convert_real_estate_notes_paper_assets

When first starting out in real estate investing, I was pretty much like everyone else. I was looking for Financial Freedom. At that time, I hated my day job working in Corporate America and was looking for cash flow in hopes of one day, someday breaking free.

I was a contractor and a realtor, and so I was drawn to real estate investing because it seemed like a safe, secure investment that not only had collateral, but even had some tax advantages with deductible mortgage interest, depreciation, and the like.

So, it was around that time that I got to about 20 units, and I had enough positive cash flow that I could entertain the idea of leaving my day job. The only real issue I had was that, when I went to double my portfolio, I soon found out that although I had freedom of my schedule, I really didn’t have true freedom of time. I had just replaced one job with another. In fact, in many ways, I had more liability and responsibility.

And then…

I was introduced to the world of notes.

Using Notes for Financial Freedom

In the beginning, I learned about notes from the hard money lenders and the seller financed note speakers at my local Philadelphia REIA meeting. Sure, I got to hear Jimmy Napier, Pete Fortunato, and Donna Bauer. But early on, I just didn’t seem to get it.

Finally, it was finding private money for my own deals that made the most sense. I started using some private money for my own transactions, and then later on I started to lend money out from my Self-Directed IRA, retirement accounts and eventually with my Home Equity Lines of Credit (HELOCs) on my investment houses and apartment buildings.

Related: Real Estate Notes vs. 401k: Which Investment Wins Out Over 30 Years?

The first eye-opener for me was when I met a local hard money guy named Jim Bennett from Stonehenge Funding. This guy at one point had well over 200 houses, and this Wharton School of Business graduate was literally the largest hard money guy around. It took me a while to connect the dots that he too was in the notes business. Maybe that starts to explain why he wasn’t trying to double his portfolio to get to 500 rental properties someday.

So, as I started to see the correlation between hard money and the seller financed note world, I was gaining more and more experience with my own private note portfolio. Not only was I doing first mortgages for bird dogs (rehab funding), but I was even holding second mortgages when I was selling off some of my own properties.

Although I was doing property management at a local RE/MAX at the time, I quickly realized the benefits of paper. I no longer had to deal with contractors, townships, tenants, and toilets. My life was becoming easier to manage, with more time, and I truly believe that I was even making more money. It just seemed easier dealing with folks who had an ownership interest in the property.

But What About Real Estate as an Exit?

This might stir the pot some, but what I started to realize after owning rental units since 1989 was that the normal real estate exits aren’t always the best. For example, I remember writing about this famous local RE guy, who owned a large number of units, and he spoke one night at a sub group, where I asked him “What is your exit going to be from real estate?”

He was even talking about how he was battling cancer and going through chemo, and he really didn’t have an exit strategy other than leaving the stuff to his daughter. It was then that I realized his real problem; it was the same as mine.

What if Your Heirs Don’t Want Your Properties?

Unless you’re setting up a Charitable Remainder Trust or 1031 Exchanging your way into a Real Estate Investment Trust (REIT), oftentimes your heirs may not want your real estate. My wife and kids would want to shoot me if I left them all the problems I deal with on a daily basis. They really just need passive income from the assets I’m leaving behind; thus the value of the paper.

Converting Real Estate to Paper Over Time

Example:

After owning a three bedroom row home for ten years, the property doubled in value, and then I sold the property to a friend’s LLC. His new commercial loan paid off the remaining balance of my first mortgage and then some. Then, I turned around and did a seller assist and held a five year interest only second mortgage for the difference of the sale price and his first mortgage. He was able to acquire the property with no money out of pocket and still cash flow, and I was able to cash flow off of a house I no longer owned.

Related: 4 Arguments for Investing in Real Estate AND Notes for Retirement

Slowly but surely, I’ve been converting my real estate investments to paper assets. Today, I have a couple of entities that own a pile of notes, and, trust me, they’re a lot less work than my real estate portfolios. It consists of private money, private seconds, institutional firsts, and institutional second mortgages.

In fact, I currently have an investor looking at my 18 remaining rental properties, where he is looking to use a commercial blanket, and I’ll gladly give this investor a seller assist and hold a nice commercial second mortgage for him. I’m hoping that 2015 is the year of the deal. He’ll get a great cash flowing portfolio with little or no money out-of-pocket, and I’ll continue to cash flow off real estate I no longer own or have to deal with. Now, that’s true financial freedom in my eyes, and I’m sure my heirs will be thanking me later, too.

So, what’s your exit strategy …read more