Note Buying Basics for RE Investors

Note investing puts you in the position of the bank. Instead of buying properties, you buy the debt secured by properties. When you purchase a real estate note, you acquire the right to receive the borrower's monthly payments, the security interest in the property, and the right to foreclose if the borrower defaults. For investors who want real estate exposure without the headaches of property management, note buying offers a compelling alternative.

What is a real estate note

A real estate note (also called a mortgage note or promissory note) is a legal document where a borrower promises to repay a specific amount under specific terms. The note is secured by a deed of trust or mortgage on a property. If the borrower stops paying, the note holder can foreclose on the property to recover their investment.

Performing vs non-performing notes

Performing notes

The borrower is making payments as agreed. These are passive investments: you buy the note, collect monthly payments, and earn yield on your investment. Performing notes trade at a discount to the unpaid principal balance (UPB), typically 70-95% of UPB depending on the interest rate, remaining term, borrower credit, and property LTV.

Non-performing notes

The borrower has stopped paying. Non-performing notes (NPNs) trade at steep discounts, typically 30-65% of UPB. The investment thesis is that you can either:

• Work out a loan modification with the borrower (re-performing the note at a higher yield)
• Negotiate a short payoff (borrower pays a lump sum less than the balance)
• Foreclose and acquire the property at your note purchase price
• Offer a deed in lieu of foreclosure (borrower deeds you the property voluntarily)

Where to find notes

• Note exchanges and marketplaces: Paperstac, LoanMLS, FCI Exchange, and Waterfall Asset Management list individual and pooled notes for sale
• Banks and credit unions: Financial institutions sell notes they want off their books, especially non-performing loans. Building relationships with bank workout departments gives you access to these opportunities.
• Government sales: HUD, Fannie Mae, and Freddie Mac sell pools of non-performing notes through periodic auctions
• Private sellers: Individuals and companies who created notes through seller financing and want to cash out. Owner-financed notes from the strategies in our owner financing guide eventually become available for purchase.
• Hedge funds and servicers: Larger pools of notes are available from institutional sellers, typically requiring $500K+ minimum purchases

Note due diligence

Before buying any note, verify:

• Collateral value: Order a BPO or appraisal on the property. Your investment-to-value (ITV) ratio determines your risk. Aim for ITV below 70% for performing notes and below 50% for non-performing notes.
• Payment history: Review the complete payment history from the servicer. How consistently has the borrower paid? How many late payments? Any previous modifications?
• Note and mortgage documents: Verify the note is properly executed, the mortgage is properly recorded, and the chain of assignment is complete. A note without a clear chain of title is unenforceable.
• Title search: Check for liens senior to the mortgage (tax liens, HOA liens, mechanics liens). Senior liens must be paid before your mortgage gets any proceeds in a foreclosure.
• Borrower status: Is the borrower in bankruptcy? Bankruptcy stays can prevent foreclosure for months or years. Check PACER for active bankruptcy filings.
• Property condition: Drive by or get photos of the property. A performing note on a property in severe disrepair signals that the borrower may stop paying soon.

Pricing notes

Note pricing is based on yield analysis. You determine the price you are willing to pay based on the return you want to earn. Key variables include:

• Unpaid principal balance (what the borrower owes)
• Interest rate on the note
• Remaining term (months until payoff)
• Monthly payment amount
• Your target yield (the return you want on your investment)

Use a financial calculator or note pricing software to determine the present value of the remaining payments at your target yield. That present value is your maximum purchase price.

How note buying connects to wholesaling

Note buying and wholesaling are complementary strategies. Wholesalers who create owner-financed notes can sell those notes to note investors for immediate cash. And note investors who foreclose on non-performing notes sometimes need wholesalers to help them sell the acquired property quickly.

Building relationships with note investors expands your buyer network. When you have a deal that does not work for your typical flip or rental buyer, a note investor might be interested in acquiring the property, creating a note, and holding it for yield.

Risks of note investing

• Borrower default: Even performing notes can become non-performing. Economic downturns, job loss, and medical emergencies cause borrowers to stop paying.
• Foreclosure costs and timeline: In judicial foreclosure states, foreclosure can take 12-18 months and cost $5,000-$15,000 in legal fees. Budget for this expense on every non-performing note.
• Property condition at foreclosure: If you foreclose, you inherit the property in whatever condition the borrower left it. Vandalism, hoarding, and intentional damage are common.
• Bankruptcy stays: A borrower filing Chapter 7 or Chapter 13 bankruptcy triggers an automatic stay that prevents foreclosure proceedings. The stay can last 3-5 years in a Chapter 13 case.

Related articles

• Owner Financing as an Exit Strategy
• Land Contract Investing Guide
• Tax Lien Investing: A Starter Guide
• Creative Exit Strategies

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