When economic conditions and markets change, all sorts of normal assumptions and company business models get turned on their heads. Sometimes, market conditions change from good or great to quite poor within a matter of days or weeks. This was especially true with the Covid-19 virus outbreak in March of 2020. Although the outbreak actually started a few months earlier in China, it hit the U.S. hardest in March and the months following. It was a shock to many, as the stock markets slumped (temporarily) and unemployment exploded.
A recession is generally defined as two quarters in a row of declining GDP (gross domestic product). The reality is that a recession is often obvious and in place well before the official recognition of it. The impact of the recession depends on its severity and how long it lasts. A short-lived and mild recession will have minimal effect on most people and companies.
A severe and longer lasting recession can cause obvious results like:
- Higher unemployment across multiple industries and geographies (often worldwide)
- Lower incomes across a variety of demographic segments
- Declining or stagnating real estate prices
There are also less obvious but critical changes such as nervousness about the future and anxiety about putting food on the table for many people. This lower confidence means that people will spend less on most goods, forgo vacations and higher-end purchases, and spend more time at home.
How Do Note Investors React?
In similar ways to other investors and bankers, most note investors get more careful and conservative at the start of a recession or during bad economic times. The note investors are more concerned than normal about higher default rates and declining property values.
As a result, they will want more detailed information about the property and the note. They will insist that there be more equity in the property than normal as a buffer against any potential future price drops. They may stop buying notes for certain property types or in certain states. And often, the note investors will demand higher rates of return on their investments.
The note buying process may also be altered. While the basics of reviewing the documents, getting a drive-by appraisal, and ordering a title commitment will nearly always happen, the note investors may insist on discussions with the payer, demand more details about any unusual parts of the transaction, and take more time to complete the process.
How Do Note Holders React?
In the early stages of a recession or real estate market decline, many note holders will be in denial about the value of the property. They will remember what the house or building used to appraise for, and think that value is the lowest that it can go. This was especially true during the 2009 real estate downturn.
Some note holders become fearful, and may choose to do nothing rather than risk making the wrong move. Perhaps they had been thinking about selling their note but decided to wait out the cycle. Unfortunately, if the payer on the note then stops making payments on the mortgage or stops paying property taxes, the note becomes less valuable. While the note holder might have received a high amount of money if they had sold the note before the default, they may receive only half of that or less if the note becomes delinquent.
What Should Note Holders Do Now?
If you prefer receiving the monthly payments to receiving a lump sum of cash and are confident that the payers will be able to continue the payments, then you may want to hold on to the note. Be aware that even formerly creditworthy payers may struggle during a recession and default on their payments.
If you are considering selling your note, it is better to act now rather than wait. Find a competent and customer-oriented note buyer by checking reviews on Google and the Better Business Bureau. Make sure that the note buyer has at least five years of full-time experience in the business, is a licensed real estate broker in a home state, and seems like someone whom you can trust. Avoid new brokers or people who promise you unreasonably high prices, as they will most likely not be able to complete the transaction for you.
As the note holder, do an honest evaluation of the strengths and weaknesses of your note. Recognize that the property value may have gone down. While you may love the property and see it as unique, note buyers will care about the objective opinion of an appraiser.
Consider that perfect pay history by the payers in the past does not mean that will continue in the future. The payers could go through a job loss, experience divorce, or have other life changes.
Educate yourself about the note selling process and a reasonable value on your note by talking with a qualified note buyer. That person should be able to tell you the pros and cons of actions that you can consider.
