Are Promissory Note Funds the Missing Piece in Your Passive Investment Strategy?

[Whitney Hutten]

Think promissory notes are only for distressed deals? Think again.

Most investors overlook how powerful promissory note funds can be when used strategically. Many high-earning individuals dismiss these investments without understanding how effective they can be, especially when properly structured.

They assume promissory note funds are only deployed to salvage troubled deals, carry excessive interest rate risk, or lack tax benefits—making them not worth the trouble. But the truth is that when structured intelligently, a promissory note fund can provide passive investors with priority access to predictable returns, without taking on the full risk of equity. And no, this isn’t a financial Hail Mary.

Promissory notes, when properly used, are tools that smart operators rely on to stabilize assets more quickly, maintain equity positions without dilution, navigate around restrictive lending terms, and deliver contractual, asset-backed returns, all without the market volatility that often comes with equity.

So if you’re sitting on cash, waiting for the “perfect” equity deal while your money earns 0%, it’s worth asking: what is that indecision really costing you?

Let’s run a quick example.

A $100,000 investment earning nothing stays flat at $0. But placed in a promissory note fund yielding 10% or more over 24 to 36 months, that same capital could generate $21,000 or more. That’s not just return—it’s peace of mind.

The Cost of Not Understanding the Capital Stack

Consider two investors. Investor A is committed to equity-only investments. They appreciate depreciation and tax benefits and have heard equity is the key to long-term wealth. But when interest rates spike, refinancing stalls, and cap rates rise, their returns evaporate. Now they’re locked into an illiquid deal: no cash flow, no timeline, and no control.

Investor B takes a different approach. They diversify, allocating a portion of their capital to a promissory note fund backed by stable, income-producing multifamily assets. They know exactly where they sit in the capital stack—behind senior debt but ahead of equity. Their return is contractual, reliable, and immune to market swings. Investor B has clear terms and a clear timeline for payout.

That said, not all promissory note funds are created equal. Some are unsecured, others are cross-collateralized across underperforming properties, and some fail to provide transparency about where your capital is going or how your return is generated. This is why knowing how to evaluate these funds is essential.

How to Evaluate a Promissory Note Fund the Right Way

Step 1: Know Your Place in the Capital Stack. Your first question should always be: Where does my capital sit, and when do I get paid?

Ideally, you should sit just behind the senior debt and ahead of equity. This positioning means you are not tied to appreciation or speculative exit timelines, and you aren’t dependent on operator goodwill to be paid. Your payout is contractual and legally senior to equity, offering more predictability and reduced risk.

Step 2: Understand How the Fund Is Secured. Fund structure matters more than slick marketing. A promissory note fund should be secured, treated as a project expense alongside property taxes and insurance. This structure prioritizes your return before any profits are distributed.

Rather than focusing on loan-to-value alone, assess cash flow coverage and how disciplined the operator is with their structure. Look for funds backed by performing assets with strong occupancy rates, consistent rental collections, and solid Debt Service Coverage Ratios (DSCRs), ideally well above 1.0x. That ensures the assets can support their obligations in today’s market.

Avoid funds that cross-collateralize assets. With siloed structures, if one property experiences a shortfall, your investment won’t be jeopardized by unrelated performance issues elsewhere.

Before investing, ask:

Is this note secured or unsecured?

Is it tied to performing assets?

Are the properties isolated or cross-collateralized?

If the answers are vague or unclear, walk away.

Step 3: Underwrite Like a Pro. Even experienced investors can stumble here. If your capital is going toward stabilizing or repositioning a property, that’s not inherently a bad thing—as long as the operator has a solid, data-driven plan.

You should request a revised pro forma that clearly shows how the new capital supports the business plan. Look for stress tests that account for conservative assumptions on rates, occupancy, and exit timing. The fund should also offer a clear exit strategy, ideally with multiple options such as sale, refinance, or recapitalization.

Ask for reserve levels broken down by property, not just at the fund level. And understand how your return is structured: is it paid currently, accrued until maturity, or capitalized into principal? A red flag to watch for: if your “return” is really just your own capital being recycled back to you from an overfunded raise, that’s not income—it’s a mirage.

But What About the Tax Benefits?

It’s true that promissory notes don’t offer depreciation or paper losses. That’s by design, not a flaw. These instruments aren’t meant to reduce taxes. They are meant to preserve capital, generate consistent income, and reduce portfolio volatility.

Not every investment should check every box. Use equity for appreciation and tax benefits. Use promissory note funds to smooth out income, plan for liquidity, and strengthen your position in the capital stack. That’s how sophisticated investors build resilient portfolios.

Not Just for New Investors

If you’re already an LP in a multifamily equity deal, a well-structured promissory note fund can actually help protect your equity position. It brings in non-dilutive capital, gives operators the ability to act quickly without issuing a capital call, and helps stabilize the asset more effectively.

When structured properly, this strategy enables all classes of capital—debt and equity alike—to perform better.

The Bottom Line

Promissory note funds aren’t a last resort. They are a first-class option for investors looking for income, safety, and clarity. In this environment, you can’t afford to let your capital sit idle or risk it all on speculative equity plays.

A strong note fund offers yield with downside protection, backed by real assets, with a clear structure and a clear payout.

If you’re looking for consistency and control in your passive investments, this is a tool worth considering.

Curious how promissory note funds might fit into your portfolio? DM me your questions and I’ll be glad to walk you through it.