We are in the midst of uncertainty. Collectively all over the world, we all have been feeling the disruptions caused by the COVID-19 Pandemic. It is testing almost all institutions, such as healthcare and finance. In this episode, Dan Deppen goes over his current thoughts on the crisis, and how it may impact the note business. He covers short-term and long-term impacts, as well as how it may affect the supply and pricing of notes. Pointing you out of this dark tunnel in the near future, Dan then provides some great advice that will help prepare you to take advantage of the opportunities waiting to arrive.
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Thoughts On The Current Crisis
Observing The Market
I’m going to be talking about some of my takes on the crisis and where things might be going. It’s definitely a unique time in the world, in the note industry in particular. Certainly, nothing like I’ve ever seen. I don’t know that anybody has ever lived through anything like this unless you’re over 100 years old and you were around in 1918. I’ll talk a little bit about what my thought process was heading into this before I even knew anything was going to happen and then where things might be going overall. I’ll talk about some of the things that I’ve been observing in the market. The first thing I noticed was not even related to notes, but the whole thing with hoarding food and toilet paper annoys me. I’m amazed and disappointed at how people are able to do that.
The toilet paper thing, in particular, is stupid on a number of levels. Number one, it’s not even a necessity. Number two, there’s not a shortage. It’s interesting to me that the trucks are still running. There’s no threat of it running out and they’re even cranking up production. My wife was at the grocery store and they didn’t have any in there. When I was at Costco getting regular groceries, it was interesting looking around and it seemed like most of the people had toilet paper and in some cases, multiple packages of bottled water. I don’t understand that either because this isn’t the thing that affects the water supply. I’m pretty judgy when I’m walking around the store looking at some of the things that people are doing. It’s fascinating to me how a lot of people seem to have lost their minds.
I grew up in Florida and we used to have hurricanes and then the threat of hurricanes where people will be scrambling for supplies. Even then, it’s a little bit different because in a hurricane, you’ve got the threat of physical destruction. Power lines going down and going off, structures getting destroyed, flooding issues with the water supply. In those situations, I totally understand why you’re getting any bottled water and maybe bags of rice or whatever. It’s something like this, it makes zero sense. I’ve been very disappointed with a large segment of the public. I had to get that out there. I would love for a psychologist to explain some of that behavior because I simply don’t get it. I understand people being fearful or being concerned about loved ones who might not be in the best of health already and be particularly susceptible to having problems. Some of this stuff of hoarding things that don’t even relate, I don’t understand. I would not have expected that.
I want to talk a little bit about the note market. Leading into this, my thought process and my thesis over the last months have been that the note market had been pretty tight. We’re more than ten years from the 2009 crisis. That whole backlog of nonperforming loans had been worked off or anything that was still remaining was probably not something that you wanted to touch. We’ve seen a decrease in the supply of notes available and an increase in pricing, which has made it a little bit of a challenge to find good deals. However, I’ve still been able to do that. A number of other friends in the industry have been able to find deals as well and make money in the industry. My theory was if I can make money and build a note machine that’s profitable when the market is very tight, then when we get to the point where there’s another recession, it should work that much better. I’ll be able to scale it up and make even more money.
My thoughts were that we’ve been overdue for a recession for a while. Back in 2017, I started moving some money out of the stock market because I was concerned about how high the stock market had gone and I had invested through the dot-com boom and bust years ago. The ‘08, ‘09 crisis, I know how startups can pull back 30% in the blink of an eye. We’ve seen pretty wild swings in the stock market, although I still do have a significant amount of funds in the stock market. It’s not like I exited it. My thinking was we were overdue for a recession. It’s been over ten years. I spent a lot of time looking at economic data. I’ve always done this. It’s almost a hobby. If you look at charts of all the recessions since World War II, they tend to come along every so many years. We were overdue. That had been a long run without one.
The effects of the pandemic on the economy are going to be a lot larger than what people realize. Click To TweetWhat I had seen the economy was it seems like a lot of investors, a lot of people still had a lot of cash. Typically, when you head into some economic crisis or recession, it’s usually because everybody’s over-leveraged and everybody runs out of cash. The music stops and then asset values start to drop and people can’t cover loans. People are forced to sell assets. That drives prices lower and you get this cascading effect. This situation is a little bit unique in that we weren’t that over-levered. What I was expecting to happen at some point, either right away or within the next few years, was that we would have a mild recession. Maybe a recession that was more similar to the one around 1991, ‘92.
