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Real Estate Note Investing: How to Calculate your Yield when Buying Notes

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Real Estate Note Investing: How to Calculate your Yield when Buying Notes

When investing in notes, you need to consider many factors - conduct due diligence, evaluate the return on investment, consider how notes will be serviced, and what you will do if the notes become delinquent. Only by making informed decisions will you be able to earn money on investments in notes.

This article proposes first to study the issue of Return on Investment (Note Yield) when deciding to buy notes. It makes no sense to incur the costs of hiring an REO agent for real estate valuation or an attorney to check the documentation if buying this note does not bring you the desired profitability.

Methods to Calculate Your Note Return

To evaluate an investment in notes, use the same methods for evaluating any other investment. Namely - ROI (Return on Investment), IRR (Internal Rate of Return), NPV (Net Present Value). Each of the techniques has its pros and cons.

ROI (Return on Investment) is a metric used to calculate an investor's benefits concerning his investment costs. We recommend using this metric to evaluate the results of your transaction, i.e., when you closed the sale of the note. And it is considered as - the money received minus expenses (servicing, due diligence, liquidation) divided by the purchase price of the note. 

NPV (Net Present Value) determines the purchase price of the note based on all future payments on a note given at the time of purchase using the discount rate. We do not use this method to evaluate investments because the discount rate is unique for each of the note buyers.

IRR (Internal Rate of Return) considers the rate at which the NPV of investment in a note is zero. This method is most common when evaluating any investment, including investment in notes. And the term Note Yield is most often used interchangeably.

How to Calculate the Note Yield, and What Does It Show?

The easiest way to calculate the Note Yield is to use the built-in function in Excel or Google tables - “RATE”. How to write this formula correctly. 

Note UPB is 61,000 with 130 monthly payments left: 

(Yield Calculation Example)

= RATE (130, -646, 45 000)*12 

So in this example, if you buy a $61,000 note for $45,000, your Note Yield will be 13%.

Congratulations! You can now make a qualitative assessment of your investment decisions in just a couple of clicks.

However, please notice that this calculation does not consider your servicing costs of this note investment. We will talk about this in our next article.

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