Are Notes/HML the right approach for me?

Question

Hi all,

My "real estate goal" is very straightforward - I am looking for an approach that can yield a 6%+ annual return with as little active work and time as possible, after a learning period (of up to 5 years).

By 6%+, I mean risk-adjusted, not nominal. I also prefer stable income streams rather than volatility, otherwise I would have just stuck with equities. I am not looking to maximize my returns or strike it big. Just looking for a nice income stream business that I can run on 5-10 hours a week or less and ideally remotely. These qualifications are what led me to thinking about notes/HML as opposed to hands-on flipping or even landlording, which take up more time, stress, and hands-on activity.

I am also looking for an approach that can be successfully executed with less than $500K starting capital. Not sure if that is too low for notes or HML given the lack of diversification. One thing I learned from my finance days is that it is all about dversification and spreading your credit risk amongst as many uncorrelated counterparties as possible.

So with the above said, is note investing and/or HML something that could meet my return and time commitment goals? Am I barking up the wrong tree?

Thanks

Bob Malecki · Answer

Got it, I was referring to NPLs which have a much more aggressive upside when reworked for performance.

Rob Cee · Answer

Bob it depends what you mean by "decent value".  There are portfolio and larger national HML's that sell performing firsts in major metros of CA & WA at low LTV's.  But you are not going to get 15%.  More like 8-10%.  But you also are getting a note that is performing right now,  no headaches and don't have to do any collections and deal with deadbeat borrowers or have collateral on your notes that is low cost houses in rougher parts of the South and Midwest.  It depends what you are looking for.  OP was talking more about passive investing.

Bob E. · Answer

@Bob Malecki hit the nail on the head.  The main thing is to make sure there is some equity in the note.  Keep in ming if the borrower defaults and you get the property back there is likely to be some deferred maintenance and other costs.  For lower price band assets I like to look at neighborhood rents.  That way,if I get the asset back I have the option to rent it out and sell to an investor.

Bob Malecki · Answer

Vik, I think Bob E.'s advice of buying performing or re-preforming notes would be your best option if >6% is your goal. These are typically longer term than HM loans and if performing you should see at least 6 months of seasoning more preferably 12 months or more. There are many note buyers like my company that buy distressed residential mortgage debt then rework the loans with the borrowers into reperformance. We then sell them off after  a few years to recapitalize our funds to acquire new assets and 'rinse & repeat' so to speak.

Other than underwriting the collateral and seasoning on the note, your risk is having the borrower stop performing. Typically you will have your note boarded with a servicing company who will work with the borrower or pursue foreclosure on your behalf if things go sideways. It can be a very "hands off" way to get decent cash flow once you have your vendors and contacts in place.

Bob Malecki

Vik C. · Answer

Thanks all for the interesting discussion and helpful feedback.

Bob Malecki · Answer

Absolutely, and definitely not for the passive investor. A classic portrayal of risk vs. reward for sure.

Originally posted by @Jay Hinrichs:

@Bob Malecki

and of course a good deal of effort on your part... I think the OP wants passive.

Jay Hinrichs · Answer

@Bob Malecki

and of course a good deal of effort on your part... I think the OP wants passive.

Bob Malecki · Answer

I've been buying NPLs in my self directed IRA account and getting them modified for reperformance and cash flow for the past year. Good luck finding anything of decent value in WA,OR or CA.. The lenders tend to keep those on the books or the larger funds will keep them rather than sell downstream to the smaller investor.

I'm also starting a private equity fund with a very seasoned note partner to raise private capital to buy distressed mortgage debt to get loans reperforming for cash flow on a larger scale. When buying single assets I pay a relatively premium price and the pickings are slim, when buying larger pools we will be able to get better pricing and selection.

Bob

Rob Cee · Answer

Vic there are also a lot of HM lenders running funds you can invest in if you are accredited.  This is truly passive and "set it and forget it" way of investing in HM loans and takes zero time other than your initial due diligence on who is running the fund..  A nice plus is you can automatically re-invest the interest income and get the effects of compounding easier in a fund.  With the rule of 72 at 10% your money doubles every 7 years.  With funds you also have ALL your money invested ALL the time earning %, vs. when you fund individual trust deeds (like myself) there are times when you money is on the sidelines not earning any interest while you wait to find the next loan to fund.   You would have to do a lot of research on the fund manager and make sure they have a long track record and have been though multiple market cycles.  I have not invested a HM fund myself because I'm a control freak with my money and have a lot of trouble trusting others and turning money over to them:)  But I'm sure there are some very solid ones out there.

Rob Cee · Answer

Hi Vic,

I'm in a similar situation to you looking for passive investments that are not J.O.B's.  Right now I fund HM 1sts though HM brokers who source the loans for me and I make 9-11.5% depending on risk, all on the west coast.  Use both SD IRA money and cash in bank.  I fund the entire loan myself, no fractional.  So I get to make all the decisions myself during defaults.  I do both loans on flips and rentals..  There are pros and cons to long term vs. short term loans.  Long term loans mean you don't have to always go out and find the next deal to fund.  But over longer periods borrowers can get themselves into more difficulties (BK) and deferred maintenance can happen.   Short term is nice because your money is not locked up that long in case new investment opportunities arise.   It does not take a lot of my time.  When a new opportunity comes across my desk and have to put some time into due diligence.  Most important is the property valuation.  There are some garbage appraisers out there just trying to get valuations to come in so the deal works for the HM broker.   You need to really look closely at many, many facets of an appraisal and possibly pay for an appraisal review by someone YOU hire.  To me the valuation is the #1 thing you need to be good at to protect your capital.  You may think you are at 65% LTV but really be at 75% if the appraisal is inflated.  There are also good and bad HM brokers.

I very recently started looking at buying existing performing 1sts in addition to HML.  I may only want to buy performing 1sts in non-judicial foreclosure states in the west coast, probably only in major metros in CA or WA for me personally.   I am in the very beginning stages of looking at investing in performing firsts so I know very little about it.

Does anyone else out there invest their own funds in performing firsts right now?  What types of returns do you get?  What states?

I'm not looking at NPN notes right now because that looks more like a business (J.O.B) vs. an investment.

Are Notes/HML the right approach for me?

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