Real Estate Note Investing: A Beginner's Guide

Real estate note investing, or mortgage note investing, can be a lucrative way to diversify your portfolio and to create a passive income stream. But what does it really mean? A real estate note is a legally binding document for a loan that is secured by real estate. If you buy or invest in a real estate note, you are—practically speaking—the bank. This allows you to earn interest from the loan.

This guide explains the ins and outs of real estate note investing, providing the tool belt and knowledge you need to jump into the game.

What are Real Estate Notes? How Does it Work?

A real estate note is a document evidencing a debt, usually secured by a mortgage or deed of trust on real property. It's basically an IOU for money borrowed to buy or refinance real estate.

Note sellers are the original lenders, most likely banks, mortgage companies, and individuals who first issued the mortgage loan for the property. Sellers often choose to sell notes to free up capital or manage risk.

The note buyer is simply the investor buying the note. This can be an individual, fund, or another financial institution. The buyer wants return on their investment via the interest payments being made by the borrower.

Types of Real Estate Notes

• Performance Notes: Notes where the borrower is current with their payments.
• Non-Performing Notes: When the borrower is delinquent on the payments.
• First Lien Notes: Notes which are in the first line before all other liens against the property.
• Second Lien Notes: These are notes which are subordinated to the first lien notes.

Practical Steps to Start Investing in Real Estate Notes

Before venturing into real estate note investing or mortgage investing, you will need to establish specific investment goals for yourself. Consider the following:

Setting Investment Goals

What kind of risk are you willing to take? Performing notes pose a lower chance of risk but normally yield lower returns; non-performing notes may be riskier but have a potential to be more lucrative. How much earnings are the target for your investment? Your target returns will drive the kind of notes that one can buy or sell and ways used in the process.

Building Your Real Estate Note Investment Strategy

Research the market of real estate notes to be able to differentiate the type of notes, the risks and rewards, and issues involving legality. Also, conduct full due diligence about the borrower and property, and about the present status of the market before consideration of making any purchase. Additionally, approach current and established note investors, brokers, and servicer to obtain important insights and guidance obtained from these sources.

Resources and Tools for Real Estate Note Investors

You can pick up the basics and the advanced concepts of note investing by taking online and offline courses. You can also interact with fellow investors; share your knowledge, views, and experiences in return. Moreover, utilize professional services designed to help you in your investment and risk assessment of certain notes.

Strategies for Investing in Real Estate Notes

Here are some key strategies one should keep in mind while investing in real estate notes:

1. Understanding Real Estate Notes

Real estate notes are promissory notes, commonly collateralized by either a mortgage or a trust deed. So in essence, when you do real estate note investing, you're simply stepping into the shoes of the original lender to receive principal and interest payments from the borrower.

2. Perform Due Diligence

Due diligence is not an easy task in real estate note investment. It incorporates the research of the details of the note down to aspects such as property value, creditworthiness of the borrower, and terms of the note. Some key factors are:

• LTV Ratio: This is the relationship of the loan to the value of the property. The lower the lower-to-value, the less risky it typically is.
• Credit History of Borrower: One will have to understand and assess the financial history of the borrower to evaluate the chance of any person paying on time.
• Condition of Property: The property's physical condition can reveal information as to its marketability and value.

3. Diversification

One of the basic tenets of investing is diversification, and that also applies to real estate notes. In this venture, it is important to spread investments over geographically distinct locations and property types to avoid risk due to economic downturns in general, regional market changes, or issues particular with one borrower.

4. Choosing Between Performing and Non-Performing Notes

Real estate notes can either be performing or non-performing:

• Performing Notes: These notes have borrowers who are current with their payments. They provide steady, predictable income but may yield lower returns.
• Non-Performing Notes: These are notes where the borrower has defaulted. Riskier, non performing notes for sale can typically be bought at a discount and can have a higher potential return through foreclosure, loan modification, or resale.

5. Working with a Note Broker or Investment Firm

For newbies in real estate note investing or those looking for a more passive approach, work with a note broker or online platforms like Concreit. These professionals are highly experienced in the sourcing, underwriting, and management of the notes themselves. This helps investors uncover opportunities in the market that would be hard to come by as an individual investor.

6. Consider the Exit Strategy

Have an exit strategy in mind before buying a real estate note. Some of these scenarios include:

• Holding to Maturity: Collecting payments until the note is fully paid off.
• Resale of the Note: Selling the note to another investor when market conditions or personal circumstances change.
• Foreclosure: Transferring property ownership if the debtor defaults, then selling it to recoup the investment.

7. Understanding the Legal and Tax Implications

Other legal and tax considerations exist with investing in real estate notes, but those are best understood after consulting with special legal and tax professionals. Generally, interest earned on the notes is considered ordinary income. In the case that the note isn't performing as it should, state specific laws and regulations, including those related to foreclosures, can be very important. Federal and state lending regulations should specifically be complied with to avoid litigation.

8. Managing Risks

Like all investments, real estate notes carry some element of risk. These include:

• Insurance: Maintaining the property securing the note to ensure it has adequate coverage under an insurance policy.
• Monitoring Market Conditions: Stay abreast of trends in the real estate market that may affect property values and the borrowers' ability to repay.
• Asset Protection: Structuring investments in such a way as to provide personal asset protection, such as limited liability through an LLC.

9. Continuous Learning and Networking

Real estate note investing is an ever-changing market where trending laws and opportunities change very quickly. This requires constant learning—books, seminars, and courses—to keep investors up to date. Networking with other investors and professionals gives very good insight into various opportunities.

How Concreit Simplifies Real Estate Note Investing

For individuals who want to participate in real estate note investments in a simple and friendly way, there is Concreit. This platform enables investors to participate in a diversified portfolio of consistent, first-lien mortgages, a strategy traditionally favored by institutional investors.

Concreit's experienced team are seasoned experts, possessing over $10 billion in asset management experience. Your money is diversified with hundreds of income-centric mortgages in the USA to reduce potential risk and generate wealth.

With more than 100,000 investments to date, Concreit has earned the credibility of over 40,000 customers who have leveraged the platform. It gives you the power to enjoy the opportunity that comes with real estate debt without the real pains of direct property ownership. 

FAQs

How do I evaluate a real estate note? 

Get the creditworthiness details of the borrower such as his credit history, income, and employment status to access repayment capability of the borrower. Second, secure an appraisal or comparative market analysis that provides the current market value of the property. Thereafter, calculate the optimal loan-to-value ratio, a lower ratio typically holds lower risk, and determine if the note's interest rate and yield potential meet your investment goals.

What are the risks of investing in real estate notes? 

Real estate notes carry their own set of inherent risks. The major one is the risk of the borrower defaulting on the loan, thus leading to the potential loss of the principal and interest. Additionally, the full investment might not be realized by the foreclosure process if the property value drops radically.

How can I mitigate the risks associated with real estate notes? 

Diversify the investment and multi-pronged strategy to mitigate the risk. Proper due diligence must be inquired about the borrower, property, and legal documents of the borrower and property before the investment. Lastly, divide the capital across several notes with different risk profiles, borrowers, and geographic locations.

Can I invest in real estate notes with a small budget? 

Yes, you can invest in real estate notes even with a tight budget. Consider buying partial notes in which you own part of a note or by investing into funds that specialize in real estate notes. Real estate note funds  allow investors to pool money together to gain access to a diversified portfolio.