Dave Franecki originally wrote this article which was published in the March 2021 NOTEWORTHY NEWSLETTER
Whether you are a seasoned real estate / note investor or a new to the note space, buckle up as this article addresses both audiences. Do you see what is happening as inflation or deflation in the next 3 years? This article will focus on inflation therefore a weaker dollar vs deflation and a stronger dollar.
We are entering the most turbulent period in US financial history…
That’s because severe crises are brewing on multiple fronts and are converging. There’s going to be much less stability of any kind—financial, economic, political, social, cultural, or military—in the months to come. The whole system will have a complete reset, and soon. We’re in an economic no-man’s-land…
There is a stock market bubble, a real estate bubble, a bond super-bubble…
It’s really an Everything Bubble. The coming financial volatility will be unlike anything we’ve ever seen before… It could be the BIGGEST thing not just since the Great Depression of 1929 to 1946. It could be the BIGGEST thing since the founding of the USA. The enormous and unprecedented effects of this have only just begun. Almost EVERYONE could lose money in the ensuing economic collapse. The question is how much. That means most investments YOU own are likely overvalued and high risk.
How did this happen?
In a desperate attempt to paper over their problems, governments have printed trillions of new currency units, brought interest rates to below zero, and bailed out failing institutions.
But those gimmicks have now been exhausted. We are in the beginning of the GREAT RESET. Nobody has ever seen a market so good and so bad at the same time. This black swan has a split personality!
The top layer of the data onion looks good. But the more layers you peel off the smellier it gets, and the more you’ll want to cry. On the surface, things are looking good. But in the deeper layers of data, the current state of the industry shows some major red flags. And the deeper you look, the future of the industry looks downright scary. Investing basics have gone by the wayside because of the fear of missing out for [more].
How does this inflationary time impact notes as a passive investment?
A “set it and forget it” buy and hold passive note investor a is typically in for the long term yield. They want the 10+ year run of “guaranteed returns”. It feels good. But, inflation, the eroding of the dollar’s purchasing power over time erodes those payments just as it has since 1913.
Ask yourself this question. Today, if you spent $1,000 at WALMART, how many carts of groceries would that buy as compared to ten years ago? A huge difference. What about in 3 years ago? With just food prices escalating, it may be safe to assume a 20% drop in buying power with all the funny money being pumped into the system. Find todays real inflation #’s here.
The Wolf Report had a great article on this subject. The Dollar’s Purchasing Power Dwindles to Another Record Low.
Do not expect the borrower to refinance as refi applications are now down 72% because most of the people with perfect credit have already refinanced.
No matter what, keep a back door open. What is your exit strategy? Make sure you are covering your “asset “. What if the real estate bubble pops, and property values drop. Now the note investor is facing both eroding buying power on the monthly payments and a depreciated equity position. If you plan on holding it forever, you are setting yourself up for a loss. Things change. There are Black Swan Events.
In essence it means buying any asset class with the end in mind.
Oh, but you say that could never happen? Really.
Ever heard of ENRON. It was flying high in October, 2000. 14 months later, it filed for Chapter 11. Ever heard of Lehman Brothers? It was founded in 1847 and filed for Bankruptcy in September, 2008. Too big to fail. Yea, right.
I have personally experienced the pain of 3 huge cycles. 1981, 1991, and 2008. I am speaking totally from experience. I was a legend in my own mind. When the bubble pops, expect a lot of pain or set yourself up to thrive.
So, let’s distill it down to basics when buying notes.
What does this mean for you the seasoned or newbie note investor? What should you do?
Phrased another way is all about WHEN TO BUY AND WHEN TO SELL.
Prepare for the unknown before you pull the trigger. Investing is a risk. Plan for the worst, and hope for the best.
Remember profits/yield is not realized until you sell. Do not get drunk chasing yield. Focus on return of capital vs return on capital. Think about how to get out, if a worst case scenario pops up. My recommendations have NOT changed since 2015 when I organized the Phoenix Note Investors Forum.
The following recommendations are very simple and straight forward:
#1. Recommendation–Get back to basics.
#2. Recommendation—Get Back to Basics
#3. Recommendation—Mitigate the inevitable.
#4. Build in your stop losses.
The real estate industry has been propped up by the FEDS for a while.
This reminds me the story of the old turkey farmer and how he encouraged his new poults to grow. For 100 days he come into the turkey yard playing music and spreading out handfuls of grain. Eventually the now growing poults became totally friendly toward him. They relied on the goodies. Then on the 100th day he came into the yard—carrying a manchette. They had no clue what hit them. They were so set up.
Does this resonate? I am not sure about you but I’d rather be the farmer vs the turkey on the 100th day.
Why not plan on being the farmer? Today, the economy is/has been propped up with fake everything. Investors are on a drunken high. No clue of what is going on. Another black swan event couldn’t happen again. Could it?
With that in mind let’s go back to my current filters when buying notes to mitigate risk. When buying performing notes, don’t get drunk on yield. Take several factors in mind. When figuring out the LTV, take the current BPO value, subtract 20% and then take 60% of that # to filter LTV for future what if scenarios. Let’s put that in perspective. Asset values can, will and do drop. As they drop, your investment is more exposed to what if situations. But, as the upb decreases, your investment becomes safer.
Assume a BPO value of $100,000 x 80% = $80,000 x .6 = $48,000 for LTV purposes. Factor in $40 monthly servicing fees to calculate your current yield. Servicing fees are INCREASING. Shops that were charging $30 are in some cases charging $40/month. Some less.
Look at the pay history of the borrower. Is it solid? What do they do for work? If they work at a restaurant or other industry hit hard in COVID, evaluate your risk. What happens if they loose their income? Do you want to own the Asset if they stop paying? Cover your back side for what if situations.
There are no rules in today’s market place. There is no rhyme or reason. Remember the lawmakers can change anything at any time. If eviction rules can be changed with the stroke of a pen, so can foreclosure laws. What happens if you buy an NPN and you cannot foreclose? What happens if a perfectly reliable, great paying borrower stops paying due to a Black Swan Event? You are left to work it out—receiving proceeds that are not worth what they are today. When the NPN volume increases in the next 12 months, keep your filters in place. In 2014, I was buying NPN assets with an ITV and LTV not exceeding 30-35% depending on the asset. Allow for the unknows. NPNs can be messy. Taxes, title and blight will take you to the turkey yard. I was conservative. It worked well.
At this time, I am only buying short term performing notes at a steep discount. That is a way to keep the value of your investment in check. Your risk will be reduced every time a payment is made. When the market drops/stalls and it will, you are where you are. There is no going back. Be prepared for the pain and jump the opportunities.
Survive and thrive when this economic crash comes. Be the hunter vs the hunted.
When one typically is buying it is about greed. When one is selling it may very well be about fear.
When they intersect, there could be challenges.
Bottom line it is all about When To buy and When To Sell.
NOTES AS WELL AS MOST ASSET CLASSES ARE OVERVALUED.
The dollar is loosing value, therefore your payments in 3+ years will not buy as much. Your unpaid principle balance will not worth what it is now. You have become the turkey vs the farmer.
Set yourself up for success in the years to come.
Avoid being slaughtered.
Feel free to call me @ 480 232 5477 or email me at Dave@CapstoneCapitalUSA.com
Wish you all the very best!