Investing in Real Estate Notes

[Johnny Aloha]

I've searched this forum, as well as others, for some detailed information on buying RE notes.  I'm having a hard time finding anything worthwhile that discusses the process of purchasing, due diligence, and risks.  (I haven't checked out books from the library yet though!).

I know there are some note investors on this forum.  Could you recommend any resources?

Some the questions of the bat are:

- do you buy through a broker?  What are the fees / commisions?
- What is the cost to service the loan?
- What sort of due diligence is required, other than selecting a foreclosure friendly state and checking borrower and property quality?
- what is the ballpark cost and time to foreclose if the owner stops paying?

In general people say notes can be very profitable, and I understand the basic concepts and calculations.  But I've yet to find unbiased and detailed information.

[thedayisbrave]

Yes! Thanks Johnny for posting this, as I've been trying to read more on the exact same thing.  Specifically, notes in IRAs, which I believe will need to be self-directed in order to invest in RE notes considering they're not the plain vanilla stocks/bonds that are offered. 

I'll second the request for resources, recommended reading, etc.! Thanks!

[arebelspy]

Not much discussion on this one...

I've done some note investing, so I'll chime in.

The problem is most of your questions are so broad, that the answer is just "it depends."   It's like someone new to rental real estate asking really, really broad questions.  :)

- do you buy through a broker?

It depends.  That's one way to acquire them.  Others include direct mail advertising to note owners (via public information), networking, etc.

(Rental equivalent question: Do you buy from the MLS?)

- What is the cost to service the loan?

It depends.  Performing, not performing, what type of servicing are you looking for?

(Rental equivalent question: what are your monthly expenses?)

- What sort of due diligence is required, other than selecting a foreclosure friendly state and checking borrower and property quality?

It depends.  What type of note is it?  First? Second? Performing? Non? Age? Check into tax history, other liens, borrower is huge, check on the note itself (chain of title, for example), FMV & LTV, etc.

(Rental equivalent question: what sort of due diligence do I have to do?)

- what is the ballpark cost and time to foreclose if the owner stops paying?

It depends.  Every state has different processes.  (I could ballpark a number for you, probably 3-6 mo., but that's a pretty broad range - check on your specific location.)

(Rental equivalent question: what if the tenant stops paying?)

In general people say notes can be very profitable

It depends.  Absolutely they can.  Or they can be a disaster.  But yes, they are their own realm.

(Rental equivalent question: I've heard rentals are profitable...)



You know I'm just teasing you, JA, with the "It depends" and rental equivalent question stuff.  :)

That being said, those are quite broad questions.  It may help you to look at specific scenarios and/or note types and ask questions about those (like someone looking at a 3/2 and asking questions about it, and then branching out, rather than trying to figure out fourplexes, storage units, and condos all at the same time).

[Johnny Aloha]

You know I'm just teasing you, JA, with the "It depends" and rental equivalent question stuff.  :)

Indeed - and much deserved on my part! 

If I may make a suggestion - starting a sticky thread for notes, similar to what you have for rental properties.  Would be great to see a place where people recommend books on the subject. 

[BBub]

I'm reviving this thread to inquire a bit about notes... sorry if there's a better discussion elsewhere.  I'll try to post as many details as possible. 

I know someone who deals in notes and am considering the possibility of investing w/ him at some point.  Here's the deal:

He originates and services the notes.  He holds most of them himself.  The borrowers are investors only, and the properties are mostly rental houses - some are commercial, or multi, etc.  I would invest in mainly 15 yr fixed amortizing loans at 12%.  1st lien position, performing.  Average LTV is 50%.  He services the loans for a 1% fee, so my net interest is 11%.  He does everything.. originates, collects payment, sends it to my bank monthly, deals with delinquencies (which he claims are very rare), reports to the IRS, generates a monthly statement and 1099. 

So, I put up the money over time, and he will build out a laddered 15 yr note portfolio with 11% net interest.

