Posted by: docktohome | July 1, 2011

Investing in Real Estate Notes

In my last article I touched on the fact that the average individual fails to optimize their investment opportunities by limiting their investments to
only stocks, bonds, mutual funds, and institutional savings accounts.  One additional investment option to be considered is real estate.  There are ways to invest in real estate both directly and indirectly.  A direct investment into real estate would be to actually purchase a property and perform or outsource all the necessary responsibilities that go along with owning property.  An indirect investment into real estate would be to purchase real estate paper/notes (private loans secured by actual property) or become a private lender.  A benefit of investing indirectly is that you don’t have to deal with the stress of actually owning the property.  A detriment is that your return on investment comes usually in monthly payments
vs. a lump sum.  Both the indirect and direct investments into real estate require the investor to have some knowledge of the associated markets.  Failing to educate yourself when considering any investment is reckless so be sure to do your research before spending your cash. There are two ways to get into real estate notes, you can purchase existing notes or create new notes by providing some sort of private financing.

The note market is growing as cash and institutional financing are becoming increasingly scarce.  This scarcity promotes owners and investors to provide private financing to buyers.  A note is created when a seller provides private financing for a buyer, unlike bank financing there is no cash actually given to the buyer.  The terms of the financing are dictated in writing in the form of a Promissory Note.  The note holder or payee then receives a monthly payment from the payor.  The payment, interest rate, and term are all designated in the terms of the Promissory Note.  The market for buying & selling notes is driven by a payee who wishes to have cash now rather than wait for the completion (balloon) of the note.  Usually the purchaser of real estate notes has the benefit of buying them at a discount, encouraging motivation for a purchase.  The amount of discount depends on the position, type and location of collateral, and the structure of the note.

Creating a note by providing seller financing is simple but when making the choice to buy/sell real estate notes I encourage you to spend a significant amount of time shopping and educating yourself on the market.

Here are some Pros & Cons for investing in real estate notes vs. buying actual property:

 Pros

  • No management
  • No maintenance
  • No dealing with tenants
  • Mailbox money
  • Avoid taxes on lump sums with monthly payments

Cons

  • Payback is long term
  • Possibility of foreclosure in the case of a
    default
  • Small monthly payments vs. larger lump sums
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