Wealth Formula Episode 270: Is a Wave of Mortgage Defaults Coming?

Catch the full episode: https://www.wealthformula.com/podcast/270-is-a-wave-of-mortgage-defaults-coming

Buck: Welcome back to the show everyone today my guest on Wealth Formula Podcast is a friend of the show. He’s been on more than anybody else. He’s also a friend of mine. He is the founder and chairman of AHP Servicing. His name is Jorge Newbery. Jorge welcome back.

Jorge: Thanks Buck. Thanks for having me back on. I’m trying to stay ahead of the rest of the pack in terms of the number of appearances on your show.

Buck: Yeah I think you’ve at least I think you’re at least two or three ahead.

Jorge: Okay good let’s keep it that way.

Buck: Yeah so Jorge okay so you’ve been on a number of times and in the last few shows we’ve sort of jumped to the meat of the content which was what’s going on right now and that sort of thing but since we started and you started coming on I think the first time you came on there might have been about 10 listeners to the show and now you know we have about over 20,000 downloads per month. So tell us a little bit about your background. What you did and what and what you’re doing now.

Jorge: Sure you want me to start at the beginning?

Buck: Well I mean it depends. There’s a book on that right?

Jorge: That’s true yeah for the full history there’s a book called Burn Zones that’s available on Amazon that you can learn the full story. But I’ll get the short the the abbreviated version. I started buying real estate. In 1992 I bought a four unit building and then I bought a 19 unit building then a 60 unit building and I kept buying bigger and bigger. And what I would do is buy the biggest most troubled properties that I could find in the country and I turned them around and I had great success doing this and made a lot of money. The challenge is that my biggest building I ever bought was one called Woodland Meadows in Columbus Ohio 1100 units and that property got hit by an ice storm which triggered an extraordinary sequence of events which resulted in me going from owning 4,000 apartments and having a net worth in the tens of millions to losing everything and being 26 million dollars in debt. So quite a turnaround of the not the way you wanted to go and I rebuilt myself through American Homeowner Preservation which started out as a non-profit with a mission of keeping families at risk of foreclosure in their homes. It’s since evolved and now it’s been a for-profit for more than a decade and in the last decade we bought more than 10,000 defaulted mortgages. And our strategy now to achieve that same social mission is to buy defaulted mortgages at discounts from banks and hedge funds and then go to the families and try to work out consensual solutions for instance if they want to stay we can often provide them a loan modification which is share some of the discount with them in a form of reduced payments, forgiveness of principle and or forgiveness of some of the delinquent amount that they owe. And so it’s been successful and it’s evolved we now are national mortgage servicer AHP Servicing. We also have a platform where we sell defaulted mortgage notes one by one to local investors called pre-Reo. I’m a partner law firm called activist legal and which handles foreclosures and default services across the country and we are now soon starting a title company AHP Title Company that’s starting it. Actually we’re buying an existing title insurance company. So it’s evolved into several related and interconnected businesses that all work towards the same mission of keeping families risk of foreclosure in their homes. And in addition we have a nationwide mortgage originator which tries to originate micro mortgages. So the majority of our work is done in low and moderate communities and to whatever strategies we can utilize to do social good as well as make a profit.

Buck: Well and that’s all Jorge? I mean jeez I consider myself an entrepreneur but this yeah you’re kind of taking it to the next level my friend. But the common theme for the last gosh almost I guess almost 30 years for you now here has really been in residential homes mortgages that kind of thing and when you started. Maybe you can talk a little bit about what the environment was like when you first got into the space of non-performing notes because that was what year that was right pretty close to the great recession right?

Jorge: Yeah 2008 AHP started in 2008 which was the last downturn started you know we’re anticipating now another downturn but in 2008 Cincinnati Ohio property values collapsing you know significant disruption to the economy especially the housing markets.

