Buying non-performing notes to purchase real estate

Tax Liens & Mortgage Notes
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Buying non-performing notes to purchase real estate

John Havel
Member since 2020 · 10 posts · 1 vote

Recently heard about buying mortgage notes and it got me thinking about potentially using this strategy in the future for acquiring real estate. Anything you can tell me about this especially in the case of non-performing notes would be extremely helpful in my education on the topic. 

The main thing I would like to know currently is how the process would work in the case that you buy a non-performing note and foreclose on the note. Lets say your goal in buying this note was to acquire the property at a discount for a buy and hold rental situation.

If you own the first lien but there are other liens on the asset and instead of selling the asset decide to keep it are you as the new owner now on the hook for the other liens or is the person who the liens were against on the hook? 

What if you are a second lien holder and foreclose how would that work if there still exists a first lien?  

Is it even possible or worth it to foreclose on the property in this case? 

What other pitfalls might there be to be aware of in this investment strategy?

Again any information would help immensely.

John Havel

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Jamie Bateman
Investor · Baltimore County, MD · Member since 2014 · 466 posts · 439 votes
6y

@John Havel, I have some helpful resources and more information on my website (primarily found in the blog posts, most of which I have also posted here on BP) but @Chris Seveney's podcast and website has a lot more information, to be honest. The most clearly written book I have read on note investing is @Joshua Andrews book "Paper Profits" but there are certainly many other quality books about notes. There are so many niches within this niche that it is impossible to put out one book to address everything. I would go back through the previous forums here and just read them. There is a ton of value right here, mostly from investors who have been doing this a lot longer than I have.

To address your question about geography, many note investors target specific states and some target only local deals. Obviously, this limits your options from a supply standpoint but I do recommend not casting too wide of a net location-wise, at least at first. There is a lot to learn regarding each state's laws when it comes to licensing, foreclosure, etc. And like Chris said, there are many associated risks to be aware of. It is not as easy as many of the gurus portend. 

With all of this said, don't let us discourage you. There will undoubtedly be opportunities in the next 6 to 18 months to find note deals that you could turn into cash-flowing rentals. Or you could go the other direction, find a great deal on a property and then create a note for yourself. The fact that there are so many options and strategies in this space is one of the reasons I really enjoy it. 

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  • Jamie Bateman
    Investor · Baltimore County, MD · Member since 2014 · 466 posts · 439 votes
    6y

    @John Havel, here is a recent BP blog post of mine that shows how we turned a non-performing note into a rental. We bought the note about a year ago, took back the property via deed in lieu, and rehabbed the property. The tenants just moved in today. https://www.biggerpockets.com/... 

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  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    6y

    @John Havel

    Buying notes takes a good amount of education and is truly a journey (which I talk about in my podcast).

    To answer a few questions:

    1. If you are in first position and foreclose junior liens are wiped but taxes, code violations and m superior liens stock with the property. This you need an attorney as well as some education in the state laws. So if you are in a junior position you need to payoff senior liens.

    2. You also have to consider situations where a borrower reinstates or files for bankruptcy. In those instances you will not be able to foreclose and will hold the note for years.

    3. If you buy notes on vacant properties that is very high risk as you do not get to see the inside of these properties prior to purchasing the note - you could be left with a disaster.

    Most note investors do not invest in notes to own the real estate - they do it to keep the borrower in the property (as that is typically more profitable). A business model of buying to foreclosing would be difficult and my recommmendation would be to stick to conventional real estate as you cannot predict if and when you would get a property nor for what price. I have had borrowers leave me with $10k water bills, flooded basements, buckets filled with feces... I could go on...

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  • John Havel
    OP
    Member since 2020 · 10 posts · 1 vote
    6y

    @Chris Seveney @Jamie Bateman

    Thank you both for your insights into this. 

    The case study was along pretty much exactly what I was thinking of doing. Although, I see what you were saying about the significant risks involved in buying notes for this purpose Chris. My thoughts were best case I purchase a note that could be used to acquire a property for buy and hold rental. Or if it didn't seem to work out that way there were always other exit strategies to utilize with the note like bringing it to performing status and flipping it or continuing to hold it for the purpose of creating a monthly cash flow. 

    I am currently looking into a number of real estate investing strategies and this one caught my interest. I am trying to determine what is the best use of my money and time since i am just getting started with real estate investing. I'm leaning toward more conventional rental property strategies but this might be an avenue to pursue later on once i get a handle on the basics. 

    Certainly, there is much I need to educate myself on with regards to note investing. Do either of you have any suggested books or other resources on the topic?

    Another question as well with regards to buying notes.

    As I understand it it is easiest to get into note investing through local banks or private notes. Do you typically get the option to buy notes from a specific city or region or are they usually just whatever is available from the lender be it a note in your city or on the other side of the country?

