Notes, Paper, and Tape
Kids are back in school and if you have kids, you probably did some shopping for school supplies. Binders, pencils, notepads, paper, tape, and much more. Although summer was over, as a kid I enjoyed picking out my trapper keeper and NFL pencils with the different teams. Did you know you can invest in notes, paper, and tape in real estate and generate passive income?
Most people with some knowledge of real estate understand generating passive income from rental properties. However, a little-known method of real estate investing is buying, holding, and even selling notes, also called “paper”. In the real estate lending world, a note, typically called a promissory note or a secured note, is the document describing the terms and the agreement between the lender and the borrower. If you own a home and have a mortgage on your property, a promissory note was one of what probably felt like hundreds of documents when you purchased your home. It is simply a promise to pay.
You can also create a note when you sell a property called seller financing. If you do not have a mortgage on your property and you don’t want a lump sum of cash when you sell, you can sell, and the new buyer/borrower makes payments directly to you instead of getting a loan from a bank or another lender. You essentially become the bank for the new buyer. The advantages of this if the property is an investment property is tax-savings and passive income. For a nominal fee, you can use a loan servicing company to collect payments and handle escrow payments for taxes and insurance. You sit back and receive a direct deposit into your account each month.
The main concern for new investors is, “What if they stop paying?” The loan servicer can also handle the foreclosure process and you would own the property again. At that point the property has probably gone up in value and then you sell it again either the traditional method for cash or again with “seller financing”.
How do you purchase a note? Notes are for sale for various reasons just like properties are for sale for various reasons. The lender wants to “cash out”. To receive cash the seller of the note will need to sell the note at a discount to make it appealing to a note buyer. Here is an example:
Current note balance: $100,000
Interest rate: 8%
Amortization: 20 years
Monthly Payment: $836.44
Amount left on loan: 18 years
Property value: $130,000
Loan to Value: 77%
Cost to purchase note: $80,000
New note owner still receives: $836.44/mo
New rate of return: 12.5%
New Loan to Value: 61.5%
How do you find notes for sale? There are note brokers you can find online just like brokers of properties. Have you ever had a mortgage and got a notice that your loan is now with a different bank? Banks and other large lenders, even hedge funds are constantly exchanging notes. Facebook groups, LinkedIn and other social media outlets are another source. Just like wholesalers of real estate you could find notes and resell them for a wholesale fee.
What is “tape” in real estate note investing? A tape is simply a group of notes bundled together that note brokers or sellers will market to sell in a package.
What are the different types of notes? There are performing notes and non-performing notes (NPNs). Performing notes are ones with the borrower paying on-time. You typically want to buy performing notes with some payment history. Non-performing notes are ones with a borrower who is behind on payments.
Why would you want to buy a non-performing note? NPNs are sold at a larger discount than performing notes. If there is enough equity and you want to own the property to fix up and sell or rent out this might be a great strategy. You can also buy NPNs and re-negotiate the terms of the note and keep the borrower in-place.
When I was shopping for school supplies as a kid I had no idea I would still be buying notes, paper, and tape in the business world as an adult. Bridge South Investments is actively purchasing notes. If you have an interest in learning more about notes or working together, please contact us.