Big Profits From Real Estate Notes By Steve Gillman At Isnare.com Ezine Articles

Discounted real estate notes provide a good return without having to actually buy or sell any real estate. This has become a competitive market, so it can be hard to get started. But the risks are low and the returns high.

What are real estate notes? They are the loan documents for real estate loans. Also called "paper" or just "notes", these are the contracts that obligate a borrower to pay back a loan on certain terms. A mortgage is actually a separate document that pledges a piece of property as collateral for a loan. It is a promise to surrender the property if the terms of the note are not met.

Real estate notes can be first or second mortgage loans. They can be what are referred to as a "contract for sale" or a "land contract" in the case of seller financing. Essentially they are the contracts for any loans or money owed on real estate.

How To Invest In Real Estate Notes

You may have seen the ads in the classified section of the newspaper. They will usually say something like "We buy notes," or "Tired of collect payments? Cash out now." These are placed by investors who want a good return without investing directly in real estate.

Suppose John sells a piece of land for $48,000. The buyer has just a few thousand in cash, so John agrees to take payments for the balance of $45,000. At 9% annual interest, amortized over 10 years, the payments are $570. It seemed like a good idea at the time.

Now a couple years later, John is wishing he had that cash. The buyer still owes him $40,000, but he has to keep collecting just $570 per month for many years to come. Or does he?

After seeing an ad in the paper, John calls a note buyer. The investor looks at the property to determine if the value is there for security. It is worth $50,000 or so. He asks John about the payments - do they come in on time? The buyer has been paying for more than the 12-month "seasoning period" that the investor likes to see. The interest rate is higher than current mortgage rates. He likes that.

He makes John an offer of $34,000 cash. John isn't thrilled, but in the end, he decides to accept. The contact is bought, and the buyer of the land is notified that he has to make his payments to a new name and address.

As an investor, you can see that it is better to be the buyer of the note than John. Since the interest rate on the note is above market rates, you have effectively bought $40,000 for $34,000. You made a profit - or you will as it is paid - of $6,000 on top of the interest you collect. Actually there will normally be a few hundred dollars in expenses (possibly an appraisal, for example), so your profit would be closer to $5,500.

Notes sometimes sell for as little as 70% of their "face value." Why? For a variety of reasons. First, if the interest rate is low, you would be better off just putting your money in the bank, right? These notes obviously aren't worth what is owed on them. On the other hand, if mortgage rates are at 6% and a note is paying 15% - that might sell for full face value.

Second, you are taking a risk, and you expect more profit for more risk. $50,000 worth of land as collateral for a $40,000 debt isn't really all that safe. If the appraisal is off and it takes a year to sell it for $46,000, and you pay the sales commission as well as the legal costs of foreclosure, you might make very little for your investment of time and money.

Finally, notes sell cheap because investors want as much profit as they can get for their time and trouble. If someone is willing to cash in their $100,000 note for $72,000, why would an investor pay more? People get desperate for the cash after years of getting little payments every month. It's their business why they will lose so much of the equity to have it all now.

What kind of return do you get? Figuring the rate of return on your investment is actually fairly complicated in these cases. In the above example, you are making 9% interest, but not just on your $34,500 that you invested. You are making that rate on the whole $40,000, plus you eventually realize the profit of $5,500 - but it takes perhaps 8 more years to do so. Annual rates of return around 20% are probably common in this kind of investing.

If you recall in Number 1, one way to make money in real estate is to buy for cash and sell with easy terms. You can buy a little house for $65,000, for example, and then sell it for $75,000 by offering a low down payment and easy - but high interest - payments. Buying notes may be a way to effectively accomplish the same thing with your cash: instant equity gain. But even better, you don't have as much work or transaction costs.

If you want to get into buying discounted real estate notes as an investment, start by getting educated. It is difficult to find good books on the subject, but you might find a note buyer who will give you some pointers, if he is from another area, so you won't be competing. If you have note of your own that you are holding, you can get a free quote or two just to see how the process works.

This is obviously an investment strategy for someone with a chunk of cash to invest. If you can average a 15% return by constantly reinvesting those payments that come in on your real estate notes, you can double your money every five years. That turns $100,000 into $800,000 in 15 years.

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