Mortgage Note Investing

[Mike Colucci]

Hi everyone, I'm currently in the market for performing institutional first position notes, but I'm not sure where to start. I have Dave Van Horn's book and have listened to it twice, but when it comes to actually taking that first step, I'm lost. I was considering using a broker, but if I do who should I use, and do they do the due diligence on the notes I buy or do I? I found a website that explains the process in detail here: https://notevestment.com/note-... , but again the info is like tying to drink from a fire hose. I would definitely need help doing the due diligence process as I've never had to do anything like it before. Thanks.

[Edwin Epperson]

@Mike Colucci may I ask why you are interested in institutional notes?  

For clarity, when you say institutional, do you mean consumer?  Meaning you're interested in buying performing notes where the note is collateralized against a personal residence?  If so there are several considerations you may want to consider...

#1: Depending on the state there may be licensing requirements. There are actually three types of licenses required in the note investing space. A lender's license, a broker's or loan originator's license and a "bankers" or servicers license. Each state has requirements and they can vary significantly. In some states, you are required to have a broker's lic but not a lender or a servicer lic. In some states, you may need a license long as the asset is a SFR while if the asset is commercial no license is required. In other states you need a lic, but not if the borrower is an entity (LLC or Corp for example). Knowing the lic. law is important. For your requested investment type you should look at a "bankers" lic or servicing lic. If you are investing in FL, you can service up to 10 loans secured to personal residences without a lic, but the law is very vague if that's at one time or over your entire investment time.

#2: Institutional loans are what we in the industry refer to bank or credit union loans.  The problem with that is most banks/credit unions package their loans up and sell them on wall street as MBS or mortgage-backed securities.  You cannot individually pick loans to invest in, you have to invest in the MBS as a whole.

#3:  Especially in FL, should the performing note turn non-perfoming you would have to wait a VERY long time to foreclose and take the asset back, and that's if it's not contested.  If the Homeowner hires an attorney you could be looking at years of litigation, which could very well eat away all your equity or assumed equity in the asset

#4: Speaking of equity, if you somehow do manage to purchase an institutional loan the amount of equity would be negligible, probably less than 20% maybe as low as 3%.

You should also be aware of your intended goals behind investing in notes.  Is it cash-flow or is it with the hopes that your mortgagor will default and you will be able to get the property back at a discount and capture the equity?  If it's an equity play then please refer to the concerns above. If it's cash flow then you may seriously consider investing or "originating" investment loans. Originating or creating the loan, specifically an investor loan offers several risk mitigation capabilities that are simply not available in the owner-occupied space.  

#1: Originating investor loans, typically means you are lending to an investor, and savvy, experienced investors (like plenty found here on BP) buy properties and request loans for those properties using their LLC. In the eyes of the federal government and most states these types of loans are considered B2B or "commercial paper", and the rules are very relaxed. The assumption is you're a business making a loan to another business and therefore the owners are on the business owners to be sophisticated enough to determine the risk-to-reward of that obligation, your loan.

#2: In most states, there is no licensing requirement for making a loan to an entity, regardless of the asset type.  This is NOT universal so you will have to do your own research.

#3: The ability to control risk yet generate a great return are phenomenal in this space, as most loans are interest only and short term.  Meaning your capital is only exposed to the market for a very short period of time < 24 months, and the shorter the time the less risk you have to the housing market fluctuations.  I typically make loans in the <12 month range and I'm very confident in my underwriting.

As to your question about brokers and working through brokers, you will have to be aware, very much aware, of the broker you may decide to work with.  As @Chris Seveney pointed out a broker is NOT looking out for your best interest as the lender/ servicer.  They are only pushing the deal to close because they will get paid points when it closes.  If it doesn't close they get paid nothing.  As a newer note investor you have to have the ability to sift through the BS and make your own determination on whether the deal is a good deal or not, ask me how I know .... smh.

At the end of the day there is an incredible world open to those who are willing to take up the task of studying and becoming a note investor/ private lender.  Another option I recommend to any new note investor is to simply partner with an experienced lender and ask to participate in a fractional note.  This is the way that I lend.  Happy to have a conversation about some lessons learned and best practices if you would like.  best wishes and much success.