REAL ESTATE NOTES: THE MOST IMPORTANT FACTORS

For people who are new to investing, there are a lot of terms and concepts that might seem foreign at first. Understanding the basic principles of investing can help to make you a more competent and efficient investor. A good place for any new investor to start is with the concept of notes. Real estate notes are essential to your investment strategy, and the right knowledge can have a dramatic effect on your portfolio.

When I first started in trade options, I didn't know all of the terminologies. It took me
some major trial and error to discover what worked. While this is fairly typical of any younger person in any field, you can dramatically increase your success by learning the ropes first. One way to get to know the basics of an industry is to take a course with a tutor who can help you learn key concepts along the way. With knowledge of the right terminology, you can get a head-start on the competition. The jargon used in notes is not the same as real estate, but learning the language is a good place to begin.

Understanding a Real Estate Note

A note, or promissory note, is just a promise to repay a loan. In real estate, the mortgage is a recorded document that allows the loan company to attach a lien against the property that can be seized and secures the loan. A borrower agrees to pay a certain amount of the loan within a specified period. If not paid, then the terms of the contract dictate what remedies the guarantor of the loan can enact. Penalties may include late fees and other remedies to collect the debt.

In conversations with investors, a note usually refers to a secured note that uses real estate to guarantee the loan. This real estate can be used to pay off the loan if the borrower defaults. There are different types of notes. A secured note is backed by property. This could be a car or real estate. Physical items do not back unsecured notes. For example, student loans, debts for medical bills, and credit card debts are all forms of unsecured loans. Although, some credit cards may be considered secured if a deposit is required. Additionally, residential and commercial notes also exist. There are also first and junior liens.

A mortgage most commonly means a mortgage or deed of trust. These terms may differ depending on the particular state. When borrowers fail to make agreed-upon payments, then the lender forecloses on the mortgage or deed of trust. A lien is then placed against the property to recover the cost of the loan.

The Difference Between Performing and Nonperforming Real Estate Notes

The definition of a performing or nonperforming note may vary depending on whom you ask. An investor might say that a nonperforming note is any loan where the borrower is not paying regularly. A banker might see it as a loan that hasn't been paid in 90 days or more. They may even go a step further and state that they don't even consider a loan as late until the 90-day mark. Loans that are bought in bulk typically place loans that are less than 30 days late into the same price bucket. Banks generally won't take any action on a loan until it is 90 days late.

When talking about performing notes, these are considered notes and mortgages that are being paid on regularly. If a loan does become nonperforming, it's not considered performing again until it has been paid on time for 12 consecutive months. Until that time passes, the loan is known as a re-performing loan. This game of semantics is confusing, but depending on the situation, it can determine how much a loan is worth.

The Difference Between First and Second Notes

There are both first and second notes, and the decision to invest in one of them depends on your goals. There is a different degree of risk associated with each loan type. A first note, also known as a senior lien, is recorded first. This means it has a claim on the second note or junior lien.

First mortgages are safer than second mortgages. In the event of personal bankruptcy, the second loan could get crammed down. This could make it harder and even impossible to collect on. The property where the appraised value doesn't secure any of the second note's debt could be completely stripped in a bankruptcy court. First mortgages are at least partially backed by the value of the property. This is important to understand when determining relative risk associated with different types of loans.

When all of the capital is invested in a first mortgage, it can increase risk. Spreading it out over several deals can help make a loan safer, and it can reduce the possibility of a portfolio losing all its value. The fact is, most loans are paid. This makes investing only in the safest loans a less profitable option. The same is true of commercial deals since most of the values are all in the same deal.

Price point and other factors also make the difference between a first and second loan. The buyer may focus on factors like taxes, escrows, homeowner's associations and insurance. With second loans, the first loan takes care of most of these issues. There is also less competition for a second loan, and it makes it easier to diversify.

The Difference Among Equity, Partial Equity, and No Equity Deals

The more value a note has, the less risk there is associated with it. This means that equity notes are less risky than partial, and no equity notes. When you have to pay a premium to get an equity deal, it can be a better use of money to get a partial or no equity loans. In an up market, it makes sense to purchase equity deals, as they are typically more plentiful.

In our current market, senior loans are more important than loan-to-value. This is because most second loan pools don't have equity. Consider all of the factors that go into purchasing a loan, including whether it's in foreclosure, bankruptcy and other factors. Diversify your portfolio, and purchase a variety of loans to get the best return and the most value for your carefully orchestrated risk.

Written by Jason Gordon