Fred Moskowitz, public speaker, entrepreneur and author, joins us to discuss the ins and outs of mortgage notes investing, creating value, and much more
Connect with Fred at https://www.fredmoskowitz.com/
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Welcome to The DJE Podcast, where you will learn about real estate investing from real life examples. Here’s your host, Devin Elder.
Oh, hello and welcome to the show. Honored that you join us today. Thank you so much. My guest is Fred Moskowitz, and we’re going to talk about notes. These are mortgages that we hold as investors where we are the bank, just like the bank figured out a million years ago that it’s really good to hold the note, maybe not necessarily asset and all the trouble that comes with owning the asset, but the note. And so Fred has made a career of this. He was a computer engineer and after the dot-com bust in 9/11 20 some odd years ago, he decided he needed a more stable source of income, so he turned to note investing. He buys notes now, and we dive into this, some of the nitty-gritty on how he’s finding notes, how he’s creating some value within the things that he’s buying, and then just a lot of education.
I was very curious. We at DJE, we actually hold a lot of rural land notes and I absolutely love it. The business model, it’s relatively simple and it’s been very good to us. But just diving into the nitty-gritty on how all this note investing stuff works, just kind of a primer, I would say, to get into note investing. He is also the author of The Little Green Book Of Note Investing and just a good guy. Been at this for a while and was knowledgeable and kind enough to come on the show, and we had a good conversation almost exclusively about note investing. So we’ll dive into that in a moment.
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This episode is brought to you by DJE Texas Management Group, a San Antonio, Texas based real estate investment firm with a track record of transacting on several hundred million dollars of multifamily land and industrial deals throughout Texas. DJE’s been in business for over a decade and is approaching 100 team members in San Antonio. To learn more about DJE, visit djetexas.com or the link in the show notes of this episode. This episode’s also brought to you by apartmenteducators.com, a complete ecosystem for professionals to learn how to find, finance, and operate large multifamily properties for profit. You can get started with a free mini course and learn more at apartmenteducators.com or visit the link in the notes.
Hey, Fred, welcome to the show. It’s great to have you. Thanks for joining. How are you?
Thank you, Devin. Doing fantastic. Great to be here.
Excellent. So we’re going to talk about real estate today like we do here on The DJE Podcast. Little bit different today in that you’ve done note investing and you are an author and a speaker and an investor in that arena. So I’m excited to kind of talk about something a little bit different than our normal multifamily conversations. But first, how about your background? What’s your story? Where do you live? How’d you get into real estate?
Yeah, it’s been an interesting journey for me. I’m based here in Philadelphia. I’m on the East Coast, and my background is that I’ve had a very long successful career working as a computer engineer. I spent many years working at technology companies at all these different startup companies. Real exciting. And what happened for me was I watched my entire industry get flipped upside down from the bursting of the dot-com bubble. And right around that time we had the September 11th terrorist attacks. And so that put the whole tech industry into shambles. A lot of companies went under, tons of job losses everywhere. And all of this made me realize that I was way too dependent on the income for my job, and I loved the work I did. But the jobs I had, they were always full of all these circumstances, completely out of my control.
And what I learned was that no matter how talented of an engineer I was or how valuable of an employee I was, if things were not going well at the company, I could quickly lose my job through no fault of my own. And so I realized that it was so important for me to start to have other sources of income so that I wouldn’t be dependent on the paycheck for my job. And with that, I turned to investing in alternative investments. And my goal was to acquire, buy, build assets that would generate income for me. And I did many different types of investing, a lot of real estate deals for sure, which I love.
But after a number of years of that, I got introduced to the concept of note investing. And a lot of real estate investors know about note investing from the seller finance perspective. But what I got involved in was buying notes that existed already that were institutionally originated. And so we buy notes on the secondary market and we can get more into that. And so that has grown over the years and now is my primary business and where my main focus is.
I love it. Well, thanks for the background on the overview. Let’s dive into this concept of these institutionally generated notes. Are they all against a certain asset class here? Is it all kinds of things?
I don’t really have any experience with that. But you’re talking about one of the big banks doing the underwriting and originating this thing and then turning around and selling it on a secondary market, right?
