Cash Flow Notes: Step by Step How to Invest in Performing Notes

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Are you tired of real estate ownership? I know I was getting tired of owning real estate earlier this week. I am what you may call a “Night Owl.” I like working late into the night as my brain usually works the best with no distraction around. Hence I usually head to bed in the early morning hours.

This past Wednesday started off as any ordinary Wednesday. I worked from 9am to 1am with breaks in the middle for a run, deal making,  managing capital partners, administrative tasks,  and  juicing (I started the juicing lifestyle nearly 30 days ago now thanks for my girlfriend.) I head to bed by 2am.

5am and my  cell goes off.  I miss it by sleeping through it

5:15am and my cell starts chirping again. I am thinking “Who in God’s Name is Calling Me at This Hour!?” I decide to ignore the call and stay asleep.

5:45am and I hear my text message bing. I am now up and I am cranky before my first cup of coffee and only 3 hrs of sleep. As I wipe the sleep out of my eye, I see that it is my property manager (god bless him for being a great asset to my firm) and the text message states:

“Call me ASAP. Problem at Armstrong Ave”

I am thinking the worst has happened:the house burned down or something happened to one of the tenants. I quickly scroll to my missed call log and dial him back:

Ring Ring

Manager: Morning boss. We got an issue!

Me: What is the issue? (Still half asleep and crabby; missing my cup of coffee still!)

Manager: The sewer backed up into the basement and tenant is complaining that the house is smelling like [email protected]!#. I need to know if I can call in for a emergency repair as it will cost over $600 to snake and clean up the basement.

Me: Of course, as we cannot let the tenant live in that filth.

(Internal Dialogue) “… I hate this asset and why did not anyone warn me about this when I was getting into landlording!”

This one of the few reasons that I continue my discussion of “No Toilet” Investment Assets with you, the readers. This week we turn our attention to Cash Flow Notes as a potential passive “No Toilet asset class.”

What are Cash Flow Notes?

Cash flow notes are a debt instruments or promissory notes wherein an individual or business borrows money from another individual or business. The note is the proof of the debt . The note can either be secured or unsecured. If the note is secured then it will be accompanied by a mortgage or UCC document. This article will discuss the asset class of Performing 1st Mortgage Notes (hereafter referred to as Performing Notes.)

What are Performing Notes?

Performing notes are mortgage secured debt instruments that are current or where payments are less than 90 days past due. The mortgage, also known as the security instrument, pledges the property as collateral to ensure the performance on the obligation. This allows the note holder to sell the property and re-coop his investment in the event the payer does not pay as agreed.

I had a realization after I owed my first condo for nearly one year. Realization: Notes are sold many times over. In fact during my one year ownership period my note was sold three times which I realized when I was notified that my loan is being serviced by another lending institution.

Why and How to Buy Performing Notes?

Investor who want to earn monthly cash flow can do so by purchasing cash flowing notes without having the headaches of a sewer backup or toilet issues. When you buy cash flow notes, you become the “lender”  so the borrower pays you back the principal plus interest. Investors can make money purchasing cash flow notes  at a discount and hold out the note to earn money through interest from the repayment of the note from the borrower. Okay so how does an investor purchase Performing Notes?

Below is a simple step by step outline to buying performing notes:

Step 1 – Cash Flow Note Profile

What type of cash flow notes are you interested in purchasing. The following categories can you help you better define your cash flow note profile:

-Risk Profile (Loan to Value, Last Valuation date).

-Type of asset securing the Debt Instrument (Retail, Residential, Multifamily, Industrial etc.)

-Borrower Profile (FICO, Debt to Income, Recourse provision)

Step 2 – Who Can you Buy the Note From?

A. Brokers: You can find local mortgage brokers through an online search and express your interest in buying cash flow notes and see which cash flow notes are available for sale.

B. Banks: You can utilize the county court house or the MLS to locate assets that were financed by local banks or private lenders. Create a list of these banks, lenders and properties.  Get on the phone or start sending letters out to them.

C . Loan Sales Platform: Companies like Loan MLS, FCI Exchange, PPR (Dave Van Horn a fellow Biggerpockets member website), and Loan Market who source and provide the notes for you to buy on their platform. If you do not have a geographic limitation on where you want to own notes then these sites can be a huge time saver for the eager No Toilet Investor.

Step 3 – Analyze the Note

Once  you get a prospect performing note, grab the terms and conditions for the cash flow note. Find out from the selling source the principal owed on the cash flow note, the interest rate and the term left on the cash flow note. Utilize the following guide posts when analyzing the note prospects:
Risk Underwriting:

Margin of Safety:  What is the loan exposure to the current asset value? This will help define the margin of safety utilizing:
Loan to Value = (Unpaid Principal Balance/Current Fair Market Value of Asset); The lower the ratio the better.
Debt Service Coverage Ratio= (Total Annual Payments/Net Operating Income or Borrower Gross Income); The higher the number is above 1.0 the better.

