Partial Note Purchase: A Detailed Guide for Investors

Note investing is a popular strategy for real estate investors looking for passive income opportunities. While many investors are familiar with options like performing and nonperforming mortgage notes, there is another avenue worth exploring: the partial note purchase. In this comprehensive guide, we will delve into the world of partial note purchases, providing investors with the knowledge they need to make informed decisions and maximize their investment returns.

Key takeaways:

A Partial Note Purchase is a financial agreement where an investor buys a portion of a promissory note or mortgage note from the current note holder. This means the investor will receive a portion of the payments on the note, sharing the cash flow with the original note holder.

Understanding Partial Note Purchases

A partial note purchase involves buying a portion of an existing cash flow instrument, such as a seller carry-back note or structured settlement, from the note seller or holder. This strategy is often intertwined with seller financing, where the seller carries a note on a property to facilitate a sale. Instead of purchasing the entire note, investors acquire the rights to collect a specific number of future payments in exchange for a lump sum of cash. This alternative approach allows note sellers involved in seller financing to access immediate capital without resorting to full purchase buy-outs on the secondary mortgage market, which often entail steeper discounts.

Benefits of Partial Note Purchases

Investors opt for partial note purchases for several reasons. Firstly, sellers may choose this route to secure upfront capital instead of waiting for monthly payments. This is particularly advantageous for sellers with stable performing notes who prefer a lump sum payment. Additionally, partial note purchases offer a way to mitigate risk. By selling only a portion of the note, sellers retain some ownership and remain invested in the performance of the remaining payments. This shared risk factor benefits both the seller and the buyer involved in the transaction.

Moreover, partial note purchases provide an attractive opportunity for investors with limited funds to enter the note investing market and still enjoy a decent return. Investors with smaller amounts of capital can invest in partial notes, which typically represent 60-80% of the overall value of the collateralized asset.

Structuring a Partial Note Purchase

When structuring a partial note purchase, it is crucial to consider factors such as the terms of the original loan or note, the borrower's creditworthiness, and the desired investment return. Several approaches can be employed, each with its own characteristics and potential benefits.

1. Straight Partial

In a straight partial, the investor purchases a fixed percentage of the remaining payments on the note, including both principal and interest. The investor receives their portion of the payments as they are made by the borrower. This straightforward approach is the simplest form of a partial note purchase.

2. Balloon Split Partial

A balloon split partial involves purchasing a percentage of the remaining payments on the note, along with a stake in a balloon payment due at a future date. For example, if the original note includes a $50,000 balloon payment due in five years, the investor may purchase 50% of the remaining payments and 50% of the balloon payment. While this type of partial note offers a higher return on investment, it also carries more risk.

3. Split Payment Partial

In a split payment partial, the investor purchases a percentage of each payment made by the borrower. For instance, if the original note requires monthly payments of $1,000, the investor may acquire 50% of each payment, or $500 per month. This strategy provides a steady stream of income for the investor.

4. Reverse Partial

A reverse partial involves purchasing the final payments on the note first and then working backward to acquire earlier payments. For example, if the original note comprises 60 monthly payments of $1,000, the investor may purchase the final 20 payments at a discounted rate and then acquire the remaining 40 payments at a later date. This type of partial note can offer a higher return on investment but also carries more risk.

5. 50/50 Partial

In a 50/50 partial, both the investor and the original lender split each payment made by the borrower. For instance, if the borrower makes a $1,000 payment, the investor receives $500, and the original lender receives $500. This type of partial note provides a balanced risk and return for both parties involved.

6. 10 for 12 Partial

The 10 for 12 partial involves purchasing 10 of the next 12 payments on the note at a discounted rate. For example, if the borrower is scheduled to make 12 monthly payments of $1,000, the investor may purchase the next 10 payments for a discounted rate, receiving $10,000 immediately, and then receive the remaining two payments at face value. This type of partial note offers a quick return on investment but also carries more risk.

Documentation for Partial Note Purchases

When buying or selling a partial note, proper documentation is essential to transfer ownership of the note portion. Key documents typically include a purchase agreement, promissory note, and mortgage or deed of trust. To protect the rights of all parties involved, it is crucial to have competent legal counsel review the partial purchase agreement and ensure its compliance with applicable laws and regulations.

Potential Risks and Mitigation Strategies

As with any investment, partial note purchases carry inherent risks. One significant concern is the possibility of default by the borrower. In such cases, the partial note buyer may experience a reduction in expected returns or even lose their investment. However, there are strategies to mitigate these risks and protect the investor's interests.

Buying the Note Partial Back at Schedule B

One option that may be offered by the seller is to buy the partial note back at Schedule B, which refers to the original price paid by the note buyer for their percentage of the note. This option ensures that the buyer recovers their initial investment, minus any payments made before the default. While this may not provide the expected returns, it can help minimize losses.

Replacing the Note with Another Partial of Equal Return

Another option the seller may offer is to replace the defaulted partial note with another partial that offers an equal return. This involves finding another note partial that meets the buyer's investment criteria and provides a similar return on investment. This approach allows the buyer to maintain their investment portfolio and expected returns.

It is important to note that the options offered by the seller may vary, and the specific terms will depend on the defaulted partial note. As with any investment, default risk exists, but having these options available can help mitigate potential losses.

Legal Considerations and Selling Securities

When engaging in partial note purchases, it is crucial to consult with an attorney to navigate the legal complexities involved. Depending on the level of involvement in the investment, selling a partial note may be considered selling a security. Factors such as the passive or active nature of the investment and the number of similar investments can determine the legal classification. Engaging legal counsel in these transactions ensures compliance with relevant regulations and helps protect the interests of all parties involved.

Conclusion

Partial note purchases offer a unique and potentially lucrative investment opportunity for real estate investors. By understanding the various strategies for structuring partial note purchases and the associated risks and benefits, investors can make informed decisions and diversify their portfolios. One related strategy to consider is the option to sell mortgage note holdings for immediate liquidity or to free up capital for other investments. Remember to seek legal counsel to ensure compliance with regulations and protect your interests, especially if you decide to sell a mortgage note. With careful planning and diligent research, partial note purchases, as well as the option to sell mortgage notes, can provide a path to passive income and long-term financial success.