40 Bob Malecki and Finding Opportunities With Distressed Debt
Bill Fairman (00:04):
Hi everyone. Bill Fairman with Carolina Capital Management. Wendy is not with us today. We are not letting her come in. She had some other things to do. Jonathan Davis is with us today. He is actually the guy that does all the work around here. Wendy and I just smile and talk a lot. So don’t forget to like, subscribe, thumbs up. What else?
Jonathan Davis (00:32):
Contrary to my age, I’m not that hip with the town.
Bill Fairman (00:35):
That’s right. You’re a millennial. You’re supposed to know all that social stuff. By the way, we do have a fund and we would love people that are accredited investors to check it out. It’s CarolinaHardMoney.com go to the investor tab, fill out a form and schedule an appointment and we’ll talk it over. Now we are a lending fund only and we lend money to other people. You get a return. Anyway, we have the pleasure of having Bob. Geez Bob. I’m sorry I messed up your last name. Help me.
Bob Malecki (01:17):
Bill Fairman (01:18):
Malecki I’ve been saying it like for 20 minutes and as soon as I’m supposed to say it, I forget it.
Bob Malecki (01:24):
I hear you.
Bill Fairman (01:25):
By the way, forgive me. I flew from the West coast to the East coast yesterday and we were through the daylight savings change as well, so I’m suffering from jet lag, not to mention old age.
Bill Fairman (01:40):
So Bob is in the note business and you know we’re in the note business as well. The difference is we create new notes and Bob bills and notes that have already been created. Bob, give us kind of a background how you got into that business and then we’ll talk about the current things.
Bob Malecki (02:03):
Absolutely. Bill, thanks for having me on. By the way, I started I think in 2013 or so. I was a house flipper. I own some rentals. When involved in real estate since about 2000, late 2006 or so and one of my agents on a who helps me liquidate my flips. She was buying mobile homes and repositioning those and she found a couple in Sammamish Washington. I’m near Seattle. I’m on the West side and Sammamish is on the East side and they wanted to sell their note. They had a note on a mobile home that they sold to another couple and they, these, these folks were moving to Arizona to retire, but they needed the cash and they needed to sell it fast. And so Deb, Deb contacted me and connected me with this couple, and the note was only $14,500 or so, but I offered them 7,000 or 7,500 for purchase, 50% on it.
Bob Malecki (03:01):
And they accepted that. And when I did the math on the monthly payments over, I think it was a five year, I could just got paid off or finished it, but it ended up being about a 40% return on my money and I bought it my IRA and kind of hit me in the head. I’ve gone to REIA meetings where Eddie Speed has shown up and talked about notes and I couldn’t understand why he was talking about notes and now it finally get me. So I bought the note in the IRA and collected the cash flow and that got me really going on learning more about distressed mortgage debt, which is what I do. I buy distress debt and reposition it with the borrowers, get them re-performing if possible, and it really magnifies the return. So over the past, what is that, seven years or so I, I stopped flipping homes about three years ago.
Bob Malecki (03:50):
The market turned over here, made no sense anymore. I’ve actually sold off a few of my rentals. My standing joke is that I have a tenant who pays me money every month and leaves me alone and I realize that those are called borrowers, you know? And it really made more sense for cash flow to have a borrower paying me money on a monthly basis than a renter, although there’s not as many tax breaks. Doing it in my IRA made a lot of sense. And since then I started to private equity funds. The first was resolution capital management, which is, acquires first position, non-performing debt. We raised a few million dollars, we’re in the third year of a five year closed ended fund. And we’re, we’ve got about 95% of the loans re-performing or liquidated one of the other. And that was great. It was, it was an opportunity for me to partner.
Bob Malecki (04:45):
I’ve got a partner, Kevin Mowen in Seattle and Ben Cotey in San Francisco and, we work virtually. We use FCI for our servicing. From there, I met my partner now Josh Andrews and Scott Ruzich and they approached me about it back in 2017, late 2017 they wanted to start a private equity fund to buy distress mortgage debt. So I consulted with them for, well it took us about nine months to construct the fund and put everything together. But by the time that we got everything put together, they invited me to, to be a partner with them, a third party partner and run the fund. And so we launched that in spring of 2018 and that fund is a little bit different in that we’re buying primarily second position, the stress debt, he locks, that kind of thing in markets, you know, if we can control the acquisition, we buy small pools from hedge funds, but the ideal loan for us is appreciating market where the borrowers is current and paying on their first position note.
