You might know all about house flipping, BRRRR, and wholesaling, but have you heard of high-yield real estate note investments? High-yield real estate notes are an excellent way for investors to diversify their REI business or enter the real estate market with less hands-on, everyday involvement.
Take out your notebook because today, we’re going to REI school to discuss how you can start investing in high-yield real estate notes!
What Are High-Yield Real Estate Notes?
Investors can purchase high-yield real estate notes from private lenders, banks, and other financial institutions.
This fixed-income investment allows the investor to receive monthly principal and interest rate payments from borrowers.
Benefits of High-Yield Real Estate Notes
Passive Investment Income
High-yield real estate notes are a way to invest in the real estate market mostly passively — no renovations, tenants, or landlords. Your primary concern is that the borrower is making their mortgage payment each month.
The interest rate on mortgages is typically higher than the interest rate in other investment sectors. This means your monthly return is high yield — as long as the borrower pays their mortgage each month.
Collateral
If the borrower defaults on payments, then the property transfers to you by foreclosing on the property. Some real estate investors make this part of their business model when seeking out high-yield real estate notes, and they’ll intentionally invest in the riskier non-performing notes because the likelihood of the borrower defaulting on payments is higher.
This is where you need to do extensive research on a property before investing in a non-performing note, as you don’t want to foreclose on a home that’s a poor investment.
Discounts from Banks/Lenders
Banks and lenders sometimes sell high-yield real estate notes for a discount, reducing the investment risk. This allows the bank/lender to offload some of their risk or non-performing notes, which we will go into more detail about below.
Risks of High-Yield Real Estate Notes
Borrower Defaults on Mortgage
One risk of investing in high-yield real estate notes is the potential scenario of a borrower defaulting on their payments. If you are the first-position lien note, you may have to foreclose on the property. Then, you have a property in your portfolio without the income from the borrower’s monthly payments.
Property State
If the borrower defaults on the loan and you foreclose on the property, you are attaining an asset that might not be able to return your investment, causing you to lose money. This is why it’s important to do your research on the property before investing.
Market Changes
If the real estate market shifts, interest rates and property value may change, which could affect your high-yield real estate note. For example, in the case of a market crash, your collateral might not have the same value to make your money back if the borrower defaults and you have to foreclose on the property.
Various Types of High-Yield Real Estate Notes
First-Position Lien Note: A first-position lien note is a secured debt. If the borrower defaults on payments, then you, as the lender, have the first opportunity to repossess the home.
Second-Position Lien Note: If you’ve invested in a second-position lien note, this is a higher risk because the first-position lien lender gets the priority of recouping costs with the foreclosure and sale of the property. Because of the higher risk, a second-position lien also typically requires the borrower to pay higher interest rates.
Mortgage-Backed Securities: This type of investment is similar to a bond, as you’re investing in a group of mortgages. These are asset-backed securities.
Performing Note: If a buyer is making payments on time, then a note is considered performing and, therefore, carries less risk.
Non-Performing Notes: If a borrower defaults on payments, the note would be considered non-performing. While there is more risk with a non-performing note, these often have higher interest rates because of that risk. Some investors seek out these notes as they see foreclosing on the property as part of their overall investment strategy.
How to Invest in High-Yield Real Estate Notes
Due Diligence
It’s important to conduct extensive due diligence before investing in high-yield real estate notes. Make sure you are doing business with a reputable financial institution or bank. You should also conduct due diligence on the borrower, including income, payment history, and credit score.
Also, collect as much information as possible about the property to see if it’s a solid investment in case you have to foreclose on the property.
Purchase the High-Yield Real Estate Note
Once you’ve done your research, make sure the loan terms are clearly laid out in the paperwork. If all the details of the payments, interest, and collateral are correct, move forward with purchasing the high-yield real estate note.
Monitor Payments
While investing in high-yield real estate notes is mainly passive, you’ll want to pay close attention to make sure you receive the correct monthly payment.
Parting Wisdom — How to Diversify Your Portfolio with High-Yield Real Estate Notes
Investing in high-yield real estate notes is a great way to diversify your REI business. It’s a less hands-on way to get into the market — there’s less day-to-day management for a more passive investing experience. It’s important to do your due diligence with any investment, so to use an age-old lesson parents have been teaching kids for decades, check how deep the pool is before you dive in headfirst!
And! Interested in learning more about notes? We’ve got you covered, with Lee Arnold’s Income Notes training program, teaching you how to bird-dog, broker, and even invest in performing and non-performing notes, step by step.
