Early in my note-buying career, I learned many valuable lessons that I would like to pass onto my blog readers. Certain lessons stick with you forever.  One of the best lessons I took to heart was - small notes are often the best.  I've been in this business over 20 years, and I'm still following this advice.

The advantages of small notes are many but often hidden.

For example, institutional investors most often kick junior liens out of underwriting.  Because of this - very few "private investors" or brokers seek out small notes probably because their institutional investor disqualifies them.  The advantage is that I have far less competition.

Other benefits to buying small notes are bigger discounts with higher yields. One small note has the potential to put you in control of a single-family house that you can put in your self-directed IRA, with very attractive "senior position" financing.  In addition, small notes prospects may be the holder of larger notes.

A handful of small notes can create multiple "opportunities" to negotiate better transactions.  This restructuring can be something as simple as restructuring to induce an earlier pay off.  In addition, small notes allow you to spread your investment capital over a number of notes.  This is good during times when the market might be fluctuating.

Are there disadvantages?

In the same breath there are disadvantages to buying small notes . . . basically the opposite of the advantages stated above.

One disadvantage to the small note is the closing cost per transaction.  The same amount of paper work and documentation is needed for five notes rather than the one, and at an average closing cost of $500 +/- per transaction, your closing expense are magnified by the number of small notes you are purchasing.

Another disadvantage could come from a large senior lien (note), that is ahead or larger then your small note.  This senior lien could greatly increase your risk should there be a default.  Institutional investors stick to the 2:1 ratio (1st to 2nd) for this reason.

Conceivably - in the case of a default, you could spend $150,000 just to protect your $20,000 investment.  You could save a large outlay of your investment capital by foreclosing "subject to the first."  This means you would need to bring the note that is in first position - current by the number payments past due, plus pay default expenses and, if incurred, attorney fees. Then you would have to continue to make the payments on the first note during the notification and redemption period, and during the time it takes to sell the property.  (Don't forget realtor fees and other closing costs).

In my underwriting articles, I explain these risks and the importance of in depth analysis in more detail.  Armed with this information, you can make educated decisions before you accept or turn down a small note.

What Dollar Amount of Note Should You Buy?

The Paper Source, the note-buying industry's leading newsletter, www.papersourceonline.com provides a list of the maximum purchase amount per note for most institutional investors (The range is $300k to $500k maximum average, but a few say "unlimited").

When looking for leads, I open the list up and do not let the data source restrict the size.  By knowing that I can always broker a note I do not have financial capability to buy, I get a full spectrum of note information for my search.  Because I also do not tell them to strip duplicates out, I find holders of multiple notes.

In addition, my State's population is smaller than most, so I mail to every potential note seller and Land Developer I can.  Don't get me wrong however.  For a private investor on a limited budget, scaling back by limiting to local counties or limiting the notes' dollar amount is very acceptable.

Outselling the Large Institutional Buyer

Another reason I like small notes is that I can outsell the large institutional buyer.  It is a good thing when I hear the note seller say they got "30 letters from companies like mine."  Experience tells me that 90 to 99% of these letters are from "out-of-state" buyers.  As a local investor, I find it is easier to take business away from large institutional buyers then other local companies.

That doesn't mean I get every deal that comes across my desk.  However, those out-of-state, institutional note buyers typically disqualify the note seller in the first few minutes of the call, which makes them appear nasty and uncaring.

Maybe they are trying to save the company money, or they mail to so many people all over the country it requires a short phone conversation.  I don't know; but the feedback I get about these large company buyers is they rarely bother to say, "Thanks for talking with us" and they are "very quick" to disqualify small note sellers.  This leaves the seller with a bad impression--giving me the opportunity to be the "caring professional."

How hard is it to convince the average local private Note Seller or Land Developer (assuming everything is just about equal) to do business with you?  Not hard if you are local.  Especially a local person, who is a member of the BBB, operating a business registered with the Secretary of State, with the financial backing of the largest and most experienced institutional investor in the country.  I point out this entire list of facts in one statement during my call.

"Mr. Seller, who would you rather do business with?  A local person like myself who is registered with the Secretary of State to do business in this state -- or some 'voice' on the other end of the phone... in Florida.  I'm only an hour away and better yet, you can check me out with the local Better Business Bureau."

Please note: there is nothing wrong with the State of Florida, but to the average note seller / Land Developer, any state - other than their own - seems a long ways away.

AND if you would like to learn how I and other veteran cash flow buyers find notes -- field-tested techhiques that really work in the real world, techniques we use every day -- join us at the Paper Source Note Symposium:  Finding Notes & Marketing Your Cash Flow Business, April 28 - May 1 in Las Vegas.  Go to www.PaperSourceSeminars.com or call 1-800-542-2270.

---