Nine notes of rural land paper, and I think my discount is too thin

Package came from an operator who's been flipping recreational parcels for about six years and wants capital back to buy more. Nine performing notes, total unpaid balance $191,700, average balance $21,300. Coupon on all of them is 9.9%, terms are 84 to 120 months, seasoning ranges from 4 months to 26 months. Down payments on origination ranged from 6% to 14% of sale price.

He's asking 72 cents on UPB, so about $138,000. My first pass yield to maturity on that is somewhere near 18% assuming everything pays as agreed, which nothing does.

What's bothering me is the collateral. Every note was originated at a price that included the owner-finance premium, so the parcels were sold at something like 20% to 40% above what a cash buyer would have paid. Three of the nine are in one county where I can find almost no closed sales at all. If I take a parcel back at a balance of $19,000 on ground that cash-sells at $12,000 and takes seven months to remarket, my recovery on that note is well under par even before the cost of the takeback.

Instruments are mixed. Six are contract for deed in one state, three are notes with deeds of trust in two others, which means my remedy and my timeline are different depending on the file, and I'm having a lawyer in each state look at that.

Where I'm stuck is the loss assumption. I've penciled 15% lifetime default with 55% recovery and the price still works, but I made both of those numbers up. Anyone actually watched a book of rural land paper season out?

2 replies

1karen_whitfieldPG4APRO7

I've held land longer than I've held anything else, and the number I'd argue with is your 55% recovery, not your 15% default.

When you take a rural parcel back, you get the dirt at whatever the dirt is worth to a cash buyer, minus the months it sits. You do keep every payment made to that point and the down payment, which people forget, so the economics of a takeback on a 26 month seasoned note are much better than on a 4 month one. Run recovery per note by seasoning instead of one blended figure and I think the picture separates hard. Your fresh notes are the ones that hurt.

The three in the county with no comps, I'd price those close to zero above the raw land value you can defend yourself by driving it. If the operator can't show you what similar acreage in that county actually closed at, and it may be a non-disclosure state where he genuinely can't, then you're being asked to accept his origination price as evidence of value. It isn't. He set that price.

One more thing. On the contract for deed files, ask whether the buyer's interest was recorded. If it was, and depending on the state, curing that after a default can be slower than anyone expects.

1monica_tran3SF4CPRO6

Servicing. Nine notes at $25 to $35 a month per note is $225 to $315 monthly against roughly $1,580 of interest coming in, so you're giving up 14% to 20% of your interest income to the servicer before a single one goes late. Late notices, escrow analysis if you're collecting taxes, and any modification work usually bill on top of that.

From what I've seen in my own service business, the cost structure is the same everywhere: small accounts cost nearly what big accounts cost. Get a written fee schedule with the collection and default work priced out, because that's where the surprise lives.

Nine notes of rural land paper, and I think my discount is too thin

2 replies