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Understanding Partials And The Rules Of Its Game

GDNI 101 | Understanding Partials

Are you in need of immediate cash, but either can’t fully let go of your note or can’t seem to find someone who can take it in full? In today’s episode, we are going to be talking about one of the extremely powerful tools that can help you with that dilemma: partials. Attesting to that with 32 partials among his 200 active notes, Chris Seveney takes over the podcast to give us a great understanding of it and how it can aid our note investing journey. He lays down the important rules of the game and the advantages and risks involved. Breathing life to the topic, Chris then shares some case studies that show different strategies and techniques we can learn from for when we use this in our next transaction. Don’t miss out on important information about partials, which proves to be a great tool we can add in our toolbox.

Listen to the podcast here:

Understanding Partials And The Rules Of Its Game

We are talking partials and it’s going to be one of those episodes that is a topic I love and people can get this into their portfolio and how to do this. It can be extremely powerful, which I’m going to show you. I manage about 200 active notes, and of that, 32 are partials that we’re going to talk about. I’m going to roll right into this because this topic can get a little lengthy. We’re talking partials. First, what is a partial? It’s when you’re selling upfront payments on to an investor. It should be on an asset that’s low risk because you as a sponsor, the way I structure them, are responsible for any additional costs. If you have a performing note that has $200 a month, 200 months left, you can sell 100 of those payments to somebody. That’s as simple as it can get with a partial. One thing to note is the payment stream is principal and interest.

The risk with partials is that if it goes non-performing, you're liable for the costs. Click To Tweet

The reason that’s the case is you’ve got a borrower paying you principal and interest. If you have someone do interest-only, it can cause problems later on down the line where you pay that person back their portion. You want to have it mimic, for the most part, the loan that the borrower has in regards to payments. Now you can have it be less than what the borrower is paying, so you can put a little cash in your pocket. I want to comment that it’s principal and interest. That’s a big thing because people think it’s interesting only and they’re like, “I have a $5,000 partial and the payment is $300 a month.” If it was interested only, the payments would be about $40 a month. People look at it from that perspective and think the returns are low, but it’s interest on what’s remaining on that principal.

What are the rules of the game? I was thinking of Fight Club when I was writing these. If you’ve never seen that movie, the first rule of partials, you only do this on performing assets. The second rule of partials is you only do this on performing assets. I hope this is clear as can be. Rule number three, assets should have equity. It’s not 100% mandatory, but when you look at risk, you want the assets to have equity. If the borrower does stop performing, more than likely they’re going to file bankruptcy, versus taking the property back and having to spend money on foreclosure costs, which would come out of your pocket that we’ll talk about. The fourth rule of partials, always carry a reserve and I’ll explain what that is.

Whatever money you get from that investment, make sure you carry a reserve in case the borrower doesn’t pay. I used to joke to people saying, “What are the chances of my 30 partials? Everyone stopped paying.” Now I could see that happening based on what’s going on in the world. You never know when the type of situation is going to come up. I always want to carry a reserve. We’re going to talk about that. The fifth rule of partials, if you spend reserves, never do it on a nonperforming asset. A way to explain that is if you sell a partial for $15,000, don’t take that $15,000 and reinvest it.

GDNI 101 | Understanding Partials
Understanding Partials: On a non-performing deal, you’re not guaranteed to make money. That’s why you get an asset re-performing because that’s going to be your best profit.

 

You can take a portion of it. That’s about risk and what level you want to take and invest it. If you do, you put that back into a performing note. The way I’ll say that is if you’ve spent $15,000 on a note performing and spend $300 a month, you sell that partial for $17,000 as an example. You might keep two in reserve or I like to keep six-plus months of payments, which I’m going to explain all this and show it to you if this is a little over your head. That $15,000, if you put it back out in the street, you put it back on a performing asset, you are doubling down on lowering that risk.

FAQs About Partials

Some frequently asked questions that get asked a lot on partials as we go through these is, “What happens if the note goes nonperforming? What happens if the borrower pays off the loan? Do you record assignments? Who pays the investor? Do we wait until the borrower pays to pay the investor?” There are a lot of questions that I’ve written down right here. The way I structure the deals is if the note goes nonperforming, there are three options that you can take. You can continue to pay the investor. You can have a pause period where I give you time to get the person reperforming or you can buy out that person. It’s pretty much the three options. Typically, I go with option A. I keep paying the person.

