Real Estate Note Investing: Using Mortgage Notes to Passively and Massively Increase Your Income

INTRODUCTION

The Accidental Note Investor

Real estate networking meetings tend to all look the same. They’re held in either a ballroom in a local Holiday Inn or a small banquet hall in a decent restaurant. Both banquet hall and ballroom sound much too elegant for what’s really going on in these places—a meeting of minds. It’s basically just a room full of, more or less, middle-class men and women aged twenty-five to sixty (with some exceptions, of course) all looking to get ahead. I didn’t know any of this going into my first meeting, of course, but it’s something I’ve come to notice over the years.

Looking back now, I realize I didn’t know what I was getting myself into the first time I walked into that ballroom full of real estate investors. As a newer real estate investor myself, I had already achieved my personal BHAG (big hairy audacious goal), which was to buy my first property. In fact, before attending my first meeting, I had already purchased quite a bit of property as a real estate investor—everything from single-family and multifamily homes to one small apartment building. I had done this mostly with traditional bank financing on the first few properties and with some creative financing strategies I’d picked up over the years with the rest of my portfolio.

Twenty Units Free and Clear

At this point in my career, I thought I was pretty smart, except for the fact that I didn’t call my BHAG a BHAG, because I didn’t know what that term was quite yet. I also didn’t know that my goal of twenty properties owned free and clear wasn’t really where I’d end up. See, in my mind, twenty properties seemed like a lofty idea, a goal I could one day dream of achieving. One hundred properties would be even better! So good, I could hardly imagine it. At either point, I could probably sell one property a year after that and live pretty well into retirement. Now, this wasn’t a bad goal—and it still isn’t for most people—but I was fortunate enough to hit a fork in the road around ten units. That was the point when I learned that I didn’t really need to follow that exact plan, because there might be a better way.

My Financing Problem

As a guy who owned ten units and was doing pretty well, why was I in this banquet hall just outside Philadelphia on a Thursday night in the fall of 2003? It was simple, really: I had run out of money. I had purchased about ten properties in my own name and had hit a financing roadblock. I needed money. Or at least that’s what I thought I needed.

Coming up in a pre–social media era, I had, up until this point, always operated solo, networking only with friends, family, and the occasional Realtor or broker I’d meet as a part-time Realtor myself. Over the years, I’d heard about a local chapter of a national Real Estate Investors Association (REIA) group called the Diversified Investor Group, or DIG. I never could seem to get around to attending a meeting, but it was always an interesting idea to me. It wasn’t until I needed something, when I was without any other options, that I decided to go. I thought I could ask other investors how they got around the financing roadblock that had stopped me cold.

Before I even entered the meeting room at my first DIG event, I noticed a row of vendor tables. Too intimidated to walk in, I struck up a conversation with a vendor, an investor-friendly mortgage broker from Pittsburgh, whose specialty was in residential and commercial loans. He naturally asked whether it was my first meeting and why I was there, so I described my dilemma to him. Needless to say, my problem wasn’t exactly uncommon. It’s actually why he was sitting at that vendor table. We exchanged information that day, and he ended up providing me the financing I needed to get out of my rut. Problem solved! But my story doesn’t end there. I didn’t just find some financing and head home. That was only the beginning.

Later on, this very lender showed me multiple ways to access capital, and ultimately he helped me refinance and leverage my properties. I didn’t realize it at the time, but my very first encounter at DIG was with someone who showed me one of the powerful concepts in real estate and note investing: leverage.

The Power of Leveraging Connections & Knowledge

Attending the meeting was informative but certainly not groundbreaking—at least not at first glance. Something did stick with me, though: Not only had I made a great connection with someone who would help me solve my financing problem (and met a few other interesting folks), but I had seen what was happening right in front of me: people standing around as if they knew everybody, talking about deals and transactions they had going, and sharing ideas. It was something I hadn’t been doing nor had I experienced in that capacity before that night. You could feel something in the air, an exchange of knowledge that was almost palpable.

I didn’t sign a contract for a loan that night—or even get exactly what I thought I was looking for—but I knew if I kept going to these meetings, that would change. So I made a commitment to get more involved and to learn. Every last Thursday of the month, DIG would bring in a speaker to educate attendees on a topic, and many speakers would follow up the next Saturday with a one-day workshop, usually in hopes of selling their wares, which could be anything from a book to a course to a full-on mentoring program. I knew they wouldn’t all be right for me, but if I attended as many meetings as I could, I would see a wide array of speakers, learn a little bit about nearly every facet of real estate investing, and maybe find a niche to reach my then-BHAG of twenty houses free and clear.

