What are the most misunderstood aspects of note investing?

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What are the most misunderstood aspects of note investing?

Fred Moskowitz
Fund Manager · Philadelphia, PA · Member since 2019 · 41 posts · 52 votes

What do you feel are some of the most misunderstood aspects of note investing? 

Partials? 

Structuring deal exits? 

Due diligence?

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Bob Malecki
Investor · Kingston, WA · Member since 2008 · 1k+ posts · 1k+ votes
7y

I think that one of the most misunderstood aspects of this business is the flexibility we have with non-performing debt. Being able to modify the coupon rate or the term or the balance of the loan to get borrower re-performing is kind of magical. 

Most real estate investors understand how renovating a home can add value and profit for them, but they don't understand how "renovating" distressed debt is relatively easier and creates profitable cash flow while keeping a bottle where in their home. It's a win-win for everyone in the deal. 

Also having the ability to recapitalize a project by selling partial term on a performing loan is much simpler then, let's say, trying to refinance a rental property -- especially if a bank is involved!

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  • Logan Hassinger
    Specialist · Fort Worth, TX · Member since 2014 · 528 posts · 226 votes
    7y

    @Fred Moskowitz

    That’s a great question. 

    For me, it’s been the misunderstanding with investors of the mechanics of how one goes about purchasing debt and how you can profit from it. 

    Like anything, there is learning curve. Hence why this site exists to help accelerate the time it takes for someone brand new to real estate to get going. 

    Although note investing is under the real estate umbrella, it’s a concept that I have found is difficult for most to understand.

    As for the items you mentioned earlier, I believe it comes down to simply having a mentor/coach show you the way and then it becomes a repeatable process. Yes, each deal is different and no loan file is the same, therefore each DD is unique. However there are key items to be looking out for and in a broad sense, once you can check those DD boxes, you can make a yes/no decision. 

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  • Brett Burky
    Investor · Orlando, FL · Member since 2014 · 110 posts · 90 votes
    7y

    @Fred Moskowitz that's an interesting question. I get the process of partials pretty well. Some of the parts that are confusing is the loss mitigation of if a partial goes non performing.

    I guess all of the structuring of who does what in the process. It seems it can done multiple ways.

    Any insights are very welcome.

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  • Fred Moskowitz
    OP
    Fund Manager · Philadelphia, PA · Member since 2019 · 41 posts · 52 votes
    7y

    @Brett Burky if a partial goes non-performing, the buyer of the partial has first right to enforce the lien, or they can defer that right to the owner of the back end of the note (if agreed in advance). If the lien is fully enforced resulting in a payout, the buyer of the partial gets made whole first, then the holder of the back end of the note gets made whole next.  The same thing happens if the loan is paid off sometime during the partial period. It is good practice to spell this out in advance in the purchase and sale agreement for the partial.

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  • Fred Moskowitz
    OP
    Fund Manager · Philadelphia, PA · Member since 2019 · 41 posts · 52 votes
    7y


    @Logan Hassinger I agree on all points.  Good education, mentoring, and guidance will help new investors to be successful in the long term.

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  • Brett Burky
    Investor · Orlando, FL · Member since 2014 · 110 posts · 90 votes
    7y

    @Fred Moskowitz,

    Thank you for this information. I'm very interested in the partials play, it seems like a great way to recapitalize.

    1Reply
  • Stanley Nguyen
    Rental Property Investor · San Jose, CA · Member since 2019 · 78 posts · 23 votes
    7y

    @Logan Hassinger what are the key things we can look for in DD files?  TIA

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  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    7y
    Originally posted by @Fred Moskowitz:


    @Logan Hassinger I agree on all points.  Good education, mentoring, and guidance will help new investors to be successful in the long term.

     Fred I have a question for you..  AS a fund manager and I am taking a guess its a note fund.. I have heard others say that partials need to be handled like non registered securities when your fractionalizing a Deed of trust.. Like I know in Oregon is not legal to fractionalize a deed of trust with out securities offering.. 

    how does that play in your world.. I got nailed on it in Oregon that's why I know about this in Oregon... got a cease and desist and a small fine .. and not fun getting dressed down by the regulator.. someone turned me in.. :(

    So what I did in Oregon to recapitalize my notes was to hypothecate them to my bank.. that worked.