What happens if the borrower pays off the loan? If the borrower’s UPB was $35,000, you have a $15,000 partial, I’ll show you the amortization schedule. If it paid off at month eight, you pay that person off and you get to keep that balance, which goes to one of the questions lower down on that upside that we’ll talk about. Do I record an assignment to an investor? No. I do not record an assignment to the investor. I have an agreement in place that is a collateral assignment and partial agreement. I’m not going to talk too much about that. I can do a follow-up, but I want to show you the power of partials. The reason I’m answering all of these questions is if you look into doing partials, these are a lot of questions that you should be prepared to answer.

Who pays the investor, the sponsor or servicer? Some people may set it up with their servicer to have them send the payments directly to that individual. I have it come through me and I cut them a check. That rolls into that next question of, “Do I wait until the borrower pays to pay the investor?” No. Typically I don’t. My partials, if somebody is due on the first, I make sure they’re paid right around the first. I don’t wait to see all the borrowers paid on the third. The reason why is I’ve got 30-plus of these to try and manage all of that would take too much time. What is the downside risk involved in partials? The risk is that if it goes nonperforming, you’re liable for the costs. You need to make sure you keep reserves so you can pay for any foreclosure or anything that needs to happen. That’s why you want to make sure you’re very selective about the assets that you use for your partials.

Can this be done with CFDs? Yes, it’s better done with CFDs. The reason I say that is either CFDs on non-judicial states. If it does go into a default, then your costs are less and your time is much faster from that perspective. The last question, someone said, “Why do you do this? What’s the upside?” I’ll show you an example coming up. The upside is you’re not splitting profits on anything. It’s like a loan essentially against that asset. They’re getting set payments. For example, you sold $15,000 in UPB was $30,000, they pay that loan off tomorrow, that person gets their $15,000, you get to keep $15,000. It’s not like, “I’ve got to split profits,” or anything like that. There can be some considerable upside.

A question came through with the investor, “Is that purchase of the partial?” Yes. That’s the purchase of the part and that person assumes none of the risks of the underlying notes. There’s still risk involved in the sense of who the sponsor is. From the risk perspective, you’re buying 100 payments, you’re anticipating on getting those payments. If there ever was a fault with the actual paper behind it and the loan was determined invalid or the sponsor steals your money, that’s the only way some of the underlying risks. The other is looking at loan-to-value. I typically try to have my partial partners have loan-to-values of 30%, 40% or less. You’re getting like a $10,000 or $15,000 partial. That property is worth $40,000, $50,000. If it did ever have to foreclose, you’re the first one out.

The risk, honestly, it’s with anything in notes. Who’s behind it? Who’s the person? There could be some bad deals and stuff. When in partials, that should be low risk because it should be a performing asset that’s been performing for some time. You don’t take a newly originated note and put it as a partial unless it’s somebody who’s got an 800 credit score, then maybe that’s a different story. You find Tom, Dick, and Harry living down the street and the three of them combined to make $2,000 a month and you’re trying to put them in $500 a month payment that they barely qualify for. They’ve had four foreclosures in the past. You’re not taking that originated note input and a partial on it. If you are, you’re going to end up in trouble, possibly.

Case Studies On Partials

Let’s roll into some of the meat of the case studies. I put this up because I think this is powerful to show off what happens in a partial. You have a home. This one had a fair market value of around $95,000. It had a first position mortgage and $15,500 was a balance left at 9 and 3 As. I had $250 a month times 93 months. A seller sells this to you at $11,000, which is a 16% yield after servicing cost. Some people will say this is arbitraging, which in a way it is, and that’s why you’ve got to be careful with the leverage or how much is being backed on this. You take this note and you split it into two buckets, an A bucket, and a B bucket, or think of a train. You’ve got the lead car and then the caboose. The lead car gets the payments until a period of time and then you get the back end. In these 93 payments, what I did is I broke it up into 76 to the investor and I kept 17, so they’ve got $230 because I took out $20 a month for service.