Buck: Yeah and then so what have you seen since that time and when you talk about it in terms of cycles and you actually just reference that you see something potentially coming up obviously since that period of time there was a gigantic boom and what did you see happen in the housing market and as it relates to you know the defaults and that kind of thing say up until pre-Covid?

Jorge: Sure when we first started 2008, massive number of foreclosures, massive number of REOs for sale just huge supply limited demand so prices kept dropping dropping dropping for real estate that lasted 2009, ’10 ’11 ’12 ’13 ’14 you started seeing a floor and in some cases you started seeing appreciation on a modest level and that continued for several years. And I’ll tell you when we first started buying defaulted mortgages more than 10 years ago, we entered as a buyer, very small buyer working with maybe a million dollars and we were buying from some of the biggest banks in the country and that was awesome but the reason for it was because there were so few buyers, huge amount of defaulted mortgages, not that many buyers. So though these sellers will sell to anybody as this market improved

Buck: So by the way that means huge discount.

Jorge: Huge discounts yeah we’d be buying you know a loan. I mean this is a typical loan back then and it’s evolved but we would buy a loan that was they owed a hundred thousand the property value was only 50 because the property values had dropped we could buy that loan for twenty thousand dollars and that was a pretty typical numbers on loan that we purchased. Now over time, that 20 became 25 became 27 even started to hit 30. and that was just the passage of time where the real estate market became more predictable stronger instead people thinking when we first started buying people thinking that oh this may go down. Now they’re thinking okay how much is this going to go up. And and that continued to the point where in 2019 when we had started the newest fund AHP service and we went we stopped taking investments because we were having trouble investing the money that we were raising because the prices there were still loans available but the prices had gone so high it just didn’t make sense in many cases to buy. And then Covid hit and Covid I thought was going to be that inciting incident where this long upcycle which was longer than than historic averages in terms of the upward part of the cycle so it was due for a downturn and usually there’s a trigger and in this case I thought okay Covid’s going to be the trigger and everything’s going to start crashing down. And the opposites happened. The market has experienced almost another upcycle on top of the prior upcycle without the middle down cycle. And not only that, it’s compressed. We’ve had a 20 to 30% appreciation more or less a year and so it’s compressed the time frame.

Buck: So let’s talk a little bit about why that might be because to me what I’m thinking what happened during Covid is I think a lot of people thought yeah hell’s about to break loose and that kind of thing but then you had these you know essentially moratoriums on you know people being able to stay in their house you had huge stimulus so that people could actually pay their mortgages and all those things the huge amounts of government support probably meant that what you would expect in terms of inventory of defaulted loans didn’t happen. Do you think that that’s it or is there something else?

Jorge: I think you’re absolutely right you touched on two big things. One is the foreclosure moratoriums which have done two things. Have constrained inventory also you know a lot of families that maybe are struggling the right you know the right part of that is that they’ve been able to stay in their homes in many cases without paying. And the other part is a government stimulus which has been extraordinary in scope and has just flooded the system with cash which I think two artificial ingredients which have made probably prevented the downturn. But maybe it had some unintended consequences. I don’t think that the intention of all this flood of cash into the system was to fuel a significant appreciation in asset values and that’s what’s happened in many asset classes and at particularly real estate. So again it’s artificial components to this surge you know you couple the stimulus with the foreclosure moratoriums and with the record low interest rates. And you put all those combinations together and you have the super robust real estate market. But those factors cannot I mean it’s artificial. Those factors are not market driven they were programs by our government that won’t last and you pull those out and I think it’ll be fairly ugly what’s really there and these have masked these artificial ingredients have masked the true damage to the economy which I think is I mean there’s certainly industries that have done well they’ve been covered winners but there’s a lot of losers in there and I think a lot of families have been financially ravaged and businesses too and you know once the PPP money runs out the stimulus runs out and maybe the interest rates start up ticking that we’ll be exposed and I think that will be you know at some point there’s a trigger for the downturn and I think from pretty weak footing you know that the big ingredient for our federal government to intervene when things are going wrong is to lower the interest rates. You can’t really lower them any lower than they are today so you have a weak economy and low interest rates so it’s gonna be very challenging.

