As with any asset acquisition the due diligence process is critical. We are always mindful of Warren Buffet’s quote Rule No.1: Never lose money. Rule No.2: Never forget rule No.1. With all potential note asset we complete a thorough due diligence process
Tax and title are key elements of due diligence for note investments. Purchasing a note without checking tax and title is gambling, plain and simple. While sellers of notes are generally well intentioned, their information with regard to lien position and taxes due should be taken at face value and verified prior to purchase of the note.
We check title using an Ownership and Encumbrance (O&E) report or title search. The O&E is a lite version of a full title search which focuses on the current owner, or the last two owners, and does not track ownership backward beyond that. These can be sourced from title companies and other title related businesses which specialize in providing these details to investors. A typical O&E will include the following:
- Effective Date
- Property Address
- Mortgages/Deeds of Trust Listing
- Liens and Judgments Listing
- Tax Section
- Legal Description
- Mortgage/Deed of Trust Document(s)
- Deed Document(s)
- Other Documents
The first thing to check is that the O&E report is for the correct property address and the effective date is fairly recent.
Verify Lien Position
The second thing we check is the mortgages /deeds of trust listing. My goal here is to ensure that the lien position on the note we are looking at, is as it should be. The O&E will call out basic information on each mortgage, starting with 1st position and progressing from there. The list is usually numbered to indicate lien position. We are matching on the original balance number found on the tape (or online listing) to the original balance on the lien in the O&E. Under each lien there may also be the chain of mortgage assignments. This reflects who has owned the lien since it was originated, Total Junior and Senior Lien Amounts
Liens and Judgments
These are simply non-mortgage liens which encumber the title. We check the filed dates on these carefully to determine which are junior and which are senior to the subject mortgage. (Seniority is based on recorded/filed date.) In the mortgage and lien review,we add up the total amounts of both junior and senior liens and include that in our analysis spreadsheet. This information is necessary to determine which exit strategies are feasible.
Another thing which may be found in the Liens and Judgments section is a reference to a pending foreclosure. These may also be cited in the mortgage section. Usually when in the mortgage section the citation will include the term Lis Pendens which is just a legal term for a lawsuit involving real estate. There will be a case number included which could be used to look up details. A pending foreclosure is important information to take into account. As we only acquire 1st lien mortgages, are purchasing a 1st lien and the foreclosure is on the second, that’s not good. If the foreclosure is on the note we are purchasing, it could be good if we are interested in acquiring the property as we have as one of our criteria that we only acquire assets where we as the new lien holder can assume the role of plaintiff without re-starting the process. Taxes
It is important to understand the total taxes due now, the annual tax rate (which influences holding cost), and whether there is a tax deed sale pending. We also monitor when the next tax deed sale is scheduled. As lien holders, we have a vested interest in monitoring taxes and making sure they are paid so we don’t lose our collateral to a tax deed sale.
We ensure that the deed is a fee simple deed which conveys ownership.
Mortgage/Deed and Other Documents
We review the the Mortgage /Deed and other documents included in the file, and focus on anything that seems out of the ordinary. While this might sound like a unimportant step, it is important because its part of the educational process. Different states have different ways of doing things and the norm in one state is not the norm in another. Crime
Another factor we consider is crime. We avoid high crime zones.
The complete process of due diligence helps to eliminate problems. potential note investment.