I figured at that point, the foreclosure rate will go up. Some amounts of foreclosure rates have been extremely low and you’ll get some more nonperforming assets on the market. Nothing remotely like 2009, but that probably would increase a little bit. Prices would come down somewhat and then I could turn up the volume on my business and conditions would be a little easier to operate. I’ve been trying to get ready and build my machine for those types of conditions. Now the territory rent is way different than that. I don’t think we’re looking at a mild 1991 type of recession. You look at the economy shutting down with all the quarantines, which is unprecedented. There’s never been anything like that before.
Individual consumption is something like 70% of the economy. To have a ton of that ceased is going to be nuts. Some of the estimates and the GDP drop from the banks vary a lot. Where I’ve been getting a lot of my news is from The Wall Street Journal. I get this email where they’re showing updates to all these charts and then also what some of the big banks are thinking. The contraction in GDP is going to be like nothing seen since the late ‘20s, early ‘30s. The way a lot of people are looking at this is this is a temporary thing. As soon as the virus crisis is over and they lift the quarantines, everybody is going to go back to work. You’ll see this V-shaped where the activity goes down and then it fires back up.
Take Advantage Of The Coming Opportunity
There’s some truth to that, but there’s going to be a lot of underlying damage. There are going to be a lot of secondary and tertiary effects going on that are going to be hard to predict. I’ve seen a lot of note investors on Facebook and in other places who seem to think that it’s going to be something relatively transient that passes quickly. I’m in a little bit of a different camp there. In the short and medium-term, I’m probably more pessimistic than most about the economy. The effects of the economy are going to be a lot larger than what people realize. At the moment, I’m continuing to monitor the situation. I’m still bidding some things, but I’m not going too crazy trying to buy assets until we get a little bit better idea how this is going to shake out.
The big thing though is while I’m more pessimistic, most people I’ve talked to in the short and medium-term, they’re going to ultimately be a lot more particularly nonperforming assets sitting in the market at some time in the future. It’s going to take a while for those to work their way through the system. It can be twelve months plus until the opportunities trickled down to the part of the market where we can participate and pick up some good discounts. I’m not so much worried about trying to pick up deals over the next few months. If I find some good ones, I’m definitely going to grab them. What I’m trying to do is make sure I’m in a position to take advantage of what is a much larger opportunity that could come. This stuff is super hard to predict. The opportunities are ultimately going to be far greater than what some people seem to think, which is good news for note investors.
What that means is you want to basically get your house in order now, get your processes and procedures dialed in so you’re ready to move. Be able to do due diligence and pricing quickly, cultivating relationships with sellers and do all that stuff. When the opportunities hit, you’re ready to go. When the assets start hitting the market, you’re going to see all people who are brand new to it say, “There’s an opportunity here. Let me get in here and figure this out.” By the time they get it all figured out, they will have missed a chunk of the opportunity. I highly encourage everybody to do their homework now and get ready. I’m not so much worried about missing stuff in the near term or the next few months. This is a big event and there are going to be lots of opportunities. Nobody is going to miss out and I would not be too influenced by people who are out there talking about, “I’m not afraid of this crisis. I’m out there buying right in the midst of it.” That’s good for them, but don’t feel like you’re missing out on anything because I don’t think you are going to at all.
As far as what I have been seeing so far in my journey into this crazy crisis, I was a little bit lucky in that I had exited a few deals right before all hell broke loose. I sold 3 or 4 REOs and one of them closed on March 17, 2020 after the crisis had started. I was a little worried that the buyer was going to back out, but they didn’t. They closed. I only got one REO. That’s a duplex where half of it is rented out and I’ve been collecting rent on it. At least so far, I did in March. We’ll see what happens in April. That may or may not change. My renter, the local restaurants, they might be shut down for a little bit. If that’s the case, I’m going to work with them given everything that’s going on. I also sold a note and I had that close in the middle of the crisis as well. I thought maybe that buyer would get squirrelly and back out, but he’s followed through as well. That’s all been nice.
