Often, fellow real estate investors ask me why I do notes or how I got into the note business. The truth is, though, that just about everyone is in the note business. People oftentimes have car loans, student loans, credit cards, or mortgages. It’s just that they’re usually writing checks to banks instead of receiving them “as the bank.”
At first, I was a real estate agent and a painting contractor who just happened to have good credit and the skills to fix up properties — and I thought the only way to get rich was by working hard and investing in physical real estate. At that time, I hadn’t realized that all cash flow isn’t created equal.
Owning Notes vs. Property Management
It wasn’t until I joined a real estate networking group that I discovered hard money, private money, and seller financed notes, along with other new concepts and strategies, such as owner financing and carrying a second mortgage as the seller.
As I was looking to expand my personal portfolio of buy and hold properties, I was running out of options with residential loans. It was either commercial loans with tougher terms, more fees, plus tighter margins due to lower cash flows, or I had to get more creative with things like lease options, “subject to” deals, and private financing.
The real game changer for me was realizing I could lend out money from my IRA and from HELOCs (Home Equity Lines of Credit) that I had on all my apartments and SFRs (Single-family Residential Properties). The yields were nice (15-18%, one year interest only, oftentimes with points), and I had several friends who could put my money to work. As my portfolio of short-term rehab loans grew, it became too obvious how easy this type of cash flow was to earn compared to property management.
At the time, I had 40 units of my own, and I was managing approximately a hundred units as a RE/MAX agent. Property management took a lot of time. I had to deal with tenants, repairs, contractors, townships, inspectors, and eviction court.
With notes I had to deal with a homeowner/borrower, but not with repairs, townships, contractors, or inspectors — and I rarely dealt with legal situations like court.
I quickly noticed that this other form of cash flow backed by real estate without tenants was pretty cool. Up until this point, I managed properties for over 15 years the old-fashioned way, and I had even gone into commercial properties like mobile home parks, storage centers, and commercial office condos all in an effort to get away from the typical tenant. But nothing had compared to the ease of note investing.
Advantages of Notes
There are many advantages of note investing besides just cash flow. One is that you can start with deploying a small amount of capital. For example, some peer-to-peer lending companies allow you to purchase partials, or portions of a note, for as low as $25.
Another advantage is that you can enjoy increased liquidity. Notes can be sold or recapitalized very quickly. You can even borrow against the note using a Collateral Assignment of Note and Mortgage. You can also sell a partial.
Although you don’t have depreciation deductions like you do in hard real estate, it’s still much better than earned income, tax wise, since it’s considered passive. It even has what I call “phantom appreciation.” This isn’t appreciation in the true sense of the word like in real estate, but if you own a partial equity note and more equity comes back in the marketplace, suddenly your note has become more valuable. Notes with a discount also have the potential kicker, which is the difference between the purchase price and the payoff, if the borrower were to pay off early.
As you can see, owning notes can be a very scalable way to increase cash flow.
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