Many people with full-time jobs turn to mortgage note investing since it is a passive form of investment. But how passive is it really? Chris Seveney answers this question by sharing valuable advice on managing this profitable venture. Tune in as he talks about time commitment, operational oversight, and the potential returns of each approach. Discover the pros and cons of note investing and which strategy aligns best with your individual investment goals and risk tolerance.

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Passive Vs. Active Approaches In Mortgage Note Investing

Introduction

I want to do an episode talking about how passive mortgage note investing is. This is a really interesting topic because a lot of people will make comments about mortgage note investing as mailbox money, set it, and forget it. It can be the case, but it’s like anything. There’s still a level of responsibility and is that responsibility considered passive where you have to worry about certain things? Just like owning real estate and having a property manager, it can be extremely passive until something happens and then you have to be extremely active.

I want to talk about that in this episode. First, for those who haven’t read us in a while, mortgage note investing and what is mortgage note investing? I’ll just do a very brief introduction for people. Mortgage note investing is when you are the bank. You take over as the lender in a situation where the borrower mails their payments to the servicer of whoever you hire every month.

 

I did not know about this investment strategy before. I was a little upset when I found out about it because I thought it was pretty cool. That’s just, again, high level. We’ve gotten 250 episodes, which primarily focus on mortgage note investing. If you’re interested, go back and take a look. I also have membership training on it and I’m happy to tell people more about it.

Let’s get back to the topic at hand of mortgage note investing and passive income. Let’s first define what passive income is and what does it mean in the context of note investing because there is this variability of passivity based on a borrower’s behavior. Now I will say if people are going to invest in non-performing notes, I don’t care what anybody tells you, it is not passive. The only argument somebody can have about passive investing in notes is on performing loans.

Let’s break down the passive side of things in regards to mortgage loan investing. You buy a loan that’s performing, you’re either going to have a good borrower whose payments are seamless, predictable, maybe on ACH, that money just comes every month. That’s great. You then have the problematic borrowers that you know are akin to a tenant who’s not paying, and you have to deal with those issues.

Individual Note Holder Responsibilities

People will think that when you’re doing it yourself, it’s passive because this person’s on ACH, and you don’t have to do much. Let’s outline some of these other responsibilities as an individual note holder that you have. First, you got to acquire the note, do all the due diligence and the costs involved with that because there’s going to be opportunities you look at that you spend money on that you don’t end up buying.

You still have to manage the servicer, oversee the loan performance. If it goes delinquent, again, whole other animal. Also, there is the issue of all the accounting. You’re going to have to open an LLC, you’re going to have to add it to your taxes, you’re going to have to do the bookkeeping, all this other stuff as part of it. I was active in node investing because I wanted to grow it into a business.

However, what happens in many instances is people who want it to be passive will look at it and say, “I can get 10% to 12%, maybe more. If I want to be passive, but then I got to have the LLC, do all this other stuff, find the deals and really wonder, “Is this really worth it?” Especially if you have $25,000, “I’m going to make $2,500 this year at 10%. How much time and effort did I spend learning node investing, meeting the people who are going to sell me the loans, doing the due diligence, opening the LLC, and again, doing all the bookkeeping for all of that stuff?” Make sure you get your 1099 or 1098, whatever it is, from your servicer.

All of that plays an active role. Even though you are “passive,” I would find it hard to believe you could do it for less than 80 hours a year. If you do the math and you make $2,500, you’re making $30 an hour. Is that really worth it? If it’s actually your first year, take all the time you have to learn, put a calculator together and do everything else, you’re probably making the equivalent of what you’d be doing at McDonald’s.

I’m not trying to scare people off from note investing in any way, shape or form. I’m not trying to spin this in another direction of, yes, we’re going to talk about being passive and investing in funds. I’m just telling you the reality of it. For people who want to do it and want to make a side gig out of it, it’s fun. It’s awesome. Just understand that early on, the returns are not going to be exceptional for the amount of time that you spend on these deals. You just want to really be thorough and explain to people that it’s going to be active. You’re going to spend a good amount of time educating and everything else.

