There are several ways to generate cash flow through real estate investments, and promissory notes can be a great method of cash flow investing in Nashville without having to deal with the headaches of ownership or management. After all, when you own a real estate note, you receive regular payments and never have to worry about maintenance issues.
WHAT IS A PROMISSORY NOTE?
A note is a promise to pay over a period of time; sort of an IOU, if you will. In the world of real estate, before a buyer can purchase real estate, a promissory note will be created to define the terms of purchase. The terms of purchase will include the loan amount, interest rate, payment amount, amortization schedule, and consequences of default.
Promissory notes for real estate are secured by mortgages or deeds of trust. There’s a fundamental difference in how each state treats the title to a property. In title theory states (e.g., Tennessee), the lender holds the title until the promissory note is satisfied. The deed of trust (the security instrument) is held in trust by a trustee. The deed of trust also has a power of sale clause, which provides the lender the right to sell the property in the event of a default in the payment of the promissory note. A default generates a notice of default, which initiates a foreclosure sale without a judicial process.
In lien theory states, the property buyer retains the title. The lender retains the mortgage security instrument and records it as a lien against the property, until the promissory note is satisfied. In the event of a default, the lender has to initiate a judicial process – Lis Pendens (pending lawsuit) to recover the title from the borrower/notepayer.
All deeds of trust are mortgages, but not all mortgages are deeds of trust. The power of sale clause will ultimately decide. The takeaway – promissory notes are secured, marketable instruments.
BUYING AND SELLING REAL ESTATE NOTES
While accepting monthly payments from the sale of real estate may be a good idea to promptly close on a transaction, circumstances can change and sellers often find themselves preferring cash today, rather than waiting on future installments.
Let’s specify that a noteholder refers to the person who is to receive the note payments, but it can also include any lender who comes into play at any moment thereafter. This is very important because that’s where you, as a real estate investor, may enter the market.
When a noteholder can no longer afford to wait for the note payments, you can offer to purchase the existing note at a discount from the noteholder. Notes are sold at a discount because you are purchasing future payments using today’s dollars (remember that the $1,000 you will receive in the future will be worth less than $1,000 today). So, for instance, you could purchase a $1,000 note for $850 to obtain the right to collect the full $1,000 from the payer. This provides instant cash to the noteholder, and affords you a $1,000 payout for an investment of $850.
Evidently, there are risks involved, including inflation, interest rates, and the notepayer’s potential default on the note. You, of course, have recourses against the latter and can take the notepayer to court to obtain payment (along with interest charges, if stipulated in the terms of the note). However, the legal recourse for default involves time and money, so purchasing promissory notes should be done with caution and expert advice.
Some questions you need to ask yourself include:
- Is the interest rate appropriate, when compared to current and anticipated market/inflation rates?
- Do the terms support stable or predictable cash flow?
- Is the note payer credit-worthy?
- Does the note provide for all legal recourses in the event of a default?
If, after assessing the risk, you’ve decided to buy or sell a note, the most important step is to determine what the note is worth. When evaluating the investment or future value of a note, there are six main factors to consider:
- The credit of the note payer
- The collateral (i.e., the property or the asset)
- The down payment
- The terms of the note (e.g., interest rate, number of payments, etc.)
- The performance of the note or the seasoning
- The documentation for the note
Once you have all the numbers, it becomes much easier to determine if the note in question is a profitable investment to generate future, stable cash flow.
First, assemble the documents:
- Original Promissory Note
- Mortgage/Deed of Trust/Land Contract
- Settlement Statement
- Lenders Title Insurance Policy
- Hazard Insurance Policy
- Loan Statement With Current Balance
- Record Of Your Buyer’s Payment History
Then, review all documents and conduct thorough due diligence. This includes evaluating the note payer’s credit and payment history, appraising the property/collateral, and conducting a title search.
Finally, make an offer and define an agreement. The agreement should include an indicative bid (a reasonable estimate of the price that will be paid, and not a guaranteed price).
Are you receiving payments on a mortgage note, deed of trust or land contract?
Would you like to have cash instead?
At Beacon Property Solutions, we purchase 1st lien mortgage notes, deed of trust or land contracts for residential, commercial real estate or land in Tennessee, Alabama, Georgia and North Carolina. We provide purchasing programs for the real estate financed notes of homeowners, land developers, builders and investors with loan portfolios.
Through our affiliated institutional relationship, our investors have purchased over $500 million in notes over the past thirty years. As a full service note buyer, we can provide fast closings, fair pricing and underwriting that looks for the redeeming value in every unique situation. Our mortgage note purchase options include full purchase or partial purchase.
Call today and receive a free, no obligation quote.