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Passive income lovers, rejoice!
There’s many ways to invest in real estate: landlording, fixing and flipping, wholesaling, and even real estate note investing.
Wait, note investing?
What’s that?
I had the same thought before I learned about how powerful and potentially profitable they can be.
Rather than buying, managing, and collecting rent from tenants on a piece of real estate, real estate note investing simply requires buying a note— which is the loan document issued to the buyer of the property.
You could make this part of your portfolio of investments that provide you with steady income.
That is, if you know how.
In this article, we’ll take a deep dive on real estate notes, and how you can get started investing in them.
Let’s take a look at what a real estate note is first.
A real estate note is also known as a promissory note. A promissory note is a “promise” to pay back the loan taken out on a house, or the mortgage, over time.
So, real estate note investing is when you buy the mortgage note, and in turn, act as the lender.
This includes receiving monthly income from the person who pays the mortgage.
The main allure with real estate notes is the passive income.
You get to reap the rewards without all the work and it’s free of the headaches that come with being a landlord.
For those who want a hands-off investment, real estate note investing is a great choice.
If you diversify your investments in the right way, it can lower your overall risk.
How?
When you have several different asset types, you won’t be overexposed and vulnerable to volatility.
Consequently, you have the possibility of earning a higher than average return.
Depending on the notes that you invest in, you can accrue interest throughout the life of the note, which raises your ability to profit off of it significantly.
Disadvantages of real estate note investing include a high default risk.
For example, if a borrower stops paying the note, a foreclosure could take anywhere from three to six months (and even a year or more).
That’s a long time, and a lot of your investment could be eaten up in legal fees while you wait to get your money back.
Plus, note values are sensitive to interest rates and overarching economic trends that could reduce your returns in unpredictable ways.
Furthermore real estate note investing is by no means a simple undertaking, it is rife with legal and financial nuances that demand a rigorous understanding of the laws of the land and your locality before you get in.
This is why most potential investors consider investing with an adviser rather than going it alone.
That brings up the question: is a note the same as a lien?
Real estate note investing requires a mortgage note which is a promissory note collateralized by real estate, whereas a lien is a security interest against real estate due to unpaid debts.
As an investor in mortgage notes, you are hedging your bets by purchasing the note, assuming the role of the lender, and receiving interest from your borrower.
In contrast, a lienholder is at a disadvantage because they are not the lender and they don’t have access to earned interest.
Rather, a lienholder is essentially a silent party waiting to get paid when the property is ultimately sold or refinanced, which could result in longer waits and more uncertainty when compared to real estate note investing.
Performing Note: This is a performing note where you have current outstanding principal and interest being paid.
This type of note is considered lower risk, provides consistent cash flow, and is typically easy to monitor.
Non-Performing Note: Here, the borrower is in default and desperately behind on payments.
This is a highly risky thing to buy, but it can also be purchased very cheaply, and might end up paying off well if you can get the borrower to refinance and get more payments out of them.
Let’s take a look at a few strategies for buying and selling real estate notes.
Buying the lowest-hanging fruit is the simplest strategy. Just buy the note at a discount, collect payments from the borrower, and bring in pocket change in interest. Ideal for passive income.
Purchasing performing notes allows you to collect income that is relatively safe and low-risk – again, this is where due diligence comes into play.
You will want to check the creditworthiness of the borrower and the value of the property as best you can to minimize your chance of seeing the borrowers default on the note.
Rehabbing notes means that you buy non-performing notes at a hefty discount, rework with the borrower to restructure the loan, and turn the non-performing note into a performing note.
This converts a worthless piece of paper into a performing note that is worth multiples of what you paid for it.
BOOM!
This type of real estate note investing is much more hands-on, requires you to understand loan modifications, and requires working with the borrower to find a mutually agreeable solution; but the rewards can be large as you buy the notes at a premium discount, but end up multiple times your cost as you take a non-performing note and turn it into a performing note.
Or you can hold the note all the way to maturity.
That provides the longest term income and the lowest level of effort, and is what a conservative investor might do.
When you hold a note to maturity, your interest rate is fixed at the beginning of the term, so you know ahead of time the amount of income you’ll receive over the life of the contract.
This, in turn, means a more stable, less speculative strategy – and an opportunity to earn the full monthly interest payments that each period brings as long as the market holds up.
It’s also a perfect strategy for real estate note investing in a stable or declining interest rate regime as your returns are not affected by a market that continues to drop.
When looking to get into real estate note investing where can you purchase them?
If you want to earn steady passive income and diversify your portfolio, real estate note investing is a fantastic opportunity.
The best part of all is that you can make it a full time gig or side income to supplement your current income.
If you haven’t already, I recommend adding this real estate method (don’t forget, its passive!) to your portfolio!
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