Many people talk about flipping and buying properties, but a niche area of real estate investing that most people are unaware of is called note buying.
Today, Clint Coons of Anderson Business Advisors talks to Bill Mencarow of Paper Source Online. The Paper Source, Inc., was founded in 1987 by Bill and his wife and business partner, Alison.
Bill and Alison have been note investors since the 1980s. Also, he is the editor and she is the publisher of The Paper Source Journal and they co-host the radio talk show, First Couple of Texas Radio.
- What is a real estate note? A promise to pay—mortgage secured by real estate.
- What’s your role if you own a real estate note? You’re the banker, not the landlord.
- Why not be a landlord? You have to deal with tenants, toilets, and termites.
- What are the reasons to buy/own real estate notes? Cash flow, higher yields, lower risk.
- How the process of buying notes work? Sell note for lump sum to investor at a discount.
- What are the different types of notes? First, second, or third position against note.
- How do you know what you are buying? Perform due diligence—paper, property, payer.
- How do you verify payments, borrower’s credit, and value of note to know what to offer?
- What do you need to get started buying notes? Cash investment or broker note.
- How to find real estate notes? Network to establish context with people with notes.
Full Episode Transcript:
Clint: Hey, what’s up, guys? It’s Clint Coons here. In this episode, what I wanted to do is bring to you someone who’s an expert in their field and talk about an area of investing that a lot of us just don’t realize is out there. So many people talk about flipping property and buying property, and I teach you strategies on how to address those types of investments, but there’s a wide range of opportunities when it comes to real estate investing.... Read Full Transcript
In this episode, what you’re going to learn about is something that’s called note buying. What I thought I’d do is I would bring to you one of the foremost experts in this field. His name is Bill Mencarow and he is with Paper Source. He started this company. I’ve been following him for years. In fact, we actually spoke at his event.
He has a very interesting life story where he’s been a radio talk show host. He’s been working in Congress before. He’s on a transitional committee for Ronald Reagan. So he has a lot of experience, but more so he’s been investing in this niche area. What better way than to bring to you an expert in the field. Bill, thanks for joining.
Bill: Thank you, Clint. It’s a pleasure. I appreciate the opportunity.
Clint: Great. Hey, so why don’t we start off by telling everyone a little bit about yourself and how you got started in this business?
Bill: Well, you covered a little bit of range, my background a little bit. I still do a radio talk show, by the way, with my wife, Alison. We’re called The First Couple of Texas Radio. That’s our website, in fact, firstcoupleoftexasradio.com. We talk about all sorts of things, including real estate, by the way.
I have to credit our tenants for getting us into notes or buying real estate notes, we’re obviously going to explain more of that in a moment. When I say my tenants got me into it, being a new landlord, not really knowing how to be a landlord. Now, I’ve been a landlord for about three decades, so I started getting it. But they call it tenants, toilets, and termites that you have to deal with.
When you own a real estate note, I discovered that if a tenant or homeowner causes a problem, they don’t call you, you’re the banker. If there’s a problem in the house, somebody in the middle of the night does not call a banker, they call the owner of the property. But if you own the note, you’re the banker. That’s one reason we got into it.
Another is for cash flow. You can get higher yields or interest rates than you can with most other investments, certainly with a bank CD these days. That’s combined with lower risk than almost any other investment I know of. For example, if you buy a mortgage on a half a million-dollar house and you put $80,000 into buying that first mortgage, you just hope it goes into foreclosure. That’s what I mean by lower risk. Obviously, there’s always a risk in any investment.
Another point is you can determine what interest rate you want on your money. Show me another investment where you can do that. So those are some of the reasons. We’re still in the real estate. We have a number of properties locally in our town in Texas, but we certainly also buy notes.
Clint: I think sometimes people fall into something they don’t intend to start off that way. Maybe they start seller financing and they realize, hey, property is no longer my concern. It’s their concern. I just hold the paper on it. So maybe that’s how you possibly got started because I know several investors that have done that themselves. For those people who are not familiar with it, what is a note?