Bob Malecki (05:51):
And there’s equity above the first and our second position note. And for those kinds of loans, we’re finding that those borrowers are very willing to come to the table for a loan mod or if the balance is pretty low, they’ll just pay it off and refinance their, themselves out of the first and get a lower rate. So it’s been a really a good time in the economy to have second position notes in most markets where it’s appreciating and we’re continuing to run that fund through 2023 it’s a closed ended private equity fund under reg D, 506B I believe.
Bill Fairman (06:28):
So when you raise the capital in these funds, are you utilize, in other words, it’s closed end funds or you’re raising the capital and you’re buying all the notes at one time and then you have a five year workout or you’re buying them in different phases?
Bob Malecki (06:44):
It’s basically as we acquire the capital, then we deploy that into assets. So it’s a rolling deployment so to speak. And then the, the fund is, so whoever comes in in the year three basically has two years left of preferred return paid out to them. It does not, some funds will do a five year where you, the first day you engage with the fund, it’s five years before you get your money back. Ours is basically cumulative.
Jonathan Davis (07:09):
So you’re, you’re constantly raising money through the entire closed into term?
Bob Malecki (07:13):
Jonathan Davis (07:14):
Okay. So you didn’t do like a capital raise and then, then move into it. You are going on the whole time.
Bob Malecki (07:20):
Jonathan Davis (07:21):
Bob Malecki (07:23):
Yeah. And what we found is because I’m fairly popular on a forum called BiggerPockets, I’ve had a pretty good following and we ended up in our first year and a half raising $2.5 million and now we’re, we have a $5 million caps or continually raising as we go along. And we, you know, the first, what I’m finding too is at first position distressed mortgage debt from 2008 that inventory has pretty much really shrunk a lot. I’m not seeing a lot of viable assets that we can acquire in and reposition for a reasonable return. So that’s good that we’re winding down resolution capital, but with notable capital management, my partner Josh has got some very good connections with asset managers that he’s worked with over the past six years and there’s still quite a bit of inventory on distress. Second position debt.
Bill Fairman (08:18):
People get scared when you’re talking about second mortgage positions, but you’re getting those for a lot less money. And…
Bob Malecki (08:28):
Bill Fairman (08:28):
It’s also a longer, a little longer term play. Most people are gonna want to get in involved in the refinances and you can’t do that if you have a second position lien you, you have to, nope, you’re not going to subordinate. Right. So they have to work out something with you, right?
Bob Malecki (08:48):
Yeah. Yeah. And what we’re finding is only about 3% of the, of the assets in our portfolio we’re actually going to foreclosure on, which is a good thing cause we, you know, both in both funds, foreclosure obviously is not good for the borrower, but it’s also quite, quite a disruption for the fund because it entails obviously more expense for us for, from the fund. And then the risk of getting the asset back and not knowing what’s inside the house can be kind of surprising sometimes. And, and we can actually lose money on some notes because the condition of the house is just so bad that we can’t resell that asset as, as an REO and recapitalize at a profit.
Bill Fairman (09:33):
Right. Well, I’m going to, someone who just bought a house that has all kinds of stuff in it. He knows what you’re talking about.
Bob Malecki (09:40):
Yeah. Hopefully no raccoon in there. That was, that was, yeah. There you go.
Bill Fairman (09:48):
But, your number, and I want to stress this to the audience out here. Your goal when you were buying distressed notes is not to foreclose. It is to try and work out a deal because you’re getting it at such a discount that you have the power to go in there and renegotiate the terms and still make a good money, turn them into performing assets and then turn around and sell them to somebody that is looking for performing loans. Right?
Bob Malecki (10:14):
Jonathan Davis (10:15):
I have two questions if you dont mind. Yeah. One is what is your typical CLTV constraint when you’re going into this? I mean it’s probably, you know, market-driven, I’m sure, but then you know, my other question is if you’re in second position and you’re going into foreclosure, what’s the workout process with the first lien holder and how does that work? You know, because there’s a chance that your lien can be extinguished through the foreclosure process. So what, what do you all do in there?