Monitoring Payments
The other thing I’ve been monitoring is the payments that have come in my performing loans and most of my loans have been performing. I was surprised the second half of March how many borrowers made payments. If I had bet ahead of time, I would have thought a lot more would have missed. We’ll see what happens in April. I expect things to change a lot. One of the things that I’ve been asked about too is, “How do you deal with borrowers in the midst of this?” A lot of borrowers are going to miss payments because their work is going to be affected by this. A lot of people are stuck at home, particularly hourly workers who make a large percentage of my borrowers. People have asked if they should be proactive and reach out to borrowers ahead of time. I’m not doing that because my concern with reaching out to a borrower preemptively would be you might give them the idea that it’s okay to miss. I don’t know who’s affected and who’s not. Some borrowers may be tempted to say, “I’m affected. Can I get a break? Can I get some free months of living here or whatever?” My plan is to monitor the situation and then when someone does miss a payment, then reach out to them directly and see what’s going on.
My approach will be, “You missed a payment. Talk to me and let me know what’s going on. I’m willing to work with you, provided you communicate. If you miss and don’t communicate, then we do what we normally do in those situations.” Different people’s opinions on this vary, but I’m not trying to be proactive because I’m worried about inducing borrowers to miss payments if I do that. I have seen another number of sellers put assets on the market. A lot of the tapes that I’ve seen are ones that people had put out in the last few months and wanted pricing that didn’t make sense. Now there are companies like, “No, I want to sell it.” I’ve stayed away from that stuff. A lot of those assets to have tended to be junky, recycled stuff. We’ll see how that goes if anything better shows up. I’ve not been doing any specific asset manager outreach because I’m monitoring the situation.
Mapping The Market
I also had some discussions with my investors and partners. They were all a lot more game to do deals than I would’ve expected. I thought maybe everybody was going to sit back and not look to do anything for a while. A lot of people are interested in doing things provided that they make sense given everything. I’m being careful of the assets that are getting recycled and hitting the market. Some of the things I am doing is I had a project underway prior to all this where I’ve been mapping a lot of the note market and doing a lot of research in some of the recording sites and drawing a map of where notes come from and where they go and how they flow. I discovered a lot of interesting things in that study.
Performing notes are riskier right now because you're going to have borrowers who've lost their income and can’t make payments. Click To TweetOne of the things that was interesting about that study is how the sources of notes tend to evolve over time. In 2014, ‘15, you saw a lot of people buying from Condor, then it switched to Granite, then to Harbour Portfolio, then it switched to Window Rock and home opportunity. The question in my mind before all this went crazy was, “What’s the next thing going to be?” Because Harbour shutdown and Window Rock and home opportunity are done and what is left over is not worth looking at in my opinion. I’ve already looked at it 27 times. With all of this happening in a lot of the non-QM lenders, some of them have already declared they’re going belly up, which I find interesting. We’re not even that far into the crisis. A couple of things I do find fascinating. As soon as everything broke loose, they’re not a loan business, but Boeing had their handout for help from the government two days into it. You see some of these non-QM lenders throw their hands up right away, which I find funny because we haven’t hit all the effects of the crisis. If you’re that fragile and you’re going down that quick, that’s probably not a good sign.
Since the crisis broke, I’ve been amping up those efforts to map the market and look at who owns these types of riskier assets. They’re going to be more likely to go nonperforming and who might be selling them and who the contacts are. I found some interesting software. I’m not going to dive into in-depth, but I found some interesting software tools that are enabling me to pull phone numbers and emails that I’ve never been able to get access to before. I’m building that database and building that battle plan. Before too long here, I’ll start putting that into motion to hopefully find some good deals as they began to become available. I’m trying to set myself up for that long-term. I’ve also been beefing up a lot on my systems and processes. I’m updating a lot of my LinkedIn stuff and then some of my email marketing and other things. I’m doing a lot of deep dives into digital marketing and even spending some time looking at potential non-notes-related business that I’ve been thinking about for a while. I’m starting to run some experiments related to that using Facebook ads and lead pages to gauge the market in this area to see how much interest there is.
Everything has slowed down and will probably stay slowed down, I encourage everyone to keep doing stuff. Use it as an opportunity to spend time on a lot of these things you may have had in your backlog or things to do but haven’t had the time to sit down and do them. That’s what I’ve been doing. As far as the business, it’s still business as usual, monitoring a loan. I’ve got a bunch of tax reports from pro titles, so I’m monitoring delinquent taxes and taking care of those and doing all of my normal activities that I keep track of in my CRM. I’m following up when borrower’s insurance are set to expire to make sure that they renewed it or else put force-placed insurance and all that stuff. It’s been nice because the general level of email traffic has slowed down. That’s freed up a lot of my time and a lot of my mental space to get things dialed in.
