Host Toby Mathis, Esq. speaks with Bill Mencarow, founder of The Paper Source and 30-year veteran of real estate note investing. Bill writes for Think Realty magazine and has authored several guides and seminars on notes. He has been interviewed on numerous radio and TV programs including “Good Morning America,” national networks and in major U.S. newspapers and magazines.
You’ll hear Bill and Toby discuss the pros and cons of note investing, including how and when you can buy and sell, getting cash out of your note, and what to look for when buying a note – including the three P’s – Property, Paper, and Payer.
Highlights/Topics:
- What is note investing?
- Selling notes for cash
- Pros and cons, options for using this ‘negotiable instrument’
- Selling your property using a note
- Where can you find notes to buy?
- What you should avoid- rules of thumb
- Slicing and dicing your note for sale
- Why go to a megabank corporation when you can get a note with someone in your community?
- Sign up for Bill’s free eCourse or email him for advice
- 3P’s – Look at Paper, Property, and Payer
Resources:
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Full Episode Transcript:
Toby: Hey, guys. This is Toby Mathis, and I’m joined today by Bill Mencarow, who is the only guy I talk to about notes. He runs an investment group, which is an educational group and a great platform that deals with this area.
Today, all we’re going to talk about is building wealth with note investing. It’s one area of investing that a lot of people don’t know anything about, so we’re going to make sure about it. First off, Bill, thank you for being here. Second off, what is note investing and why should somebody consider it?
Bill: Well it’s about the only investment I know of where you can decide what interest rate you would like on your money.
Toby: That’s interesting. That’s a good way to put it.
Bill: And it’s a secured investment, unlike a lot of other investments. What is it? Real estate note. People call them trust deeds, mortgages, contracts for deeds in some states. It’s a legal document created when somebody sells a property, and lets the buyer purchase it without involving conventional lenders.
Instead, very briefly, the buyer pays the property seller in installment payments over time, for the amount of the purchase price plus interest, less any down payment that was made.
Just to give you a simple example, let’s take a $300,000 single family house, somebody selling their home. Buyer comes and it’s free and clear, or it’s got a fairly low balance that can be paid off on the mortgage. $300,000 house, buyer comes along, gives a 20% down payment ($60,000), balance is $240,000.
Now, normally they would go to a bank or some other lender and get that cash. Well, in this case, the seller of the property says no. I will take back a note. It’ll be 9% interest, 15 years. The property buyer will then pay the seller, instead of the bank paying the seller every month, in this case about $2400 a month.
The note is held by the property seller, and it’s secured by a lien on the property. If there are any defaults or anything, ultimately the seller could get the house back. That’s, in a nutshell, what a real estate note is.
Toby: For example, when you’re teaching and you’re teaching people how to invest in notes, they might go and buy that note from that owner, or that owner may say, I want some more cash. I’d like the cash in my pocket. They’ll go sell that note.
Similar to what the banks do. The banks sell all their mortgages, too. They securitize them. This is just a private transaction, is that accurate? Is that what they’re doing?
Bill: Yeah. It’s a negotiable instrument. The person who takes back the note when they sell their home and get $2400 a month, might someday decide, well, I need more cash for whatever reason, or I’d like to take a trip around the world, or whatever it might be. They’d like a lump sum of cash.
This note is a negotiable instrument. They can sell it to someone else and get cash for it. They sell it at a discount because a lot of the payments have already been made. They might have to sell it at a different interest rate or something, but that’s certainly done.
The notes, I should say, somebody said, oh, 9%. That’s high for these days. We are getting close to that as for conventional interest rates. But the seller carryback notes, private notes, whatever you want to call them, are usually quite often, almost all the time, carry a higher interest rate than a conventional loan.
The pros for the seller of the property who carries back this note can get full price for their property, or even more, sometimes. There’s an old saying in real estate—you can have price, you can have terms, but you can’t have both. You’ll get a higher return. The property seller gets a higher return compared to other investments. Higher interest rate. There’s no waiting or wondering if the buyer is going to qualify for a conventional loan.
You have a quicker closing, getting a substantial monthly income secured by the house. If it’s your home, you know that house and how valuable it is, and it’s secured by that house that, God forbid, if there’s a default, you get it back.