Exactly, exactly. [inaudible]. And I’m sure everyone can relate to that, right? I mean, who-
Right. Yeah, everybody’s got a home mortgage or…
Right. Everyone has a home mortgage or even a mortgage on an investment property. Let’s say you refinance or you buy the property and this comes up so much. Within one, two or three months after closing, you get that letter in the mail from your lender saying, “Dear Mr. And Mrs. Homeowner, please be advised, we have sold your loan and here’s the contact information for the new lender. And starting next month, please start sending your payments to them. And by the way, don’t worry, none of the terms of your financing, your interest rate, your payments will change. Everything will be the same. However, please send your payments to the new lender starting next month.”
And so this happens to almost everyone, everyone I’ve known. And that’s the secondary market where loans are bought and sold every day, every single day. And back to your question though, Devin, what type of assets are these notes on? Now, notes exist on every kind of asset actually. I focus on residential mortgage notes, which are your Fannie Freddie definition of a residential property, one to four units residential all across the U.S. But there are notes on commercial properties, on multifamily properties, even aviation, on airplanes. There’s auto debt, there’s all types of notes. Where we found the most success and logically the most availability of notes, the most common are single family residential. And so that’s most plentiful out there, and that’s what we focus on.
Great. Thank you for that. So if, let’s say somebody buys $100,000 house for easy math, they’ve got a $70,000 note that’s originated by Fannie or Freddie, why buy that note at, let’s say it’s $80,000 balance. Are you buying it at $80,000 whether it’s a 4% or 5% interest rate and you’re buying that income stream for the next 30 years, or is there some kind of a discount? What’s the angle on that?
Yeah, that’s a great question. So the angle is that yes, there is a discount. And so that $80,000 loan balance note might sell for $75,000 or $70,000 depending on the risk characteristics. There’s a lot of parameters there. And so what that does to that 5% or 6% interest rate for the investor starts to jump up. The yield goes up because of that discount. And so that’s where the power of notes actually exists, and that discount will vary depending on the risk profile and different characteristics of the asset. And so that’s in a nutshell how the notes investing landscape is. Like any real estate, when we buy, you make your money when you buy the asset. You can buy them at a discount and the better discount that you can negotiate and buy accordingly, if there’s problems with the note that you can solve that cause the value to go down, that’s potential upside for the investor as well.
Yeah, absolutely. So you’re buying it at a discount, an $80,000 note at a 5% rate, you’re getting higher than a 5% rate if you buy that note at $70,000. So you’re creating some leverage there. Now, how are you buying the notes? Is there a complicated process or are you just coming in cash and saying, “Hey, here’s $70,000 for an $80,000 note”?
Yeah, the notes are traded in cash transactions for sure. That’s customary.
Now as far as how we buy them, an investor can buy notes individually or they can buy notes in larger pools, which allows you to negotiate volume pricing and better discounts and everything. And that’s a lot of what we do. Other ways to get involved in note investing if an investor prefers to be passive, is you can invest in a note fund, which a note fund is very similar to how a real estate syndication works, where fund managers raise capital from investors, they pull that capital together, and then they go out to the secondary market and buy notes in bulk and they can negotiate better pricing, get better discounts. And the benefit for the investors is that they’re now leveraging the expertise and the experience and the relationships and access to notes that the fund managers have. So it’s a great arrangement and it comes down to whether the investor wants to be active in the business or passive as an investor.
And there’s no right or wrong answer. Yeah, it comes down to each individual’s objectives, what you’re seeking to do, how much time you have, and for someone that wants to get hands-on, get really involved, they have a lot of time and want to learn the business, go out and buy individual notes and be active. Now, on the other hand, if you prefer to be passive, maybe you’re a professional with a great career or a business owner and you’re focused on that and you’re just seeking to diversify your investments into a different asset class, then maybe investing in a note fund is a great option.
Perfect. Yeah, just like other real estate asset classes that if you’re the operator, that’s real work, takes expertise, sometimes years of learning and building, and the reward is on par with that experience. And then there’s passive options too, where maybe you take a smaller piece and give up some control. Trade off is you can go work that business, that job or enjoy retirement or whatever the case is. So you’re right, no right or wrong way on that approach.
You mentioned adding value, and that’s what I wanted to explore here in this note world is, okay, buying an existing note, cash makes sense. Okay, maybe you get a little bit of a discount. Well, that’s going to juice that return percentage a little bit over whatever the rate is on the mortgage. What are some other ways, you mentioned maybe some distress or problems that you can solve. How does one go about creating value on what, as I understand it is like, Hey, this is an existing contract. It’s already an asset with a first lien against it. What can you go in and do after the fact that will create value for an investor in that scenario?
