Sometimes people get into trouble with their mortgage payments, but then they get back on track and have their loans modified. These become good performing notes that sell at a discount. Bob Fraser of Aspen Funds says this is where they specialize in. They buy discounted notes that are performing, aggregate the notes, and manage the cashflow. Bob goes into detail about mortgage note investing and the unique opportunity in it, and shares why he’s chosen this niche from the get-go amidst great challenges.
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Financial Friday Episode 4: Mortgage Note Investing with Bob Fraser of Aspen Funds
My guest is Bob Fraser of Aspen Funds. He’s the Cofounder. We’re going to talk about mortgage note investing. Bob, welcome to the show.
Thanks, Patrick. It’s great to be here with you. Kudos to you for what you’re doing, all this great education you’re giving to these people.
I appreciate that and thank you as well. You and your company were one of the sponsors of the Cash Flow Wealth Summit and we appreciate that. We appreciate the support and I’m excited to get into some of the details of your presentation and your business. The presentation I gave at the Summit talked about that investment isn’t just the investment idea and that it’s also the underlying business that orchestrates the investments. The first part is talking about your niche, why it exists, what the demand is, what the opportunity is, what the investment opportunity is and what the idea is. We’re going to segue toward the end and talk about your team and how you operate and look who’s behind the curtains. That says a lot about the success of a company that’s been in business as long as you have. Let’s start with the investment first. Tell us about note investing, whether it’s private notes or non-private notes.
What we specialize in is performing notes on consumer homes. We buy discounted notes that are performing. A lot of times, it’s newly originated seller finance paper. Sometimes it is people that have had their loans modified. They got in trouble, but then they got back on track and now it’s good performing paper but it sells at a significant discount. We love those discounts. We buy that paper, we aggregate that paper, and then we manage it. We manage the cashflow. It’s a cashflow-based investing using retail residential mortgages.The greatest non-cyclical thing out there in the real estate world is owner-occupied real estate. Click To Tweet
One aspect of real estate, in general, is that it’s not necessarily liquid collateral but in a sense, everyone needs a place to live. It’s a very in-demand collateral. Talk to us about why this market exists. Why wouldn’t someone go and refinance in a conforming or a conventional type of loan?
Loans are often modified. FHA for instance, during these big auctions they’re selling billions of dollars of non-performing loans while they buy it by hedge funds. These hedge funds buy these non-performing assets and a certain percentage of them end up re-performing. About a third if you look at the auction results. A lot of times they take possession of the property, but a lot of times they do not take possession of the property. They talk to the borrower if the borrower wants to stay in the home and they do a loan modification. If they can afford, they put that in place and the borrower starts paying again. It’s a huge market. There are $30 billion in what’s called troubled debt restructure held by US banks that’s in compliance. It means it’s in compliance with its modified terms. It’s performing paper. It just went bad at one point in its life. That’s one option.
Another is the low balance area, which we love. These are loans on homes that are under $100,000. It’s a place that the big boys don’t want to play. It’s very complicated if you have to take back the property. If you put in $20 and have to fix it up, that’s a significant amount. Borrowers have less wherewithal so it’s a much more problematic space and the easiest thing to do is to avoid it. Most of the big service providers, big funds and financial institutions avoid the low balance market. We love the low balance market. The low balance market is in the Midwest. Here I am in Kansas City in the Midwest and it’s a fantastic market. In fact, I argue that it’s a non-cyclical market.
If you look at the price of a home that’s $100,000, the replacement cost for that home is close to $200,000 because of the price of lumber and labor at everything. Doesn’t that argue that it has to go up in value at some point? You’re not seeing a lot of new construction. I’ve done a lot of financial analysis and economic analysis of the housing market. You’ve seen single-family homes have been significantly underbuilt in the last decade since the crisis. There’s a shortage of single-family homes. In my view, the affordable low balance homes are the ones that have the greatest upside and the least downside. It’s a market that not only do we love for its discounts but also for its safety and its non-cyclical behavior.
How did you arrive that this was your bread and butter, that this was where you learned to play and that it was your niche? It makes sense because some of the questions I had was, “Banks have a ton of capital and they’re still able to access it relatively cheap to the Fed window. Why aren’t they participating in this market?” My point was getting into why you’re in this specific niche. Was there a story behind that or was that the opportunity from the get-go?