Bob Malecki (10:46):
Well, yeah, I mean strategically and my partner Josh really runs that portion. But from my background and working with him in this fund, you know if there’s equity then the extinguishment through the court system is pretty minimal. If there’s not equity, if the, if the combined loan, the value of the CLTV is higher than the value of the home, we may not foreclose. We may sit and spin on that one cause we don’t want to risk extinguishment. If there is equity and we foreclose and the first is sitting there and it was pay being paid, then we would typically take over the first payments and then liquidate the property as quickly as possible to pay off that first. Cause once we foreclosed the second position, we are now the new owners of the property so to speak. Although the liability for that first is still towards the borrower, the former owner of the house that we don’t want that first foreclosing on us as the new new quote unquote owners so to speak.
Jonathan Davis (11:44):
Bill Fairman (11:45):
Nice. So I’m biased because I’m also in the loan business or note business. But I like the fact that when you have a note that you are in control of the asset without being responsible for the asset. And you know, we talked about tax benefits of owning property and the importance of having as many of your notes in a tax deferred or tax exempt vehicle. You want to expand on that a little bit? Can people buy notes from you at all? Or..
Bob Malecki (12:27):
Sure, sure. Yeah. Right now we’re not selling much of our portfolio. Our goal is to keep it in, keep all the assets as many of the assets in the portfolio as possible so that when we liquidate at the end of the term of the fund, we have a performing portfolio that we can sell off and we’re buying these notes because they’re second position. We’re picking them up for around 30 cents on the dollar. So the value increase, the equity we have in the notes when they’re performing and rolling along is, is pretty immense. We do occasionally sell a note to recapitalize for various reasons and we do have a list that people join on our website and they can buy directly from us but to get back to the self directed IRA retirement accounts, you know we, we do take capital from investors through their IRA and we don’t use any leverage in the fund.
Bob Malecki (13:20):
Usually if a fund like a syndication would probably have up to 70% leverage on a syndication. When a self directed IRA comes in as an investor there are exposed to the UDFI which is on what is it, unrealized debt financed income and they could actually be responsible for paying some tax on that and all that and let me be invested on the return they’re getting. So we were on leveraged and basically the self directed IRA custodian. We work with them onboarding their clients investment into the fund and then that client is treated alongside the same as any non self directed IRA. The nice thing about that and I think Bill, behind your question is is the income is straight, just straight income. There’s no tax sheltering. If you own a property in your IRA, you’re going to have or not, not in your IRA. A property is going to give you some tax sheltering benefits, depreciation, so forth, but if you own a note outside of your IRA, it’s straight income and you’re going to pay income tax on that. Whereas in an IRA, having the note makes much more sense because especially if you’re on a Roth, you’re not going to pay any income on that and it’ll grow your, your capital income will cut over from P and I payments will grow that IRA.
Bill Fairman (14:37):
Yeah. I always tell people, if you’re going to invest in this space, use your tax deferred or tax exempt vehicles to invest in the lending side of things and then use your cash to buy properties with or invest in funds than on property is at least in a fund that owns property, they’ll pass through those depreciation benefits and stuff through to you and you’re not, you’re not able to take advantage of it in an IRA because you’re already tax deferred or tax exempt.
Bob Malecki (15:09):
Yeah, that’s true. Well, I think there’s certain circumstances where you could utilize the tax benefits even in an IRA. For instance, if you did have your invested in, you know, syndication where you are subject to some UDFI tax, I believe, and I’m not an accountant, so don’t, don’t take my word for it, but I believe that then the tax benefits might, might be beneficial.
Bill Fairman (15:30):
And you’re, you’re, you are correct. And I’m not an accountant either, so let’s make all that clear. I’ve heard from others that you can offset that tax because that tax is only charged on the profit. So if you do have some depreciation in there, then eliminate some of that paper profit that you’d have to pay the tax on. But in reality, if you do have a self directed IRA and you are subject to some sort of attacks, be thankful you’re still making money, right? And it’s going to be less tax than you normally would pay. Well, it’s a higher tax, but it’s a smaller percentage of your actual tax. So if you’re making money, you’re going to pay money to somebody eventually. Right. So are your notes nationwide?
