Peter Fortunato needs no introduction to veterans of this business. He is a lifelong practitioner of the art of the deal and has been buying, selling and using paper in transactions for over 30 years. His students, no matter how experienced, are always amazed at what they learn from him. He changes people’s lives by changing the way they think about money.
In this interview Pete explains how he got started, why he treats paper as a tool rather than an end in itself, and how he builds deals that give each party what it values most.
Getting started in real estate and paper
Q: Pete, how did you get into the business of making money and teaching others?
In 1965 I graduated from high school and went into the real estate business. A major reason was my determination never to work for anyone. Pretty much everyone who knew me believed I was unemployable. They were right! I still am.
In August of 1965 I got my real estate license, and in late September I earned my first commission. All through college I worked in real estate sales. I represented clients buying houses and, later, investment properties.
Investors were easier for me to work with. I liked the logical sequence of structuring an investment for yield or for profit. People buying homes for their families would constantly ignore my good advice and their financial well-being because their grandmother’s dining room suite did not fit in the house I knew they should buy. I was more successful with investors, so I finally decided to deal with investors exclusively.
I was one of the few commercial and investment real estate agents on the North Shore of Boston at that time. I was a young man attending college, not grey enough that people would look to me for investment advice or risk their money with me.
So I attended many real estate and investment seminars and began presenting free seminars to introduce myself to potential clients. Typically I’d get eight or ten people at the office. I would explain the benefits and responsibilities of investment property for an hour, answer questions for 30 minutes and hope that one or more of them would return as a buyer or seller. Seminars and speaking engagements have generated business for me from the very first.
Learning that value is personal
Starting out with no money was a great blessing. I had to make deals work. What was especially helpful is that I was anxious to learn.
Every time I took a course, I went with my dad. He wasn’t a numbers guy; he was a people guy. I was good with the numbers. My dad would say a deal would be good for this or that person. Having him there to show me the human side of deals was a great benefit.
I also study a lot, and I enjoy title law. Not only do I understand and apply the numbers, I understand how to use title to real estate. That has always been a reason a lot of my transactions closed.
A big boost came when I took Warren Harding’s classes. He always made sure we understood title. It’s not just the net present value of the deal; you have to ask who this is appropriate for. Who would use this income stream? Many, many times I found someone who was delighted to get a 10 percent income stream when the market was 14 or 16 percent. Warren called that “shooting the income stream.”
By combining what I learned from my dad and from Warren, that value is personal rather than market-driven, I have been very successful using notes and mortgages to buy real estate, provide cash flow and build equity.
Using notes to make real estate deals work
For example, I would find real estate deals with negative cash flow, and I couldn’t afford even a small negative. One of the first uses I made of a note was to buy a $5,000 note for $3,000. That note paid me $100 a month for 60 months.
By putting that note together with a rental property I had just bought with negative cash flow, the note payments covered the negative and made it a break-even deal. By the time the note ran out, the real estate had matured and carried itself. When I was starting out, I often used mortgages to carry many of my more highly leveraged houses.
Another way I work is to definance real estate. The myth is that you exchange up and up, and when it comes time to definance you have a big tax problem. Because taxes don’t involve net present value, you can exchange up into property with more debt at par, when in fact you have exchanged down into property encumbered with less present-value (costly) debt than the property you gave up.
Q: Where did the paper come in?
Paper came in because, in the investment business, paper is what you use to turn what you dream up into something that really happens. When I sit down with people to negotiate a deal, it is the paper structure that makes the transaction worthwhile for them and for me.
John Schaub asked me, “Do you remember the days when we had our entire net worth in our gas tank?” I remember those days well. They were responsible for my developing a facility for beneficial transactions rather than just throwing money at a deal.
When I negotiate, I am very focused on creating a result that I want. Since value is subjective, I have had to learn to listen to find out what people want to have or accomplish. Then I have to promise them something better, to them, than what they are giving up. That promise has to be documented so that it will happen even in my absence. That documentation is paper.
Why houses beat paper as a long-term investment
Q: When you started, investing in houses must have been something people had never heard of.
Correct. I first heard of single-family investing after I’d been in business for a couple of years. Charlie Huggins was successfully syndicating houses in the D.C. area back then, the first time I’d heard of anyone doing that. Then I read Jack Miller’s articles about “horizontal apartments.” Jack talked about rental units that were single-family houses, in which the tenants did not talk to one another.
My biggest success with single-family houses stems from my ability to acquire them as an investor. My analysis and determination of value are based on an investor’s mentality: I have a financial purpose in acquiring each property.
When it comes time to sell, I can sell at retail to a user. Selling a home is very different from dealing with income properties, which are bought and sold by investors who simply capitalize the income stream to determine value. I believe houses offer greater profit potential and easier management than the alternatives. I find houses easier to understand, so I get myself in less trouble with them, and I can introduce them easily to new investors. Houses are less off-putting than most investments available.
Q: Was doing creative deals with paper also almost unheard of?
No, I don’t think so. Others were doing things with paper in the sixties, and long before. In most marketplaces, notes secured by real property offer predictable cash flows and attractive yields that are competitive with, or superior to, the alternatives. Whenever people have taken the time to make sellers and creditors believe they will receive what they have been promised, transactions involving paper close.
I use paper as a tool. It enables me to achieve the results I want. Because paper runs out and real estate doesn’t (if well located and maintained), property is a far safer investment than paper secured by property.