Does this sound legit - anyone had similar experience with originators / servicers like this?  Seems like a really great deal (almost too good), but I'm not too familiar with this market.  What type of due diligence can I do?  He said the process is that he originates the mortgage under his company's name then transfers the mortgage to me and files it w/ probate court.  He is not licensed because he doesn't loan to consumers - only investors.  The guy has been in business for about 20 yrs & I know some others who have had a positive experience investing with him...  He comes from a good and well known family, yada, yada.. but we've all heard those stories before. 

Mustachians with experience in this area, what do you think about this setup?

[arebelspy]

What investors are paying 12% on a long term note?  That's near hard money rates.

That's a red flag for me.  You can easily earn 12%+ on notes, but usually by buying them at a discount (i.e. they were originated at a lower rate).  Who is taking a note originated that high?  And if they are, how long until they refi out of it?  Just once they have seasoning, so then you have a velocity of money problem.

I mean.. I guess.  I tend to fall on the side of skeptic and do lots of due diligence, and this would require that.

[BBub]

Those were my thoughts.  12% on 15 yr fixed seems too high.

He said many of his deals are short term, which investors use on flips or whatever.  Sometimes interest only, or balloon.. they find it easier to get money from him than deal with banks for short term deals.  That makes sense.

But the loans he'd sell to me would range from 1- 15yrs fixed and amortizing at 12%, which seems unrealistic to me in today's environment... unless the borrower is low quality, or some other factor is off.  When I asked him about this he just said that he has repeat clients who have done business w/ him for a very long time, and they keep coming back because they like dealing with him.

What due diligence would you recommend?  I asked him if before investing in a note I could walk through the property, see his files on the borrower, title search, transfer docs from probate, etc... He said absolutely. 

Anything else I can do to check into it?

[arebelspy]

Short term hard money makes sense, but then structure it that way.  15-year for near hard money is screwy.

Due diligence on the buyer and property, yes.

What is his cut?  A 1% fee for ongoing servicing, but what about all the upfront stuff?  He's literally doing all that work AND servicing it, for a paltry 1%?  What if it pays off in 6 months?

[BBub]

Yes.  1% fee.  I think there's also a $10/month admin fee.  But that seems like peanuts.

He said that he basically sells off the notes for liquidity.  He maintains a large portfolio of notes himself - and for his family.  They've been in this business for a long time.  So, when he gets short on money to loan out, he can sell off a note to an investor like me.  It frees up money for him to loan out somewhere else.  I even asked if he was making a gain selling the notes to me at a premium (i.e. he originates it out at 15% then sells to me at a premium to yield 12).  He said he was not.

Edit: I will add that I have seen statements back to 2011 from a friend who invests w/ him.  This friend has just under $500k invested and generated just under $55k in interest last yr.  The checks have been on time every month since 2011.

[BBub]

In terms of checking him out.. his business has no complaints, no missed payments, a good reputation.  On a deal by deal basis he seems willing to let me pour over the paperwork until my heart's content.

What else would you do if you were considering putting your money with him?  Or would you even consider it, given that 12% long term fixed seems almost "too good to be true" in today's rate environment?

[ShoulderThingThatGoesUp]

Why not offer one of his clients that you'll refinance at 10%? See what they say, maybe you'll find out the secret reason they are going with him. It just seems like there has to be more, but we don't live in a world of perfect information.

[BBub]

Yeah that would probably piss him off, but it could be done.. I wouldn't have to actually refinance the note from the client - just talk to him.  I know several investors who buy notes from him, but I don't know any of the clients who are borrowing from him.  I'll find out who they are, talk to several of them & get a better feel for the operation.

[arebelspy]

Yes.  1% fee.  I think there's also a $10/month admin fee.  But that seems like peanuts.

He said that he basically sells off the notes for liquidity.  He maintains a large portfolio of notes himself - and for his family.  They've been in this business for a long time.  So, when he gets short on money to loan out, he can sell off a note to an investor like me.  It frees up money for him to loan out somewhere else.  I even asked if he was making a gain selling the notes to me at a premium (i.e. he originates it out at 15% then sells to me at a premium to yield 12).  He said he was not.

