Smart note investing means that you give yourself the capacity to assess all aspects of a potential deal to see what could go well and what could go wrong. In this industry, you have to be well-informed about the decisions you make because one wrong move could spell disaster. Fred Moskowitz is an experienced note investor who also trains others to create passive income streams of their own. Dan Deppen talks to Fred about the many things you need to consider when entering into a note investment deal. Let Fred and Dan teach you the smart way to go about your investments today!
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Investing In Note Funds Smartly With Fred Moskowitz
I’m joined by Fred Moskowitz. He is a note investor, entrepreneur and public speaker. He’s trained a number of investors from all different walks of life on helping them to create passive income streams on their own. He’s also a fund manager. He manages a mortgage note investment fund and is an authority and an industry veteran within the note business. He’s an advocate for spreading awareness about self-directed IRA investing and enjoys teaching investors how to accelerate their financial growth using their self-directed accounts, such as their self-directed IRAs and even self-directed health savings accounts and other vehicles. Fred, how are you doing?
I’m doing fantastic. Thank you, Dan, for hosting me on your show. It’s a pleasure.
Thanks for coming on. We met a couple of years ago at Note Expo. It’s good to chat again and have you on. Maybe we can start by telling us a little bit about some of your background in notes and how you got started.
I got started in note investing many years ago. The way I learned about it was, at that time, I was actively involved in real estate investing. I happened to be attending a real estate seminar that was about negotiating and it was being presented by Jimmy Napier. You’re probably familiar with him. He is someone that I consider the grandfather of note investing. He started with this probably in the ‘70s. He wrote an excellent book called Invest in Debt. In any event, he was teaching a class on negotiation for real estate investors. I was in the audience and it often happens when you attend these types of training and seminars, sometimes the most valuable golden nuggets come from when the instructor gets off topic and goes on the side discussions.
He started talking a little bit about note investing and I will never forget this. He said that real estate, in general, is a great avenue to build capital when you’re first starting out, but if you are able to take that capital that you’ve built in real estate and then redeploy that by investing into debt instruments, you can skyrocket your rate of return. That little statement stuck in my mind. At the end of that seminar, I went and bought his book, Invest in Debt, and took it home with me. I said, “I need to look into this.” That started my whole journey in this business. It’s been a fantastic experience learning along the way. I’ve found that there’s a very tight-knit community of note investors throughout the country. Over the years, everyone gets to know each other and do business with each other on an ongoing basis.
It’s a very small industry. I’m jealous that you were able to find it years ago. I wish I had found it that long ago. It sounds like you’ve probably got more of the benefit of the flood of notes that hit the market after the financial crisis.
That was the environment in which I started around that time. I’ve watched things evolve and change over the past years drastically. It’s good for note investors to be able to be nimble and flexible and adapt to changing market conditions. If you’re able to weather that, that’s what gives you longevity in this business. As you know, we see a lot of people get involved in note investing and then they hit some difficulties and challenges and then totally exit the space.
I’ve seen that a lot in my few years in the business. Sometimes people come and go fairly quickly, but then there are other ones that hang around for years. What’s been your primary focus lately that we’re in this different environment that’s maybe a little tighter?
My primary focus has been a change of direction and I’m certainly looking for a note acquisitions at a higher level doing larger transactions. I’m also adding an educational component. I’ve had many people approaching me asking to learn from me, asking to work with me. I’ve been doing quite a bit of speaking and teaching and education as well. I’ve found that very rewarding. What I find is of the people that I encounter, we end up doing business together in some format at a future date. It helps with building relationships with people and establishing that community.
People are always looking for more information on how to invest in notes because it’s a small community. It’s nichey and a little opaque, but a very cool and very profitable industry once you get in there and can figure out what you’re doing.
One thing that happened is over the years, I never took on partners. I had over and over again, people approaching me asking if they could work with me or partner with me in some way. That was what inspired me to eventually launch a fund so that I could work with investors and have a partnership and doing it in the right way that is legal and within all the guidelines of the SEC. That’s been an exciting journey for me. I thoroughly enjoyed it. I find it very rewarding. Those are some of the changes in the years that I’ve been through.
