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The recent stock market volatility has left many investors looking for reliable returns that provide cash flow, rather than unpredictable variance. Investing in real estate notes is one of the most straightforward and secured methods of investment. Mortgage notes are a great way to diversify your portfolio and also provide cash flow.
Here is how it works:
Investing in a note is essentially putting up a lump sum in order to purchase a contract that promises to pay you a stream of payments. These payments will provide you with a return on investment (ROI).
When someone purchases a house, they make a down payment, usually 20-30%, in order to take title of the house. Then, they continue to make monthly mortgage payments to the bank with interest. Of course, if the homebuyer does not make payments, the bank will take the house back through the foreclosure process.
Sometimes, the bank needs cash quickly and will want to sell this stream of payments to an investor for a lump sum. Good investors are concerned with the preservation of capital. Because of this, how the loan is secured is very important. Let’s look at how investors evaluate the loan collateral.
When the bank loans out $80,000 on a $100,000 house, the bank’s Loan To Value is 80%. For most investors, this Loan to Value is too high. In fact, many target a much more secured 65% Loan to Value. That way, if the homebuyer does not make the mortgage payments, the investor will be able to take back a $100,000 house for only $65,000. As you can see, the lower the Loan To Value, the more secured the investment is.
The original note is an $80,000 with 6% interest. However, if the note is purchased for $65,000 the Return on Investment to the investor jumps to 8% as the result of the discount.
In order to find this return on investment, use the 10bII financial calculator…
If your portfolio is invested 8%, it’s value will double every 9 years.
In this circumstance, the more secured the investment is, the better the ROI is. For instance, if you were able to negotiate the purchase price of this note down to $50,000, instead of $65,000, you would be in at a 50% Loan to Value, and the return would be 11%, instead of 8%. Unlike stocks and bonds, real estate notes have many options like these to get the investor a better return without making the investment riskier. Not only this, the investor can count on receiving this monthly payment regularly, regardless of what happens in the unreliable stock market.
Like I mentioned in an earlier article, the most important part of this process is making sure you have properly valued the property. The loan collateral is the most important part of the investment, so make sure you are looking in an area where the value of the properties is stable and get in at a low Loan to Value.