Posted about 7 years ago

How to Reduce the Risk of Real Estate Investing

As professional Note Investors, we routinely meet the acquaintance of real estate investors, those who would like to become real estate investors, Realtors, and other real estate professionals. Often, when we introduce ourselves to a new acquaintance as Note Investors, we get a blank stare. The unspoken response is: What, exactly, is a Note Investor?

Unlike traditional real estate investors who buy properties — single family homes, duplexes, other multi-family properties, and commercial properties — Note Investors buy the financing; we buy the “paper.” We become “The Bank.”

A favorite slogan of Note Investors, one which admittedly is intended as a good-natured poke at traditional real estate investors, is that Note Investors don’t have to deal with “tenants, toilets, and termites.” The slogan is true in most cases. If you’re a traditional real estate investor, when was the last time something went wrong at one of your properties and your tenant called The Bank to whom you send the mortgage payment every month? It doesn’t work that way, does it? Of course not! The tenant calls you (or your property manager).

Once our new acquaintance begins to understand what it is that we do as Note Investors, we move from the “blank stare” part of the conversation to the “oh, that sounds risky” part of the conversation.

The perception of “risk,” we explain, is more a result of a lack of knowledge and familiarity with note investing, rather than a reality. We tell our new acquaintance that although there is risk in every investment, we believe that a Note Investor is in a much more secure position — that is, a less risky position — as compared to the traditional real estate investor.

“Wait!” our new acquaintance will protest. “Did I understand correctly? Note investing is less risky than traditional real estate investing!!!???”

Yes. That is exactly correct, is our response.

When things go wrong in the real estate market in general, or when things go wrong in a particular deal, who typically “takes the hit” and who typically comes out okay? In our experience, the individual, traditional “brick-and-mortar” real estate investor is more likely than The Bank (that is, the Note Investor) to take the “hit.”

If we think about it, this makes sense. In any deal, the traditional real estate investor “owns” the equity in an investment property. The equity, of course, is the most vulnerable “piece of the pie.”

If, for example, the market value of an investment property is $100,000 and the loan against the property is $70,000, who takes “the hit” if the value of the property declines by, say, $30,000? Here’s a clue: it’s not the Note Investor.

It gets even better. Note Investors buy notes at a discount — that is, Note Investors buy notes for less (usually much less!) than the face value of the note. So even if the value of the property in our example were to decline in value by more than $30,000, the Note Investor — who likely purchased the Note for considerably less than $70,000 — would probably still make money.

Note Investing is not a “get-rich-quick” scheme (although amazing profits are possible). It is however, in our opinion, a very safe and secure alternative to traditional real estate investing.

After this explanation, our new acquaintance will often have that “Ah ha!” look, you know, that look which comes when someone sees something they had not seen before, even though that something had been hiding in plain sight the entire time.

Comments (2)

  1. Great write-up. I think far too many people are scared out of note investing/private lending solely because they are misinformed on the topic.

    What is your perception of the added risk that comes with a second position lien?

  2. I would really like to learn more about this!!