February 3, 2023

JF3074: Note Investing for Cash Flow & Stability ft. Fred Moskowitz

Fred Moskowitz is a fund manager and investor who buys and manages residential mortgage notes. In this episode, Fred tells us about how he buys notes on the secondary market and the profitability of this business strategy and investment vehicle. 

Fred Moskowitz | Real Estate Background

  • Fund manager and investor who buys and manages residential mortgage notes. 
  • Author, speaker, advisor, and trainer on various topics related to entrepreneurship and investing.
  • Portfolio:
    • 450 doors
    • GP in a mortgage note fund
    • LP in multifamily syndications
  • Based in: Philadelphia, PA
  • Say hi to him at: 
  • Greatest Lesson: It can take the same amount of time, effort, and expense to do a small deal as it does to do a much larger deal. Because of that, your ROI will be much better on larger deals.



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Slocomb Reed: Best Ever listeners, welcome to the best real estate investing advice ever show. I'm Slocomb Reed and I'm here with Fred Moskowitz. Fred is joining us from Philadelphia, Pennsylvania. He's a fund manager and investor who buys and manages residential mortgage notes. He's also an author, speaker, advisor and trainer on a variety of topics related to entrepreneurship and investing. In his portfolio, he currently has 450 doors. He's GP of a mortgage note fund and LP in multifamily syndications. Fred, can you tell us a little bit more about your background and what you're currently focused on?

Fred Moskowitz: Yeah, absolutely. Thank you, Slocomb. A little bit about my background - it's interesting, I started out working as a computer engineer, and I had an awesome career working in the technology realm; I worked at lot of startup companies, witnessed the birth of the internet; it was an exciting time. And what happened was I watched my entire industry get turned upside down from the bursting of the dotcom bubble. And then that was immediately followed by the September 11th terrorist attacks. And what happened was all of that turmoil, it made me realize I was too dependent on the income from my job. I was taking on this huge risk. And it didn't matter how talented of an engineer I was or how valuable of an employee I was. If things were not going well financially at the company or in the industry, I could quickly lose my job through no fault of my own.

So I came to this realization that I needed to have other sources of income, other than the paycheck for my job. And with that, I turned to investing and got really into alternative investing. And over the years I have been involved with numerous asset classes. I love real estate in general; I really think that it is an asset class that everyone should participate in in some form or fashion. And also, I'm heavily involved in note investing, because I love the cash flow, I love the stability of that asset class. And we can get more into this discussion, but I feel like a lot of real estate investors, when they think about a note and a mortgage, they think about it from the perspective of being the borrower, and not as being the lender. But with note investing, you're able step across the aisle, and step into the shoes of the bank, and now you're the lender. Now you're the one receiving the monthly payments instead of the one making the monthly payments. And that's what note investing is all about.

Slocomb Reed: Fred, I'd like to say a couple of things before I dive back into asking you questions. The thing you were saying about the risks involved in your job reminds me of a quote from Napoleon Hill... I don't remember exactly how it goes. I think it's from Think and Grow Rich. I've read three or four of his books, he had quite a few... But one of the things that he said, or at least an idea that he spoke on was that everyone is a business owner. If you are a full-time employee and that is your only source of income, then your business has one client, and any business with one client is at risk.

Fred Moskowitz: Yeah, it's so true.

Slocomb Reed: It's a really interesting way to think about volatile times; we're recording at the beginning of 2023, and I feel for employees in the tech sector, because they were promised for so long high-paying, stable, secure jobs, and they're experiencing now that they are business owners with one client. And a lot of them are losing that client, and needing to find other ways to generate income. So yes, thank you for speaking to that, Fred.

Let me give you my understanding of note investing, so that you can tell me where I'm wrong. Tell me where I'm right as well, but jumpstart the conversation for our listeners. So my understanding with note investing is you start by thinking about a mortgage that a bank made a couple of years ago, or in 2021 - some people got their homes in the twos, some people got their investment properties in the threes, and some in the fours. Now those interest rates are double, at least. However, there are still a lot of people sitting on those notes.