Mortgage note investing can become a side hobby or gig since it is fun and awesome to manage. Share on X

Let’s roll over to the other option that people do have of investing in a fund, which is a more passive approach. I will tell you, you still need to do as much due diligence, but typically, you just got to do it once, which is upfront on that sponsor. You do due diligence on the sponsor, understand the team, how the report, the risk factors, what they’re buying, how the fund works, where are you in the capital stack? All of the above. The upfront initial time, I would almost tell people you’re probably going to spend the same amount of time whether you’re going to be passive or active.

Where it’s very different is the reduced time commitment and operational oversight because you are truly passive. You are in the passenger seat. That’s one of probably best analogies I tell people of being active versus passive investor in notes and even performing notes. If you’re doing it yourself, you’re still in the driver’s seat. You may have cruise control on, you may be on some very main highway that’s really rural. I-95 through Carolinas or somewhere where it’s late evening and just you and some truckers on the road.

You got it on cruise control. You set it and forget it, but you still got to pay attention and you still have to manage up for gas. Very similar with a performing loan. Check on it, check with the servicer, check taxes, as I mentioned, and all those things. If you’re a passive side of things, you’re in the passenger seat, someone else is in control, but you still got to watch them, make sure they don’t fall asleep. You might have to change radio. Old school is the person would be holding the big open map to tell you where you need to go and where to get off. For me, that’s really the main differences of each.

There are pros and cons. Pros of the doing it yourself is, again, you are in control. You can get in and out of a deal when you want. I wouldn’t say there’s the liquidity issues because you control the asset. You control when you get in, you control when you get out. I think that’s a big pro. The cons are, is it worth the returns from being passive? You’re going to need more education than you would probably on the passive side. I’d still want people to get as educated as possible and let’s say the experience, that someone else probably has more experienced in that passive investment syndication.

Advantages Of Passive Investing In A Fund

Now let’s jump back over to the passive side, investing in a fund. What are the pros? Reduced time commitment and operational involvement. You give somebody the money, they take it and run with it. It’s typically a diverse portfolio you’re investing in. The returns are in risk, I’d say, is more spread out from a diversification component because if it’s you, you’re probably just investing in 1 or 2 assets within a fund. For example, in our fund, some invest $25,000. Now we’ve got 700 to 800 investors, so they’re a smaller piece, typically more diverse. There’s a diversification risk factor. Some of the tradeoffs, though, or the cons, are that returns might be a little lower because you’re paying somebody to do something. Basically, you’re paying them a management fee. We don’t charge a management fee, but we have salaried employees. We make money in others that we have reduced control over the investments. It’s more illiquid. You can’t typically get in and get out when you want. If there’s an emergency where you need cash quickly, investing in a fund typically is not what I would recommend. I’d honestly recommend putting it in some short-term account where that money is significantly more liquid.

If there is an emergency where you need cash quickly, investing in a fund is not recommended. Better to put it in some short-term account where money is significantly liquid. Share on X

“Chris, what do you recommend? There are the pros, the cons. You’re flip-flopping back and forth. What do you recommend?” When people ask this question, I’m an engineer, so I usually like to give a very thoughtful and defined answer. My response is typically, “It depends. Let me know more about you as an individual.” Let me share a story about myself. I like to invest, and my specialty has been real estate.

During COVID, I was little bored as well and I was like, “Let me look into stocks and put in calls and options.” I spent a weekend researching it studying, I’m like, “This is actually pretty cool. I liked this.” I opened an account with Tasty Trader and started doing a little bit and stuff. I realized i’ve got to do this every single day and monitor what’s going on. If I’m buying, let’s say, a call on Disney, I want to pay attention to what’s going on with Disney every day, even though I’d have gates where if dropped to a certain level, it automatically selling stuff, but I felt the need that I need to be involved and do it every day.