Bill: A note is a promise, a promise to pay. I could give you an IOU and it would be paid over time. Usually, it’s a mortgage secured by real estate. We call it a note for short. Technically, it’s not a mortgage, but we won’t go into that. It’s a note secured by real estate. It’s a promise to pay.
Let’s say, I sold a house and instead of having the buyer go to a bank and get a bank loan, I say, I like your credit, you’ve got enough down payment, you just pay me the payments every month instead of paying the bank. So you sign this note, I owe you for (just make up a number) $100,000 to buy my house and you give me a nice hefty downpayment. Now I’m getting that money every month. I’m getting $1000 a month, $1200, or whatever it is from you that bought my house.
Then I decided I’d love to take a cruise or I have some other reason that I’d like to have a chunk of money rather than just $1200 a month coming in. I go to an investor and I say, are you interested in buying this note and you getting $1200 a month if you give me a lump sum of cash? That’s what the investor does. Then the investor, I just tell the guy who bought the house from me, instead of spending the $1200 a month, you send it to this other person who has bought the note and he’s now your banker if you will. That’s how it works.
Notes are sold at a discount. So I would sell my $100,000 note for something less than $100,000 because of several things. Number one, I’m selling payments to be made in the future. There’s no guarantee, something might go wrong. Also, just the time value of money. $1200 today is worth more than $1200 to be paid 10 years from now, so notes are sold at a discount.
That’s what makes it very attractive for an investor because he’s getting $1200 a month, but he didn’t spend $100,000 to get it. He might have spent $80,000 to get it, which brings his interest rate higher than the face interest rate of the note. Does that make sense?
Clint: Yeah, so what I’m hearing you’re saying is that I am buying a mortgage from a bank, essentially. Instead of the purchaser of that property, the borrower paying the bank, now they’re going to start paying me that money on a monthly basis because I’m going to own the rights to receive those funds. I’ll have the secured interest in the property.
Clint: Well, how do I ensure that that position is secured and that people know that I’m involved with it?
Bill: You mean, how does the payer know to pay you instead of the other person in the bank?
Clint: Yes, correct. If I bought a note from you, how are they going to know to pay me?
Bill: Okay. I let them know, they know me. They don’t know you. You can’t send them a letter and say, well, I’m Clint, so start paying me. They don’t know you but they know me. I say, I have sold it to Clint and I’ve never had anybody question that.
Clint: For example, if I was going to buy a note and I’m interested in this, there are different types, as we say. There’s first position, second position, third position. I was talking to an investor the other day or a couple of months ago and he said, oh yeah, I took a second position against this property. I have this note. I said, you do? He goes, yeah, I loaned the money, I’m now holding this notice.
I said, what did you loan? How much against the overall value? He goes, 100% against after rehab value because this was a rehab deal. I thought it was kind of risky because now he’s holding this paper where he loaned this individual investor money against the rehab. Say he wanted to turn around and sell it to you, you would step in and buy a second then on that property. There are risks that come with that. What I’m asking is, do you buy seconds or do you stay with first?
Bill: I stay with firsts. I have bought seconds in the past. You can do that if you understand what happens, for example, in the case of a foreclosure, where if the holder of the first lien forecloses, you have to step in. Otherwise, you’ll lose your investment. You have to step in and pay off that first lien to protect your investment.
I don’t particularly want to fool with that, but other people do. I wouldn’t touch anything beyond the second, that’s for sure. That sounds a little scary to me. For one thing, it’s 100% of—did you say after rehab it’s 100% loan to value?
Clint: After rehab value, correct.
Bill: Yeah. I mean, number one, you never know if the rehab is going to happen or how it’s going to be after its so-called rehab. That would kind of scare me.
Clint: When you’re looking at the notes, you have to know what you’re buying, be it the first or second note.
Bill: You have to do what’s called due diligence, which I know you’re familiar with. For notes, that’s what I call the 3 P’s. You have to look at the paper, you have to look at the property, and you have to look at the payer. First, you look at the paper. That means, what’s the interest rate on the note? How’s it written? What’s it secured?
