Economic Cycles and Note Portfolios - Posted by Stacy (AZ)

Posted by John Behle on November 23, 1998 at 12:41:28:

I’ll send you some details

Economic Cycles and Note Portfolios - Posted by Stacy (AZ)

Posted by Stacy (AZ) on November 16, 1998 at 17:52:53:

As the economy cycles though buyer’s and seller’s markets, and low and highly inflationary periods, are there strategies to follow regarding note portfolios? I’m fairly new to the note business, still just learning, and I’m curious about the volitility of the business as it relates to the economy.

If I would start my portfolio now, and over the next year or so accumulate some of the good notes described in the posts and articles here, would I need to do anything with the existing notes if the economy starts a down cycle? How about buying and selling new notes in a down-cycle? Are there different strategies for finding notes or funding sources?

The note business seems to parallel hard real estate investing to a large degree. However, are there differences for which one should plan ahead of time in order to be positioned correctly in a down-cycle?

Would I sell-off the lower producing notes to take advantage of bargains that could be had when the market changes? Or am I trying to make an analogy that doesn’t exist?


I Love “Refunding” - Posted by John Behle

Posted by John Behle on November 17, 1998 at 12:33:21:

Here’s the article I mentioned.

I love “Re-funds”
(By John D. Behle)
A student in my training program had questions about a section of my book “The Paper Game.” As I read through it, I realized it helped to illustrate the potential yields and profits available through “Improving” paper (private seller financing or discounted mortgages).

One of the most profitable areas of paper is “re-funding”, which is the term used by portfolio managers when loans pay off early. For C.M.O.'s it’s a nightmare they don’t know how to solve. For us, it’s a windfall profit that is nearly impossible to duplicate in any other form of investment. If you purchased the loan at a discount - your yield can be very dramatic.

Let’s look at your yield if you trigger an early payoff by offering a discount to the payor of the note. Let’s look at a $10,000 note purchased at a 15% yield for $5800 ($5803.06).

Line 1 shows the payor paying off with a 10% discount
Line 2 shows the payor paying off with a 20% discount
Line 3 shows the payor paying off with a 30% discount


I````PMT````````PV```````FV`````````N 308.51``$73.38``$5,800.00$9,000.002 223.39``$73.38``$5,800.00$8,000.002 132.81``$73.38``$5,800.00$7,000.00```2

Sharing your profit with the person paying on the note is a sure way to up your chances of him paying off early. The chart above shows the returns if the person is offered a one, two and three thousand dollar discount. The average person might jump at the chance to pay off a loan at a discount. If they don’t have the cash, that’s okay, because we already thought of that possibility.


If the people do not have funds readily available, you will want to show them how they can refinance and make a profit by paying you off at a discount. In essence, you are buying their note at a 15% yield and selling it to them at the same yield as the market interest rates. If they make the same amount of monthly payment, the term will be shorter. If the loan is paid off early, they will realize the discount and have a substantial savings. During the time they are paying on the loan, they will have an increased tax savings due to the higher interest rate.

I``````PMT``````PV`````````````````FV``````````N 8```````$73.38$10,000.00(orig. note)````360 15$73.38$5,800.00```````(Our cost)``````360 9```````$73.38$9,000.00(9% loan)338
9$73.38``$8,000.00(10% loan)228 9```````$73.38``$7,000.00```````(11% loan)169


Okay, now let’s get really creative and find a way to make everybody more money. If the person paying on the note has equity in their property, they could be enticed into refinancing by giving them the ability to not only pay off the note at a discount, but also lower their house payment and even make more profits.

As long as they are getting a loan, they could get a larger amount and invest the difference in paper at a higher yield than the interest rate that they are going to be paying. The extra cash flow can be profit to them or can be used to pay off their home much earlier.

