Reasons NOT to Buy a Performing Note

Many investors are adding performing notes backed by real estate to their investment portfolio. They enjoy the cash flow at a good yield, and they’re happy they don’t have to deal with the property itself. The buyer (not a renter) pays the taxes and insurance and maintains and repairs the house as issues arise. However, not all performing notes are created equal, so we still need to do our due diligence before buying.

One of the first places I turn when investigating a new possibility is the website trulia.com. After putting in the property address I scroll down the page until I see the crime map of the area surrounding the house I’m interested in. Often, what I observe will end the due diligence of that property in the first few minutes.

Here are a few examples of what I mean. These three houses are all in Columbus, OH and the numbers are all reasonable. The houses themselves look fine, but their associated crime maps put a quick stop to my investigation. I’ll put the house above its map so you can understand what I’m talking about.

Although we almost never see a perfectly clean map, the ones we buy look a lot better than these. As you can see from the scale at the bottom of each map, the greener it is, the better. Moving toward the red end means an area with more reported crimes. We don’t have to live in these neighborhoods, but I wouldn’t want to try to sell a house with this kind of problem.

Here’s a different type of problem. The neighborhood is as safe as it can be, but the town is just too small. Unless there’s some mitigating factor, we don’t want to buy a note in a town smaller than about 20,000 people because there aren’t enough potential buyers if we get the house back.

We could show many other examples, but one more will give you a good idea of how digging deeper can reveal a problem a more cursory look won’t show you. Here’s a nice home, with some low-level crime associated with the used car lot across the street. That in itself might not scare me away, but then I found it’s only a half mile from the Akron Fulton International Airport. As the local realtor who created the BPO put it, “This house is within the Noise Exposure Map for this airport, so this location would be a negative factor for a large percentage of the buyer pool.” That’s enough for me!

I know that all these homes have families living in them, and other investors with a higher tolerance for risk will buy the notes to them, but as the fiduciary for my investors, I choose to keep looking for a better package. There’s no such thing as a perfect note, but with so many to choose from, why not lessen the risk as much as possible?