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  • Logan Hassinger
    Specialist · Fort Worth, TX · Member since 2014 · 528 posts · 226 votes
    7y

    @Stanley Nguyen

    That depends on your strategy. 

    We buy Nonperforming Notes with the goal of getting the note reperforming. 

    Here are a few things I’m looking for:

    - Payment History

    - As is Value not ARV

    - P&I Amount (for us it’s >= $400/month)

    - Back Taxes

    - Borrower Filling Bankruptcy

    - Local Market Conditions

    - Local Economic Indicators

    - and many more

    As far as collateral file review:

    - Chain of Assignments

    - Note and Deed of Trust match county records

    - Appropriate Allonges

    - Liens and Judgements 

    - and many more

    Even with all that, 50% of the time I will still end up taking the home back. So with that I have to be comfortable owning that home at the end of the day. If not sold at FC auction, then our intentions are to fire sale the home at a price that makes it a win win for us and the buyer. 

    1Reply
  • Fred Moskowitz
    OP
    Fund Manager · Philadelphia, PA · Member since 2019 · 41 posts · 52 votes
    7y

    @Jay Hinrichs when working with other investors who are investing passively in your deals, this is considered the offering of a security in most cases.  Using a properly registered offering with a PPM actually provides a great deal of protection to both the deal principals and to the investors. I do recommend always consulting with a securities attorney to evaluate your situation and to provide appropriate guidance for maintaining compliance.

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  • Jamie Bateman
    Investor · Baltimore County, MD · Member since 2014 · 466 posts · 439 votes
    7y

    @Fred Moskowitz, excellent question. 

    I think for people with no experience, one common questions is: "Why would you buy something considered non-performing, a loan where the borrower is not making payments?"

    And I'd say for a note investor with a little experience, one topic that can be hazy is how to calculate bids (how to develop your ROI calculator), especially for NPNs.

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  • Ian WalshBusiness Member
    Lender · Philadelphia, PA · Member since 2016 · 2k+ posts · 1k+ votes
    7y

    Not just note investing but all investing.  - Assessing the true value.

    1Reply
  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    7y

    @Fred Moskowitz

    I had someone tell me they want to learn notes as this business is a gold mine. I may have burst their bubble but it’s like any type of investing. It takes a while and a lot of work and there will be bumps in the road. Another person posted about making $300k a year in notes and I would guess there are very few people who make that much $ on a consistent basis just in notes.

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  • Fred Moskowitz
    OP
    Fund Manager · Philadelphia, PA · Member since 2019 · 41 posts · 52 votes
    7y

    @Chris Seveney

    Yes, I agree that the note business is a slow road which will be filled with cash flows that are quite random and lumpy.  You did the right thing by sharing this reality with the person that you were speaking with.

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  • Bob Malecki
    Investor · Kingston, WA · Member since 2008 · 1k+ posts · 1k+ votes
    7y

    I think that one of the most misunderstood aspects of this business is the flexibility we have with non-performing debt. Being able to modify the coupon rate or the term or the balance of the loan to get borrower re-performing is kind of magical. 

    Most real estate investors understand how renovating a home can add value and profit for them, but they don't understand how "renovating" distressed debt is relatively easier and creates profitable cash flow while keeping a bottle where in their home. It's a win-win for everyone in the deal. 

    Also having the ability to recapitalize a project by selling partial term on a performing loan is much simpler then, let's say, trying to refinance a rental property -- especially if a bank is involved!

    4Reply
  • Chad U.
    Investor · Boca Raton, FL · Member since 2012 · 1k+ posts · 1k+ votes
    7y

    @Fred Moskowitz

    Hey Fred, good to see you on here, welcome to BP!  

    I think the most misunderstood aspect of this business is navigating through various regulations and compliance mandates, which can vary state by state.  One example, determining statute of limitations, the difference between an enforceable lien and ability to collect on a debt.  Another example is understanding bankruptcies, the different chapters and their effects on the loans.  Another is the registration requirements and/or needing licencing, etc.  Most attorneys don't even know the answer to this last example in most cases.  

    I could go on, but I find "you don't know what you don't know" can land many in hot water in this business.   

    1Reply
  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    7y
    Originally posted by @Chad U.:

    @Fred Moskowitz

    Hey Fred, good to see you on here, welcome to BP!  

