In mortgage note investing, investors can deploy various techniques to gain profits from the investment. However, investing in performing notes is the best and easiest way of doing it, especially if you are starting this venture.
However, you cannot get a small bunch of performing notes, and you need to be ready for that. Or, you can choose any of the following options:
- Be a lender yourself (this gives you the power of creating your notes)
- Source performing notes from real estate investors
- Purchase re-performing notes
Let’s understand these points in detail:
1. Private Lending
Many investors want to have steady but quick access to cash; private lending is the best way to do it. In this method, investors can quickly close a deal after assessing the risks, terms and conditions, and the credibility of the borrower. These are beginner-level investing fundamentals used by investors of every vertical, and theft are tested methods. Online REIA meetups are the best places to look for these people.
The borrower has to do 80% of the task, but you can sit back and get a steady income. However, if the borrower fails to provide interest for a month, or two, you can be in trouble. Usually, there’s a grace period, and after that, you can take action appropriately.
2. Source Notes From Real Estate Investors
The correct term for these notes will be notes financed by investors/ sellers. It is another popular way of dealing with mortgage investing. You can buy the note from another investor and can do anything with it. You can use it for private lending (however, the chances are slim), borrow some money yourself (this will result in the release of the capital).
Apart from that, you can hold a portion of the note and sell another half to a third party. If the note is already assigned to a borrower, it comes with a risk, especially, if this person is not very credible.
3. Buy Re-performing Notes
Re-performing notes were once non-performing and were modified to collect payments from the borrower. If these notes are on sale, the seller is most likely to benefit from this whole deal rather than you.
So, you have decided to go with the first option. How will you proceed?
1st Step: Understand the Property’s Value
A property’s value changes according to its category, house, condo, apartment, industrial, or commercial buildings. Your success in note investing will depend on it.
What will you assess? The building’s present wholesale value (it will depend on the condition). If the building is in ruins, then the value will not be much higher. If it’s in a stable condition, then you will probably get a higher value.
Why do you need to assess this? You need to understand if the property is worth investing in or not. Whether the borrower can pay the amount, or will you have to think about liquidation. It is necessary to consider the worst-case scenario too.
Suppose the building is in poor condition, the owner will have to make some repairs. This can considerably lower the price, and the After Repair Value (ARV) is the one thing you need to consider during private lending.
After gaining this crucial information, you need to understand what your borrower wants to plan. By doing that, you can set realistic goals, and ensure that you get enough profits from this option.
The purpose of this method is to ensure you have access to the accurate scope of work information. While doing so, you can also do a physical inspection. We think that doing this is mandatory. We don’t want any item to go missing, and the evaluation becomes awry.
This will not just cause to you as a lender, but also for the borrower. I mean, this can make the borrower default on his payments. This is not something any investor would want.
After that, you need to decide the lending risk, and it is a significant move. If the budget for rehabilitation overshoots, it is a red flag for you. The lending risk is directly proportional to the accuracy of the calculation. A rule of thumb is to go for projects that can offer higher profit margins (possible with accurate predictions).
You can ask for third-party evaluators to evaluate the project or use the tools available online and offline. For example, you can ask a broker and see what his opinions are, but what you will get is defined as Broker’s Price Opinion. Yes, there’s a scope that the broker might change something, so it’s best to take the advice with a grain of salt.
However, if you are acquainted with a trustworthy borrower, then go for it.
If you are looking for a professional look, then we have the perfect solution for you, CMA (Comparative Market Analysis). In this process, you get a full report from a real estate agent. In this report, you get to know the prices of properties with similar characteristics, and you can draw inferences from the rest.
You can ask for it from a broker too. You can calculate the Net value of the property after subtracting all the repairing costs. The last option is to go for a state-sanctioned appraiser. He will provide a detailed report (similar to a CMA but with much more information) to help you come up with the best idea.
There’s a lesser chance of encountering errors in this method. The thing is, these people are expensive, so make sure you have enough cash. Second, they will take some time to produce the report.
Other options would include drive-by appraisals, but we would not recommend it to you for the private lending scenario. We will discuss it in another episode to give you a detailed overview. Later, we will show how you can get trustworthy borrowers for your private lending business. But for now, we are signing off until next time.