Would you buy real estate hundreds of miles away from home? Most people would say, “No way!”
Would you buy a real estate note hundreds of miles away from home?
Before you say, “No way!” think about this: call the note a “stock” and you wouldn’t care where the real estate is — even if it’s offshore. Stock investors rely on the anticipated success of the company (the growth approach) and/or the book value (the value approach, i.e., the liquidation value of the assets).
Do you know that if a company goes under, stockholders are behind both bondholders and owners of preferred shares? Stockholders are, at best, third-position lienholders.
In default, which would you want to own: a stock secured by a company’s assets in which you are the last to be paid off (assuming there is any money left), after bondholders and owners of preferred shares, and you share third position with hundreds of thousands of investors? Or would you rather own a note secured by a house in which you are the first to be paid off and you share that status with nobody?
Also think about this: stocks are almost always sold above book value. Mortgage notes are almost always sold below book value. Do you want to sell a stock? Call a broker and take what the market will pay. It doesn’t matter how many you call on a given day, you will get the same number. Do you want to sell a note? Call investors and negotiate with them. You will get different numbers, some higher, some lower. If you don’t like the numbers, sell the next X number of years of the payments and keep the rest. Or sell half of each payment and keep the other half. Try that with a stock!
Some people just don’t like the idea of buying a note on a house they can’t keep an eye on. I know that feeling, but that has to be directed toward its proper place. When you buy a rental house, by all means, know it. Kick the bricks. My rentals are all within 15 minutes from my house, and I drive by each one every couple of weeks. I want to see if the lawn is mowed, if vehicles are parked on the grass, if trash is visible, etc. I want my rentals to look just like the owner-occupied homes in the rest of the neighborhood.
But when you buy a mortgage or trust deed note, you are not buying the property. You are buying an IOU, a promise to pay. Like a stock, it really shouldn’t matter to you where the property is located. Granted, if things go sour, you may end up owning the property, but that possibility is pretty remote if you buy right.
I will not buy a note, no matter what a great deal I think it may be, if I do not want to own the property. What would I do if I ended up owning an abandoned factory or a gas station with environmental issues? I know what to do if I find myself owning a single-family house, a farm, or some other property type with which I am comfortable.
The lesson is to stay within your comfort zone!
In the unlikely event of default, if you do your due diligence before you buy the note, and if you follow your personal risk criteria, default can be very profitable for you.
Speaking of taking the right precautions, a friend told me that he once bought a first mortgage note at a considerable discount with tremendous equity that gave him a yield (“interest rate”) well into the double digits. He had about $15,000 invested in an $80,000 property. The debtor stopped paying after a few months. My friend sent the usual letters demanding payment or else. The drunken debtor called him in the middle of the night and said, “F-you, I’m going to burn down this place right now!”
My friend – whom, as the first lien holder, was the primary insurance beneficiary — replied,
“Don’t do that! Wait until I get there with the gasoline and matches!”