    I think the most misunderstood aspect of this business is navigating through various regulations and compliance mandates, which can vary state by state.  One example, determining statute of limitations, the difference between an enforceable lien and ability to collect on a debt.  Another example is understanding bankruptcies, the different chapters and their effects on the loans.  Another is the registration requirements and/or needing licencing, etc.  Most attorneys don't even know the answer to this last example in most cases.  

    I could go on, but I find "you don't know what you don't know" can land many in hot water in this business.   

    yup on my little issue with the state my attorney told me no problem only to have the state tell me big problem .. :) 

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  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    7y
    Originally posted by @Chris Seveney:

    @Fred Moskowitz

    I had someone tell me they want to learn notes as this business is a gold mine. I may have burst their bubble but it’s like any type of investing. It takes a while and a lot of work and there will be bumps in the road. Another person posted about making $300k a year in notes and I would guess there are very few people who make that much $ on a consistent basis just in notes.

    maybe after rolling them up for 10 to 20 years.. When I ran my HML company in Oakland in the late 80s we had 250 note investors.

    most were 200 to 500k out making 12 to 15% annually..  we did have a few big ones.. One of my clients who owned radio stations had 5 million with us so he made 500 to 700k a year.. 

    these were all performing or were suppose to perform  :)

    to make the money your talking about 300k a year out of the gate would require a lot of capital upfront.. which most don't have personally ..  

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  • Patrick Desjardins
    Real Estate Investor · Amherst, VA · Member since 2015 · 386 posts · 400 votes
    7y

    The biggest misunderstanding is that this is a legal and finance business, not a real estate business. Legal is the biggest expense and will make or break your note investments.

    People recommend setting aside 3,000-3,500 for legal. That is well and good until something goes wrong and you're paying that $3,000 PER MONTH in legal fees. Many of us here have cases where the legal fees amount to more than 20k, sometimes more than the price of the note.

    I have a case in Florida still going strong after 3 years in court.

    You need to be well funded. 

    3Reply
  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    7y

    @Patrick Desjardins

    Great point. You need to have $ to do this business. I see a lot of people who try and do notes and have zero money. It is like any business, you need to be well capitalized to grow it.

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  • Steve HodgdonPro Member
    Investor · Novato, CA · Member since 2015 · 433 posts · 321 votes
    7y

    Most misunderstood....

    Gross vs. NET

    Costs of servicing, paying back taxes, attorney fees

    State/local rules

    BPO's aren't appraisals aren't guaranteed street value

    The inside of the house always looks like the mortgage payment history.

    Counter party risk. No regulatory authority governing the niche.

    Says the guy chasing 2 BKs and a lawsuit today. 

    0Reply
  • Robert Harpster
    Investor · Federal Way, WA · Member since 2020 · 42 posts · 10 votes
    6y

    @Fred Moskowitz

    Stumbled across this thread and really enjoyed reading the comments. Very helpful for the new note investor. 

    0Reply
  • Andy Mirza
    Lender · Ladera Ranch, CA · Member since 2014 · 1k+ posts · 1k+ votes
    6y

    I agree with @Patrick Desjardins. Most newer folks to notes come from a real estate background. Many look at buying NPNs as a way of getting the real estate. If this is the primary consideration when buying NPNs, it's a mistake. What the borrower does is outside of your control and you have to accept and take into consideration other exits besides the REO route.

    Notes are financial instruments and need to be looked at primarily as such. A real estate background is very helpful but the new note investor needs to make the mental shift to be successful.

    0Reply
  • Jamie Bateman
    Investor · Baltimore County, MD · Member since 2014 · 466 posts · 439 votes
    6y

    If you are getting into land contracts or any kind of seller financing, it can only help to know real estate as well. If you deal mainly in clean, institutional notes, maybe having a real-estate background is not quite as critical, but it can still aid in evaluating the value of the collateral and comparing exit strategies. But I agree that note investing really is largely about #s and $. If someone is more of a hands-on rehabber or rental-property manager, note investing may not be the best fit.

    Back to the original question, one of the main things I didn't quite understand in the beginning (and I later read here in the forums) is that if you are running a note business (not just investing in a note or two), the whole thing is really made up of three activities: finding deals, finding money, and managing deals to exit. Pretty much any task can be put into one of those three buckets.

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