Borrower Financial Status: Borrower is your counter party so you want to mitigate this risk by understanding their profile better:

FICO: What is the borrower middle FICO score; The higher the FICO score the better.
Debt to Income: Total Monthly Debts/Gross Monthly Income; The lower the ratio the better.

Return Underwriting:
Current Yield: (Current Payment x 12)/Target Investment Price

Debt Yield: Property Net Operating Income / Loan Amount; The Higher the Ratio the Better

The goal to buying performing notes is that you get a in-the-money current yield to compensate you for the foreclosure and the non-payment risk associated with holding a debt instrument.

Step 4 – Buying the Note

You present a offer compensating you for the risk of owning the note and the seller agrees to your price. Now what?

Next you need to hire a lawyer who will help create an assignment of the promissory note to transfer ownership of the lien rights and benefits. When you buy a cash flow note, you are now the lender of the principal amount of that note. In most note transactions typically once you open escrow you are on the fast track to a closing date as you usually provided all the due diligence prior to acceptance of the offer by the note holder. You close on the note by giving the note holder the lump sum cash and you get the note

Step 5 – Collect that Check Baby

You are now the owner of the cash flow note and due the monthly payments, including principal and interest for the borrower to repay the loan. You need to collect the monthly payments, keep accounting, send out monthly statements, make sure taxes & water are paid. But wait Ankit you said this could be passive no toilet investment asset class? It can be if you decide to hire a servicing company. Hiring a professional servicing company is the key being able to keep Performing Note Investing a passive investment enterprise. There are firms such as Iserve, FCI Exchange who will do the note serivicing function for reasonable fees – usually $150 set-up fee and $10 – $15/month per loan.

Performing Notes come with their unique set of risks (which I did not get a chance to highlight in my post so please do further research) but they can be a great Passive, “No Toilet” Cash Flow asset class for the finance oriented cash flow investor. Consider this asset class as a part of your diversified alternative asset portfolio.

I would to hear your thoughts and feedback on this asset class via the comments below.

Until next time, Happy Cash Flow Investing!

Photo: qwrrty

About Author

Ankit Duggal

Ankit Duggal(G+) is the Investment Director of a New Jersey Income Operating & Consulting Company . Ankit is a seasoned value investor who enjoys achieving a zen through surfing, hot yoga, and snowboarding.


  1. I can relate Ankit, I am also a night owl.

    I think buying notes is a great idea! In my private lending business, I create the very notes you talk about in your post. I have a group of investors who buy most notes I create.

    I think buying collateral-based private notes is profitable because the investor ‘becomes the bank’ and receives the monthly cash flow check – just like a bank…AND the investor is secured by marketable collateral. Bankers have been making money like that for years, I am glad the everyday investor can now partake as well.

    On a related topic, the investor can also buy cashflow notes through their self-directed IRA where they can earn compound interest tax free/tax deferred.

    Lee Carney

  2. I’ve done the whole landlord thing on a very small scale, being a beginner wanting to get into the note business. Ideally how much capital would be needed to get into this business and are there investment groups willing to partner up with a beginner?

  3. Hello Ron,

    There are several investment groups in every large city. Internet search Meet Up groups in your area and you will find them.

    Regarding funds, it can be any amount, but most of my loan’s value here in Spokane, WA are around $50,000. However, at times, an investor will only have, for example, $40,000. Then I remain on the Deed of Trust with the investor with my original $10,000.

    Either way, I encourage you to get involved and start making money like a bank does. Leave the landlording and hard work to your borrower. To your GOOD Wealth!

    Lee Carney

  4. Would you expound on the debt coverage service ratio? I have heard this term before but don’t recall anything about it. Your help would be appreciated.

    John Thedford
    Naples, Florida

    • Ankit Duggal


      The way I analyze DSC is as follows:
      DSC= Net Operating Income / Total Debt Serivce Payment

      If the ratio is greater than 1.25 then the asset is producing 25% greater cash flow than needed to cover just the interest payments.

      This ratio is a margin of safety measure in terms of how far can cash flow diminish before it impacts your interest payments.

      I think it is vital to use this ratio whether you are an asset based or income based lender as value investing principles (which drive my investment thesis and strategy) promotes high margin of safety investments.

      I hope this helps.


  5. John,
    The DSCR is a measurement of the borrower’s ability to generate sufficient cashflow to cover the cost of the debt service. It’s calculation is this:

    Net income+depreciation+amortization+interest+capital divided by current portion long term debt+interest.

    I don’t use this ration too much anymore in my private lending business as we are collateral-based private lenders vs. cash flow lenders.

    Lee Carney

  6. This is a great topic and one that I am currently exploring from the other side. I’m in a late stage short sale with a submitted purchase agreement and I’m currently working with the bank’s negotiator on a multi unit property. At the same time I’ve contracted to lease option the same property at a 30%+ profit from the short sale price, which will close on the same day. I have a significant option fee in escrow from the tenant/buyer.

