REIA 320 Fred Moskowitz: Diversification by generating cash flows from Mortgage Note Investing

This is the Real Estate Investing Abundance Podcast. I'm your host, Dr. Allen. I just want to take a moment to introduce you to our company, Steedtucker Capital. Steedtucker Capital is a real estate investment firm. If you'd like to learn more about real estate investing, head over to our website, steedtucker.com. And while you're there, take a moment to get your one-page guide to the 10 steps to passive real estate investing. Downloading this PDF will also enroll you in our Enlightened Investor Circle, and by enrolling in the Enlightened Investor Circle, you'll be the first to know about any new investment opportunities that we are getting involved with. Look forward to hearing from you. Enjoy today's show. Hello, Enlightened Investors. Welcome back to the show. I'm delighted to be back with you again today, and we're going to take a look at how we can seriously diversify our portfolios by generating cash flow from mortgage note investing. And with us today, we have an expert in the field, Fred Moskowitz. Is an educator and bestselling author who has trained countless investors from all walks of life on how to create passive income streams. As a fund manager, Fred manages a mortgage note investment fund and is considered an industry veteran within the note investing arena. Fred teaches the concept that individuals, investors are able to step into the shoes of the lender through note investing and effectively become the bankers. Fred, take us into the show and share a memorable experience that helped you to be who you are today.

Thank you, Allen. It's great to be here. Appreciate the opportunity. And, uh, absolutely, I can share an experience that, that I've been through. Uh, I'll tell you a little bit about, about myself. I came from having a very long, successful career working as a computer engineer. I spent a lot of time working in the technology industry and working at all these different technology and startup companies. And what happened was, after watching my entire industry get turned upside down from the bursting of the dot-com bubble, which was then followed by the September 11th terrorist attacks, and out of all of that, all of that turmoil, I realized that I was far too dependent on the income from my job. The only income I had was my paycheck from my work, and I loved the work I was doing, but my job had all these circumstances completely out of my control. And I'll tell you what I learned was that no matter how talented of an engineer I was or how valuable of an employee I was, if things were not going well at the company, I could quickly lose my job through no fault of my own. And so that led me to start getting interested in investing in assets, buying and building assets that would generate income for me. And that's really what got me started in this world of alternative investments.

Well, that is so true. If we have only one stream of income, whether it's a W-2 job or whether it— we're entrepreneurs and we rely upon one stream of income, we're leaving ourselves in a very vulnerable position because there are outside forces that none of us have any control over. So diversification, multiple streams of income, as you've learned, is a wise thing to have. So Fred, take us into note investing and tell us what is note investing?

Note investing is the idea of buying and owning a note. A note is— comes from the term a promissory note, a promise to pay, and that's a debt instrument. And so those, those can be bought and sold. But what's interesting with mortgage notes is that it's a debt instrument that also has collateral backing it. There's security interest in that debt. And so that comes in the form of a mortgage, or if you're living in the western part of the US, it's called a deed of trust. And those are the the financial instruments that encumber the property and secure the debt. And so that gives the lender a lot of security and protection in their investment. So let's talk about note investing though. What is it? A lot of people know about investing in real estate and participate in that, whether it's single-family houses or commercial property or apartment buildings, multifamily. But note investing is when we talk about investing in the paper, the notes and the mortgages that are associated with those properties. And I find that this is a really interesting part of the real estate business. And a lot of real estate investors, they don't pay much attention to it. For most people, when they think of a note and a mortgage, they think of being the borrower and not as being the lender. When you get involved with note investing, it allows you to step across the aisle and become the bank. And now you transition from being the one making the monthly payments to becoming the one receiving the monthly payments. And so what that does is it's just a great way to increase the predictability of your cash flow.

Yeah, fascinating way to diversify. So the big question is, how does somebody get started in note investing? I mean, first of all, where do you find them? That's going to be a big deal. And then the second thing is, how do you know you are getting a note of value?

Yeah, no, those are, those are great questions. Very important. Very important. So let's start with this. How does, how does someone get started with note investing? There's 2 ways to get involved. The first way is to be active as an investor in this space. And so you go out to the marketplace, you find notes to buy, you evaluate them and build a portfolio, buy them, start building a portfolio that you manage on an ongoing basis. And so that's the active form of note investing. And another way is by getting investing in a note fund and getting involved with a note fund. And what is a note fund? A note fund is typically structured just like a real estate syndication where the fund managers and the fund operators, they will raise capital from investors who are passive investors, and then they will go out, find notes to buy, perform the due diligence, acquire the notes, and manage the portfolio. And so it's really 2 approaches.

So that's, that's, so that's really similar to a limited partnership.

Yes.

In a syndication.

Absolutely, absolutely. And they're both great ways. And really, it comes down to how much time do you have? And how much time do you want to dedicate to note investing? It is, it's a business, it's, it's a business. So if you have the time and you want to learn, great, you can do really well, start building, building a portfolio and acquiring notes. However, for someone that might already be a business owner, or they're busy professional, and they don't have a lot time, then maybe being a passive investor and investing in a note fund could be a better option. But it's a very personal decision. There's no right or wrong answer, and it's something that each investor should consider.