We got into space from the non-performing loan side. We buy the non-performing loans. There’s a great space because we get to help people. We’re about people and we get to wipe out a massive amount of debt and help people stay in their homes and we created a lot of this re-performing paper. We help people stay in their homes and that means they get a new loan and they start paying on the loan. We discovered there were IRS issues. It’s a huge phantom income problem if you do a loan modification. I won’t get into the technical details, but we had to sell it. At the same time, I had a good friend come to me and say, “Bob, I have a settlement, I have an inheritance, I have a nice chunk of change, how do I earn income?” Where do you go to get a good safe income? In the public markets, it just doesn’t exist, Patrick. Not that safe and not that’s nonvolatile. I said, “I could create that for you by buying these assets that are secured.” They’re at a discount there. They have a lot of safety on them. I said, “Let’s put together a fund.” We put together an income fund based on loan modifications and learn to manage that very effectively. I’ve done well for our investors.
We got in for wanting to help people and wanting to solve an income need that’s a tough need. The rally has been fantastic. A lot of people have made money in the rally, but it’s getting a little long in the tooth. How much further is it going to go? I’m a computer scientist by background, so I’m a super math nerd. I can show that the future earnings and future growth in the stock market are highly correlated to PE ratios. They’re inversely correlated. The higher the PR ratio, the lower the expected earnings ten years out. We’re roughly around 30 right now. You can expect it to earn about 1% in the stock market over the next ten years annualized. That’s not that attractive. When you look at the bond market, that’s not very attractive. Even alternatives, which most alternatives are facing real estate. Is that getting long in the tooth? I’ve been in the investing world for 30 plus years and I’ve seen several real estate crashes. What’s to say this isn’t going to happen again? You’re looking for countercyclical or non-cyclical investments in my opinion. That’s another thing. When we designed this and when we went after space and after the strategy, we are looking for something that is non-cyclical. The bread and butter homes are non-cyclical, but I’ll give you a tip. The greatest non-cyclical thing in the real estate world is owner-occupied real estate.
A lot of the guys that have lost money were in hard money loans. This is fix and flip loans, developer loans or construction loans. What’s the value in the housing crash of a piece of partially developed land? It disappears. What’s the value of a home that you’re currently living in? Patrick, if you experienced negative equity in your home. The Zillow says the paper value of your home goes down, are you going to hand the keys back to your lender? No, you’re not and people don’t do that. In investment real estate, the first thing that people do when they have troubles is they just give the keys to the lender. It’s your problem now. Not with owner-occupied real estate. They do not. That’s what we buy. It’s the owner-occupied real estate. It’s uber sticky and. In my world, home equity is less important than the job market. I can show you correlate the false. It correlates not to the price of equity but to the job market.You probably let your home go before you let your dog go. Click To Tweet
I have a background in economics where financial models are very straightforward in a sense, absolute assumptions. Something that surprised me is based on the conversation I had with the chief economist of Fannie Mae. I had a long dinner with him and it was amazing. One of the things he told me was that they weren’t communicating well with their borrowers. They experienced that people left their homes and they were in default. What they did is they correlated the demise of Fannie Mae that the fact that Fannie Mae went into bankruptcy or receivership to them no longer having a mortgage, therefore they couldn’t stay in their home. It doesn’t make sense to us because we understand certain elements of finance.
Sometimes human behavior is outside of that rational line of thinking. Nonetheless, they communicated with their borrowers and they communicated what was going on. They started to do surveys and they continue to do it. They use artificial intelligence as well now and they’re able to understand how to price risk in a way that they wouldn’t have been able to experience before the financial crisis. I look at where you find safety in anything. I would say more lends to the expertise that you have any experience and it sounds like you found that because you’re in a market that isn’t that volatile. You also have people that will stay in homes for a long period of time, which is the Midwest sector.
Oftentimes it’s easy because you know what your assumptions are, and you know what you need to get to a rate of return. You know you need to buy at and you know how to communicate with people. I’m assuming that you initially worked in the non-performing space. In the non-performing space, people weren’t paying their mortgages. You figured out ways and you have a system where you spoke to them and you modify the terms of their loan so that it was affordable. They recommitted and now it’s performing because they’re making payments on it. That is an insanely valuable piece of this. It’s a 5% mortgage at $50,000 and you buy it at discount for $40,000. You have a system in place in which you’re communicating to the people. They’re going to be paying you. That’s one of the most valuable pieces of this puzzle.
