Should I Invest in Performing Notes?

Question

Ok so here's my scenario.  Would love some feedback on whether a performing note would be the correct option for me.

I'm in the process of opening an SDIRA.  My first investment in that will be a rental property which I'll be buying for cash all in at ~$80k.  I'll put about $8k into some low expense ETF's to hopefully earn a little interest but more importantly be usable as an emergency fund for the rental.  I will have around $50K left in the SDIRA so this comes to the my question.  Should I invest the remaining money into a performing note?  Or should I put that $50K into low expense ETF's while looking for another good rental property to purchase at a later date.  As a side note I'll still have ~$40K in my Betterment IRA investing in stocks so I'm not putting all my eggs into the real estate basket, just a majority of them :).

Jay Hinrichs · Answer

why would you buy a rental in a SIDRA  you lose the depreciation benefits.. which is one main reason to buy a rental in the first place.. notes are the best vehicle for retirement accounts.

UNLESS you think there is going to be some VERY significant appreciation at play  ..

you may want to talk to your accountant before you do that.   for fixed assets I have bought timber land in Oregon in my SIDRA and that worked great..  and I like the IRA for a syndicated investment as well were the real goal is upside in 5 to 7 years.. which folks are HOPING for.. :)  but a 50k rental on its face is usually in a market with little to no appreciation and a lot of expenses to run it..

Bob Malecki · Answer

Hi @Eric Schwake I think a performing note in your SDIRA would be a good option since the interest income is considered ordinary income not taxed assuming a Roth or deferred if not a Roth. You may want to run an analysis on leveraging the rental as to what your net ROI would be after paying UDFI tax on the leveraged portion. If positive you could redeploy that capital into another asset. Just a thought.

Bob

Bob Malecki · Answer

Well, @Eric Schwake, other than the tax advantages for rentals, collecting a mortgage payment from a borrower is like having a tenant who pays you monthly, doesn't ask to have anything repaired, does not move out and require you to turn over the property,  and keeps really good care of the home (mostly).

Eric Schwake · Answer

I really appreciate everyone's advice.  It's really been helpful.  I think the way I'm wanting to go currently is with a rental property like I mentioned and then purchasing a performing note.

Natasha Hunter · Answer

You have some great responses here already but I will chime in. It's great that you're not putting all of your eggs into one basket. I think buying a performing note would give you extra cash flow at a great return. You wouldn't have to worry about the management of the asset because you own the debt, not the house. When the buyer decides to sell, you will reap in the remaining balance all at once which will possibly give you enough to get into another flip if that's what your investment vehicle is. Performing notes are truly passive as your servicer handles most of the work and you just collect the check. You also don't have to use all of your remaining funds to purchase a note. You can find notes that are cheaper than $50k and still give you great returns. This may allow you to diversify a little more while still exploring the note industry.

Jay Hinrichs · Answer

Notes done right do not have expenses in 20 years you will need to replace all major systems in that rental to have any value.

just food for thought..   notes again done right will easily cash flow better in an IRA than rental houses..

Appreciation aside.. of course..  but again talk to your accountant about this..

Eric Schwake · Answer

@Jay Hinrichs I've run some calculations on the property I was looking at and it looks like I would bring in around $600-$700 month after expenses.  Would you think that's a bad thing to invest in within my SDIRA?  I obviously don't know how much appreciation I would get out of it but I'm 40 so I can't touch anything in the SDIRA for at least 20 years so I'd hope it would appreciate some by then as well as hopefully getting small gains in rental income over time.

Should I Invest in Performing Notes?

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