Too Little Time & Not Enough Capital: Turnin’ Your Property Into A Bank

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For many, here’s how the story goes. They have one small investment property, maybe two. Total value is around $250,000 or so. They own ’em free ‘n clear. They’re racin’ to finish payin’ off their home mortgage so that when retirement hits, maybe in about 10 years, they’ll not have that to pay every month. In fact, they don’t like thinkin’ about it much. Social Security says they’ll get around $25-30,000 yearly, assuming they call it quits around 65ish. The rental, a triplex they’ve owned for quite some time, has proven reliable. But it nets ’em only around $20,000 a year, and that’s before taxes. They’ve looked at every possible way they could improve their likely post retirement income, but it always ends up with the same answer. They need more income to help pay off any new property they might buy, in time for retirement. They certainly can’t afford to buy for cash. They don’t wanna work into their 70s either. The way they see it, they’re dead if they do, and dead if they don’t.

Sound familiar?

They’re resigned themselves to an income, give or take, of $50,000 — all of it completely taxable. Without a house payment, plus a good budget, it should work. But it’s not what they bargained for when they began investing. A feeling of disappointment and resignation begins to take over. Here’s a way they can create another income stream, while still arriving at retirement with a free ‘n clear home and rental, AND at 65. It’s nothin’ new under the sun. Most folks just haven’t had it presented before.

Here’s the gist.

They might consider puttin’ a new loan against their rental, which is worth around $250,000. Doin’ so isn’t even a taxable event. The loan would be for roughly 70% of that value, around $175,000. Today’s terms means they’d be payin’ around 4.5% interest (30 yrs., fully amortized), which comes out to a monthly payment of about $887. So far, so good.

Let’s then have them go out and acquire a note (or notes), secured by real estate, that they buy at a discount. Now, discounts are all over the map, from over 50% to just 10%. Let’s say they find something they can buy for around 65% of the notes’ face value. At a $175,000 purchase price, that means they can buy notes totaling $270,000. (Yeah, I rounded up a few hundred.) The payments/terms are as follows:

10% interest, amortized for 30 years — no balloon. Monthly payments total around $2,370. (a few pennies less)

They’ll pay taxes on the part of the payments that is interest. Let’s say they net about 70% or so — roughly $1,660.

The strategy calls for them to then apply the after tax note payments — $1,660 — to the new triplex loan. Do this for about 80 months or so, less than seven years, and they’ll have paid off the triplex again. ‘Course, it’s a bit more likely than not, that the notes they bought will have paid off before seven years passed. It’s also completely possible they wouldn’t have. The last several years have shown, however, that the typical life span of these notes tends to be less than seven years, sometimes far less. It’s completely random. Predicting note payoffs is a fool’s errand to say the least. There’s a huge difference between ‘tends to be’ and what actually happens to any individual note. NEVER make investment plans predicated on a note(s) being paid off early, unless disappointment is your friend. πŸ™‚

It’s 10 years later and time for them to retire.

At this point they know what they have for income. There are three separate and completely independent sources. Social Security, the triplex, and the notes. SS gives them $25,000 a year. Their triplex spits out about another $20,000. Their notes, assuming none have paid off early, are good for a tad under $28.500. Add ’em all together and they’re retired on approximately $73,500 annually — every penny of it completely taxable. But, on the bright side, that’s a smidgeon over 63% more than they’d of had without the note income. ‘Course, if the notes had paid off during the 10 year period between purchase and retirement, they’d of paid the taxes on their profit, and bought more notes totaling higher face value, and yielding bigger monthly payments.

Built in raises

What’s so attractive about this approach is that once retired, life goes on for the notes. They get paid off, some sooner, some later. Each time a note gets paid off, our happy retirees take the after tax proceeds and buy a bigger note(s). In other words, every now and then they get raises. πŸ™‚ In fact, let’s take a brief look at a credible potential scenario.