Whenever this is over, and you don’t know when that’s going to be, I’ll have Fusion Notes dialed in, running smoothly. It’s nice not to have this backlog of emails and tasks in my CRM to do, which I never seem to quite keep up with. I’ve got that pretty well under control. I’m doing some things to set that up to make it easier to manage in the future. I’ve been able to tackle some of these projects that I’ve been wanting to do for a long time and never had the time to do it for not coming up for air. I’m setting myself up for the next wave of acquisitions rather than running out and trying to buy stuff right in the midst of this market where there’s a lot of uncertainty.
Pricing Changes
The next thing I wanted to talk about was pricing and how that might change. As we came into this crisis, pricing was as high as I’ve ever seen it. Not that I’ve been around for that long, but pricing was very high and the market was very tight. Now I expect pricing to change. The first thing I talk about is performing notes. Performing notes are the riskier area because even a lot of the solidly performing notes, you’re going to have borrowers who’ve lost their income and there’s going to be nothing they can do to make payments. I don’t know how many, but a lot of those are going to go nonperforming. Those get dicey. If I was going to buy performing, I would want a solid pay history, which would indicate to me that even if the borrower lost their job, when they get that back on track, they’ll begin paying again.
I would want some discount because I would be assuming that I’m probably going to miss some number of payments in there more than likely. A lot of loans won’t miss at all. If you look at the averages. Let’s say you go out and you buy 1,000 performing notes, not that I’m ever going to buy that many anytime soon, there will be some percentage that don’t miss a beat. There will be some percentage that miss some number of payments because the borrower had a job loss. There will be some that the borrower throws their arms up in all this and they go completely nonperforming. It’s a matter of sitting down and thinking about what those percentages are on those probabilities and then adjusting your pricing to take that into account.
At any given note, you’re not going to know how all of that is going to shake out. Exactly how to price those is a little tricky. I myself am staying away from those for a little bit. On the nonperforming side, there’s a little bit more to work with. On the nonperforming side, we’re seeing a lot of moratoriums on foreclosures and evictions. This is one of those areas where I’m not going to try to talk about it in detail because this stuff is changing day by day. I know they’ve announced some things for FHA loans, GSC loans and then there’s a lot of county by county actions. What I’m doing is I’m assuming that anything that’s coming up on a sheriff’s sale will get delayed by probably a few months and then evictions will get delayed by probably a few months.
As far as that leads into pricing nonperforming, your timeline is going to get longer. With that, your holding costs go up as well. The other thing I’m factoring in is a reduction in the real estate prices. A lot of the assets that I’m buying that are sub $100,000 houses, those aren’t going to fluctuate as much as a $2 million house in California, but there’s going to be some change there. You want to have that factored in. If possible, the value is going the other direction. I’ve talked to some people who are very smart and know this stuff very well. They said, “The Fed is printing so much money that the value of hard assets like real estate will go up.” That would be great if the value of the real estate did go up.
In talking to some folks and some top 1% Keller Williams realtors, prior to all this breaking loose, they were looking for housing prices to dip down at some point as we move into some recession because the values have been on such a tear for the last ten years or so since the previous crisis. For me, I’m banking in being extra conservative on my values of the property. I’m doing that anyway because it seemed like every REO I take back, they’ve all sold for less than what I predicted ahead of time. In some cases, a lot less. I’ve had some real surprises on the interior condition of some properties. I’m going to get probably even more conservative on the values and then assume that the timelines are going to stretch out. As far as buying stuff, I’m going to adjust my prices as I see fit. I’m going to be conservative here for at least a few months. That’s the buyer side of the market, but you’ve got to have someone who’s willing to sell to you at those prices.
What is going to happen is sellers will move their pricing down somewhat, but it’s going to take time for them to lower pricing to a point that makes sense and has value. Some of the discounts I’ve seen offered so far, they’re discounting it a little bit, but I don’t think that makes sense given the amount of uncertainty in some of the things that the economy is facing. That means I may not buy a whole lot over the next few months. I may not buy anything at all and I’m totally cool with that. I’m very content to sit on my hands and do nothing for a few months as far as buying if I need to. I’m going to be building my relationships and building my map of sellers and improving my tools and processes and be ready to go big when the real opportunities hit the market. It could easily be twelve months down the road. I’m not interested in doing a handful of deals that might be thin. I’ve had a few deals that have gotten a little bit sideways. It’s interesting how the deals that I don’t make any money on end up taking up most of my time.
