You probably confirm the destination before you hop on a plane. Knowing where you are going is essential to the journey – not just while traveling, but also in real estate investing.

Putting our money into a real estate investment can be daunting. How can we mitigate the risk of losing money? How can we encourage higher returns? 

These questions all relate to how we plan to EXIT the deal. Our plans for exit will then determine our offer price. In real estate, it is said that we make our money  when an asset is bought, but that money doesn’t come until you follow-through with a solid exit strategy.

As a savvy real estate investor, you want to have multiple exit strategies mapped out. In Note Investing, your list of potential exit strategies may be the longest of any investment.

When growing your wealth through Real Estate Backed notes, you can leverage an extensive list of exit strategies to mitigate risk and increase your returns. 

Let’s look at our top 4 exit strategies for investing in Non-Performing Notes that we implement most often. Of course, there are combinations and further options within each of these strategies.

We’ll also present the specific risks with each exit strategy and historic returns. Of course, there are always risks when investing and there is never a guarantee on any returns. We can’t cover every risk in Note Investing here, but will attempt to help you understand the difference between these exit strategies. 

First, let’s quickly cover why we have so many exit strategies with note investing.

Why Do We Have So Many Exit Strategy Options With Note Investing?

Great question.

It is all in the discounted purchase price. We buy notes at a steep discount such that we can add value and sell the Note for a higher price. Think your typical fix-n-flip strategy here – only we don’t need to hire any contractors or swing any hammers.

We underwrite our offer price to the most conservative exit strategy. That way when we are pursuing our favorite exit strategy (helping borrowers get back on track with payments through loan modifications), we have lots of options if something doesn’t work out. 

Let’s dive into the strategies. 

We’ll start with our favorite strategy and end with our base-line or back-up strategy.

Exit 1: Re-Performing Note – Adding Extreme Value

When we buy a non-performing note, our borrower is not making regular payments. The basic strategy here is to restructure or modify their loan (new term, new interest rate, etc) and help them get back on track with payments. 

Once the borrower has been making regular payments for around 12 months, we have a Performing Note. We can then sell that Performing Note for a much higher price than when we purchased it just over a year prior.

There is a lot of flexibility in here that can make our chance of success even greater.

For instance, once a borrower has been making regular payments for 6 consecutive months, we can offer an incentive to keep the borrower motivated to pay, such as a reduction in interest rate or even a portion of loan forgiveness. 

We have the wiggle room to play here because we bought the original note at such a steep discount.

Many investors want the regular cashflow of a Performing Note in their portfolio. We can even sell the Performing Note at a discount to get our capital reinvested quicker.

We love this classic real estate win-win-win example.

• The borrower wins by getting to keep their most valued asset and begin a cycle of generational wealth.
• Our partnership wins with great returns.
• The Performing Note investor wins by getting a solid cash flowing asset for their portfolio.

Risks When Pursuing Loan Modifications

This exit path may get complicated with stalling tactics from borrowers, like filing for bankruptcy or asking for more time to make payments. To mitigate this risk, we work with a licensed debt collector and servicing team. 

Our servicer team understands state foreclosure law and will take action as soon as a borrower starts to stall. Sometimes, this means issuing notice to foreclose. We often find borrowers more willing to keep up with payments or move toward one of the next exits once they see that we aren’t messing around. Our primary objective is always to preserve and grow capital and our next is to help the borrower.

Historic Returns on Re-Performing Notes

These loans can be purchased with discounts anywhere from 50-70%. With a hold time of 1-2 years and sale prices at 90-95% of purchase price, the returns can be pretty high.

Getting steeper discounts often depends on how many Notes are purchased from a seller. We schedule our partnerships all to purchase Notes at the same time, helping us to buy notes in bulk and access these steeper discounts. We don’t pool money to make these purchases. Rather, we simply time all our purchases to be made at the same time.

Exit 2: Short Sale Exit – Get In And Out Quick

A short sale is when we, the lender, accept a discounted balance amount and the borrower pays off the balance in full.

A classic example here would be a borrower who owes $200,000 on their home that is only worth $180,000. They haven’t been making payments for several months. A Note investor purchases that Non-Performing Note (with an unpaid balance of $200,000) for $125,000. 

The new Note investor offers to accept a full payoff of $180,000 even though they can legally collect $200,000 so that the borrower can sell the house. We may choose to require monthly payments during the sale process to mitigate risk.

And our return – 44% in just 6 months.

All of a sudden that $20,000 discount looks like a pretty good offer for everyone.

Again with the win-win nature of this exit: 

• The Borrower wins by preserving their credit by not going to a foreclosure and saves them $20,000. 
• We win by saving the time and expense of filing foreclosure and selling a property and still getting a great return on our capital. 
• Our realtor wins by getting to make a profit on the house sale.

Risks When Offering A Short Sale Exit Option

Short sales can also lead to more stalling from the borrower. If the house is going to be sold for the pay-off, we want to perform our own due diligence to know if the sale price is reasonable for market conditions. Luckily, we’ve already done this during our initial due diligence process. We have even already connected with a realtor who will list the house. We can also connect to local investor networks to offer the sale off-market.