Though their original note acquisitions didn’t adhere to the 2-5 year payoff trend, they did pay off in around nine years. After payin’ taxes on the profits, their net was roughly $235,000 or so. They immediately rinsed ‘n repeated, buyin’ around $350,000 in more notes. Their note income then rose immediately from $28,500 to, give or take, just over $36,000 annually — a raise in note income of over 26%. That would’ve meant their initial retirement income would’ve surpassed $80,000 a year. Either way, they’re much better off having turned their trusty triplex into their own personal bank, even if only for a short while. Again, and please, burn this into your memory. Notes pay off randomly, not predictably. This is especially true if they’re fully amortized.

This option is nearly universally available to those who find themselves nearing retirement with less than acceptable income. The more free ‘n clear equity you have available, the more income you’ll be able to generate. What appeals most to folks, at least in my experience, is that it allows them to return their income property to loan free status, and in a reasonable time span. In other words, it’s not ultimately a zero sum game. What really attracts ’em though is the future raises that will randomly occur over time.

Turning your small income properties into temporary banks can make the difference between a disappointing retirement, and one with hope.

About Author

Jeff Brown

Licensed since 1969, broker/owner since 1977. Extensively trained and experienced in tax deferred exchanges, and long term retirement planning.


  1. Not to be negative here, but with the coming inflation these folks are going to be behind the eight ball so to speak with their cash tied to fixed long term low interest rates.

    However I would like to be on the other side of the transaction in paying off the debt with a depreciating asset the US dollar.

    I would think these folks would be better off taking that money and putting it into bricks and mortar with a management company in place.

    That’s my plan, accumulate REI to the point where the cash flow can accommodate a good management company. Plus investing in some premium stocks, which unless I totally loose my mental facilities should be no problem managing from my I Pad.

    I have in the past created notes to get properties sold, but I am not sure why I would have sold one of those cash gushing notes, except to move the money into something with a shorter term payoff in the case of an inflationary period.

    • Dennis,

      You make a valid point on having 270k of notes with 9% actual inflation (I never believe the govt reported inflation). It loses around 24k in value each year.

      During these times, having a 6% fixed rate debt with 9% inflation is an interesting proposition. I’m very curious your take on this Jeff.


      • Jeff Brown

        Hey Jason — I love you’re thinkin’ about inflation. In the post, our couple made 16.25% cash on cash per annum on their $175,000. Your example of 9% inflation doesn’t touch that, right? When the notes they bought begin to pay off, that return goes through the roof, even after tax, due to the profit being realized.

        What if — After the couple in the post paid off their triplex in 80 months, looked at interest rates at that point, they’d gone up to 6.5%. But instead of retiring in a couple years, they had another eight years to go. If you were them, wouldn’t you borrow another 70% LTV? Wouldn’t you wanna hit retirement with around $540,000 in face value notes you’d bought at a handsome discount?

        Discounted notes are the friend of retirees when it comes to inflation. Back in the 70s in San Diego we had monster inflation, hitting somewhere around 14-15% or so. The notes I was buying for myself were yielding 18% if paid as agreed, and far higher if paid off early.

        • Thanks for the reply Jeff. With discounted notes, achieving higher than inflation returns is very possible. Just wanted to hear your take on it.

    • Jeff Brown

      Hey Dennis — Let’s think this through, ok?

      They borrow at 4.5% in order to obtain a 16.25% cash on cash yield. They use that spread — after taxes, mind you — to pay off the 4.5% debt in less than seven years. Tell me how they’re being hurt by 9% inflation. Let’s keep goin’.

      As I said to Jason, below, what if they do it twice? If you’re right, which I think is absolutely possible, and we get inflation, what is the value of the triplex after the second round of note buying? What are its rents? Since real estate values and rents track inflation like a hound dog, they end up with the same free ‘n clear triplex, but worth a lot more while sportin’ far higher rents.

      They slaughtered inflation.

