An Introduction to Investing in Notes: Why You Should “Be the Bank”

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The general concept of investing makes perfect sense: It is the art of using money to make more money. So, how does this simple idea so often get lost on so many people?

Well, it comes down to two beliefs in nearly everyone’s core philosophy…

The first is that many people believe if someone wants to make a lot of money, then they need to work hard at their job. It’s true that a good work ethic is an honorable trait, but does money always come directly from hard work?

While this of course can be true, the fact is that most of the world’s richest people work hard in a different sense; they put their money to work for them.

Secondly, many people were and still are taught to save money rather than to invest it. They go to work all week, and every Friday, they save a certain portion of their paycheck and put it into a savings account.

Now, don’t get me wrong, reserves are important; building and maintaining them is a key to a healthy investment future. But at a certain point, a dormant savings account becomes just that, dormant. Most savings accounts offer an incredibly low interest rate, and keeping money in an account like this does very little to increase personal wealth.

In fact, the bank is the only one that is truly making any money in this scenario because they are paying you a nominal fee to lend back out your money for a much higher return.

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Be the Bank

So why not think like the bank? In fact, why not be the bank? Like the bank, always keeping your money moving in a liquid investment is not only more profitable, but also just as safe as leaving your money in a near static savings account.

Related: Real Estate Notes vs. 401k: Which Investment Wins Out Over 30 Years?

In any given loan situation, most people feel the banks have all the power, and in many ways, they’re right.

If a borrower pays off their loan, who wins? The bank — although the borrower gets to own their own house free and clear, it was the bank that made the financial profit.

If a borrower decides not to or can no longer afford to make payments, who wins? The bank — they have the option to take ownership of the property because it was deemed collateral in the loan contract.

So, when someone purchases a note, they have become the bank, and they’re entitled to some of the advantages and security that the bank is usually accustomed to.

Everyone is in the note business; they just don’t realize it because they’re on the wrong side of it. It’s hard to find a person who doesn’t have a credit card, car loan, student loan, or a mortgage.

The only problem is that most people are writing a check to a note owner instead of receiving one. The best way to get onto the other side of that equation is to start owning notes, rather than the other way around, and to do so, one must start by gaining a better understanding of the note business.

If you want to get clear on a few important definitions, I previously wrote an article, “Real Estate Notes: Key Concepts to Consider,” which may be helpful.

Why Invest in Notes?

The three most common asset classes that generate cash flow are: businesses, paper assets, and real estate. All of these have differing advantages and disadvantages, but notes have a number of benefits over other investment options. One of the most advantageous is the passive cash flow and synergy created between the other asset classes, which oftentimes can improve the chances of a more favorable outcome.

For example, an investor can have a note business that involves paper assets backed by real estate. Also, when a note is performing and being repaid by the original borrower, the holder of the note will receive payments every month, and more importantly, there is no work required to continue receiving these payments.

Aside from being an investment that is excluded from market fluctuation, some of the main advantages of investing in notes include the passive cash flow (as mentioned above), the level of volume and control, the collateral behind a secured lien, and the versatility regarding exit strategies for the note.

Volume and Control

As many of us do, banks also own real estate, but they would rather finance properties than own them. Sure, there’s much less, if any, property maintenance involved, and note portfolios can be managed via phone and computer from anywhere. But the main reason is that loan portfolios are more scalable and more liquid than property portfolios, and banks figured this out years ago. For example, it’s much easier to liquidate/sell a note than it is to liquidate/sell an REO.

Collateral

Unlike other paper assets (stocks, bonds, certificates of deposit, etc.), a note and mortgage is secured by real physical property. Owning a secured lien tied to a property, especially with equity, involves little or moderate risk, mainly because if the note stops paying, you have the option to foreclose on the property and recoup the initial investment. You also have the opportunity to offer foreclosure alternatives to homeowners, who would like to stay in their home. As “homeowners,” borrowers are less likely to vacate their property due to the emotional attachment (or emotional equity) to their home.

Related: 4 Arguments for Investing in Real Estate AND Notes for Retirement

Versatility

Many investors love investing in property or hard Real Estate for all the varying opportunities it provides for making a profit. What most investors don’t know is that almost anything that can be done with a house can be done with a note.

