This is a rant and might be hard for some of you to read. I decided to write it because I get contacted several times a month from individuals who purchased what they were told was a good note that went bad and they are asking me for advice on what to do. So, hear it is…
I buy performing first position Seller Financed Notes secured by real estate. I actually buy a good amount of notes every year.
Should you?
Probably not.
I’m not telling you to not buy notes; owning notes has its advantages. However, before you start investing in notes, realistically check yourself. Below are some statements. If you find yourself agreeing with any of them, alarms should be going off in your head.
You’ve Listened to a Guru in the Last Year – Note business gurus and note investing gurus are full of it. They are paid to sell information. The more they can get you excited about making an investment using their “system,” the more money they make. How do they get you excited? By making every aspect of note investing sound easy and lucrative. In other words, by convincing you that you live in an imaginary world where any novice can make millions overnight.
How do you know if you should tread lightly? Well, ask yourself the following: Do you feel excited about investing in notes and want to get started as soon as possible? Are you putting together a plan for when you’ll retire? Do you have visions of yachts and Ferraris in your near future?
If you answered yes to these questions, stop. Don’t rush into things—take time to learn the business, and temper your expectations.
It’s never that easy. Whether performing, non-performing, first position or second position, investing in notes is a job. Expect years of hard work and learning before you start making much headway.
You Don’t Have Much Money – Don’t buy a note with a credit card, your home equity line of credit or by borrowing the money in some other way to buy a note. Sure, you could “win” and make some money. You could also win on the slot machines at the casino.
Let’s take an example: You buy a $50,000 note for $40,000 that you borrowed. You receive the payment on the $50,000 note every month and make the payment on the $40,000 loan every month. With none of your own money invested, let’s say it gives you $100 per month in positive cash flow.
Upside – There aren’t many ways this situation can get better. The payor makes the payments on time every month and everything is peachy. However, if or when the payor gets into a financial hardship situation, you find yourself relying on their future possible payments to justify your investment and you find yourself praying that their payment comes in every month on the due date so you can cover your payment on the loan you got to buy it. It is at that point; you cease being a value-based investor and become a speculator.
You know who else is a speculator? Yep, Grandpa on the slot machines in Vegas.
Downside – Catastrophic risks are huge: The local economy changes. A Pandemic occurs. The payor goes bankrupt. The property taxes go into default. The hazard insurance lapses. The point is, there are innumerable things outside of your control that could happen with your note.
So… limited upside and significant downside risk? Doesn’t sound like a great model, does it?
Sure, people have made money using this approach of borrowing money to buy a cash flow, but how many? Was it a result of luck? Probably. If you want to read more about this, check out the book Fooled by Randomness by Nassim Nicholas Taleb.
You Want to Leverage the Money You Do Have – I’ve heard the argument that notes are a great way to get leverage. For little to no up-front costs, you can own a lot of notes (by using OPM, other people’s money, and borrowing money to buy notes).
This is baloney. Notes are not a great way get leverage. Some reasons why:
Interest rates on real estate loans are much higher than other alternatives. Last time I checked; 30-year mortgage rates are 4.1% for the best credit worthy individuals. The highest rate on Interactive Brokers (a company that brokers stocks, options, futures, EFPs, futures options, forex, bonds, and funds) is 1.58%.
You can get more leverage in other ways. Take a glance at derivatives. Trading futures and options can garner you over 100:1 leverage. You should never do this, but if you really want to “get rich or die trying,” that’s the way to do it.
You Have a Full-Time Job – This is controversial, but it comes down to time commitment.
From my 30+ years in the note business a guideline I like to use for first-time note investors is the rule of 10s. For every 1 note you buy (20-hour time commitment), you’ll get offers accepted by 10 (5 hours each); for every 10 accepted offers, you’ll look at 100 notes (1 hour each).
In total that is 170 hours for your first note, or a little over a month of full-time work at 40 hours per week.
Be brutally honest with yourself. Do you have that kind of time?
Conclusion – Why You Shouldn’t Buy Notes – Notes make a lot of sense when you’re big. Big is relative, you do not have to be a millionaire to buy notes, not by any means. Big can be $100,000 for some people for other it can be millions. Thanks to economies of scale, when you are big everything starts to get cheaper: servicing, vendors, management, closing costs, lawyer costs, accountant costs, etc. Plus, you might be able to afford to delegate many of your lower-value tasks.
What can you do in the interim? If you’re passionate about notes and view it as a hobby, by all means get cracking.
If you’re only interested in notes as a way of making money, then you have two options:
- Learn everything you can while saving up, so that when you enter the note market you can start with economies of scale.
- Find someone who has economies of scale and invest along with them. Notice I said along with them—make sure they have skin in the game and a strong track record.
Thanks for listening and I hope this gives you a bit more perspective on buying notes. Be kind, keep safe and stay healthy. Remember success demands action, keep on marketing, it’s going to work! TWITA! (That’s What I’m Talkin’ About!)
Jeff Armstrong of Armstrong Capital has been a note investor and broker specializing in the performing seller financed note industry since 1991. For more updated and current information on how he can help you with your note business, note investments, note appraisals or to request pricing options on a note visit www.armstrongcapital.com to email him and subscribe to Jeff’s Weekly Training & Tips Newsletter.
Thanks Jeff, very sobering words on a subject that can cause alot of unrealistic expectations.
Jeff, Thanks for always giving valuable advice!