    • Jeff Brown

      It depends if you’re gonna be a business or not, Dale. I tend to avoid anything whatsoever to do with the SEC. πŸ™‚

      Investors, for the most part, are gonna be buyin’ notes and stockpiling them, not treatin’ ’em like a used car lot. On the other hand, if they’re owned by a Solo 401k, they’re considered an investment.

      One of the things I’m currently researching is the SEC. So far, I’ve not run into any potential ‘spiders’. Where folks get into SEC-Land is when they put gigantic investment ‘groups’ together. At that point you’ll probably get to know those guys on a first name basis. πŸ™‚ Stay small, stay private. But in the end? Get your attorney to give you the green light.

  2. Hi Jeff, you brought up some very interesting points with your article. For the pass year I been thinking about selling some properties and buying notes with the money. I have a question: if one was to buy notes and get a good return, how can you live off the returns and still keep investing? Unlike rental income, it’s not perpetual. With real estate- you have renters, maintance and management. With notes- no renters more freedom but more taxable income.

    • Jeff Brown

      Hey Jim — But, unlike real estate, and a bonus for the more ‘mature’ investor, is that every time a discounted note pays off, the investor buys a bigger one with higher payments in terms of dollars. Meanwhile, if they want more money from income property they must A) hope for demand to overcome supply, or B) simply buy more income property. Notes bought at discount will almost always produce a higher income per invested dollar. That said, I’m not in any way, shape, or form movin’ away from real estate. This is part of an overall strategy for investors not nearing retirement, though they’d incorporate the note strategy in sometimes completely different ways.

      It’s sometimes the only strategy for investors too old to make real estate their income source, as their time ‘window’ is simply too narrow. Make sense?

  3. Which bank is giving home equity loan these days without full doc? And it seems the couple you speak of are already maxed out on their DTI ratio. So unless I’ve misunderstood, or unless you know something we don’t, there is no way to turn any house into a bank these days.

    • I would agree banks are just about insane dealing with small multi units like triplexes.

      I am in the process of refinancing a single family home that at present is on an expired line of credit with interest only payments at a very low interest rate. The house at present is a cash gushing machine with a payment of $150 and rent at $900, taxes and insurance are less then $2000. The holder of the note extended the time period of the balloon to 2014.

      Back to the lender, this bank is requiring documentation like I have never seen before. I have several businesses the lender wanted P+L’s on each, self employment letters from my CPA, rent roles, copies of the lease etc.

      I was also going to refinance the 3 unit but decided the existing private mortgage at 7.75% interest was cheaper to keep then to deal with trying to refinance with a bank.

      I told the lender if they are not satisfied with the info I have given so far, they can pound sand as I now have until 2014 to deal with the loan.

      All this B.S. and for a $70k loan I could pay cash and clear. Did I mention the lender said I have a 830 credit score?

      So just figuring these low income low asset retirees don’t have a chance in this credit market of getting that underlying mortgage on the triplex.

  4. Hi Daniel

    How are they maxed out of the debt to income ratio if the income property is free and clear and produces income to offset any future mortgage payments on the cash out refinance? I agree with you that there’s no escaping full documentation loans these days.

    • Jeff,

      Don’t get me wrong I agree with all the positive replies this is innovative thinking.
      But like anything else, innovative thinking sometimes is pie in the sky when tested in the market.

      If this fictitious couple had indeed completed such a transaction just before the RE bubble burst their retirement would be in dire straits to say the least. If their timing had been off in this way then just after the crash of values mixed with the bevy of foreclosures I would bet these folks would be penniless.

      My biggest issue with such a use of leverage is this is what got most homeowners and quite a few (innovative) investors in a world of trouble.

      A better idea would be to leverage the triplexes against another income producing property, with the idea of increasing tax advantaged income.

      In a leveraged property one or two vacancies could wipe these folks out.

      As an example; at this time I have a block of buildings, all 3 units with 1/3 of these units are vacant.
      In my case I have very little debt allowing me a nice cushion and the ability to enjoy the Thanksgiving break as I could sustain a 1/2 vacancy rate.

