Mortgages & Creative Financing

How to Use Notes to Get Better Real Estate Deals

Expertise: Business Management, Mortgages & Creative Financing, Landlording & Rental Properties, Real Estate Investing Basics, Personal Finance, Real Estate Deal Analysis & Advice, Commercial Real Estate, Personal Development, Real Estate News & Commentary
228 Articles Written

The road to me discovering notes wasn't always easy to navigate. In some ways, it was a long and arduous path. A lot of it had to do with it taking so long for me to find them! It's funny, it wasn't until I was around 46 or 47 years old that I realized this would be where the next stage of my working life would go — shaping my career, not only as an investor, but also as a writer and business owner. Over the years, on my path toward the institutional note business where I work today, I saw many savvy investors using notes to get better real estate deals.

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At the time, I hardly realized it. It was only when I was writing my new book that I started to put the pieces together. Back in those days, I was focusing on my “We Buy Houses” business and little else. Although I was well aware that the best sources of deals were from motivated sellers (like probate, divorce, out-of-state owners, etc.), what I didn't know was that some investors were putting that business model on steroids.

Other Investors Were Being Creative

I first learned about creative strategies that were similar or related to the note business from friends who were bidding at foreclosure and sheriff sales. This can definitively be a viable way to acquire property, but back then I was never too excited by the idea of buying real estate sight unseen and in a bidding situation. I also didn't feel like it was too easy to scale this business.

Next, I noticed those who were buying REO (real estate owned) properties. I did this on a small scale at the time, too, going after one-off deals like HUD houses and bank-owned properties that were usually listed through the MLS. Later on, I figured out during the economic downturn that there were large entities doing this in bulk by buying large tapes of REO properties — usually geographically. Banks tend to like selling REO's in this fashion, because they can often make more money selling to buyers who want their local areas.

And then of course I realized buying distressed mortgage notes existed, the space where I play today. Where you tend to be ahead of everyone including the sheriff sales and the "we buy houses" folks. In other words, as a note owner, you're first in line.

Related: An Introduction to Investing in Notes: Why You Should “Be the Bank”

Using Notes For Better Acquisitions

Acquisitions of real estate deals can get better with notes, too. For example, when I was doing the “We Buy Houses” business it was all about solving motivated sellers' problems and having the right tool in the tool belt. And that's exactly what I did with notes and creative financing ideas by making multiple offers, some of which involved notes. Sure, I can make a low cash offer like anyone else, but perhaps I can make different offers with flexible variations of financing and let them pick the situation that's best for them. Keep in mind, all of the offer structures already fit my needs and may even differentiate me from any other "we buy houses" bidders.

Making Multiple Offers

So let’s say a motivated seller — a pair of senior citizens for instance — called in about my “we buy houses—any situation/any condition” ad and wanted to sell their home. Their motivation was to move closer to their children who were out of state, which is a pretty common occurrence. Like many seniors, they have lived in their home for more than 40 years. The property is paid off. There is some deferred maintenance and some things in the home are just functionally obsolete, but it would still make for a good rental property. Let’s also say they’ve accumulated a lot of stuff in the home over the years. They tell me they intend to sell and move in with their son in California. This would be the perfect multiple-offer situation.

At the time, in my area of expertise, a 3-bedroom/2-bathroom house may sell for $125,000 in pristine condition. This house, with the average renovations, may also need approximately $25,000 in updates to get it that way. So they're probably asking an unrealistic $115,000 for it. Now they're probably not willing to give me a 30-year mortgage on this property. But in this case, I might make my offer something like this: $110,000 for 10 years at 5 percent interest, amortized over 30 years. Then after the 10 years is up, I can either refinance or sell the property to pay them back the remaining balance on the loan. I could also make it a shorter term (like five years) but in that case, I would try to go to interest-only, lowering my monthly payments. I would then show them these options and how it would've compared to them selling and putting the proceeds in the bank. Since I won't need a new mortgage from the bank, this will also save me money in bank closing fees. After I explain all of this, I say, "Think about it. But here's what else we could do."

Related: Real Estate Notes vs. 401k: Which Investment Wins Out Over 30 Years?

My second offer might be $90,000 with a $25,000 seller second mortgage carried over five years that’s interest only. This allows me money to fix it up and still get a first mortgage on the property either through a traditional bank or with private money. After which, I again say, “Think about it; but here’s another option.”

My third offer might be $75,000, all cash, “as is,” and “will close quickly.” Depending on how truly motivated they are to leave, this may be the right fit. Other variations of these may come up in our conversation, but either way, I’m giving them options.

Seller Seconds

If you noticed above, my first two options involved owner financing through what is known as a seller carry note or seller second mortgage. This is one of my favorite owner financing strategies when going to sell my rental properties, because to put it simply, I can still cash flow off of a property AFTER I sell it and WITHOUT owning it. Yes, you read that correctly. And for the buyer, a seller second can also be used to cover down payments, closing costs, and even repair credits. So it really can be a win-win scenario for both the buyer and the seller — but we'll get to that in a bit.

Using Notes for Better Exits

As I approach retirement age, I've been paying off many of my rentals one by one, moving them into a family trust in anticipation of rising interest rates and a little bit of appreciation. My plan after that is simple: outside of a few really great properties I expect to keep, I'll sell the remaineder with owner financing. I'm thinking of using a commercial, twenty-year, interest-only note, with a seller assist and sell them at market value (based on appraisals) to some local investors from my networking groups. They'll cash flow nicely with low out-of-pocket capital invested, and then I’ll place those notes with a loan servicer. I’m sure my wife and heirs will appreciate this planning, and I’ll start to enjoy a life with less maintenance and tenant issues.

