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A Real Life Mortgage Note Buying Case Study

With the backing of real estate, potential for monthly income, and the opportunity to buy at a discount, buying mortgage notes can be very profitable. In this case study, I'll show you exactly how I doubled my money on this non-performing note over 3 and a half years from acquisition through to exit via sale of the real estate

David Garner

Published On: August 15th, 2022

A Step-by-Step Real Estate Note Investing Case Study

I’ve been buying and selling mortgage notes and participating in private money lending for about 12 years now, and I’ve completed hundred’s of transactions.

In fact, my first ever investment in the US housing market (and my steepest learning curve) involved the purchase of a pool of non-performing notes from a distressed bank (GMAC) back in 2010.

I’ve had some great wins and some tragic losses along the way, but every real estate note I’ve been involved with, either as a buyer or seller, has taught me something new.

In this article, I’m going to walk you through the exact timeline of a mortgage note I purchased back in August 2016, from my initial purchase as a non-performing note, through taking possession and eventually selling the property in February 2020.

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Some Background Info

The first stop on this real estate note buying journey is at the door of a private money lender.

This gentleman was a client and friend of mine. He had extended a small loan to real estate investor from the West coast who was buying rental properties in Southern states.

The deal was pretty small at $45,000, but nevertheless the borrower managed to screw up and ultimately stopped making payments on the note. This left my friend in a bit of a pickle.

Buying Mortgage Notes and Private Money LendingSince 2010

Although the real estate was located in a non-judicial state (Mississippi), potentially making a foreclosure quicker and easier than it might otherwise be in a judicial state, the lender didn’t want to spend any more energy on this already time-consuming and stressful project.

And that’s lesson number 1 right there…

Find out what’s motivating the seller.

Sometimes their problem is money, sometimes its time, sometimes its just stress!

Take the time to find out, because if you can solve their specific problem(s) for them you stand a much better chance of getting the deal done at a price that works for both of you.

Now, taking a lowball offer from me would certainly result in a financial loss for this seller, but it would also leave him with some cash in his hand immediately, and more importantly, the ability to walk away.

So I set about figuring out how to solve his problems while at the same time getting me a great deal on note with some good upside potential.

But before we talk numbers, I had some work to do.

Making an Offer to Buy the Note

First things first, I usually like to buy performing notes. I like income, and i like reinvesting that income for compound growth even more.

But this was a non-performer, so instead of steady, reliable income, I was getting a big purchase discount and the potential for a big profit. But I was also picking up a bunch of hassle, and way more risk.

Once significant issue with this note was that the borrower was already 6 months in arrears, and he had stopped communicating with the lender about 3 months ago.

I had been buying real estate notes for a while by this point, so I knew it would potentially be a challenge to even get hold of the borrower. That would be a problem if I needed to get them to agree to a deal, sign paperwork, or whatever else might be needed.

Because it seemed unlikely that I’d be able to work this one out with the borrower, I had to weigh up the potential value of the underlying real estate, and the time, effort and money it would likely take to take ownership, carry out any required repairs to maximise value, and expediate a profitable sale.

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Property Condition and Value

The first thing I did was have a local guy drive by and take some external photos of the house for me. These folk are easy to find on odd-job websites like Fiverr.

When I got these back I figured we were dealing with a vacant property that had not actually been renovated at all, at least not recently.

At the same time, I spoke with a local realtor about the potential value range for the property – from wholesale to retail – I found out that there were not many retail sales in that neighbourhood. It was mostly a rental market, but some local RE investors sell to locals with seller financing.

Next up was figuring out my rehab budget. At least now I knew that it’s be a rental level rehab, and not a full retail level HGTV style makeover.

Renovation costs can overrun by thousands of dollars so make sure you get as accurate a quote as possible based on the level of access you have

After speaking to a couple of local contractors, it looked like we would probably have to spend about $15,000 to make the property suitable for the local rental market, or to sell with owner financing.

Remember, this is back in 2016. Building materials and labour were way cheaper back then!

