The Quest for Yield

As the Fed keeps interest rates tethered at near zero, it has become harder and harder to find investments with strong yields. Bond yields have plummeted, and alternative fixed-income investments aren’t much better.

It’s not just the US either — the global interest rate environment has been compressing for years, with some countries even experiencing negative interest rates.

I’m not saying interest rates won’t eventually go back to pre-pandemic levels … but what was so exciting about 1.5% anyway?

Private individuals and companies find it harder and harder to obtain superior returns without an unacceptable assumption of risk. Stockbrokers can offer a range of investment vehicles … but one thing they notoriously can’t offer is cash flow.

The result — an ever-growing cohort of lost investors, wandering aimlessly in search of the last egg from last year’s Easter Egg hunt.

The Solution — Real Estate Notes

By “note,” I mean the promissory note that forms the debt instrument of a mortgage loan.

Many investors don’t realize that they can actually assume the position of the bank in a real estate investment, not just the buyer. We all intuitively know it’s good to be a bank. Heck, Super Bowl LVI was played in “SoFi Stadium.” SoFi is a bank! When you are the namesake of the Super Bowl venue, you know you’re doing something right.

Here’s the secret — you don’t have to be a bank to own a real estate note. You can originate loans, or buy a note from a bank, note broker, or other investor. Once you own the note, you can collect mortgage payments on the note, and even foreclose and collect the property if it comes to it.

Landlords notoriously have to deal with the “Terrible T’s” — tenants, toilets, and termites. When you buy a real estate note, Instead of being a “landlord,” you become a “lien-lord” — owner of a real estate lien. As a lien-lord, not only do you get to skip all three “T’s,” but you have significant advantages over landlords, including:

1. Monthly Mailbox Income
2. Debt Secured By Real Estate
3. No Managing Tenants — Truly Passive Income
4. Can Be Purchased at a Discount from Face Value
5. Liquid Secondary Market

1. Superior Yield, Monthly Mailbox Income

Let’s face it — savings accounts, CDs, money markets, and mutual funds just don’t cut it. “Investors” in these products trade a low risk tolerance for paltry yields that don’t even keep up with inflation.

The owner of a real estate note gets to collect the borrower’s mortgage payment. By collecting this payment, the note-holder gets access to something bonds can’t offer — yields higher than 2%. Sometimes the yield can be much higher, as we’ll discover in #4.

The note-holder also gets access to something stockbrokers can’t provide — cash flow. That mortgage payment turns up as a monthly cash payment in the mailbox every month. For investors who want predictable monthly income, real estate notes are hard to beat.

Maybe yields of 4%-6% don’t get you salivating, but a well-curated note portfolio can present unique opportunities to produce unconventional returns in unconventional ways — even double-digit returns, enough to make a banker blush.

2. Debt Secured By Real Estate

One overlooked aspect of other “fixed-income” assets is their lack of collateral. We think they are “safe” and “low-risk,” but think of it this way — a government bond is basically backed by nothing other than the government’s credit, i.e. their word of honor. Who wants to bet their life savings on that nowadays.

“When you get to be the bank, its heads I win, tails I don’t lose.”
– John Reid

Real estate notes, by contrast, are secured by real estate. Worst-case scenario — if the borrower defaults and the note becomes uncollectible, the note-holder can file for judicial foreclosure, just like a bank, and seize the property as collateral.

With minimal due diligence on the subject property, note-holders can reduce their risk of total loss to almost zero and even come out ahead in the event of default.

3. No Managing Tenants — Truly Passive Income

Many investors come to real estate in search of “passive” rental income … only to discover that owning rental real estate is far from passive. Remember the “Terrible T’s” — tenants, toilets, termites. Who wants to chase rent checks, fix toilets, or eat the cost of catastrophic system failures? You can outsource these jobs, but that adds expenses and eats into your cash flow.

Note-holders, by contrast, have no expenses, no operational responsibilities. The one thing you might outsource, for a small fee, is the collection of the mortgage payment (called “loan-servicing”) to a third-party loan servicer. Once you do this, voila — truly passive income.

4. Can Be Purchased at a Discount from Face Value

Let’s back up a little … How much do you have to pay to buy a mortgage note? If the balance due on the loan is $200,000, you probably have to pay $200,000 to buy it … right?

Not necessarily. Investors can often pay much less than the face value of the note to collect the mortgage payment.

If a note is “non-performing” i.e. the borrower is in default and not making mortgage payments, the note-holder may be willing to sell it at a discount just to get it off their books. A lender may be willing to sell a non-performing $200,000 note for $140,000 or less.

Of course, by paying less than face-value for the note, your yield becomes much higher than the contract interest rate. It might take some legwork and negotiation on your part to get the borrower making payments again — maybe forgive some of the balance, accept a lower payment, maybe just make contact. But once the note starts performing again, you have a passive asset with yields that would humiliate your average bond broker.

This isn’t the only way you can pay less than face value for a note. You may be able to purchase the right to collect a series of payments on someone else’s note. There are a million ways to get creative about building your note portfolio.

5. Liquid Secondary Market

Real estate is a notoriously illiquid investment. Whereas you can sell a share of stock at will, to cash out of a real estate investment you have to actually sell or refinance the entire property.

Not so with notes. A robust secondary market exists to liquidate existing real estate notes. You could sell your note through a note broker, or sell it directly to another investor.

If you need cash but don’t want to let go of the note entirely, you can often sell the right to collect a series of payments — for example, the next 12 payments — to an investor who wants to create cash flow without buying an entire note.

Life happens. For investors who find themselves in sudden need of liquid cash, a healthy note portfolio is a godsend.

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Interested in learning more about note investing? Acquiring your first real estate note or adding to your note portfolio? Reach out to REID Lending Partners!

Finding a worthwhile note can be a chore if you try to do it yourself. We bring the right lenders together with the right investors, helping them build a high-yield real estate note portfolio the easy way.

At any given time, we have a “menu” of available real estate notes, customized to fit the needs of any investor. From short-term with balloon payments to long-term guaranteed rates, your quest for yield ends here