Real estate just can’t seem to catch a break. Every time that a nugget of good news about property values or sales appears, it seems to be offset with dismal news about some other part of real estate. One analyst predicted that ten million mortgages will default (1 in 5) if Congress doesn’t take action. Of course, my opinion would be that all of the “action” that the politicians have taken so far has done little more than waste billions of dollars.
In this environment, we as investors must calibrate future risks relative to the potential rewards. Whether you are a pure property investor, a mortgage note buyer, or have another role in real estate, the risks are bigger than ever.
In the past, I’ve written extensively about the ins and outs of investing in mortgage notes (also called real estate notes). A knowledgeable note buyer will have a good understanding of a property’s value, the payer’s credit and pay history, the details on all of the documents, and the likely scenario in case of a default. Contrary to the opinions of some people who have sold a property and carried a note, a mortgage note is not risk-free and certainly is nothing like a CD or savings account.
Clearly, there are many advantages of being a note buyer/investor. As a professional who has personally bought dozens of notes and brokered hundreds more, I’m a believer in notes.
A note buyer enjoys much higher yields (rate of return) than one can get at a bank or most any other place and, in my opinion, at less risk than with the stock market. A creative and smart note buyer can even buy notes in cases where the payer has weak credit or where the property has challenges, by ensuring that there is a sufficient equity buffer.
For instance, a couple of years ago, I bought a deed of trust note on a mobile home with land in central California. Beyond those high risk characteristics, the property was outside of a small town, the payer was on disability with less than great credit, and the pay history was brief. Here were the basics of the original transaction:
Sales Price: $120,000
Down Payment: $10,000
Original Note Amount: $110,000, 6% interest, balloon in 5 years
The note had additional issues that made it even less desirable, but I was able to make it work by understanding the note holder’s needs, and offering to buy just the remaining monthly payments and part of the balloon. To date, the payer has made all of their payments on time and the original note holder has come back to me twice to buy additional small pieces of the balloon. Even after all of that, my investment-tovalue ratio is still only about 50%. So far, so good.
If you’re thinking about investing in real estate notes, ignore the late night infomercials. Study up on the subject and then get yourself hooked up with someone who is knowledgeable and has actually bought notes. Unless you’re bringing viable notes to the investor, you’ll need to pay him or her a few hundred dollars for their time and expertise. I always recommend that new investors broker their first few notes before putting their own money at risk. That way, you can learn while you earn and build a good knowledge foundation. Once you feel comfortable with the business, buy a few small notes and build up to a bigger portfolio. In time, you’ll be a full-fledged note buyer and enjoy all of the fun and rewards that go with that.
REAL ESTATE NEWS FROM THE WEEK
* Nationwide, average loans that completed foreclosure in July had no payments for 599 days, up 25% from 478 days in August 2010 (Wall St. Journal, 9/19/11)
* Default notices in California spiked 55% in August (Housing Wire, 9/19/11)
* Home prices expected to drop 2.5% this year and rise 1.1% annually through 2015 according to a survey of 100 economists (WSJ, 9/21/11)
* The government owns about 1/2 of the REO inventory in the country (WSJ, 9/22/11)