Yeah, absolutely. So there are a lot of potential problems that can come up. And some of the different things we’ve seen, the note can have a less than perfect payment record. And a lot of times that can be resolved with working with a good, having a good loan servicer on your team. They’re doing some good outreach and working with the borrower. Sometimes all that’s needed is to restructure the note to some different options like that. Or other things that I’ve seen a lot of is there’s issues not with the payments, but there’s issues with the documentation where the closing documents were done hastily and not everything was correct. And so now there’s a documentation issue which causes the note not to be able to be put into a securitized pool and it gets kicked out. And so a lot of those type of problems, whether it’s a title issue or documentation issue, all of those problems, they require hands-on activity by people that know what they’re doing. Maybe sometimes legal work is involved.
All these problems can be solved and it’s going to take a little bit of time and some money to invest in it. But what’s nice is after you do that work, you’ve now increased the value of your asset. You’ve made a little investment there, you’ve increased the value of the asset, and along the way, you’re collecting your payments each month. So the cash flow is there, cash flow was not impacted. And so that works out really well. And that’s something we’ve seen a lot of, especially during the years of the mid-2000s. There was a lot of loans written and originated where there were shortcuts taken, things were not done properly. And so it takes a careful eye and attention to detail to clean some of that up, but it definitely can be done. And it’s one of the ways we seek to add value.
Others are having great relationships in the note industry where we’re uniquely positioned to take advantage of different opportunities that come up. A big one we see is whenever there’s liquidity needs by another investor, maybe it’s a hedge fund, a larger note fund, they have some liquidity needs, and so they’re going to be more willing to sell loans at a discount in exchange for a quick closing, especially when they’re dealing with someone they have a relationship with and a good track record to perform on a transaction and close quickly.
Yeah, that makes a lot of sense.
And you see a lot of parallels to the world of real estate and multifamily investing happens all the time.
All that sounds very similar to our experience with all of that.
A lot of parallels. Yeah.
Yeah, no doubt. No doubt. We’ve been creating notes for a number of years on rural land, and we hold the notes, but I found it to be this amazing business. When people, and we’re in all kind of things. We’re in multifamily development land. I mean, we do all kind of real estate in central Texas, but if you can get a decent borrower and then this note’s cash flow and it’s a 30-year amortization, looking at this is pretty hands off. And we haven’t had to foreclose anything. We haven’t even had any missed payments and I’m thinking, “These guys are paying me to let this asset appreciate.” If they default in five years, I’m just going to take that asset back out to market and sell it. I mean, have you guys had defaults or anything where… I guess what is the risk? If you’ve got a portfolio of…
There’s always risk. It doesn’t come up that often.
Of course. Yeah.
It doesn’t come up that often. And here’s a perfect example I’ll share with you. If any of your listeners out there are investors that try to purchase properties at foreclosure sale, they go to sale, try to bid. Well, what you’ll notice that happens is that out of every 100 properties that get published for sale, probably over 90%, maybe even 95%, the sale doesn’t happen. It gets postponed, it gets adjourned, it gets canceled because there was some agreement that was reached at the last minute. And so really it doesn’t come up a lot. It doesn’t come up a lot, and people are surprised about that.
But what I love in this business, and this is something banks have figured out long ago, is that they rather be in the business of being a lien holder than being a property owner. When you’re a property owner, you have to be responsible for maintenance and upkeep of the property and taking care of everything and managing and liability, all those things. The lien holder, the lender, they have none of that. They are responsible for making sure that the property owner has their taxes paid up, that has their insurance in place, that they’re making their payments. And really beyond that, there’s not that much else. And so this facilitates the ability to scale, to buy many, many notes and have a large portfolio. And so it’s something that if you’re successful with it, you can scale up and do a big portfolio rather easily.
Yeah, that’s certainly been my experience is the workload does not scale up on a one to one ratio with the portfolio size. I mean, we use a loan servicer. They’re great. They kind of handle all of it. The- [inaudible].
Let’s talk about that.
Loan servicers, I’m glad you brought that up. They play a pivotal role in management for the lender. Think of this, the loan servicer, what do they do? They manage collecting the payments from the borrower. They take care of issuing the tax statements each year that go out, the interest tax statements. They send monthly statements to the borrower. They take phone calls. They manage the amortization schedule so that if there’s a payoff, they handle everything, coordinate it with the title company and release the lien and receive the funds. And they do all of this for a very nominal fee. Most of the time it’s between $15 and $30 a month. That’s it.
