Investing in notes and mortgages has become an increasingly popular alternative investment strategy in recent years. Mortgage notes provide investors fixed income streams with the collateral of real estate backing the notes. However, there are risks involved when investing in mortgage notes that need to be fully understood. This article will provide a comprehensive review of investing in notes and mortgages, including the opportunities, risks, and key factors to consider before investing.
Mortgage notes provide steady cash flow with real estate collateral
Mortgage notes can generate steady cash flow for investors in the form of monthly interest payments on the notes. This provides a stable source of income similar to bonds. Additionally, mortgage notes are secured loans backed by real estate collateral. If the borrower defaults, the investor can foreclose on the property. The real estate backing provides security compared to unsecured investments like stocks. However, foreclosure can be a lengthy and expensive process.
Mortgage notes can produce high yields compared to other fixed income
Interest rates on mortgage notes are typically higher than rates on Treasury bonds or CDs. For example, rates on performing mortgage notes range from 5-12%, depending on factors like the origination date, loan-to-value ratio, and borrower’s credit. This allows investors to achieve much higher yields than traditional fixed income investments. However, higher yields correspond with higher risk, as borrowers with lower credit tend to pay the highest interest rates.
Investors have options to purchase performing and non-performing notes
Performing mortgage notes involve borrowers that are currently making payments on time. These provide lower risk steady cash flows for investors. Non-performing notes involve borrowers who have fallen behind on payments. These notes can sometimes be purchased at a steep discount but involve taking on higher risk borrowers. Investors can choose notes that fit their risk tolerance and targeted returns.
Proper due diligence is critical when purchasing mortgage notes
Conducting due diligence on mortgage notes for sale is crucial for identifying risk factors. Key items to research are the property valuation and condition, borrower’s financial situation, loan terms, payment history, and originator. It’s also important to work with an experienced professional for guidance. Insufficient due diligence could lead to investing in fraudulent or extremely high-risk notes.
Lack of liquidity makes notes more difficult to sell
Mortgage notes are not traded on public exchanges, so they lack liquidity compared to stocks and bonds. It can be challenging to find buyers if an investor needs to sell a note. This makes notes more of a buy-and-hold investment. Investors with short time horizons or unpredictable cash flow needs may want to avoid mortgage notes due to the liquidity risk.
Mortgage notes provide opportunities for high yield income streams backed by real estate collateral. However, proper due diligence is essential to mitigate risks with individual notes. Illiquidity also makes notes more difficult to sell than traditional investments. Overall, mortgage notes can be attractive to buy-and-hold investors comfortable with the risks involved.