Most real estate investors understand the importance of a deal’s return on investment (ROI). What they often overlook is an important factor in ROI: time. Time has a monetary value, and it differs from investor to investor and strategy to strategy.
In note investing, the faster you earn back your principal and earnings, the higher your ROI. This case study shows how one active note investor worked with a borrower to shorten that time frame and boost his return.
The note in this case study
This case study comes from Donna Bauer, a private investor and note buyer. Donna and one of her students, “Sally,” bought this note and later sold it to another investor. Here are the details:
| Detail | Value |
|---|---|
| Term | 360 months, full balloon after 60 months |
| Interest rate | 7% |
| Monthly payment | $805.02 |
| Payments made | 32 |
| Payments left before balloon | 28 |
| Unpaid principal balance (UPB) | $117,521 |
| Pay history | Perfect for 2.5 years, direct deposit into the seller’s bank account |
| Fair market value | $150,000+ |
| Occupancy | Owner-occupied |
| Security instrument | Deed of trust |
| Property taxes | Current, per the seller and checked with the county auditor |
| Purchase price | $80,475 |
What made the note attractive
There was a lot to like about this note:
- It is owner-occupied.
- It is secured by a deed of trust instead of a contract for deed. Deeds of trust are usually easier to work with if there is a default and you need to foreclose. Make sure the security instrument you use is legal in the state where you invest.
- The taxes are current.
- It has a perfect 2.5-year pay history, verified with bank statements.
- The house is in excellent condition.
- The loan-to-value (LTV) is only 78%, which is very reasonable.
- It has a relatively high interest rate for a seller-financed note.
- The borrower has a solid job in an administrative position at the local hospital.
Three ways to exit the note
Sally, the note’s owner, had several attractive options.
Option 1: Keep the note
The key “X-factor” here is the balloon payment. The borrower had some minor credit issues and might have trouble getting financing, which could make it hard to pay off the balloon when it comes due. Sally might then have to carry the note for the full 360 months.
Verdict: still positive. Even then, Sally would earn a nice 11.47% return. If the balloon paid off as written, her return would grow to 25.3%.
Option 2: Sell to an institutional buyer
Sally and Bauer first tried to sell the note to a large institutional buyer. They agreed on a price of $108,090, subject to the borrower having excellent credit and a broker price opinion (BPO) showing a property value of $150,000. That would have meant a quick $27,615 profit.
Result: failed. The BPO came in low, which killed the deal.
Option 3: Sell to a private investor
Next, they offered the note to a private investor we’ll call “Ivan” for $95,000. That was less profit than the institutional offer, but it still represented a $14,525 profit.
Ivan stood to gain too. If the borrower couldn’t pay off the balloon, Ivan would earn a 9.38% return. If the borrower did pay it off, Ivan would earn 17.16%.
Verdict: a very positive option for everyone.
How the deal actually played out
Surprise: Ivan was more than a passive investor. He worked in the mortgage industry and helped the borrower refinance just three months after he bought the note. He paid $95,000 for the note, and three months later he received the full $117,000 payoff when the refinance closed.
The breakdown:
- Sally received the $80,425 purchase price she wanted for her note.
- Bauer earned $14,525 in fee income for arranging the deal, which she split with her student.
- Ivan earned $22,000 for buying the note and helping bring about an early payoff.
- The borrower likely refinanced at a lower interest rate.
Everyone won in this deal.
