Sell rentals to invest in real estate secured notes?

Question

I currently own 2 rental properties in a very good rental market and market with a very limited supply of homes on the market (seller's market). I have been wanting to get into the note investing space for about a year now. I am finding that with a turn-key company the bare minimum to invest is usually $25,000. My wife and I have been on a debt reduction crusade the last few years so every extra dollar we have goes to paying down debt, therefore I haven't been able to save up to invest. My thought was to sell my current rentals (while market is hot) to be able to pull the needed money to invest in real estate secured notes. I am looking for some analysis tips to be able to study if I should stay with the rentals or sell them and invest in what I want. Specifically, I am having trouble putting a number on my return from the rentals because I have $0 into either of them, so therefore my cash-on-cash return is infinite. Any suggestions on how to compare the two investments side-by-side? I am an accounting geek so hard numbers seem to sway my decisions (probably sometimes more than it should!) Thanks in advance!

Patrick Desjardins · Answer

It's not clear from your message what your objective is. You mentioned that you're working on getting out of debt which is great. Note investing is excessively cash intensive - to the point where the only way to grow is to use OPM. Unless all you intend to do is find loans to foreclose, you're going to run into a lot of note deals where all the expenses are front loaded (buying the note, servicing fees, legal fees, insurance, etc) and you get paid long term as part of a workout agreement.

If you're getting infinite returns from your rentals then keep them. They have better tax treatment than notes and will provide you with a solid base. If you're excited about the shiny object that is notes, save up the 20-25k and then do a JV with an experienced note investor. Just don't sell good assets to jump into a niche industry you know very little about.

If you started out with a 100k IRA or something then dropping landlording to start investing in notes would be fine. It's just not a great investment vehicle when you need to save enough to buy "one" note which may turn out to be a stinker.

Bob Malecki · Answer

I would agree with Patrick's perspective. Your rentals are providing you a good tax deduction and if your expenses and/or cost of ownership is low, then keep them in your portfolio. If you are a tired landlord and don't need the tax savings then sell them and buy notes.

Ideally you may want to have some rentals for tax considerations and notes for income/ease of management both in your portfolio.

Bob

Bob E. · Answer

If you want to get your feet wet try buying some from end payments, maybe 2-4 years worth of payments on a 10-15 year note.  You can ask for an option on the balance and you will get a chance to test drive the process at a much lower cost.

We hel[ed one friend do this last year when they bought 12 payments from us, they are now getting ready to roll that over for a longer period.

Mark B. · Answer

Looking at the long term (15-30 years), if you put you money in notes the notes, as they pay you back the notes eventually don't exist. You can reinvest the receipts into new notes, but you may need to build up enough cash to do that. What are you going to do with the cash in the mean time (possibly pay down debt). As the note ages, it be comes worth less because, likely, there will be inflation and it will be paid off at some point.

With the rentals, they will (hopefully) keep producing cash long term, way more cash in the future with inflation (probably). Not sure how your debt is structured so I'm going with an assumption here, but have you considered a HELOC on the rental to consolidate and close other lines? The rate may be much lower. The important thing is to close the other lines if you are leaving debt behind forever (not everyone agrees with that - but I respect that position a lot).

If you really need to scratch that note itch, possibly drop a few thousand on a non-performing second and try to work it back to performing (many resources here-just follow the laws, onboard with a server even if you are going to the grunt work!). Just seems like you are in a stable cash producing spot which could be easily upended when you are transferring a (it seems like) substantial portion of your equity to something that is untested for you.

Mark Nolan · Answer

Investing a solo 401k in notes and real estate is a good idea. Also, don't put all your eggs in one basket so considering investing in some equities and precious metals as well.

John Thedford · Answer

That is a tough decision. There are advantages to both. Holding RE long term can be great for appreciation, cash flow, and great tax advantages. It can be intensive if you manage them yourself and can drive you nuts with the wrong tenants. Notes, on the other hand, can return great numbers, give you no tax advantages, and are "toilet free" investments. I do both. I hold RE for cash flow, appreciation, and generous tax treatment. I hold notes inside my SOLO 401K for income for retirement. If you are young, I would probably consider working toward both goals. Continue to hold the RE as long as the market appears to be in your favor, and work towards notes as well.

Bill S. · Answer

@Austin S. the way to analyze/evaluate opportunities against your rentals would be return on equity. For example, if you have a rental that is worth $250,000 and you have zero of your own money in it but you owe $200K on it and it rents for $1,500 per month which nets you $250 per month (after taxes, insurance, mortgage, management, and maintenance). This returns you $3K per year on your $50K of equity. This gives you a 6% return on the equity. So, in theory, anything you can do with that $50K that makes you more than 6% is a win. My numbers are fairly crude and so you should be careful to consider all expenses. This does not consider appreciation which can be significant in your market. In your case I'll use 10% appreciation which adds another $25K in income so you now have $28K of income on $50k of equity or 56% return. Much tougher to find something that will do that.

Dean Dubach · Answer

Austin,   As the others have indicated, notes are front loaded, and capital intensive investments.   I switched to notes due to the lack of inventory in the Denver area, so I feel your pain.

Based on your picture, it looks like you might be a young couple, so even if you don't need or cannot use the deductions today, I believe they carry forward.  You can let them build for a bright sunny day when your situation changes,  consult with a tax professional, I am not.

If you are a tired landlord, figure out a way to hand that work off to others.  Get a good  property manager to take over the day to day operations.  Let them take the middle of the night calls, finding contractors to service what ever broke Friday night, etc..

Expect to pay 10% of the rent for a good manager, but mine are worth their weight in gold.  I'm in the Denver area, so my property manager that I love doesn't service Sterling (I assume the properties are local).

Check Craigslist for rental listings, see if you can find a couple of property managers in the area, don't be surprised if they are part of a real estate agency.   Check references, with other RE investors, etc.   Bad property managers cost you money, just like bad tenants.

DenverDean

Joshua Andrews · Answer

This is sound advice.

Josh

Sell rentals to invest in real estate secured notes?

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