For you, the note has been paid off early for a large profit and you can make a profit selling them some paper. If you can buy the paper at a 15% yield, you could sell it to them at a 12% yield. Everybody profits and you have also added paper to your “paper portfolio” and “no risk investors”. You may even want to make a monthly fee by collecting the paper for them.

In the example below, the “investor” (notice how we turn a person paying on a note into an investor–that’s creative finance at it’s best!) borrows $20,000.00 instead of the original amount. We will figure the amounts based on the investor paying 10% for the money they borrowed and paying off the note to us based on a 12% yield. The payoff to us would be $7,133.54.

This would leave the investor $12,866.46 to invest at a 12% yield. The payment will be higher, but the income from the notes we sold the investor will more than offset the payment. (See “How to Lower Your House Payment” and “Paying Your Home Off Early”).

I`````````PMTPV``````````````FV`````````` N 8````````$73.38````$10,000.00````(orig. note)```360 9````````$202.85```$20,000.00````(new loan)`````180 12$154.42```$12,866.46````(invested)`````180

$48.43 difference between loan pay. and income

This increases their cash flow by $24.95 per month. This could be profit to the investor, or if applied to the loan, the loan would pay off in 144 months instead of 180–over 18 years early. Plus, the income of $154.42 would continue for three years after the $20,000 loan is paid off.

Now let’s look at the profit you would make by selling the investor the notes.


8```````$154.42$16,158.51````n/a`````180 15``````$154.42$11,033.19n/a`````180 12``````$154.42```$12,866.46n/a`````180

Difference in value $1,833.27 (your profit)

This would give you a total return of $9,113.57 (including two payments of $73.38) in 60 days off of an investment of $5,800.00. In addition, now you have a source of more paper that you can buy when you need it. This comes from $7133.54 pay off on the $10,000 note, $1833.27 profit in selling the new note to the investor and two payments of $73.38.

The rate of return here is 305.76% annually. I didn’t include any costs of title work or document preparation, but I also didn’t include the commission or referral fee you should get placing their new $20,000 loan.

By the way, if you could do this continually, your initial $5,800 investment would compound to over $87,000 in just one year. In 4 and a half years it’s over a million. A little over 7 years and you’re a billionaire. Beats the bank.

Strategies and funding - Posted by John Behle

Posted by John Behle on November 17, 1998 at 12:03:57:

There are definite strategies to follow. Some are mentioned in a post at the bottom of the page in an interchange about risks.

I buy and finance notes at a set rate. I deal with the spread that is locked in. If I buy a note at a 14% yield and borrow at 12%, I can keep that return until the note is paid. If the rates go down, I can refinance the note just like you would with real estate. The yield I am receiving is still 14%, but I may borrow money at 10% to pay off the 12%. If yields and rates increase, I may have to pay more money for the initial amount needed to buy the note.

When rates lower, a great deal of “Refunding” takes place. This is the term CMO’s use for getting paid off early and losing their yield. For them it is their greatest problem. For a note investor, it is a windfall profit. I’ll attach an article called “I Love Refunds” that addresses this a little.

If the market fluctuates as far as property values, there are some definite strategies. It is very rare for a real estate market to crash. It takes somewhat of a collapse of the national market in which case, everybody is in the same boat. It can happen when a local economy collapses or downcycles. A prime example is Washington state many years back when Boeing shut down. There was such a mass exodus that someone even put up a billboard stating “Would the last person to leave Seattle please turn out the lights”.

The side of this you don’t hear is about the Canadian investors that came in and bought up all the real estate they could and made millions when the market re-bounded.

If you are a paper investor (or real estate) you want to be aware of the possiblities of too much reliance upon a particular employer or industry. In my area, I am leary of notes that are too close to a large steel factory nearby. At the same time, I am extremely comfortable with notes near BYU that would never be shut down (except in sports).

In general, as a note investor you run the same economic risks of a real estate investor - except - you are sheltered by the equity. If a market dipped 20% in property values many real estate investors would be wiped out. Paper investors would only be beginning to be worried - since their equity is below or in front of the owner’s equity.

