The number one tool you need when you are learning how to buy cash flow notes is a financial calculator. The HP 12c is an easy to use financial calculator that costs about $80. It will be one of the best investments you ever make. Many investors use financial calculators to figure out the payments on properties. But that doesn’t begin to touch the calculating power and potential when it comes to figuring out how to buy cash flow notes at a discount.
First, let’s take a look at what you are buying when you are buying a note. Simply put, a note is a certain number of payments for a set amount of dollars. A typical real estate note may have a $100,000 initial balance, 6% interest and extend for 30 years. The monthly payment is $599.55 for 360 months. In essence, that note, over the course of 30 years will generate $215,838 to the lender.
But 30 years is a long time. What happens to the value of a dollar in 30 years? What are the odds the person will keep paying on the note for a full 30 years? More importantly, what could the lender do with cash today instead of a series of payments strung out over 30 years?
That is where the opportunity to buy cash flow notes comes into play. Many lenders, private and institutional, sell their notes for cash. In fact, during the boom, many lenders were really loan originators, loaning the money and creating the note, and then selling the note immediately to Wall Street firms. Many sold the notes at a premium. That is, a $100,000 note may have sold for $103,000 or $105,000. The bank or lender made their money on the loan origination and processing fees and a little bit on top of that. But it was fast turn money. In fact, the $100,000 never really went out or got paid back in.
Would it be worthwhile to pay a premium for a note? Depends on the terms of the note and the security. Most investors, however, buy notes at a discount, thereby increasing the yield that they get.
An Example Of How To Buy Cash Flow Notes
Let’s use that brand new $100,000 note at 6% as an example. While 6% isn’t a bad return on your money, most investors want to see 10%, 12% or more. In fact, the offer that they make on a note is based on the return that they want to get. In essence, you’re going to use your financial calculator to figure out how much you should pay for that $100,000 note to get the return you want. Let’s look for a 12% return.
Look at the top row of buttons on your calculator. You will see the letters: n i PV PMT FV
n = Number of Payments
i = Interest Rate
PV = Present Value
PMT = Payment
FV = Future Value
Key in 360 for the n
599.55 for the PMT
-100,000 for PV Make sure you input this as a NEGATIVE number.
Put 0 in the FV just in case there is any number still left in there from an old calculation.
Then press the i button.
You will see 0.5. That is an interest rate per month. Now type in 1 (12% is 1% per month) and hit the i button again. You will get -58,287.25.
In order to make a 12% return on this note, you need to pay no more than $58,287.25.
If you were to buy that note five years into the payments, you would have 300 payments of $599.55 available. ($179,865 generated when all the payments are made.)
300 = n
1= i (12% is 1% per month)
0 = FV
599.55 = PMT
Press PV and you get $56,925.20.
That’s how much someone would pay you to buy the remainder of that note and get a 12% return. Would you sell it? Maybe if you needed or wanted the cash. Let’s calculate how much profit you would have made on your money in that time.
You bought the note for $58,287.25 and sold it for 56,925.20. You are out $1,362.25. However, during those five years, you collected $35,973 in payments. What was your return on your investment? 528.14%. That’s a pretty good return when you only set out to get 12%!
How To Buy Cash Flow Notes – Things To Take Into Consideration
You can buy all of a cash flow note or part of the income stream. The payments made at the beginning of a note are worth more money than those at the end. A note that is “seasoned,” meaning it has a proven payment history, is worth more than a brand new note. The security that is pledged against a note may affect your offer.
Buying and selling cash flow notes is big business. Your financial calculator is your best friend and most used tool in this business. Once you learn how to buy cash flow notes, an entire world opens up to you.
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