So to sum up, for the seller like me offering secondary financing, there can be quite a few advantages:

  1. By offering terms to buyers, you can sell the rental property easier, especially to another investor — like we did in the first example.
  2. Through these terms one can possibly eliminate multiple costs. The private sale, due to creative financing, often eliminates the need for a realtor and their commission fees. Plus, the seller can offer a seller assist to a buyer with the money she saves in these fees, making the sale more appealing. This type of financing can also lower the costs of transfer tax and capital-gain tax.
  3. The seller can continue to cash flow after no longer owning the property. Making money without dealing with tenants, maintenance, inspections, and contractors is a wonderful thing.
  4. In the event of a default, the seller is familiar with the asset they had once previously owned.

Advantages for Buyers purchasing with a Seller Second

It’s not gravy only for the sellers either. What I love about seller seconds is that there’s also of course advantages for the buyer as well, like:

  1. They can often buy a rental property with little or no cash out of pocket. If they’re an investor-buyer, this is extremely beneficial since it gives them an infinite rate of return with zero cash into the deal. This also enables the investor to build their portfolio faster and easier than if they had to seek any sort of traditional or private financing.
  2. For the investor-buyer, the home is rent ready without needing any of the downtime required for a major renovation. In other words, it's a turnkey deal.
  3. For both the investor-buyers and tenant-buyers, all inspections by townships, home inspectors, wood infestation, etc., have all been completed at the time of transfer or closing.
  4. Due to the lowered sales price, the buyer can also save on mortgage fees, transfer tax, and some insurances (i.e. PMI, homeowners, and title insurance).
  5. By not leaving any equity in the property, the investor-buyer is maximizing their yield on their total investment capital.

So as you can see, notes can be a pretty powerful tool when it comes to your hard real estate, whether you buy or sell. And don’t forget, notes are a pretty great investment in their own right as well!

Do you want to invest but don’t want to deal with tenants, toilets, and termites? Do you want to make a long-lasting passive income stream—from paper? If you answered YES to any of these questions, this book is for you! Pre-order today!

Now let me ask some of my fellow BP-ers, “What are some of your note investing strategies to make your real estate investing lives a little bit easier?

Share them with me below!

Since 2007, Dave Van Horn has served as president and CEO of PPR Note Co., a $150MM+ company managing funds that buy, sell, and hold residential mortgages nat...
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    Harry Hertz from Lakewood, New Jersey
    Replied over 2 years ago
    Dave, Thanks for the excellent article. You have opened my mind to an entirety new way of investing/purchasing properties. If you are selling these houses to investors,for them to buy and hold with basically no money in them. What is stopping them from leaving them if there are problems arise. I understand that you can put the house into forclosure etc.. and take back ownership of the house, but you will be back to square one. Is there anyway for you to sell investors properties that they need to have skin in the game?
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied over 2 years ago
    Thanks Harry! I think a lot depends on who you’re giving financing too. If I thought I might have to foreclose, I probably wouldn’t do the deal and usually I’m only lending to someone I know and trust. But if you want to add an additional layer of safety you can require a down payment or cross collateralize the loan with with another property.
    Kristina Lobrin
    Replied over 2 years ago
    Thank you for this amazing article.
    Rob Cook from Powell, WY
    Replied over 2 years ago
    Harry, that is a good question. I too am planning on seller financing as a landlord exit strategy, swapping rent for interest income eventually. Without at least 20% down from a buyer, a repo could be a loser to the seller/lender even without much damage having been done to the property. Transaction costs of a turnover/resale are high enough when all goes well. The other problem is, of course, that the seller who finances his property to the buyer, essentially maintains all of the market/future risks without enjoying the potential upsides like appreciation. The higher the loan to value, the riskier to the lender. Period. And without appreciation, a seller who finances the sale, and has to foreclose during a market downturn (Usually the only time this will happen – when the buyer/borrower is not able to sell it to get out from under the loan- saved by the bell by appreciation) is likely to get hurt if he was at 90% LTV or above. I like the way Dave is thinking and operating, and I am sure he knows what he is doing, etc. But in my mind, the only way to really pull this all off is to stay close to typical lending terms and not bend over backward to accommodate the buyer by taking on too many risks via the seller fi terms. You can still make a seller fi deal attractive to a buyer, even if you required a down payment of 20% and had a 5 or 10 year Balloon to mitigate long-term risks. Because this is still Private money to the buyer, permitting avoiding loan apps and process and expenses, as well as appraisal and loan closing costs. A seller as a lender is a lot easier to deal with than a bank from the buyer’s point of view.
    Rebecca Jackson Rental Property Investor from Dallas, TX
    Replied over 2 years ago
    This sounds really creative and I love the approach. Just to clarify, though, you cannot do this on a house you currently have a mortgage on already? The lender probably won’t allow it. Since many newer investors don’t own our properties without financing, I don’t see how seller financing would work. I love the flexibility of cash vs terms but that’s only where you are able to offer it.
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied over 2 years ago
    Rebecca you could do what is known as a wrap around land contract – since you didn’t transfer the deed until the last payment is made. But mine are paid off in these scenarios.
    Replied over 2 years ago
    Hello Dave Van Horn…. “How to Use Notes to Get Better Real Estate Deals” thank you for giving such a wonderful article. Really very useful for me and also ho looking for real estate topic… Making multiple offers topic impressed me. We can sale our home with this kind of ideas. You gave lots of ideas. Please keep posting…
    Tim Swierczek from Saint Paul, Minnesota
    Replied over 2 years ago
    Dave this is my favorite of all your articles. Thanks
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied over 2 years ago
    Thanks Tim!
    Cornelius Charles Investor from Oxnard, California
    Replied over 2 years ago
    Great article Dave. In your scenario, what about the 25K in updates that the house needs? it looks like you might have that factored into your all cash offer, but what about your other 2 offers?