My understanding of the opportunity involved in note investing is that there are opportunities to purchase notes below the book value, or for less than what is borrowed, and effectively inherit the position of being the receiver of the mortgage payments and the owner of the balance of the mortgage. So a couple of things there... One is if what you paid to put yourself in that position is significantly less than the value of the note, your returns when payments are made are significantly higher, because the returns are based on a smaller value for you. The other is that if that note gets paid off, what's getting paid off is either the full balance, or an amount of money that's less than the full balance, but significantly more than what you paid to buy the note, meaning that you have a profit there simply from the mortgage being paid off, whether or not the real estate is tied to [unintelligible 00:06:59.03] Fred, am I completely off-base? Is that a fair summary? Please correct me anywhere--

Fred Moskowitz: Yeah, that is a great summary, but it's only one part of the picture. There are so many different ways to invest in notes. That is definitely the most common, and that's where I'm active in. We buy notes on the secondary market; they were already originated, usually by a bank or financial institution. However, for all your real estate investors out there, think about this - you know about the concept of owner financing. You own a property, you have a lot of equity, you sell it, and you carry a note for the buyer. And it can be for all of the value of the property, or a portion of it, however you want to structure that. But the beauty there is that when you sell property with owner financing, it becomes appealing to a buyer that maybe can't qualify for traditional bank financing.

We see this a lot with commercial deals, it's very common to have owner financing involved as part of the transaction. But the beauty of it there is that you as the seller becoming the lender, you're still going to be earning cash flow from that property, and you don't own it anymore. And that goes on into the future. And that's beautiful, because you bought the property, you held it for a long time, you made money with it, you managed it well and increased the value... But then when you sell it, you can still be earning cash flow and not having to own and manage and have the responsibilities of that property any longer. And there's even some tax benefits possibly as well coming through that, because capital gains on a sale with financing structured into it, it gets spread out over the amortization schedule of the loan. So for some people, that can be another benefit to you, especially if you have a big tax burden coming from selling a property. So there's a lot of ways, Slocomb, and it's really fascinating. I find it a fascinating business, and I think there's so many ways that you can get involved.

Slocomb Reed: Fred, more specifically, I want to ask about how you are involved. Buying notes on the secondary market is a lot of lingo that we've all heard before, but don't understand how to apply in your case. The vast majority of our Best Ever listeners are not involved in note investing, but they are involved in commercial real estate investing to some degree. So what does that mean? What secondary market? What notes are you buying? Which leads to the follow-up question of "Where is the profitability in your business strategy and in your investment vehicle?"

Fred Moskowitz: Yeah, great question. So here's something that most all of you listeners can relate to. You buy a property, or refinance a property - and this happens most common in the residential space, with your residential mortgages; you go to closing, you sign all these documents, and within one to six months after closing - this happens a lot - you get a letter in the mail from your lender saying "Dear Mr. or Mrs. Borrower, please be advised your loan has been sold to new lender. Here's their contact information, here's their new address, and starting next month, please send your payments to them. And by the way, don't worry, because none of the terms of your financing will change; the interest rate, the payments, all of that is going to be the same. However, starting next month, please make your payments to the new lender."

So what has happened there is that loan originator, their business model is to originate loans, and then immediately sell them as fast as possible, so that they can recapitalize and then go out and originate a new loan. That's what they do. Now, there's this whole secondary market that exists to buy mortgages; they're packaged up according to quality level, and risk level, and all of these factors; they get put into bonds, into Wall Street mortgage-backed securities, and all of these financial instruments or products. And those are held for some time, but after a number of years, those bonds are broken down and collapsed, and then all the assets, they're being sold off, and now the risk profile has changed on them, the grading system on mortgages, they change characteristics... Because let's face it, life happens to people, to borrowers; maybe they had a less than stellar payment history on the note, and now that note is worth less, because it's deemed higher risk, and it gets sold at a greater discount due to that increased risk. So for us buyers on the secondary market, we can buy those notes, and if you're willing to take on more risk, you can earn a higher rate of return, because yes, you will get a better discount for those loans, and there's some possibility of upside, as you mentioned earlier.