They’ve got 76 payments at $230 a month, which was a 10% interest to them. That price was $13,000 and then I got on the backend 17 payments at $230 a month, which if you do the math is another $4,000 roughly. What I did is I acquired a steal. I sold the 76 payments upfront. If you notice, I bought it for $11,000, I sold the partial for $13,000. I’m already up to $2,000 on this thing. Plus, I’m getting seventeen payments down the line. I know people who sit there and I’m a yield guy, but I’m talking yield. My yield is infinity on this thing because I have no money in this deal. Whether I get this money 2, 5 years from now, is the money worth less than five years than it is now? Yes, but I didn’t pay anything for it. One of the things that I want to mention is important is if I’m buying something for $11,000, I’ll try and sell it for additional and I’ll sell little more payments. What I’m going to do is take this $2,000 or maybe even a little more and put that in a separate bank account as a reserve.

This other $10,000, $11,000, I’ll go out, buy another performing note and rinse and recycle this thing. I’ll show you at the end how powerful this is. Does this make sense for people? What I’m doing is I’m buying something for $11,000 and because it has more value to somebody who’s passive, and I showed 10% on this. I showed 10% to the investor and that’s where I paid them. This is a real deal, by the way. I hear people out there saying, “I’m selling partials at 5%, 6%, 7%,” which is great. These numbers look even better, but at 10%, I’m going to show you that these are still good deals. This is what you’re doing. The whole premise of this is, why do you do this? I’m going to compare this to a nonperforming note.

This UPB at 16.5% on a nonperforming side, you’re probably going to pay, $5,000, $6,000 for it. When you JV with somebody, what are you trying to target for them, 12%, 15%? At the end of the day, you’re trying to target 12% on a $6,000 acquisition. You’re trying to get them like $1,000. It’s not a lot over a course of a year if this was nonperforming. One of the things I asked myself is because I bought this as a performer at $11,000, will you spend more than $5,000 to get this to perform? Probably not. It’s like, “If I bought an evaluating nonperformer versus performer with the same UPB, where do things end up?”

If you're doing partials, interest is taxed at ordinary income. Click To Tweet

If you were to foreclose on this thing but a time you did everything, say you even made a 50% profit on that thing, you put $3,000 in your pocket and $3,000 to your investor. I’m looking at this through my eyes. I know people who buy nonperforming notes, when you have to go through a foreclosure on nonperforming notes and stuff, is it not a pain? It’s a lot of work. If you are trying to target 15% for yourself or 20% for yourself, on a deal like this, even if you put $10,000 or $11,000 in a deal, you’re trying to make $1,000, $2,000. $2,000 is 20%. I made that upfront, that $2,000. As long as this thing stays performing, I put that $2,000 in my bank.

I made 20% on a performing note right off the bat. I bought it for $11,000 and I sold it for $13,000, I made $2,000. I didn’t wholesale it where I sold everything. I still got seventeen payments at the end of the day as well. If I was dealing with a nonperformer in this price point, when you’ve got a six $10,000 investment, you might lose. You may make a few thousand. Say you’ve made $5,000 on the whole deal. The investor gets $2,500, I get $2,500. You might get in a year. Because I sold the partial for more upfront and gave a few more payments upfront, I’ve already got that money.

People are going to say, “If it goes nonperforming, you have to put that money back out.” You’re correct. Also, on a nonperforming deal, you’re not guaranteed to make money. You get an asset reperforming, that’s going to be your best profit. If you get an asset that you’ve got to take back, you open those doors and look inside that thing, you are not guaranteed to be making that money. I’ve got a bunch of people on here who I’ve teamed with and we’ve had some ugly stuff. Does that make sense to people? Let me go to case study number two.

This is one that these are interesting because if you target these types of assets, they have a humongous upside to them. I’ll explain why. This one, the home value was $50,000. The first position mortgage was $35,000. The interest rate on the loan was only 7%. It’s $246 a month with 320 payments remaining. The seller sells a set of 15% yield at $17,000. It’s half the price. Think about that. You’re buying this for a nonperforming price because of the interest rate. This is a real live deal. I’m not making this stuff up. This is a partial that I have. I turned around, I split it into two buckets where I sold 138 payments for $18,500 and then I kept 182 payments. I’m not going to see any money from this for ten years down the line.

