Investing in Notes vs. funding Flippers

[Andrey Y.]

Hope this is the right forum category. Hope everyone is having a fantastic weekend so far!

My question is, would you go out and bother to learn note investing, ie. read a lot for 6 months, talk with note investors, etc. versus simply fund a successful flipper for the same 10-12% ROI. With the performing/non-performing note, it is passive until it defaults (if it does). Whereas, funding the flipper you have the added security of the asset (usually better than a $40-50k note which I see 90% of the time), as well as other assets and cash of the flipper.

I am talking about "passive investing". If you could make the same 12% from funding a flipper you trust, or even an established REIT, why would one even consider going the note route knowing there is a small chance you may have the headache of repossession, lawyers, etc.

[Dion DePaoli]

  

If you give money to an operator you will want to secure your money somehow to ensure repayment.  You can do that a couple of ways:

1. Taking equity within the entity (LP,LLC, etc) that will be title to the asset. So the capital injected by you goes into the company and the company uses those funds to purchase and perhaps repair the asset. Then then the cash flow or proceeds of sale will come back into the company and net down to be distributed to the members of the company. An operating agreement will define those disbursements. Any asset held by the company would be subject to the terms of the operating agreement put in place. The investor would rise and fall with the profit and losses from the company. This is like investing in a REIT or fund, the investor gets limited shares of the business.

2.  Taking debt against the property involves giving funds to an operator where the operator grants an interest in the real property by way of mortgage or deed of trust.  The security instrument gives remedies to the lender in case of default but does not grant possession.  

3. Arranging title, such as Tenants In Common or Joint Tenants, to relate to the equity allocation of each owner on title. This would mean that proceeds from cash flow or sale would follow the percentage of ownership defined by the TIC or be simply 50/50 in JT. Possession can be a little hair but both parties own the real property having both legal and equitable title.

None of those three are any more or less involved than the other at inception.  It depends on how you setup the structure with the operator.  As a mortgagee, in #2, you have a limited set of rights as structured in the security instrument.  You do not have possession of the property, no equitable title, so you have a limitation on how you can cure default.  You can not simply go in and start finishing construction.

Similar barriers may be present within the equity route.  That will depend on how the operating agreement is written and what rights or limitations are imposed on the investor and granted to the operator.  If the investor joins the company as a Member, Limited Partner or alike they may not have rights to legal direct the company or assets.  So dealing with defaults or failed disbursements can get complicated.  The resolution will still involved a legal suit.  Probably more involved in pursuing than a foreclosure.  Not uncommon though.  

The title route is pretty straight forward like the mortgage/deed of trust route.  Since you are legally a part owner of the real property you are entitled to proceeds from settlement.  So upon the sale of a property all members on title get a check for their share of the property.  Cash flow is not as straight forward as it can be collected and not dispersed by the operator in which case a suit would need to be filed.  Settlement/Sale proceeds are distributed by the closing agent and those funds do not pass through the operator.

None of these are straight forward solutions to what can end up being a complicated mess upon default.  They each have pro's and con's.  Some investors may choose #1 or #3 to potentially realize more return than a flat rate.  All three can have their own headaches upon breach or default.