tax-implication-notes

“Appreciation” is often used to describe something that increases in value, such as a piece of real estate.

Property values may go up over time due to a number of factors, including inflation, market fluctuations, and overall cost of living. Or maybe you’re adding value either by improving the property (i.e. finding the “highest and best use”) or by increasing cash flow and decreasing expenses (for example, separating the utilities so the tenant can pay them directly).

Another way real estate can increase in value is from a change in financing terms, like a refinance that lowers the interest rate or shortens the term on the mortgage. This happens often in commercial real estate, where an increase in cash flow raises the value of the property, allowing the property owner to refinance.

But what about other types of investing, like real estate notes? How do notes rise in value?

Related: 5 Areas to Study to Know if You Bought a Good Real Estate Note Deal

Phantom Appreciation

Phantom appreciation is really just a made up term to describe when a note rises in value. Notes are much different than real estate because note values, especially the UPB (or unpaid principal balance), are usually going down over time (unless it’s an interest-only loan) as long as the P+I (principal and interest) payment is being paid by the borrower. In other words, the amount borrowed on a mortgage rarely goes up.

That said, there are a couple of scenarios where you’ll see some appreciation.

3 Ways Your Real Estate Notes Can Rise in Value

1. Pay History

Pay history has a large impact on the value of your note. If the note is a re-performing note, meaning that it was once delinquent but is now back on track, that positive change can make the asset more valuable. Once a re-performing asset hits certain milestones—like 12 months, 18 months, 24 months, etc.—it becomes more and more valuable because a potential note buyer sees the asset as being more consistent with a better likelihood of continued payments.

I remember how shocked I was when I first found out that a newly originated mortgage could sell for more…