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Clifton M. Dugas, II
clifton.dugas@klgates.com
+1.214.939.4953
Eugene F. Segrest
gene.segrest@klgates.com
+1.214.939.4991
Matthew Lopez
Introduction
Many investors are once again looking to purchase real estate-secured notes at a
discount from face value in order to capitalize on the steadily declining real estate
values prevalent in todays market. If history is any indication of what we can
expect as a result of the current downturn (e.g., investors profits from the RTC days
of the 1990s), investors may indeed be able to profit from the downturn in todays
market and the resulting pressure on banks to get certain assets off their books.
matthew.lopez@klgates.com
+1.214.939.5683
Prior to closing on a typical real estate note purchase, an investor must determine,
through financial due diligence, (i) whether the borrower and/or guarantors of the
note being purchased have the financial capability to honor the note, or (ii) whether
the value of the collateral exceeds the amount paid for the note together with
incidental costs. Either or both of these questions must be answered in the
affirmative in a loan purchasers determination of whether the transaction will be
profitable and thus worth the risk of a borrower default. The investor must also
analyze the underlying collateral for title issues, lien priority, materialmens liens,
environmental and architectural concerns, etc., in preparation for ultimately owning
and operating the property, should the borrower default on the note and the investor
elect foreclosure as its remedy. While an investor seeking to purchase a single note
or a pool of notes may think of itself as simply an investor in the traditional, financial
sense of the word, it is essentially a mortgage lender, real estate purchaser, financial
analyst, real estate operator and due diligence expert all wrapped into one. A
successful purchaser of real estate notes must possess expertise in all of the
foregoing areas or be prepared to engage third parties who are experienced in such
transactions.
It is important to remember the parties goals as a backdrop to the note purchase
transaction. The ultimate goal of the party selling the note is either to remove a bad
asset (i.e., a defaulted, underperforming, or soon to be defaulted loan secured by real
estate) from its balance sheet or to sell the distressed loan (or even a fully performing
loan) at a profit. The purchaser in a note purchase transaction will seek to make a
profit by (i) receiving a payoff from the borrower in an amount exceeding the
purchase price of the note, or (ii) foreclosing on and liquidating or operating the
underlying real estate in manner that renders income to the purchaser that exceeds
the purchase price of the note.
The keys to limiting the investors liability during the note purchase process and
enhancing the likelihood of an eventual profit to the investor are through due
diligence and careful documentation of the transaction. An investor purchasing a
pool of real estate notes must analyze the transaction as though it were purchasing
the underlying collateral securing the notes. Considerations and issues differ
depending on the type of note and the type of collateral securing the note.
Moreover, engaging counsel experienced in these types of transactions may help
investors avoid potential liability. This alert includes a discussion of the various
(ii) Note
With respect to the note itself, the note
purchaser should first determine whether
the note evidencing borrowers payment
obligations is a negotiable instrument. In
order for the note to be negotiable, the
Uniform Commercial Code requires that the
note (i) be signed by the borrower, (ii)
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