As we previously discussed, valuing a note is as much an art as a science. The main reasons why arriving at a realistic valuation is difficult, and branch to a judgment factor, is that no public market exists where notes are bought and sold and where prices are published. Each note transaction is a underground transaction between one buyer and one seller. A cash value is different from a theoretical value. Nevertheless, underground notes must be valued when they are bought and sold, gifted, inherited in an estate, part of a dispute (divorce or partnership dissolution), and when making ready financial statements.
The six main factors that conclude the fair market value of a note have been outlined in the prior article, but will be repeated here in brief form as a refresher.
Collateral security--its value and quality
Borrower's credit and financial information
Terms and conditions of the note and mortgage
Loan to Value Ratio - What is the ratio of the balance of the note to the current value of its collateral security?
Seasoning & cost History - How many payments have been made and how many were late and are any delinquent?
Interest Rate - How does the note's interest rate collate to interests rates currently available to an investor?
In the real world of buying and selling notes for cash there are fundamentally two types of valuations or appraisals. One type is an abstract, theoretical value based on the contact and training of the appraiser. The other type is the estimation or valuation that the actual buyer uses. I call these two types:
"Paper Appraisal"-For wage Tax purposes, for Gifting purposes, for Estate Tax purposes, for divorce purposes, and for Partnership Liquidation purposes.
"Check Book Appraisal"-For purposes of buying the note
The next logical ask that requires an answer is-who buys underground mortgage notes? The answer: An unorganized, disbursed secondary market of buyers/investors does exist. But, knowing who they are and how and where to find them is a challenge, and a specialty in and of itself. To keep track of these individuals requires being actively engaged in the secondary underground mortgage market on a quarterly basis-buying, selling, and brokering notes. Three major types of the secondary market players are:
Unsophisticated, underground investors
Sophisticated, underground investors
Professionalnote investors and institutional note investors
The cash value of the same note will be different to each private in each of the above categories. Their valuations will be subjective.
Being able to understand the goals, fears, knowledge, capital availability, and time frames of each private buyer/investor is obviously a skill not taught in a classroom. But, it is a vital requirement to being able to value the note properly from their private points of view.
In summary, obtaining the highest cash value for a promissory note requires locating the accurate buyer for that specific note.
How To Value A Promissory Note - Part 2