Buck: Yeah you know you’re absolutely right and I just wonder about the pattern of government both fiscal stimulus you know the interest rates from the fed and buying back bonds and then all the government intervention together you know there’s always a question of does it have to stop and one of the questions you know I’ve been asking myself is maybe they just don’t think they have to stop at this point right? I mean so what’s ultimately happening with all of this intervention is we are seeing real inflation. And so the question is you know in your mind obviously you think there’s a downturn I mean the fed or you know interest rates are not going to go up unless it’s really something that the government and the fed are okay with right I mean they have a lot of different ways to artificially suppress those rates. So what do you think when you when you think of the trigger? What’s the trigger and when do you think this is happening?

Jorge: Yeah it’s tough to say what it will be it’s it can often be an emotional one something that we don’t see coming like Covid. I mean Covid shouldn’t but it could be emotional sentiment political change it’s hard to say would it be the trigger I mean but I’ll make some predictions which I would not put a wager on but here’s what I would think is going to happen: these foreclosure more times will continue through the end of 2021. I think that’s highly likely in fact I think they’ll even be expanded in scope and that will keep the market robust like it is right now and probably even continue to appreciate somewhat 2022 those foreclosure moratoriums and other consumer protections will start expiring rolled back but there’ll be significant regulatory pressure and government pressure on mortgage holders and servicers to not foreclose and instead to work with the consumers to try to find solutions to keep them in their homes. And I’m talking about foreclosures but there’s also similar protections voluntary and involuntary on other types of debt that consumers may be struggling with. And so I think 2022 will be a year of modifications of other types of workout programs that do help some families get back to the point where they can pay. But 2023 would be the year that I think now there’s we’ve had a year of trying to work these things out with these families some of them have made it and then whoever hasn’t 2023 I think will be a crushing year in terms of foreclosures. And then now you’re going to start seeing significant inventory flooding the market and that may not happen in late 2023 or 2024 as these processes move through the court system but at some point maybe late 2023 2024 you start seeing a flood in the market of distressed assets and that will dampen prices prices will start going the other way. And then you know I think the unfortunate consequence is that people who bought by today who are buying it 20 to 30 percent more than these homes were worth a year ago. Now fast forward a year or two and be under these property values start going the other direction and they’re sitting on they put down three percent and now they owe you know 97,000 on on a home that has now you know the home across the street identical home is selling for 70 or 80. People even if they can pay some point they’re going to say you know why should I pay? I’m totally underwater. I’m never going to get back where I want to be. I’m just going to stop paying my mortgage and now that’s this is what happened last go-round and then you start seeing okay now gets even worse. So I started seeing this thing where it got better and better and better and now gets worse and worse and worse and the damage expands. So I hate to paint a bleak picture but we’ve seen this movie before I think it’s coming back.

Buck: I think that there’s a difference in terms of what happens with the housing markets at the high end versus the middle and lower end or do you think it’s all the same?

Jorge: You’re right oftentimes there’s a home or price range is fair particularly better or worse than others this go around though this post Covid bump in values has been almost across the country in almost all price ranges and that I think is means that it’s gonna negatively impact you know the comeuppance is going to affect the same thing all across the country. All price ranges I think we’ll see I mean at some point it’ll go slowly. It won’t be a bloodbath day one but I think it turns into a bloodbath and I hate to say that I’m not saying that cavalierly because the problem is you know behind all that blood are real families who are stuck in real pickles and they’re doing a good thing today by buying a home thinking that’s the right thing to do. And it may well be I mean in fairness to step back one of the reasons people are buying today is they’re saying hey I’m paying two thousand dollars a month for rent I’m buying this home with a fixed rate 30-year mortgage and all in I’m paying 1500 that totally makes sense to go so in some of these families hopefully we’ll get to that point where maybe they are underwater but the housing cost is still affordable enough and makes sense that they will continue to pay their pay their mortgage and see it through because eventually as you see you know the people who did make it through 08,09,10 made it to the other side you know many of them have been you know now their home values have been restored and some in most cases have gone up. But I do fear that there will be big challenges. At the same time we’re paying back you know all the government stimulus all the low interest rates all these things are not good long-term for our economy at some point these artificial ingredients will have their unintended consequences will start to show and that will probably have some negative impacts on some families abilities to pay some \ industries and whatnot.