If a market started to turn, you could start requiring lower LTV ratios or choose not to buy notes, but to broker only. You could sell off a good portfolio in a matter of days. I love the liquidity of notes.

Beyond all this, is the fact that my long term note portolio is not “long term”. It is constantly being improved, “refunded”, and is very liquid. That is too much to get into here, but the article should help.

Re: I Love “Refunding” - Posted by Redline

Posted by Redline on November 21, 1998 at 20:59:27:

“By the way, if you could do this continually, your initial $5,800 investment would compound to over $87,000 in just one year. In 4 and a half years it’s over a million. A little over 7 years and you’re a billionaire. Beats the bank.”

John, this all sounds really interesting and you’ve definately made me want to find out more about the paper business (for sure). But one question: These returns you show are huge. It’s hard to imagine then why anyone would be involved in other RE when you look at these numbers. How many people do you meet in your travels that are truly making a million plus off paper? “If it were that easy, we’d all be millionaires!” I’m NOT trying to be negative, I’m just doing my “beginners due diligence”. I plan on investing my time learning more from you about this biz.


Most do it at a very basic level - Posted by John Behle

Posted by John Behle on November 22, 1998 at 24:32:08:

Most paper investors are not truly investors. They make their money brokering the notes as a job. Most of the investors are just large brokers. They package and pool the notes and either sell them, finance them or sell an interest in them.

VERY FEW people have any idea of the techniques I share here. The number of people in the paper market has increased dramatically the last few years - while at the same time, the level of education and sophistication has lowered substantially. Sure, there are a few more creative funding techniques for those that sell notes, but not much more than that.

So, with the current state of the industry, the “upside” for most brokers is winning the cars and prizes given away each year by the funding sources.

VERY FEW individuals are amassing portfolios of paper. Those that do are highly successful, yet most of them do not have the type of knowledge and techniques we discuss here.

One of my franchisees was hyped into attending an “Advanced” seminar a couple years ago before a Noteworthy convention. He fell asleep. That’s just to illustrate, the average person in paper is just scratching the surface. By the way, the student that fell asleep made 100k his first year in the business and was making 60k per month by his third year. He buys, finances and improves notes.

Re: Most do it at a very basic level - Posted by Darrell

Posted by Darrell on November 22, 1998 at 12:08:26:

In a couple of your posts you’ve referred to your “franchisees.” Do you mean to say students, or do you actively franchise?

Re: Most do it at a very basic level - Posted by John Behle

Posted by John Behle on November 22, 1998 at 13:01:54:

We franchised the note business back in 1993. After spending hundreds of thousands to get the franchise up and going, they radically changed the franchise laws. I decided I didn’t want to spend more fees and didn’t need to. Another attorney researched the situation and suggested we could do all we needed with a branch office or license agreement and did not need the cumbersome, costly franchise structure.

I also decided that unless or until I found a test that could tell me who would be successful or not, I would not venture the resources and expenses in training someone so intensively and dedicating a territory of the country to them. I also found it had to be structured very different from how most franchises are.

Some that I thought would be superstars never put forth the effort. Others that I somewhat reluctantly agreed to let into the program were immensely successful. Only when someone proves themselves step by step can you be sure. It isn’t about intelligence. background, charisma or skills - it’s about “intention” like I mentioned in the article “The 3 Most Important Ingredients of Success”.

My solution is to just continue training people through my one year “Associate Training Program”. As students show they have the drive and begin being successful in the program, I will then discuss a branch office relationship with them.

Associate Training Program - Posted by Mark

Posted by Mark on November 23, 1998 at 14:03:46:

Could you please post some details of your “Associate Training Program?”

Re: Most do it at a very basic level - Posted by Darrell

Posted by Darrell on November 23, 1998 at 09:56:25:

Could you post some details re your “Associate Training Program?”