How to Use Notes to Get Better Real Estate Deals
The road to me discovering notes wasn’t always easy to navigate. In some ways, it was a long and arduous path. A lot of it had to do with it taking so long for me to find them! It’s funny, it wasn’t until I was around 46 or 47 years old that I realized this would be where the next stage of my working life would go — shaping my career, not only as an investor, but also as a writer and business owner. Over the years, on my path toward the institutional note business where I work today, I saw many savvy investors using notes to get better real estate deals.
At the time, I hardly realized it. It was only when I was writing my new book that I started to put the pieces together. Back in those days, I was focusing on my “We Buy Houses”business and little else. Although I was well aware that the best sources of deals were from motivated sellers (like probate, divorce, out-of-state owners, etc.), what I didn’t know was that some investors were putting that business model on steroids.
Other Investors Were Being Creative
I first learned about creative strategies that were similar or related to the note business from friends who were bidding at foreclosure and sheriff sales. This can definitively be a viable way to acquire property, but back then I was never too excited by the idea of buying real estate sight unseen and in a bidding situation. I also didn’t feel like it was too easy to scale this business.
Next, I noticed those who were buying REO (real estate owned) properties. I did this on a small scale at the time, too, going after one-off deals like HUD houses and bank-owned properties that were usually listed through the MLS. Later on, I figured out during the economic downturn that there were large entities doing this in bulk by buying large tapes of REO properties — usually geographically. Banks tend to like selling REO’s in this fashion, because they can often make more money selling to buyers who want their local areas.
And then of course I realized buying distressed mortgage notes existed, the space where I play today. Where you tend to be ahead of everyone including the sheriff sales and the “we buy houses” folks. In other words, as a note owner, you’re first in line.
Using Notes For Better Acquisitions
Acquisitions of real estate deals can get better with notes, too. For example, when I was doing the “We Buy Houses” business it was all about solving motivated sellers’ problems and having the right tool in the tool belt. And that’s exactly what I did with notes and creative financing ideas by making multiple offers, some of which involved notes. Sure, I can make a low cash offer like anyone else, but perhaps I can make different offers with flexible variations of financing and let them pick the situation that’s best for them. Keep in mind, all of the offer structures already fit my needs and may even differentiate me from any other “we buy houses” bidders.
Making Multiple Offers
So let’s say a motivated seller — a pair of senior citizens for instance — called in about my “we buy houses—any situation/any condition” ad and wanted to sell their home. Their motivation was to move closer to their children who were out of state, which is a pretty common occurrence. Like many seniors, they have lived in their home for more than 40 years. The property is paid off. There is some deferred maintenance and some things in the home are just functionally obsolete, but it would still make for a good rental property. Let’s also say they’ve accumulated a lot of stuff in the home over the years. They tell me they intend to sell and move in with their son in California. This would be the perfect multiple-offer situation.
At the time, in my area of expertise, a 3-bedroom/2-bathroom house may sell for $125,000 in pristine condition. This house, with the average renovations, may also need approximately $25,000 in updates to get it that way. So they’re probably asking an unrealistic $115,000 for it. Now they’re probably not willing to give me a 30-year mortgage on this property. But in this case, I might make my offer something like this: $110,000 for 10 years at 5 percent interest, amortized over 30 years. Then after the 10 years is up, I can either refinance or sell the property to pay them back the remaining balance on the loan. I could also make it a shorter term (like five years) but in that case, I would try to go to interest-only, lowering my monthly payments. I would then show them these options and how it would’ve compared to them selling and putting the proceeds in the bank. Since I won’t need a new mortgage from the bank, this will also save me money in bank closing fees. After I explain all of this, I say, “Think about it. But here’s what else we could do.”
My second offer might be $90,000 with a $25,000 seller second mortgage carried over five years that’s interest only. This allows me money to fix it up and still get a first mortgage on the property either through a traditional bank or with private money. After which, I again say, “Think about it; but here’s another option.”
My third offer might be $75,000, all cash, “as is,” and “will close quickly.” Depending on how truly motivated they are to leave, this may be the right fit. Other variations of these may come up in our conversation, but either way, I’m giving them options.
If you noticed above, my first two options involved owner financing through what is known as a seller carry note or seller second mortgage. This is one of my favorite owner financing strategies when going to sell my rental properties, because to put it simply, I can still cash flow off of a property AFTER I sell it and WITHOUT owning it. Yes, you read that correctly. And for the buyer, a seller second can also be used to cover down payments, closing costs, and even repair credits. So it really can be a win-win scenario for both the buyer and the seller — but we’ll get to that in a bit.
Using Notes for Better Exits
As I approach retirement age, I’ve been paying off many of my rentals one by one, moving them into a family trust in anticipation of rising interest rates and a little bit of appreciation. My plan after that is simple: outside of a few really great properties I expect to keep, I’ll sell the remainder with owner financing. I’m thinking of using a commercial, twenty-year, interest-only note, with a seller assist and sell them at market value (based on appraisals) to some local investors from my networking groups. They’ll cash flow nicely with low out-of-pocket capital invested, and then I’ll place those notes with a loan servicer. I’m sure my wife and heirs will appreciate this planning, and I’ll start to enjoy a life with less maintenance and tenant issues.
So to sum up, for the seller like me offering secondary financing, there can be quite a few advantages:
By offering terms to buyers, you can sell the rental property easier, especially to another investor — like we did in the first example.
Through these terms one can possibly eliminate multiple costs. The private sale, due to creative financing, often eliminates the need for a realtor and their commission fees. Plus, the seller can offer a seller assist to a buyer with the money she saves in these fees, making the sale more appealing. This type of financing can also lower the costs of transfer tax and capital-gain tax.
The seller can continue to cash flow after no longer owning the property. Making money without dealing with tenants, maintenance, inspections, and contractors is a wonderful thing.
In the event of a default, the seller is familiar with the asset they had once previously owned.
Advantages for Buyers purchasing with a Seller Second
It’s not gravy only for the sellers either. What I love about seller seconds is that there’s also of course advantages for the buyer as well, like:
They can often buy a rental property with little or no cash out of pocket. If they’re an investor-buyer, this is extremely beneficial since it gives them an infinite rate of return with zero cash into the deal. This also enables the investor to build their portfolio faster and easier than if they had to seek any sort of traditional or private financing.
For the investor-buyer, the home is rent ready without needing any of the downtime required for a major renovation. In other words, it’s a turnkey deal.
For both the investor-buyers and tenant-buyers, all inspections by townships, home inspectors, wood infestation, etc., have all been completed at the time of transfer or closing.
Due to the lowered sales price, the buyer can also save on mortgage fees, transfer tax, and some insurances (i.e. PMI, homeowners, and title insurance).
By not leaving any equity in the property, the investor-buyer is maximizing their yield on their total investment capital.
So as you can see, notes can be a pretty powerful tool when it comes to your hard real estate, whether you buy or sell. And don’t forget, notes are a pretty great investment in their own right as well!