I was talking with a New York investor and he said that one of his top investments was loans on pets. I was like, “Are you kidding me? Who’s going to default on their dog and get their dog to repossess?” You let your car be repossessed before you let your dog be repossessed. You want a little bit of the emotions attached to something as well. We’ve all seen the financial models. A lot of the models out there that traditional bankers use is dumb. The reason I’m making money is because their models are incorrect. I found a better way to do what they’re doing. I found different ways to solve the problems that they couldn’t figure out. There’s a lot of opportunity by building better models. We love having owner-occupied homes and helping people stay in their homes. It just creates something that’s very sticky and not correlated to the home price entirely. It’s a great place to be.
Bob, this is an investment niche and alternative type of investment where there are tons of opportunity and you’ve clearly articulated that. We both are on the same page in regard to what success is in any business. This investment has an underlying business that operates it. Would you speak about your experience in the business world and the team that you’ve put together to orchestrate this great opportunity?
My background is I was a computer scientist, but I ended up starting a company in 1995 that became one of the largest ventured capitalized companies in the Midwest. It was a tech company and it started in my attic with my sister-in-law and $100,000 from mom. We grew to 300 employees and hired some of the best people in the city and learned a ton by doing that. I learned a ton from the guy I hired to run my business. My president learned about what it takes to run a business by the guy who worked for me and ended up winning in 2000 the Ernst & Young Entrepreneur of the Year Award, which is a big honor. I’ve rubbed shoulders with them of the top entrepreneurs in the world as a result of that. I even have a quote from Richard Branson. He said, “I’ve never been that interested in money. I’ve been more interested in ideas.” The best entrepreneurs are not bottom-line focused. You’d be surprised. They’re solution-focused. They want to make the biggest impact. It’s just different than TV people think.
That greatest strength of entrepreneurs is often their greatest weakness.
It can be. A lot of people who are the best entrepreneurs and having watched a number of venture capitalist companies rarely end up running the company. That’s just an absolute it seems. Through all that, I’ve learned that people are the most important asset. Getting great people matters. It’s the key driver of success.The best entrepreneurs are not bottom line-focused. They're solution-focused; they want to make the biggest impact. Click To Tweet
It’s the right people in the right places doing the right things. Always on the same page. I look at your team and maybe you can comment on some of them and how you guys operate. It sounds that they have extensive experience in banking and also in this niche. There was some project management and systems expertise as well. Can you talk to us about the different positions that exist in your business and how you guys operate?
One of the first guys we hired in the non-performing shop that we did was a guy named Stephen Gryglewski. He’s a banker. He is a 29-year bank veteran at the time we hired him with fifteen years of experience running the workout shop in the bank. When a bank loan went bad, he was the guy they heated hot potato to. He’s super compliance oriented. He’s super knowledgeable and he was a conference speaker. He was the guy that went to the lost mitigation conferences. I’m sure you’ve spent a lot of those conferences. He loved them as much as I am. He was the speaker. We hired him. He has since built a team in Maryland of have all bankers. We have seven full-time staff and part-time staff out there who handle all loss mitigation efforts and do a fantastic job. They know more about the statute and limitations issues about bankruptcies, about foreclosures, which are different in every single state than most lawyers do. We make money primarily because we know how to buy and we know how to avoid the pitfalls. We know how to get deals done for people and at the same time helping people. Here we are, we’re buying bad debt but only 3% of the time. We ended up closing three.
Are you in credit in a specific way? You say scalable, but what do you credit the sub-skill level?
It’s exactly what you said. It’s communication. We reach out to the borrower. We educate them. We put them in touch with home counselors supplied by the government who tells them, “Talk to these people.” The biggest issue we have is getting them to talk to us. I wish some of these borrowers would call us sometimes because we’ll do miracles for them if they will talk to us. They’re afraid and they think that they don’t have any answers, so they’re not going to talk. The truth is if they will work with us, we’ll do miracles for them. That’s the key. We’ve hired a fantastic team and continue to hire a fantastic team. We were in this for the long haul and we want to grow to a very large company. I love scaling a business. It’s the most fun thing on the planet, in my opinion. I do that with people.
It’s easy to get a return with one deal or two deals when you get to 10,000, 2,000 or 5,000. This is where I felt so strongly about the presentation I gave at the same summit you sponsored and presented at. The BI Triangle that Robert Kiyosaki came up with or helped it to improve, which talked about the successful operation of a business. The smallest piece is the actual product or the investment itself. The underlying mission, values, systems, financials and so forth is vital. There’s one element there which is profound that I’m picking up on with you is the team. Your title originally was the CEO and President, but it sounds that you have essentially delegated a lot of those responsibilities to others. It’s paramount to any business that wants to scale to find those that are best at doing what they do. Putting them in that position and then putting you whatever other role is in a position where you are going to be the most valuable. Can you talk to that briefly?