Then you look at the property. Well, the interest rate and the other terms of the note. Actually, believe it or not, I have a copy of it. I once saw somebody send me what they called a note and it was an IOU. A guy wrote on it, I promise to pay $100,000 on or after this date. You have to look at the paper. Obviously, that’s a worthless note on or after not on or before.
Then you’d have to look at the property. My rule of thumb is, would I be happy owning the property that the note is secured by. That means I wouldn’t buy a note on a nuclear waste dump, gas station, or a big industrial building. I don’t know what to do with those properties. I would rather stick to properties that I would want to own, a nice single family house or an office building maybe. I might consider other things like that.
Then you look at the payer, what’s their credit? Is the note brand new? That could be risky because then there’s no track record of the payer paying. On the other hand, there’s what we call a season note, which might have six months, a year, or five years of on-time payments. That’s great. That makes the note worth that much more.
I look at the payer, the property, and the paper, and then you have to look at what state the collateral is located in. Are they creditor-friendly or debtor-friendly states? You might think twice about buying a note in a debtor-friendly state. It’s going to take you a lot longer if there’s a problem to foreclose or do whatever you have to do to cure that note.
Is it a judicial foreclosure state or a non-judicial foreclosure state? In a judicial foreclosure state, you go to court to foreclose, and that’s usually going to take you longer and be more expensive than in a non-judicial foreclosure state where the property is sold and the courthouse steps in an auction to the highest bidder. So those are some of the major things to look for when you’re buying a note.
Clint: Okay, so everything that you just brought up there, there’s a lot to unpack, but one of the things I would be really interested in understanding is if somebody approached me and they said, here’s a note that I have. It’s a $200,000 note. They’ve been paying me for six months. I’m looking at that and they want to sell it.
First off, I’ll give you the questions in order. How do I verify the payments that they’ve been paid to this individual so I know that the borrower has been paying on time? How do I know the credit of the borrower? Then how do I determine the value of that note, what I would offer for it?
Bill: First of all, proving the payments that have been made. It’s ideal if this note had been serviced by a servicing company. There are such things, of course, then you just have the records of that. If the person who owns the note has been collecting the payments themselves, ask for copies of the deposit slips or the bank statements showing that those payments were deposited. Those are different ways to prove that those payments have been made when they’re due. What was the second question again?
Clint: How do you determine the credit of the borrower?
Bill: Legally, and I’m not here to give legal advice. Obviously, I’m not qualified to do that. But from what I understand and what I’ve read, under the Fair Credit Reporting Act, if you are in contemplation of loaning money and it’s been interpreted as buying a note, you can pull the credit of the payer. That’s the best way. Obviously, to do that is to pull credit if you’re doing that.
I suggest that it’s best to protect yourself, to ask the note holder to ask the payer to sign a paper giving you permission to pull credit. You can do it without that paper, but just to protect yourself, I suggest you do that.
Clint: How do we determine the value then? This note is $200,000, we’re six months in, and then they want to sell it. They’re going to make an offer, I’m going to make an offer, what do you do?
Bill: Well, after you’ve looked at the payer, the property, and the paper and you’re satisfied, take a look at how much interest you want to make or yield (as we call it) do you want to make. I’d like to make 500%. Well, that’s obviously not going to happen. There’s a range of yields that will make your offer possibly acceptable to the note owner.
Let’s say, okay, the note is written at 6%. You say, well, I want 10% interest or yield, you have to learn how to operate a financial calculator or go online to a financial calculator site, and you just plug in the interest rate that you want, your 10%. You plug in how many payments will remain and it will give you what you should pay for that note at 10% yield.
I’ve known people who don’t use a financial calculator, they just make up a number that’s a discounted number. They say, whatever they get is really good. You can do that too. If it’s a $200,000 note and you offer him $140,000 […] and he takes it, I guarantee you that’s going to be a good yield.
