Welcome to another episode if you’re new to the show, remember to subscribe because I would hate for you to miss a future episode of the content that we cover. We have passed the 300 episode mark over the last five-plus years. Yes, it’s been five years. We are heard around the world in over 150 countries, but mostly in the US Canada, Great Britain, and Australia. That’s the bulk of our market.
So anyway, today I wanted to talk about the predictable income that you can get from promissory note investments. Now, why am I talking about this? Well, recently I’ve been getting a lot of questions, even from seasoned and accredited investors about promissory notes. They have an understanding of what they are and how they work. But some of the questions that I’ve been getting have just led me to say, Hey, I’ve got to record an episode about this, so I’m not going to make it a long episode, but I want to give you some content about promissory notes and what they are and what they’re not.
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And this was our sister company, Norada Capital Management has been offering throughout this year. And I think we’re on our sixth or seventh round of offering note investments. That average out to be about 15% per year, paid monthly with auto-deposit into your bank account. So they’ve actually gone up to higher than that. I can’t remember what the average was, but right now we have offerings that are going at a 16.7% average rate of return per year in terms of interest. And these are on three-year notes and I’m getting people asking me questions that seem to be coming up over and over again. So I thought, Oh, this is a good opportunity to record an episode on it. So let’s just break it down and peel back the layers of the onion here. So what is a promissory note? Well, very simply put, it’s just a written promise to repay a debt.
It’s a contract, it’s a paper instrument, a financial instrument where one party, who’s the issuer also known as the maker of the note. They make a promise in writing to pay a fixed amount of money to the other party, which is the payee at some sort of agreed upon the future date, and with payment terms, that may be simple interest and it could be paid monthly. It could be paid quarterly annually in one lump sum at the maturity of the note, there are many ways to create a promissory note. So there’s no standard one way, but if you’re familiar with mortgages mortgage notes, then you’ll understand that there’s a monthly payment because the lender or the bank that gave you that mortgage, that loan on your property, they’re requiring you to repay that each and every month with a payment. Now, in those cases, it’s principal interest, but it doesn’t have to be, it could be an interest-only note if you remember that from back in 2005, 2006, 2007, there were a lot of interest-only loans, and that’s just one variation.
But the main feature of a promissory note is it’s a written document. It contains a clear and unconditional promise to pay a specific sum to a specific person at a particular period of time or on a particular date. It’s essentially clearly defined. It is typically drawn up and signed by the maker. The person issuing the note. So they’re essentially selling quote-unquote, that note to you, the person who is the payee or the person funding that note. So the names need to be specific. Of course, the amount to be paid should be clearly written out in both figures and in words, and the payment should be made in, of course, the legal currency of the country that the note is issued in.
Now, there are two general types of notes. There are performing and nonperforming notes. Simply put a performing note is a note that is current. It has regular monthly payments coming into the lender from the borrower. And so there are no issues. Those are worth exactly what they say on the note, but then you also have notes that are non-performing and those nonperforming notes are ones that are in default. When you look at real estate and mortgage notes that are in default, this is where you see those situations that become foreclosures. And the speed of the foreclosure is determined by another document that rides on top of the promissory note, which is the security instrument. And it is often called a mortgage, but in some states, it’s referred to as a Deed of Trust or a Trust Deed. So that is how you also slice and dice promissory notes. You’ve got performing a nonperforming and then you have secured and unsecured.
The unsecured means that there’s no asset or collateral that is backing it up. Now I gotta be careful when I say that because of what we’re offering and I’ll give you an actual example. So when we talk about, on an unsecured note, it just means that the note doesn’t have a security instrument as a rider attached to that note that is providing collateral as the security for that note. But essentially what it means is that if one party is in default and they are in arrears, there’s usually language in the note or the security instrument that allows you to essentially foreclose on the promissory note and take over the asset that has been pledged as collateral. So it’s not so much that it’s security in the sense that it is collateral against the loan or the money’s lent through that promissory note. The flip side is that if you have an unsecured note, that means there’s no collateral being pledged, but then here’s the, where the butt comes in.
The butt is even though it’s unsecured, it doesn’t mean that is higher risk because I have to look at what assets are behind that note. Now you can’t necessarily collect on those assets. If the note goes into default and it is now aging, and you have no recourse other than to maybe sue the party that issued the note, but there may be many businesses or assets or equity or cash flows that are the foundation of that unsecured note. So when you look at it that way you could take a secure note that is backed by a piece of real estate that, Oh, by the way, might be a real piece of junk in a dilapidated condition, in a poor, poor area. It’s still collateral. It’s still property. The title can still be committed as the collateral to secure that note. But if you compare that note to another note, that’s unsecured and has a higher rate of interest, it’s paying you more, but fundamentally it is backed by a company or corporation or publicly traded company that has strong cash flow, has reserves, has a cash balance, is doing business. Maybe has a lot of assets and equity on the books that essentially make it a very solid stable company that can service that note without a problem going forward. I would argue that the unsecured note in that scenario is a better, less quote, unquote, risky investment than the secure note with a piece of property that I may not actually want. And if I did have it, I would pull out my hair trying to spend the money to renovate it and turn it around. If it’s not of high quality or in a good area, I think you get my point. I don’t need to reduce this to the ridiculous, but that’s essentially what I’m doing is reducing it to the ridiculous.