Buck: Well that makes me feel good about just buying a house right now.

Jorge: You have to get out I mean I know you’re buying a house right now if you’re going to buy their long-term I mean right but if you get out of there if your intention is to buy it fix it up and resell it and you can exit in this market it could be fantastic but this is just look into this like a pyramid scheme you know the pyramid schemes everyone wins until the last people in and the last people in lose. And so I mean from a business perspective you need to buy it now exit into this market you probably do very well if you wait takes too long though and you’re exiting after this pyramid is collapsed you know then you’re the last guy in and that may be unfortunate.

Buck: Or you just say hey I’m gonna stay in this forever and you’ll be fine.

Jorge: Yeah that’s true it still feels weird though when you’re sitting in a house where it’s twenty percent more than you’re paying a mortgage twenty percent more than itself for sure it’s worth it just well this doesn’t feel good.

Buck: Yeah so Jorge how does you know because you have it and obviously your past is in the apartment space right and that’s a lot of what I do and through our real estate syndication stuff. How do you think that the crises that you would foresee happening in the mortgage space? How do you think that those things will affect rentals apartment buildings things like that in some ways you would think that you know those kinds of properties might benefit from an onslaught of people needing to rent but I’m just curious how you see those two things interplaying or how they have historically?

Jorge: Yeah okay so historically I think you’re right there will be more people you want today there’s people coming from rental renters turning them into homeowners and that’s great that’s the way it should be. But in a downturn it’s likely that some of those homeowners will go back to being renters unfortunately. And so operationally that could be good in terms of demand for apartments. I get a little nervous on the apartment investing side though a lot of the high prices because some of these multi-family properties are selling for extraordinary prices today and that’s a major primarily driven by these low interest rates for sure. So at some point these rates go up I mean the numbers are just going to dictate a lower value you almost can’t get any lower than today’s interest rates. So that there has to be I think in a downturn you’re going to see some just like last time you’re going to see single-family homes went down so did multi-family and I think the same thing will happen I don’t think there is an exception without they’ll be able to survive any better than single family.

Buck: I think the goal in those types of situations for people who are looking for you know investing is to to not try to speculate quite as much right I mean if you can buy something that is cash flowing you create value you can drive up rents now and create stability you’re much better off than you know just going in there and trying to flip homes and hope that the game of the musical chairs.

Jorge: Yeah I mean if you could like long-term even bitcoin look at bitcoin and I know you’re familiar probably more than me but look at the wild market fluctuations that it’s experienced over the last few years. If you get out in a panic when it’s down or you buy in a you know in a euphoria when it’s up there it’s just you see on a much greater basis these wild fluctuations that have occurred. And I think my point is if you can withstand those stay the course you know you’ll probably do okay in the end as you know wild roller coaster ride. So same thing with real estate it’s just like it’s not so wild it moves more in slow motion but at some point you’ll start feeling hey these things are going right now it’s going up you know then it’s going down you know if you’re going to jump out as soon as it starts going down then that may not be optimum.