Clint: Yeah. All right, so that really answers one of my questions that to get started in note buying, you’ve got to have cash, right? Have you ever run into a situation where someone’s going to sell it to you like on a […] on an installment sale? Let’s say, listen, as long as you can give me $50,000 upfront and then give me payments over time, I’ll sell it to you. Then I keep collecting the payments and I’m paying someone else out, other than the cash option.
Bill: Absolutely. That’s a good idea, that’s a good suggestion. You can wrap it. You can go in with a partner on a note where you each share the payments or maybe your partner puts up most of the cash and they get most of the payment. That’s another thing that’s great about notes, there are all sorts of creative ways to do it.
Let’s say you and I go into a note together. I say, well, I can put in about 20% of the cash, but you want to put in 80%. But then you get 80% of the amount every month in the payment and I get 20%, or you get the next X number of years’ payments and then they revert to me. If it’s a 10-year note, you get the next 7 years of payments, for example, and I get the next 3 because of time value money.
There are all sorts of ways you can do things like that, or you can broker notes where you don’t require any cash investment at all. That’s simply finding a note, getting the information on the note, the payer, the property, the paper going to an investor and saying what would you offer for this note? The investor tells you, you go back and offer a different price to that, and the investor offers $50,000 for the note. You come back and tell the note owner, okay, I can get you $45,000. If they accept that, your commission is the $5000 difference. There are a lot of different ways to buy notes without actually using your own money.
Clint: When you’re doing that though, would you recommend that someone who is interested as far as building out a team, should they have a title company involved and an attorney to help ensure that their note is perfected so that everyone knows that they’re the owner of it vis-a-vis the borrower?
Bill: Absolutely. Yes to everything you just said. Use an attorney, especially if you’re just getting started, but I always use an attorney just to make sure that particularly, if I’m buying a note out that’s not in my state and I’m not familiar with the state laws, I definitely want to have an attorney who is looking over the deal, making sure that the note—particularly in the deed of trust, mortgage, or contract—is written in accordance with state law.
For example, I used to live in Virginia. I think there’s some language in it. I don’t remember now what it was, but there’s a phrase that’s used in all notes. But in Virginia, if that phrase is not in all capital letters, the note is void. How would you know that? You got to have an attorney? You got to have an attorney to know stuff like that.
Clint: If I’m going to buy a note, do you put together your own purchase and sale agreement between the parties? So if I was buying yours, I would have a note purchase and sale agreement that you would give me certain warranties in that. Is that typically the way it works?
Bill: That is absolutely typical. You have seller’s representations and warranties like you do in a lot of transactions, real estate transactions, for example. You have an agreement of sale. They’re fairly simple. We have them available on our website. People can get it for $1 I think is what we charge for, but it’s pretty simple. I have known people who have bought notes and just written out an agreement on a napkin. I don’t recommend that, but it can be done. It can be a valid contract even written on a napkin.
Clint: Okay, so then it’s going back to the properties themselves. Maybe you could explain to us, what are the things you should be looking for? You said one thing: a property that you would want to take over if you had to foreclose. But are there some other criteria there for someone who’s trying to evaluate this as a potential revenue stream for them that they should be aware of and what they should look out for particularly?
Bill: Yes. As I mentioned, I wouldn’t personally buy a property that I wouldn’t want to own. Not everybody agrees with that, obviously. You’ll say, well, you can always hire a realtor to sell it. That’s true, in some cases. If it’s not a property that you can visit easily or very often, you want to have somebody just driving by to make sure it’s still there. You might want to have a friend, hire a realtor, or somebody to do that for you.
When you’re considering buying a note, you want to have an appraisal done. It’s not going to be a formal, full-blown appraisal because remember, you’re not buying the property. You’re buying the note on the property. The appraiser can’t get into the property most likely because the payer has nothing to do with you buying the note. So you probably won’t have them get in the property, but you can have a drive-by appraisal.
They shoot pictures of the outside and all four sides of the house, for example. They shoot pictures of the neighborhood. They give you comparable sales so you know what that’s worth. That’s if you’re buying a note and you’re unfamiliar with the area. Other than that on properties, I can’t think of any other advice.