So generally speaking is better than unsecured, everything else being equal, but you also have to put into your decision-making process that a secure note that’s offering, let’s say a six, seven, or 8% rate of return versus an unsecured note that might be offering a double-digit return. Sometimes even in the mid-teens that is unsecured, but is backed by strong company or strong cashflows or multiple companies may be the better way to go. That may be the better choice. That’s a decision you need to make. It’s probably a personal decision, but you can evaluate these things as you underwrite them. So to summarize, there are essentially two types of notes for if you want to slice it this way, performing nonperforming, secured, and unsecured. So you can look at it as a grid.
So now what are the expected returns? Again? There’s no hard and fast rule. If it’s real estate, it could be as low as 4%, but it could be six, 8%. If you’re into hard money loans where you’re lending money to buy, to have someone else buy fix, and flip properties. And then they’re just paying you for that money that they’re borrowing for six to 12 months. Well, those rates of return can be seven to 10%. Um, regular mortgage notes. As you know, today is in the 3, 4%, 5% range. So I mean, that is not all that exciting. Sometimes they have bonuses what I sometimes refer to as a kicker. So a note might be paying X percent interest. It could be pay quarterly or even monthly, but there may be an extra bonus interest that is paid out towards the end of that note on the maturity date. And that’s exactly what we’re doing at Norada Capital Management. There’s a two-tiered investment structure. So if you’re in the upper tier, you’re essentially getting 15% per year and then a 5% bonus kicker on top of that. So if you average it out, it works out to 16.7% simple interest per year paid monthly. And so that’s just the way it’s structured with a bonus.
Sometimes notes are structured where the interest is accrued. We’ve done many of those back in 2015, 16, 17. So the interest is not paid monthly or quarterly. It just accrues. And then you get one lump sum back of principal, plus all the accrued interest on the maturity date. So that is more common in the hard money world where loans are being made to buy, fix, or renovate and flip property. So those are the expected returns. Now, do you need to be accredited? It depends if it’s a short term note, a real estate based note generally. No, but if it is a corporate note or what is sometimes referred to as a bond where the note term is more than nine months long, then yes, you do need to be accredited because the SEC considers it a security, even though a lot of people argue that it is not a security in their eyes, it is, and I don’t make the rules. They do. So yes, you do need to be accredited by definition. The SEC’s definition of what it is to be an accredited investor. And by the way, just real quick, what that means is that you have an aggregate net worth, meaning everything you own, except your principal residence of a million dollars or more, or you have an annual income of $200,000 or more over the last two years. And if you’re married, it’s $250,000 per year over the last two years, I believe that’s combined. So that’s their definition of being accredited.
So are there cons to investing in the promissory notes? Not really. I mean, note investing is making a lot of sense for me cause I can just invest my money and not think about it from month to month, year to year. And that’s really the most passive form of investing, not real estate investing, but the most passive form of investing is when you have that predictable income from something that doesn’t have the volatility like the stock market does, but you’re getting it paid from a source, the borrower of your funds, your capital through a promissory note investment.
So that’s pretty much it. I hope this was helpful. I tried to run through it quickly just to give you, I guess, the 30,000-foot tour of investing in promissory notes and how you can turn that into some predictable income for yourself, if you any further questions, or if you’re interested in finding out more about the promissory note investment through Norada Capital Management, that company doesn’t have a separate website yet. It’s something that is on the things to do board, but there is a page on the Norada Real Estate Investments website, just go to the homepage, scroll down. You will see the green money trees. If you will, you click on that, it’ll take you to a page called Capital Management and there’s more information on there. And then you can download an info packet on whatever our most recent offering is in terms of promissory notes, which is currently about 15% per year on a two to three-year note. And there’s a 5% kicker on that as well on the upper tier. So it averages out to 16.7% and those are monthly deposits right into your bank account. It’s just done through ACH, essentially direct pay. And that just starts immediately. It starts the following month after you fund your note. So anyway, if you’re looking for more information, you could just go to the website and download that information.
I hope this was helpful. And if you’re looking for real estate, remember we offer free strategy sessions through our investment counselors. And I am glad you were here today. I greatly appreciate you. Thank you for listening and we will see you on our next episode.
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