Your New Instrument Plays Real Estate Notes

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Real estate note investing has been an important part of well-diversified portfolios of financial institutions, hedge funds, and small private investors for many decades and even centuries. In the broadest sense, notes are used in all types of daily financial transactions. Car loans, credit cards, student loans, and personal loans are all types of financial notes. A note is simply an IOU – an agreement between a borrower and lender where the borrower agrees to repay the lender under the terms laid out in the note. Real estate notes are IOUs that use real estate as collateral for a loan.

Many Types of Real Estate Notes

There are, in fact, two parts to every real estate note — a promissory note and a lien. The promissory note contains the terms of the loan. The lien (usually a mortgage deed or deed of trust) is a separate instrument that is recorded with the county land records against the title to a piece of real estate. Most notes and liens have many things in common. Still, at the same time, every one of them is unique because the property involved is different, and the conditions of the loan can be written to satisfy the specific needs of the lender and borrower.

What people are most familiar with are conventional real estate transactions with large financial lenders (banks). This is when a buyer makes a down payment, obtains a loan, and signs a note promising to pay a certain amount each month to the lender until the loan, plus interest, is paid. 

In a private real estate transaction, a buyer makes a down payment, does not obtain a loan, but instead signs a note promising to pay a certain amount each month to the seller until the price of the real estate, plus interest, is paid. The noteholder becomes the bank. The conventional transaction is considered a loan, and the second is an installment sale.

Many people are familiar with private real estate transactions such as seller financing. However, there are many other versions of private real estate notes. For instance, a home buyer might begin a traditional purchase with the help of a real estate agent to find a family home. But when it comes time to finance the purchase and close the sale, a private lender, such as a Solo 401k owner, is brought in to pay off the seller instead of a traditional lender.

There are many examples when a private lender is used instead of a traditional lender. It is estimated that over $17 billion in first-lien private real estate notes are created annually. About 100,000 are created each year — almost 300 a day! That number could double if second liens are included.

A Note for Real Estate Investors

Real Estate Notes

Another relatively common example is private loans to fix and flip real estate investors. For Solo 401k real estate note investing, the basic process is similar to the closing process involving a real estate agent above. What will be quite different are the terms and conditions of a loan involving a fix and flip property. Instead of a 20 or 30-year mortgage, a flix and the flip investor will only want a 6 to 18-month loan. The Solo 401k real estate note will be fully repaid at that time. There can be many other variations to the terms of these loans. For instance, there might not be any monthly payments while the fix and flip investor is repairing the home. It might be one lump sum payment after the house is upgraded and sold to an end buyer. Another version involves financing both the purchase of the house and the repair cost. In this case, the Solo 401k finances the purchase of the house and then makes additional incremental loans to finance the repair based on project milestones being completed.

And there is a secondary market for Solo 401k real estate notes investing, which is huge. The secondary mortgage market is a global marketplace where mortgage notes are bought and sold by various entities, including financial institutions, banks, and other investors. The secondary market is especially important to liquidity. For instance, you might like the security that comes with investing in 30-year notes, but you don’t want your Solo 401k to be tied up long-term in a 30-year note. Through the secondary market, you can sell that 30-year note at any time to move your Solo 401k into a different investment.

The secondary market is where you could begin investing your Solo 401k, or it could be where you sell a note that your Solo 401k originated. In its simplest terms, it is a place where investors go to buy or sell mortgages that have already closed between the real estate buyer and the real estate seller. Although the terms and conditions that apply to the real estate owner cannot be changed, some terms on the secondary market can be negotiated, such as discounts and premiums, when acquiring an existing loan.

The types and variations to Solo 401k real estate note investing are so vast that many books have been written on the subject. The examples used here are residential real estate, but commercial real estate contains many more examples. Below is a partial list of domestic or foreign real estate investments that you can make with your Solo 401k:

Solo 401k Real Estate Note Investing for Passive Income

Passive income from Solo real estate note investing is known as one of the best ways to put a reliable source of revenue in place, attain security in retirement, and ultimately design a roadmap to achieving financial freedom. Passive income is ideal for Solo 401k accounts because the IRS restricts how involved you can personally be with an investment owned by your Solo 401k. As the trustee of your Solo 401k, you can perform many administrative functions, such as negotiating the purchase and sale of real estate notes and hiring contractors to perform repairs if needed. However, you can not personally do any work. Passive income is a major reason why real estate note investing is a favorite among Solo 401k investors.

Types of passive income generated by Solo 401k real estate notes:

  • Investing in real estate notes can have high returns without any of the hassles of property ownership. After all, lenders take interest payments from borrowers. They don’t have to deal with houses or tenants or pay property taxes.
  • Regular monthly income is based on the interest rate of the note.
  • Notes are secured with physical real estate.
  • Rehab a nonperforming note into a performing note and resell it at a higher price.
  • Notes can be purchased at a discount on the unpaid balance.
  • Lower recurring expenses since investors don’t have to pay real estate agents or property managers.
  • Real estate notes investing is not limited to accredited investors. It is open to all investors.
  • Less competition – there aren’t as many investors operating in this niche.