Clint: How do I go about finding notes? Personally, I wouldn’t know where to look, if I wanted to start investing notes. Where do you go?
Bill: There are a lot of different ways. Some are better than others. I prefer networking, establishing contacts with people who are in a position to see notes come across their desk, and you start thinking about well, who would that be? Well, attorneys, real estate attorneys, estate attorneys.
Quite often we get notes from people who passed away and the family says, well, I don’t know what to do with this. I don’t want it or I understand I can sell it for cash. That’s what we want to do. Bank trusts officers see notes. Real estate agents and brokers see notes. Title company officials see and know about notes.
I know of someone who made arrangements with the title company and paid them to include when they sent out the statements to the note owners every month. You get a statement from a title company or servicing company every month. They were also a servicing company, I guess. When they sent out the monthly reports, yes, the note was paid this month, here’s the balance, and here’s how much interest and principal is paid, et cetera.
He paid them to put his business card in with that mailing saying, are you interested in selling this note? If so, please give me a call. So I thought that was a great way to do it. Another way would be real estate investment clubs. A lot of these people in real estate investment clubs are very active in selling property and carrying back a note, or they might know people who are.
There are companies that buy notes, that’s their business, but they don’t buy notes under a certain principal amount. Let’s say, they won’t buy a note under $50,000, for example. There are quite a few of them that have that requirement. Go to them and say, well, I’ll pay you a referral fee if you would refer notes to me that don’t meet your criteria. You pay the fee but after you buy the note, by the way.
We do have a Facebook forum where notes are advertised. You just go on Facebook and it’s under Paper Source groups. You can find it on Facebook, and you can join the forum, ask and answer questions, ånd look for notes that people have posted there as well. So there are a number of ways to find notes.
Clint: I imagine there are other data feeds out there you could subscribe to that would let you know what type of transaction is in place. Whether or not it’s a private party carrying back the paper you could approach them to see if they’re willing to. What about distress note buying? I’ve seen that term used before. What does it mean? I mean distress notes, actually.
Bill: Yeah, in the last few years, distress note buying or non-performing note buying has become quite popular. When I first heard about it, I have to admit, I have had non-performing notes but I’ve never bought one. They just became non-performing. So I asked Gordon Moss, who is probably the expert on non-performing seconds, I said, why in the world would you buy a note that person isn’t paying on? It’s in default.
He said, the reason is, (1) they’re cheap, (2) if you buy a $50,000 note for $5000, you can go to the defaulted payer and say look, I don’t want to foreclose on you. It’s your house. We don’t like to do that. How much are you paying right now? I’m paying whatever, (let’s just throw a number out) $1000. That’s what I’m supposed to pay, but I can’t afford it.
How much can you afford? Well, I could afford $650. Okay, we’ll do an amendment to the note, you pay $650 for the next few years, and then we’ll see where we are on that, see if you can afford more. Well, why would you do that? Because you only paid $5000 for the note. You invest $5000 and it gets settled at $50 a month. I don’t know what the yield is, but that’s pretty darn good, so that’s why people buy it.
Unfortunately, too many people have found out about it so you’re not going to buy a $50,000 note for $5000 anymore. A lot of companies have come in and bought these up in bulk from banks. You can’t usually walk into your local bank and say, I’d like to buy one of your mortgages. But if you’re a company or you have deep pockets, walk in and say, I’d like to buy all your non-performing mortgages or notes. That’s what a lot of these companies have done. They have gone through them, pulled out the best ones, and then offered the bottom of the barrel stuff to investors and raised the prices.
It’s become a much tougher market these days. It can be done. There are people who do it. I know one guy who was speaking at our upcoming note convention who got started with us with Paper Source. I think it was about two years ago. He’s now got something like a $10 million business going with it. So it can be done. He’s going to be there and talk about how he put it all together too. It can be done. It’s just harder than it used to be.
Clint: Yeah, so you bring that up. You have a convention coming up in May where my partner is speaking at. If you could just share with everyone a little bit about what they would learn if they wanted to come out to that convention in Vegas. There’ll be a link to the convention in the show notes. But if you can explain it, that’d be great.