Buck: Let’s talk a little bit about AHP Servicing these things that you’re talking about specifically the potential for negative activity in the housing market actually benefit AHP servicing as a business. So basically the idea and I’m just going to try to sum this up for people who are trying to understand this because they obviously AHP has been a sponsor of the show for a long time the commercials. So what AHP does is basically goes in and for people who are struggling they buy these mortgages for less than the people actually owe and then they negotiate they try to negotiate with the homeowners to try to keep them in the home. Basically trying to get a maybe a mortgage that they could pay maybe for giving some of what’s owed on the back end and that kind of thing. So in that regard it’s a very you know socially responsible type business. The only other options I guess they would have in that situation if somebody can’t do that then would be to foreclose which they don’t want to necessarily do or you know you could potentially pay somebody to leave and then sell off the asset but the goal of AHP Servicing as I understand it Jorge is really to keep people in the house. Did I kind of get that right?

Jorge: You did. I’ll just add one component is that in addition and historically all we did was buy mortgages. Now there’s an added component that we buy and service mortgages for both the ones we own and owned by third parties and so that outreach that mission to achieve consensual solutions in a rapid fashion which is what we try to do now we do it not just on loans we own but for third parties and once that downturn hits you know there’s a lot of money a lot of people especially right after Covid hit, a lot of people are raising a lot of money. Hey the downturn is going to come we’re going to buy these to faulty mortgages and other types of debt and try to make money do that. And that just hasn’t been a whole lot of loans to buy so that hasn’t been the case yet but once this downturn hits we want to be in a position to service for any you know mortgage holders who have those defaulted mortgages who need high-touch servicing to work them out.

Buck: There are a couple of nice features about AHP servicing as an investor that I think are useful to know. One is you don’t have to be accredited. So I know all the emphasis a lot of times and what we talk about in this group is private investing people who are accredited and then if you’re you know if you are accredited you join our backend private group and prove that you’re accredited and have that kind of thing. But you don’t need to do this if you’re a listener, you’re not accredited and you’ve even got a few hundred Bucks you can participate, right Jorge? You want to explain how that works?

Jorge: Yeah exactly it’s a minimum investment of a hundred dollars we accept accredited and non-accredited investors and accredited investors can invest as much as they want not accredited. There’s limits based on your income and or net worth but yeah it’s basically open to everybody. And I think that’s one of the unique things and we made the entry you know that minimum investment as low as possible in order to make the investment as accessible as possible

Buck: What’s the situation with liquidity? I know this is kind of a been an issue just in terms of I mean the goal is to be able to you know which is a unique aspect of this fund is to be able to retrieve your funds if you need them. How does that work?

Jorge: Yeah sure so we call our best efforts redemption feature and how it works is investors who need their money back for any reason can request that it’s returned to them and that their investments redeemed and will undertake our best efforts to redeem within 30 days. And historically we were able to do that and it was a nice you know hey people invest thinking you know hey I don’t need this money but then all of a sudden they find a great opportunity or life circumstances change business circumstances change and they need the money back and they can get it. And we have through the beginning of Covid we were doing just fine with that and by and large we’re redeeming within 30 days. But once Covid hit we had an extraordinary spike in redemptions. You remember back then you know businesses were struggling stock market was fluctuating wildly and people needed their money to make payroll to cover margin calls and all kinds of other reasons and or they were just nervous about you know what’s gonna happen so we had an unprecedented number of redemptions which we’re still working through. We’ve made huge progress I think in the last 30 days we’ve redeemed you know there’s millions of dollar of redemptions completed in the last 30 days or in process to be done in the next 15 days. So a lot of money has been redeemed but we’re still working on a significant backlog. So right now I would invest knowing that that feature is there and I’d expect within the next few months we’d be back to returning within 30 days. But now that has not been the case. One other caveat to that if you do redeem early in the first year we typically your return is reduced by two percent and if it’s done in the second year by one percent after two years of being invested in full there’s no offset.

Buck: What’s been the record in terms of meeting the expected returns?

