"PASSIVE INCOME"

Ahhhhhh that term...it's what a lot of us are in search for.
It's what a lot of us are trying to build.
It's what a lot of us are struggling to grasp.

Passive. Frickin. Income.

Well, as I sit here, trying to evaluate my next investment opportunity, there's a huge pull for me to experiment in the world of note investing, which requires little to no work at all from me, but can provide very respectable returns. Let me explain.

Does the sound of bringing in passive income sound great?
What if it required absolutely NO work?

YES! I WANT THAT!

Here's where investing in performing NOTES comes into play and why it's so appealing. I've always heard about investing in notes...but honestly, it's been a somewhat difficult strategy to really grasp as there's not a ton of content out there! So, keep reading for some great information from BiggerPockets:

​What is a note?
It's a promise to pay. For example, a personal check is a note. When real-estate is sold with financing there is a document called a promissory note which defines the terms of the loan, including the loan amount, percentage rate, payment amount, the number, frequency, and timing of payments, late payment penalties, etc. The note, by itself, is simply a promise to pay and is not secured by collateral. In a financed real-estate transaction, the note is secured through a security instrument. This is either a mortgage or deed-of-trust, depending on the state. The security instrument ties the note to the deed as a lien on the property as collateral. It also spells out the lenders recourse (foreclosure) should the borrower fail to pay, among many other details which we won't go into here.

What is note investing?
If you invest in a note, the note is purchased along with its security instrument. Basically, investors purchase the secured debt and become the lender, after which they are entitled to receive payments from the borrower. Generally, note investors purchase notes at a discount to the remaining principal balance.

Lien Position
Before we get into different types of note investing strategies, we should cover the topic of lien position. When a debt is secured by real property, it's recorded as a lien against the deed. The rule for lien position is "first in time, first in line." This means that lien position is establish by the relative date and time a lien is recorded against the deed. For example, a first mortgage is in first position solely because it is recorded prior to subsequent liens like a second mortgage. There are a couple of exceptions to this. Delinquent property taxes is the most common exception. When a municipality liens a property for delinquent taxes, the lien cuts in line to the front. The other exception is HOA dues in "super-lien" states. In these states, delinquent HOA liens act like tax liens. Lien position is important in note investing primarily because in the event of foreclosure, the lien holders are paid from the proceeds of the sale based on the position of their liens. The first position lien is paid first, and if anything is left over the second position lien is paid, and so on.

Common Note Investing Strategies
There are many strategies in note investing and the common ones which are; Performing Note Investing, Non-Performing 1st Lien Investing, Non-Performing 2nd Lien Investing.

Performing Note Investing - Buy and Hold
A performing note is a note in which the borrower is making regular payments, and investors purchase them to achieve a stream of recurring passive income. This is similar to purchasing a rental property, but without the headaches of property management. This is what I'm really interested in!

Many of the performing notes for sale were created in owner financed real estate purchases, where the seller desires to cash out rather than continuing to receive monthly payments. These notes are generally purchased at a discount to remaining principal balance, providing the investor with a higher effective yield than the interest rate of the note. Double-digit yields on these investments are quite common. Why would someone sell at a discount? Sometimes life circumstances dictate that money now is more important than money over time.

Non-Performing First Lien Investing
In this strategy, the investor purchases a loan in which the borrower has stopped making payments.  The banks have many of these on their books right now, and have chosen to sell some of them to investors to get them off of their books rather than take the time and incur the expense of foreclosure. Because these notes are non-performing, they sell at a steep discount to principal balance. Investors who purchase these have several exit strategies to consider:
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• Workout - A loan purchased at a discount can be modified to forgive arrears and reduce the principal balance, thus lowering payments. Many borrowers with severely underwater homes have stopped paying simply because they don't see a point in paying on a loan balance which is double or more the current value of their property. Others have suffered employment setbacks and have found themselves so far behind on payments that they can no longer bring the loan current, so they give up on it. Whatever the reason, a workout can solve a painful financial problem for homeowners and provide the investor with a re-performing loan acquired at a very nice discount.
• Deed-In-Lieu - When a workout is not possible or feasible, taking possession of the property via deed-in-lieu can sometimes be a workable approach. With this approach, the borrower signs the deed over to the lien holder as consideration for the debt.  The thing to keep in mind with a deed-in-lieu exit is that any junior liens will remain on the deed.
• Short Sale - Just like a bank, the note holder can approve a short sale by the borrower. As with deed-in-lieu, junior liens can make this approach unfeasible because clear title must be conveyed in a sale.
• Foreclosure - This approach can be the only option in some cases. The downside is that it takes time and incurs holding cost and legal expense. The benefit is that junior liens are removed, leaving clear title.

Non-Performing 2nd Lien Investing

Because the lien position is junior to the first lien, non-performing 2nd liens can be purchased at extreme discounts. It's common for these types of notes to be partially or completely underwater with regard to property value. Workout is the primary exit strategy, as foreclosure and deed-in-lieu from 2nd position will leave the 1st lien in place. Because of this, non-performing 2nd lien investors tend to look for for notes with a  performing 1st lien, and scrutinize the quality of the borrower rather than focusing on the value of the collateral property.

In Conclusion
As you can see, the world of note investing can be quite intricate. As of now, I'm really only considering performing notes, as the appeal of having an on-time borrower paying monthly, without any headaches, is SUPER appealing.

​-Tyler

​My Fourth Property...

My Fourth Property...

What am I going to do? What’s my next investment?