Having scaled a business from two people to 300 people, I learned that you only do that when you have to give up control. You are limited to what you can control and you’ll never get bigger than what you can control. The truth is when I own a thousand notes, I can’t control. I can’t get my head around a thousand notes. I’ve got to have it subdivided. I’ve got a capital department, I’ve got a loss mitigation department, I got an acquisitions department. I’m not in control of any of those things. I hired people who run those divisions and are doing a fantastic job doing that. It’s not just people. The other key to scaling is systems. I read a book called Total Quality Management back in the ‘80s, back when Japan was ruling the world. The book is all about TQM and it was all about systems creating quality. The key to being one of the other keys besides getting the right people in the right spot is getting systems for everything. Everything is systematized and that means a super high level of quality. That’s why McDonald’s can make the hamburger that tastes the same regardless of whether you’re in Singapore or in San Antonio. It tastes the same because it’s completely systematized. There’s not a creative element in there. It’s all done the way it’s supposed to be done through training and systems.
That’s why most entrepreneurs are not systems guys. They understand systems and the importance of them, but they don’t follow them. There’s an underlying foundation of a business that has to be systematized. There’s another layer of it they can’t be and that’s more of the creative ideas adapting to markets and so forth. If you don’t have those systems and you’re trying to scale, it’s a disaster waiting to happen.
I was a computer programmer for twenty years so what I do is I built a system and I built them to scale so I understand about building systems. The creative element is also super important. Even that, there’s a way to be creative. I’ve run shops of computer programmers and creatives and there’s a way to get them to do well. You have to put boundaries around it, around the creative side even.The keys to scaling is getting the right people in the right spot and getting systems for everything. Click To Tweet
One of the coaches I’ve had was in charge of all the developers. She’s the vice president of development and it was fascinating to talk to her about how they operated. The tech world has it done. You’ll see a lot of the business operation guys that are essentially modeling what the tech world is come up with, whether it’s scrum or agile systems. There are so many different ways to do it. It is a uniform quick efficient way to get things done, which is just business in general. Because of tech, there are so many different moving parts and elements that was a requirement to make any type of tech project viable and successful.
How do you get a bunch of uber creative independent-minded people all work together and like each other? It’s magic for sure. Technology is our big helper too. It’s just so easy. We are a thousand miles apart and we’re communicating. My team does the same thing. We communicate through technology. We use software platforms to manage all of our activity. Everything is systematized. I do analytics all pulling data from the accounting reports to the servicer reports to everything. From my home, I have knobs and dials on every aspect of the business.
I have the same thing. There are so many different moving parts, but technology has made it so that you can pull up a dashboard and you can have all of the different primary measurements that tell you whether things are going the way they should or not. Bob, this has been a fascinating interview and I appreciate your time. Let’s talk briefly about how people can get involved and learn more about Aspen Funds and some of your opportunities. Can you talk about that a little bit?
Our website is AspenFunds.us. That’s the best starting point there. There are webinars. People can learn about what we do and why it’s cool and how we do what we do and see our team. That’s the best place to jump in and get started.
Is this restricted to accredited investors or are there opportunities for non-accredited investors?
This is all accredited investors. You understand the regulations as I do. It’s the way we were able to offer these kinds of things. We have to enforce those rules.
Bob, it’s been a pleasure. Thank you so much for joining us and we’ll make sure that we get the word out and people can learn more about your business and how to make investments.
It’s been great to be here with you.
- Aspen Funds
- Cash Flow Wealth Summit
- Stephen Gryglewski
- Total Quality Management
- Click here for Aspen Funds’ exclusive offer for Wealth Standard Listeners: http://aspenfunds.us/wealth-standard/
About Bob Fraser
Bob Fraser has 20+ years’ experience as a finance and technology executive and is a Magna Cum Laude U.C. Berkeley computer scientist and a former Ernst & Young Entrepreneur of the Year Award winner. In 2012 Fraser co-founded Aspen Funds, a fund management company focused on real estate note investments. In 1995, Mr. Fraser founded NetSales, Inc., a back-office e-commerce provider. As a CEO, Mr. Fraser raised $44 million in investment capital, and guided the company to an average of 20% month-to-month revenue growth, becoming the metro area’s fastest growing company between 1997 and 1999.
Since 2002 Fraser has founded and served several non-profit organizations as a board member and CFO. Fraser has also been involved in a number of entrepreneurial initiatives, including book publishing, financial consulting, and an investment fund managing member.