So the money to be made is in negotiating a good deal. Just like real estate, you make money when you buy. But in addition to that, it's in that cash flow, because during your ownership of the note, you're getting cash flow, monthly payments coming in every month. And that consists of interest, plus a portion of principal each month from the amortization schedule being paid down. And holding those over the long term, with a lot of assets, with a large volume of a nice portfolio, you can do really well, because that creates a lot of cash flow. And that, in a nutshell, is the nature of the business.

Slocomb Reed: Fred, I want to give a blunt paraphrase of what I heard you say about which notes it is that you're buying. In short, the risky ones, because there is more return. I want to ask, why is it that those notes or those bonds are considered to be higher-risk? What is the risk in those ones that you're buying?

Fred Moskowitz: Well, we buy what's called mixed pools, so there will be variables there. Some are higher risk, some are lower risk. So let's talk about risk. I cover quite a bit about this in my book about note investing, but with risk, you look at the profile the borrower - what's the track record, what's the payment history on the note. A note that has the past five years of payments being made perfectly on time comes in one risk category, but then you could have a note that they're only making 11 out of 12 payments each year, and falling behind little by little, yet payments are still being made on the note every month. It's just that it's getting behind. Or there could be a delinquency of several months of missed payments, yet each month a payment is being made. So it's not perfect, but it's not horrible either. Notes can be bought in default, where they stop paying altogether. Notes can be bought where there's some kind of documentation defect, and we saw a lot about that during the fast and loose days of 2006-2007, around that time, where closing loans was not done in the most organized fashion; not all the dots were dotted and the T's crossed. So you had some documentation issues that caused the loan value on secondary market to go down; it takes a hit.

Now, for a savvy investor, if you're able to buy that loan, clean up the file, clean up the defects... Because let's face it, we live in America, and with enough time and enough money, just about any problem can be solved. You get proper attorneys involved, you get your documentation experts, and a problem can be solved. And it might take six months, it might take a year to get through all that, but in the end, now you have a loan file that is all tidied up, clean as a bean, you resolve the issue, and now you've increased the value.

Think about this - the same way you could buy a distressed property or a property that has deferred maintenance, or some kind of material issue, and invest money to correct that and resolve that, and now the problem is gone, and now your asset value has gone up - the same thing can be done with a financial instrument.

Break: [00:16:26.00]

Slocomb Reed: Fred, two questions here. One is beyond the interest rate on the mortgage, where does your profit come from on your deals? The margin between X and Y when Z, or something like that. I also want to ask if you have metrics for your average return per note that you've invested in. Also, could you give us a couple of examples?

Fred Moskowitz: Yeah, absolutely.

Slocomb Reed: You don't have to tell us who the borrowers were or anything like that, but give us an idea of the actual issues that you had to resolve, and the actual numbers behind them, and what made it such a juicy investment for you.

Fred Moskowitz: Yeah, absolutely. Great questions. So here's a situation that happens where there wasn't a problem with the note, there was a problem with the prior owner of the note. This was years ago, back when I was first getting started. To give you an idea on numbers, this note was having a loan balance of 80,000, and being paid on time, and everything; good track record, plenty of equity covering the property, the debt. Now, the seller of the note - they needed to recapitalize quickly, because they were going into a larger deal. They needed money, they needed liquidity. So they sold that note at a steep discount. And I had the opportunity to buy that, because of my personal relationship. I got a phone call saying "Hey, we need to sell these notes. We know you're liquid. Are you interested to take a look at it?" I was able to buy that note at a discount around $50,000.