As you alluded to, most people don’t know that you can sell that note. Or you can borrow against it from a bank. You can sell part of it. You can sell the next X number of payments. Or you can sell half the note. You can do all sorts of things.
You can trade it. You could trade it for real estate, for a down payment on some real estate. Or a car, or whatever. As they say, to use a legal term it’s a negotiable instrument. There’s a lot more you can do with notes. It’s a tremendously flexible thing. If we have time, we’ll go into one or two of those things.
Toby: That’s perfect because I think you laid it out. Now, a carryback, like if I’m the owner and I’m selling a property, I’m carrying back and I’m holding a piece of paper that’s going to give me an income stream, I’m doing that because it’s spreading the tax hit out.
I can elect to treat it as an installment sale under 453 and spread it out over many years, which means I don’t have to pay tax on that sale all in one shot, like if I sold it and there was bank financing. Here, I actually have this thing. And I’ve done this, by the way, actually, on behalf of clients that had carryback notes.
What’s the typical discount on that? Let’s say that I have a $100,000 note that’s getting $2000 a month, let’s just say it’s 9% interest. I don’t know if the numbers actually work, but let’s just say you had that note. Would I sell that to somebody? And if so, at what discount is the market usually going to give?
Bill: It depends, of course, on again, the investor wants to determine what interest rate they’re going to get on their investment. If it’s a, let’s say $100,000 note, depending on how many payments have been made. Let’s say, only a couple of payments, so it’s $12,000 of $100,000. You’ll probably get somewhere. It depends, of course, on the interest rate; you said a 9% note.
There wouldn’t be a whole lot of discount on that. There are investors out there who are looking to buy a note on the secondary market, if you will. Not a second note, but a reselling of a note. Maybe $85,000, you might end up with. The way it works, as you, Toby, know very well, notes are sold at a discount.
I wrote down some numbers here. This $300,000 house that I mentioned before, $60,000 down, $240,000 balance written at 15 years, about $2400 a month that the payer is paying. The seller wants to sell that note. The interest rate that the investor wants is 12%. You plug that into a financial calculator, that comes to $200,000. The investor pays $200,000 for that note, getting $2400 a month. If you plug that in the calculator, that’s a 12% return on your money.
The investor who buys that note has converted a 9% note to a 12% interest rate note, yet the terms, the note payer’s interest rate is still 9%. The monthly payment is still the same. The number of payments doesn’t change. Nothing changes for the note payer itself. It’s just by buying the note at a discount, you increase your return on your money from 9% in this case to 12%.
It’s not usury because the payer is not paying anything more. Payer may not even know the note has been sold until he gets a notice, we’ll make your payments to Mr. Smith now instead of Mr. Jones. It’s kind of a beautiful thing. What I like about it is that there’s so much you can do when you own a note. And that’s just one example.
Toby: Where do you find them? If I’m an investor, that sounds really attractive to me. I’m looking at it going, right now, the money market might get you 5%, some CDs get you 5%. But you’re saying, I’m willing to take a little more risk, and I know the market’s going nuts right now with the raising of the interest rates. Are there any of these out there? And if so, where do I find them?
Bill: There are a lot of them out there, and there are a lot more being created now. It’s common sense. As conventional mortgage interest rates go up, fewer people can qualify to get a loan. Every time we have an uptick in interest rates, there’s a smaller and smaller pool of potential property buyers. When a property seller realizes, a year or so ago I could have sold this house like that, but now it’s sitting on the market, what do I do?
Well, people can’t qualify for a loan, but maybe I’ll offer to hold a note and become, in other words, the bank. It won’t be a bank involved. It’ll just be me selling the property, holding that note, and getting the monthly income.
Once you offer what they call seller financing, again, a word I don’t like to use because regulators love the word financing. It’s not financing, in my opinion. When you have a seller carryback situation, properties sell a lot faster. And they can sell for a full price because again, you get terms or you get price, but you don’t get both. But you’re asked where to find them?
Toby: Yeah.
Bill: Well, on our website we have a link to our Facebook group. We have close to 6000 members on our Facebook group. We get pretty much every day people posting notes for sale. We don’t get involved in the transactions. It’s just a bulletin board. People put their contact information in, we’re not involved. You see a note that might look interesting, you contact the seller directly.