Previously, we talked through one option I’m familiar with: Single Family Homes.
Now, let’s chat through another option I’m familiar with: Small Multi-Family (2-4 units).

Having recently closed on a duplex (2 units), my goal in acquiring that asset class was to scale my portfolio and grow. And grow it I did...tripling my portfolio from a whopping 1 unit to 3 units hahaha!

OK, that’s kind of a joke. But, it’s also true. Tripling your portfolio is an achievement, and if you view real estate as your path toward Financial Independence, you’ll most likely have to scale. Which is where the beauty of small multi-family comes in.

Keep reading for the PROS and CONS of investing in Small Multi-Family properties!

PROS

• If you have experience in single family investing, this is a nice way to ease into bigger properties and learn the ropes of dealing with a multi-unit asset
• Economies of scale start to kick in. For example: having to replace the roof on a duplex will probably be around the same cost as a single family house.
• You have the option to "house hack," meaning you can live in one unit while your tenant(s) help pay down your mortgage.
• House hacking also allows more loan options and flexibility because the property would be considered your primary residence. For example: I've been required to put down 25% on my rental properties, but as a primary residence, you can find ways to put less than 4% down.
• Higher cash flow and Cash on Cash returns. You can generally purchase a duplex for less than two single family properties so there's less cash out of your pocket. Rents also stay pretty consistent.

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CONS

• Higher operating expenses than a single family home. Obviously with multiple units, you're bound to have higher repair expenses. So factor in bigger cash reserves...because there may be a day when you need to replace 2, 3, or 4 water heaters at once :(
• Generally a higher tenant turnover. I'm not sure there's concrete data behind this, but from talking with fellow investors, most of us agree, there's higher turnover in the multi-family world. I'm thinking maybe it's because there's less pride of ownership in the property?
• Slower appreciation. Single family properties appreciate faster than small multi-family and usually garner higher sales prices because you're often dealing with retail buyers. And their emotions. For the most part, someone buying a small multi-family property is a calculated investor. Someone who's running the numbers and is more apt to walk-away if the numbers don't work for them.
• Limited group of end buyers. As just mentioned above, someone buying a small multi-family property is typically buying it as an investment. That limits your buyer pool.

 
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There are plenty of PROS and CONS to evaluate when buying a small multi-family. I'm personally starting to really understand the impact of scaling up and having more units under one roof. So the economies of scale are a huge benefit. But those PROS always come with CONS.

​Key Takeaways

• If you want to scale your portfolio, small-multi family investing is a great option
• The ability to "house hack" and take advantage of the economies of scale are some of the biggest benefits of small-multi family investing.
• Always have more cash in the bank for future repairs, as your operating expenses will rise in the multi-family world
• Expect higher tenant turnover, slower appreciation, and a limited buyer pool if you try to sell.

​-Tyler

I SWEAR.

​When I'm in REAL ESTATE mode...I'm IN REAL ESTATE MODE.

What do I mean by that?

Well, within the last 5 months, I sold a house. I bought a house. I bought a duplex. And now, I'm ready for the next investment.

What's my grand strategy for this next investment, My Fourth Property? To be honest, I'm really not sure yet. I plan to deploy about $25k-$35k for this next investment, so I definitely have options. But again, I need to weigh different strategies.

So let's take a look at the first investing asset class I'm considering: SINGLE FAMILY HOMES

Technically, this is where I have the most experience. Which isn't a lot. But, I've purchased 2 single family homes and also sold one. Let's touch on the Pros and Cons of investing in single family homes.

PROS

• One of the most affordable investments. You can find quality cash-flowing properties for less than $100k.
• Longer tenant leases. Tenants in single family homes usually stay longer than tenants in multi-family. This might be because there's a higher sense of ownership, and single family properties often attract families, where stability for the kids is more of a priority. Longer tenant leases and less turnover increases overall ROI.
• Best chance of appreciating in value and holding resale value. Single family properties have a larger buyer pool (which means demand) because you're not only factoring in investors, you're factoring in a large pool of retail buyers. You know...the people that aren't looking to necessarily buy an investment...they're looking for their first house, or to "upgrade," or to find their dream house.
• Reduced operating expenses. Owning less units often = less expenses. By default, with only 1 unit, you easily should have much lower expenses than a multi-family. That's less toilets to have to fix, less furnaces to replace...

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CONS

• Single family properties don't take advantage of the economics of scale. For example: a new roof on a single family house (1 unit) will have a similar cost for a roof on a duplex (2 units).
• When you have 1 vacancy, you have 100% vacancy. If you're in the middle of turning over your property and it's vacant, you very well might have to pay a full mortgage payment on your own. With multi-family, 1 vacancy hurts, but you should at least have income coming in from the other units.
• It can be hard to scale with single family homes because of the management and work required to keep the portfolio running smooth. Would you rather own 100 houses? Or one 100-unit apartment building?
• Opportunity cost....in terms traditional financing. You can only get 10 loans under your name. Do you want to use one of those slots for 1 unit?

As you can see, there are plenty of PROS and CONS to evaluate when buying a single family home. I'll say this: because I started off with this asset class, and a lot of investors do, it's a great way to get started. It's a great way to "ease" into real estate by keeping things relatively simple. I really got my real estate education from single family properties and I'll never forget that!

Key Takeaways

• Evaluate your investing priorities. Single family homes offer a great option if you're just starting out because they are generally cheaper than a duplex or larger multi-family (if you're looking in a cash flowing neighborhood), they generally have longer tenant occupancy rates, and they hold resale value (if you buy in the right neighborhood).

​-Tyler