My whole game plan is to build passive income and not now when I’m working full-time. Five, ten years from now. I still put $1,500 into that holding account at the beginning and then sold off 138 payments. When you take 182 times $226, it’s $40,000 of payments that I’ve pushed down the road. Here’s the thing, what if I went to this investor or this borrower and the borrower all of a sudden got married, something happens? What’s the average time someone has a mortgage? Seven years. What if in four years this borrower turns around, paid this loan off? Personally, I sold the partial. Their principal is probably reduced, call it to $15,000. UPB on this thing is probably still in the high 30%. He gets paid off. I pocketed $18,000. That’s why doing the partial versus a JV on something like this is so much more powerful. You do take on risk, but you also have that upside. Something that you have to weigh. It’s up to you. It’s what you want to do and that’s why you’ve got to evaluate these things.

Also, I don’t recommend the moment you buy a note, just roll it into partial. You want to hold it for 3, 6 months to make sure you understand this borrower. Here’s an example of what I did. If we look at this again, the same thing. If I was buying a $35,000 nonperforming asset and say the value was at $35,000 to $50,000. Let’s say $35,000 because typically most of them are right around value. I bought it for $14,000. Will I spend more than $3,000 to get this performing? Yes. Buying nonperforming note with these lower interest rates sometimes can be beneficial. If this deal made 50% on it, which would be a great deal on $14,000 or even $17,000, you’re making $3,500 or $4,000. It’s good money. I’ve put $1,500 upfront, which is 11%. If I was targeting 12%, again, I made it right off the bat.

GDNI 101 | Understanding Partials
Understanding Partials: If you want to be a note investor, you have to set up your systems and attorneys and everybody else behind you.

 

Here’s a simple calculator that I put together. I did test cases 1 and 2. Property values, the UPBs, the interest rates, calculate several payments, what the principal and interest are, what I paid for it. I have here my target sales price. The way I target that is I try and target between 6 to 12 months of reserves. If there was a need to foreclose or do anything, I’d have six months of payments that would be paid to them. Also, you still out of pocket for your foreclosure costs. That’s why you want to make sure that you have plenty of reserves. The reserves I typically bid these off of are the guy who misses a payment here or there. I’ve got six months in my back pocket.

If the person had to foreclose, that’s money that’s coming directly out of your pocket. It’s risky. This is a high risk in some instances. That’s why you want to make sure it’s a note that is pretty confident and it’s going to stay performing. My target price, what I got the partials for, then the second column is the number of payments that I sold and what those payments were at what interest rate. I try and target loan-to-values that are low. Here’s my investor summary. On these two, I’ve got $3,500 at my kitty, plus I’ve got these payments coming through. I’ve got $48,000 in deferred income on two partials.

Calculating Payments

It’s spread out over a long period of time, but I feel like the federal reserve. I’m creating money out of nothing in some sense, if that makes sense. I bought something, I turned around and sold a portion of it for the value that I paid for it and I’m keeping that back end. I’ve created value because I’ve got a passive investor who doesn’t want to have to deal with nonperforming assets or deal with a performing note on their own. They turn around and we’ll take it at a lower interest rate. One question that comes up is calculating their payments. Here’s a calculator that gets attached to the contract and it was $18,000 at 10% and it was say $240 a month. They’ve got 119 payments, what their total interest is. All of this goes into the contract. If this started on May 1, and this thing paid off on in December, here’s your beginning balance, here’s your ending balance. They paid it off. I’ll cut them a check for $17,200. It’s like looking at a mortgage loan or a car loan amortized over time is what they get paid.

My goal on with partials is back end a lot of performing loans that I use my own funds from to put those funds back out, but then keep stockpiling on these payments and stockpiling them on the back end. How powerful are these? I keep a master spreadsheet. I have every partial. I whited out all the names and then I have all these fancy formulas, if ors and if ands. Here’s how much is coming in the door, here’s how much I’m paying on a partial, here’s how much you’re servicing. I use this as an example. I plugged some numbers in for people because I’d be happy to share this. What it would let you do is build over time to show you the end of each year how much are you gaining from your partials? I’m going to be 45 at the end of 2020. The first three years, I don’t have much coming in at all. When I turned 50, all of sudden, I’ve got $5,500 coming in a month on average that year.

