OK, OK. Before I start, I should say that I love real estate. Really, I do. I wouldn’t be where I am without it. Investing in hard property is why we’re all here after all, and I’m by no means saying we should drop all of our holdings and run into the note business. In fact, what I’m suggesting is far from it. Every asset class has its pluses and minuses. But there are quite a few advantages to notes that make them one of my all-time favorite investments. Though some of these advantages apply to all types of notes (whether it’s hard money, seller financed, etc.), when I say “notes” in this context, I’m mostly referring to institutional notes.
The Tired Landlord
When I first started thinking about entering the note space on a serious level, it almost seemed too good to be true. I had read a few books, attended some classes and workshops, and started to gravitate toward some other folks who were doing the business, but I still wasn’t sure it was right for me. Then again, I was pretty set in my ways.
You see, I was at this crossroads where I had to ask myself, “Should I continue on with my long-term goal toward owning 100+ units? Or do I interrupt this strategy to incorporate a new (to me) strategy that seemed like less hassle with just as many rewards?
Now, I wasn’t just trying to hit this admittedly arbitrary number of 100 units for my health. What I was really looking to do was create a more balanced life for myself while maintaining a valuable cash-flowing portfolio. After 15 years of real estate investing, I was starting to become one of those tired landlords — there had to be a better way to work smarter and not harder.
I think you might know by now which road I chose. Keep in mind; I didn’t realize all these advantages when I decided to take that initial leap. Some of these I only came to understand over time. And fortunately, because of notes, this tired landlord ain’t so tired anymore!
Advantage 1: Truly Passive Cash Flow
For me, owning hard real estate had always offered many great tax advantages (and still does), especially when including depreciation deductions that can offset positive cash flow. Although I consider my real estate to be passive from an IRS tax perspective, what many people (including myself) have failed to realize is how much active work is required for managing and maintaining property. For the owner/landlord, active work can include everything from dealing with tenants and their liability to maintenance and townships, as well as the ever-increasing property taxes. Even for those of us who own property “hands free” (through turnkey investments or outsourced property management), we still may find that managing the managers can be work.
When a note is re-performing and being repaid by the original borrower, the holder of the note will receive payments every month with little-to-no work required in order to continue receiving these payments. This makes the investment entirely passive. And there’s no toilets, tenants, or maintenance required to earn these payments. I often say, “Do you think Wells Fargo has to worry about plumbing issues?” Not when it’s only in possession of the paper (as opposed to the property).
Advantage 2: Volume and Control
I’ve always tried to keep my residential holdings simple. The majority of my properties are in the same county, are the same property type, and usually cost close to the same price. I found it easier to manage when it was cookie cutter (a limiting idea when you think about it). And then when I started to venture into commercial, that’s when I started going out of state to invest. Managing people and properties in other areas proved to be not only tiresome, but inconvenient — even with managers in place.
Owning a Note Portfolio is Easier Than Owning a Property Portfolio
A note portfolio (either performing or nonperforming) can be managed from the phone and computer without ever requiring leaving the house or office. This enables servicers to manage notes on properties all across the nation. And in those rare instances when there are issues, in the note industry we have what are known as mortgage servicers and property preservation companies to handle them. Servicers handle accounting and payment management plus any issues that arise with the resident. Property preservation companies deal with any physical issues with the property.
Advantage 3: Notes Are Profitable in Various Market Conditions
Unlike with the volatility of say, the stock market, note prices in the marketplace are directly correlated with real estate values. So in an up market, when the economy is in full swing, there are fewer foreclosures, and home prices are high and climbing:
- There is a smaller supply of delinquent notes available in banks’ portfolios, which enable the bank to gain a higher price for its notes — especially because all notes are more likely to be fully covered by equity.
- Although investors…