“You can make a living brokering notes, but you get wealthy owning notes!”
This statement from a pioneer real estate note investor provided one of those “lightbulb” moments for me. Determined to start owning notes, I left a 10-year “job” in the corporate note-buying world to start my own note business in 1997.
Note ownership and long-term interest income are truly attainable with little to no investment of your own cash funds. But how does a note broker or real estate investor start making the move to note owner? Here are five strategies that can help you make money and become your own investor.
1. Broker Notes to Gain Knowledge, Pay Overhead and Generate Leads
Brokering notes will supply insights and knowledge, enabling you to earn while you learn. We all have marketing costs, business overhead and personal expenses, so brokering notes to “earn a living” or a cash fee at closing makes good sense.
It also provides the marketing machine to generate leads that can be matched with an institutional investor, a partial investor with tail-end opportunities or your own portfolio. Even when buying a majority of notes for long-term holding, it still proves useful to broker a portion. Not all notes will fit your parameters, and it helps to stay apprised of current market conditions to keep pricing competitive and personal portfolios liquid.
2. Create Your Own Notes
When selling real estate, mobile homes or other property, consider creating your own notes. Converting all or a portion of profits from the sale of property to long-term financing provides an opportunity to receive ongoing payments at an interest rate and terms that meet your needs.
This was a strategy we used on a four-unit investment property that we sold for $129,800 with 10 percent down; a new 80 percent loan-to-value, first-position bank loan; and a $12,980 owner-carried second—the old 80/10/10. The down payment and buyer’s first loan enabled us to pay off our purchase mortgage at closing and walk with a chunk of cash for our next investment. The second note helped maximize the sale price and allowed a portion of profits to keep earning interest backed by a piece of real estate we knew well.
3. Utilize Retirement Account Funds
Did you know it is possible to use your IRA, Roth, SIMPLE, SEP and 401(k) retirement accounts to buy notes and real estate? Many investors who are tired of dismal returns in the stock market are turning to notes and real estate through self-directed retirement account administrators. This provides access to capital and takes advantage of earning money tax-deferred or, in the case of a Roth, tax-free!
This concept allows us to aggressively pursue small-balance notes for double- to triple-digit yields backed by real estate. You will find that due to their balance minimums, larger institutional investors often overlook notes under $30,000.
4. Participate in Future Payments or Tail-Ends
The “buy full, sell short” strategy is one of the best ways to initiate note ownership. This technique is based on your purchase of the full payment stream from the note holder or seller with the resale of a shorter payment stream or partial to an investor.
This enables you to earn a fee on the initial sale of the partial to the investor and keep a portion of the future payment stream as a personal wealth-building vehicle. These payments that remain after a partial investment has paid off are also known as the tail end or back end of a note.
Let’s look at a real-life example. We were approached to purchase a mortgage note secured by two lots that each had an attached mobile home. The property had sold for $70,000 with $8,000 down, and the seller had received four payments on his owner-financed note.
The full cash flow purchased from the seller:
• Full Balance: $61,927.97
• Note Rate: 12 percent
• Payment: $637.74
• Payments Bought: 356
• Pay Price: $41,489.26
The partial cash flow sold to an outside investor:
• Partial Balance: $47,937.79
• Yield: 13.17 percent
• Payment: $637.74
• Payments Sold: 140
• Pay Price: $45,500
The outside investor’s pay price was used to fund the seller through a double closing at the title company. The broker fee earned at closing was $4,010.74 ($45,500 less $41,489.26) less costs.
In addition to earning a fee at closing, we retained the right to future payments. Only 140 payments of the 356 remaining payments were sold to the investor to meet his yield and investment-to-value (ITV) requirements.
We retained the right to 216 payments of $637.74 each, commencing in 140 months as specified in the partial agreement.
How much of our own capital is at risk? None.
What is the return? Good enough. (Hint: To calculate yield, put at least $1 in your financial calculator as the investment or PV amount).
5. Leveraging
Leveraging is a familiar concept to real estate investors, allowing properties to be purchased and financed with a minimal investment. Using a similar concept, there are financial institutions that will lend money secured by an assignment of the note and mortgage (or deed of trust) through a line of credit or the hypothecation of an individual note.
Money is earned from the spread, which is essentially the difference between the interest rate charged by the bank on the advance and the presumably higher rate of return earned on the note purchased at a discount. While the line of credit has been our primary leveraging tool, other private investors have also used their home equity line of credit or even credit cards.
Leveraging comes with greater liability and is better suited for an experienced note investor with strong underwriting and collection skills.
Challenge yourself to make note ownership part of your wealth-building plan. You won’t be sorry when those monthly payments and unexpected payoffs start arriving in your mailbox.
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