Real Estate Investing Basics

How to Avoid a Haircut on your Note

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One of the first lessons we learn in real estate is that you make your money when you buy. Sometimes that is a hard pill to swallow, especially when we make a good real estate purchase that turns into a bad deal, only because of unforeseen circumstances.  However, in note origination there are several instances where you can make or lose your money even after buying correctly. As a note investor, it is these instances that determine how big or small of a discount you would have to offer to make your note appealing to an outside investor.  

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The following list includes the types of discounts I am talking about and what factors should go into each discount:

Note Discounts: Kinds and Factors Behind Them

Extremely Large Discounts:

Have you ever encountered an investor who haphazardly sells properties with seller financing just to get a warm body in the property? Maybe they are just starting out, or maybe they just don’t know or care about how to originate a good seller financed note. In any case, investors who sell properties on contract with poor due diligence, poor recordkeeping, over-inflated sales prices, and small down payments, have few avenues left if they want to sell their note on the investor market. These note originators can only hope that the person in the property will continue to pay, otherwise the note has very limited value to anyone besides them.

Large Discounts:

Here’s some helpful information I’ve learned from personal experience. Originating notes in undesirable cities and/or neighborhoods requires you to look at your note with realistic expectations. Having originated notes in markets that most of the country looks upon unfavorably does not give you much room to work with in how much of a discount you can give to investors. It is not uncommon for a perfectly good note with a perfect checklist of proper due diligence and recordkeeping to only command 50-60% sales value on the investor market. Location of notes is just as important as any other factor you deal with in traditional real estate investing.

Moderate Discounts:

Here is where seller financing investors really start making good profits. Notes that are properly set up with a prospective homeowner, which have a good payment history in desirable markets and are originated within twelve months, only increase in value over time. If you’re selling notes that are set up the right way with proper due diligence in this first twelve month window, you can potentially get between 65-75% of the note value in a cash sale.

Small Discounts:

Think of great notes as delayed flips in real estate.  As an investor your notes should always follow every aspect of due diligence and record keeping.  Combine that with a mortgage qualified homeowner and a desirable piece of real estate, and you now have a prospective note that buyers crave.  Now those buyers are willing to pay a higher premium on a solid purchase. These notes can command as much as 95% of their note value.

Discounts on notes can range widely depending on a host of factors, and as a result, most real estate investors shy away from selling their notes on the open market. Yet, if you’re interested in selling on owner financing, with the intention of holding the note for a short period of time and then selling it, this guide should help you establish realistic expectations for discounts on the notes you are selling.

Photo Courtesy: Vauvau