Having him pick and choose the worst notes that he wants to get rid of isn't my favorite idea, but that's a minor point compared to the below.

So here's the thing that doesn't make sense at all.

He's going to the work of doing the due diligence, originating this note, etc. and then reselling it for face value, and collecting a paltry 1% (and $10) for servicing, which would be expected anyways?  In other words, he's doing all the original work for free, then reselling it?  Why?

Liquidity doesn't make sense.  If he wanted that money liquid, he wouldn't make the loan.  Doing all the work to make the loan and then sell for the same value to get the money back makes no sense.

ESPECIALLY cause there's a thriving secondary market for notes.  If these are good, solid notes, he could be selling them for double what he's asking you (discounting them to 6%).  I own notes, and I get solicitations all the time in the mail to purchase them (as with my rentals).  The lien is recorded in public record, and people advertise at those owning them.

If he wanted a quick sale, he could mark it down to the equivalent of 8% or 10%, sell it, and make a nice profit.  (I'm simplifying, but really what happens is if the going rate is 8%, he'd mark up the price such that the 12% yield now yields only 8% on that higher value now, and he'd cash out a good chunk of change on top of his investment).

There's gotta be a reason he's not selling these notes on the secondary market for a nice profit.

One is because he's an idiot.  I'm doubting that's the case, and you probably don't think so either.  So think through then: why would he initiate these loans and sell them for essentially no profit having done a ton of work for free if he could originate them and sell them at a nice profit?  "Liquidity" isn't the answer, because that provides him even more liquidity.

So why not sell them on the secondary market?  Don't accept bullshit like "I like to deal with investors" (only investors are buying those notes) or "It's too much work" (more than originating a quality note?  No way.  And it's actually really easy) or "It takes too long" (it doesn't - if they're seasoned - and if he doesn't want to wait for seasoning, there's a big red flag). 

That's the biggest problem here: there's no profit in it for him, and an easy way for him to profit if these are good notes.  So why isn't he?

[BBub]

Yeah doesn't make sense to me either.  Thanks for the perspective.  I had some similar thoughts, but they were not as clearly defined as yours... I was thinking why the hell wouldn't he offer them to me at 8% and make a big ass profit?  I even asked him why he wasn't doing this & he said there's just not many people who will pay a premium for notes.. He sad he'd usually have to sell them at a discount.  It just doesn't add up.  Really helpful to hear your perspective as an active player in this market.  I'm going to pass on this opportunity.

You are correct, I do not think the guy is stupid - he actually seems pretty intelligent.  Buffet's advice on management selection comes to mind: "you look for three qualities: integrity, intelligence, and energy. And if you don’t have the first, the other two will kill you."

I got to thinking more about it last night, and even ran my thoughts past a friend i consider to be pretty business savvy.  My conclusion is that, while it would be a great opportunity if it's real, I would not be shocked to open up the paper and read that this operation is a ponzi scheme... The fact that the thought even crossed my mind is a glaring signal to not go forward.

[arebelspy]

It's worth looking into, IMO.

But I don't buy the "people don't want notes" - a performing first position note at 50% LTV he could definitely sell at a premium, not a discount.

[jmusic]

Apologies if I'm hijacking the thread, but do you guys know any good (non-guru) resources for learning about note investing?

[arebelspy]

Apologies if I'm hijacking the thread, but do you guys know any good (non-guru) resources for learning about note investing?

I'm not sure that's hijacking; read the first post.  :D

EDIT: Typo.

[ShoulderThingThatGoesUp]

I will add that I have seen statements back to 2011 from a friend who invests w/ him.  This friend has just under $500k invested and generated just under $55k in interest last yr.  The checks have been on time every month since 2011.

That is stereotypical Ponzi information, "Look at these statements!"

Frankly if the SEC is good for anything it should be for checking out this guy, though they ignored Madoff and Stanford because they'd rather fake insider trading against Mark Cuban.

[Mother Fussbudget]

I'm also looking for good, dense information regarding real estate notes.  (aka 'books')

My findings so far after hearing about this idea for the first time from a session at Camp Mustache:
In terms of Note Buying, the website http://www.noteworthyusa.com/ is worth a look.
Also the BP podcast (BiggerPockets.com) has podcasts on Note investing (example: show #28).