Is that a fund for accredited investors? I know that there are a million of the crowdfunding options now and different ways you can set those up.
Crowdfunding has been a very popular form of offerings with a lot of media coverage about it when it first came out. We did look into that, but it wasn’t a good fit for the business. We opted more with the traditional 506 offerings and continue that way. What I find with crowdfunding, which is the Regulation A offerings, you have to have a very large capital raise in order for it to make sense because of the high overhead and high costs involved. There’s a lot of compliance and overhead and you have to use one of the approved crowdfunding portals to manage your investments. There’s a significant expense and the numbers have to be very large, in the tens of millions in the offering of that size for the numbers to make sense to do it.
I had looked at some of that briefly and I think the attorney fees upfront were significantly higher. Some of those options require audited financials, which is not a big deal but it’s expensive to get that done. You need to have a much larger fund to get everything to work the way you want. It’s nice when you have it open to accredited investors too because it’s easier to talk about. You don’t have to worry about inadvertently saying the wrong thing at the wrong time or it might be perceived as soliciting investors when you are not supposed to or something like that. What’s your primary focus on the fund? Is it more on the performing side or the non-performing side?
Note investors have to be nimble and flexible in ever-changing market conditions. Click To TweetIt’s both, but we focus a lot on performing notes all across the country. That’s been a big focus of mine even prior to the fund. I’ve found a lot of good opportunities to purchase notes that are in the performing space. One thing I like and what I find very powerful is doing those types of transactions out of self-directed retirement accounts because it allows you to have a very powerful combination of note investing, owning the note and handling it. Since it’s a performing note, it doesn’t involve too much ongoing work or ongoing maintenance. You have a hands-off transaction, which is ideal for staying in compliance with the self-directed IRA restrictions that don’t allow you to do any physical work on the asset.
You have a service or team taking care of the note for you, managing that and the payments from the note go right back into your IRA directly so you’re not handling any of the funds. The matter of note investing, it generates a lot of tax liability for the investor. When you can combine that with the tax preferential treatment in an IRA or even better if it’s a Roth IRA, it becomes very powerful because all of that income can go back into your IRA. There are no tax liabilities incurred, which is fantastic. I am a huge advocate for people. What happens a lot at least when I’m talking to people and investors, whether they’re looking at investing in a note fund or individually into notes, I always ask them, “Are you doing this out of your self-directed IRA?” Sometimes people will look at me and say, “I don’t know what you’re talking about. What’s a self-directed IRA?”
People not involved in real estate have never heard of those.
When that happens, we have to stop the discussion and have a different conversation right there, “I’m going to give you a little overview about self-directed IRAs and why you need to consider this in your overall investment activities. Let’s see how you can work it into what you do.” Educate them about that because you can invest in notes, whether it’s individual notes or in a fund, but you’re going to be subject to taxes on all of that income, the cashflow coming from that. If you can do it out of your self-directed IRA, that makes it so much better. I find myself doing a good amount of education on self-directed IRAs, how to set them up, how to leverage them, how to move prior 401(k) accounts from the previous employer that you were at, and be able to utilize that for note investing and other alternative investments. A lot of people don’t know the possibilities of that.
It’s great to teach people about that. In the last couple of years, one thing that has come to the forefront is health savings accounts. The fact that you can use health savings accounts, there’s are a tax deduction when you put the money in. There’s no tax on the growth at all. When you withdraw the money, provided that it’s for reimbursement of health expenses, there are no taxes due. That is a triple tax benefit that you get. It’s almost like the benefits of a traditional IRA because you don’t pay tax on your contribution and the Roth IRA because you don’t pay taxes on the growth of the account. You’ll get a triple tax benefit off of this one vehicle. The best part of it is you can self-direct your HSA just like you self-direct your IRA. Any of the custodians will be able to handle that for you. The self-directed custodians all offer HSAs and it can be very powerful because when you start your growth in that account over the long haul, you can have a significant snowball effect because nothing is subject to taxes in there.
