“I want to get into mortgage notes”. But what does that MEAN

[Don Konipol]

I hear this all the time.  But what is the potential note investor actually asking?  The mortgage note field has a lot of different aspects

In general, one way to divide the note field is between people in the note business, and people who invest in notes.  Many successful people actually do both.  For people in the note business there are two basic ways they run their business.  One is a note broker that is a third party intermediary, just like a real estate broker, a stock broker, etc.  The note broker will attempt to set a purchase price for an existing note being sold, then turn around and set a higher price with a buyer for the sale of the same note. He never actually owns the note nor does he expend any of his own capital on the purchase.  A slight variation of this is  the broker that sets up the note sale for a fixed price, and receives a commission from either or hopefully both parties.

The other way brokers operate are more like wholesalers.  The intermediary will actually purchase a mortgage note using either their own capital or a line of credit from a banking institution or private equity/hedge fund.  In a variation the intermediary will bid for loans packaged or bundled together for sale, and if successful in winning the bid turn around and sell the notes either individually or in smaller bundles, of course at a markup.

For people who invest in notes I like to classify them as to where they appear on a scale ranging from active investors to passive investors.  Active investors will “work the notes” once they purchase them.  If they purchase a non performing note they’ll either work to make it “reperforming” or work to secure a foreclosure and gain ownership of the property.  Some investors do this to resell the property usually to rehabbers, though some do any needed rehab themselves and will sell it to homeowners, often carrying back financing for the buyer.  If and active investor purchases a performing note, they’ll work to increase the “yield”, often by offering reduced principal for increased monthly payments.  The “working” of a performing note to increase yield is possible because these notes are often purchased based at a significant discount to remaining principal balance.

Another type of active note investor will create a portfolio of notes by creating the note; either through originating hard money, high interest loans, or by selling property with seller financing.  In my experience this is not as profitable as purchasing notes at a discount to principal, especially a LARGE discount, but with the note market being what it is with discounts on performing notes hard to come by, creating or originating loan may be the best way to build a good size portfolio.

On the more passive side of the note investor spectrum, there are investors that purchase notes through note brokers or note originated by hard money lenders.  These investors are usually looking for a high return on investment, and are willing to learn about real property, mortgages, etc to knowledgeably invest. There more passive cousins tend to invest through note funds, leaving the purchasing decisions to the fund manager, and hopefully receiving a passive monthly income well above that offered by banking or money market funds.

If you’re a note investor, or in the note business, (or want to be), I’d love to hear how you invest and how you hope to invest in notes in the future.