There are a couple of books that are highly ranked on Amazon:
1) Performance Anxiety:  Creating A Fortune Investing In Non-Performing Real Estate Loans, by Gordon Moss
  [this one has a good preview (chapter 1) on Amazon.]
2) Fast Cash: How I Made a Fortune Buying Notes, by Lorelei Stevens

There are many others, but these are the most appealing based on reviews.   Anyone know of other books on the topic that are worth a read?

[wotan]

http://www.peterfortunato.com/
the best paper person in the country

[NoNonsenseLandlord]

I purchased a mortgage from the foreclosing bank, when it was already in foreclosure.  Big discount, and I was doing it to buy the property.  The original note was ~$380K, I purchased for $197K.  The property was worth ~$250K at that time, $360K now.  It's an all cash deal, you cannot get a mortgage to buy a mortgage.

A bit of risk.  If the foreclosure went bad, I was on the hook.  Owner damages might have been a concern.  It was a non-owner occupied building, a 4-plex.  I had to hold it through the redemption period, which was another 4-months.  All back taxes and water bills (~$5K) were mine, along with some HOA dues (6 months).   During the 4-months, I had to buy utilities too, to keep the building from freezing.

My point of this is, there may be a play buying non-performing notes if you want more properties.

[forummm]

Aren't there REITs that invest in mortgage notes? Why not just buy some of those as stocks in your IRA? They should be more diversified and presumably will be good investment-grade notes.

[Mother Fussbudget]

Q: What resources are people using to investigate / analyze notes (performing or non-performing) as investments?

I'm looking at notes on fciexchange.com - listings for performing, and non-performing notes.  Recommendations I've read are to analyze notes there, then buy one and try the process out.  Through internet searches, I've determined the homeowner's names, and occupations in these two examples.  [Please comment, face punch, etc. ]

Several of the notes found on FCI (non-performing) look like big risks.  But some of the 'performing' notes look interesting to me. Examples of notes below - first ruled out, 2nd a candidate for purchase & re-structuring.

My goal:  restructure existing notes to become (or remain) performing, help the owners stay in homes they want to live in long-term, help owner re-build credit, and restructure at a price closer to the home value so the owner doesn't have the "my house is only worth half what I owe on it" impacting their payment decisions.  Exit strategy:  be comfortable enough with the note to be willing to take it to term.  Otherwise, after 12+months payment history, re-sell the note at a profit. of Most of the non-performing notes I've looked at don't come anywhere near being where I'd actually consider a deal like this, but here are two examples of what I'm  considering. 

Note Examples (actual notes on FCI):
(Int=Interest Rate, UPB=UnPaid Balance, LTV=Loan To Value, Note Term=remaining years on original note, YTP=Years to payback note purchase)
1) Performing, Note Price: $71.2K, Note UPB: 110K, Int: 7.8%, Payment: $750/mth, House Value: $93K, Note Term: 20 yrs.
2) Performing, Note Price: $64K, Note UPB: 92.5, Int: 9%, Payment: $765/mth, House Value: $128.8K, Note Term:  22yrs.

Proposed New Note as re-structured: 
1) New Note: $95K, New Int: 6%, Payment: 681/mth,  New Note Term:  20 yrs, LTV: 75.5%, YTP=7.9yrs, Resale Price: $87K
2) New Note: $90K, New Int: 6%, Payment: 681/mth,  New Note Term:  20 yrs, LTV: 71.9%, YTP=8.3yrs, Resale Price: $83K

First house looks trashy (Google), scattered, and old.  Non-married long-term residents w/small business, and I would probably not bid on this note.
Second house looks clean, well kept and owned by a married window-treatment installer (blinds) with 3 store locations.  I'm considering buying this note.  After 10 years, the note will have paid $23K in profit (after paying off initial note price)

[arebelspy]

That second one looks good.  If your comps for the house value is accurate, you've got a good amount of equity as a buffer.