Investment-to-value is the note buyer's quickest screen, but the right number is not a rule of thumb: it falls out of the foreclosure timeline and your required return.
A good investment-to-value ratio for a non-performing first lien is the ITV at which the foreclosure path alone, with every cost and every month of waiting, still earns your required return. It is an output, not a rule. On a fictional $200,000 house, a 20 per cent target supports a bid of $90,192, or 45.1 per cent ITV, when the foreclosure sale comes at month 18; the same target supports 58.4 per cent at month 6 and 34.2 per cent at month 30.
Worked in full in The Mortgage Note Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A non-performing note is repaid by the house, not by the borrower. The useful first screen is therefore not the price as a share of the unpaid balance but your cash at risk as a share of what the property is worth: ITV, the bid divided by the value. Note buyers trade rules of thumb for it, and the rules are dangerous because they ignore the variable that does most of the damage, time. Every month between purchase and resale is a month of carrying costs and a month of discounting at your hurdle. The calculation below turns a timeline and a hurdle into the ITV you can pay.
| Input | Value |
|---|---|
| Property value (BPO) | 200,000 |
| Unpaid principal balance / total debt with arrears | 150,000 / 176,000 |
| Acquisition and boarding costs, month 0 | 1,500 |
| Taxes, insurance and servicing until the foreclosure sale | 450 a month |
| Legal fees, half at filing (month 2), half at the sale | 5,000 |
| Foreclosure sale, base case | month 18 |
| Possession, then marketing | 3 + 4 months |
| Holding costs after the sale | 300 a month |
| Cash for keys and repairs, at possession | 9,000 |
| As-is haircut / selling costs | 10% / 7% |
| Required return | 20% |
Total debt of 176,000 exceeds the 167,400 the house nets on resale, so the lender's recovery is the house, not a payoff of the debt. Where total debt is lower than the net value, a third-party bidder at the sale would pay off the debt and the recovery is capped there.
Step 1: what the house returns. 200,000 less a 10 per cent as-is haircut, less 7 per cent selling costs, is 167,400, received at month 25: the sale at month 18, three months to possession, four to market and sell.
Step 2: what it costs to get there. 1,500 at purchase, 8,100 of carrying costs over 18 months, 5,000 of legal fees, 2,100 of holding after the sale and 9,000 of cash for keys and repairs: 25,700 in all, leaving 141,700 undiscounted.
Step 3: discount at your hurdle. The maximum bid is the net present value of every flow at 20 per cent, compounded monthly.
Max bid = PV(167,400 at month 25) − PV(costs) = 110,737 − 20,545 = 90,192
ITV = 90,192 / 200,000 = 45.1%; as a share of UPB, 60.1%; as a share of the net resale, 53.9%
Excel, flows in B2:B27 by month: =NPV(20%/12, B3:B27) + B2
The discount factor on the resale alone is 0.662: a third of the house's value goes to waiting before a single cost is counted. That, not the legal bill, is why ITV has to come from the timeline.
| Sale at month | Resale month | Max bid at 20% | Max ITV | IRR at 30% ITV | 40% | 50% | 60% |
|---|---|---|---|---|---|---|---|
| 6 | 13 | 116,762 | 58.4% | 78.0% | 52.9% | 33.5% | 17.6% |
| 12 | 19 | 102,819 | 51.4% | 51.5% | 34.7% | 21.6% | 10.9% |
| 18 | 25 | 90,192 | 45.1% | 37.8% | 25.3% | 15.5% | 7.4% |
| 24 | 31 | 78,757 | 39.4% | 29.4% | 19.5% | 11.7% | 5.2% |
| 30 | 37 | 68,402 | 34.2% | 23.7% | 15.5% | 9.1% | 3.8% |
The gap between a fast and a slow state is 24.2 points of ITV on the same house. Read across a row and the other lesson appears: at 50 per cent ITV the return ranges from 33.5 to 9.1 per cent purely on timing. A buyer who quotes "50 per cent ITV" without a state attached has not yet priced the note.
| Required return | Max bid | Max ITV |
|---|---|---|
| 12% | 108,123 | 54.1% |
| 15% | 101,027 | 50.5% |
| 20% | 90,192 | 45.1% |
| 25% | 80,480 | 40.2% |
Moving the timeline six months moves the ITV about as much as moving the hurdle five points. Diligence on the state, the court backlog and any bankruptcy history is worth as much as a debate about the right return.
The common mistake is to price non-performing notes as a share of UPB. Take a second loan, identical except that its balance is 190,000, on an identical 200,000 house. If both go to foreclosure they recover the same house. A buyer paying 60 per cent of UPB for both pays 90,000 for the first, 45.0 per cent ITV and 20.1 per cent on an 18-month timeline, and 114,000 for the second, 57.0 per cent ITV and 9.7 per cent. The larger balance looks like more collateral cover and is in fact a worse price. ITV puts both on the house, which is what will repay them.
The second mistake is to compute ITV on the BPO without the haircut: the bid that matters is against what the property nets as-is, after selling costs, not against its retail value. And ITV is a screen, not a valuation: a modification or a deed in lieu may be worth more, as modify or foreclose shows, but the bid should still come from the path that needs no cooperation from the borrower.
The Mortgage Note Investor bids its judicial-state loan from its foreclosure floor month by month, one column per timeline; the workbook is among the free companion files for the book. How much the court timeline alone takes off is worked in what a judicial foreclosure takes off the bid.
Divide the price you pay for the note by the current value of the property securing it, usually a broker price opinion or appraisal. A $90,192 bid on a $200,000 house is 45.1 per cent ITV. Unlike LTV, which compares the borrower's debt to the value, ITV compares your own cash at risk to the value, which is what you recover in a foreclosure.
It depends on how long the foreclosure takes. On the fictional loan, with 20 per cent targeted, 50 per cent ITV earns 33.5 per cent when the sale comes at month 6, 15.5 per cent at month 18 and 9.1 per cent at month 30. The same ratio is a bargain in a fast non-judicial state and an overpayment in a slow judicial one.
Because a non-performing note is repaid by the house, not the borrower. Two loans of $150,000 and $190,000 on identical $200,000 houses are worth about the same if both end in foreclosure. Paying 60 per cent of UPB for each means 45.0 and 57.0 per cent ITV, and returns of 20.1 and 9.7 per cent on an 18-month timeline.
This article is one calculation from The Mortgage Note Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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