Understand your pricing, understand your model, understand what you're doing, and then act. Click To TweetThe deals that are big winners, not only do you make a lot of money off of those, they tend to not suck up a lot of the time. I don’t want to get bogged down with deals that might end up being thin and being big-time sucks depending on how they go. I would prefer to do a lot less for now and then at some point in the future, back up the truck and by a couple of million dollars’ worth of loans at juicy prices and then execute well. That’s how I’m viewing the market. I know that’s quite a bit different than most of the people that I’ve talked to out there. They may be right. I may miss out on a ton of stuff and that’s okay because there are always opportunities in the note market. There were opportunities when things were super tight and there are going to be opportunities in the future. Understand your pricing, your model and what you’re doing, then act. I’m not saying get frozen up, but don’t necessarily worry too much about missing out either. I will still buy.
The key is to be very opportunistic because you’re going to see some sellers freak out here. The economy is shutting down in a way that it never has and you’re going to have all kinds of effects. It’s not only people not being able to make mortgage payments. Multifamily is going to get hit, I would assume. Although the multifamily people I know don’t seem worried at all, which I don’t understand. That’s not my market, so I’m not an expert in it. Maybe there’s a bunch of factors there that I’m not even aware of. Think of all the small businesses and the restaurants and the other mom-and-pop businesses, they’ve been forced to close their doors and this may go on for a couple of months. Not many people have the cash sitting around to do that. That means they’re not going to be making rent payments on there. There’s going to be a big impact on commercial real estate. In fact, the commercial real estate opportunities and notes could end up being bigger than the ones in residential until this is all over. I haven’t started doing this yet, but it’s on my list of things to do.
It’s been on my list of things to do for a while, but I need to start wrapping my head around commercial notes a little better, which I know they have a lot more degrees of freedom and a lot more going on. Residential, I’ve been staying in my lane. We’ll see a lot of commercial loans going bad too. This is going to put a lot of pressure on banks. I know the government is going to print unlimited money, but we’ll ultimately have to see how all of this shakes out. There’s going to be a lot of secondary and tertiary and other effects that are probably hard to predict. The overall impacts can be bigger than some things. During the quarantine, it’s interesting for me. I know for a lot of people, it’s tough because they’re either stuck at home and they can’t do their job from home or a lot of people are working at home and they’ve never done it before. For me, it’s been better in a lot of ways.
I’ve been working at home for months so it’s not much different from that perspective. In past jobs, there were times where I would work from home for certain weeks or periods of time. When I worked at Oracle, I used to work with a group that was based in the Bay Area, California and I live in Colorado. A lot of times, there was no point in going to the office because everybody I worked with was somewhere else. For me, it’s old hat and not that big of a change. I like it because now my wife is working from home and my kids are home from school. It was nice for me because typically I’m in a house by myself all day. I’ve got three other people in the house. It’s more social for me instead of the other way around, like for a lot of people. That’s been easy to manage.
I’ve always been focused on diet and exercise, even more so in a lot of cases now. I’m doing two a days. I did a lot of working out over the winter and got my fitness to a pretty good spot. I’ve been lucky too, I haven’t had any injuries. Now I’ve been cranking that up. The golf course I play at stayed open for a long time and then closed. It opened back up but no practicing. I’ve been hitting a lot of balls when I could and I’m thinking of a lot of ball speed, hit the ball a lot further, which is nice. Once we get back to a regular season, I can get back out there and play some tournaments. I should be able to do some damage, so I’m setting myself up for that too. I’m also doing a lot of random house projects and cleaning things out. I cleaned out my closet, which I tend to do every year or so. By the time this is all over, I should have a pretty squared away garage, basement, office and the rest of the house.
I hope a lot of you are doing the same thing and hopefully, you’re taking care of yourself. I know some people have talked about this. They tend to sit around and watch TV and eat junk food and that’s bad. I’ve been eating better during all of this because one of the things when you’re not running around or eating out, you can control your diet. I highly recommend you do that. Buying good food hasn’t been hard. Buying good proteins and fresh veggies has not been an issue. People are wiping out the frozen pizzas and toilet paper, which is pretty silly for me. Hopefully, you are being able to keep your business under control. Take some time, do a lot of things that were maybe on your list but you haven’t had time. Even tackle some new projects as well and learn some new skills. That’s what I’ve got for you for now. I’ll be back with hopefully some interviews from extremely unique people to get their takes on this crisis. I’ll continue to monitor it until it goes along. Until next time, definitely stay safe and be careful.
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