How to Purchase Real Estate Notes in 6 Steps
How to Purchase Real Estate Notes in 6 Steps
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If you’re interested in investing in real estate without having to manage or rehabilitate properties yourself, then promissory note purchases may be the right real estate investment for you.
What are Real Estate Notes?
Real estate notes represent a borrower’s promise to repay a loan used to purchase property. These notes are secured by real estate, meaning the lender or investor has a legal claim to the property if the borrower defaults. Real estate investors can buy real estate notes from banks, private lenders, or other investors, earning returns through regular payments or by purchasing non-performing notes at a discount and either restructuring the loan or foreclosing on the property.
Types of Real Estate Notes
Real estate notes come in two main categories: performing and non-performing. Performing notes are those where the borrower is making regular, on-time payments according to the loan terms, for example, monthly payments. These notes provide a steady stream of passive income and are generally considered lower risk.
On the other hand, non-performing notes involve borrowers who have defaulted on their payments. While these are a riskier investment strategy, they can sometimes be purchased at a steep discount, giving investors the opportunity to negotiate new terms, restructure the loan, or foreclose on the property to potentially generate a higher return.
Pros and Cons of Real Estate Note Investing
One of the biggest advantages of investing in real estate notes is the potential for a passive income stream, especially with performing notes that provide regular cash flow without the hassle of property management. Note investors also benefit from the ability to buy non-performing notes at a discount, which can lead to high returns if the loan is restructured or if the underlying property appreciates in value. Additionally, because these notes are secured by real estate, there is an added layer of protection—if the borrower defaults, the note buyer can foreclose and take ownership of the property.
However, there are also challenges to consider. Default risk is a primary concern, as borrowers may stop making payments, requiring the investor to take legal action. If foreclosure becomes necessary, it can be time-consuming and costly, potentially reducing the expected return on investment. Additionally, real estate markets fluctuate, meaning that declining property values could impact the profitability of the investment. Because of these risks, due diligence is crucial before purchasing any real estate note.
Buying Real Estate Notes
Here’s how to go about investing in real estate notes in six easy steps:
1. Identify the Note You Wish to Purchase
Investors who are interested in purchasing real estate notes can buy existing notes from the bank, financial institution, note broker, or lender that holds the loan. It is also possible to find notes for sale from individual sellers who participated in financing the property or bought the note themselves. Finding the opportunity to buy an existing note is not easy, but with enough effort, it may be done.
2. Negotiate with the Current Holder of the Note
When contacting the holder of the note, you’ll want to ascertain why the note is for sale and what the asking price for it is.
Once you’ve agreed on the terms and conditions of the sale, you’ll need a written legal document (signed by both parties) that reassigns ownership of the note from the current note holder over to you. You should also record the reassignment of the note with the clerk’s office in the county in which the property is located. Notes can be bought in one of two ways: with recourse or without recourse. A note bought with recourse means that the seller of the note remains responsible for payment of the note if the original borrower defaults. The more normal way notes are purchased is “without recourse.” This means the seller of the note has no responsibility if the note defaults. It is very important to make the recourse or non-recourse part of the legal documentation when purchasing a note.
3. Obtain the Original Loan Documents
The note seller should turn over all of the original documents for the loan represented by the note you are purchasing. You should verify the loan amount, if possible, with the borrower, and all of the loan terms (e.g., what payments have been made, when the next payment is due, what the interest rate is, when the final payment is due, etc.).
4. Assess the Value of the Property That Secures the Note
Since the note is secured by the property, it’s important to conduct due diligence to make sure that the current value of the property is at least enough to cover the balance of the note. You can assess the property’s value through comps of nearby properties, or you can have the property appraised by a professional.
5. Check Out the Note Seller
It’s a good practice to run a credit check on the note seller before finalizing the sale to make sure that there are no pending bankruptcies or foreclosures that could jeopardize the position of your note should you need to collect on it. If possible, try to find out about the financial position of the borrower, but that is not always easy to do and therefore is part of the risk in buying notes.
6. Arrange for Financing
If you want to purchase real estate notes without fronting all of the cash yourself, a hard money loan can be a good financing option. Many hard money lenders are willing to finance note-purchase loans for first-position mortgage notes that are secured by properties with sufficient value to cover the balance of the note. In legal terms, this is called hypothecation.
It is important to remember that when you buy a real estate promissory note, you are also buying the terms that come with it, as these usually cannot be changed. As the new holder of the note, you need to be aware of the loan terms so that you know the maturity date and under what conditions you can declare a default and begin foreclosure proceedings.
Contact Montegra For Help With Colorado Note Purchasing
Montegra provides hard money financing for investors purchasing first-position mortgage notes secured by commercial or investment residential real estate in Colorado. We fund both performing and non-performing notes, offering up to 60% of the purchase price with interest-only loans. We also finance property improvements if needed and can close deals in as little as seven days. If you are interested in learning more about financing your note-purchase investments, contact Bob or Kim online at bob@montegra.com or 303-377-4181 today.