Bob Malecki (16:29):
Yes. Yeah. We buy in every state. We obviously try to stay away from the long foreclosure States like New York, New Jersey and Florida, but we’re agnostic so to speak. We buy based on combined loan to value equity. Let me start, you know, I explained what our ideal one is. So even if it’s a note in New Jersey that has a lot of equity above both, both notes, we would still acquire that because we figured that the chances of borrower working with us and not defaulting is pretty high because they have equity. Sure.
Jonathan Davis (17:02):
I started working at a, at a company where that’s what we did. We bought and sold notes and when I left four years later, there were several notes that were in foreclosure in Kings County, New York that were there when I started and were still there when I left. Four years later. So yeah, I get the hesitance in those markets.
Bob Malecki (17:27):
Oh, I was going to say, one of the notes I bought in my IRA I bought from Gemini, this was back, I don’t know, five years ago, six years ago I bought into my IRA and it was in New Jersey and it was already in foreclosure and it was a condo, like a town home, a vacant, the borrower, I believe it passed away and even after, and it wasn’t for closure at least six months when I bought it, it still took over a year, almost a year and a half to foreclose on it and get it out and get it. I think we, yeah, we ended up buss selling it at the auction, but the good news is the property had appreciated more and there was, it was so underwater that we just kept, you know, as as it went on, even though it cost us money for fees, servicing fees, and there was some overhead costs, we ended up making a pretty good amount of money on it just because the property appreciated with the market. So sometimes that timing is good, but in a down-market, obviously it’s pretty bad.
Jonathan Davis (18:20):
Yeah. So as opposed to loan sales and loss mitigation. When we say loss mitigation, I mean, you know, working, working the loans out to get them re-performing. Well I guess what’s the percentage of loss mitigation do you all or are you effective with? Cause I, I imagine it’s fairly high, isn’t it?
Bob Malecki (18:38):
What do you mean by percentage of loss mit though? I mean everything goes into the loss mit…
Jonathan Davis (18:42):
Of successful loss mits so, so actually getting them either loan modified or reinstated in some way.
Bob Malecki (18:51):
Yeah. Currently in the notable fund we’re at about a 45% a portfolio is 45% re-performing and 55% non. Yeah. And part of that is because we’re just kind of working through them, the lower hanging fruit. So we’re getting the best ones repositioned and the loss mit complete. And so that’s, that’s a bit skewed in that if all loans being equal, I don’t know if we’d still be at a 40 to 50 we might be even higher. But you know, it’s just a matter of getting everything through our pipeline.
Jonathan Davis (19:22):
That’s great. Those are good numbers.
Bill Fairman (19:24):
Yeah. So I did finally remember what I was going to say. I’m telling you the jet lag is killing me. Having notes all over the country helps you diversify in different parts of the country because we all know that real estate is local and you know, while one part of the country might be suffering a little bit, there’s other parts that are still increasing in value and having notes that are diversified geographically helps the fund diversify the risk. Just like you were saying in the Seattle area, you can’t do fix and flip there. You can’t find properties cheap enough to make a profit. And the municipality there has made it so difficult to build new. It’s very difficult to go in and, and, and do new housing as well. So it was a smart move moving to the, to the note side of things.
Bob Malecki (20:18):
Yeah. Yeah. And it’s the diversification and doing different States is, you know, helps mitigate some risk. Because when I talk about all these, you know, a lot of the notes in our portfolio have a equity above the CLTV and a prospective investor. So what happens during a downturn? What happens when there’s a recession and we’re going to have one, and I said, well, the good news is, you know, different States, different cities will have a downturn at different rates. First of all, it’s not going to be an even recession in our portfolio. Also, at least from my perspective, homeowners who have equity will tend to stick around in that house and not stop paying their mortgage just because maybe one of the spouses lost their job or they, they’ve got a lower income. Also because we’re targeting loans with the substantial equity above the CLTV. Even if the house depreciates 10% we’re still covered for the most part on the average.
Bill Fairman (21:18):
Excellent. I’m glad you brought that up because a lot of people say, well, you know, why would you buy a note that has gone into default. You know, you’re buying notes from bums. That’s not really the case. No one goes into borrowing money with the intention of not paying it back. It can be all kinds of things and what’s going on right now with the, the Corona virus scare. There’s a reason why people would default on a second, right there loss of a job for a certain period of time. Right?
