Buying Notes vs Real Estate — Video

What this episode covers

Buying notes vs real estate is often the wrong context. But let’s talk about notes for a bit. Download Audio Transcript: One of the decisions, when investing in real estate or retirement, that people make, is when they learn about the existence of discounted notes secured by real estate. Then they really light up when they learn about being able to buy them at a discount. Buying a note at a discount means, even thought the interest rate on the note might be 4%, 5%, 6%, whatever it is, and it’s, say, a $100,000 note, if it’s 5%, the payments might generate $5,500 to $6,000 in principle and interest payments per year. So if you gave the holder of that note $100,000 for his $100,000 note, you would be getting a $6,000 cash on cash return, in simple terms, if the payments for the year totaled $6,500 a month. But what if you paid him $60,000, $50,000, $70,000? That means that that $6,000 a year, let’s say you paid $60,000. You’re making 10% cash on cash. Well, now you’re talking. Then you have to say, well, it’s secured by real estate. Well, I like that even more, because if I make a mistake trying to buy low and sell high in real estate, where I’m really thinking long term, I’m just trying to make a good buy and make a profit wherever I can, in real estate. If something goes wrong with your formula, your plan doesn’t go as you thought it would, well, you either hold it forever, or you lose the property, or any number of things, most of which don’t put a smile on your face. On the other hand, you bought this note. You paid $60,000 for it. You’re probably, in real life, my experience says you’re probably making $7,000 or $8,000 on that $60,000. Okay? That note all of a sudden stops paying. You say, “Well, I don’t like that.” Nobody does. But now you may have to foreclose. Well, what’s the property worth. You say, well, we had that bubble burst. You know, when they first bought this property, they paid $130,000 for it, and they borrowed $102,000 or $103,000, or whatever 80% was. They paid it down to the $100,000, and you bought the note. The problem was, that properties not worth $130,000 any more. It’s worth $100,000. You say, “Jeff, why on earth would any bozo pay for a note who’s security is only the same value as the note? A hundred and a hundred. Isn’t that what they call 100% loan to value?” I say, “Your math is right, but your context is wrong.” The person that lent the money, from whom you bought the note, they were 100% loan to value. You paid $60,000. You’re 60% loan to value. They put out $100,000. You didn’t. So now you say, I have to foreclose. Well, that means you have a $100,000 property. It costs you 8% or 10% to sell it. You get $90,000 or $92,000 out of it. You only have $60,000. You made a profit. Of course, that sounds good on paper, but let’s kind of go through that a step at a time. What are the chances you don’t have to put a little bit of lipstick on that pig to sell it? So let’s say you have to put 5 grand. Let’s say you’ve got to put 10 grand. Well, now you’ve got $70,000 in it. Then you say, well, but I lost $10,000 in payments, because it took me a long time before I foreclosed because I had too big of a heart, and then it took me a long time to foreclose. Well, there’s another $10,000, now you got $80,000 in it. What if you sold it for $95,000, because you want to sell it in 6 days, not 6 months. Now you net out maybe $83,000, $84,000. You still got more than you put into it. So see, that’s how the discount works. Now, is it more complicated than that? Oh, you bet, and a half. There’s all kinds of of due diligence and factors.

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