  • Flip or wholesale a note (Example: selling as non-performing, as performing, or as a partial)
  • Rehab a note (Example: creating a loan modification or workout agreement with the borrower)
  • Borrow against the note (Example: Collateral assignment of note & mortgage)

Now that we’ve covered some introductory reasons to consider note investing as an option for your own portfolio, stay tuned, as we’ll be discussing how you can be successful without quitting your full-time job or necessarily having to pay a high priced guru.

Investors: Weigh in! Do you include notes as part of your portfolio? What are your questions about this form of investing?

Leave a comment below!

About Author

Dave Van Horn

Dave Van Horn is President at PPR The Note Co. - an operating entity that manages several funds that buy/sell/hold residential mortgages, both performing and delinquent. Dave has been in the Real Estate business for 25 years, starting out as a Realtor and contractor and moving onto everything from fix and flips to Raising Private Money.

30 Comments

  1. Joe Foster

    Hi David,
    I’d like to start investing in notes as part of my real estate diversification currently in rentals and rehab loans. I’ve visited your web site and subscribe to your news letter. As a first time investor in notes, I would prefer performing notes. When I started to investigate loans that meet my needs on your site, the registration, just to look required SSN.

    Could you take some time to discuss the tax reporting requirements and the documents that one needs to supply to the lender? It is my understanding that they need a 1099-INT from the “bank” aka me. Are there strict and terse requirements for reporting this to the lender and IRS?

    Also as a newb to this, I would prefer to have the first note in a location that I can easily inspect the property. If I were investing big dollars to start, the airfare may not be an issue. I do see that the notes are sometimes lower cost some as low as 20K, which would be a great entry point until comfort is established but not a large enough position to fly and check out.

    Joe

    • Dave Van Horn

      Hi Joe,
      I’m glad to hear you’re getting started in notes. One of the advantages to note investing is that it requires less involvement with the actual property (for example, I’ve yet to get on a plane to visit the property of a note I own or that my company owns). However, I do understand your curiosity. There are field services companies, who can do a property detail report or a door knock service well under $100.
      Regarding your tax reporting question, if you have a performing note placed with a licensed servicer, they do the tax reporting for you. They would provide a 1098 mortgage interest statement to the borrower, and file a 1096 with the government.
      I hope this info is helpful.
      Best,
      Dave

  2. Scott Stevens on

    How many claims of interest are on the dollar(s) you are lending? If the very first dollar created represents a promise to pay back that dollar, plus interest and that dollar gets lent again, how long will this currency system we have last?

    I realize the dollar is being digitized and printed excessively, but how long do we think this will last before a currency change?

    • Dave Van Horn

      Hi Scott, thanks for your questions.
      I’m not the originating lender; what I’m doing is investing in mortgages at a discount, where the money was already lent. Regarding your question about how long our currency system will last, I’m not sure. For me, I’m less worried about it since I invest in assets that have value regardless of what the currency is. It is one of the big reasons that I don’t prefer sitting in cash.
      Best,
      Dave

  3. JT Spangler

    The sticking point for me in my (limited) research has been that there’s no way for a guy like myself to easily get into notes other than buying them from a note broker such as yourself, out of limited inventory that’s probably already been cherry-picked by the inner circle investors.

    How do I find a deal that isn’t a dog if I’m looking for something in the 10-20k range?

    • JT, notes are like real estate in that it’s not a perfect market – people make mistakes at all level and you benefit even if you’re small.

      We just closed on a house we got back in central Florida: we bought the note from a small fund for 2,700, paid 2.5k back taxes, 3,500 to borrower for deed in lieu and 1k for minor repairs. All in 10k ish and sold for 36,500.

      That loan had been sold and resold multiple times because no one realized first mortgage had been settled. Their loss our gain.

      My point is you can make money even with the “scraps” that funds sell.

    • Dave Van Horn

      Hi JT,
      Although PPR isn’t a note broker (we take title of the notes we sell), we are a note fund. One of main reasons note funds sell notes is because they need to recapitalize to pay investors and go back to market.
      Personally, I buy performing notes. As a company, we buy non-performing notes and rehab them to sell performing. Either way, there is money to be made, although non-performing notes sell at a lower price point and involve more work.
      There are notes I’ll sell simply because equity is coming back in the marketplace. I’ll make money, and the purchaser will make money too. This correlates to real estate – someone might sell a duplex with great cash flow because they’re tired of managing it or because the market is taking an upswing.
      Patrick D. makes a good point as well. Finding a good note deal is all about your due diligence.
      There are certainly more people and funds selling notes now than there were when I started out in the business. Even if you do struggle to find a good note deal, you can originate a note for someone else. Or, you can even buy a partial note.
      Networking with others who are already in the note business could be beneficial as well. There are many note events and groups you could join or attend if you’re interested.
      I hope this info is helpful.
      Best,
      Dave

    • Sean M.

