Mastering Real Estate and Mortgage Note Investing
Dr.John Gore, Ed.D, LPC, LCADC, ACS, CCS, Certified Trauma Professional
CEO, Clear Conscience Counseling, LLC, and Managing Partner at Gore & Associates, LLC
Key Takeaways
Real estate investors who seek to diversify their investment portfolio would do well to understand mortgage note investing, including the types of mortgage notes and their benefits and risks.
To help, here is all about mastering real estate and mortgage note investing for new and seasoned investors.
What are Real Estate Notes?
Real estate notes are basically legal documents that are signed when closing on mortgages and establish properties as loan collateral. They are contracts between lenders and borrowers.
These mortgage notes contain loan details such as interest, monthly payments, and penalties for late or missed payments. They are held by the mortgage provider; borrowers get a copy at closing.
Real estate notes generally have two parts:
Investors may buy, often at a discount, the promissory portion of notes as a form of investment. The goal is to profit from the interest or by ultimately selling the note at a greater price.
The note may be sold wholly or in part, commonly to other investors. Anyone may buy, sell, or own real estate notes.
Real estate notes are especially popular among passive investors who often look for different places to put retirement account funds.
Benefits of Note Investing
There are advantages to investing in real estate notes, including:
Why Sell Real Estate Notes?
Real estate notes are commonly sold to raise capital or liquidate assets. Often, funds are used to pay debts, to support retirement, or to pay college expenses. They are also often used for nontraditional investing vehicles.
Say a girl has graduated from high school and is ready to attend college. This scenario is expensive and time sensitive. If her parents have not saved sufficiently for such a milestone, they can sell a mortgage note to quickly get a substantial amount of needed cash.
Buyers in the Note Market
Typical profiles of those who buy in the note market include:
Passive investors. Such investors often look for other places in which to place retirement-account money.
Risk takers. These investors seek greater risk and prospects for greater returns through non-performing notes.
Creative investors. The investor must use a bit of ingenuity to find good notes to purchase.
Those seeking portfolio diversification. Purchasing private notes can be a way to diversify investment holdings and mitigate risk. It also may improve cash flow.
Exploring Types of Notes
There are various kinds of note types, including:
— First lien notes. With this type, the note holder gets to retrieve the property if the debtor fails to make required payments.
— Second lien notes. Often issued by lenders, second lien notes can be obtained by borrowers using their property as collateral. If there is a default, and subsequent bankruptcy or asset liquidation, second-lien debt is paid after the first lien holder.
— Commercial notes. These are unsecured forms of promissory notes that pay a fixed interest rate. Corporations or banks typically issue them to cover short-term obligations or receivables.
— Mortgage notes. Essentially, these are promissory notes that are secured by specified mortgage loans. They are a documented promise to repay a certain amount of money plus interest. The note also specifies the interest rate time length for promise fulfillment.
Mortgage Notes Unpacked
Generally, investing in real estate notes means buying an existing mortgage. When an investor buys a mortgage note, they become the lender, with full lender rights. While the investor does not own the real estate, they can seize the property if the borrower fails to pay.
It is important here to understand performing vs. non-performing notes. Performing notes are mortgage loans on which the borrower is current — they are paying on time. Buying performing notes enables investment in real estate without having to buy, own, or manage properties.
If there has been no payment on a debt for at least 90 days, the mortgage is considered “non-performing.” Non-performing loans can be bought at deep discount and can be quite lucrative with loan modifications or foreclosures.
Take a company that purchases non-performing mortgage notes in bulk, typically at discount. Such notes, once purchased, are placed with a team of licensed loan servicers.
These servicers try to get the borrower on a new payment plan. Failing that, the note owner can use the property to exit. In other words, they can receive the deed in lieu of foreclosure or via real estate-owned sale.
Note Durations: Short vs. Long Term
Usually, short-term notes are debts a company must clear within a year. By contrast, a long-term note is a promissory note usually representing a bank loan. Payments here are due after one year.
Understanding the Risks
The biggest risk with investing in mortgage notes is the prospect for default. If the property’s borrower does not make payments, the investor will not get their expected returns.
In that case, the investor may have to foreclose on the property to get their investment back. Such processes are potentially lengthy and costly, which is why non-performing notes are frequently available at a marked discount.
There is also a risk of fraud, as some dishonest individuals may seek to sell fake notes to investors. To avoid being victimized, avoid the swarms of so-called note brokers who want investors to buy certain notes. Usually, these are notes they have discarded and marked up.
Lack of due diligence is an additional risk. Investors should research the property as well as the borrower, and closely examine loan terms.
Further, interest rate changes can also impact real estate notes. Rising rates could lower the note’s value, resulting in smaller returns.
It is also important to work with experienced and reputable investment firms or brokers to avoid potentially large capital losses up front.
Real Estate and Alternative Investments
One can go through Yieldstreet to invest in real estate, which remains a popular way to produce income and grow wealth. But unless investors go through Yieldstreet, success does generally require some degree of market know-how.
Yieldstreet is the leading alternative investment platform, on which nearly $4 billion has been invested to date. It offers private-market opportunities, which are less volatile due to their low correlation to a constantly fluctuating stock market.
Such real estate opportunities include real estate equity for IRA investors. Further, Yieldstreet has closed more than $900 million in commercial real estate transactions across over 100 deals.
Investing in real estate also serves another very important purpose: portfolio diversification. Creating a modern portfolio of varying asset types and anticipated returns can reduce overall portfolio risk. It can also improve returns. In fact, diversification is a fundamental pillar of long-term investing success.