consent. Having a servicer offer a loan modification to your new borrower during interim servicing without notifying you can be a nasty surprise!

You also don’t want the servicer to make any corporate or escrow advances without your consent.

Wire Out

Both parties typically sign the purchase agreement within 24 hours during the business week. Once both parties sign, the buyer typically wires the funds to the seller in 24-48 hours.

Again, don’t hesitate at this critical stage. Show your professionalism and solidify your relationship with the seller by wiring the funds immediately.

Transaction Completed!

If you’re the buyer, congratulations on your purchase! Upon receipt of your funds, the seller will ship the original physical collateral files to you or your custodian within the next three days.

Coastline Capital Fund Management LLC

27702 Crown Valley Pkwy D4 #268
Ladera Ranch, CA 92694

P: (949) 371-6749

andy@coastlinecapgrp.com

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