Note investing, all or none?

Question

Hi all.  I’ve become very interested in notes.  I know there’s so much to learn about notes but it doesn’t seem worth all the education and relationship building for just a few notes for diversification which is my main goal. Am I relegated to either being a serious note guy or have to settle with note funds for 10ish percent?

Bob Malecki · Answer

Chris Seveney posted a nice overview of different ways to participate in note investing. I run two private equity funds which invest in distressed mortgage debt and our subscribers essentially spread the risk across multiple assets for a reasonable preferred return.

I also have individuals who want to joint venture with me and learn about notes and obtain a higher return although we are investing in a single note which has an essential higher-risk since there's no alternative assets within the venture to hedge that risk.

Another book you should consider reading is Paper Profits which was written by my partner Josh Andrews he provides a good basic overview of note investing and how it works.

Don Konipol · Answer

@John Brennan

Depends on the size of your portfolio, and size of the notes.  When you say a few notes, are you talking about investing in four $25,000 notes, or four $2,500,000 notes?

Investors in our least risky note syndications earn 10 - 12% annually.  We just syndicated a loan that, assuming all goes as planned, will return 19.6% over 7 months, or 35% annualized.  Obviously with somewhat more risk.

On my personal note portfolio side, I am able to average an annualized 18.7% return.  This includes notes I originate as well as notes I purchase at discount to principal balance.  All require some work/effort on my part, although the monthly payments collected are passive.  All are secured by commercial real estate, first position liens.  I don’t purchase notes where I think I’ll end up owning the real estate.

Jordan Blackwell · Answer

Hi John - a good (and common) compromise is to joint venture with someone who already has the education and relationships. You become the money partner, the other one does all the work, and the profit is split 50/50. That may lead to >10% returns as opposed to note funds. Though, either way, I think it still makes sense to get an education on the subject so you have at least a rudimentary knowledge of what you're putting your capital into.

Dave Van Horn · Answer

Thanks for the mention @John Fortes!

A lot of great info above.

It's really a give or take on your time commitment, skill-set & risk exposure (especially for NPN) as well as cost of capital. Something to consider with buying individual notes is, you don't really know what your return is going to be until you finally exit. Like if you get cashed out early, that would really grow your return and it's tough to predict that.

We're also in an upmarket so that could be working against you a bit on the note buying side since prices are up and there's generally more competition with fewer product. Doesn't mean it's not worth doing but something to think about. That's also the reason why many people go into a fund (along with the passive benefits) since it may pay a higher return for the time being.

I personally do both individual note buying (only performing) and invest in note funds.

Ian Ippolito · Answer

@John Brennan , you said your problem is that you really don't want to learn everything about note investing. Unless you don't care if you lose money, my personal recommendation would be not to proceed on your own and instead hire a professional manager with that experience. Yes you will have to pay them a modest fee.  But it can end up being a lot cheaper than making expensive mistakes on your own.

Also, I think it can be incorrect to assume that purchasing on your own is going to give you a significantly higher return (5%+ more) than a fund. You can find a fund that specializes in almost any strategy, and there are plenty their engaging in riskier strategies (similar to the riskier individual notes you can buy) that yield much higher than 10%. The only difference is going to be the yearly management fee and any profit sharing that the fund manager takes. If you choose your fund well, this should not make a life-changing difference.

I also think you are comparing apples and oranges when you are comparing the actual yield achieved on a fund with the projected yield of purchasing an individual note. That individual note has a chance of ending up with a significantly lower than advertised return, if something goes wrong. A very short and not even close to inclusive list of things would be: late payments, the time and effort of going through foreclosure, rehab of the property to make it saleable, paying the taxes, paying a broker to resell, etc.). And presumably you don't know the difference between judicial and nonjudicial states in regards to note investing. If so and you have happened to have selected a note in a judicial only state, all those foreclosure costs are probably going to be 2-5x higher and take perhaps a year or more longer to finish. This is why the projected return of one is not the same as an actual return of the other.

Chris Seveney · Answer

Here is a breakdown for simplicity:

Fund - Pros are large quantity of assets = diversification and lower volatilty. Downside is returns are limited and depending on Fund may need to be an accredited investor. If you want 8-10% and do absolutely nothing, then this could be for you

Buy a Performing Note - Returns 12%+/-, higher risk as if default will you be able to manage it and returns will be lower.

JV - For performing these are always challenging because the sponsor will want their share for managing.

Partial - This is where you buy a stream of payments at a set rate (6-10%). Besides a fund this would have the lowest risk. Upside is fixed. Typically they are still managed by the Sponsor and Sponsor and depending on deal in most instances sponsor is also responsible for any additional costs. Best way to look at this is similar to a hard money loan against the note. While it is very different the way it functions is similar.

Account Closed · Answer

10% with little work and less risk is not bad

Jason Graves · Answer

@Chris Seveney

Im an accredited investor.  What funds are you talking about specificity?

Christopher Winkler · Answer

I am sad to hear you have had such problems Patrick, we have discussed some of them, though I a preparing my presentation for Noteworthy 2019 this Saturday in Newport Beach and my numbers are 56 non-performing notes purchased personally and with one-off Joint Venture partners in 4 years, 31 worked out for a 34.85% ROI.

When we look at the last 3 years after we switched to Junior liens, we purchased 36 non-performing notes, worked out 15 for a 56.42% ROI. That is why we decided to go big and launch our first Regulation D, Rule 506(c) fund for accredited investors so we can purchase them at better prices and escape the retail bidding wars that have caused most of our bids from last year to not be awarded.

I feel it can only get better with lower lending standards, and foreclosures starting to increase. I hope you can get your mojo back!

Patrick Desjardins · Answer

My outlook has changed a lot. In the past I would have said go for it, either performing or non performing notes. Good returns, worth learning.

After getting hurt by legal fees and countless mistakes from "professionals" in the industry, I would say stick with performing loans. The knowledge barrier to entry is small and the returns are still very good. NPNs not worth it right now.

Note investing, all or none?

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