Five Advantages of Note Investing
Practically everyone, investor or not, is in the note business. Most people though are just on the wrong side of it. Nearly everyone owns a mortgage, or has a car loan, student loans, or credit card debt and they're all on the "borrower side" of the note business, but even sophisticated investors often don't fully understand what goes into acquiring, managing, and liquidating the kinds of debt we all have. Now when I talk about the "note business", I specifically mean my specialty, which is Real Estate Note Investing.
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So why should a real estate investor understand the “business” side of the note business? Besides cashing a check instead of writing one, here are what I think are the top five reasons…
Note Investing Advantage #1 Collateral –
Owning a secured lien tied to property, especially with equity, involves little or moderate risk mainly because you can foreclose on the property and recoup your investment. If it was an unsecured lien, you can also sue on the note and chase the borrower instead of the property. Now unsecured could be seen as more risky, but you also pay a lot less for them. Unlike an eviction, in a default of a property with equity you'll recover missed payments, late fees, attorney fees, and corporate advances at some future date. Collateral could also be considered in the form of residential, commercial, mobile homes, or a construction or rehab project. Junior liens with no equity or low equity are also often times viable because you have a secured lien with "emotional equity."
Note Investing Advantage #2 Profitability –
Notes and mortgages usually offer comparable returns to hard Real Estate Investing after factoring in management and maintenance. Non-performing notes or notes bought at a discount can even exceed today’s Private Money mortgage yields that can range from 12%-18% plus points. So just like Real Estate, you make more money when you buy and you can make even MORE money when you rehab the note (just like rehabbing the property). And lets not forget, there’s a lot less competition when you’re a “lien-lord” versus a landlord because other than large hedge funds there are fewer individuals working today in the note space.
Note Investing Advantage #3 Opportunities –
Many times owning a note can give you low cost positioning into a deal. In a private note deal with a 1st mortgage, your maximum loan amount is typically about 65% of ARV (after repair value) meaning the most you're getting the house for if you take the property back through foreclosure is 65 cents on the dollar. Even owning a 2nd mortgage can create other opportunities. For instance, owning a 2nd mortgage that was purchased at a lower price point than a typical 1st lien may give you the opportunity to buy out the 1st lien at a discount. Another profitable example when owning the 2nd lien is where you could just reinstate the 1st mortgage, foreclose, and take over the property (with a Sheriff’s Deed) “subject-to” the 1st mortgage and just continue to make payments on the 1st.
Note Investing Advantage #4 Volume and Control –
Speaking from experience, you can easily manage more loans than properties or rehabs (e.g. it's easier to rehab 200 notes than rehab 200 properties). You can manage your note portfolio from your phone and computer, never having to leave your house! A loan servicer is also much more cost efficient than a property manager. Servicers are approximately $25 set up fee, and $15/month no matter how high the monthly mortgage payment (whether it's $300 or a $3000 payment) as opposed to a property manager who wants 7% to 10% of gross rent. There's little to no management once a note is re-performing, especially with a servicer in place who sends late fee notices, 1098s to the borrower, and they also do the accounting for both you and the borrower. It's rare to deal with maintenance, tenants, and contractors. There's usually less responsibility, for example Wells Fargo doesn't usually do plumbing repairs. You are also dealing with a lot less vacancies because it's a homeowner mentality versus a tenant's. A homeowner generally has more "sweat equity" or "emotional equity" than a tenant.
Note Investing Advantage #5 Versatility –
“Almost anything you can do with a house you can do with a note.” You can flip or wholesale a note, just like a house. You can refinance the borrower especially once there is a pay history or through credit repair. You can also sell a note whether it’s performing or non-performing. You can even “rehab the note” which is to take a non-performing note and make it re-performing. And another way that isn’t talked about nearly enough is you can borrow against the note, also known as a Collateral Assignment of Note & Mortgage. This is where you’re re-performing note and mortgage is used as collateral for another private loan with an investor.
So these are just a few examples of why I think the note business is so advantageous right now and I’m only scratching the surface. I hope I’ve gotten you thinking more about the “other side” of the note business. It really can be a great business in itself or a powerful means of supporting the Real Estate investment business you already have. Leave a comment and let me know if you have any questions, I’m looking forward to elaborating on all of these advantages in articles to come!