They say that good things come in small packages.
When it comes to investing in real estate notes, this can be very true for several reasons. For starters, this is one of the only investment opportunities I know where you can get in at a low cost of entry.
For example, you can purchase a small note or even part of a note.
I am not a franchise expert, but I am pretty sure Wendy’s isn’t going to sell me part of a store.
Sure you can purchase larger notes, but not everyone wants to start there — or even has the financial ability.
Small notes might not be as easy to find (unless you are talking small second liens which I will talk about in a minute), but they are out there.
So, What Is So Good About Purchasing Small Notes?
For starters, your yield.
We tend to purchase notes at a discount. How much of a discount largely depends on what the investor is looking for and the amount of risk. If I want to earn 14% on my money, then I just plug 14% into a financial calculator, and it tells me how much I can pay for the note.
With small notes, sometimes we just take off a flat amount and then see where the yield ends up.
Let’s say someone offers the following note for sale…
- 120 months
- 10% Interest
- 120 months remaining
- Current balance: $9,458.90
If I were to offer to purchase the note at 14%, I would offer $8,050.68
I am sure the seller would be pretty happy with that, as would I.
But, let’s say I just take $2,000 off the top and make that my offer ($7,458.90).
Now my return is 16.01%
There are a lot of reasons why offering the $2,000 discount would be the right move. There are hard costs to acquire the note, it might payoff early, or it could pay slow resulting in additional costs.
Now, let’s say I do purchase the note for $7,458.90.
What is to stop me from going to the payers and say, “Hey, if any time in the next two months you can pay me off, I will take $750 off the amount you owe.”
Sure, I will be getting less, but I will be getting ALL my money much sooner. The Yield goes up…a lot. (Watch our video on Increasing Yields With Early Payoff Incentives Here).
It is not uncommon to find small notes created for a host of reasons. The most common is an 80-10-10.
This is where the buyer of the property did not have 20% down, and the bank would only loan 80% of the value.
- Bank 80% First
- Seller Carry Back 10% Second
- Down Payment 10%
These are higher risk. They are behind a very large first position lien.
However, you can often purchase these from the seller at 50-60 cents on the dollar.
If a seller calls me with this kind of note, I tell them to keep it. I tell them they are going to get hit with a significant discount due to risk.
I do this to set up the right expectation. If they thought they were going to receive 80-90 cents on the dollar for this note, best to get them thinking realistically from the start.
If they want to move forward, I take a look at the buyer’s credit. I am hoping to purchase it and offer the payer a ‘pay me off early’ deal.
Like I said in the beginning, good things can come in small packages. Purchasing small notes just might be the thing to get you investing in notes!