How To Create Passive Income with Real Estate Note Investment?
The purchase of mortgage notes is rarely discussed, but it is one of the best real estate note investment options available.
What is Note Investing?
You can invest in notes in a variety of ways, but at its core note investing is the process of purchasing debt and its security instrument. For instance, imagine someone looking to purchase a home.
As soon as they are approved, they are given a mortgage and a note to purchase a property. The note is a promise to pay back the money — under certain terms — and the mortgage ties that promise to the property as collateral.
The bank bundles the defaulted mortgages into tranches and then sells them to a hedge fund at 20–30 percent on the dollar in the secondary mortgage market. Over the course of time, 4% of mortgages go into default. The borrower might get divorced, lose their job, have a health issue, etc. The bank then makes money by selling the tranches into the secondary market to a hedge fund.
That hedge fund then works with the borrower. Let’s say, for example, the borrower returns to work. The borrower begins making payments again. These mortgages become reasoned over time.
What Causes a Mortgage Default?
As long as the borrower has not paid their bill for 120 days, the bank is going to hold it on its books for a few years before putting the loan in a tranche and selling it to the secondary mortgage market. They do this for many internal reasons.
Now, the bank bundles it up, and then the hedge fund comes in. Now, the hedge fund can’t pick and choose, right? Since it’s a tranche, they can either take it or leave it. And then the hedge fund deals with whatever is in that bundle?
Exactly, yes. They buy all or nothing at that point. Eventually, the hedge fund tries to get the loans back on track. Is that what they do? Bundle a subset of them?
Creating Generational Wealth with Alternative Investing
As an evergreen fund, this fund launched in February of last year, so there are only $7 million in assets under management right now. Eventually, it will have a cap of $50 million, so there should be about $43 million left.
A bequest does not have an expiration date, thus the name. It is a legacy play, which means that my partner and the investors are looking to pass it on to future generations as a source of income. We are long-term players.
When we reach $50 million in about two to three years — which is what we expect to do — we’ll launch an additional fund.
Do you see any variation in people paying or not paying their real estate mortgage as a result of COVID-19? We realize the fund is relatively new, but have you noticed any trends?
What effect did COVID-19 have on real estate note investing?
When COVID-19 came along, we thought our collectability percentage would decrease to 75%. 90% is the industry standard. If we think about an investment devaluation of 62%, we can still make do with some deficiencies — such as collectability issues. So 90% is the threshold. We never want to be below that number.
The company transformed some of its processes. Instead of looking at mortgages, collection percentages, and delinquency buckets on a weekly basis, it now looks at them daily.
We found two things:
Throughout COVID, collectability was 92–93% and is now at 96%.
Quite a bit of what we were reading in the media didn’t reflect what we were seeing.
People were actually paying more attention to where they lived because they were in their homes every day, staring at their walls and floors. They were truly appreciating where they lived.
Estate Note Investing for Long-Term Gains
In other words, real estate mortgage notes investment has an inverse relationship with a housing boom. So we’re experiencing our recession now. There is a limited supply of mortgage note inventory, and prices are extremely high. So when the market turns — and it will — there will be an increase in inventory and a decrease in price.
