One of the most common questions we get asked is, how do you make money through note-investing? Chris Seveney reveals the answers in this episode as he dives deep into dealing with non-performing loans. Drawing parallels with fixing and flipping houses, Chris explores three potential paths in note investing: selling the asset, exiting through the borrower, or exiting through the property. With insights into the preferred strategies and financial dynamics, this episode provides a concise yet valuable exploration of 7e Investments‘ effective approach to note investing, appealing to both active and passive investors.

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How To Make Money Through Note Investing With Chris Seveney

In this episode, I’m excited to talk about note investing. This is for people who are active, passive interested in note investing. I’m excited because I am going to talk about one of the most common questions we get asked, which is, how do you make money when buying a non-performing loan? That is something I want to spend a little bit of time covering.

Fund Update

A few things before we get into that topic. We are recording this in mid-February. You’ll probably be seeing this in March of 2024. We want to get people an update about what we have going on. Many of you know we run a Regulation A plus and a Regulation D 506(c) fund investing in mortgage notes. We now have over 500 investors in our fund.

We have never missed a distribution for our investors and continue to grow our investor pool and loan portfolio. We’ve got a lot of exciting things working in 2024. We are seeing more inventory than we have ever seen. We’re seeing more opportunities than we have ever seen. If you are on the fence and looking to invest passively in mortgage notes, whether you have a Self-Directed IRA or cash going around, you can invest with as little as $5,000 within our offering. Check it out. 7eInvestments.com.

We are seeing more inventory than we have ever seen. We are seeing more opportunities than we have ever seen. Share on X

Making Money In Note Investing  

As I mentioned, we are going to talk about how we make money and note investing. Lauren describes this so much better than I do when you start at the high level. Probably because I’m an engineer and dive way too deep into things, I’m going to try to break it down at a high level and work my way down into the nuts and bolts, the details of things.

I love how Lauren explains it. We fix and flip mortgages, but what does that mean? Close your eyes and think about a house that you drive by that is vacant and rundown. You want to buy that house. The first question is, how do you make money with that house? The first thing you’re going to do is make an offer. You are not going to offer market value for that home compared to the house next door because it needs work. You are going to buy it at a discount.

What are you going to do with that home? You are going to evaluate it and fix it, whether it needs paint, carpet, or flooring, determine what’s needed, solve the problem, which is renovating the property, which is fixing it up. You’ll sell it back on the market for market value, which should be a premium over what you paid at a discount plus the effort that you put into it. Very similar to note investing.

The difference is instead of the property, you’re doing this with the borrower. What you mean by that is you’re trying to rework or fix the borrower to get them to pay again. We will buy a loan at a discount, particularly on a single-family home. We’ll use the number $100,000 mortgage. We buy it for $60,000. Now we’ve got three options, so we can travel down three roads.

Sell The Asset

The first road is we can turn around and sell that asset, which we’ve done on some occasions. For example, there’s a loan in Montana that we bought and we don’t have a servicer in Montana, we don’t have an attorney, but somebody we know, DJ who, bought the loan from us and we made a few thousand bucks on that loan in course of a week.

Exiting Through The Borrower

Decent return. It was bought as part of a portfolio. He bought it and also bought it at a discount but not as big a discount we did and he ended up fixing that borrower, working it out, and making money on that deal. Win-win. We make money, he makes money, borrow and got to stay in the house. Option one, turn around, sell that loan. There are two other strategies that we can go down. One is what’s called exiting through the borrower, and the other is exiting through the property.

For most people, the initial reaction is, “Let’s exit through the property. Let’s foreclose on them. Let’s get the property because you’ll make more money.” Typically not the case, believe it or not. Why? It’s because of the time it takes. Let’s go back to those other options of borrower property. How do you exit through the borrower?

First is, you’re trying to fix the borrower. Try and get them paying again. To understand how to get someone to pay again, you need to understand their situation or their problem. How do you do that? Two ways. First, when buying the loan during due diligence, you’ll want to understand what got them in this predicament. It’s typically death, divorce, temporary job loss or health issues. Those are 95% of the time the primary. Most of those, when you look at them, are temporary situations. It’s not a permanent situation sometimes, except for death, of course, but health typically is short-term. You get better.

 

Job loss, hopefully short-term. You get a job. Divorce, you put yourself back on your feet. Those are the main reasons. By understanding those and having the servicer collect as much information about the borrower, their expenses, and what they can afford, we can paint ourselves a picture of, “How can we work with this borrower to get them on a payment plan? What can we do to work with them?”

Honestly, there’s nothing you can do in some instances and we’ll talk about that. We will work with the borrower to get them on a payment plan that’s successful. If a borrower says, “I can give you $2,000 a month,” and we look in it and say they can only afford $1,000, you are better off getting that $1,000 and having it be consistent than $2,000 every 2 or 3 months for many reasons. For resale value. It’s like fixing a house but only fixing half of it.

