When it comes to note investing, having a solid understanding of how deals are made, how they evolve, and how to measure their outcome prepares you for taking on new deals and growing your portfolio.
To help you make the most out of your note investing adventures, consider this three-part framework.
Once you've mastered the basics of real estate investing lingo and the potential ways asset management could go, commit these three pillars of smart note investing to heart. The next time you're evaluating a deal, run through this quick checklist to make sure you're doing your due diligence.
Pillar #1: The Seller
The "seller" pillar in your note investing business refers to the individual or entity from which you'll buy an asset. Most likely, the seller will be an asset manager at a financial institution.
In order to ensure your note investing business has consistent deal flow, you'll need for form solid relationships with these sellers. The sellers with the most to gain from working with you are those who are highly motivated to get rid of bad debt (aka non-performing notes).
A bank with several bad loans on their plate or a hedge fund that's on the end of its term and needs to liquidate its properties are ideal sellers to work with.
Finding sellers who are distressed due to non-performing investments creates the perfect opportunity for you to swoop in, save the day, and make an offer that's beneficial to both you and the seller.
Pillar #2: The Loan
There are several factors to consider when it comes to the loan you're considering buying. When you purchase an asset from a bank, you're actually purchasing the loan that the bank has issued to the borrower.
In other words, when dealing in note investing, you will become the new lender after purchasing an asset from a bank. Therefore, it's critical that you understand the loan and the terms to which the borrower originally agreed with the mortgage issuer.
When evaluating an entire tape or a single asset, consider these questions about the loan itself:
- Is the loan enforceable against the borrower?
- Are the utilities at the property active or disconnected?
- Will a statute of limitations or other regional law affect your legal collectible balance?
- What is the foreclosure process for that asset location?
If any of these questions turn up red flags in response, be sure to look into them and decide whether or not you're still willing to get into the deal.
Just because there are red flags or challenging circumstances surrounding a loan doesn't mean it's a bad investment; you may simply need to decrease your bid on the asset. However, considering these questions early on can protect you from getting into a deal too deep from the offset.
Pillar #3: The Collateral
In note investing, you are purchasing the deal on paper, not necessarily the actual property itself. In fact, the property itself – whether it's a vacant lot, a house, an apartment complex, or something else entirely – is considered to be the collateral.
Even if a note looks like it's in a bad way and may be doomed to foreclosure from the start, by considering the collateral you can determine if you'll be able to quickly recoup your investment and then some.
For example, consider:
- Is the property occupied or vacant?
- If it's occupied, is the occupant a tenant, landlord, or the original borrower on the loan?
- Is the property located in a safe part of town?
- Is it a rural or commercial property?
- What is the current market like for similar properties of this kind?
If the collateral associated with the note is a rural property, you'll want to consider any factors that may make it harder to resell once you go through the foreclosure process – factors such as vacancy, an abandoned neighborhood, or poor maintenance. If you do invest in a property with such challenges, consider whether you have the network in place to help you rehab, repair, or demolish the property in order to turn a profit on your investment.
Once you've considered these three pillars of note investing – the seller, the loan, and the collateral – you're ready to make a decision on the deal. Are you in? Or are you out?