    It’s a triple net lease where the base lease is supplemented with Real Estate Taxes & Home Owner’s Insurance payments that adjust annually. The option purchase price (and profit) is set and will increase 1.5% per year cumulatively.

    We’ve negotiated a number of safety elements in addition to the triple net lease including a Key-man Life Policy on the Tenant/Buyer and funded by him. The property was recently renovated down to the studs (2004) and possesses a unique income opportunity for the tenant / buyer that results in additional “profit” payments beginning in year three.

    I have a conventional rate mortgage pre-approved at approx. 4.25% and the required 20% down payment for the purchase price. The plan is to close on the short sale followed immediately by the execution of the lease option. All the pieces to close the deal are in place.

    Long Setup to get here but …after closing, I want to go out and find the next deal and structure in a similar way. My only missing piece is that my 20% is tied up and I’d have to wait for it to season before being able to access these funds to then structure all the pieces of the next similar opportunity and do it again.

    Assuming I’m able to arrange a second promissory note for my original down payment, this property cash flows with a debt service ratio of 1.5x reflecting the debt of both the mortgage and the promissory note. I will remain involved in managing this investment until the option is exercised Failure to execute is reduced since the tenant / buyer will lose significant capital if the option fails to execute for any reason.

    Long Setup but: How do I find an investor that might want to even see such deals?

    I appreciate any feedback on similar experiences from either perspective. I can learn as much from an investor who had a bad experience so that I can structure my next deals to consider particular sensitivities that I may not currently be considering. My goal is creating win-win deals that allow me to continue building my cash flow portfolio.

  7. Thank both of you gentlemen for your help. I had heard DSC ratio before but could not remember its calculation and use. Because I do what most refer to as hard money lending with very very low LTV’s I don’t know if debt coverage ratio is that important. I will have to study this to determine if it has any importance to what I am doing. I am VERY tired..just read this…and not doing rea good. I need surgery (next week–triple fusion) and have been surviving on pretty heavy duty pain meds. The cloud my miind BAD…I can’t wait to get off this junk! Thanks VERY much guys…when I have a clear head I will come back and study it.

    John Thedford
    Naples, Florida

  8. Great read!

    I just picked up the book “cash in on cash flow” by Laurence Pino and was wondering if this is all still relevant in 2013 market. Do you have any more current books or resources you recommend for someone brand new to this?


  9. Jessica,
    I encourage you to read the book if you have not. One can always learn something. I know I am always reading at least two books.

    The Amazon book I recently penned is “Four Step Guide to Private Lending Profits – Earn 10% to 20% ROI without dealing with toilets, tenant, or trash.” Notes and creating of secured cash flow notes is discussed.

    I also like, “Private Mortgage Investing: How to Earn 12% or More on Your Savings, Investments, IRA Accounts and Personal Equity” by Clark and Tabacchi.

    Lee Carney

  10. Finding quality performing notes to buy takes some work. Non-performing notes are available at discounts and can be worth the work in rescheduling the borrower’s payment stream. Bank REO desks want to get rid of their non-performing notes and they may be a good source for deal flow.

    Note investing reminds me of tax lien investing. The similarities are the ability to convert discounted paper into owned real estate via foreclosure. The difference is in how the law views the seniority of liens and mortgages as claims on a property.

  11. Joe Tomko

    Only an attorney or CPA can give me advice on how to own notes, so if you reply, play reply carefully.

    I have an LLC taxed as a C-Corp and an LLC taxed as a partnership and I’m not sure which to use for notes.

    What do each of you use?

  12. Dillon Dinglasan

    Hello everyone,

    As being a beginner investor in real estate with no prior experience, would you say investing in performing notes is a reasonable beginner route? Or should i primarily focus on rental properties and build up the funds and then invest into notes?


    • Joe Tomko

      There are so many different disparate ways to invest in real estate, some totally unrelated to others. You should find the avenue that most interests you and pursue it. Every bit of knowledge will be helpful. You do not need to invest in any one thing before investing in a particular other. Pick an avenue and pursue it. Don’t be afraid to also pursue multiple avenues at once, however, when starting, I recommend against this approach. Focus, become successful, then look at other things.

      I have been a hard money lender, I have rehabbed and flipped, invested passively in a tax lien fund, and owned a duplex, which I am now selling to invest in notes. I’d be happy to help you with any of these.


  13. steven hu

    Just dug up this older post to walk through the steps. I don’t quite follow the analysis part. So here is one note from one of the posts:

    The principal balance was $452,00.00 ( original balance $480,000.00), fully amortized over 20 years, secured by retail center, 6% interest rate. LTV was 60%. The note was paid $250,000, which produced a 17.7 % annual yield to maturity.

    How to get 17.7% annual yield to maturity from this equation: Current Yield: (Current Payment x 12)/Target Investment Price? I guess LTV 60% is a good number to start.

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