Most note investors probably start out like I did, just looking for a more passive way to invest in real estate and to be able to cash flow with as little hassle as possible. The initial goal is to just build up a nice portfolio of re-performing notes, whether you originated them, purchased them performing, or just rehabbed a delinquent note back to performing status. Then, you just sit back and collect the payments, right? This is very similar to investing in rental properties, or any long term buy and hold type of real estate. It’s really the “get rich slow” model because you’re really making the bulk of your money over time. Nothing wrong with that, but is there a better way?
As the guy who used to buy and hold all of his properties and notes, I’d like to think so. So what’s the key element for improving my cashflow strategy? In a word: velocity. Let’s assume you have some capital to invest (even if it’s OPM – Other People’s Money) and you have more notes available to you than you could buy and you have some staff that could jump in and help you if you need it.
In that scenario, what’s the best possible way to make the most money the quickest? Just like you’d flip or wholesale a Real Estate deal (either before or after rehabbing) for a profit to enable you to pay your bills while you acquire a rental portfolio, you just do it with paper. So it’s simple: take some non-performing notes that you make performing (thus increasing their value), collect arrears and collect some payments to season them (which will most likely cover what you paid for the note and then some), flip ‘em, rinse and repeat!
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Three Ways to Recapitalize on Your Notes
With the capital you make from the flip you can go back to the market again and purchase some more delinquent notes to rehab, and eventually the more you flip, the more you can buy. And like Real Estate, you don’t have to “kill all of your darlings” because you can keep a few for cashflow while you focus on the flips. This same strategy can apply to notes and I can think of three ways you can recapitalize after buying some notes to enable you to go out and buy even more to rehab.
1.) Just Sell the Note
It’s very similar to Real Estate where you just need to develop a strong buyers list. Some strategies that we’ve employed have dealt with education and marketing for the most part. For example, you could teach how to invest in notes or how to raise money to buy notes as well as sell product. This will not only build you a credible reputation, but also a healthy buyers list.
Another way is to provide reps and warrants with your note sales and to provide good follow-up service just like you would in any business. We even go as far as to provide warranties on the re-performing notes we sell, and our demand for these “no-risk” notes is off the charts!
2.) Do a Collateral Assignment of Note and Mortgage
This is where you borrow money from an investor and use your note as collateral. This is acceptable by using a promissory note between you and your investor spelling out the terms and interest rate on your loan. You then record the second document (collateral assignment of note and mortgage with legal description) in the county court house where the house is located that’s behind the note in order to perfect the collateral that’s being used to protect your new lender. This is very similar to a car loan where the car acts as collateral for the loan, but in this case, the note acts as collateral for your loan.
Collateral assignments are a great technique in some markets especially when there’s equity in the note. The recording puts a cloud on the title so if the homeowner wanted to move or refinance the collateral assignment of note and mortgage would need to be addressed. We would include language in our agreements where we could substitute another note another note of equal or like value, and of course we could always just satisfy our investor and just record the satisfaction piece and enable the homeowner to move forward.
This is also a great strategy tax-wise when starting out because it’s really not a sale but a loan so you can recapitalize tax free just like refinancing a rental property you bought wholesale and rehabbed. Plus, if you’re not doing notes as your everyday business, when you finally sell this note down the road it may be considered a long term capital gain, which has its advantages.
3.) Sell a Partial Note
This is a great technique especially if equity is tight in the market place. With this technique borrowed from the “seller finance” world, you could just sell part of the loan to the investor (e.g. the first 5 to 10 years of payments) that may be an amount, term, and interest rate that’s excellent for your investor and still covered by some equity. The cool part here is you can still own part of the loan and the investor’s still safe because you still have an invested interest in the deal.
When people talk about notes, they always seem to mention the phrase, “Be the bank.” Most people can get that concept, but what they usually fail to realize is how fast and frequent the bank uses money. When I first started in notes, I thought I was being the bank, but I realized I was just parking my money in the loan I was buying. It wasn’t until I started to really flip my notes like I used to flip my houses that I discovered where the real money was. That’s when I stopped getting slow profits and started getting fast ones!