And the end result is I was getting a payment each month for a couple of years, and then the borrower went to sell the property, and the loan balance was still close to that 80,000. So now I got paid off in full. I invested 50,000, got a payoff of let's call it 77,000, because some of the loan got paid off... And I was collecting payments for three or four years. So aggregately, It was a nice deal. It was a great deal. And that all stemmed from the seller having an urgency; they needed liquidity quickly. And we see that at all levels; larger hedge funds that are active in buying and selling of loans, if there's a liquidity crunch that comes up, they start selling assets out in the secondary market. And there'll be some discounts there, for sure. So that's a great example, and there wasn't a whole lot for me to do on that deal, except do my due diligence on the note, make sure everything was okay, managed risk, and then collecting payments for several years. And that's it. And it's interesting, because there's an element of randomness in note investing, because you never know when a borrower is going to refinance a property, or sell a property.

Here's an interesting statistic, Slocomb. In the United States, the average life of a note on a residential property is about five to seven years. And as a lender, you never know when a loan is going to be paid off; it can happen any time. It can happen the next month after you bought a note, it could happen 10 years after you bought the note. Or maybe it's one of the few borrowers that they have a 30-year mortgage and they're gonna pay it out into maturity, because they're not moving out of that property, and they got a nice rate on it.

And so all of these scenarios can come into play. And as an investor, as a lender, you can't control that, and you can't dictate that. When you buy a note, you're buying a contract, you have to uphold all the terms in that contract between the original lender and the borrower. And you can't modify that, unless both parties agree.

Slocomb Reed: Fred, do you have another quick example of how you profited from another circumstance, one other than a seller who is experiencing distress because they needed their capital for a future acquisition?

Fred Moskowitz: Another example - it's really the typical loans we buy; we buy them at a slight discount. Let's say it's a $50,000 note, we might buy that for 45k, or 40k, depending on the risk profile, and then hold that note, and the payments are coming in every month. If the payment amount is high, your return on investment, it can be really high. If you're willing to buy what are considered riskier type of assets. And maybe it's a second-position note; maybe there's not enough equity to cover the full value on the loan, which you're going to negotiate a better discount for that.

And the deal could go perfectly fine, but you're collecting cash flow for years. And this is not a homerun type situation at all. But the consistency - it builds wealth; it builds wealth over time. And if you have a nice portfolio, you're running into the situation where you're constantly going back out to buy new notes; because loans are getting paid off, and payments are coming in, and you're self recapitalizing from that. And then the problem you have is you have to go out and redeploy capital. But it's a good problem to have, that's for sure. That is a very typical scenario for us as note investors.

Slocomb Reed: Nice. Fred, are you ready for the Best Ever lightning round?

Fred Moskowitz: Yeah, absolutely.

Slocomb Reed: What is the best ever book you recently read?

Fred Moskowitz: Oh, I love this question, Slocomb. I really do. It's "Think and Grow Rich." I know you mentioned it earlier...

Slocomb Reed: Yeah, I mentioned Napoleon Hill earlier, yes.

Fred Moskowitz: You mentioned Napoleon Hill. Think and Grow Rich is a book that every time I come back and reread it, I learn something new. And it's so impactful. It's something that I would say read it once a year, because every time you do, you'll take away new concepts; because we all change and evolve over time as we get more experienced, as we live more life... So you go back to that book and gain new nuggets, new knowledge. It's so impactful.

Slocomb Reed: Fred, I'm an avid book listener, and I will say specifically about Think and Grow Rich, if you are on Audible and you buy the expensive one - I think it was like 75 bucks when I bought it, which is unheard of for an audio book... Except that the expensive version of Audible also includes excerpts from some of Napoleon Hill's speeches and lectures on the topics covered in the book, which is an added bonus, for sure. Fred, what is your best ever way to give back?

Fred Moskowitz: There's a number of ways. Financially, giving to charities, getting involved in causes and organizations... But another way of giving back is through mentoring. Mentoring other investors, younger people that are coming up in the industry. And let me tell you, Slocomb, I definitely benefited from this. When I was first getting started in investing almost 20 years ago, there were some really savvy veterans, experienced people that were so generous, so giving of their time and expertise, and took a passion to helping others and teaching others. And I will never forget this, one of them said to me, "Fred, I want you to take this knowledge, do well with it, be successful, but then, after you have a lot of experience, and you've made it big, I want you to turn around and do it for someone else." And that's a lesson I will never forget. And it's so true.