Bob Malecki (21:51):
Yeah. But also in that same respect, there might be more app to be telecommuting rather than commuting to their jobs. So they want to keep their home and stay in it so they have a place to work, you know, the two example
Bill Fairman (22:04):
But, but if they have a short term period where they don’t have any money in them to make that payment, they’re typically. And what’s really unusual, typically they’ll pay their second because the payment is lower and they don’t pay their first because it’s higher, which makes no sense to me. But at the same time it’s usually a temporary loss of employment or it’s a temporary illness that get people into this position in the first place and it’s a whole lot easier to work those notes back out again. Down the line don’t you think.
Bob Malecki (22:37):
It is, it is. And again the discount you can buy the note at gives you more flexibility on that loss mitigation and the workout you do because you know let’s say a borrower there, their unpaid balance of $60,000 and we were able to pick it up for $20,000 we’ve got $40,000 of equity so to speak, to work with them. So reamortize their loan over a new period, we can lower their rate, we have a few tools we can work with to make it work it out with them so that it works for them financially and we still make a good return on our investment on that asset. So it’s kind of a win win for everybody.
Bill Fairman (23:16):
Nice. So Bob, give me your website or how you would like other people to contact you about your fund.
Bob Malecki (23:24):
Absolutely. It’s www of course, NotableFund.com that’s N O T A B L E F U N D.com and my email is firstname.lastname@example.org be happy to do a call, whatever. If you want to learn more about notes or if you’re interested in coming into the fund. We’re still open for investments. We have a fixed preferred return between 8% and 12% depending on the investment amount and it’s paid quarterly.
Bill Fairman (23:53):
Okay. Now are you taking accredited investors only?
Bob Malecki (23:56):
No. It’s open to both accredited and non-accredited. It’s a, it’s a 506B which allows us a limited amount of non-accredited investors.
Bill Fairman (24:04):
Okay. Well this would be a great opportunity for me to say we are not selling or any investment. You must read your PPM before you invest. Your mileage may vary. I love the note space. Again, we’re, we’re basically in the same space. We’re just in it at different times of the, of the process.
Bob Malecki (24:28):
Yeah, absolutely. It’s, I find it’s wonderful. It’s, it provides for, for me personally in my IRA, it provides me the ability to create cash flow without the overhead of owning property and tenants trash toilets and real estate agents and contractors and all the fun stuff that comes with that you got, and you can run it, you know, run it in your pajamas. So to speak because it’s essentially just telephone, email. I’ve never been to a property that we bought a note on. I don’t care to bids. There is a lot of field resources you can deploy. So the banks have created a great industry for themselves in doing loans and then we can tag on to their resources on the back end when we need to perform loss mitigation and, and property reviews.
Bill Fairman (25:15):
And just so everyone knows Bob is not working in his pajamas. Quarantine and actually gets to work out of his house. That’s the kind of life you want to lead. Right?
Bob Malecki (25:26):
That’s right. My golden retriever sitting behind me gnawing on his bone. Hopefully you don’t hear that through this broadcast.
Bill Fairman (25:32):
We’re good. All right Bob, listen we, we thank you so much for your time. I know it’s a difference in time zone cause you’re out there on the West and we’re not. How’s your weather anyway?
Bob Malecki (25:46):
Weather’s good right now it’s been sunny. It’s last month, we had I think 30 days of straight drizzle rain and now we’ve got a big high, what do they call high pressure sell from Alaska. So it’s dropped down into the 30s and they might have snowflakes tomorrow but it’s nice to have sunshine over here being so far up North. So.
Bill Fairman (26:04):
So you can actually see Mount Rainier today, huh?
Bob Malecki (26:07):
Yeah. And the Olympic mountains.
Bill Fairman (26:09):
Nice. Again, thank you so much for your time folks. I appreciate you joining the show today. If you want any information on our fund, it’s CarolinaHardMoney.com and click on the investor tab and then fill out the form. We’ll schedule an appointment and if you want to talk to Bob about his fund, it is Notable fund.com we’ll have the URL listed in there so you won’t have to listen to me. You can just click the link. Well I’ve been messing up all day haven’t I Bob?
Bob Malecki (26:42):
That’s okay bill, I appreciate you having me on and I hope that after we close down this session, you can go take, we can take a nap, get some rest. Cause I know what it’s like traveling like that.
Bill Fairman (26:51):
Thank you sir. Again, don’t forget the share, like subscribe, all that stuff see you on the next show everyone.
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