Historic Returns on Re-Performing Notes

The returns here are great since the pay-off typically comes quick. As soon as we learn that a borrower can’t make payments, we help them think of other ways to pay off the balance, offering a reduced balance for a quick pay-off.

Our example above shows a total return of 44%, which would yield our capital partner a 22% return on their investment. Historically, this can range anywhere from 15-25% typically.

Exit 3: Deed-in-Lieu – The Easy Property Acquisition

The next two exit strategies involve us taking back the property. A Deed-in-Lieu of foreclosure happens when the borrower agrees to sign the deed over to us instead of going through the foreclosure process. 

Often, these borrowers just want to end their loan and don’t want to keep the house. We take the house as payment in full and the loan disappears.

In some states, we can require a home inspection before accepting the Deed. This allows us to get an even better estimate of the property value. It also incentivizes the borrower to keep the property in good condition. 

Often termed “cash for keys” this exit prevents the foreclosure process from happening. We save time and money by not foreclosing and the borrower keeps a foreclosure off their credit report.

Here is how the win-win works out for this one:

• Borrower wins by keeping a foreclosure off their credit report and getting out of their loan.
• We win by preventing the time and expense of foreclosure.
• Someone else wins by getting a discounted property when we sell (typically another investor).

Risks When Accepting a Deed-in-Lieu of Foreclosure

Anytime we are moving toward possession of property, there is a risk that we will need to hold that property. We mitigate that risk by getting comparable sale prices from a local realtor before even buying the note. 

We can also select to sell the house and create the owner financed note for the new buyer. Basically, we start down the list of new exit strategies that open up once we have possession of the property.

Historic Returns For Deed-In-Lieu Scenarios

Returns for a Note investment that gets a deed in lieu of foreclosure are slightly higher than the foreclosure return scenario, or 10-20%. We can save money by not paying for a foreclosure and with a shorter hold time. We can also reduce the sale of the house to get our capital back sooner.

Exit 4: Foreclosure – Baseline Returns for Note Investing 

When performing due diligence, we always underwrite deals as if they were going to end in foreclosure. This is typically the most costly exit scenario.

A foreclosure is the legal process of taking back possession of the house, our collateral. This impacts the borrower’s credit (a foreclosure is reported to the credit bureaus) and costs us money. 

This process can take anywhere from 6 months to 2 years depending on the state laws. This timeline can be shortened if lawyers stay on top of filings and action steps. 

At a foreclosure sale, we can set the minimum bid price. Often, we discount the house to ensure that it sells quickly. We want to get that capital back and into new Notes. 

Wondering if there is a win-win scenario here? Let’s take a look:

• We win because we have collateral on our investment that we can take legal action to obtain.
• The borrower wins here by moving on. This may be a stretch, but we see this as helping borrowers to take action and move forward with the lesson of what they can and can’t afford. We hope that our borrowers have learned about why we ended in foreclosure. We have also given them opportunities to preserve credit or keep their home already. Or perhaps we just always look on the bright side.
• An Investor wins by getting a discounted property for rehabbing or holding as a rental.

Risks When Foreclosing

The biggest risk when pursuing a foreclosure is the amount of time it will take to get possession of the house or sell the house. We mitigate this risk by only purchasing notes in non-judicial states. These are states where foreclosure timelines are much shorter. This is mostly because non-judicial states don’t necessarily go to court for foreclosures. 

Risk is also mitigated since we underwrite our deals to a foreclosure scenario. That means we have reserve capital to cover the costs of foreclosure, and we’ve accounted for the time it takes when calculating our offer price.

Historic Returns of Foreclosure Exit in Note Investing

Returns for foreclosure depend upon the time it takes to process the foreclosure and the time it takes to sell the asset. We can minimize both of these in different ways. 

Since we underwrite deals to the foreclosure scenario, we don’t make offers that will yield us returns lower than 10% even if we had to move toward foreclosure. 

How Often Do We Use Each Note Exit Strategy?

Historically, we’ve seen that about a third of Non-Performing Notes purchased end with a loan modification and sale as a Performing Note. We find that another third end in either short sale or Deed-in-lieu. The final third end in foreclosure.

With those numbers in mind, it often makes sense to enter into a Note Partnership with purchasing multiple notes, or a portfolio. This increases the chances of getting some of those higher returns. 

Bottom Line

We always underwrite to our most conservative exit strategy possibility. In this case, that is ending up with the physical property through foreclosure.

Many real estate investors salivate over purchasing foreclosures for their under-market prices and potential for renovations. We prefer to sell these and recapitalize our funds back into Notes. Luckily, we know many investors who will happily buy the properties we want are looking to sell.

Join Us In A Note Partnership

Do these exit strategies sound like good plans to you? Sign up to be a part of our Flow State Investor Circle and learn what a Note Partnership with Flow State Investing looks like. We’ll go over your investing goals and see if Notes may be a good fit for you. We hope to chat with you soon!