Slocomb Reed: Awesome. Fred, I've gotta throw it back old school - one of Joe Fairless' original lightning round questions: what's the most money you've ever lost on a note deal?

Fred Moskowitz: The most money I've ever lost on a note deal... It's something that cannot be expressed in monetary value. And here's why. When I first got started in note investing, I had some fear, I had some doubt, I wasn't sure if it was valid, if it would work; I was a bit skeptical, so I was buying all the small value notes, loan balances of $5,000. I bought a couple of these small notes. And what I found was working on them to fix the problems involved and all that - they had issues, for sure... But what I learned was that in the end, it takes the same amount of time, effort, expense, and headache to work on a small deal as it goes for very large one. And that time, you can't get that back; that effort, you can't get that back. And there's a huge value on that.

So that was one of the biggest lessons I've ever learned quickly, was starting to get into larger deals, because it's going to be the same effort and headache on a $4,000 note as it is on a $40,000 note, or a $400,000 note. And for all you commercial real estate investors out there, you guys figured this out already. Most commercial real estate investors start out with single family houses, and then realize you could put in the same amount of work and effort on a larger multifamily deal. So a lot of people transition to that; it's the same concept.

Slocomb Reed: Fred, with that being said, going back to actual monetary value, what's the most you've ever lost on a note?

Fred Moskowitz: I've lost track. The thing with note investing is - let's say you buy 10 notes, and some of them are not going to work out, especially if you're buying riskier type of assets. So let's say you buy 10 notes; well, let's say six to eight of them are going to be singles and doubles. You'll do pretty well on them. And then there'll be maybe one or two where you lose money; you lose money, it was a bad deal. And then there'll be another one or two of them that are homeruns in a major way. And that happens a lot. And so the name of the game is diversification.

So instead of investing all of your money into one note, you're better off investing into 10 notes, or a pool of a 100. Now you're spreading that risk out. It's just like insurance companies, the way they operate; their business model is an insurance company isn't going to go out and ensure one person; they're not going to go write one policy. They're going to ensure a pool of [unintelligible 00:29:18.06] whether it's people, or properties, or cars, or whatever. So spreading that risk out among a population is how they manage risks. And let's face it, insurance companies have been around for hundreds of years. They know what they're doing. So for us as investors, we can take a page out of their playbook and learn from those strategies and that type of an operational thesis.

Slocomb Reed: Brad, thank you. That being said, what is your best ever advice?

Fred Moskowitz: My best ever advice is this. And this applies to you, no matter what type of investing you do. As we mentioned earlier, I'm from Philadelphia, the birthplace of our nation. And I look up to one of our founding fathers of this country. I consider him one of my mentors, Benjamin Franklin. Such a wise man, an inventor, brilliant, brilliant mind. He left us with this really impactful quote, and it goes like this: "An investment in knowledge pays the best interest." And it's so true.

Slocomb Reed: That's good.

Fred Moskowitz: No matter what you do, always invest in yourself, in your learning, in your education, in attending workshops and seminars, traveling to attend conferences; that is money well spent, because when you do that, you're going to learn new concepts and ideas and skills. You're also going to be in rooms with like-minded individuals, and you can build relationships there, that maybe your next deal comes from that.

Slocomb Reed: Fred, where can people get in touch with you?

Fred Moskowitz: Best place to get in touch with me is by visiting my website, Fredmoskowitz.com. Or, for an easier spelling, you can go to giftfromfred.com. I love connecting with investors; feel free to visit the website, reach out to me, and I look forward to connecting with you on an individual basis.

Slocomb Reed: Those links are in the show notes. Fred, thank you. Best Ever listeners, thank you as well for tuning in. If you've gained value from this episode, please do subscribe to our show. Leave us a five star review and share this episode with a friend who you think may be interested in note investing. Thank you, and have a best ever day.

Fred Moskowitz: Thank you.

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