If you know what you’re doing in the commercial real estate market, investing in short-sale promissory notes can result in extremely profitable returns on investment. However, it is important to understand the differences between investing in real estate directly and investing in commercial mortgages to avoid experiencing the reverse (a loss on investment). Here are four tips to consider before investing in promissory notes:

1. Read over the mortgage instrument documents closely to make sure that you are aware of any defenses or claims that the borrower can make to delay foreclosure of the loan or reduce the repayment amount to the lender (you).
2. There are two types of underperforming notes that are typically available for short sale: sub-performing loans and non-performing loans. Sub-performing loans are not to the point of foreclosure yet; these loans can result in a steady source of income if you are willing to expend the effort necessary to continue collecting payments, but may also have some sort of forbearance agreement in place that would hinder foreclosure proceedings. Non-performing loans are ones for which the borrower has completely stopped making payments and may have back payments and other expenses due, but are most likely ready to enter foreclosure proceedings.
3. Remember that you are purchasing the loan papers rather than the underlying property that serves as collateral for the loan. While the property’s value is an important part of evaluating the worth of the promissory note, the note does not actually grant ownership of the collateral except in the event of non-payment of the debt. Your valuation of a note’s worth should include an assessment of how much time and money it will take to convert the note into ownership of the property, if that is your intended goal.
4. Conduct due diligence of the mortgage security instrument; this includes analyzing relevant correspondence files and searching public records thoroughly. You should be able to answer questions such as the following:
   • Are there any flaws in the loan documentation?
   • Have any events occurred since the origination of the loan that would enable the borrower to contest foreclosure proceedings?
   • Are there any problems with the title such as liens with claims that are prior to the mortgage you are purchasing (i.e., is the note you’re purchasing for a first-position mortgage)?
   • Does the loan documentation stipulate the type of foreclosure proceedings that must be gone through?

Determine what kind of recourse the loan allows in the event of non-payment. Some loans have what is known as a “carve-out guaranty” or a “springing guaranty” which stipulates that the guarantor of the loan (who may or may not be the same entity as the borrower) will become personally liable for the unpaid loan if borrower commits any of the predetermined “bad” actions. Carve-out guaranties can actually increase the value of the note because they serve as a deterrent for the borrower being forced to file for bankruptcy.