It tails off and so forth. My goal is to get most of these up to $10,000. This doesn’t include performing notes that I have in my portfolio. This is strictly partials. Someone asked a question, “Is there a new assignment and allonge when selling a partial?” My contract has a collateral assignment and a loan agreement is what is part of it. If you added all this amount up, I have banked $500,000 in payments over the next twenty years of partials from starting with minimal cash in the grand scheme of things. When I say minimal, $50,000. That $50,000 keeps feeding this because it keeps getting recycled. A portion of it stays for foreclosures and things like that and I have money if I need to take a property back. That keeps getting recycled to continue to get this number to grow.

I wanted to show people two live examples of two properties. One with $35,000 UPB and one with $16,000 UPB and how I turned quickly those into what appears to be profitable solutions, which will pay me essentially what I may end up getting on a nonperforming note. These are less risk for similar returns. This is why I love partials because for those who deal a lot with nonperforming notes, it can be head scratchers. I wanted to keep this brief for people, but also show you simple ways of going back and breaking up a loan that you take after you acquire it and then turn around and break it into pieces. Some things you could do. I typically give 100% or close to 100% of the money to the investor, but I could turn around and instead give him $200 a month on this one. Their payments went up by 40 extra months. I get less months, but I do make more money on the monthly side. It’s something to consider. You can mix and match. You could do a few partials where, “I’m collecting $50 or $100 a month.” If you have $500 a month payment from somebody, you could turn around and sell a partial for $300 or $400, put $100, $200 in your pocket for the time being. If there are 50 payments, give them 35, that amount and then keep fifteen on the backend.

You can create these however you want. You can give 10% of the payment coming in the door if you want, but you’re probably going to be paying forever. I like to try and give more upfront because I’m not looking for the cash now versus cash later. If you’re a full-time investor, you may look at this and say, “I’d rather get some money now, $100, $200 a month and keep that because that’s your livelihood. You need that money coming in the door. If you don’t, you can defer it later, the better off you are. One interesting thing that I’ll mention too is, this money that I put into this account, I don’t take it out and so forth. I’m not taxed on it. It sits in a holding account as holding funds, just like if you had a JV deal that you paid $20,000 for, put $5,000 in for foreclosure. It’s the same thing. You’re putting that money in there and it’s not getting removed. It’s not something that is getting taxed on. When you close out that deal, you can take that money and then at that point in time, it would show up on profit, but until then it sits there. That’s something else, too, that you’re stockpiling some reserves that can sit there tax-free, in essence. I strongly urge everybody, if you’re selling something for the $18,500 on this, that you’re not taking that and reinvest in that whole amount.

“Could I talk a little bit more about taxes?” I could, but I’m not a CPA. What I can tell you is that if you’re doing this, interest is taxed at ordinary income. If I make $500 and I made $25,000 in my day job, I made $25,500. It’s not like rental income. If you’re the investor on this and I’m paying you, I’m issuing you a 1099 at the end of the year because you’re not in the business of it, so it’s different. Your question is if you’re the one creating these or you’re the one investing in them. Someone asked, “My investors want to see collateral during due diligence.” Yes, absolutely. I provide it to them. I provide them all of that information. They get to see pretty much everything.

It depends on who you’re dealing with. I like to remain transparent on things. I provide all that information. Others, I have no idea. I know I do. You’ll get to see BPO, note, collateral. Everything that I get, you have access too. “Wouldn’t a monthly add on be a problem in that case?” I’m not sure what that question is about the monthly add on. Here is a thing on the reserves, you don’t have to have any. What you’re doing then is you’re selling the partial for less amount. I’m taking what I paid for it and adding to what I paid. It’s not profit, it’s reserves to the entity. If I turned around and only sold it for $14,000, you notice their payments went down to 87, so I’m losing $3,000 from what I paid, but I’m getting a lot more payments. At the end of the day, I’m netting $495 for a time. The lower you sell it for, technically you’ll probably end up netting, but it’s a question of I don’t want to be out of pocket at this point in time.