      Counting in expenses for repairs and marketing and going into the winter rental market, I think any income from buying notes in your example might not look so good to the bottom line.

      My vacancy rate is due to a situation beyond my control one that is going to be short lived but may linger at least 60 days more. All it takes is one incident and tenants can and do flee an area. In my case this was due to a drug dealer setting up shop in a local tavern, this lead to a police action which resulted in the first shooting death in the areas history. The problem was the shooting was somewhat like a wild west show with many bullets exchanged and about four bullets entering a local long term residents home, one lodging in the door frame of one of my buildings.

      These are not slum properties, most are nicer then I bet 90% of the rentals offered by Bigger Pockets investors, one such property is nicer then my own residence. This is (was?) an upper blue collar area 4 years ago. I don’t know what this area will become or if the area will stabilize.

      I control or own most of the buildings on the block, except the one offending property, who’s landlord has little regard for the well being of others.

      Just in case you think this couldn’t happen to that factious couple, everybody (tenants) is on drugs or at least more are on drugs legal or illegal then not.
      Seemly normal folks sometimes wake up one day thinking they are the Joker and decide to shoot up some innocent folks, or like in the case of one of my friends who owned a village of rental properties; one such tenant decide robbery, rape, and murder made up a good lifestyle.
      This was just a bit devastating to his rental village as most single women walked away from their leases, as did about 40% of his tenants.

      Just happy I have little or no personal debt and mostly free and clear rentals, in five years they will all be paid for and I think I could weather any storm.

      As to the global money printing we all know this is going to end badly.

      Having money in bricks and mortar or some other hard asset is usually the key to coming out of any storm with some of your assets intact. I’m pretty sure if inflation really kicks in rent control will become part of every rental market as inflation outstrips wages as it always does. We can all see our government is about helping those who vote their way, and of course this is going to be at the expense of those who are deemed successful.

  5. I am guessing that there is a good reason that these notes selling at a discount and at high rates. High risk perhaps? So what is this couples risk mitigation plan?

    What if they have to foreclose? What if they live in a judicial state. It could take quite a while to get their hands on the asset. What if the asset has been trashed? What if there is a ton of deferred maintenance? What if property prices in that area have gone down since they acquired the note?

    This is a novel idea but it is fraught with peril and something I would not recommend that a couple nearing retirement pursue.

    • I wouldn’t let those reasons chase someone away. First if you are getting a discount, you have to figure the original note was for less then the entire purchase price. For example $100k property with $10k down or a note for $90k. Notes are not usually discounted because the note in non performing, but more the creditor wants his money in a shorter time frame then the note provides.

      Money now equals a discount to the person providing that quick cash to your pocket.

      Unless you are looking for non performing notes, I think a very little due diligence on the buyers part would determine if the note is in default or may be headed to default.

      In the case of a seasoned note, one that all payments are current and historically paid on time, it would be foolish to pass up an investment on pure speculation of some future default that might not happen.

      Buying a note for these folks would be easier and safer then speculating in stock or putting money in mutual funds to collect dust.

      The absolutely best way to get rich in America is to manage capital, no tenants, no toilets, no worries of ownership.

      Who do you thinks makes the lions share of profits on your financed investment properties?
      Let’s see, you put out all the work and take on all of the risk, the lender spends someone else’s money to make a return of 50% to 100% of capital in most cases over the life time of the loan. If you pay early or refinance they hit a home run getting their money back faster at the same interest rate, increasing their rate of return of capital manyfold.

      What is easier to sell in a down RE market, a building or a note? What if that note has a high interest rate, higher then most in the note market? Not much need for a big discount.
      How many property owners do you think their are who are locked into 6 and 7 percent notes that cannot get refinanced at their current income levels?

