Debt as an Asset Class

by Dave Van Horn

As an investor, I started out investing primarily in real estate, but over time, as I’ve lost my appetite for managing properties, I’ve moved more and more into investing in debt.

For me, as an investor, debt is a good thing. It’s really just another asset class I use to diversify my portfolio.

You probably know by now that my company, PPR, manages funds that invest in debt (mortgages) secured by real estate, but don’t think you need a big operation like PPR’s to take advantage of this type of asset.

There are at least 5 ways to invest in debt, and you can start doing it for as little as $25 or as much as $2M (or more).

1. Peer-to-Peer Investing

Over ten years ago a company called Prosper rolled out an innovative peer-to-peer platform for consumers that allowed them to get unsecured loans directly from other individuals, completely bypassing the banks. Shortly after, Lending Club launched a similar platform. Since then, many other peer-to-peer platforms such as Upstart and Kiva have come online, and each of them has its own special focus.

While arguably being a good option for borrowers, these platforms are also potentially good ways for investors to participate directly in lending on a fractional basis (since you only fund part of a loan, alongside other lenders). With both Prosper and Lending Club, you can hand-pick the loans you want to fund based on your criteria, or you can have pick the amount you want to invest and have the platforms do it for you.

Probably the most appealing aspect of using Prosper and Lending Club is that you can fund an individual loan with as little as $25, so you can diversify pretty easily.

Like any investment, there are nuances that you should explore, but I can say that my personal results with peer-to-peer lending has been OK but not stellar. You may also want to look online for other investors’ experiences with these platforms, like this review of his results by the White Coat Investor.

2. Debt Investing via Crowdfunding

An even newer platform for investing in business debt is the broad category of “crowdfunding” opportunities like those featured on NextSeed’s website, a portal that specializes in helping restaurants raise capital.

Crowdfunding received a boost several years ago with recent changes to the regulations that govern how businesses can raise capital, and NextSeed and other platforms provide the technological platform to make the process easier for investors.

Again, there are nuances to the ways that crowdfunding portals work and the kinds of opportunities they provide, but browsing the current offerings on NextSeed will show you that you can invest fractionally in a standard Term Note.

I’ve never personally invested in debt via a crowdfunding site, but my colleague Amy Wan has, and she has described her experiences with crowdfunding as an investor.

3. Creating Notes as a Private Lender

My first venture into the note business was actually as a hard money lender. I had gone to a local REIA looking for a private lender for my own real estate deals and quickly found out that lenders have the “best seat at the closing table” in that they earn handsome returns with none of the hassles that the person dealing with the rehab does.

Note: Hard money lenders usually require a 1st-lien note on a specific property as security for the loan.

I went on to do hard money lending out of my IRA and savings, and I even used lines of credit to fund deals for local real estate investors, and I did very well.

Not to sound like a broken record with my warnings, but hard money lending is also something that you should enter into carefully. It’s a business, after all, and one that is more heavily regulated than ever. Do your homework.

4. Buying Individual Notes

Note: For this discussion, I’m only talking about investing in performing bank-created notes secured by real estate where the borrower is making payments on a loan. You can certainly buy non-performing loans as an individual investor, but managing these notes is a labor-intensive, often lengthy, and certainly active process. I just don’t recommend this strategy for most individuals due to the complexity and compliance requirements involved.

There are definitely advantages to investing in performing notes, including…

Control.

Since you own the whole loan, you can exert more influence on the borrower, keeping in mind that contact with a borrower is a highly regulated area. By contrast, with a peer-to-peer or crowdfunded debt investment, you have little to no influence over the borrower.

Collateral.

Your note is secured by real estate, so in many cases, you have the backstop of taking back the property in the event of borrower default.

Simplicity.

In most cases your performing notes will be serviced by a third party who will collect and process payments and issue the required paperwork and documentation. In the best case scenario, you’ll get payments like clockwork up until the loan pays off over time or the borrowers refinances you out early.

Consider, however, that you also face greater responsibility and liability as a note owner than if you participated in a fractional peer-to-peer or crowdfunded loan, and the entity that buys the loan will be available on public records, which means you have less anonymity as an investor.

5. Note Fund Investing

If you’re a high-net-worth individual or couple, fund investing might be something to consider. For accredited investors, participating in a note fund means buying shares in a company or entity that acquires and manages mortgages.

By choosing to purchase shares of an LLC, there is usually little to no personal responsibility, accountability, and most importantly, liability involved in the investment. In fact, your overall exposure in terms of liability cannot be more than your investment. For this reason, fund investing meets the true definition of “mailbox money.”

Note: don’t take the “mailbox” reference too literally. Most note funds, including ours, ACH preferred returns automatically into the account you specify.

Apart from the ease, reduced liability, and scalability of investing in a Note Fund, other advantages include anonymity, simplicity, predictability, and passivity.

Is Note Fund investing right for you?

We recently published an article on the topic of the “Advantages of Investing in a Note Fund”

Advantages of Investing in a Note Fund

Wrap-Up

I’ve said for years that “we’re all in the note business, but most of us are on the wrong side of it.”

By investing in debt, whether via a peer-to-peer or crowdfunding portal, with created notes as a private lender, by buying whole loans, or by participating in a note fund, you can get on the “right side” of the business.

So, take a lesson from the banking world and experience the benefits of being on lending side of things.

Here’s to your success!

Questions?

If you have any questions about how PPR can help you get started investing in individual notes or in one of our note funds, contact our Investor Relations department by scheduling a time to talk or by calling us at 877-395-1290.

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