However, when you can renegotiate payments with that borrower, go back that example of $100,000, we bought it for $60,000, let’s say their payment was $1,000 a month, previously, we tell them, “It looks like you can afford $2,500 down, so give us $2,500 down and then if you can make six months of payments at $1,000 per month, we’ll take all your past due, all your old payments, push them to the end, roll them into a new balance and recast the loan,” which is basically re amortize the loan. Step back for a second. Why would we do that? A) We got $2,500 plus $1,000 per month. Within the first six months, we’d have $8,500.

Let’s say it took us six months to do this. Usually, 3 to 6 months. We got $8,500 in our first year on a $60,000 investment. Let’s say we also had some expenses as well. Maybe we make 12% of our money that year. Still very niche. Cash on cash, still very decent. What we can do is after years’ time, another six months of payments, that borrower is now reperforming. That’s like we rehabbed the property.

The property’s now done and finished. Paint, carpet, cleaned, walk out the door, stick the for sale sign on the front yard. We put that note out in the secondary market. Now, as a reperforming loan, like a rehabilitated home. Where do most of your payments go when you look at a mortgage and the principal and interest payments? Interest. That principal balance that was $100,000 because of all the past due actually is probably about $120,000.

Let’s say it’s still kept at $100,000. Let’s say it’s even $95,000. That loan now on that secondary market can sell for $0.85, $0.90, or $0.95 on a dollar. Now, all of a sudden, that loan could sell for $75,000, $80,000. I got a year of payments, $1,000, $12,000 plus $2,500 down, it’s under $15,000 plus I can turn around and sell that make say another $10,000, $15,000, $20,000. I’ve made $20,000 in the course of a little over a year on a $60,000-plus investment. Over a 25% return.

This does not account for your time and effort. You pay yourself a salary. That’s a gross IRR or gross yield. After you take out all those costs, you can work things out. That is our bread and butter. That’s where we like to envision a lot of our loans going. There are other ways as well that things can happen. I had this happen with one of our loans that was performing or, unfortunately, had their spouse pass away. Life insurance. What did they do? They paid off the loan.

Another way to generate revenue is borrowers do pay off loans. It’s rare, like 1% of the time but it still happens. Look at it another way. What’s the average time somebody lives in their house? It used to be seven years. I think that probably went down during pre-COVID. Now it’s probably going to be a little higher because of where interest rates are. When rates are low, people most likely are moving up faster and faster into homes. When interest rates are higher, it’s usually a slower play because you also don’t have as much appreciation on home.

Exiting Through The Property

Still, you could expect a percentage of your performing portfolio to pay off in 5 to 7 years because that person will move. Those are three ways that you can exit through that borrower. They sell the property. We can sell the asset, or they can pay it off. I would say within our portfolio, over 90% of the time, that is the path we go down. Why is that better than foreclosure? I mentioned time. The other thing I’ll mention, too, as we start talking about the foreclosure process is that it is going to cost you more money than trying to work with the borrower.

You’ll spend $5,000 to $10,000. I’ve heard some people spent up to $20,000. That’s very rare. Typically, it’s about $5,000 to $10,000. Let’s say it is $10,000 to be safe. Let’s think about going back to that scenario, and this is another reason why I love note investing, is again, you’re driving by that property and it needs to be fixed up. How many properties do you drive by or acquire if you were an investor that you can fix up for under $10,000? Probably none.

When we’re working with fixing and flipping with the borrower, you’ll spend a few thousand dollars. On the foreclosure side, you’re not fixing and flipping. It’s more capital intensive, like rehabbing the property, but you’re not rehabbing it. Thankfully, you’re also getting a significant discount that allows for you to hopefully make out. Let’s go back to the example that I mentioned.

That was a $100,000 loan, $60,000 purchase price. That property would be worth about $400,000 to $500,000 in our current portfolio. Our current portfolio has an average loan balance of roughly $200,000 and an average property value of $600,000, but we’ve got a 33% loan to value and then when we buy it at a discount or even lower than that.

I’d say, for me, there’s the good with the bad with that. Actually, there’s no bad, but the two goods are if there is softening in the real estate market or we completely blew our valuation of the property, we would need to screw up that valuation or close on a property and have it sell less than what we’ve invested into it.

 

The bad side is we don’t get the upside of that value of the property. If we’re owed $100,000 and it goes a foreclosure sale, we bid $100,000. We’re not going to bid $400,000 because then I’d have to cut a check for $300,000. We’ll bid $100,000, what we’re owed. Some investors will buy it for $250,000, $300,000, $400,000, so we get paid off. Now when you foreclose, and this is where I think a lot of people sometimes get screwed up is, back in 2008, yeah, you foreclosed because you get the property back because the properties were what’s called underwater.

