Creating Real Estate Notes

Before we get into creating real estate notes, we need to define exactly what a note is and how it is different from a mortgage.

A note is written evidence of a debt. It can be as simple as an I.O.U. scribbled on a napkin or a complex, multi-paged document drawn up by a team of hot-shot attorneys. In order for notes to be negotiable, they must comply with the Uniform Commercial Code, which we’ll talk about in just a bit.

A mortgage is a pledge of an asset to secure a note. In most real estate transactions involving a note, the money being loaned is secured by the value of the property being bought. The property is mortgaged, i.e., used as security for the note.

While this may seem simple to some of you, it is something the geniuses in banking and Wall Street overlooked when they sold, bundled, securitized, de-securitized, re-securitized and re-sold millions of loan NOTES. Somewhere in all that, many of the notes were separated from the mortgages. Why is that important? Because those notes are now unsecured loans. As you’ll find out in our article on Buying and Selling Notes, an unsecured note is worth much less on the market than a secured note. More importantly, if a note has been assigned without the accompanying mortgage, and the buyer defaults, the lender has nothing to foreclose against. The physical property is no longer tied to the note.

So how can you make sure that a note you create will hold its value should you ever want to sell the income stream or use it as collateral for another asset? You start by complying with the Uniform Commercial Code.

Creating Real Estate Notes in Compliance with the Uniform Commercial Code

The Uniform Commercial Code (UCC) was developed to harmonize all the various state laws that apply to commercial transactions. While every state has its own laws that govern various types of transactions, the UCC established a standard to be used for all interstate transactions.

Before your eyes glaze over, know that creating real estate notes that comply with the UCC is fairly simple. All negotiable instruments must:

1. Be in writing 2. State a date of issue 3. State the obligation amount 4. Name a payee or bearer or cash 5. Have a due date or be on demand 6. Promise to pay unconditionally 7. Have the maker’s signature

If you ever get confused, take a look at a check. There’s a place for the date, the amount, who is to be paid, it is a demand note (meaning you can take it to the bank for cash), it’s a promise to pay and it is signed by the maker.

Creating Real Estate Notes – The Actual Note

Creating the physical real estate note doesn’t have to be a complex process. In fact, once you have a solid note template, it can be as easy as filling in the blanks. The problem arises when investors, new and experienced, take any note and fill in the blanks to the best of their ability. What might be a good note for one transaction could be a disaster for another. That’s why it’s important for investors to read and understand all the documents they use, not just notes. More than one investor has found out that the payee from the template wasn’t changed out to the new person or that the amount was right numerically but written out improperly.

In addition, notes can be either secured or unsecured. Most real estate notes are secured by the same property that the borrowed money is being used for, but it doesn’t necessarily have to be that way. Very few real estate notes are unsecured. It is simply the nature of the real estate business as usual to provide some sort of security for a note.

Be sharp when you are agreeing to pay on a note. Some lenders, both private and institutional put in a cross-collateralization clause. That means that if you default on that note, they may be able to take other properties that you own if the property that secured the note no longer has enough value to cover the default. On the other side of the table, when you’re writing a note, you may want to cross-collateralize a note from your buyer to insure you get your money. Some lenders might ask an investor to securitize the note for a rental property with a mortgage against the investor’s personal residence. The idea is that the borrower will work harder to make payments if he is at risk of losing his own home as opposed to a rental property.

The world of notes and paper is a huge business. Take the time to understand real estate notes and how they work. Knowing the ins and outs of creating real estate notes can exponentially increase your investing opportunities.