Bill: Sure. It’s May 12–15, Thursday, Friday, and Saturday. We begin with a morning seminar on Thursday. That is about a four- or five-hour seminar. It covered a lot of the basics—for people who aren’t familiar with it—just to get you up and running for the rest of the convention. We have a whole bunch of different speakers. We have it all in the same room so you don’t have to choose among breakouts. Oh, I’m going to miss this one, and that kind of thing. It’s all in the same room.
We have speakers on how to find notes. We have beginner speakers for beginner audiences, we have advanced speakers. We have probably the best-known names in the industry that are going to be speaking on it. They’re all available for private consultations with you—no charge for those. We have an exhibit hall. As you said, Toby will be one of our main speakers and he’s going to be offering free consultations on tax planning and asset protection.
The networking is tremendous. I hear that over and over again. We have this once a year. I just hear it over and over again. The networking is just absolutely fabulous. Some people come just for networking to buy and sell notes and to meet new people. You’ll meet the national investors. I mentioned there are investment companies, servicers, self-directed IRA experts, software companies, law firms, including, of course, Anderson Advisors, a platinum sponsor of our event, insurers.
We have complimentary open bar receptions. We have a white tablecloth luncheon all included, refreshments of course. It’s going to be May 12–14 in Las Vegas. For more information, go to the link that you’re going to post on your site.
Bill: Yeah, I was just going to say, for people watching this get a discount at sign up.
Clint: Yeah, I mean, this is intriguing. If anybody’s watching this video and thinking, yeah, I’ve heard about notes before and I just don’t know how to get into them. I think that they realized from our conversation that there are certain things you need to do to evaluate it, how to protect yourself, and if you’re checking all those boxes on the front end, there can be a good return for you on the back end, but it’s knowing that process. Would you agree that it’s not something you just want to go out there and try to learn on your own?
Bill: Absolutely. You’ve got to have some kind of training. I think one company told me they charge $50,000 for training and I’ve always thought stuff like that is crazy. We charge a fraction of that for our training. In fact, I offer a free e-course. It’s an eight-part fairly lengthy e-course. I took my two-day course and distilled it down into eight long lessons, they’re available at our website papersourceonline.com, and it’s absolutely free. I wrote it so that you could see what note investing is like and note brokering—it talks a lot about note brokering—and just see if it’s for you. If it isn’t, you haven’t spent a dime.
Clint: Perfect. I’ll put that in the show notes as well. They’ll have a direct link to the convention and a direct link to Paper Source so they can go there and watch that course if this is something that they’re interested in.
Bill: Great. Thank you. Appreciate that, Clint
Clint: You bet. Is there anything you want to leave in passing?
Bill: Well, there’s a lot we could have covered and hopefully I’ll be back and maybe go into some of those. There’s one thing I think I should tell you. There are note funds out there where we’ll take your money and you’re invested in the note. We’ll just send you the money every month, and if it goes into foreclosure, you will never know about it. We’ll service and we’ll keep paying whether it goes into foreclosure.
There are a lot of those that have gone down the tubes. I would not recommend that people invest in a note fund like that where money is pooled. Investors have lost money in those. What I would recommend is if there are note funds out there that say, okay, I’ll sell you this individual note and then it’s your responsibility. We could put all the papers on it and we walk away from it. There’s nothing wrong with that. That’s another way to find notes, by the way. I would do that.
I would also (in passing) say don’t hook up with any seminar company that also tries to sell you notes. That’s an inherent conflict of interest and it’s unethical. Because the purpose of educating you is obviously negotiation and all the other things about it, but it’s so you can learn how to buy notes. You’re the buyer, you want to buy at the lowest possible price. The purpose of the seller is to get the highest possible price and it can’t be the same person. So I would urge you to stay away from any kind of situation where you learn from a company that also tries to sell you notes. That’s my spiel for the day.
Clint: Great advice. Again, thank you for coming on. I appreciate you taking the time with us and hope to get you back soon.
Bill: Thanks so much, Clint. I appreciate it. Very much.
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