Notes vs Properties: Which is Best 4 U?

By now you’ve heard all of the sales pitches… “buy properties now before they are all gone” or “they aren’t making any more land” or “more millionaires have been created through real estate investing than any other profession”. I tend to agree with each of those points, but I also think there is more than one way to take advantage of the current, super-strong real estate market:  for example, instead of investing directly in real estate properties, perhaps consider investing in notes. What’s that you say?  “I don’t understand notes. Notes are boring. There’s no appreciation upside. How secure is my note really?”. All good points but in my opinion, there is nothing boring about earning 8% fixed on your money, especially in today’s fiscal climate where the government has all but eliminated our ability to save money in any traditional sense (think CD’s or money markets that pay 1-2% if you are lucky) with its never-ending QE and loose fed policies. But maybe I’m just old-fashioned. And no, there is no appreciation upside but there are also no late-night phone calls from tenants to fix their toilets, no stress because your tenant cannot pay rent, but you still have to pay the mortgage, and no property managers to follow up with. Both properties and notes have their rightful place, so which one is right for you?

To be clear, notes are not for everyone. But you need to understand the basics before you decide if they are right for you. A note is basically an agreement to pay, codified in the form of a promissory note, that either may or may not be secured with a deed of trust (DOT) or mortgage on a property which acts as the collateral for the loan. There are performing and nonperforming notes. There are 1st, 2nd, 3rd, and even 4th lien or mortgage notes. And it can all be very confusing.  

Here are my stripped-down thoughts on notes, based on 25 years in the mortgage banking and real estate finance industry:   1. Don’t ever buy an unsecured note. Ever. Life is too short and there is no collateral/property securing the note.    2. Don’t ever buy a non-performing note.   Non-performing means the borrower is not paying.   Don’t think you are going to buy it for “pennies on the dollar” and get the borrower to suddenly pay.  I’ve tried, very difficult to do, and way too much brain damage.   3. Only buy 1st lien/1st Mortgage fully performing notes.  These are top-of-the-line, secured notes, and if the property ever goes into foreclosure, you are the one who will get paid first.  4. Make sure the loan to value on the note is low (typically < 75% of the value of the home.   This gives you tremendous downside protection should the borrower fail to pay, and you end up foreclosing.   5. If you can get a note buyback guarantee, take it, take it, take it.

It’s pretty simple really.  If you are looking for a consistent income stream (we call it “mailbox money”) where all you do is collect a check every month with none of the follow-up, maybe buying a note makes sense for you.  We work with clients mostly in their 50’s to 70’s who buy notes from us to supplement their retirement income, while avoiding the volatility and risk of the stock and bond markets, and their money is secured by a 1st mortgage on a quality property with a note buyback guarantee. Again, real estate is not one size fits all and in the current fiscal environment we are all trying to make lemonade out of lemons and that starts by thinking outside the box.   So…maybe a note is right for you…