That’s papersourceonline.com. You go to the tab ‘Other Resources’ and click on the Facebook group. Where to find them? Lots of places. If you’re a member of a real estate investors club or if there’s one in your town, start going to that. Talking to real estate investors. These guys quite often have notes that they want to sell.
Bill: Think about who in your life that you can think of would see notes on somewhat of a regular basis? Attorneys, accountants, title company officials, real estate brokers, bank trust officers, financial planners. Cultivate relationships with them. Let them know that you buy notes. You might be interested. Some of them can accept a finder’s fee. Others ethically cannot. You’ll have to work that out with that.
There are people who do other ways. They send out postcards, they put in ads, and that’s one way to do it. It costs money, but I know people are successful doing that as well. It’s a lot of work, and there is an expense. I prefer networking and online, like our Paper Source Facebook group.
Toby: Let me do a shameless plug for you. Paper Source Online is a great place to learn about note investing, too, because I know you have the Paper Source University. We also have a bunch of courses that you’ve created inside of our Infinity Investing portal, which is a great place to learn about what kind of investments.
Since we’re going to learn about this, what could you tell people to avoid? Somebody hears this video and they say, I’m really interested in going out and buying some notes. There are probably some notes that you say, don’t touch with the 10-foot pole, and then there are notes that you say, these are the ones you consider. What’s an easy rule to follow for somebody who’s out there thinking about getting involved in note investing?
Bill: I would suggest several things. Particularly if you’re new to this, I would get yourself a mentor or somebody who is experienced in notes. Maybe it’s a friend of yours. We’ll be happy to help you with no charge; send me an email. I can’t hold your hand at every moment, but I’m happy to give you some advice.
Specifically for somebody starting out, I would only stick with first position notes. I wouldn’t go to seconds or certainly not anything lower than that. I’d look for the type of property. I would stick with single family houses.
The way I look at it is would I want to own this property if I had to foreclose? What am I going to do with a factory? I don’t know anything about factories. I don’t buy notes on factories or shopping centers. I buy notes on single family houses, on farmland, some things that I personally know what to do with if I had to take possession.
Think about that. Think about the down payment. What was the down payment that was made? If it’s less than 15% or 20%, that’s a scary situation because the property value may drop and you might find yourself underwater, you don’t want the property back. The higher the down payment, the better. Notes that have property that—you’ll see this a lot with mobile homes—there’d be no money down or $1000 down, those usually default. So I stay away from those
Toby: Unless you want them, right? Unless you’re like, yeah, I would love to own that.
Bill: Exactly. That’s what I’m saying. Unless you really want to own it. Like non-performing notes, which we’re not going to get into right now—I don’t particularly think we need to—that’s the kind of thing that you got to look at. I’m probably going to end up owning this property, very likely so.
Ultimately, the value of a real estate note depends upon the economic conditions that support the value of the property. I’ll say that again. There are a lot of factors, but the value of a note really depends on the economic condition that supports the value of the property.
For example, an owner-occupied single family house, in a good neighborhood, in an area with a diversified, long-term stable economy, is about the best collateral you can get. That’s what I look at.
Amortized note is more valuable than one with a balloon because often the balloons aren’t paid, and—
Toby: You’re going to end with the product.
Bill: Exactly.
Toby: And Bill, do you have to foreclose? Somebody buys the note and the borrower starts to default. Is it all on you or are there services that you could use to go do the foreclosure or start the process? Or is there anybody that can manage notes, things like that?
Bill: Yeah. You don’t have to go to foreclosure. I don’t like foreclosure. I’ve been investing in notes since the 80s. I’ve never foreclosed.
Toby: You negotiated with them.
Bill: Absolutely. First of all, I don’t want to throw somebody out of their house.
Toby: The banks did it in 2007 and 2008. They en masse just started tossing people out. Would it have been better if the government hadn’t gotten involved and started paying the banks off? Would it have been better if we let a bunch of note investors go buy those mortgages and negotiate with the folks that were the borrowers?
Bill: I’ll go back to how you started that. It’s always better if the government isn’t involved in anything. Whatever it is. So yeah, absolutely. That was a horrible, horrible time. It put banks back in the business that shouldn’t be in the business today.
