Investing in mortgage notes and mortgages has become an increasingly popular alternative investment strategy in recent years. With mortgage rates still near historic lows, some investors see opportunities to earn relatively high yields on performing mortgage notes purchased at a discount. However, mortgage investments also carry risks that investors need to fully understand. This article will provide an in-depth review of investing in notes and mortgages, including the pros and cons, different investment approaches, and key factors to consider before putting your money into mortgage notes.
Mortgage notes provide stable cash flow at attractive yields
Buying performing mortgage notes can generate an ongoing stream of monthly principal and interest payments. Compared to other fixed income investments like bonds, mortgage notes often offer higher yields for a similar level of risk. For example, an investor might be able to purchase a 30-year mortgage note with a 6% interest rate for 80 cents on the dollar, translating to an effective yield of around 9%.
Mortgage investing allows for geographic diversification
Unlike owning physical real estate which ties you to a specific location, mortgage note investments give you exposure across different geographic areas. By investing in a pool of mortgages from around the country, you reduce your exposure to local real estate market fluctuations.
Non-performing notes offer turnaround potential
Some investors specialize in buying distressed, non-performing mortgage notes at a deep discount, then working with the borrower to bring the loan current again and eventually sell at a profit. This is a much more hands-on strategy that requires mortgage servicing expertise but can generate higher returns.
Mortgage notes tend to be illiquid assets
The secondary market for trading mortgage notes is relatively thin compared to stocks and bonds. This makes it harder to exit a mortgage investment quickly. Investors with short time horizons or who may need sudden liquidity should be cautious.
Interest rate and prepayment risks
Even performing mortgage notes carry interest rate risk and prepayment risk. As rates decline, borrowers may refinance and prepay mortgages, leaving the investor to reinvest at lower yields. Rising rates also reduce the value of existing mortgage investments.
Mortgage investing has specialized tax considerations
The tax treatment of mortgage interest income can be complex, especially for distressed notes. Work with a tax professional to understand how your mortgage investments will be taxed.
Mortgage note investment provides attractive yields and diversification but also comes with risks like illiquidity, interest rate fluctuations, and tax complexity. Do thorough due diligence before investing to ensure it aligns with your risk tolerance, time horizon, and liquidity needs.