    0Reply
  • Jamie Bateman
    Investor · Baltimore County, MD · Member since 2014 · 466 posts · 439 votes
    6y

    @John Havel, I have some helpful resources and more information on my website (primarily found in the blog posts, most of which I have also posted here on BP) but @Chris Seveney's podcast and website has a lot more information, to be honest. The most clearly written book I have read on note investing is @Joshua Andrews book "Paper Profits" but there are certainly many other quality books about notes. There are so many niches within this niche that it is impossible to put out one book to address everything. I would go back through the previous forums here and just read them. There is a ton of value right here, mostly from investors who have been doing this a lot longer than I have.

    To address your question about geography, many note investors target specific states and some target only local deals. Obviously, this limits your options from a supply standpoint but I do recommend not casting too wide of a net location-wise, at least at first. There is a lot to learn regarding each state's laws when it comes to licensing, foreclosure, etc. And like Chris said, there are many associated risks to be aware of. It is not as easy as many of the gurus portend. 

    With all of this said, don't let us discourage you. There will undoubtedly be opportunities in the next 6 to 18 months to find note deals that you could turn into cash-flowing rentals. Or you could go the other direction, find a great deal on a property and then create a note for yourself. The fact that there are so many options and strategies in this space is one of the reasons I really enjoy it. 

    2Reply
  • Logan Hassinger
    Specialist · Fort Worth, TX · Member since 2014 · 528 posts · 226 votes
    6y

    @John Havel

    • Chris and Jamie have given you plenty to think about. to answer your question about a book on note investing, I would recommend two. 
      Win-Win Revolution 
      Bullet Proof Title Due Diligence
    • A book For general real Estate investing is “What every real estate investor needs to know about cash flow”. 

      As for note buying from a local or regional bank, it is possible but unlikely. A portion of my note portfolio has come from banks all over the county but I wouldn’t recommend starting out with owning notes from coast to coast. A hurdle you will find with trying to buy notes from banks is what reason will they have to sell to you in particular.
    • No offense, but who are you for them to consider selling to. I would try to find our investors in your area that are doing seller financing and work with them. But then you’ll have to be very diligent when reviewing collateral, as I’ve found many seller financing notes to be poorly written and not worth the hassle. 
    • I work with ONE seller finance person who originates the notes EXACTLY how I want them, however this strategy is to own solid notes on solid properties. I’m not looking to own the property. One thing to remember with note investing is only buy the note if your willing to own the house at the end of the day, because someday you might and you don’t want to get stuck with something you can’t sell. 

    0Reply
  • Andy Mirza
    Lender · Ladera Ranch, CA · Member since 2014 · 1k+ posts · 1k+ votes
    6y

    @John Havel To answer one of your original questions, the strategy of buying NPNs to turn into rentals is a hazardous one. I'm glad that you later qualified it by saying that it would be just just one of many exit strategies. For real estate investors that look into notes for the first time, it's very common to have the mentality that "if I buy the note, I'm buying the property."

    That is absolutely not the case and requires a substantial shift in attitude, otherwise it will probably get you in trouble. When buying NPNs you become the "lender in due course" or noteholder, not the property owner no matter what stage of default the loan is in. You are only entitled to what you are owed according to the terms of the note. Nothing more.

    The reason this distinction is so important is because as long as the borrower remains the property owner of record, he or she can do whatever they are legally allowed to do. If a person bought a loan with the intent to acquire the property as the only exit strategy, what will that person do when the borrower files bankruptcy to stop the sale, sells the property to someone else, reinstates the loan, or pays off the loan, which are all factors outside of the investor's control?

    If the investor did not buy the loan at the right numbers or has the normal costs of capital for a fix and flip or a rental investor, their numbers and timelines will be completely screwed up and the investment will be in trouble.

    1Reply
  • Liz Brumer-Smith
    Specialist · St. Petersburg, FL · Member since 2013 · 114 posts · 49 votes
    6y

    It's definitely a viable as long as you are focusing on acquiring non-performing notes. You need to be targeting distressed assets for this to be a realistic long term strategy. I have several properties that are now rentals, and ones I've even created new mortgages for again, where I don't have to be a landlord but instead get to benefit from being the bank. All from notes I took back via a deed in lieu (DIL) or foreclosure.

    0Reply
  • Peter Walther
    Specialist · Winter Springs, FL · Member since 2009 · 1k+ posts · 747 votes
    6y

    Three things I suggest you keep in mind:

    First, just because you bring the foreclosure doesn't mean you'll wind up with title to the property.  The property is sold at a foreclosure sale with bidding open to all comers.  As the party foreclosing you'll be able to bid your judgment amount (principal, interest, costs and attorney's fees) without any additional financial outlay but if a third party bids a dollar more you'll have to decide if you want to top the bid or get back what you're owed and move on.  If nobody bids more I think its an indication local investors believe the property isn't worth more than what you're owed.

    Second, junior lien holders may have the right to payoff your lien to protect their interest in the property.  You'll again receive what you're owed but no more.

    Third, some states give the borrower a period of time to redeem the property after the foreclosure by paying off what you're owed.  Here's a link that gives some additional information.  https://www.nolo.com/legal-enc...  Good luck.

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