I’m getting on my high horse here, but the goal is to shut down all smaller banks, so that all we have are the Chase Manhattans of the world, the giant mega corporation banks. That’s what they’re trying to do, and cut out the small community banks.
Then of course, when we get the Central Bank digital currency and there’s no paper money left, the government, like in communist China where the government controls your money, and if they don’t like your opinions, they cut off your money, you can’t travel, you can’t get a loan and things like that, in my humble opinion, that’s the direction that this present US government wants to go in.
Toby: But we can combat that by doing business with each other. That’s what it seems like. It seems like you’re saying, when you sell a house, you don’t need to go to the bank. Owner carries it back. Then if he or she has an outlet, they can sell it to another investor if they need the money. Otherwise, they just take the income stream.
But like you said, I could go negotiate with you. Let’s say you had a note. I don’t need the whole thing. I might just say, I want a part of the income stream. Maybe I’m doing half. Maybe you say, I need $50,000. You have a $240,000 note. Is it uncommon for someone to say, I just need a little bit and I’ll sell you this portion of the income stream?
Bill: Oh, yeah. It’s a very good point, Toby. You can sell it all, you can sell part of it, you can sell half the payment. The investor gets half the payment, you get the other half of the payment. You can sell the investor in the next five years of payments for a lump sum of money at a lower interest rate than the face amount that you paid for the note, and that can be profitable to you. There are all sorts of different ways to do it.
Take an example of this note, the $240,000 note on the $300,000 house. Written at 9%, you bought it, you get a 12% return because you bought it at a discount. You can sell that note to another investor for a 7% yield.
I just did the figures before we got on here. If you sold that note that you bought for $200,000 because you bought it at a discount as notes are sold at a discount, and it’s a face rate of 9%, you sell it to an investor and say, how do you like 7% on your money? A lot better than getting anywhere else secured by a single family house. Great, okay.
You sell that to him for a 7% yield. Well, how much is he paying for that $2400 a month for 15 years at a 7% yield? He or she pays $270,000 for that note. What did you pay for the note? $200,000.
Toby: And the IRS would say, that’s capital gains. Whatever that face value goes up, it’s capital gains, I believe, and you just made nice little profit negotiating some notes. Is that what your people do, Bill?
Bill: Oh yeah. People do that all the time. I know we’ve just got a few minutes left, Toby, but I don’t want to skip over what I call the world’s greatest retirement plan. It’s on the same subject of buying, selling, and reselling notes.
Take this 15-year note that we’re dealing with, this $240,000 note face value. Let’s say you bought that for $200,000. The stakes of the financial calculator, and I’ve worked this out before this, if you sell the next 9 years of payments of that note to a private investor at a 6% return on their money, you’d sell it for $200,000. Exactly what you paid for it.
After nine years, the investor bought nine years of payments, after the next nine years, they’re done. They’re out of it. What happens to the rest of the payments? It’s a 15-year note. What happens to those six years of payments? You get them back. You get $2400 each month for the next six years. If you do that 10 times, you’d have, after the nine years, almost $300,000 a year coming in on each each time with nothing invested.
Toby: And people are doing this in their retirement plans. I know they’re already going to say that. Where do I get the money if I’m not sitting on money? You might be sitting on money. These are unrelated parties. You could do private notes inside of a self-directed IRA or self-trustee 401(k). I’m sure you have folks doing it in their Roths where they’re never going to pay tax anyway. They can go ahead and flip a whole bunch of these notes, and they don’t have to worry about a tax hit.
Bill: Exactly right.
Toby: That seems ingenious, and it seems pretty obvious. This is something somebody might want to be doing. It’s just, I don’t think there’s a lot of information about it because there are these behemoths that want to be dominating the lending markets. You got a Visa, you got a MasterCard. I always joke, like who’s the servant in the MasterCard? They don’t even hide it. You become their servant when you’re borrowing from these guys.
There are these huge institutions that make their money being the lender, that a lot of people don’t realize, I could just go to somebody in my community. Maybe it’s somebody that you know that you’re not related to. Or it could even be a sibling you could actually do these transactions with in a retirement plan. They say, instead of going to the bank, let me be your lender. Or you just go out and you start investing in notes. A lot of people don’t realize it’s literally that easy. Is that a fair statement?
