Spark Global Limited Reports:
Real estate investment is based on leverage — the concept of acquiring debt at an average value of 70 to 80 percent. While many property investors think about real estate, others focus on investing in the debt side of a business. The best part of this debt is called a “first lien,” which means that if the debtor doesn’t make the required payment, the note holder takes possession of the property. So how does the real estate industry work?
This is an opening axiom that tells the whole story
There’s an old saying in real estate: “You have to get a return on principal before you can get a return on principal.” That’s the truth about buying real estate notes. While it may pay a certain interest rate, those rates are washed away if the borrower defaults and you have to sell the property at a loss. So before you buy a note, you have to make sure the property is worth at least the amount of the note, if not more — and that’s with some cushion of real estate commissions and legal fees for foreclosure.
Location, location, location
So if the value of real estate matters, then it goes back to that other old adage “location, location, location” – the true hallmark of a safe investment. Whether the first-lien note is for an industrial building or a mobile home park, the key is to understand what makes this type of investment valuable and then determine the value of the amount of money backing the note.
The credit worthiness of the debtor
Just like banks, buyers of first-lien notes must look at the borrower’s creditworthiness to determine the odds of repayment. A borrower with a good track record and a large down payment (also known as a “risk on”) is a safer bet than someone who has never run a successful real estate business before and buys a property with a small down payment.
Execution notes and non-performing notes
There are two basic types of first lien real estate notes :1) performance notes and 2) non-performing notes. These are two completely different business models. A “performance note” means locking in a certain interest rate, while a “distressed note” means repossessing a property and selling it for a profit or renegotiating with the borrower for a higher yield.
Understand the risks and rewards
Whether buying a good performing loan or a bad one, the key is to understand that a successful investment always has a healthy risk-reward relationship. Sam Zell (the nation’s leading real estate investor in offices, apartments, and mobile homes) is a master of this critical area. His theory is that you always invest when the risk is low and the return is high, and you never invest when the risk is high and the return is low, and everything else falls in between. The bottom line is that if you are buying paper with weaker borrowers, it needs a much higher yield, just as bad paper with an ambiguous location has to be bought at a huge discount.
Buying first lien notes is another way to invest in real estate, but in a much more passive way. Some people actually prefer the industry, and if you know what you’re doing, there’s a steady return.
Reprint indicated source：Spark Global Limited information