More Questions About Partials

It depends. I try and target between $1,500, $2,000 above, which usually averages between around 4 to 6 months. Someone said, “What’s the market like for performing notes these days? I haven’t shopped for them.” Right now, people are afraid to buy them because of what’s going on. I don’t know if anyone saw the news that they said 70% of renters didn’t make their payments in April. They’re making this big deal about it. Does anyone know what the historical average is of renters per month not paying the rent? It’s 70%. They’re making this big to-do about 30% of people missed their rent payments. It’s 30% on average. I went through everything I have. I had two people request of forbearance. One of them is actually in bankruptcy where they got COVID-19, so bankruptcy court gave them a free pass for the month, which I’m perfectly fine with. The other one is a borrower who hasn’t paid. 2015, 2016 was the last time they made a payment. Those are the only two out of close to 200.

One thing I’ll mention is performing pricing. Once this finishes, we’ll possibly be a little higher, maybe not getting them for $15,000, maybe you’re getting them for $14,000 or $13,000. Here’s the other thing, you turn around and right now on the stuff that I’m doing these on, it’s 8% not to 9%. It’s not 10% anymore. I had some people get 12% at a point in time. Now on the partials, I offer 8% to 9%. The last round I sold to somebody was at 9%. If that 138 goes down to 9%, it’s eleven more months that I’m getting. It’s something to consider.

Question was about taxes. If you’re investing in it similar to JV deal and you get paid, you’ll get a 1099 at the end of the year. It’s 1099 interest that you give to your accountant and they’ll take care of it. I’m hesitant because I’m not by any means an expert in taxes. I don’t like to talk too much about it because I don’t want to say something that’s incorrect. The reality of it is, my taxes or your taxes versus somebody who lives in Canada’s taxes are going to be very different. The one thing I’ll tell you is if you’re using a deferred account, IRA, Solo 401(k), then the money grows in there. I don’t even think my bookkeeper sends a 1099 at the end of the year. She may, but it’s for a retirement account.

Buying And Selling Partials

“Could you sell a partial on a performing second junior lien as long as the equity would cover the first and second?” You can sell a partial on anything. On a second, you could. Your level of risk goes up a little bit. Here’s the other thing too. On the seconds, how much is their payment. You have to take that into consideration. You could. I don’t do seconds. I have one second in my portfolio. That was a throw-in that the borrowers did. I’m not a seconds person. You can do it with anything, in the grand scheme of things. Would I recommend it? It depends on what level of risk you want to take. Let me ask this question. Have any of you done partials? Would anyone consider doing partials after this, either buy or sell? From both perspectives, there are some points. As an investor looking to sell partials, you get to replenish some of your cash. You are paying 8%, 9%, 10% on it, which is higher than if you could get a line of credit at a bank or something like that. On the flip side, it’s locked into that one asset and it’s like a JV deal.

If you’re that person with that one asset, so you’re riding that asset and so forth, but it’s performing, you shouldn’t have major problems. I’ve had 30 of these and I’ve never ran into, knock on wood, any problems and so forth. Have I had people miss payments and so forth? Yes, I have but when you have 30 of these and buffers of $1,000 to $2,000, you’ve got $50,000 slush funds that now we’re okay if I miss a few payments, they can be made. The key thing is staying focused at I put in a separate account, so I know it’s specific for this and I’m not going to steal Peter to pay Paul from it. That’s where people get themselves in trouble. I keep things separate and manage it as it goes and follow each one. It’s good because you get to replenish it and turn around and work on the next one.

As somebody who wants to invest in these, now you’re getting stuff that you’ve got loan-to-values of typically very low if the property values are what they say. Even if they weren’t, even if it was worth half, even this thing sold for $25,000, they were the first ones getting paid. The agreement says they’re the first ones getting paid. As long as that house sold for $18,500, they’re getting their money. I may end up not getting anything out of the deal from that standpoint, but that’s part of doing business. I didn’t have anything into the deal from that component. It’s like a note. You want to make sure it’s insured. You want to keep eyes on the property. I still send somebody by every property every three months. Four times a year, I send a preservation company. It costs me $20 per property to drive by, snap a few photos and make sure it’s occupied.

