The world of real estate investing can be a confusing one.
There are so many different options and strategies to choose from that it's hard to know where to start. One option that you may have heard of is buying real estate notes. But what exactly is a real estate note, what is note buying, and is it the right investment strategy for you?
Let's take a closer look to get a better understanding of this asset class.
What Are Real Estate Notes?
Real estate notes are created when a property buyer finances the purchase of their property through a mortgage loan. The mortgage note is then sold to an investor, and the proceeds from the sale are used to fund the loan. The investor becomes the lender, and the property owner becomes the borrower.
The Different Types of Real Estate Notes
Now that we have a basic understanding of what a real estate note is, let’s discuss the different types and characteristics of these investments:
Performing vs. Non-Performing Mortgage Notes
Investors can purchase two types of real estate notes: performing and non-performing. Performing notes are mortgage loans that the borrower is current on, meaning they are making their monthly payments on time. Non-performing notes are loans where the borrower has fallen behind on their payments and is at risk of defaulting on the loan.
A performing note offers a lower risk for mortgage note investing because investors know that the borrower has been making their monthly payments. However, a non-performing note sometimes offers a higher potential return on investment because the investor can foreclose on the property and take ownership if the borrower defaults on the loan.
First Position vs. Second Position Notes
Real estate notes can be recorded in either first or second position. A first position lien mortgage note is a loan secured by the borrower's property. The lender has the first claim to the property if the borrower defaults on the loan.
A second position lien mortgage note is a loan that is subordinate to another loan. This means that if the borrower defaults on the loan, the lender of the second position lien mortgage will only be able to collect payment after the lender of the first position lien mortgage has been paid in full.
When it comes to potential risk and reward, investing in a first position mortgage note is generally seen as less risky than investing in a second position mortgage note. The lender is first in line to receive payments if the borrower defaults on the loan, which means there is a lower chance of the investor losing money. However, this also means that the potential return on investment is usually lower than with a second-position mortgage note.
Short-Term vs. Long-Term Real Estate Mortgage Notes
Mortgage notes come in two main varieties: short-term and long-term.
Short-term mortgage notes are typically used for investment properties such as fix-and-flips or other quick turnaround projects. The most significant risk with short-term mortgage notes is that the borrower may default on the loan before selling the property, resulting in the investor losing their investment. However, the potential rewards are also high, as investors can earn a substantial return on their investment if the project is successful.
Long-term mortgage notes are typically used for financing primary residences or other properties that will be held for a longer period of time. The risks associated with long-term mortgage notes are generally lower than those associated with short-term mortgage notes, but the potential rewards are also typically lower. However, long-term mortgage notes can still be a profitable investment for investors willing to wait for a longer period to see their return on investment.
Buying a Note vs. Buying a Property
There are two main ways to invest in real estate: buying real estate notes and buying real estate directly. Each option has its pros and cons that you should consider before making a decision.
Buying real estate notes is often seen as a less risky investment than buying property outright. This is because when you buy a note, you're essentially purchasing the debt associated with a property rather than the property itself. If the property goes into foreclosure, you may still be able to recoup your investment, whereas if you'd bought the property outright, you could lose everything.
However, there are some downsides to being a note investor. One is that you won’t have any control over what happens to the property. If the borrower decides to sell or make major changes, you won’t have any say in the matter. Additionally, if the property appreciates in value, you won't see any of that appreciation yourself - it will all go to the person who owns the property.
Buying real estate directly means that you will be purchasing a piece of property outright. This could be a single-family home, an apartment complex, or any other type of investment property. One of the main benefits of buying real estate directly is that you will have complete control over the property as the landlord. This means that you can make whatever changes or improvements you want, and you don’t have to answer to anyone else.
However, there are also a few downsides to buying real estate directly. One is that it can be a more expensive upfront investment than purchasing a note. You will also need to factor in the cost of any necessary repairs or renovations that you may need to make. Additionally, if you decide to sell the property down the line, you may not get as much money back as you originally put in.
Pros of Buying Real Estate Notes
There are several benefits to buying real estate notes, including:
1. Ability to generate passive income
When you purchase a real estate note, you're earning money without having to do a lot of work. Once you've made the initial investment, any cash flow comes in passively, which frees up your time to pursue other ventures.
2. Potential for high returns
As a note buyer, you effectively lend the property owner money. In return for this loan, the homeowner pays you interest. The amount of interest you earn is typically higher than what you would earn from a traditional savings account or certificate of deposit.
3. Security of a tangible asset
Unlike stocks and bonds, which are subject to market fluctuations, real estate is a physical asset that will always have value. This makes real estate notes a relatively secure investment.
4. No management headaches
Real estate note investing means you don’t have to worry about things like repairs, maintenance, or tenant issues.
5. Opportunity to help others
When you invest in real estate notes, you're providing financing for people who need it. Not only does this give you the opportunity to help others achieve their dream of homeownership, but it also allows you to leverage your philanthropic efforts for tax breaks.
Cons of Buying Real Estate Notes
Of course, no investment is without risk, and there are some potential drawbacks to buying real estate notes that you should be aware of before making a decision. These include:
1. The possibility of defaults
By their very nature, loans are subject to defaults and foreclosures. If the borrower stops making repayments or otherwise defaults on the loan, you could lose your entire investment.
2. Long-term commitment
When you invest in a real estate note, you typically commit your funds for 3 to 5 years. This can be problematic if you need access to your money sooner than that time frame.
3. Interest rate risk
Another risk to consider is that of interest rate risk. This occurs when market interest rates rise after you have invested in a real estate note with a fixed interest rate. If this happens, the value of your investment will decrease.
4. Illiquidity
Finally, it’s important to understand that real estate notes are not very liquid investments. This means that it can be difficult to sell your investment before maturity.
An Easier Alternative to Investing in Real Estate Notes
Investing in real estate notes can be a great way to earn potential passive income and build your portfolio. However, it's important to understand the process and potential risks before you dive in.
The traditional way to invest in real estate notes is to find a seller, negotiate a price, and then purchase the note directly from them. This can be a time-consuming and complicated process, especially if you're new to investing in real estate notes. There are also a few potential drawbacks to this method that you should be aware of:
- You'll need to do your own due diligence on the property and the borrower. This includes research on the property itself, as well as running a credit check on the borrower.
- You'll need to have the capital upfront to purchase the note. This can be a barrier for many real estate investors, especially if you're just starting out.
- There's always the potential that the borrower will default on the loan, which could lead to losing your investment.
A better and easier way to buy real estate notes is through Concreit. For years, only wealthy people could invest in hedge funds and private equity real estate. But now, Concreit is making it possible for all types of investors to invest in private equity real estate.
The app makes investing in real estate notes easy and convenient, with opportunities for participating in fixed-income first-lien mortgages through SEC-qualified Regulation A+ Tier 2 offerings.
With Concreit, you can access alternative investments through expertly-managed strategies with curated assets. Your money is diversified across hundreds of high-yielding income-focused first-lien mortgages in the United States. What this means for you:
- You don’t need to be accredited to invest
- Dividends are paid out weekly
- Frees up your time by doing all the research and work to invest your money
- When it comes to liquidity, Concreit is significantly more liquid than buying direct or compared to crowdfunding platforms. Plus, you have the option of withdrawing your funds at any time.
- Investment team has experience buying and managing over $10B in assets under management
- Average annualized return has been 5.5% over the last year
So if you're looking for an easier and more convenient way to invest in things like real estate notes, Concreit just might be the perfect solution.
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