So I figured my four best options to make a profit here were:

Renovate and sell it as a rental – likely $55,000 less costs
Sell with owner-financing – likely $10,000 cash plus $800/month payment
Renovate and keep as a rental – likely $800/month gross monthly income
Tidy up and fire sale in as-is condition – likely $20,000

So, now I had some options lined up, and I knew approximately what it would cost to renovate the property to a reasonable standard for options 1 through 3.

With all that in mind, I figured I could pay my friend about $10,000 for the note, provided of course the paperwork was in order and there were no title or tax issues to deal with.

That bid left enough money in the deal to make a reasonable profit considering I’d be at least a few months with tens of thousands of dollars out of pocket.

Collateral File Review

Next up was a review of the paperwork.

This was a commercial loan on a non-owner occupied rental property, so the collateral file was much smaller than you would find with an owner-occupied property.

I had the original closing packet with the escrow instructions, HUD settlement statement, title report, promissory note, deed of trust, pay history, and a few notes made by the lender from the times he had been in contact with the borrower.

the collateral file contains all of the information pertaining to the promisorry note, mortgage and borrower

At this point I’d been investing in mortgage notes for a while, and everything seemed in order to me, but I had a local attorney review the note and deed of trust anyway just in case there was anything I missed that might make my job harder when it came to foreclosure.

I also had the attorney run a title check for me. After all, taxes, title and liens are the three horsemen of the apocalypse when it comes to note investing.

After getting the green light from the attorney, I set about making my offer.

Negotiating and Closing

I explained the situation to my friend over the phone, and sent him an email confirmation of my offer of $10,000, being sure to include my promise to close within 24 hours hours (or as soon as he was ready), and reiterating that as soon as we close it’s off his plate for good.# and he can move on to bigger and better things.

He obviously wasn’t particularly enamoured with the idea of taking a $35,000 loss. Initially, he wanted me to pretty much double my offer to $22,500. That would equate to a 50% loss for him, which was of course still a significant haircut.

But with the cost of rehab, future value potential of the property, and the amount of risk I’d be taking, that just wouldn’t work for me.

I knew he had no time or inclination to take on the project himself. Besides, he could also use the loss as a much-needed write of come tax season.

After I explained the level of work and risk involved on my part, he somewhat reluctantly agreed to my original offer and we had an assignment etc. drawn up through the attorney.

We closed on the note purchase through escrow with the attorney remotely. That’s one of things that makes it easy to buy real estate notes from wherever you are in the country, or even abroad like I was at the time.

Fast forward a week and I was now the proud owner of another non-performing note. Next, I set about the process of project management and trying to turn this thing into a profit.

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Owning the Real Estate

So far with all my out of pocket expenses, I’m in for about $11,000 and change, and I know I’m going to have to spend considerably more to put this thing upright and turn a profit.

Plan A for this property was to renovate, rent and sell in the shortest timeframe possible. That was going to cost me at least $15,000 just for the renovation. Then I’d have closing costs on top.

Plan B was to renovate and sell with owner-financing.

Plan C (the contingency) was to do a very minimal ‘spit and polish’ rehab (trash out and tidy up) and try to sell for about $20,000.

Remember that the borrower had gone dark months ago? So obviously I assumed I would have to foreclose. That alone could take months, even in a non-judicial state.

Always have multple contingency plans when plotting out a potential mortgage note purchase

But as my late Father used to say; assumption is the Mother of all f*ck ups!

So I decided to stick to my process and tried reaching out to the borrower before I started official foreclosure proceedings. In my experience, trying to speak to the borrower first is always the best starting point.

Maybe, I thought, by some miracle they would respond to me. Maybe they’d even look at some kind of deal. Who knows, right?

Well, to my astonishment, they picked up the phone first time.

I introduced myself, told them I’d bought their mortgage from their private money lender, and that I’d like to do a deal with them to take the property off their hands.

And guess what… they were delighted!

I guess they had been avoiding the original lender because they were embarrassed that they’d screwed up the deal and the lender was going to lose money. But they had no such issue with me, and were more than happy for me to take the problem off their hands.

be thorough and stick to your process no matter how sure you are of an outcome. things often work out differently than you first thought

That’s lesson number 2…

Don’t assume things are going to go the way you think they are based on your initial review of the collateral file. They’re probably not.