I realized I did not have the time. That is an area where I’m sharing this story because most people overestimate their capabilities when they start something and they’re excited about it. I was overestimating the amount of time I had to want to get involved in this and I thought it was cool. I did learn a lot, but it came to a point of like, “I can’t do this.” It goes back to what do I do? My wife handles all of our stock portfolios, but it’s somebody else managing it. Whether it’s a third party that you have an account, Fidelity or somewhere else, you have someone managing your accounts, it’s the same thing. You need to determine your commitment. I think that is the first and most important because if you can’t make the commitment, I don’t recommend you take the approach of trying to do it on your own.

Now, let’s talk about several other factors that come into play. Your investment goals. Are you, “I just want pure income generation,” or do you also want to learn and have a hobby/side gig that you want to take on later in life or at a different period of time? Another is risk tolerance. What is your risk tolerance? Some people say, “I want to learn this. Instead of paying somebody $5,000 or $10,000 to learn it, i’ll put money in this thing. If I lose some of it, that’s my cost of education,” or, “I don’t want to lose money.”

I will say that for every investment, whether it’s a fund yourself, there’s an ability within that offering that could cause it to lose money. If anyone says you can’t lose any money, unless it’s like a bank type of account, that possibility is there. There are different risk levels depending on if there’s debt involved or many different factors. Understand also that is part of that risk tolerance, investing in a single asset or would you rather invest in a portfolio. Those are some of the factors that you really need to focus on in determining the level of passivity that you want to take on.

There are also some hybrid approaches that I’ve seen people do as well. I have many investors who do this, which is they do both. They manage a note and also invest in a fund. I have a small membership group where I have some investors from our offering say, “Can I join your membership group?” Yes, we bring them into the membership group where we talk about how to bid on assets, how to do due diligence on assets, where to find assets and really understand note investing more and be more thorough about it.

 

Educating Yourself About Note Investing

People say, “Chris, why do you do this?” Two reasons. One is, I come from a family of educators. My father was in the school system for many years and was a teacher, principal, superintendent. It’s ingrained in me that I like to try and provide education and teach people. The second component is that I enjoy our investors when they are educated and they know what’s going on. An informed investor is your best investor. That is another reason why I provide that.

As I said, there are some hybrid approaches where you could do both or there’s other approaches where i’ve seen people joint venture with another individual where they have a little bit more of managing that person, but they’re not involved in the day-to-day, but they know what’s going on. When I started out note investing, after doing multiple deals, I took on some joint venture partners and some of them would learn the ropes and turn around and want to know more.

I will tell you that 95% of those people end up just investing passively at the end of the day. Same thing for people who want to get started. When I got started, I would take a bunch of these education courses, see a lot of people get involved, and I remember going to a event where there was probably 200 people and the majority of people in that room may have done 1 or 2 deals over five years and then realized how much work it is. I just went passive.

At the point in that time, I’d been in no investing for maybe a year and I had probably done like 50 deals and I probably was one of the top five people in the room for the number of deals that had been done. By the way, I’m not saying this to brag in any way, shape, or form. I’m using it to go back availability of time and resources that I talk about where people overestimate how much time and resources they have. They also find it more difficult than what people promise them that it’s going to be easy. You can find notes, you’re going to make all this money, everything in life is hard. That quote I love is everything is life is hard, so choose your hard.

Wrapping Up

As we wrap up this episode of passive versus active in notes, things I look back on my years of speaking to people and really thoroughly understanding is everyone needs to make their own decision. You need to consider your skills, your time and your resources. As I mentioned, note investing can be passive. The circumstances vary but to me, if you’re going to be involved in owning loans, the level of activity is going to be questioned.

Investing can be either passive or active. But if you are involved in owning loans, the level of activity will be questioned. Share on X

I recommend people now do some due diligence and determine what approach aligns with your goals. Talk to other node investors. Talk to fund sponsors. I’ll tell you, most fund sponsors are probably going to tell you to go passive. Two reasons. One is because they probably want you to invest in their fund, but secondly, they know how much work it is. You also talked to some other note investors, and I’m happy to give people some names to talk to. It’s a lot more work than people thought.

You’re running a small business. If you’ve never run a business before, it’s hard work. I recommend people to explore those resources and talk to some experts and others and make an informed decision. Thank you for reading this episode. As always, make sure to leave us a like or share on your favorite station.