In my view the paper business and the real estate business are equal. Each lets the salesman control great inventories without having to buy them, with limitless opportunities to sell and profit.
But when the day comes that you want to invest and let your capital produce without your active participation, real estate wins without question. Besides the fact that rents are inflation-hedged and tax-advantaged, the greatest difference between rental income and interest income is that at some future date interest income ends, while rental income continues.
I am very concerned about the number of young people who invest their limited savings at interest and the number of older people who abandon equity investments. You can imagine the interesting feedback I get when I bring up this topic in seminars.
Q: Of course you have to pay attention to your paper investments, but many people, me included, have been through hell and back managing real estate.
Management is a lot worse in paper than in real estate. Certainly there are more day-to-day calls with property. People don’t call you when you own the paper secured by that property. When things are good, that is great. When things are bad, they don’t call you either.
Deferred management accrues like unpaid interest. It accumulates and compounds, and the noteholder is much less able to respond and protect his investment than the property owner.
If I were your tenant and not paying rent, how long would it take to get me out? If I were the borrower and not paying the mortgage, how long would it take? Rent is paid in advance while interest is (usually) paid in arrears, and many landlords hold a security deposit and last month’s rent, so the landlord has the advantage over the mortgagee. In most jurisdictions, evictions are simpler, faster and less costly than foreclosures.
I think the freedom from management in paper is dramatically overstated. When I have a problem, as a mortgagee or as a landlord, that problem requires action. Fixing it is always easier as a landlord than as a mortgagee.
Value is subjective. The same goods or services are worth a different amount to each individual. I find that people who believe value is absolute and objectively measurable fail overwhelmingly in all businesses. Unless you understand how personal value is, you will have difficulty getting transactions to close.
I like to talk about the joys of being a capitalist. People have to know that it is possible to replace themselves as the breadwinner for their family with capital. People who believe this is possible will dream the dreams, set the goals and take the actions needed to free themselves to enjoy the things they like to do and the people they like to be with.
How the paper business is changing
Q: From your 30-year perspective, how is the paper business changing? For better or worse?
I am seeing many more people active in the paper business. A couple of years ago I saw many more dreamers and a much smaller percentage of doers than I see today.
There is certainly no shortage of opportunity. My crystal ball sees more and more self-employed people in our future. These are people who won’t qualify for, or tolerate, institutional financing.
I am also seeing a growing variety of annuities available for investment and new niches in paper. I have spent time with Randall Simoes and Tom Boleta of Prosperity Partners discussing structured settlements and ways to deal with their non-assignability. I am impressed by trailblazers who go into investments like these, which require tremendous courage and creativity.
Non-real-estate cash flows will be a staple of future growth in the paper business.
Q: With growth comes the threat of government regulation. Do you see that coming for the paper business?
I hope not! I don’t believe there is any greater enemy any of us face than the government. Government takes enormous amounts of wealth from people by force and by threat of force. The costs of regulation and taxation eat up 40% or more of our gross national product each year. That money rightly belongs to the people who produced and owned it. One should never deal with any government agency if it is avoidable.
I am surprised that a nation of people whose ancestors had the courage to risk their lives, families and assets to be free, who held the Boston Tea Party over a 1% tax, now allows itself to be taxed and regulated at such levels. I am in favor of no government intervention of any kind in the marketplace.
Ethics without a written code
Q: Do you think the note industry needs a written code of ethics?
Years ago, marketplaces regulated themselves. If you were a rogue constantly injuring people, your neighbors warned others: “Don’t deal with him.” Dangerous people and practices were shunned and unable to keep doing business. With today’s ease of travel, such people can move elsewhere and damage others. With developing computer networks, though, we will increasingly be able to identify dangerous people and practices so others can make informed decisions.
I am not in favor of codes of ethics for industries. Each person must have a code of ethics he or she lives and works by, and standards of behavior he or she expects of others. I know what it is to be ethical. What I believe is correct, others may disagree with. When I try to inflict my vision of perfection on others, that creates problems.
I think each of us has a responsibility to warn others about dangerous people and practices, and to encourage others to do good business with good people. That is part of due diligence.
Before doing business with me, you should ask around: “Have you done business with Pete Fortunato? How did it turn out?” If you like the way I do business, you will do more business with me. If you don’t, you won’t! That is how the marketplace works, and it doesn’t require a code of ethics.
Recent deals: splitting the benefits
Q: What deals have you recently completed?
Right now we are acquiring a waterfront home by purchasing an option to buy the property from a very creditworthy person. That $30,000 option consideration is tax-free to him.
He will then buy the property from us at a price we negotiated below its retail value. Then another entity will lease the property from him, so he has no management. The investor who bought the option has the lion’s share of the appreciation. The man who used his credit but no money has all the tax benefits. The company leasing it has a property it will use and enjoy.
So we have distributed the benefits of use to one party, the tax benefits to another and the appreciation to a third. That is the kind of transaction I enjoy, building it block by block.
In a recent week we had four closings and an option payoff. In three of those closings, we bought subject to existing debt from people who were in over their heads. We simply took over their loans without paying them anything.
The other closing involved a note a friend’s IRA bought at a discount. We arranged for the property securing that note to be sold, the note was paid off in full, and the discount was earned in my friend’s IRA.
