Buyer or Seller: Who Really Has the Edge in Note Sales?

By: Tim Buss, CCIM, Senior Vice President-Special Asset Solutions at NAI Global


Note sales – more irrational exuberance!?!?  Like most things in a relatively free market environment, prices of goods and services flow through the spectrum of balance and imbalance as the pendulum swings, oftentimes too far to the extreme. This creates opportunities for both buyers and sellers before settling, albeit briefly, in a balanced state.  The note sales environment is firmly in that cycle today. 

But why?  I have seen countless examples where the notes secured by commercial real estate have traded for values that exceed the underlying fee.  Is it because the investor perceives value that is not obvious to the seller, or is it because the seller, oftentimes a regulated commercial bank, is so motivated to shed the asset that it is willing to leave money on the table? Or is it because the capital that has been impatiently sitting on the sideline has now determined that deals must be done regardless of the price? Or is it because, like the market, knowledge also has a market cycle and that knowledge is currently out of balance, favoring sellers over buyers? 

What knowledge could be out of balance?  Perhaps the experience gained through the last few years of working out of or collecting loans, wherein commercial bankers have realized that the time, cost and exposure is far more expensive than a less informed and experienced note buyer realizes.  Several recent studies have shown that the collection, foreclosure and ownership of an asset for the first year of holding title can cost 25-35% of the note value.  So it follows that the experienced lender who is willing to recognize the true collection/ownership/disposition cost is net-selling the note at a  discount of  25-35%. 

But is the less experienced, unsophisticated note buyer aware of the same cost, or is the perception that the note seller is simply coming in line with the market and the spread between bid and ask is finally converging?  The truth is likely somewhere in the middle.  All the market forces extenuated by the recent experience of bankers points to a trend that at least for now, plays in the favor of the note seller; but further, the reality in practice is often what I would call entitlement value.  Like the value creation that is achieved when a developer goes through the entitlement process, taking raw land to the point where it can be sold to a builder or end user, (a process that takes both up-front capital, incremental capital and experience) the collection/workout process similarly presents an opportunity to take advantage of a vision and goal.  For the commercial lender, the goal is to rid the balance sheet of the asset and the bank of the borrower, and oftentimes in the process, lender fatigue sets in.  But for the buyer, the vision and goal is to obtain title as quickly and efficiently as possible.  Where the bank has focused on the broken promise to pay, the note buyer simply wants to gain control.  That difference in vision and goal means that often the note buyer can compress the time and cost associated with “collecting” the loan.  So although there are still costs including attorney’s fees and time value of money, the investor is able to compress both time and cost creating a small positive arbitrage.

About the author

Tim Buss, CCIM is Senior Vice President-Special Asset Solutions at NAI Global...

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