And so think of a loan servicer. It’s just like a property manager managing a rental property on behalf of the owner. The loan servicer manages the note on behalf of the lender, and it’s one of the most valuable vendors and partners on your team as a note investor.
Yeah. And it’s incredible, to your point, what they charge.
It’s not much, and there’s a lot going on. There’s a lot.
There’s a lot that goes into it, and I guess they must just have enough scale and processes and automation to make it worth that.
I think I pay $35 a month or something and the borrower pays it. It’s in their bill so it’s net, doesn’t cost us anything.
Yeah. Yeah. They’re set up to handle very large volume and they’re good. They have good systems in place and they’re good at what they do.
Yep, absolutely. So if somebody was just looking into this, let’s say you’re an investor, you got a couple hundred thousand dollars to invest. You have an active track that you could take. You have a passive track. Could you walk the listeners through what you might do if you’re in that situation? Okay, I’ve heard about note investing. I want to explore this. What are my first steps as, say, an active investor?
Yeah. As an active investor or passive, either way, it all starts with education like anything else. There’s lots of great books on the topic about note investing and lots of podcasts that you can listen to now, as well as different workshops and conferences that you can attend. I always encourage people, start there first and then beyond that, start to build some relationships. One of the best things that you can do is surround yourself with successful people. It doesn’t matter what business you’re in, get around successful people so that you can bounce ideas off each other. You can learn from each other, and the best part, you can do deals with each other.
Those of us in the note investment industry, we all know each other. It’s a small world and we’ll buy and sell notes all the time, all the time. And a lot of this is about building relationships. And so get good at that. That is a skill that I would say no matter what business you’re in or what type of investing you do, if you get good at building relationships and nurturing them, that’s going to serve you so well and set you up for success. So those are some suggestions about getting started. But absolutely always essential is education, because with note investing, there are a lot of pitfalls. It’s very easy to lose money very quickly if you don’t know what you’re doing. So get educated first before you do anything.
Yeah, 100%. Great advice. And that does apply to any business that you’re in, but I totally agree. One of the nice things about note investing is you’re really kind of inherently building cash flow from day one. Any business that can cover its expenses with recurring revenue is just going to be a much safer business, a lot easier to survive and grow if you got recurring revenue. I own a bunch of businesses and my favorite ones are the ones that have recurring revenue. They’re covering the expenses, makes it a lot easier, and-
… note investing kind of inherently builds that. What are some of the other strategies? As you’re building a portfolio in notes, are you bundling and selling that? Are you just always buying and trading based on different note characteristics? Or what’s the game that once you’re a couple years into note investing that you want to be playing?
Yeah, absolutely. So one thing that’s very important is you’re going to always be redeploying capital. It’s about the concept of velocity of money. Now, here’s what happens with notes, which is different than real estate. Both can generate cash flow. However, real estate will appreciate over time. That’s the historical trend. Now, notes because of the amortization schedule with each payment you receive, you receive interest and a portion of your principal back. And so the loan balance goes down each month. So that’s the value of your asset. It’s decreasing over time.
And so for an investor and you have a portfolio of notes, you’re getting money coming back every month along with some loans that get paid off because they were refinanced or the property was sold. And so money’s coming back every month. And so it’s up to the investor to keep redeploying that capital. You go out to the marketplace buying new notes as often as your capital allows for it. It’s not like you can just take the cash flow and then go off and spend it because that’s not going to be sustainable in the long run. And so the main thing is to always be watching to redeploy capital. And there’s a lot of liquidity that comes up.
Like I said, the average life of a note of a mortgage note in the U.S. residential is five to seven years. That’s because people refinance. People move or they downsize, upsize their property and they sell them. And this happens all the time, and you never know. There’s that element of randomness. You never know when a payoff comes in. And a payoff is great, usually any upside comes in during the payoff, but then what do you do next? Immediately after that, you start looking for your next note. Where’s the next opportunity for you to redeploy that capital? Because idle cash sitting in your account and your balance sheet has a rate of return of zero.
And arguably -5% or -10% depending on what you think the CPI numbers really are, right?
Absolutely. Absolutely. So it takes constant work to keep that capital deployed and getting it to a level of efficiency. You want to keep some handy for your expenses and maybe buying opportunities that may come up. However, you want to keep a close eye on that as an investor.
