Discount note investing durring different market cycles

[Tom Dillon]

I've always been a fundamental real estate investor, buying single family homes in Austin after the stock market dot com crash when foreclosures were plentiful and renting them until the market came back. Moving into value add apartment buildings in Arizona and Texas, after the 2008 crash, when prices were dirt cheap. 

As the market recovered, and building became cheaper than buying, we went into some new development deals. 

Now prices are high and we are selling into demand taking profits. So capital is coming back. Great! right? Well kind of. Capital doesn't cash flow by itself, and a CD isn't going to keep up with inflation let alone give a return.

So what to do?

I'm exploring discounted notes. Looking into PPR's Note Fund. 

Is it a bad idea to invest in notes with the market heading into higher territory? Is there enough of a discount built in, to protect my capital and still cash flow through a market correction?

Looking for input, thoughts, experience.

[Andy Mirza]

@Tom Dillon Yes, my strategy was referring to 1st liens although you could make it work for 2nds in certain cases. You can foreclose as a second lien holder and make payments on the 1st. I've seen some investors do this successfully and have positive cash flow. Over time, you'd be paying the principal on the 1st increasing your equity and return. It's not our strategy, though. The idea of foreclosing on a 1st and renting the property out is at the end of the option list. But at least it's an option in case we need it!

The 1st lien is entitled to collect all funds up to the total debt that's owed. Any excess proceeds go to the next lienholder in order of priority (2nd). Any further proceeds go to subsequent lien holders in order of priority. (3rd, 4th, etc.) Anything beyond that goes to the owner of record. It doesn't go in reverse i.e. if a 2nd forecloses, the excess proceeds go to 3rd, 4th, etc, owner and NOT to the 1st.

Examples:

Underwater

1st Lien                                 $100,000

2nd Lien                                $100,000

The 1st forecloses and the property sells for $150,000 at auction. The 1st gets $100,000, the 2nd gets $50,000, the former owner gets 0.

____________

Equity

1st lien                                $100,000

2nd lien                              $100,000

The 1st forecloses and the property sells for $250,000 at auction. The 1st gets $100,000, the 2nd gets $100,000, the former owner gets $50,000

_____________

2nd forecloses, Underwater

1st lien                              $100,000

2nd lien                             $100,000

The 2nd forecloses and the property reverts to the beneficiary (2nd) because 99.9% of bidders will not bid more than market value. The 1st is owed $100,000 and the 2nd becomes the new owner of record. The prior owner gets nothing. The 2nd needs to keep payments current on the 1st or the 1st may foreclose