Why be a landlord when you can Own the Note?
Clearly investors have turned toward the buy, fix and rent model. That’s great if you are looking for a 6% to 8% yield and are prepared for the headaches of being a property owner and landlord. Our response is “why be a landlord when you can get a higher yield without the hassles of being a landlord by purchasing the mortgaged backed note?”
In 2012, Wall Street clearly recognized the opportunity to buy distressed single-family homes (SFH’s). The private equity firms had typically avoided this space but unattractive yields in other entities caused them to look at single-family homes as a better investment so they entered the market in a huge way.
Private equity firm, Blackstone, has purchased over 29,000 SFH’s in less than a year. They recently raised billions to purchase more. Carrington, Colony America, Silver Bay and others have a combined purchase of tens of thousands more SFH’s.
“It’s hard to find a private-equity firm on the planet that doesn’t have a strategy in this space,” Gary Beasley, chief executive officer at Waypoint Homes, said last week at the American Securitization Forum’s annual conference in Las Vegas.
But it doesn’t stop there. Wealthy Americans, looking for better and safer yields, are pooling funds into partnerships that purchase SFH’s. According to a recent article in Bloomberg:
The firm’s unit that caters to individuals and families with more than $5 million, put client money in a partnership that bought more than 5,000 single family homes to rent in Florida, Arizona, Nevada and California, said David Lyon, a managing director and investment specialist at J.P. Morgan Private Bank.
We doubt that most of them are simply enamored by real estate. We doubt that they really want to be a landlord and have all of those responsibilities. In fact most investors would argue that being a landlord takes a fairly high tolerance level in dealing with tenants and tenant related issues even if you have a property manager. So why are they purchasing and renting? Is it the yield? In the same Bloomberg article, David Lyon said:
Investors can expect returns of as much as 8 percent annually from rental income as well as part of the profits when the homes are sold, he said.
Other fund managers, such as Sandeep Bordia, from Barclays, said:
Even as the housing market probably will do well across the nation, areas where property prices already are high such as San Diego, Los Angeles, Denver and San Francisco, will see lower rental yields, of 4 percent to 5 percent
Is that kind of a yield really worth it? Are they making the kind of yields that they hoped?
Blackstone reported a 6% yield and although 85% of their renovated homes are leased, their department head said, “We have an awful lot of homes to continue renovating.” Bruce Rose, CEO of Carrington Homes, said, “We just don’t see the returns there that are adequate to incentive us to continue to invest.” American residential Properties and Silver Bay both reported loses in the first quarter of 2013.
So what has happened? Did they over pay for the properties? Did the under estimate the renovation costs? Did they not anticipate the time and cost of getting a qualified tenant? Are the costs of property management and property upkeep cutting into their margins?
The short answer is yes. Yes on all accounts.
Is there a better investment that can provide better returns without these other issues? Can an individual investor do better?
Yes! Invest in performing and re-performing mortgage backed notes.
When you invest in these notes, you:
Do not pay to renovate a property
Do not have to get a tenant
Do not have to hire a property manager
Do not have to deal with any tenant issues (because you don’t have one)
Do not pay to upkeep the property
Do enjoy monthly cash flow
Do enjoy double digit yields
Do have a secured investment
Do have an automated system where the debt servicer collects the payment and wires it into you account
Do have a debt servicer who verifies property taxes and insurance payments are made
Do have the ability to make this tax free (an allowable investment for an self-directed IRA or 401k and other retirement accounts)
Do have the ability to buy these at a discount
If you compare this to the landlord model, there really is no debate. Mortgage backed notes simply make a better investment. After all, you are simply acting as the bank.
To give you an example, this week we entered an agreement to purchase a performing note. The original note was created for $45,000 after the buyer put $20,000 down on the purchase of a $65,000 SFH. The note was created at 8.9% interest for 150 months. After 11 months, the note owner decided to sell the note.
The note has an unpaid balance of $42,772. We have an agreement to pay $36,199 for the note giving us a 12.75% yield. We will receive $499.59 a month for 139 months. No land lording, no hassles; simply monthly auto-deposit cash flow backed by a $65,000 SFH. This puts us at a 56% investment to value ratio, meaning that the collateral is worth almost twice as much as our investment.
Another larger multi-family deal that we have under a purchase agreement this week will produce a 15% yield. This property sold for $490,000. The buyer put $125,000 down and created a $365,000 note with the seller. The note was created at 4% for 84 months.
After receiving a few years of payments, the note owner decided to sell the remaining 56 months of payments for cash now. We will buy the note, with an unpaid balance of $253,109, for $191,714. So we will receive $4905.55 for 56 months for our $191,714 investment. Is it safe? The property is worth about $500,000! That means we are at a 39% investment to value ratio.
Knowing what you now know, why would you buy, fix and rent when you can just own the mortgage backed note and the monthly cash flow it represents?
