I think part of the reason is because the secondary market for notes is relatively opaque and there isn’t an Amazon.com for notes, so pricing isn’t as efficient as it is in some other markets. Sometimes requested pricing is driven up because the seller paid too much when they bought the asset and they don’t want to take a loss. Or pricing can be high because the asset manager is content to work out the asset on their own, and are only willing to sell them off if they think that will yield a better profit. There can also be other dynamics going on within the selling firm that drives their pricing down. Are they in the process of liquidating a fund or portfolio? Do they need to free up capital to purchase a new pool of notes? Or are they fat dumb and happy with where their portfolio is but may sell off a few things opportunistically?
At the very beginning of this year I bought some performing notes from a seller at reasonable pricing levels. When I tried to buy from them again at mid-year they wanted 90%+ of UPB for performing notes, and 65%+ of value for non-performing notes. I wasn’t sure what happened, but figured I wouldn’t be able to buy from them again because their pricing expectations had become unreasonable. Then last week I was able to buy 2 very high quality NPNs for ~55% of value. I don’t know why their pricing expectations changed. Maybe they are clearing some inventory out during the fourth quarter? So pricing not only varies between sellers, but can vary for the same seller depending on when you are talking to them.
Overall market behavior will also change over time, based on the state of the real estate market and how many non-performing notes are out there. The price you could acquire a given note for four years ago may be different than what you would have to pay for it today, and there may be yet another market price for a similar note in the future.
So What Should a Note Investor Do?
At the end of the day, it doesn’t necessarily matter what the sellers reasons are for trying to get a certain pricing level. Here are some things that you should be doing to understand what price you can or can’t pay for a given asset:
- Have a solid model for analyzing note deals and stick to it.
- Make sure you understand what kind of assets you are looking for, what your preferred exits are, and then make sure you can predict with a reasonable accuracy what your returns should be for various exit scenarios.
- Talk to lots of sellers, and just pass on the expensive deals.
- The more sellers you talk to, the more you will find with assets that meet your pricing criteria. Don’t get discouraged if you run into several sellers in a row with unrealistic expectations. If you keep looking you will find assets you can buy at a good price.
- If a deal fits your model and gives you an acceptable return, take the deal.
- If you understand what returns you need, and have a good model to predict those returns, then you should accept deals that meet all of your criteria. I talk to a lot of note investors who lament that pricing is higher now than what it was 4 or 5 years ago. It would be nice if pricing was lower, but don’t allow yourself to get anchored on market conditions of the past. If you have done your homework and the deal makes sense go ahead and do it. Whether you could have found a better deal 5 years ago is completely irrelevant. I could rant for much longer on this one but I’ll stop here…..