Someone says, “Purchase partial provides good monthly income with nearly no maintenance, so they’re making sure the income comes in. I think rolling the partials like you’re doing is a powerful method for the long run.” You’re absolutely right. There are a lot of people out there who can be a note investor and investing in notes. People who buy partials are investing in notes. If you want be a note investor, you have to set up your systems, you have to have attorneys and everybody else. There are a lot of costs involved in that. It is a pain in the ass. That’s why you see 500 people rush into this business after taking some type of training and of those 500, 5 stick within three years. I’ve been in this for under five years and I could rattle off 25 names of people who at one point in time were all over social media about notes. I haven’t seen or heard boo from them in 6 to 12 months.

What happens is it’s a lot of work. It’s not simple and there are a lot of risks and there is a lot of management because again, all of it is out of your control. You’ve got to rely on attorneys, servicers and everybody else. There’s substantial cost with setting up that business and feeding the machine. At the end of the day, people who have $100,000 or whatever it is sitting in their IRA account, what would you tell people right now? “I’m going to go through throw money in the stock market,” or “Do you want to buy 75 payments of a loan at $230 a month at a 14% loan-to-value?” It seems like less risk. Stock market, much more upside. Your upside here is limited because it’s to that and plus you’re getting principal and interest. Eventually, you want to look to reinvest that interest component to it. You do 1 or 2 of these, it’s nice, but when you start doing twenty-plus of these as an investor, you can generate yourself some pretty good cashflow. Get your mortgage payments paid for the next twenty years, whatever it is. The only challenge is paying Uncle Sam all that stuff.

People who buy partials are investing in notes. Click To Tweet

If you did this with your IRA, you buy a performing note with your IRA, sell a partial and then keep stockpiling these payments in your IRA, now you’re not even paying Uncle Sam until you start pulling this money out. That’s another option. I would consider us a little more advanced strategy. The reason I say that is you’ve got to be very disciplined and make sure you understand notes and what you’re dealing with from that perspective. Make sure that you have adequate reserves in how to manage your business to make sure what if the 32 I have, 10 of them go nonperforming. Do I have the costs covered and so forth and so on? You need to evaluate that and not go out and buy twenty performing notes and try and flip them into partials. You’ve got to be careful. If you did that with your own money then you got your money back, you should technically still have that money there, which should definitely cover you. A lot of people sometimes can get undisciplined. When you start getting undisciplined, that’s where you get yourself in trouble.

Partials And NPNs

“How would I compare my back office for partials versus my back-office for NPNs?” I’ll be honest. With my partials, I’ve put everything in. I switched from Wells Fargo to PNC and I do PINACLE banking with PNC, so I can do ACH versus Wells Fargo. A check takes a week to get. It’s actually a pain, to be honest with you. I set everyone up on ACH now. What I did in Wells Fargo, I put in the full twelve months of payments for all my partials for that year and let them ride. Put everything in Wells Fargo and then it probably took me an hour and a half. Every payment was going out. I set it for January, February, March, April, May, June, all twelve months, first of each month. Here are the payments are going out that day.

One of the things you’ve got to be careful of when you do that is when I send checks, there are two checks for each partial, a principal and an interest. This is a key point. Whenever you pay anybody in the note space, you want to make sure you label it whether you’re paying them principal or interest. At the end of the year, the 1099, your bookkeeper, whoever, needs to know how much you paid in interest. What I’m doing in the process is I’m putting in what I call neck batch files or whatever. I’ve started putting in batch files for May, June, July of every partial I have and all the payments, and then it’s automatically set.

On the first of the month, ACH is right into their account. That’s it. Of course, I check to make sure borrowers on the loans are paying and current, but that’s part of normal business operations. I don’t have to worry about, “Did the demand letter expire? What’s the next step?” It’s no different than having a performing loan. The only difference is that the money that comes in, I’m paying some of that out. One of the biggest challenges that I had with the partials was getting an attorney agreement because you’ve got to be careful with the partials and here’s why. You’re selling partial payments that you’re keeping control of. Are you selling a security? Because they’re passive and they’re expecting payments, it doesn’t pass the Howey Test until you get the point of, which it says in my agreement, “If it goes nonperforming, you become involved in a decision-maker.” We have the discussions on what the next steps are. It reverts back to trying to make them a business partner.