      I am paying a private investor 7.75% on a 15 year fixed note, he was previously getting 1% on his CD and wondering how he was going to eat in his retirement. I have no plan on refinancing this note as the property was one of the best deals I have ever bought. I cash gushing machine, that was purchased at a 70% discount for cash. This lender made this a no money at all down deal with a $25k paycheck at closing which covered all repairs and holding fees until tenants were installed, leaving $15k to give to my happy wife. The lender has no intentions of selling the note, but maybe his not so smart heirs will. If that happens I will refinance the note.

      Did I mention this retiree has a few more CD’s coming due? He also is kind of tired of tying up his money with a mutual fund Dustiodian.

      • Jeff Brown

        Hey Dennis — Thanks for the first belly laugh of my week. You’re awesome, as is your comment. I’ll put one more dagger in the argument against notes, though yours is clearly compelling. (For the record, my target for note purchases are performing notes, period.)

        The purchase price of the notes in the post reflected roughly 65% of the note’s face value. I don’t advise buying notes with less than 20% equity behind them. That means these notes had a maximum LTV of 80%. It also means the buyers of these notes had a MAXIMUM LTV — based on capital invested (65% of the note’s face value.) — of just 52%. But what does that mean in real life?

        It means if the value of the property, ascertained during due diligence, was $125,000, and the note of $100,000 was acquired for $65,000, the note investor’s LTV was a paltry 52%. In other words, if the property went into foreclosure, and its value had dropped 40%, the seller would still get their money back. That ignores the double digit cash on cash return they enjoyed before foreclosure. Also, let us not forget chronological context. The property worth $125,000 today, was worth far more in 2005, as the bursting bubble did its bloody work. Buying notes when market values for real estate have already sunk to recent historical lows is not a bad deal. πŸ™‚ In fact, let’s say he bought this note at the height of the bubble, and had to foreclose. Even in my hometown market of San Diego, loss of value pretty much bottomed out at around 35%, rarely more. That means he’d of sold the foreclosed property for just over $81,000. If his selling costs were 10%, he’d of still netted around $71,000 for a note for which he shelled out $65,000.

        But let’s go further. What if they can’t sell it for some reason? They own a free ‘n clear home who’s cash on cash return in today’s market, conservatively speaking, would be 5-10 times what the 10 yr/Treasury Bond is today.

        The #1 rule when buying notes at a discount is this:

        If, when considering the purchase of a discounted note which is secured by real estate, you’re not completely and positively elated at even the thought of having to foreclose — DON’T BUY THE NOTE.

        I’ve been dealing with notes since Carter was in office, and discussed them with serious gentlemen like Robert countless times. They’re simply not cut out for that sort of investment. Nothin’ wrong with that at all. It’s just not their cuppa tea.

        Great stuff, Dennis.

        • Jeff,

          Maybe I was not clear my comment were not to put the last nail in the note buying coffin. Quite the contrary, I like the idea. I have never bought a note and to tell you the truth I would not by a note with 10% of equity on the property I would leave that to the Federal Government who has much deeper pockets then I.

          I have in the past created a few notes to sell properties and signed notes with a private lender.

          I gauge some of my investments as a Return on Risk not so much as a return on my invested capital. In your example their really is no appreciable risk as you are buying in a bottomed market. Some of the properties I have bought could not be built for what I paid, so I believe these also have very little risk.

          Is there really anybody invested in 10 year T bills as a means of making a positive return?

          I do feel sorry though for all of those folks who’s retirements were in instruments of debt like subprime notes. But then again every sane person knew these were foolish investments with smoke and mirrors return percentages.

    • Oh, in that case never mind.

      Next post please fill us in more on buying notes, this is one subject I have always been interested in. It’s like a shadow business full of mystery.

  6. Jeff,
    Great post on notes. I especially love your mention of how this is a great way for retired folks to get into real estate when their window is short. My question is how? My parents own their home and a small vacation home, would it be wise to get a line of credit against either of those and invest in notes? Or should you not touch your personal residence?

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