What is the best way to invest in notes with a partner?

Question

Hi guys....I am interested in moving from the buy and hold side of real estate to investing in notes. I've been researching and studying and now ready for action. I have an investment partner who does not have the time or interest to commit to research or maintenance. What is the best way to structure a note partnership? Should I just create an interest rate arbitrage and borrow at one rate with the idea of getting a higher return? JV agreement? 50/50? What kind of exit strategy do I plan on with a partner? What if the note goes full term, how do I pay out my partner?

If anyone has any thoughts or ideas on the matter, fire away! Thanks guys!

David Faulkner · Answer

This idea is a disaster waiting to happen IMO ... if you are new to notes, then learn on your own dime and become an expert before even thinking about taking on investment dollars from a partner. Being a buy and hold investor in no way, shape, or form prepares you to be a RE notes investor ... it is not just a completely different investment, but a completely different asset class. If you wanted to put your money to work as the investment partner to an experienced note investor and ride shotgun to learn along the way, that would be a different thing entirely and not necessarily a bad idea. However, taking investor money while you learn how to invest in a new asset class is NOT a good idea IMO. Starting out, you will make mistakes, and those mistakes will cost money, only it will not be your money that is lost but another investor's money, and then you will have to go back to them and explain that you are sorry that you lost some of their money but you don't really know what you are doing yet, or more likely go back to them and try to make up excuses for why it isn't really your fault and how were you to know that would've happened, when an experienced note investor would've seen it coming from a mile away and avoided the situation. Literally just yesterday I was chatting with a fellow investor that got themselves in a similar situation as the money partner with an inexperienced note investor as a JV partner ... it does not end well, trust me.

David Faulkner · Answer

I don't proclaim to be a note expert either, but I would say it depends on your risk tolerance and return expectations. Having said that, you don't yet know what you don't know, so there is some wisdom IMO to starting out in performing firsts ... do that long enough and a few of those performing notes will turn non-performing, and that is how you get your experience there. If you do start out with non-performing, I would stay in 1st's and compute your expected returns based on foreclosing on the property and resale rather than assuming you will be able to pull off a work out with the buyer, because statistically that is the most likely exit.

Bob Malecki · Answer

I agree with @David Faulkner, learn on your own dime then consider taking on capital partners when you have the expertise to facilitate the processes needed to create profit for you and your partner. To address your question, typically a profit split of 50/50 is common, other sponsors may arbitrage the note, borrowing capital to purchase the asset then pay the lender/partner a fixed rate of return and keep the difference from the interest earned on the performing asset. Bob

Andy Mirza · Answer

@Eric Hyde I was in a similar situation to you. I wanted to invest and didn't know how. I had a partner who put up all the capital to buy rental condos. I did all the work: research, acquisition, rehab, transition to property management, and ongoing, overall management of the portfolio. Made my partner a lot of money and built trust. I dipped my toe into notes by developing a relationship with someone who was a full time note investor. My original partner put up the capital. We did and continue to do very well on those notes. (We bought 2nd's at a great time and those deals aren't easily available anymore.)A found another seasoned note investor and my original condo partner funded our deals, all 1st lien NPN's and reperformers. These have been going very well. I get a share of the profits but I've learned a tremendous amount in the last few years, which has been fantastic.The warnings above are on point. You can lose a lot of other people's money if you're not careful. I got lucky in that my original partner is an experienced investor who is careful about how he invests his money and that we had equity in our rentals in case we ran into problems with our notes.

Eric Hyde · Answer

@David Faulkner and @Bob Malecki what advise would you guys give regarding first liens vs. second and also performing vs non performing? Remember, I'm new to notes....

Eric Hyde · Answer

Thanks @Bob Malecki. I knew your name sounded familiar! Lol....great podcast! Thanks for the insight.

Eric Hyde · Answer

David Faulkner I think you're right. I have the money to do a couple notes but I'm also looking down the road and want to learn the best structure with a partner so I can jump when the opportunity arises. Thank you for you're feedback.

Eric Hyde · Answer

Probably performing to start is my thought. I'm still learning which strategy fits my style.

Dennis Weber · Answer

Performing or non performing?