Well, but I mean, I would think that if you're new to the business, that you could learn a lot by investing in the note fund as a limited partner, essentially.

Absolutely. And absolutely.

And learn the business that way rather than starting out trying to be an active investor. That's just my guess. So there's 2 ways to do that. Let's get into a little bit more detail here about the note fund. A lot of syndicators are going to require that the investors be accredited investors. Do note funds generally have that same requirement?

Some do and some do not. There are, there's different types of funds, different structures. And so it's a matter of understanding if you're an accredited investor or not, and then finding the right fit. But, uh, there's definitely both types out there for sure. And so there's a place for, for everyone because, uh, let's face it, some, some people may not be an accredited investor. However, they're on the path to become one. And I, I— right on the way there. And that's great because you're building your experience, you're building your expertise and advancing your, your financial future. And, and so it's on the, on the path to that. But So to answer your question, either, either way, there's different funds out there that can accommodate that. And it's just a matter of finding, finding the right one.

What is, is there generally a minimum on how much one can invest in a fund?

Generally, yeah, there, there will be minimums. I've seen minimums on the low side of $25,000, $50,000, and on the higher side, $75,000, $100,000 and up. And so funds are all set up with different parameters and different structures. And so it's something you can find some— find the fund that's the right fit. But it's, it's all across the board. And it's— there's nothing set in stone. But it just needs to be defined upfront when the fund is being created.

Enlightened Investors, if you haven't done so already, Be sure and click that like button and also click that share so others can take advantage of the content. And finally, be sure to subscribe so you don't miss a single one of our upcoming episodes. In most syndications, there's, there is really no liquidity. You're going to be in a syndication from generally a minimum of 3 years to 5 to even 10 years, depending upon the particular property involved in that. In note fund investing, what is the liquidity like?

It's very similar. There will be, um, 3, 3 years, 5 years is very common. And, uh, I've seen others with shorter time frames as well. And, um, usually there's, there's different trade-offs that come into play. Usually your rate of return is higher when you're at— when you as an investor are willing to commit to a longer time period.

And so what, speaking of rate of return, what is a typical rate of return from a note fund?

From a note fund, it comes down to risk tolerance. And I'll give you some ranges that are from funds that I've seen. I've looked at many. So for something that is lower risk, safer, typically is going to be somewhere in the area of 6%. rate of return that's paid out. And if you're willing to take on higher risk, then you can get— start climbing up from there— 8, 9, 10, 12, 12% even, and higher. Uh, some funds focus only on residential properties, and other funds focus on things like hard money loans to investors doing buy and flip properties, buy and renovate deals, those generate much higher rates of return. There's more risk there. Those are shorter-term loans too. Those are typically— they're originating 12 to 18-month duration of loans. And so there's all these variations, and it really just comes down to considering all the options and seeing what you're comfortable with. With most investments, what I've seen is that investors just starting out for the first time, going to go with something lower risk. And then as their experience starts to build and, uh, have more expertise, then you can start looking at being comfortable with some higher risk and, uh, pursuing that as well. It's an evolution, but I feel that that pattern applies to most types of investing in general.

Well, when you are looking at a note fund, are you investing in a fund broadly, or are you investing in specific properties, or are— do funds vary in terms of that criteria?

Yeah, that, that's a great question. That's actually one of the main distinctions between investing in a fund or investing in individual notes, right? If you're investing in individual notes, typically you as the investor own the entire note, and that's it. Now, with a fund, your investment does not get tied to a specific note. It's going to be tied to a percentage of ownership across all the notes in the fund, which is nice because now there's a huge diversification. If you're investing in a large fund, your investment could get spread out over hundreds of notes or maybe even thousands of notes. And so that's some serious diversification there. So it gives you both options.

So you had mentioned that fix and flippers is one of the more risky ones, whereas an A-class multifamily property is probably one of the lower risks and lower payouts on those. So you're talking about diversifying across a wide range of opportunities. So are the fund managers setting these up by— do they just put in a, I guess, a tossed salad of There's fixers and flippers and there's A-class properties all tossed together in one salad and you purchase that, or are they discriminating by risk level in terms of your opportunity to purchase into the fund?

It could be either way. It could be either way. There, there could be funds that focus only on one very specific type of asset, and then there are others that in order to pursue additional diversification, then they'll, they will break it up, maybe have a percentage of holdings in this type of notes and another percentage in that type of notes. And so it can be either way. You— we definitely see that a lot with, with larger funds where they're, they're diversifying into different, different areas like that.

How can investors use their retirement accounts to invest in notes?

