Perhaps you've heard of "notes" or "mortgage note investing" as a specific investment option for your self-directed IRA. In this video, Nathan Turner will show you how he determines which real estate notes to invest in from the available options.
What is Mortgage Note Investing?
Investing in mortgage notes is an alternative investment strategy that allows individuals to generate passive income by essentially stepping into the role of a lender. Note investing has gained popularity among real estate investors as a way to diversify their portfolios and take advantage of the cash flow opportunities that mortgage payments provide.
Mortgage note investing involves buying the debt that is secured by a property. When a homeowner or property owner takes out a mortgage loan, they sign a promissory note agreeing to repay the lender with monthly payments over a set period. As a note investor, you are purchasing this promissory note from the original lender, becoming the note holder, and collecting those payments instead.
There are two main types of notes you can invest in:
- Performing Mortgage Notes: These are notes where the borrower is consistently making their payments on time. As a note buyer, you receive steady cash flow through monthly payments, similar to the income you would get from a rental property.
- Non-Performing Notes: These notes are in default, meaning the borrower has stopped making payments. While riskier, investing in non-performing notes can present opportunities to negotiate new repayment terms or even acquire the underlying property through foreclosure.
Why Consider Note Investing for Your Self-Directed IRA?
Mortgage note investing can be a valuable addition to your self-directed IRA because it offers unique advantages not typically found in traditional investment classes like stocks or bonds. Here’s why real estate investors might find note investing appealing:
- Passive Income: With performing mortgage notes, you can enjoy regular, predictable cash flow without the responsibilities of property management. For many passive investors, this is a major draw, as it means earning income without the hassle of maintaining rental properties.
- Diversification: Adding real estate notes to your investment portfolio helps diversify your assets, reducing overall risk. This can be particularly beneficial for those looking to hedge against the volatility of the stock market.
- Alternative Investment Opportunities: Mortgage note investing offers exposure to real estate markets without the need to own physical properties, making it a great choice for those interested in real estate investing without becoming property owners.
The Importance of Due Diligence in Note Investing
Due diligence is a crucial step in mortgage note investing. Before purchasing a note, note investors need to thoroughly evaluate several factors to ensure the investment aligns with their goals and risk tolerance. Here’s what due diligence typically involves:
- Assessing the Property Value: Knowing the current property value that secures the mortgage is essential. This will help you determine whether the note is worth the investment, especially if you’re considering non-performing notes, where foreclosure could be a possibility.
- Evaluating Borrower Payment History: For performing mortgage notes, reviewing the borrower’s payment history is fundamental. It provides insight into the likelihood of continued monthly payments, which affects your expected cash flow.
- Understanding Interest Rates and Terms: Different notes come with varying interest rates, repayment schedules, and terms. As part of your investment strategy, you need to determine whether the potential return matches your financial goals.
- Reviewing Foreclosure Laws: If you’re investing in non-performing loans, understanding the foreclosure process in the state where the property is located is critical. Foreclosure laws differ by state and can impact your ability to reclaim the property.
Types of Notes and Investment Strategies
In the note business, there are different types of notes that a note investor can consider:
- Residential Mortgage Notes: These are loans secured by single-family homes or multifamily properties. They are the most common type of mortgage notes and can range from short-term loans to long-term fixed-income assets.
- Commercial Real Estate Notes: Notes secured by commercial properties like office buildings, retail spaces, and warehouses. These investments can be attractive to those interested in commercial real estate without managing physical properties.
- Private Notes and Seller Financing: In some cases, property sellers provide financing directly to buyers, creating private notes. Note buyers can acquire these private notes from sellers or financial institutions, often through secondary markets or private equity firms.
Each type of note carries its own set of risks and rewards, so understanding the fundamentals and metrics of each is vital for a successful investment strategy.
Considerations for Beginners in Note Investing
If you’re new to mortgage note investing, here are some important factors to keep in mind:
- Liquidity: Mortgage notes, especially non-performing loans, can be illiquid. This means it may be challenging to quickly sell the note if you need access to cash. Make sure your investment property strategy accounts for this.
- Property Management vs. Note Management: Unlike owning a rental property, you won’t need to handle day-to-day property management. However, you will still need to stay on top of note management, which includes monitoring payments and staying informed about the real estate note’s performance.
- Potential Risks and Rewards: Investing in notes, particularly non-performing ones, involves risk, such as the possibility of needing to go through a foreclosure. However, with proper due diligence, there are opportunities for high returns, including capital gains if the property value appreciates.
Building a Balanced Investment Portfolio with Note Investing
For real estate investors seeking to diversify their retirement savings, note investing through a self-directed IRA can be an effective strategy. By including mortgage notes, commercial real estate loans, and other types of real estate notes, you can build a balanced portfolio that generates passive income, benefits from property value appreciation, and offers some protection against market volatility.
Interest rates, market conditions, and the track record of the lender or original note holder are all factors to consider when developing your investment strategy. With proper due diligence, note investing can be a reliable way to achieve fixed income through alternative investments that complement traditional assets like stocks, bonds, and REITs.
Conclusion
Mortgage note investing is an exciting way to participate in real estate markets without direct ownership of the property itself. It allows for flexibility, steady cash flow, and potential capital gains, all while offering the benefit of diversification. Due diligence is essential in this asset class, as it ensures that you make informed decisions and mitigate risks. Whether you’re looking to invest in residential mortgage loans or commercial real estate, performing or non-performing notes, having a solid understanding of the fundamentals is key.*
ABOUT THE AUTHOR
Nathan Turner is known in the note world as "the Canadian Note Guy." With a degree in Business Management, Nathan had owned his own businesses and been a franchisee before he discovered that real estate is in his blood. He got a taste for real estate investing in Canada starting in 2006 but shifted to US real estate two years later. He started in the states by creating loans and eventually evolved into buying non-performing notes with the intention of taking back the house in order to seller finance. Having had the experience of working in key partnerships, Nathan then branched out on his own. He started to build a portfolio in the spring of 2015 and over the last few years has transacted over 100 deals. Nathan is well known in the note community and has spoken at various conferences.
http://www.canadiannoteguy.com/
*Mainstar’s role as custodian of self-directed accounts is nondiscretionary and/or administrative in nature. This information is for educational purposes only, and should not be construed as investment, legal, tax or financial advice or as a guarantee, endorsement, or certification of any investments. Mainstar encourages individuals to consult a financial or legal professional when making investment decisions.