That’s nice to get savings from the taxes on both ends as opposed to one or the other. Where do you stand on checkbooks in self-directed IRAs? That’s one thing that comes up sometimes that’s controversial. I’ve never used one myself, but I get people to ask me about them a lot.
They exist, but I don’t like them personally. The reason why I don’t like them is I don’t ever want to have to go through the ordeal of defending my account or having it gets scrutinized. I think having a checkbook IRA opens yourself up to a lot of scrutiny from the IRS and I don’t want to deal with that.
I’ve been on the same page. I’ve got a regular self-directed IRA at Quest. I’ve never been the master of self-directed IRAs. I know enough about them to probably be dangerous. I am having them be on the screen for everything. If I go inadvertently to try to do something you’re not supposed to, I’ve got them in the way to stop me. Usually, I can get stuff funded within a couple of days. I’ve never been in that bigger hurry. People like it because they can write a check and fund immediately. For me, that’s never been an issue. It’s usually a few days of processing time and I can set things up, so that works. It’s not a big deal.
I totally agree with you on that. I’ve never had a problem where I needed so much speed that required writing a check outright. If you have a good relationship with custodians, if you need to get a deal done quickly, you make a couple of phone calls and ask and explain the situation and they will be able to process it for you quickly if you need it. I’ve had a problem with it and I agree. They’re providing a function of keeping your account in compliance with all the rules and I liked that. I think that’s a significant benefit. I don’t use the checkbook arrangement at all, but I know a lot of people that do and they’re okay with it. It works for them. It’s something you have to assess how much a raise you want to take or how much you want to expose yourself? In reality, it’s just your tax return and the IRS. You can be aggressive with how much deductions you want to take, but you have to be ready to defend yourself in an audit if you needed to. How much are you willing to press that? How aggressive do you want to be and how aggressive is your CPA with doing that? Ultimately, they’re the ones you’re going to look to represent you in an audit.
I like having my IRA out of sight and mind. I’ve got my old IRA that has mutual funds and things in it and then my self-directed one, I have some performing notes that sit there. That way, I can put all my brainpower towards my normal business and other things in life. I’ve always had the feeling with checkbooks. They’re probably fine if you know what you’re doing with them, but I’ve never wanted to devote the time to get to that comfort level. I let my custodian handle that for me. That’s their job.
Even if you are doing everything fine, you’re exposing yourself to additional scrutiny that you might still have to defend in an audit. Your IRA getting looked at and even if you are doing everything fine, you’re looking at a significant drain on your time and expenses that you will have to pay for representation. Even if you’ve done nothing wrong in the end, you could be found that everything’s good, nothing wrong, but you spent all this time and energy and expense in defending yourself in an audit. I prefer not to expose myself to that.
Going back to the note funds a little bit, the note funds are fairly popular and I get asked about them a lot. What kind of things should investors be looking for if they’re going to evaluate some of the various note funds that are out there?
There are a couple of things that are important. What comes to mind is the track record of the fund operators and the principals and the fund, which is one of the most important aspects. I think that investors don’t spend enough time looking into that because it doesn’t matter what kind of fund it is and what assets are being looked at. You have to trust the principles of the fund, the fund manager and the team. You want to look at their track record and consider that you’re entering into a long-term relationship with them and to determine if you’re going to be happy working with them or not. What is their track record? How long have they’ve been in operation? Have they established themselves in the business that they’re in or the industry that they’re in?
All of these things, you need to do a good amount of due diligence on the individuals themselves, which includes running a background check, a Google search on the people and on the company you’re dealing with. I find it amazing to hear horror stories of people that have gone into a business relationship or an investment where they would have done fifteen minutes of Google searching. They would have found a lot of negative information that would’ve changed their decision prior to getting involved. It’s something that’s so simple. That’s just a scratch on the surface. You should be running background checks on people to see if there are any prior lawsuits, prior issues and all of those things that will come up. That’s important.
