ESG & Real Estate
ESG and real estate investing may seem like two entirely different topics but there are ways to create significant impact with real estate investments that you might not know about.
The incorporation of ESG criteria into real estate investing is a fairly new concept. Mortgage notes are a great way to invest in the real estate market while following your values. This article is going to show you why note investing is such a powerful ESG investment.
What Is a Note?
When most people think about investing they think of stocks and bonds. But not too many people are familiar with note investing.
A note is just an IOU; it is a promise to pay. When someone purchases a home they are usually taking out a mortgage loan to finance the purchase of the property. During this process, the new homeowner also signs a promissory note, which is just a promise to pay back the loan under the terms of that loan.
The note includes the interest rate of the loan, payment amount, loan length, and other terms like late payment penalties. The note is secured through the mortgage which ties the promise to pay to the property itself.
So when you buy a new house you get a mortgage, you sign the promissory note, and a million other things later you move in and start sending checks to the bank each month to begin paying off your loan.
As a note investor, when you purchase a promissory note you become the bank. The homeowner pays you since you become the new lender once you’ve purchased the note.
Why Most People Have Never Heard of Note Investing
Most people are pretty unfamiliar with mortgage notes or don’t even know that this investment option even exists. There’s a reason for this. Your brokerage and your 401k don’t offer notes as an investment option.
These are the big guys. They make money when you invest through them. They aren’t going to recommend you start moving your money towards alternative investments. It is not in their best interest to do that.
A good brokerage gives you a lot of flexibility and a lot of different investment options; stocks, bonds, mutual funds, exchange-traded funds, certificates of deposit, options, futures, annuities. But brokerages typically don’t deal in many alternative investments like mortgage notes.
I began investing in notes for two reasons.
- I wanted to have a portion of my retirement outside of the stock market.
- I wanted to create positive social impact with my money.
I wanted investments outside of the stock market because I don’t want to take the chance that I won’t be able to retire when I want to because of a stock market downturn or recession.
A while back I was speaking to a retirement education specialist and I asked a very direct question… “What happens if at the time I am ready to retire there is a recession?”
I know the classic advice is to hold more bonds than stocks in your portfolio by the age you are looking to retire. But both stock and bond funds fell during the 2008 recession.
Vanguard’s Total Stock Market Index Fund, VTI, is a good representation of the U.S. stock market. The U.S. stock market and VTI fell by over 50% during the 2008 recession.
Source: Yahoo Finance
For bonds, Fidelity’s Total Bond Fund, FTBFX, is a good representation of the overall bond market. FTBFX and the bond market fell by over 15% during the 2008 recession.
Source: Yahoo Finance
Yes, the tales are true. Bonds are less volatile during times of recession. That being said, a 15% drop in your portfolio is still pretty significant.
But remember that we’re not talking about a 15% drop in your portfolio because most advisors still recommend that stocks remain part of your portfolio even as you’re getting ready to retire. If you have a 90/10 portfolio of bonds to stocks then you would have seen your portfolio drop by closer to 20% during the 2008 recession.
I know that I wouldn’t want to have to withdraw money from my retirement account during a drop like that. Yes, I have some time before I can retire but I don’t want to have to push back my retirement date because there happens to be a market downturn at that time.
That is a big reason why I have chosen to invest in mortgage notes.
What Does Note Investing Have to Do With ESG Investing?
What does note investing have to do with ESG? Remember that as a note investor you are the bank. Banks are built on bureaucracy. They have policies and procedures; rules and regulations. That doesn’t mean banks are bad. They are just rigid and they have rules they need to follow.
Note investors aren’t constrained by the same bureaucracy as banks. They can be flexible when necessary. They can treat their borrowers like people rather than case numbers.
Note investors have the unique ability to work with people to keep families in their homes. The “S” in ESG investing is for “social”. Socially-focused investing is all about people. It is hard to find another investment where you can say you helped a family stay in the home they grew up in.
I think that is what personally drew me to note investing.
When I was writing this article I had really gone back and forth about how personal I wanted to get but I want to share a bit of my story because if it convinces just one person to consider note investing as an ESG investment then I’ll know I’ve been able to make at least some impact.
When I was younger my parents got divorced. A pretty common thing these days. But afterward, my father moved halfway across the country. This left my mother by herself with me and my 3 siblings.
My mom is a nurse and she has always been incredibly hard-working. Picking up extra shifts, working nights, taking care of her kids. She loves her patients and she goes above and beyond for them. She is a great role model.
That being said, all of that hard work didn’t really matter after my parents divorced. We were living in a home that my mom could slowly no longer afford.
At some point, my mom was given an ultimatum. She could pay back all of the missed payments with penalties in a lump sum or the bank would foreclose. I don’t remember what the exact number was but it was something totally unfathomable at the time.
I remember a lot of weekends, my siblings and I would need to make sure our rooms were clean because there were going to be people stopping by to look at our house.
My family and I would go for walks around our neighborhood while strangers wandered around our house. I remember feeling like I was a stranger in my own home. The bank eventually foreclosed on us.
Banks are not evil. Banks are filled with good, decent people like you and me. I want to emphasize this because it is not the bank’s fault that my family could no longer afford our house. I wanted to share this experience for anyone out there who might be considering note investing.
As a note investor, you have a lot of flexibility when working with your borrowers. You can have a significant impact on the lives of other people. The best part of this is that note investors create win-win scenarios. This is not philanthropy or charity. Note investors can help others and still generate a great return on their money.
I am not a financial professional and I will never tell you how I think you should be investing. But I did want to share how I utilize note investments in my personal portfolio. I currently have about ⅓ of my portfolio invested in mortgage notes.
I opened a self-directed retirement account using an IRA-LLC structure. I know that might sound like gibberish to most of you and up until a few years ago, it was nonsense to me too.
Basically, I opened an IRA outside of my job under an account that allowed me to invest in alternative assets. Alternative investments are things like real estate, mortgage notes, precious metals like gold and silver, and investments in private companies.
I invested in a note fund that allows me to be diversified in the same type of way that a mutual fund allows diversification. I have one investment that is diversified across more than 90 different notes. I trust the manager of the fund and I know his values align with mine.
I’ll admit that the process of setting up the IRA-LLC takes some work but you can completely skip that step if you aren’t interested in investing within a retirement account. I chose that route for the tax benefits. Overall, note funds are fairly passive investments.
Where to Learn More
I want to give you two resources you can go to for some additional information about note investing and self-directed retirement accounts.
“Note Investing Made Easier” by Martin Saenz is one of the highest-rated note investing books on Amazon. That’s why I bought it. This book is a great introduction for anyone interested in learning more about investing in notes.
The second book I’ll recommend is “The Self-Directed IRA Handbook” by Mat Sorensen. Again, I have this one too. If you are interested in investing in notes within a self-directed retirement account then I think this book is a must.
There are a lot of rules and regulations that come with something like an IRA-LLC account. You need to make sure you are following these rules or you could definitely run into some problems. However, if you aren’t interested in investing within a self-directed retirement account then you can skip this one.
This is just a basic overview of notes and note investing. There is a lot more that goes into notes. Including lien positions, performing and non-performing notes, workouts, partials, servicers… That is all outside the scope of this article. I just wanted to introduce this topic so I could explain why it is such a great ESG investment.
Mortgage notes can be a powerful tool for ESG investors and note investing is a great way to diversify your portfolio outside of the stock market to protect yourself. But note investing also allows you to create true social impact with your investment dollars.
With all the other ESG investment options out there I feel like notes are something that is often overlooked. What are your thoughts about note investing? Leave us a comment below!