Steps to Investing in Distressed Debt
Making money with distressed debt is not that different than making money with an actual house you purchase as an investment. That’s why we at Oakwood Investments have transitioned to investing in distressed debt. Once you understand the numbers, you can control the assets and avoid the risks and expenses involved with tenants, repairs & maintenance, Taxes, and Insurance. There are basically 4 steps to making money in distressed debt.
They are:
- Have a plan
- Know your numbers
- Fund your plan
- Execute your plan
Have a plan:
With any investment property, you must have a plan. What are you going to do with the asset? Are you going to Wholesale it for a quick buck? Are you going to rent it out long term for the cash flow? Are you going to fix and flip it for possibly bigger gains? Each strategy has its pros and cons. The point is, you better know which strategy you are going to take because that determines your actions and your costs. If you don’t have a plan, then you won’t know what makes for a good deal when buying.
The same holds true for purchasing distressed debt. What makes distressed debt better than purchasing property is that there are even more exit strategies when purchasing a Note All the same exit strategies exist, plus several more. Because you own the note, you are “The Bank”. When you are the bank, you can reinstate the note and make it perform again. You can modify the note. You can do a Short Sale, Deed in Lieu, or Foreclose (more on those strategies later). If you chose the latter and end up owning the property, then you proceed the same as you would with any typical property purchase.
The point is, you need a plan. Your plan helps guide the purchase and estimates your costs which in turn determines your profit.
Know Your Numbers:
In other words, do your “Due Diligence”. There is more due diligence required with distressed debt than is required with investing in a property because you are purchasing the debt and everything that comes with it. You need to research more than just what the property value is and what it could be worth if it was fixed up. You need to know what debt is attached to that property, including all liens, back taxes, utility charges, and code violations, to name a few. You need to know the foreclosure laws in the state the debt located in, as well as, the cost to foreclose there. You need to have relationships with mortgage servicing companies to work through the deal. You need relationships with attorneys in the state if foreclosure is or may be part of your exit plan. You need relationships with realtors if Short Sale is your plan. You need contractors to rehab if renting or retail sale is your plan. Fortunately, we already have those relationships in place.
Fund Your Plan:
Whether you are funding the deal yourself, using private money, or joint venturing with someone else, you need to have the funds ready to deploy with short notice. Many investors chose to joint venture with others and split the profits. If that is your strategy, those relationships should be forged prior to you making a bid on an asset. That way, when your bid is accepted, all you must do is explain the financials of the deal to your partner rather than try to gain trust and explain what a distressed asset is all at the same time. Some chose to fund the deals themselves. There is nothing wrong with that. However, distressed assets can take as long as 12 to 18 months to begin to produce cash flow. If you are using your own money, you run the risk of running out of funds for your deals until they begin producing income. This can limit the number of deals you can enter per year.
Execute Your Plan:
Now that you have a plan, know your numbers, and have the deal funded, it is time to execute your plan. This is where those relationships with servicing companies, attorneys, realtors, contractors, and other investors come into play. Once the asset is yours, you will need a servicing company to contact the occupants, track down the borrower, and work out the some of the specifics of your plan. You must be able to adapt to changes in your plan because they will happen. That is why it is important to know your numbers and have a backup plan as well as a back-up to the backup plan. You will need local realtors if you are going to do a short sale as well as if you are going to foreclose and fix and flip the house. You need investor contacts if you are going to sell the property as an REO or turn-key rental. There can be a lot of moving parts. This is a people business and solid relationships will help you execute your plan.