Once you do that, then you can look at the funds’ characteristics. What’s their investment thesis and business model? You have to make sure that’s in alignment with your risk tolerance and what your objectives are. Some people have an objective where they want steady in common cashflow and you want to make sure the fund is set up for that. It would not be a good fit if the fund was a fund that doesn’t pay any cashflow. It’s strictly growth where all the payments are going to be on the backend of the fund. You want to look at that timing, make sure that there was a good fit from the investment perspective and what your individual goals and objectives are. For an investor that is investing out of your retirement account, they’re relatively young and they may not be looking for immediate cashflow. They can defer it until the end and that’s fine.
Sometimes you have someone that does need the cashflow to cover their living expenses. They’re looking for that, then a different type of fund would be more appropriate for them. The main point is to look at the fund operator and vet them thoroughly. If you need help with that, engage someone to help you with it who are familiar with this. It’s one of the most important things. There are horror stories that we hear about and a lot of them could have been avoided if the investor did their homework upfront before they got involved.
It’s amazing how many bad actors are running around out there. I know when I started a business, I was probably a little bit naive about that because as we’ve talked about it, it is a small industry for the most part. People tend to know each other. You would think all the bad actors would get scrubbed out fairly quickly, but they do lurk around here and there. They need to check people out before you invest with them.
Always be ready to defend yourself in an audit if needed. Click To TweetThere’s an analogy I heard that the way to approach this is you have to consider that you’re betting on the jockey more than you’re betting on the horse and it’s true. Your evaluation of the principles of the fund and who’s the operator of it is so important even more so than what the asset is or what the business is. Both are important but you need to consider that level of priority. This goes for any type of private investment, whether it’s a real estate syndication, apartment, buildings or commercial syndication. You want to focus a lot on the principles and fund operators of that deal to make sure that you have someone with experience, competency, ethics and a good reputation. That is important and I can’t stress enough.
Especially with the non-performing side of notes day-to-day, it’s a hard business to run and you start getting a lot of them. It’s a lot of work, so you’ve got to make sure you’re going to have somebody in there that does what they say they’re going to do and follows through.
What I find is that when you have a good match and a good fit between an investor and fund principles, that relationship will extend far beyond the life of the fund, far beyond the return on that investment. You will build a long-term relationship where the investment ends, all the capital’s returned, everything is finalized and the investor wants to reinvest their capital again. Where are they going to go? They’re going to go back to the people that they had a good experience and a good relationship with. It’s like any other business relationship. When you do business with others and it goes well, the next time you have a need, you’re going to go back to the people that you have a relationship with. I see it as a long-term relationship.
It seems like the successful fund managers tend to do fund after fund as time goes by. A lot of those are with the same investors where they’re rolling over time as they go. You said that you were focusing a little bit more on the performing side of notes, what are some things that note investors should be looking at when they’re considering buying a performing note and trying to analyze them to figure out if something’s a good deal or not?
There’s a number of considerations. For the investor, they need to establish what kind of return they’re looking for as well as what is their risk tolerance? What level of risk are they comfortable with? Sometimes for a new investor, they don’t know. They’ll start looking at different deals and that’s totally fine because you have to go through an iterative process to arrive at something that is going to work for you. Maybe when you’re starting out, you’ll want to look at safer deals in return for a lower rate of return until you get comfortable. That’s understandable and acceptable. I recommend for newer investors if they’re wanting to buy into a note directly, a great way to do that is to buy a partial.
There are a few reasons why. One thing is that, on a partial, you’re in a sense that you’re partnering up with the seller of the partial who’s owning the backend of that note. For the benefit of everyone, a partial is where a note is taken. Let’s say there’s a twenty-year note. It has twenty years of payments and a partial can be sold where five years are those payments can be sold off, carved off the note and sold off to another investor. The buyer of that partial owns five years of payments and has the right to receive them and then the partial seller still retains the backend of that, the remaining fifteen years of payments. The partial borrower who may be less experienced and not still be learning about the note industry, they’re going to rely on the expertise of the person that sold them that partial and help manage the note, deal with any hiccups that might come up and so on.
