Mortgage Notes: A Viable Alternative To Rental Property Investing?
By JD Esajian on December 15, 2014
Mortgage notes have been getting heavily promoted in the wake of the foreclosure crisis. While very few paid attention to them when the real estate market was healthy, the note industry has now exploded onto the scene. In fact, mortgage note investing can be highly profitable. However, it is complex. The idea being pitched to passive income real estate investors that want to take over hard assets and convert them into rental homes is that non-performing loans can be ripe for foreclosing on, essentially giving investors a back door.
This has become more attractive to some, as some hot real estate markets have seen advertised home inventory shrink, and have been thrown into heated competition over the few REOs banks left on the market. Non-performing mortgage notes theoretically put note investors ahead of those directly bidding on short sales and REOs. So what are the flaws and risks in this strategy?
What Happens If They Start Paying?
Laws on saving properties and bringing them current again can vary widely across the United States. Investors need to be keenly aware of these laws. They also need to understand the rights of owners and borrowers. Most borrowers will simply need to make a payment or two to avoid foreclosure. What then?
Subsequently, investors may be stuck with the note, without any hope of grabbing ownership. Obviously this may be the best thing for the homeowner, but many investors might not see that as a plus in the heat of the moment. If the borrower keeps paying on time, the note holder can collect the income. They may also choose to sell the note after 12 or 24 months of on-time payments.
Why Are These Notes Being Sold Anyway?
There is a reason that these delinquent notes are being sold, versus being held and taken over as REOs. They are being sold because they are not performing. They are not producing the cash flow expected. The longer they are held, the more costly they can become for the note holder. Attorney’s fees, hard legal costs, dealing with the borrower, paying property taxes, insurance, and any applicable condo or HOA dues can add up, especially when no income is coming in.
Ultimately, these non-performing loans are being sold because it is seen as the most profitable option for the banks holding them. They are willing to cash out, often at a discount, in order to at least get some of their original investment back.
Wait, There’s More…
Even if individual real estate investors are able to successfully navigate the process to take ownership and control of these properties, what is the time, expense, and stress involved? Could this wipe out any perceived advantages?
It is not uncommon to go months without a return. In some areas, foreclosures are still backed up for years. This doesn’t even get into other potential issues, which could arise from poor due diligence. Clouds on title, other liens, poor property condition and more could mean more costs, and substantially longer periods of time before any income and real returns can be seen.
Contrast the net acquisition cost and time to begin seeing returns with other options, such as turnkey property investing. A great turnkey property investment could potentially deliver the same value going in, or better, and deliver immediate returns from the first month.