Bill: Oh yeah. It’s not rocket surgery, it’s not brain science. Nobody has to be embarrassed. Nobody’s born learning this stuff.
On our website, I took my three-day intro course on notes and boiled it down to seven fairly lengthy digital sessions. It’s free. I just made it free. You can sign up for it at Paper Source Online. It’s an introduction on notes to give you an idea, is this something I really am interested in? Do I want to do this? It takes some effort, and you have to learn some terms that you may not be familiar with, but the rewards can be tremendous.
I’m not a guy who says, you’re going to make a million dollars a year in your pajamas and all that stuff. I don’t like a lot of that stuff.
Toby: You and me both.
Bill: Exactly right. I think that’s why we get along so well because we both have the same attitude about that kind of stuff.
It can be a tremendous thing. As you pointed out, Toby, not many people know about it. That’s something people I think at least take the e-course and look into it. You might say this is not for me. It’s not for everybody, but check it out.
Toby: A little bit of education never hurts. You can chew gum and walk at the same time. You can learn about different investments. This is one of those areas that I would recommend people really get to know. The more you get to know about notes, it’s going to help you in other ways.
When you’re going in and negotiating, if you’re ever buying a home or something like that, all of a sudden you’re going to realize, maybe I don’t have to jump through all the hoops with the bank, go through their underwriting, do what this person, that person, the amount of paperwork this thick and everything else. Maybe I can go to a private individual and I find a group where there are people that would love to be your lender.
Toby: I know there’s still Dodd-Frank and there are still some rules that these guys have to follow, especially if it’s a primary residence. But everybody’s aware of the rules and everybody’s aware of what’s necessary, and all of a sudden it’s so much easier.
I’ve done this myself personally, especially when I was growing my portfolio and levering up. I would look for somebody that I knew and say, I don’t want to partner on this deal, but I wouldn’t mind having if you want a decent return, then we can negotiate something that you’re going to get. It’s better than what the bank’s going to offer. There are not as many fees and there are not as many of these crazy costs that they lump on to these things.
And like you said, so much faster. We’re keeping the bank out of it. The banks are making profit on these things. Why don’t we just keep the profit to our private community and help your neighbor out?
Bill, this has been fantastic. I’m going to tell people to go to Paper Source Online. I’ll put it in the show notes. I can’t recommend highly enough to go to an individual like Bill, who is not selling a course. He’s not trying to get you to do this, that, or the other.
I’ve never figured out how Bill makes his money. Other than that, he’s a really good investor, and he’s got a really good community. I know you do an event because I get to come speak at it every year in Vegas. You have a really, really good group of professionals that are part of this organization, that are part of The Paper Source. I get to meet him all the time. I got a bunch of his clients, great people.
Bill, thank you for sharing your wisdom today. Is there anything else you want to throw in there?
Bill: We covered a lot, Toby. There’s actually a lot more we could say. I’ve got notes here. I think we covered a good part of them. I just say again, it’s something that people should look at.
One thing we could cover are the three Ps very quickly. You look at the paper, you look at the property, you look at the payer before you buy a note. The payer’s credit history, employment. I heard somebody say once, check their car out. See what the condition of their car is. Is there a bunch of trash inside of it? Also look at the radio to see what stations it’s set on. If it’s set on something you think is crazy music, don’t buy the note. Or don’t rent to.
Anyway, you got the paper, the payer, the property. You look at all those things and make sure the paper is in order. Again, would I want to own this property that’s secured by the note? That’s key.
We’ve gone all over those things. Thank you again for the opportunity. It’s papersourceonline.com. If people want to know what my wife and I do in our spare time, we do a talk radio program on a commercial FM station in the Texas Hill country. You can go to firstcoupleoftexasradio.com and you might find some interesting things.
Toby: Perfect, Bill. I know you have a diverse background. That’s awesome. But in the meantime, everybody go to The Paper Source Online and go learn about note investing. See if it’s something that will help you build up your wealth.
A lot of people are always willing to help you when you have a big pile of money. We want to help you get the big pile of money. Bill, you’ve been really, really helpful in that over the years, helping so many people. I hear about it from your clients all the time. Thank you for joining us. Guys, go check it out.
