Passive income from real estate is a fascinating topic. Anyone who finds income from property-secured notes boring is free to stop reading now. I pick up tips from real estate sources every so often about how cash flow notes work. I have never invested in one but I know just enough to figure out where to start.
Beginning with cash flow notes means finding reliable information. Personal Real Estate Investor magazine has plenty of articles on strategies for selecting properties and avoiding bad decisions, but I didn't find anything there on cash flow notes. Google searches for "cash flow note investing" and related word combos reveal plenty of sites claiming to offer education on note investing. The most realistic introduction to the topic I've found is W.J. Mencarow's The Paper Source, which offers plenty of free background information on researching notes.
Brokering notes seems more difficult than buy-and-hold investing because it requires a constant search for counterparties. Investing in a note for the long term simply requires a search for available inventories. The secondary market for notes linked to real estate are private placements, but I suspect that crowdfunding portals covering real estate will eventually list them for sale. That would be a huge step forward for transparency.
Professional investment managers offer funds that buy pools of available notes and work with homeowners who are delinquent on payments. This turns non-performing notes into performing notes after a few months of renewed payments. The key to success for these firms is their ability to buy nonperforming notes at large discounts. I do not have firm data on the size of this market; banks obviously have some non-performing notes they want to remove from their balance sheets to avoid impairments. Fannie Mae and Freddie Mac sell large blocks of notes as "tapes" priced in nine figures. Hedge funds and private equity firms buy these tapes and resell them in smaller lots to private money managers. Fund managers who refuse some non-performing loans in those tapes may give the large private equity firms the chance to foreclose on homes and become landlords. Foreclosing on hundreds of houses is a lot of work, which is why most private equity firms getting into landlording prefer to make all-cash offers on normal home sales. A smaller fund that buys their non-performing notes directly from a bank has a similar opportunity to become a landlord.
Investing in these notes reminds me of tax lien investing. The similarity with tax liens is that purchasing one allows the opportunity to foreclose and take possession of real property. The difference is that investors must purchase tax liens from municipal government agencies, and must purchase notes from banks or large asset managers. Purchasing liens may offer an investor seniority over a mortgage note owner, although I have read conflicting interpretations on how one is senior to the other. Nolo's discussion of liens and mortgages in foreclosure illustrates how recording dates can complicate matters. That is a very important thing to know if competing investors seek the most expeditious route to foreclosure. Nolo's discussion of mortgages and deeds of trust will be of interest to investors purchasing notes outside their own state. Knowing which category prevails for a note will determine whether the foreclosure process is attractive.
Foreclosing on delinquent notes is not the only result of a note investing strategy. Buying and holding them to collect the cash flow is the stated rationale of the private funds lining up to buy them and restructure their payment terms. Retail investors who do not qualify for the gates in privately managed note funds always have the option of buying publicly traded funds that manage ABS and MBS paper. That route does not involve the cumbersome, labor-intensive approach through private placements. Privately managed pooled note funds have defined life spans and high fees. They are not transparent and the field is prey for scams.
I would consider cash flow notes for my own portfolio in normal economic times. These are not normal times. The strong possibility of hyperinflation in the US means debtors can pay back liabilities with future dollars that are worth much less. Owning a cash flow note backed by real estate exposes the holder to asset destruction during hyperinflation. The underlying real estate remains but the note becomes worthless. Aspiring landlords should remember how high inflation can turn their pile of notes into a pile of manure.
Nota bene: None of this discussion constitutes investment advice. I have to state that out of concern that some nutcase will make false claims against me. I do not give personal financial advice.
Beginning with cash flow notes means finding reliable information. Personal Real Estate Investor magazine has plenty of articles on strategies for selecting properties and avoiding bad decisions, but I didn't find anything there on cash flow notes. Google searches for "cash flow note investing" and related word combos reveal plenty of sites claiming to offer education on note investing. The most realistic introduction to the topic I've found is W.J. Mencarow's The Paper Source, which offers plenty of free background information on researching notes.
Brokering notes seems more difficult than buy-and-hold investing because it requires a constant search for counterparties. Investing in a note for the long term simply requires a search for available inventories. The secondary market for notes linked to real estate are private placements, but I suspect that crowdfunding portals covering real estate will eventually list them for sale. That would be a huge step forward for transparency.
Professional investment managers offer funds that buy pools of available notes and work with homeowners who are delinquent on payments. This turns non-performing notes into performing notes after a few months of renewed payments. The key to success for these firms is their ability to buy nonperforming notes at large discounts. I do not have firm data on the size of this market; banks obviously have some non-performing notes they want to remove from their balance sheets to avoid impairments. Fannie Mae and Freddie Mac sell large blocks of notes as "tapes" priced in nine figures. Hedge funds and private equity firms buy these tapes and resell them in smaller lots to private money managers. Fund managers who refuse some non-performing loans in those tapes may give the large private equity firms the chance to foreclose on homes and become landlords. Foreclosing on hundreds of houses is a lot of work, which is why most private equity firms getting into landlording prefer to make all-cash offers on normal home sales. A smaller fund that buys their non-performing notes directly from a bank has a similar opportunity to become a landlord.
Investing in these notes reminds me of tax lien investing. The similarity with tax liens is that purchasing one allows the opportunity to foreclose and take possession of real property. The difference is that investors must purchase tax liens from municipal government agencies, and must purchase notes from banks or large asset managers. Purchasing liens may offer an investor seniority over a mortgage note owner, although I have read conflicting interpretations on how one is senior to the other. Nolo's discussion of liens and mortgages in foreclosure illustrates how recording dates can complicate matters. That is a very important thing to know if competing investors seek the most expeditious route to foreclosure. Nolo's discussion of mortgages and deeds of trust will be of interest to investors purchasing notes outside their own state. Knowing which category prevails for a note will determine whether the foreclosure process is attractive.
Foreclosing on delinquent notes is not the only result of a note investing strategy. Buying and holding them to collect the cash flow is the stated rationale of the private funds lining up to buy them and restructure their payment terms. Retail investors who do not qualify for the gates in privately managed note funds always have the option of buying publicly traded funds that manage ABS and MBS paper. That route does not involve the cumbersome, labor-intensive approach through private placements. Privately managed pooled note funds have defined life spans and high fees. They are not transparent and the field is prey for scams.
I would consider cash flow notes for my own portfolio in normal economic times. These are not normal times. The strong possibility of hyperinflation in the US means debtors can pay back liabilities with future dollars that are worth much less. Owning a cash flow note backed by real estate exposes the holder to asset destruction during hyperinflation. The underlying real estate remains but the note becomes worthless. Aspiring landlords should remember how high inflation can turn their pile of notes into a pile of manure.
Nota bene: None of this discussion constitutes investment advice. I have to state that out of concern that some nutcase will make false claims against me. I do not give personal financial advice.
