Ultimate Guide to Real Estate Note Investing

Real estate note investing can be a great way to generate income from real estate without having to deal with the physical headaches of buy and hold or ground up development. In note investing, you essentially act as the bank for a rental property loan. This can be done with small and large amounts of capital, and also private money notes or institutional notes. Note investing can provide a consistent and reliable stream of passive income, however, it can also come with risks such as borrower default.

Real Estate Note Investing Definition

Note investing (also called Promissory Notes or Mortgage Notes) in real estate is a strategy in which an investor provides the capital for a mortgage note. The mortgage note is essentially a legal IOU that outlines the terms of the loan, including the interest rate, payment schedule, and other details. Most notes can be classified as private or institutional. Private notes are those directly with the property owner, whereas institutional notes are existing notes held with existing banks or lenders.

Performing vs Non-Performing Notes

In real estate note investing, a performing note refers to a loan where the borrower is making their payments on time and the loan is not in default. A non-performing note is associated with a loan where the borrower is behind on payments or in default. Non-performing notes can typically be acquired at a discount and have the potential for higher returns if the investor can successfully navigate the recovery process.

What is Lien Position and Why it’s Important?

Lien position refers to the order in which claims against a property will be paid in the event of a default that results in foreclosure. This is important in real estate note investing because it impacts the likelihood of recouping investment funds if the borrower defaults. The first lien position is typically held by the primary mortgage, and will be the first to be paid from any proceeds from a foreclosure sale. Junior or subordinate liens, such as a home equity line of credit, are paid afterwards, which can be risky if the foreclosure sale does not generate enough funds to cover these additional liens. Understanding lien positions can help assess the potential risk and return of a real estate note investment.

Important Note Investing Terms

Collateral – In the context of real estate lending, collateral is the property that secures the loan. If the borrower defaults on the loan, the collateral can be seized by the lender (or the owner of the note) as a form of repayment.

Deed in Lieu of Foreclosure – Deed in Lieu of Foreclosure is a document that transfers the title of a property from the borrower to the lender when the borrower is unable to make mortgage payments. It can serve as an alternative to foreclosure, as it can be less damaging to the borrower’s credit.

Pros of Note Investing

1. Passive Income – One of the key advantages of real estate private note investing is the ability to generate a consistent and reliable stream of passive income. As the lender, you receive regular payments from the borrower, which can help to supplement or replace traditional income streams.
2. Higher Returns – Real estate private note investing can offer higher returns compared to other traditional investment options, such as real estate stocks or bonds. This is because private notes often offer higher interest rates and less competition, allowing investors to earn a premium for taking on the risk.
3. Diversification – Investing in real estate private notes can offer diversification to a portfolio. It can provide exposure to real estate without the need to own or manage properties directly, and can also help to hedge against stock market volatility.

Cons of Note Investing

1. Potential Risks – Real estate private note investing comes with inherent risks, including the potential for borrower default, property value decline, and changes in interest rates. As such, it’s important for investors to conduct thorough due diligence and risk management strategies to minimize potential losses.
2. Limited Liquidity – Private notes can be illiquid investments, meaning that they cannot be easily sold or traded. This can limit the ability to access capital quickly, and investors should be prepared to hold their investments for longer periods.
3. Complexity – Private note investing can be a complex investment strategy, requiring significant research, knowledge, and expertise. Investors should be prepared to commit the time and resources necessary to properly analyze and manage their investments.