A question was asked, “Services don’t distribute?” No. That’s better in some sense because if I get a March payment that the borrower makes, here’s the other thing is you do go cash negative in the sense of you’re putting money out before it comes in. Allied typical pay is around the day they get the money. If you use Madison, that payment comes in March 1st, you’re not seeing it three weeks later. If you’ve got 10 or 20 of these and you’ve got a servicer sending payments and the payment isn’t made to them, that person could say, “My payment wasn’t made.” I’ve got to figure out what’s happened. It’s ten minutes of time times ten. It’s 100 minutes you spend an hour and a half each month, at least chasing down money. I cut to the chase with that and it would be like, “No. Money comes in to me, money goes out to them.”

It’s almost treated as two separate transactions in the way I manage it. My deal with the borrower is one and my deal with my partial person is another. They’re still connected, but if this one fails, what am I doing here? I’m not solely relying on this to do this. If this one is two weeks late, the person still gets paid. When you’re dealing with IRAs and stuff, because it takes them time to put the money in the account, you would spend your entire time fielding phone calls that would be, “I didn’t get paid or why do I only get paid this amount this month?” or whatever it may be. When you’ve been around this business a long time, you’ll realize that you try and keep what your servicers do. This is not to knock the servicers. You’ll find that you want to try and keep what you have them do limited to the least amount possible because the more that people do, the more potential there is for errors.

I’m curious if anyone has partials, if they split it and have the services. I know some people turn around and sell a partial, they give it to that person to manage and it’s like, “It’s your note. You’re managing it now.” I’m like, “No,” because I’ve got backend interest in this thing. I don’t want somebody who has no clue what they’re doing, trying to figure something out, especially because it’s nonperforming. If someone said if I were to sell partial from IRA, I want to have an IRL LLC. Your IRA should already be an LLC if you have one. Whether it’s with new View Quest or whatever, you already are an LLC.

“401(k) is a trust?” It is a trust but it’s an LLC. Do you have any EAN number? I have a Solo 401(k). Seveney Construction, 401(k), LLC trustees, Christopher Seveney. That’s why I also like using my IRA for performing notes because it’s nonperforming. Your name jumps out at you on the documentation. Some people set up those what land trusts and all that other stuff. For me, I don’t because I don’t understand them and I’m not sure what benefit I’m going to have for them. On a performing note anyways, I’m not worried about having my name out there.

I hope people found this very beneficial in regards to understanding partials to target ways that you’re buying something at 12% to 15%. If you can turn around and sell components for 8% to 10%, you get to keep a piece of the sandwich and take a little bit of it upfront. “What type of agreement did you say you use for the sale of partials? Do you use an attorney where you live the draft?” I use the same attorney to do all my documents. I have one for note, CFD. They’re the same. The only difference is once this land on installment contract, the other one says mortgage deed of trust. This agreement entered on this day, so who’s the agreement? Here’s the information on the land installment contract. It’s a CFD. I attach exhibit A, which is the actual contract and documents. This is their terms.

GDNI 101 | Understanding Partials
Understanding Partials: Investing is not simple. There are a lot of risks and a lot of management required because all of it is out of your control.

 

Here are the terms of the person buying the partial. It continues to go on, prepayment. What’s their payment if it’s paid in advance? What’s the term or the rate? The other thing is default resolution. What I do is should it be in default for a period of 120 days or longer, seller and buyer must consult with each other regarding resolution strategy for defaulted asset. It’s not selling security because you’re involved. Similarly, buyers and sellers should discuss entitlement. Parties hereto agree that in default I can care to default and terminate the agreement within 60 days by paying them in full, continue paying them if I want or pursue foreclosure at my sole expense and the conclusion, pay them their fee.

When you start getting undisciplined, that's where you get yourself in trouble. Click To Tweet

In essence, I technically could stop paying somebody for 120 days. After 120 days, I have to keep paying him off or pursue foreclosure and pay them off. What I’ve honestly done typically is continued to fund. Good fun stuff that’s in here. That’s the Notes and Bolts of it. It’s a six-page document, which actually is four pages because I have the exhibit A and exhibit B page as well. It’s a pretty simple document in that sense. Brian Gallagher is my attorney from Baradel. He’s a real estate attorney. He’s very involved with notes, represents some hedge funds and stuff like that as well. He writes up all my stuff for me. Thank you all for joining me. If anything comes up, let me know.

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