Invest in Debt

When I look back at those first DIG meetings I attended, only now do I see how serendipitous they really were. The first full Saturday meeting I attended may have been the most serendipitous of all, actually. The very first person I got to see speak was a man by the name of Jimmy Napier.

Back then, to me at least, that name didn’t mean much. There was no way of knowing he would be considered a so-called founding father of note investing and the author of what is now probably the most famous book on note investing ever written, Invest in Debt. During his full-day Saturday talk, he spoke about everything from understanding debt to how to work a financial calculator. I found it all fascinating, but at the time, I just couldn’t see myself in that world. I was a real estate investor, and before that, I had been a contractor. The realm of discounted debt in relation to the finance world seemed so foreign to me as a guy who was still managing all his properties himself, even doing much of the physical handyman work.

After meeting with one of the greatest minds in the note industry, I did what most people would probably do…absolutely nothing. Well, nothing with notes anyway. I was still dead set on my goal, and learning more about hard real estate was part of the plan. I attended the Thursday-night meetings and Saturday workshops every month, and on the off nights, I went to subgroup meetings whenever I could, building my networking skills and absorbing as much as possible. I kept up this strict regimen of meetings for several years, and it was through these meetings that I was introduced to an endless well of real estate investing strategies and concepts, expanding my network of close friends and acquaintances who invested in all types of vehicles along the way.

My Aha! Moment: Everyone Is in the Note Business

There was an aha! moment I should’ve recognized that day with Jimmy Napier, and maybe I did, but I didn’t know what it could really mean for me. That moment was this: Napier opened my eyes to the world of debt and how we’re all a part of it. In fact, now, when an investor asks me how he or she can get into the note business, I often reply, You’re probably already in the note business. Almost everyone is. Most people just happen to be on the other end of it. What I mean when I say that is this: Most of us tend to be on the side of the borrower, the one making a payment on a note, rather than being on the side of the lender that receives the payment, like a bank. It’s pretty hard to find a person who doesn’t have a credit card, car loan, mortgage, student loan, or medical bill payment to make. The best way to get on the other side of this equation is to gain a deeper understanding of debt, leverage, and notes.

Good Debt vs. Bad Debt

I’m not the first person to talk about the concept of good debt versus bad debt, and I hope I won’t be the last. How to better utilize debt should always be a topic of conversation among investors and consumers alike. The crux of the good debt versus bad debt concept is that debt can be just as helpful as it can be harmful. Good debt is something that can create value, build wealth, and generate additional income. It’s often deductible debt, as well, some examples being mortgage interest, student loan interest, and credit card interest, if it’s through your business and for your business. Conversely, bad debt does the opposite and is merely an expense; examples include car loans, the majority of personal credit card debt, and most personal loans (unless they’re being used to improve or expand something that can create more value or income later).

Many of us, myself included, have fallen prey to accruing bad types of debt. For some of us, it can seem inevitable, like when incurring debt to pay for necessities like education, food, or shelter. Sometimes it’s not even the debt itself that’s the worst part but all the excessive fees that come along with it, with many borrowers being obligated to pay higher-than-average rates and fees for things like insurance, bank loans, and credit cards because of poor credit or financial standing. I definitely found that to be the case in my early years as a working adult, but as I continued on my journey as an investor, I started to see the light. At the end of the day, debt is really just a means to access capital. Making debt work for you is the best way to remain free of bad debt and build wealth, and one of the best ways to do that is by utilizing notes.

Types of Notes

In its simplest form, a note (or a promissory note, as it’s officially called) is a promise to repay a loan. A mortgage is the recorded document that attaches that loan (also known as a lien) against real property that secures the note. A more detailed definition would state that a promissory note is a contract in which one party (the borrower) agrees to repay a certain portion of the loan to the other party (the payee) within a set period of time under specific terms, which could include interest rate on the loan, penalties for late payments, etc. So that’s what a note is theoretically, but there’s much more to note investing than just an IOU.

With so many different types of debt—whether it’s commercial versus residential or secured versus unsecured—it would be an understatement to say that not every note is created equal. You could even go as far as to say that every single note is different and unique in its own way, with different borrowers, lender regulations, locations, prices, etc. But there are categories that all notes fit into. The notes that the majority of real estate investors refer to are secured residential mortgage notes—the two biggest delineations of which are seller-financed notes and institutional notes.

Seller-Financed Notes

Jimmy Napier, and many others who followed in his footsteps, worked more in the world of seller-financed notes. Seller financing (or owner financing, as it’s often called) is exactly what it sounds like: Instead of the buyer getting a loan from the bank, the investor selling the property lends the buyer the money for the purchase. The two parties then complete this lending transaction by executing a promissory note detailing points such as interest rate, repayment schedule, and consequences of default. These notes can then be brokered and sold in the seller-financed marketplace.