      Sol,

      I’m a Canadian, bought a few US notes and with our dollar going down I now buy in Canada. Yes you can buy notes in Canada, but I have not found any dedicated market places / brokers in the same way as the states. The amount of inventory is much smaller, with notes selling incredibly fast here, and I have never come across a npn for sale in Canada (though I’ve only been looking in Canada for a few months). Prices in Canada seem higher as well. The plus side is you might find you are more familar with the asset locations, and can even drive by and see the house yourself. More passive option here include MICs, and some similar options.

  4. Cory Adams

    Hi Dave, Can you discuss some of the loan origination strategies that people can employ and what is required to stay Dodd Frank compliant?

    Also if not more importantly do you caution against originating loans on properties that already have a primary loan? I ask this because I realize many small and large investors were burned by the last down turn by having the first loan holder often force the secondary to take pennies on the dollar during a foreclosure and or short sale.

    • Dave Van Horn

      Hi Cory,
      The easiest way to stay compliment is to use a licensed mortgage broker to underwrite the origination of your loan. The other way around it is to only do commercial loans (hard money loans to LLCs). PPR only buys existing loans.
      I don’t caution against originating a second mortgage, third mortgage, etc. so long as there is sufficient equity backing it.
      I don’t know if I fully understand your statement about the foreclosures and short sales in the down turn, as it doesn’t mention what the investor may have bought the existing secondary non-performing loan for. It may have been more profitable than you think.
      I hope this info is helpful!
      Best,
      Dave

  5. Hi Dave,
    I just recently had a Realtor tell me to “Become the bank.” I own a home, with deed in hand, and just can’t seem to propel myself to move out and rent it for the $800-900/month. I guess I have that ” Emotional Equity!” I purchased it some 3 years ago and have literally put “Blood, sweat, and tears” into it.

    I can easily purchase another home and do the same, but I suppose its more difficult when you have put personal touches and have memories.

    Thank you for sharing as this sheds light on the matter. We are all on some side of the Note. I have to choose when to move to the other side….

  6. James D Geeza

    Hi Dave,
    I have been looking at the note vault allot. I have tried to read and learn but can not figure it out. I have a little money sitting dormant in a self directed roth. Is there someone I can contact to get advice on what note would by good to purchase for my first one. I just want to get started I think that is the only way I will learn. I been a roofer for 30 years my back is wore out and my brain isn’t real good. I really need some help, do you have any suggestions? Thanks

    • Dave Van Horn

      Hi James,
      Thank you for reaching out. Well, if you’re looking for something more passive, I would suggest performing notes. These are notes, where the borrower is making regular monthly payments. Purchasing performing notes typically involves less of a time commitment and less risk tolerance, than say, purchasing non-performing notes, where the borrower is not making regular monthly payments. If you’re interested, feel free to private message me, and I’ll provide some additional resources for education, as well as contact information for someone to speak with.
      All the best,
      Dave

  7. John Tu Nguyen

    Hi Dave,
    This is very interesting area to invest in real estate. Are there any books or websites that a beginner can learn the fundamentals of note investing. How to find them? What to look for? How to due diligence? Where to resell them? Etc…Also can you leverage buying notes like you do buying properties?

  8. Jerry W.

    Dave,
    Thanks for the article. My brother and I bought a note from our father who sold a property and the guy quit paying, and another from a friend of his who did the same thing. In both cases the folks in the home started paying again when we began foreclosing on the property. it is a lot like renting but no property management is needed. One guy misses about 1 payment a year, but it still pays out fairly well. We borrowed against a rental property for the money to buy the notes. I do not know how to find notes for sale on local properties. Is there a type of service that lists notes by the area where the property is located?

  9. Edwina Johnston on

    Dave

    I just became aware of investing in mortgage notes and it seems a safer way than the stock market. What do you think of investing with a company that handles everything and promises about 11% on a 100,000 investment. This is a Texas company and I would have to check them out thoroughly. But how to do that? I live in Seattle. If I could e-mail you privately, I could tell you their name. Perhaps, you already know them.

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