Yeah. It’s interesting. I have this fantasy about building all these notes and X amount of cash flow for decades. Oh, this is a really good retirement plan here. But then a month ago, I got a text from my broker, “Hey, man, I got $600K coming back at you.” And I was like, “Oh, okay.” We’re one year into a 30-year amortization, and the owner of that property that we’re holding the note on decides they’re paying it off. Good for them. They probably got a better rate or who knows what they’re doing. But okay, well now we have a liquidity event and need to redeploy. And so yeah, it’s a balancing act, but you’re right. You never know when the payoffs are coming.
Yeah. It’s that element of randomness.
Yeah, yeah. Which is a good thing. That’s a good surprise.
It beats the alternative of, Hey, all your money’s gone. But it is kind of interesting, something you need to plan for in addition to building the long-term cash flow. But you have a liquidity event and you just go out and redeploy it. And if you’re getting educated and building systems around that, then ostensibly you’ve got a way to redeploy that or some portion of that capital, right?
Yeah. Let’s talk about resources. You’ve written a book. You’ve got the website. Tell us how folks, we agree that education is kind of the foundation if you’re new to this space and you want to do that and get networked and educated before you really do anything or spend any money. But tell us about the book and what other resources can people use to get started doing this?
Yeah, absolutely. Thank you. I’ll talk about a couple of great resources. So as far as books go, one that I love, and this was one of the first books I read about note investing. This was written by Jimmy Napier, and if any of you real estate investors have been around for a long time, you’ve probably heard of Jimmy Napier. He wrote this amazing book called Invest in Debt, and it’s still in print. You can find it online. It’s a pretty technical book. It gets into using a financial calculator and the skills you need for that, which are very important. And so that’s a great one that gets… I would say that’s not a basic book. It’s more of a getting more on advanced topics, but it’s very, very well written.
And my book is called The Little Green Book Of Note Investing. It’s available on Amazon, and this book is a great introductory level overview of note investing and the note investing industry. We talk about why notes are bought and sold and how the secondary market works. There are chapters on how to perform due diligence, how to analyze a note, how to perform a transaction to purchase a note, how to do all of the management that’s needed, getting it set up with a loan servicer, getting your documents in place, how to review that, as well as some other topics about scaling and growing your portfolio. How to you use self-directed retirement count capital to invest in notes, which is a wonderful strategy. I always love talking about that. And it’s going to really give an overall picture to someone that’s new learning about the business and deciding which angle of note investing is right for me, what makes the most sense. And so we lay out all the options and that helps the reader make a well-informed decision.
I love it. Well, thanks for sharing those resources. What do you see ahead? We’re talking in Q1 of 2023. What do you see ahead for the next year for your company?
Well, we see a lot of opportunity in the marketplace for sure. A lot of the larger note sellers are taking time to make adjustments, re-strategize, selling off assets, which are not in line with their strategic objectives. And so we’re seeing a lot of notes coming in to the marketplace to be sold and a lot of opportunity. Even though we’re in uncertain interest rate environments, if you think about it, a lot of the notes we buy, they were originated several years ago. And so the interest rates of today and tomorrow, it’s not as much of a significant impact as one would think because the interest rates on those notes, they’re already set. And so it does cause some uncertainty, but it’s like anything else. With any investment, when there’s uncertainty in the world, uncertainty in the marketplace, it creates opportunities for investors that have the good skills, the know-how and the relationships to keep moving forward.
Isn’t that the truth? I love it. Well, we’ll end on that, Fred. If somebody wants to connect with you on the website, where can they do that?
Yeah, thank you. The best way to connect with me is by visiting my website, which is fredmoskowitz.com. And if you prefer an easier spelling for that, you can visit giftfromfred.com and it’ll take you right to my website where there’s more information available. I’d be happy to send out a special report about note investing, and if you prefer to text me using your mobile device, you can text the word money to this number, which is 215-461-4433 and then follow the prompts. I always love connecting with investors, meeting people, talking to investors, learning about what you’re doing in the investment space and building relationships. It’s the most important thing that we can do. Thank you.
Yeah, I totally agree. Well, we’ll link to that in the show notes. If you’re listening, you can scroll to the bottom and click through to visit the website there. Fred, thanks so much for joining. This is a breath of fresh air learning about something a little bit different outside of what we normally do day to day, and a very intriguing space that’s going to be around forever. Note investing’s not going anywhere, so I love it. I encourage people to learn more about it. Great meeting you. Thanks for spending some time
Thank you, Devin.
… wish you success in the year ahead.
All righty. See you.
You as well.
Thank you so much.
Thank you for listening to the DJE Podcast. For more information, please go to djetexas.com.