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Advantages & Disadvantages of Investing in Real Estate Notes

House Renting, Buying, Selling ContractAlternative investments have been getting more attention recently, specifically note investing through self-directed IRAs. This increasingly popular type of investment product is rooted in the open real estate market. Here’s how it works: Whenever two parties reach an agreement for capital used to buy property, a real estate note is created. The real estate note is comprised of the documents that set the amount of debt as well as the terms of repayment. Deeds of trust, land sale contracts, promissory notes, and other forms of real estate loans may be considered notes. Commercial, industrial, agricultural or residential property may be financed with real estate notes.

Being the bank can be a good thing for your IRA. These investments can produce reliable returns and are secured by a lien against the underlying property.

As with all investment approaches, real estate note investing offers unique advantages and disadvantages.

Investment Advantages of Real Estate Notes

• Real estate notes offer higher rates of return than available in bank accounts and many other forms of investment. Rates typically range from 7-9% for longer term loans to as high as 12-15% for shorter term loans such as those to investors rehabbing and flipping properties.
• With a real estate note, the investor buys the whole mortgage amount, so he or she will continue to receive the payments and interest every month for an extended period. If the property owner sells or refinances within 5 years (as is often the case), the investor enjoys an early payoff.
• Because the note is tied to real property, the investor has a backup method of recouping his or her funds. Namely, the investor can foreclose on the property and sell it.
• Real estate notes are much easier to manage than rentals. Landlords must resolve all kinds of problems that note owners never face. Evictions, maintenance, contractors and tenant communication—all of these are avoided by owning the loan, rather than the property.
• With real estate notes, you’re working with investors or homeowners, not renters. Many investors prefer to buy notes because this means they’re accepting payments from someone with an equity and/or emotional stake in the property. This connection between the borrower and the property make notes a “safer bet” than the month-to-month mentality of renters.

Investment Disadvantages of Real Estate Notes

• There’s always a risk that the borrower will default. As with all credit investments, the danger is that the borrower will stop making payments. In that case, the note owner must go through the hassle of taking possession of the property through foreclosure, or suing the borrower. While not as “safe” as a CD or savings account, notes can perform much better. As the investment risk rises, so does the potential yield.

Smart IRA investors do their homework on each real estate note to uncover:
• The property’s value
• The payer’s credit rating and payment history
• The details of the loan documents
• A plan for what will occur in the case of a default

In any case, it’s not possible to invest in real estate notes (or real estate itself, for that matter) with a traditional IRA. Only self-directed IRAs will allow you this kind of freedom in investment choices. Call us today to learn how our self-directed IRA plans can help set you up for real estate note investment success.

[Photo by: Mark Moz via CC License]