You’re most likely course of action will be through the borrower, and servicer notes only tell you so much about their specific situation, circumstances, problems and requirements.

You’d be surprised how many borrowers will be willing to do a deal, despite what the loan servicing file might say.

I’ve bought plenty of notes where it looked like the borrower stopped cooperating on a deed in lieu or pre-foreclosure proceedings part way through the process.

Many times this has just been down to some attorney speaking to them like crap, or the lender or loan servicer not listening to them, so they just stopped communicating and buried their heads in the sand. or worse.

When a fresh voice calls them with open ears and an open mind, more often than not they’ve been prepared to pick up the process and cooperate. And believe me, a borrower who cooperates is a blessing in the note investing business.

So make sure you stick to your process. Don’t take shortcuts no matter how convinced you might be of the outcome.

There are many ways to negotiate a deal. You will not always have to foreclose on the note if you can strike a deal with the borrower

So, let’s get back to the story…

I knew the borrower just wanted rid of this whole debacle, just like the lender, so we agreed that I’d take a deed in lieu of foreclosure, and I promised to get it across the finish line as fast as possible with as little hassle for the borrower as was practical.

My attorney prepared the paperwork (a deed), and we set a closing date to suit the borrower. I paid for everything which amount to about $1,000.

So it’s now about a week later I’m already in possession of the house!

Considering I was assuming a foreclosure was my only option I was already months ahead of where I thought I’d be at that point.

Now we could get to work right away, so the house wasn’t going to sit vacant for months risking damage. The borrower even dropped off the keys at the attorney’s office which saved me the cost of breaking into the house to secure it.

Renovation

This part of the process is always fairly risky.

I’ve completed well over 100 rehabs, and there’s always something that comes up that you didn’t/couldn’t plan for.

I was also running this project remotely. That added another layer of risk as I would not be available to inspect the work myself. I was going to have to relay on the capability, capacity and competence (and honesty) of my contractor, and then pay for a home inspection.

I engaged the contactor who provided the best bid, and by the ‘best bid’ I don’t mean the cheapest.

I chose to work with the contractor that I felt was most professional during the bid process (I actually spoke to 3). He went to inspect the property within 48 hours, provided a comprehensive itemized and costed scope of work (SoW), and had an excellent local reputation.

We agreed that I’d pay for the project in 3 tranches. $5,000 upfront, a further $5,000 to be drawn down on completion of the first phase of work, and the final $5,000 on completion of the project subject to a satisfactory independent home inspection.

We had a projected timeline to completion of about 3 weeks, subject to no further work being identified during construction.

When dealing with contractors always get a comprehensive Socpe of work and a clear contract defining the job, cost and timeline

We drew up a contract, signed remotely via DocuSign, I wired funds, and we got started.

When it came time to for the construction draw, the contractor provided multiple detailed photos of all of the items that were completed as per the scope of work and contract, and I wired the agreed funds same day.

I think this is really important, so let’s call it lesson number 3…

I hear many real estate investors complain about contractors missing deadlines or delivering shoddy or incomplete workmanship. But it works both ways.

If you want your contractor onboard with you and aligned with your expectations, then make sure you do what you say you are going to do. Have a clear contract in place, stick to your end of the bargain, and make sure you pay them on time.

Anyway, the contractor finished up after about 4 weeks total, and I hired a home inspector to complete a review of the property including an inspection of everything included in the SoW, and produce a snag list of anything that he felt was not right, or would either fail code or be required to be completed before selling/leasing the home.

There were a couple of minor items that weren’t included in the original SoW, so I agreed with the contractor to complete those and send me an invoice. It was only a couple hundred bucks, and other than that the house passed with flying colours.

Now on to the task of leasing and/or selling the property to get some cash rolling in and pull my original investment and profits out.

Leasing and Selling

At this point I was all-in to the tune of about $27,500 all things considered. That included the purchase of the note, closing costs, taking ownership of the property, and the renovation.

The next step was to get this house sold, but as my Plan A was to sell to an investor as a turnkey rental, I needed to find a long-term tenant first.

Once I had a tenant, I would then have to hold it for at least 3 months myself in order to ‘season’ it.