So with seller-financed notes, investors can maximize their profits on a real estate deal by creating a note and attaching it to the property they’re selling…or they can purchase a note like this and buy right into it as a cash-flowing asset. This was the world of notes I was first introduced to, and not too long after my encounter with Napier—when I really started to network, learn, and ramp up my real estate business—I would use seller-financed notes to create additional profits. But I don’t want to get too far ahead of myself without mentioning the other side of the note business.

Institutional Notes

There are also institutional notes. These are similar in concept, but instead of buying a note that a seller created, an investor is buying a note originated or underwritten by a bank. Through reading this book, you’ll come to learn all the reasons why this is the side of the business I reside in today, but if I had to sum it up in one sentence: It’s one of the best ways to be like the bank. And why would I want to be like the bank, you might ask?

Banks Have It All Figured Out

In the abovementioned notes, there is one common trait: The investor is not only the borrower—the investor is both the borrower and the lender at the same time. This is one way banks make their money. By persuading everyone to save money for a future need (whether it be out of fear or peace of mind or for a rainy day), banks pay customers a small percentage for this capital and use this money to generate income. The movement and redeployment of this money creates leverage, with arbitrage.

In the United States, with government approval, banks help create growth and finance loans by leveraging depositors’ money. They do this by borrowing against depositors’ capital (up to seven to ten times, depending on the status of the bank and its reserve requirement) from the Federal Reserve (a.k.a. the guys who print the money!) for a fee so they can then lend even more money out to bank customers for an even larger fee than what’s paid to depositors. It may sound complicated, but it’s simply brilliant. Personally, I think that many people know this but haven’t figured out a way to apply these concepts to their investing portfolio.

Jimmy Napier’s talk wasn’t my first exposure to this idea, just as I’m sure my retelling isn’t to you. It was actually my money-and-banking course in college that gave me a 30,000-foot introduction to how banking really works and how money flows through the economy to facilitate businesses, housing, and overall economic growth. This growth is usually connected to new construction, business loans, consumer loans, auto loans, etc.—all of which is finance driven. Once you understand this, it’s not hard to see that the facilitators of the money in our society are banking institutions.

How I Built My Wealth by Being like the Bank

Most of the wealth that I’ve been able to personally accumulate wasn’t solely from buying, selling, or owning notes or hard real estate. These things were just a piece of the pie. Where my real wealth has come from isn’t the result of any one vehicle but multiple ones—all using strategies employed from thinking and acting like a bank, or in other words, utilizing arbitrage or leverage along with other banking strategies that I detail in the following chapters.

Throughout childhood and into adulthood, most of us are programmed to the ideas of studying hard, going to a good school, getting a good job, and saving, all of which translates into success and making lots of money. Well, I studied hard, went to a good school, and had a good construction job, and I still plateaued. Even when I became a part-time Realtor and, eventually, a full-time investor, I had more income (even much of it being passive), but it still didn’t translate into the so-called American dream of success. What I learned, standing in those banquet halls full of real estate investors over the years, slowly becoming one of the successful ones, was that the typical path wasn’t the only way. You don’t have to be a high-income earner to become wealthy. The old phrase It takes money to make money isn’t necessarily untrue, but I feel as if there should be an addendum to it: "It takes money to make money… but it doesn’t necessarily have to be your money that gets you there."

The majority of self-made millionaires and billionaires in any industry, but especially in real estate, in one way or another leverage people, money, and time to build wealth. For me, this was first accomplished by using banks’ money for leverage. Initially, I did this to acquire real estate. Then I used my assets to leverage more money from the bank, raised private money from other individuals to leverage into commercial and residential property, and, finally, through purchasing notes myself at a discount from the bank, really harnessed the power of leveraging money and debt!

I can’t completely credit this, and what I’m about to tell you, only to Jimmy Napier, but he was certainly one of the many people who helped me realize the potential of notes. The number one thing about notes and debt is this: Notes are versatile, and there are many ways in which investors can leverage debt and utilize notes and banking concepts to build wealth more effectively, efficiently, and quickly— now more than ever.

The Goal of This Book

Let’s fast-forward to today, where I’m cofounder of a company that owns and manages more than $100 million worth of institutional notes and an investor who has exponentially maximized his real estate portfolio to far surpass his expectations of wealth with twenty or even one hundred free and clear houses. After years of attending meetings, watching speakers, reading books, and connecting with other