Backed by Collateral

One attractive aspect is that notes are backed by collateral. The physical property associated with a note offers a safety net against potential investment losses.

With stocks and bonds, investors risk losing significant value in their original investment when the stock market declines. They may find themselves waiting a long time hoping for a market rebound. While they wait, they lose out on additional investment returns.

A note is different. Even if a borrower defaults on a mortgage, the physical property and accompanying equity provide you the means to recover expenses on a default.

Foreclosing or obtaining a deed in lieu, and rehabbing and selling a property, enable you to fully recoup your investment.

Earn Returns in Multiple Ways

Note investing offers multiple opportunities to realize a return on investment. It can be a flexible, lucrative strategy.

One way in which note investors realize a return is through monthly principal and interest payments that provide a steady income. Over time, investors recoup their initial investments plus a return from interest payments.

Another way investors realize returns is through the collateral gap, the difference between the outstanding debt on a note and the market value of the associated property.  Performing notes are purchased at a moderate discount. Non-performing notes are purchased at steeper discounts due to the depressed condition of the notes.

When a borrower pays off a loan, usually by refinancing or selling a home, the note investor receives the difference between the discounted rate they paid and the actual full value of a note. Investors who purchase a non-performing note, rehab the property and sell it to another investor at a higher price can realize even higher returns.

Other ways you can make money and mitigate risk with note investing include:

• Buying and selling partials (arrangements with other investors to buy or sell part of the payment term of a note)
• Borrowing against a note. 

Either way, the investor uses an initial investment as a vehicle to free up funds to invest in additional notes. That’s how investors build up capital to invest. 

Easy to Manage

Notes are a passive investment that’s relatively easy to manage.

Investing in performing notes takes some work, including due diligence before buying. A servicing agent can manage mortgage payments and escrow disbursements for a small monthly fee.

Non-performing notes may involve some work such as loan modifications, possible foreclosure proceedings or rehabbing and selling a property.

But unlike rental property, a noteholder is not responsible for ongoing property maintenance or other issues that landlords manage.

Because of its simplicity, you can own and manage multiple notes from the comfort of your office. Since much of the work is paper-based, you can earn an even larger return.

Cash Commitment

Compared with traditional investments like stocks or bonds, the amount of money you need to purchase a note is considerably higher. That’s because investors are essentially paying upfront for the cost of a house. 

While investors recover their upfront investment over time through monthly payments, investors are committing considerable funds to an illiquid and cyclical asset. Those funds could otherwise go into investments such as stocks and bonds.

Appreciation of Properties

While note investors count on appreciation of property value as one means to earn a return, such appreciation is not guaranteed. 

Investment losses can be triggered by a property that loses some market value or doesn’t generate the expected income.  Assess the risks and losses in terms of missed opportunities and holding costs. 

For instance, if a high-yield corporate bond can earn you 4% interest, your real estate investment should seek to at least cover that “missed opportunity for income.” Hopefully it will provide a higher return over a given period of time.

Borrow Default

No matter how much due diligence you conduct, there’s always a risk that a borrower will run into financial difficulty and stop making regular payments. 

In this situation, the noteholder must work with the borrower to return the account to good standing. Or the noteholder must initiate costly foreclosure proceedings.

Learn What You’re Getting Into Before You Invest