Yeah, this is a great question, and here's why. It's because of the tax treatment of note investing. Note investing is an activity that generates a lot of tax liability. All you have is interest income and capital gains. There's no deductions, there's no depreciation like there is with, with real estate. And so there's a pretty hefty tax treatment. And so when you invest out of a retirement account, where you're subject to preferential tax treatment, whether it's a 401 or traditional IRA or Roth IRA, which is, I feel, very powerful. You can do the note investing and have that growth and be subject to preferential tax treatment. And so your return over the long term is significantly accelerated. And so it's a great strategy. I always, when I speak with investors and I talk about this in my book, Look, it's so important. I always ask investors, if you're doing note investing, have you looked at or considered doing something, some deals, some activity using your retirement account? And a lot of people just didn't even know that it's possible that, that you could do that, that that's an option. But absolutely it is. It's very common to own. If you speak with IRA custodians, self-directed IRA custodians, most of them will tell you that in their accounts, their clients The number one asset that they have are notes in their account holders' accounts. And that's why it's, it's because of that. And so it's something I always like to teach about and talk, talk about when I have conversations with investors is see if this is something that you can incorporate to what you're doing. Because when you have that preferential tax treatment combined with a long-term time horizon, it's very powerful.

Yeah, there's a lot of people that don't know about that because your retirement fund managers don't want you to know about alternative investments.

Yeah, this, this absolutely, Alan. This is an area where it's on us as investors to pursue our own education, our own learning, for sure. And it's all there. It's right there in the tax code. It's not like this is some kind of a new strategy. This has been around since, uh, retirement accounts were first, first put together. But, uh, it's, it's something that each of us has to learn about and pursue that education.

And there, and there are rules and regulations, but they're spelled out quite clear and plain in the, in the tax code. But, uh, you do, if you're using a retirement account, you do have to have a self-directed account to do these things. And your self-directed account manager should know whether you're getting into a problem or not.

Absolutely. They will watch over, and part of their responsibility is they don't want their clients, their account holders, to get into trouble, to go ahead and do a prohibited transaction. So they're going to take steps to make sure you don't do a prohibited transaction and jeopardize your account. And they often have education and training to help, help their clients really get up to speed and learn about this space.

You were talking about the reason to use retirement accounts with note investing is because of the tax liability and note investing, which there, there really is no protection. So without going too deeply into the weeds here, how does— what is it, the UBIT tax, right, that comes with the, uh, the retirement funds. How does that work with a note as opposed to a real estate investment?

With a note, it doesn't apply, and here's why. Typically, you're going to see those taxes like UBIT come into play when leverage is used on an investment. But since notes are purchased with all cash and note funds operate from that same perspective, then it, it's not a problem at all. And so It's, it's not, it doesn't apply.

Okay. Well, that would make sense then to utilize those retirement accounts since they do have tax shelters built into them. Well, Fred, tell us about your company. You, you are a fund manager and own your own company. So tell us about that and how our viewers and listeners can get in touch with you to invest with your fund.

I'll tell you, my company is really focused on, on education and teaching investors about cash flow. And I've done a lot of that with my book, which provides a really great general overview for investors. That education is always the place to start, no matter, matter what you're, you're doing, especially with investing. I always stress that, um, that point. Start with education, get some good books to read. Listen to podcasts, learn, pursue your education, and that's, that's the best place to start. And so in my business, we always emphasize the importance of, of education and, and building relationships. You know, in this industry, in, in node investing, one of the most important skills that we work on to develop is the skill of building relationships. Because all the opportunities to buy notes and transactions and everything, it comes down to personal relationships. And so those that are good at that skill, they tend to do really well in the business. And so that's, that's something I always stress. And I feel it's, it's a cornerstone of what we do, whether we're doing business with others in the industry or talking to investors. I feel it's, it's very important.

And viewers and listeners, you can get hold of a special report from Fred by going to giftfromfred.com. And Fred, while we're on this, what's the title of your book?

The title of my book, it's called The Little Green Book of Node Investing, and you can find it on Amazon. And it provides a great high-level overview of node investing, how to get started, how the industry works, how to analyze and find notes to buy, and how to analyze note funds as well. And we have a couple of chapters dedicated to what we were speaking about earlier, using— how to use retirement account funds together with note investing. And so that book is available on Amazon. You can go, go on and search for either the title by name, The Little Green Book of Note Investing, Or search under my name and it'll come right up.

Fred, one last question. What is the best investment that anyone can make?

The best investment that anyone can make is this. I'm going to refer back to one of my mentors, one of my heroes. I'm from Philadelphia. And so I like to look back to the past, to one of the founders of our country, Benjamin Franklin. And he left us with this wonderful quote, and that is that an investment in knowledge always pays the highest dividends. And so with that, always, always be investing in yourself on an ongoing basis. Learn, listen to great podcasts like this one, read books, attend workshops and seminars, learn your skills, learn new skills. That's something that's going to serve you well no matter what you do, but especially in the investment And I always encourage everyone, be a lifelong learner and always seek opportunities to expand your skills and your knowledge.

Wonderful advice, Fred. Thank you so much for being with us. It's been a pleasure having you today.

Thank you, Alan. It was great to be here. Thank you.

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