Nowadays, people have that equity. When we do foreclose, again, it is very rare, typically, it is a vacant property or the borrowers don’t want the home because in the environment now, like I said, they would rather sell it at market value than try and let it go to foreclosure. How do we make money when we do foreclose? Use that $100,000 loan. We bought it for $60,000, and we spent $10,000 on legal. In most states, we can add that legal balance to the loan, but now they owe us $110,000. We own it for $70,000, it goes to auction and sells for $200,000.

You might have a higher gross dollar value return on that foreclosure, but that timeline typically can take eighteen-plus months. It can be a much longer timeline because not only do you get the property you may sell, but if for some reason you did take it back, which is going to happen in the future because values will come down. I’m pretty confident on that. If you do take it back now, we will not renovate it. We will not upkeep it. Only once have we ever kept a property because it was an apartment portfolio that was such a screaming deal that it was worthwhile to keep. Other than that, we don’t fix up a single-family property.

We will have a third-party nationwide company. Find an agent who will list a property. They will assist us in getting it sold and we are completely hands-off. People ask, “Why don’t you fix it up?” I spent fifteen years working in commercial construction for those who do not know. I built my own primary residence. I have renovated numerous properties. I added everything up in today’s dollars. I’ve renovated and built over $1 billion in real estate.

I’m not bragging, but I have seen a lot of construction, and if you are not keeping an eye on that project every single day, things will get wrong and be done wrong. Nobody will care and they’ll keep going. I can tell you horror stories of things people put in pipes, people leaving walls, people doing things wrong and putting things through ductwork. You name it, I have seen it. Imagine trying to renovate a property from 500 or 1,000 miles away. Especially being the control freak I am, there’s no way it will get done the way I want it.

 

When you ask people, “Do you renovate from afar?” “Yeah.” Ask them how they do it. It’s like when I was younger, I did the polar bear club, where I jumped in the ocean on New Year’s Day. I know cold plunging is a thing nowadays, but good luck to all of you guys. Have fun. Girls, have fun with that. Renovating from afar is like that. You do it once, learned my lesson and I’m never doing it again. That is typically how most people are with renovating afar and probably with cold plunging. You will not make money, eat up time and lose money in the long run over a portfolio of loans. That is the reason why we do not.

To highlight again as we exit through the property, it’s two ways. We eventually sell it. It’ll either get sold through a foreclosure auction where we never hold title to it. We may foreclose on it and then if we take it back again and liquidate it. The other is cash for keys, where we’ll tell the borrower, “We’re going to spend a few thousand dollars on foreclosure. Instead of giving it to attorneys, how about we give the money to you and you hand a deed. Give us the keys and sign the deed over to us.”

This is not as common as I thought it would be. It blows my mind why some borrowers wouldn’t do this. The same thing happened with tenants. I can’t tell you how many times we’ve offered tenants $1,000 or $2,000. Rent is $1,000 from $1,500 to get out now. They’re like, “No.” Their eviction’s like in two weeks and they get evicted and it blows my mind.

The most memorable time of this, which I’m going to digress a little bit, was we had a property we were for closing on and offered the borrower $5,000 cash for keys. The borrower actually contested the foreclosure. We go to court. Borrower admits to not paying. The borrower basically had no defense. The judge is like, “Why are we even here today? Why are we even hearing this case?” My attorney said, “Your Honor, they contested it. We did offer the borrower $5,000 cash for keys to avoid foreclosure. They did not accept it, and we are requesting the court to allow us to proceed with the foreclosure.”

The judge literally looked at the other attorney and the borrower, and I’m going to paraphrase this, but essentially said, “You’re idiots for not taking that deal.” The foreclosure was scheduled. This was back in probably 2018 or ‘19. The property actually didn’t have equity. It was upside down. The borrower owed a lot more.

We also offered to not have deficiency judgment, offered all these things, and went to foreclosure. We got paid after taking it back and so forth. The borrower basically could have been given $5,000 and they didn’t. Sometimes, common sense does not prevail in this business, but it does not hurt to try. That wraps up how I wanted to talk about how we make money in note investing. I also will be issuing an episode on How to Lose Money in Note Investing.

Sometimes, common sense does not prevail in this business, but it does not hurt to try. Share on X

I’d like to share the tale of the tape for both. I want to thank everyone for reading this episode. For more information on note investing, our note fund and how you can get involved, make sure to check us out at 7eInvestments.com. Also, make sure to like this episode and leave us a review on your favorite station. I look forward to hearing from all of you in the future. Take care. Have a good one.

 

Important Links

• https://7einvestments.com/invest/
• Https://www.LinkedIn.com/in/christopherseveney/