Jorge: Sure so we were doing extraordinarily well through my last full year was 2017 we had an over 40 return we changed leadership for 2018 and 2019 and those returns went to the single digits I came back in mid-2019 and made some significant strides Covid hit and our returns have not been where they should be but there’s huge asset value it’s just assets that we own and luckily with Covid as we talked earlier those assets have gone up in value. So today what’s happening is we are selling all the loans we didn’t sell any loans at scale since I came back aboard in mid-2019. Today we are selling all our paying loans, all the loans that are re-performing we’re selling these often in the 90s so 90 91 92 cents on loans that we oftentimes purchase for you know 50 around 50 cents so huge gains which are in the portfolio which we are now realizing REOs when we get REOs through the system today which again with the foreclosure moratoriums we can’t always do but we can let’s say on a property that’s vacant and we are allowed to foreclose we’re putting those on the market multiple offers selling them a huge gain. So I think 2021 will be an exceptionally good year in both of our outstanding funds

Buck: How does that translate for investors now Jorge and in turn because usually there’s a fixed return has that sort of and what is it now and have you been able to meet those demands?

Jorge: Yeah we pay the first pers a predetermined percentage to investors provided we have money available so in the AHP servicing fund we pay the first 10 percent of what we earn to investors and that’s a 10% annual return in the next upcoming funds which are AHP title and pre-REO we expect to pay the first seven percent annual return to investors. There’s multiple funds that were paid that predate these funds where all the investors have been paid including their predetermined returns and so that’s what we pay. And then people say what happens if you make more than that where does that money go? That’s what we earn. So basically at the end of each of these funds we return all the money to investors they’ve gotten all their returns whatever’s left is ours. So the more we can make you know the more there is for us at the end to the extent we succeeded in our mission. And these have been bumpy these last couple of years have been bumpy first with the leadership change which didn’t go quite as well as hoped and I’ll elaborate a little bit we brought in a new replacement CEO from a large bank and she was good in some ways she kind of added a structure management structure to the company that was helpful but was conservative in investments and dispositions of investments and that kind of dampened the returns. So I’ve brought that back but it’s been with Covid hitting it’s been a little bit challenging to show those results until this year.

Buck: Sure and then have those impacted the investor returns have they been?

Jorge: No we’ve had enough cash available so think about this we still have a lot of money that comes in every month on performing loans. Again it’s because we’ve just been holding these we have a lot of money that comes in you know somebody pays off a loan or settles a loan. So with the exception of the first couple of months of Covid where for a while we weren’t selling REOs people were having trouble paying their mortgages there were a couple of months where we were several days late with our returns distributing returns because probably I recall we were just squeaking by in terms of having available cash but now we’re back to the point where we have significant available cash.

Buck: So bottom line is folks the returns have been pretty darn consistent you know going from you know ten down to seven and stuff you might be wondering why but I assume you know what you’re seeing across the board is that this kind of impact happens when there is incredibly low interest rates yields go down too. And so that’s what you’re seeing here Jorge. If people want to get involved, how do they invest? And they can just let it compound too right so your seven percent might actually end up you know compounding on itself and becoming like nine percent a year or something like that but how does it all work?

Jorge: Sure so investors can choose as you said they can choose to each month have their returns distributed to them or they can also choose to have them reinvested. And you’re right so that would create a compounding effect that’s only in effect for the first two years of a fund. As long as it’s open to investment we can accept reinvestments. Actually with AHP servicing we’re able to extend it for three years or up to three years it’ll close the day that AHP title offering goes live which should be in the next month or so. Today an investor can go to AHPservicing.com and learn more about the investment if they choose they can make an investment fast forward a couple of months and we’ll be able to say the same for AHP title.com and prereo.com

Buck: So everyone check all those things out. Jorge is like I said he’s one of the smartest entrepreneurs I’ve ever met and you know it’s funny when there was a change in leadership a little bit I was a little bit nervous because I know Jorge has a special sauce so it’s nice to see Jorge back in control over there and anytime Jorge is involved I think you’ve got some pretty good odds in your favor. Jorge thanks so much for being on Wealth Formula Podcast again and we will make sure that you stay in the lead and come back in a few months.

Jorge: I appreciate that Buck.

Buck: We’ll be right back.