That generates a payment history from the tenant, and allows me to deal with any immediate maintenance issues that come up once the tenant has moved in. Both of those things make it easier to sell as a turnkey rental, and less of a headache for me and the buyer post-closing.

I called round a few local property managers. Two of them had time to visit the property and provide me with a more accurate rental estimate now the home was almost ‘rent-ready’.

Handing over to a professional rental property manager makes a lot of sense

The consensus was that the home would likely rent for $800 per month, which was in line with my original estimate from back when I was running due diligence on the note purchase about 2 months earlier.

I signed a management contract with my chosen PM, and they arranged for a deep clean of the property and started marketing for long-term tenants.

There were multiple applications from prospective tenants, and the house leased within a couple of weeks for $800/month.

The agent took 1st and last month’s rent, and an $800 security deposit. The tenant was due to move in the following month (November, 2016).

On move-in, the agent took 1 month’s rent as their placement fee, with an on-going management charge of 10% of contracted rents monthly.

I received my first rent check on 1st November 2016, and save for a few minor maintenance items in the first couple of months I received pretty much all the gross rents less management costs.

In the end, I decided to keep hold of this house for a while. Rents were good and the property the market was stable. There wasn’t a great deal in the way of capital appreciation, but houses weren’t depreciating either.

While its important to stick to your process, the plan can change at a moments notice, so be prepared to pivot for success

That’s lesson number 4…

And this is a big one that applies throughout the whole process, and remains relevant at all times. Be prepared to pivot.

Just because you made a plan, don’t blindly stick to it no matter what. Sometimes (often, in fact), taking a different course of action to that which you had originally planned might all of a sudden be more appropriate.

In this case, my original plan was to sell the house right away. But now I owned a stable asset that wasn’t giving me any trouble, and was paying me net $500 per month after all my holding costs.

So, I decided to hold for a while.

What I did do however was borrow $27,500 from one of my private lending clients. This gave me 100% of my capital back and cost me $183 per month in interest at 8% p.a.

So I was now getting $320 per month NET or thereabouts in rental income (considering variable occasional maintenance costs), and I had ZERO capital tied up in the deal.

So now… my ROI was INFINITE!

I did eventually sell the property, but not until February 2020. So I held this investment for a total of 42 months from start to finish.

Here’s a summary of the timeline and financials.

Summary of Timeline and Returns

The timeline of my investment from start to finish looks like this:

August 2016: Non-Performing note acquired.
August 2016: Title to property acquired via deed in lieu of foreclosure.
October 2016: Renovation complete.
November 2016: Tenant move-in.
January 2017: Borrowed $27,500 against the property.
February 2020: Sale of property closed.

My total expenditure for this investment looked like this:

Note purchase: $10,000
Closing costs: $1,000
Deed in lieu: $1,000
Renovation: $15,500 (including utilities etc.)
Tenant placement: $800
Refinance origination: $1,725
Loan Interest: $6,600

My total expenditure came to: $36,625

My total income for the whole investment looked like this:

Gross rental income: $32,000
Property management: ($3,200)
Maintenance: ($2,875)
Insurance: ($1,525)
Property taxes: ($3,425)

My total NET income for the term came to: $20,975

I sold the property for $60,000 in February, so my total investment scenario looked like this:

Total cost: $36,625
Total NET income: $20,975
Property sale income (NET): $57,000
Total NET return on investment: $41,350
Total NET ROI: $113%
Simple annualized ROI: 32% p.a.

So there you have it folks. That’s how I more than doubled my money over 3 and a half years buying a mortgage note.

Now it has to be said, not all notes work out this well. I’ve had a few stinkers in my time, too. But his is a great example of how buying mortgage notes can work out if the stars align for you.

I don’t buy many notes nowadays. I stick mostly with buying real estate for our affordable housing program, and managing investments for other investors through our Private Lending Program.

That said, if the opportunity arose to get hold of a deal similar to this one, I’d certainly give it some serious consideration.

Happy Investing!

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A Real Life Mortgage Note Buying Case Study

David Garner

A Step-by-Step Real Estate Note Investing Case Study

Some Background Info