Note investing has become an increasingly popular way to invest in real estate in recent years. It involves purchasing existing mortgages or promissory notes on properties at a discount. This allows investors to earn interest income from the notes while also acquiring the underlying real estate assets if borrowers default. Though note investing can be lucrative, it does come with some risks. In this article, we will explore the advantages, risks, and strategies involved in note investing in real estate.
Note investing provides passive income with real estate exposure
One of the main appeals of note investing is that it generates mostly passive income for investors. After purchasing the note, investors receive regular monthly payments consisting of interest and principal from the borrower. This creates a steady stream of cash flow, similar to owning a rental property but without the hassles of dealing with tenants or repairs. At the same time, note investors gain exposure to the real estate market and benefit from any property appreciation when the note is paid off.
Note investing can provide high returns for the risk
Note investing tends to provide higher returns compared to other fixed income investments such as bonds or CDs. Notes are usually sold at a discount to their unpaid principal balance, allowing investors to achieve yields upwards of 8-12%. Default rates on notes are also generally lower than some riskier investments, so note investing can potentially achieve higher returns for the level of risk involved.
Investors can take title to the property if the borrower defaults
If the borrower defaults on paying the note, investors have the option to foreclose and take ownership of the secured property. This allows investors to acquire real estate without having to provide any down payment or go through traditional financing. Investors can then sell the property, rent it out, or make improvements and resell it for a profit depending on their strategy.
Lack of control and illiquidity are risks of note investing
One downside to note investing is the lack of control investors have over the underlying property. They must rely on borrowers to maintain and pay taxes on the property. Notes are also illiquid assets that cannot be readily sold like stocks or bonds. This makes exit strategies more difficult. Investors must hold the note to maturity or find a buyer willing to purchase the note on the secondary market.
Extensive due diligence is critical when purchasing notes
Thorough due diligence is extremely important when buying notes in order to properly assess and price risk. Investors must evaluate factors such as the equity position in the property, payment history, creditworthiness of the borrower, property valuation and condition. Legal review of the mortgage documents is also essential to confirm lien position and recourse in the event of default. Working with professionals experienced in note investing helps mitigate some of these risks.
Note investing offers real estate investors an alternative path to earning passive income while also providing opportunities to acquire properties below market value. However, the complexities and illiquidity of notes require extensive due diligence. Implementing prudent strategies focused on risk management can help investors capitalize on this niche asset class within real estate investing.