Because real estate note investing generates high interest and the interest payments are taxed at the income tax level, a tax-advantaged Solo 401k is the most tax-efficient way to invest.

Important Considerations for Solo 401k Real Estate Note Investing

You are now among the few people that have an understanding of Solo 401k real estate note investing. Even fewer know the secret that makes investing in notes so profitable — real estate notes are sold at a discount from the balance. Buying notes on the secondary market for less than the outstanding balance makes them worth more than the interest rate being paid by the borrower.

For example, you purchase a note with a $50,000 balance on the secondary market at 6% interest and 120 monthly payments of $555. If you bought it for $50,000, your yield would be 6% percent. That in itself is a good rate of return. But what if the note seller is hurting for cash and needs to sell the note within the next week (or something else)? They might sell the note to you at a discount of $40,000. You would still be collecting 6% interest on $50,000, but you only invested $40,000. If you put that in a financial calculator, you would find that you are actually earning 11.18% interest on your $40,000 investment.

That might be as good as it gets on a performing loan that the borrower is current on. However, these types of deals and higher paying ones exist on loans that are nonperforming — loans where the borrower is not current. Of course, there is more risk with a nonperforming loan but remember that these loans are secured by real estate.

Real Estate Notes

Before you jump all the way in, you want to fully educate yourself on how to evaluate risk and reward. When getting into Solo 401k real estate note investing, a good place to begin is with the 3-P’s of Note Investing — the Paper, the Property, and the Payor.

The ‘paper’ refers to all the documents involved since the loan originated. This includes the note (mortgage or trust deed or contract for deed), property settlement statement, payment history, etc. You also need to be familiar with laws in the state where the note originated. Beginners are wise to have a real estate attorney walk them through the paperwork.

Questions for Real Estate Notes

The types of questions that you are looking for answers to include:

  • Is the note performing, nonperforming, or reperforming (stopped but is again performing)?
  • If you are considering a nonperforming note, what is the foreclosure status (if any)?
  • Is the note secured by a mortgage, trust deed, or contract for deed?
  • What was the original balance, and what is the current balance?
  • What is the interest rate?
  • How much are the payments?
  • Are payments due monthly, quarterly, or based on something else?
  • When was the first payment made?
  • How many payments have been made?
  • When is the next payment due?
  • How many payments remain?
  • What is the amortization of the note?
  • When is the final payment due?
  • Is there a balloon payment due? If so, when is it due, and what is the balloon amount?

As you learn more about a particular note, you should expect more questions like these to need answers.

The ‘property’ is your security that the loan will be repaid. One of the first things you want to do is get the most recent copy of the appraisal. Very possibly, this will be the appraisal when the loan originated. You should consider how long ago that was and what might have changed that affects the current market value. In some cases, you might want to have a current appraisal conducted. Just be careful about spending your Solo 401k money before you buy the note. One inexpensive option is a broker professional opinion (BPO). If you have doubts about the current market value of the property, it might be better to move on to a different note.

Questions that you want answers to about the property include:

  • Address and recorded location of the property?
  • Type of property (single family, duplex, double-wide trailer, etc.)?
  • What was the original sales price, and is there a second mortgage or any other lien?
  • Is it owner-occupied, vacant, or rented?
  • If it is rented, how much is the rent? If vacant, how much can it rent for?
  • If tenant-occupied, how much is the rent, and how long has the tenant been there?
  • What was the original sale date, and how does that compare to the payment history?
  • How large of a down payment did the buyer make, and how much equity do they now have?

As you find answers to these questions, others will certainly come up.

The ‘payor’ will be responsible for paying back the loan. You want to know as much as you can learn, but unless the original application can be produced, this might be limited. Generally, you can not contact the payor directly, at least not until you have purchased the note.

Real Estate Notes

Still, there will be reliable information available. What you are looking for includes the following:

  • What is the identification information for the payor (name, current address, and Social Security number, if available)?
  • Has the payor been late with any payments? If so, how many times and how recently?
  • Are they current on payments? If not, how far behind are they?
  • Has the current note holder done anything to return late payments to the current one?
  • What reasons are given for any late payments, and what has been done to resolve the issue?
  • What is the payor’s current history of employment?

Again, the more you learn about the payor, the more questions that are likely to arise. You want answers to all your important questions before your Solo 401k begins real estate note investing.

A final consideration is understanding that the lien is separate from the note. The lien will be a mortgage or deed of trust, depending on the State the real estate is in. You want to have it recorded against the title to the real estate with the county land records. This gives your Solo 401k the right to take ownership of the real estate if the borrower defaults on the terms of the promissory note.

The Solo 401k is a Secret Weapon for Real Estate Investors to Retire Wealthy

Set Up Your Solo 401k and Start Investing In Real Estate

The Solo 401k comes with many tax advantages and wealth-building opportunities. Among the best are real estate investing and real estate note investing. A phone call with one of our experts makes it extremely easy to do. We can set it up in no time.

Start where you are. Use what you have. Invest in what you want. We help get your retirement funds into your control — where they belong! Act Today by Booking a Free Call with One of Our Experts.

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