People who want to invest in real estate but don’t want to own a home may want to consider purchasing mortgage notes.
The loans that borrowers take out to buy a property are mortgage notes. Banks or lending institutions grant the loans, and often these entities sell these mortgage notes to free up their cash. Note buyers play the role of the bank, sometimes buying discounted notes and collecting the principal and interest rate payment from the borrower, says Greg Forest, real estate advisor at Engel and Volkers in Palm Beach, in Florida.
Mortgage Notes can be a good real estate investment for people looking for passive income, but investors need to know what they are buying. It takes some research to understand the borrower’s financial situation, property values, and the different types of tickets available. Here’s what you need to know when you dive into the world of real estate mortgage note investing:
• Types of mortgage notes.
• Verification of borrowers.
• Purchase of mortgage tickets.
Types of mortgage notes
Mortgage notes fall into different asset classes, generally divided by residential or commercial loans, says Joseph Polakovic, owner and CEO of Castle West Financial in San Diego. Residential loans include single and multi-family homes, while commercial loans include shopping malls, office parks, warehouses and other buildings.
Institutions like banks usually make mortgage notes. In a private mortgage note, a borrower makes payments directly to an individual entity and can be part of a portfolio, says Forest. There are two types of mortgage loans. A loan secured by a property is called a secured loan. The other type is an unsecured loan with nothing to back it up.
There are also two main categories of risk. Performing mortgage notes are when the borrower is up to date on the payment. Non-performing notes occur when the debtor is behind in payments, Polakovic says. Non-performing grades are sometimes referred to as distressed grades.
“The [are] two ends of the spectrum of how conservative or speculative investors want to be, ”he says. “If you are looking for a secure and very predictable income, this will push you to play notes. If you want a higher internal rate of return, that will push you further towards underperforming ratings.
Forest says note buyers should do their due diligence and review the borrower, checking the person’s credit history, income, and payment history to get a feel for the borrower’s ability to continue to pay. make payments.
The buyer should also know how much has been borrowed, the loan interest rate, the loan repayment schedule and what happens in the event of default.
Forest says investors can get a good idea of a borrower’s payment methods once the borrower has about two to three years of payment history. This is when many buyers will purchase a mortgage note.
“We see people move every five to seven years. So that two-year mark is probably a good time to step in because you know that person has paid and they’re probably not going to move for another three to seven years, so you’re going to get consistent payments, ”he says.
Notes are characterized as non-performing generally after 90 days of non-payment. At this point, the debtor is likely entering the initial stage of default, says Forest. Often, investors can purchase these notes from banks or lenders at a discount and receive an interest rate higher than the nominal interest rate.
Doug Fisher, director of Essex Realty Group, said during the housing crisis during the 2008 financial crisis, buying and selling distressed mortgage tickets was common. He says his company was selling mortgage notes for institutions at the time.
When reviewing distressed mortgage notes, the original lender will likely sell the notes for less than the real value of the property. The buyer has several choices: help the borrower make their payments by perhaps giving up part of the loan balance, or take control of the property in the event of foreclosure.
He says investors considering distressed mortgage notes should carefully consider what they are buying. Usually, buyers get the mortgage for less than the value of the property. But there is always a risk. During the Great Recession, sometimes property values continued to deteriorate and fell below the amount paid for the mortgage, he adds.
“You have no control over the underlying property with the mortgage; the owner has that control, ”he says.
Buy mortgage tickets
Polakovic says it’s helpful for investors to know real estate and understand the values of buildings and land.
“If it’s all going south, you want to know what it’s really worth,” he said. “If he’s in a foreclosure situation and you become the physical owner, what is that liability and what is that value? Sometimes it’s only worth the value of the land, ”he says.
It can be difficult for individuals to purchase mortgage notes directly from banks, so many brokers use mortgage notes, which can find both public and private offers, he says. Online marketplaces like NotesDirect.com, an online trading platform, can facilitate the purchase of Notes by retail investors.
Like any investment, Polakovic says there’s a fair amount of tedious research that goes into mortgage notes. He says buyers should weigh a note’s potential rate of return against another financial benchmark such as the historical return of the S&P 500 to estimate whether the note can be a profitable investment. This is especially true if buyers take a long-term approach and invest in high-performing notes.
“Historically, the S&P 500 has performed around 8% to maybe 10% over the long term. Your approach to mortgage notes should be: what can I expect? ”He says.
He adds that if investors can find something at least 10% or more, it may not be worth it. Investors could be better served by investing in stocks.