It all started back in 1984. That is my experience in dealing with Fractionated notes. I had just retired from the California Highway Patrol where I served as an Area Commander and had begun training as a Commercial Real Estate Investment Broker. I received a call from the Superior Court Judge that subsequently led to my appointment as a Referee in 1983. The case involved a fractionated note structured by a local Real Estate Broker with 165 fractionated interests, clearly in violation of the rules and regulations of the Securities and Exchange Commission. My job was to “service” this note.
Having known the Judge for at least two decades and been motivated to establish a new identity as a pro in the Real Estate Community, I gladly accepted the challenge without knowing where to begin – and neither did the Judge, the Attorney, the local lenders, associates or financial investment advisors. Needless to say, I did figure it out, accomplished the task to the satisfaction of the Court and the Investors.
That fortunate appointment was actually our introduction to how to build a portfolio of notes, providing the appropriate rules were followed and the safeguards built into the structuring and management of the note. When the real estate market went into the “tank” in the 1980’s we were able to not only survive by investing in notes but also build and increase wealth. The intrigue in “how money moved” and our increase in knowledge gained through education on the subject together with experience gained as a loan broker and mortgage lender and more recently in the cash flow industry has opened the door of opportunity for our clients to successfully invest in multi-lender notes. When a structured property with the appropriate safeguards in place, these kinds of notes can be incredibly lucrative to you and/or your investors.
First, let’s define a Multi-Investor Note as one where there is more than one investor in the note. This can occur when a partnership has owned a property for some period of time. When they sold the property they were unable to be paid entirely and elected to carry some of the funds in a carryback note. There may be any number of investors in this type of note and they all expect to receive their check each month.
Sometimes there will be an estate involved where there are many heirs, all needing to receive payments on a regular basis. This will occur when the will is probated, even though the original beneficiary was a single person, the will makes the distribution to the heirs according to the manner specified.
Before we discuss the safeguards that need to be built into the notes, let’s take a look at the opportunity for you, as a Note Broker to create a Note Portfolio for yourself through the careful structuring of a Multi-Investor Note. If you were to find a note that has a large remaining balance or a value that is greater than you alone have the funds to purchase or you are unable to find a single investor source to fund the note, then thought should be given to bring others into the purchase of the note/loan with the broker.
This can be done by offering to individual investors a piece of the investment, providing this is done in compliance with the statutes for the state in which this transaction is taking place.
(In California a real estate broker has an exemption in the statute that permits this to be done providing the entire transaction meets the requirement of Section 10229j B&P Code.) The Code allows you to place up to ten investors in a loan. This provides an excellent opportunity for a broker to place more loans and possibly keep a piece of each of the loans for their own investment portfolio.
So, let’s take a look at an example: Say you have an opportunity to purchase a note with a value of $150,000 and you cannot locate a single investor with this amount readily available. However, it is perfectly feasible to locate ten investors with $15,000 each. In fact, you, as the broker could be one of the investors by building a portion of the discount as your portion of the investment.
This is a simple example of how you can either originate or purchase a note at a discount to yield 12%. Considering the returns available in the money market today using alternative investments, this type of example is perfectly doable. The note in this example will pay $1,500 in interest-only; if each investor were to receive a 9% return on their $15,000 they would receive $112.50 each month as interest on the investment. So you would receive $1,500 and payout $1,125 and keep $375 for yourself. Not a bad return for having nothing invested. Of course, there has been no discussion of the fee charged to the seller or borrower when the transaction was put together.
The basic procedures for handling the transaction are as follows:
- Obtain the agreement of the holder of the note for the terms, conditions, and time frame to complete the purchase of the note;
- Review your client base to see which of your investors may be interested in the type of note you have tied up;
- Prepare the necessary disclosure documents to be delivered to the potential investors in the note;
- Pick up and deposit the investor’s funds into the title company or trust account and close the transaction.
Instruction is given to the escrow holder to complete an assignment of the Deed of Trust and/or Mortgage to the individual investors based on the percentage of interest each investor has in the note. An endorsement on the note providing the same information should be placed on the reverse of the note, or by an attachment to the note.
Seldom is it practical for an individual Broker to handle the collection and tracking of these loans, they are better served by having a loan servicing company handle this aspect of the note. As you can see from the above example the calculations to track the interest, principal, remaining balance, late charges, along with the reporting to the regulators can be daunting. In addition, it will be necessary to have an IRS 1098 form prepared for the borrower and an IRS 1099 form prepared for you investors at year-end.
Depending on the state where you are located, there could be and probably are, reporting requirements to the Regulator. It would be advisable to check. For instance, In California, the Broker must report to the Department of Real Estate the very first instance where they have done a Multiple Investor Loan or Note. In addition to this report, if the threshold status has been reached, the Broker must have a Certified Public Accountant review the Trust Account used for the money collected and the distribution to the investors, and then the CPA must prepare an independent report on a quarterly basis for the Department of Real Estate.
For years Brokers have been stumbling over these arduous and costly reporting requirements, which in many cases have kept them from capitalizing on the opportunity to increase wealth through the structuring of multi-investor notes.
Now, here is the good news. Brokers are alleviated from meeting these CPA and reporting requirements when they use the services of a Licensed Note Servicing Company. Well, you are probably asking, “is the reporting eliminated, or is it required by the Servicing Company”? No one knows the answer better than we do, the reporting becomes the responsibility and at the expense of the Servicing Company.
Recognizing these benefits, more and more Brokers, like you, are taking advantage of the Note Servicing Center who takes care of this reporting as part of the routine services provided. This will save you hassle and aggravation to say nothing of the expense which increases your margin of profit. Most of all, it will free up your time so you can do what you do best… Build Your Business!
This article was modified from an article originally written by Note Servicing Center and posted to this site on 2004/05/31.