Calculating Rate of Return/High Yield Return on Investment

Boston, Massachusetts
Tax Liens & Mortgage Notes
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Calculating Rate of Return/High Yield Return on Investment

Michael Terry
Member since 2020 · 17 posts · 7 votes

When you get a brochure for an asset in Note Investing, and the displayed Rate of Return/High Yield Return on Investment is 6%, 8%, 14%, how is that calculated? I have done research and am seeing different calculations for different types of real estate. I'm just not sure how it applies to Notes specifically.

Is it just a matter of punching in values into the 10bii calculator? Or are there different values and calculations that lead to a specific final calculation and result?  

There are discussions happening amongst my investors comparing the best investment vehicles - mutual funds (7%-10% ROI historically) vs. note investing (6%-14% depending on the asset).

Thanks all! Appreciate the input.  

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Chris SeveneyBusiness Member
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Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
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@Michael Terry

This is a question to ask the sponsor as I have seen it calculated in many different ways (with many being wrong).

When they are in a syndication it’s easy to compare because it is typically in the form of a monthly or quarterly distribution.

If it's a JV deal then cash flow is not consistent so they can calculate it based on forecasts.

If it’s a straight loan then it is straight interest but if principal is returned and you are not reinvesting the principal your return will be much lower than an investment that is interest only - but of course none of this takes into account risk (or tax consequences)

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  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    4y

    @Michael Terry

    This is a question to ask the sponsor as I have seen it calculated in many different ways (with many being wrong).

    When they are in a syndication it’s easy to compare because it is typically in the form of a monthly or quarterly distribution.

    If it's a JV deal then cash flow is not consistent so they can calculate it based on forecasts.

    If it’s a straight loan then it is straight interest but if principal is returned and you are not reinvesting the principal your return will be much lower than an investment that is interest only - but of course none of this takes into account risk (or tax consequences)

    7e investments53 Reviews
    WebsiteView Page
    3Reply
  • Ned CareyPro Member
    Moderator
    Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes
    4y
    1Reply
  • Bob Malecki
    Investor · Kingston, WA · Member since 2008 · 1k+ posts · 1k+ votes
    4y

    Hi @Michael Terry I use a present value calculation that I have set up on my excel spreadsheet 

    Months (A) Desired Rate (B)
    		 Payment (C)
    		 Present Value (PV)
    330 9.00% $ 912.93 $111,384.30

    =PV(B/12,A,-C)

    2Reply
  • Bob E.
    Queen Creek, AZ · Member since 2014 · 2k+ posts · 1k+ votes
    4y

    @Michael Terry The way that I do it is on a 10bii, with the following considerations. For performing notes: UPB for the note, number of payments remaining, payment amount - make sure the rate coming back to you matches the rate on the note. This is a basic check. Remember, seller financed notes are usually basically subprime lending, that is why most borrowers go this rout. Nobody who can get a 3.5% mortgage is saying let's go with the 9% loan.

    Next change the UPB to reflect your purchase price, if there are any costs to you as a note holder (servicing being most prominent) adjust the Monthly payment. For a one time charge, like paperwork fees, recording fees etc adjust the purchase price.

    The most dishonest thing I see is people selling low balance loans with with small payments (sub $300) and not factoring in the servicing fee.  I have seen people advertise notes with an 8% return that I calculate as closer to 6.5%.  Given that I can 4.7% on Verizon stock, in perpetuity, I would just say no to anyone advertising 6%.  I would hazard that you could also get a 6+ yield on a preferred stock.

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  • Joseph King
    Aliso Viejo, CA · Member since 2019 · 53 posts · 10 votes
    4y

    Sound like you are looking at bonds or note funds, not necessarily individual notes. In my experience, larger portfolios, funds, and even bonds will be calculated differently, with the main difference coming down to expenses and the discount you get from par when acquiring. To answer your question, variable Yields as your title indicates, could be the result of a waterfall distribution which can only be calculated with an understanding of how it was originated from the Sponsor.

    For individual notes, the calculation is simple, but it is essential to understand the difference between the Rate of Return and Yield. They are not always the same.

    With a performing note, the Yield is the same as the internal rate of return (IRR) if the rate never adjusts and the payments remain the same over the term. For example, if the loan has an adjustable-rate mortgage (ARM), your monthly payment will change over time. In this case, the internal rate of return becomes a more valuable measurement than a rate calculated from a single payment for the Yield. This is because the IRR considers all monthly payments in the amortization schedule even if they are different by taking weighted averages over time.

    The proper way to calculate the net yield of a “fixed-rate” performing note is to consider net income over time against your investment. I agree there are many ways companies are evaluating their Yields. They can be calculated on an individual note level, through a fund, a bond, or even through privately held portfolios. The main difference in the yields should come down to your discount at purchase and expenses like servicing, management, equity sharing, etc.

    The most common way I have seen the Yield calculated is by solving for the RATE and assuming there are no adjustable rates. The fixed-rate Yield can be easily calculated in Excel using the “Rate” function.

    RATE (nper, pmt, -pv, [fv])*12

    • “nper” is the number of periods remaining on the loan.
    • “pmt” is your net monthly income
    • “pv” is the present value - your purchase price plus direct expenses
    • “fv” is the future value of the loan which is set to 0 because this is the value when the loan will be paid off.

    Here is an example of the calculator we use for dissecting notes.

    2Reply
  • Joseph King
    Aliso Viejo, CA · Member since 2019 · 53 posts · 10 votes
    4y

    One other thing I would like to mention is when comparing mutual funds and notes, there is a risk component to consider. When the mutual fund loses value, you will take a loss with no way to recover outside of a market rebound which can take many years to recoup.  When a note goes into default, your investment is secured by the real estate the note is tied to, meaning you have the ability to recover your losses through foreclosure in a relatively short time frame comparatively.  In my opinion, you can mitigate risk through note investing. A well-managed fund or joint venture can give you higher yields, lower risk, and peace of mind.  Of course, there are exceptions to the rules with the type of notes your invest in and how current Interest rates affect inventory and yields. That said,  well-diversified portfolios will have a mix of non-performing, performing, 1sts and 2nd position loans with many exit strategies designed to maximize profitability.

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