What kind of investor are you? Active or Passive - Property or Paper?

Question

For years I only purchased rental properties.  I own many now.  Some are good and some are not so great.  The last two years are the first two years in twenty that I made money overall on my rentals.  I'm hoping the headaches will pay off at retirement?

Over the last five years, I started buying mortgage notes instead of rental properties.  I've enjoyed this type of investing more than owning properties.  I've realized that even though I'm elbows deep in real estate every day with my lending business, as an investor, I would rather buy passive real estate investments and not deal with the tenants, toilets or trouble.

I'm wondering how many people are like me?  Which type of investing do you prefer and why?  I would love to hear from people that own properties and mortgage notes to see which they prefer and why.

Paul Birkett · Answer

Like most people I started out in RE. I was buying SFH's and renting them out. It was a great business. I bought most of the homes in 2010 and 2011 in nice areas in AZ and FL. They rented fast and were a nice sideline to my day job. Then the problems started!

After about 40 units I found it very tough to run it as a sideline (even with managers in place). Weekends disappeared under a pile of paperwork. It became a drag. Then, as values improved my initial 10% - 12% cap rates fell to 9% then 8%....rents were not keeping up with capital values.

So I started buying in PA...lured by low prices and high S8 rents. Well, 10 of those babies will truly break your heart! High cap rates, even higher stress rates!! There was always something going wrong. Usually there were many things going wrong.

About 3 years ago, we started buying notes. The downside: there is a ton to learn...its 5x more complicated than flipping or buy and hold (especially if you opt for second liens and non-performing loans). The learning curve is steep and took about a year of hard work as I sold off the SFH and other RE investments.

The upside: it is much more scalable and produces much higher returns if you work them hard.

I'm delighted that Im down to just a few RE holdings now and we have purchased 10x the number of notes in half the time it took to buy the SFH's. Notes are the future for me. It's not entirely passive -  but I think its the best option. Long term cashflow backed by a hard asset at very low LTV with almost no borrower contact. What's not to like?

Joel Owens · Answer

It's all relative to your skillset.

Personally in the last few years I do not like all the regulation that has been placed on residential notes.

It seems that commercial and business notes would have more room for creative structuring.

I love commercial real estate but it is what I focus on daily. What an investor deems as a viable strategy will depend on your funds.

Someone with 100k to invest will be very different from someone with 10 million etc.

When you get into larger assets with national tenants it is pretty much passive. You look at a management report once a month and occasionally make decisions. The companies that are PM have decades of experience and systems in place.

If you were comparing notes  to dumper starters house with newbie management PM's and high maintenance tenants then I can see notes being the better option there in some situations. What someone likes for 1,2,3 reasons can be the exact opposite of what another investor can't stand.

Dawn Anastasi · Answer

If you only made money just the last 2 out of 20 years, then I would question the kind of rentals you have.  I try to go into my rentals making money every year.

Jay Hinrichs · Answer

@Darren Eady

I think the answer to the question lies in whats the easiest to understand and obtain.

when folks start to think of RE investing the idea of owning a rental is the most common form of RE investing its the easiest to understand and the easiest to get into. Its the same transaction basically as buying your personal residence and most investors have done that.

I think back on my many years in the Note business and in the rental home business.. What I see is a progression.. many note investors start at rental houses then gravitate to Notes especially if they are straight forward.. IE investing with a very GOOD local hardmoney lender or other easy to obtain notes... The investor that starts with rentals and stays with rentals will over time want to be like @Steve Olafson Better quality multi family or commercial as they soon get burned out on SFR's ( again only talking about passive investors not investors that own SFR's for a living like a @Dawn Anastasi)  or many others.

And buying paper to reposition is a very high skill level endevour so I don't see that as passive at all... Like @Bob Malecki talks about.. there is a reason you get the nicer returns you need to be very smart about what you buy and know the laws inside out.

As for tax advantages  owning a few mid priced rentals I don't believe throw off enough in tax advantages to make that a part of the equation.. if you own 50 to plus door then I see that.

I personally see the Crowd funding when the new rules come into play as a huge option for the person who would consider getting started in RE with a low priced rental IE under 100k rental. The investor can get in on short term notes with not a lot of exposure and make as much if not more than owning the asset.

Risks:

Notes:

Note buying risks are your payor stops paying and you have to foreclose this could be worse than a bad tenant. but only a one time event usually... Again why you have to pick your HML or your notes carefully and it is more complicated up front than buying a rental house.

Rentals  ( SFR I will use that because that is the majority of the rentals Bp folks buy)

Risk are on going management issues.. Learning curve... buying in a market were the values never go up thereby leaving you with little to no liquidity. Once you own it you own it. And to sell will most likely produce a loss... Were as a seasoned note will sell for what you paid for it if you chose correctly in the first place.

Darren Eady · Answer

The notes I purchase are three year notes at 12% minimum return, so inflation doesn't really play much of a part in that.

Ali, some of my rentals are much like your hassle free rentals, but some are not.  Be glad you've found a great situation for your investment properties!

Andrew R. · Answer

I am largely passive in that I own owner finance properties mostly. The only down side with it that I have found is it takes time to find a quality buyer. Other than that, I love it.

Rob Cee · Answer

This is a very good post.  So many people on BP sugar coat things to make them sound easy (especially if they are selling something or promoting something), and so many people talk a lot about their wins but you rarely hear of their losses (or all the work that went into the wins).  Paul's response is much more honest IMO.

Bob Malecki · Answer

Actually, if you buy the note at a good discount below as-is value and you buy in a market that is stabilized or appreciating, foreclosure may provide more profit than the cashflow from the interest payments.

I agree with Paul Birkett's perspective on owning notes vs. the asset, less ongoing operational overhead and very scaleable. None of my borrowers have ever called me to get their toilets fixed either............  ;^)

Marco Santarelli · Answer

@Darren Eady  --  Good question here.

My personal favorite for many reasons are income-producing investment properties.  Performing notes can be good if the returns are there but they are taxed differently than the income from investment-grade property.

Both can be considered "passive" although there is no truly passive investment.

I always opt for property over paper, and we suggest our client to do the same.

Continued success!

Patrick Desjardins · Answer

Another is that notes don't hedge you against inflation unless you're actively trading them up. The nice $500 payment today will be the not so great payment of 500 25 years from now (assuming no sale/refinance). Meanwhile rents should have increased considerably in 25 years.

Both notes and real estate have their place in a passive investor's portfolio.

What kind of investor are you? Active or Passive - Property or Paper?

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