The owner of the note has a vested interest in making sure everything goes smoothly for the life of that note. You have that partnership in a sense. It’s a loose partnership for those five years until year five comes. At the end of year five, payments revert back to the note holder. That’s one area I recommend, but other things to consider on a performing note is the condition of the property. It is important to look at that and the borrower and their track record. Look at the payment history. What’s the track record of the borrower and their credit history and character? You look at the collateral, which is the property condition, what does that look like? It’s easy to obtain reports and have someone go out, look at the property and if you need to, take some exterior photos.
There are a lot of online tools like Google and other mapping services that you can do a satellite view and drill into a property. You can look at whether the exteriors maintained and the grass is cut regularly or is a property where the grass is fourteen inches high and there are eight junk cars parked out on the front lawn of the house. We can look at all those things or if the house is located in an extremely rural and isolated area or is it in a suburban subdivision that looks very nice and has a lot of curb appeal. You can look online at them and go on to Realtor.com or any sale sites like Zillow. Look at houses for sale in the vicinity. Sometimes the house where the note was listed for sale recently and you can see interior photos of the house because they stay there.
In Realtor.com, there’s so much information available to us at our fingertips. This is not even getting into any of the information that the seller of the notes has provided to you about looking at the loan documents. All of those are important, but that level of due diligence is key and critical. You want to dig into that information, there’s so much available. You can look at what people have posted online. People have blogs and social media accounts. You can look at all of that and get a sense of what you could be potentially getting yourself into and who are the people you’d be dealing with.
There’s a lot you can look at notes and it’s nice that you can do a big part of it online.
I often will look at that as a first test before I started digging into loan documents and those types of things because the loan documents are pretty standard. We buy a lot of institutional or originated notes. They usually use standard Fannie Mae and Freddie Mac forms. The loan documents are very similar. I would say that’s not a first pass look. I would look at many other parameters first before delving into that level. Once you make the first cut, then you can go down and dig deeper, do a deeper dive when you’re looking at loan documents and legal aspects at that point.
Usually, I’m not digging into that stuff unless I’ve already been on it and it’s been accepted. Prior to that, I’m looking at more of the information that’s readily available. One of the things I’ll do too is when I look at the Google images, sometimes you see those junked cars and other things that caused me to pass. I’ll look at when the Google photo was taken to see if it was the same borrower because sometimes those Google maps photos are a few years old. If I see a lot of junk and it’s the same borrower, then it’s probably still like that. Sometimes I see them with a picture of six or seven years old. It was somebody else in there and I’m like, “Maybe I can proceed with this one and then get eyes on it. Maybe some of that stuff has been cleaned up.”
Trust the principles of the fund, the fund manager, and the team. Click To TweetYou can look at the neighboring houses as well to get a feel for the neighborhood.
Looking down the street is never a bad idea. Sometimes you’ll see ones that are boarded up two houses away, which is not a great sign. Thanks, Fred. I would like to have you on again at some point in the future. How can people get ahold of you if they want to talk to you more?
They can visit my website, which is FredMoskowitz.com. If anyone is interested, sign up for my free newsletter, which is about note investing and other investing topics as well. If they text the word, NOTE, to 55-5888 and follow the prompts, you can sign up for the newsletter and interact with me that way. Anyone interested in connecting with me, I would love to hear from you. I always enjoy connecting with other investors and talking about note investing.
Thanks again, Fred. I’ll see you all next time.
Important Links:
- Fred Moskowitz
- Invest in Debt
- Realtor.com
- Zillow
- http://www.FredMoskowitz.com/
- Text the word NOTE to 555888 to sign up for Fred’s free newsletter on note investing
About Fred Moskowitz
Fred Moskowitz is a note investor, entrepreneur, and public speaker who has trained countless investors from all walks of life on how to create passive income streams of their own. As a fund manager, Fred manages a mortgage note investment fund and is considered an industry veteran within the note investing arena. Fred is an advocate for spreading awareness about self directed investing and enjoys teaching investors how to accelerate their financial growth using self directed investment vehicles such as self-directed IRA’s and self-directed Health Savings Accounts.
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