Episode 77 – How To Create Passive Income With Real Estate Note Investing with Martin Saenz

Mortgage note investing is rarely discussed, but it’s one of the best real estate investing opportunities available. In this episode of The Agent of Wealth Podcast, host Marc Bautis is joined by Martin Saenz, Co-Founder and Managing Partner of BeQuest Funds, an alternative investment fund, and Founder of Note Investing Made Easier (NIME). BeQuest Funds was created with the dual purpose of helping investors grow their wealth and helping mortgage borrowers stay in their homes. Saenz, a successful entrepreneur and real estate investor for over 15 years, shares his strategy and experience in this episode, all while motivating you to create a passive income with note investing.

In this episode, you will learn:

• Why investors should consider alternative investments.
• What exactly real estate note investing is.
• How real estate note investing can create a passive income or can be used as a long-term investment for retirement.
• The pros and cons of real estate note investing.
• And more!

Resources: 

BeQuest Funds | BeQuest Funds LinkedIn Page | Note Investing Made Easier | Bautis Financial: (862) 205-5000

Disclosure: The transcript below has been lightly edited for clarity and content. It is not a direct transcription of the full conversation, which can be listened to above.

Welcome back to the Agent of Wealth Podcast, this is your host Marc Bautis. On today’s show, I brought on a special guest, Martin Saenz. Martin is the co-founder and managing partner of BeQuest Funds, an alternative investment fund. Welcome to the show, Martin.

Thanks for having me on Marc, much appreciated.

I’m excited to talk about today’s topic of alternative investments, and specifically investing in mortgage notes. Nowadays, I think investors are looking for alternative ways to invest for a couple of reasons: Diversification and building passive income are two common ones. I also think some people are nervous about the current, bullish stock market, especially compared to the real estate market right now. So let’s get started. Can you give us a quick background on what real estate note investing is, and how you got into it?

In 2003, I was fired from a corporate job — it just wasn’t the right fit for me personality-wise. My wife and I determined that I needed to do something for myself, be in the business for myself. So we started a government contracting company and, through the course of time, we accumulated a number of commercial and residential properties as a buy and hold play. We were landlording for a while. 

What we realized, in 2012, is that operating a small business of landlording took a lot of time, attention and effort. And we were interested in building more freedom of time in our lives. So we sold the company — we still manage the properties — and I got into the mortgage/real estate note industry. 

What is Note Investing?

There’s a number of ways you can go into note investing, but at its core note investing is the process of purchasing debt and its security instrument. Let’s take an individual that’s looking to purchase a home. First, they go into a bank and complete a mortgage application. Once they get approved, they receive a mortgage and a note to purchase a property. The note is a promise to pay back money — given a certain set of terms — and the mortgage ties that promise to the property in the form of collateral. 

Well, over the period of time, 4% of mortgages go into default. So something happens in the borrower’s life that causes them to stop paying: They get divorced, lose their job, have a health issue, etc. The bank then bundles those defaulted mortgages into a tranche, and sells them into the secondary mortgage market to a hedge fund at 20-30 cents on the dollar. Well, that hedge fund goes and works with the borrower, because let’s say the borrower now has their job back for example. The borrower starts making payments again. Over the course of time, those mortgages become re-seasoned.

BeQuest Fund’s Approach

From that point, BeQuest Funds purchases them at 70-80 cents on the dollar, which equates to about a 12-13% yield. In return, we pay investors that come on board a 9% annual preferred return in the form of monthly payments. 

The model is pretty simple. We receive borrower payments monthly, and we pay our investors out monthly. The “secret sauce” to all of this is that the mortgages held in our portfolio are all owner-occupied properties. These are people that have emotional equity in their residential properties — they’re people’s homes.

Perfect, that was a great introduction. I have a couple of questions. First, what determines when a mortgage goes into default? Is that something the bank decides?

What Causes a Mortgage Default?

Generally default takes place when the borrower’s beyond 120 days past due. The bank’s going to hold it on their books for a few years before they consider bundling in a tranche and selling it to the secondary mortgage market space. They do that for a number of internal reasons.

Okay, and then the bank bundles it up and the hedge fund comes in. Now, the hedge fund can’t pick and choose, right? Since it’s a tranche. They either take it or leave it. And then they deal with whatever’s inside that bundle?

Correct, yes. They’re buying all or nothing at that point.

Then the hedge fund tries to get those loans back on track. Do they then do the same thing? Bundle a subset of them?

Yes. When I first came into the space, I launched a hedge fund. I actually have two different operations: One, the hedge fund that works on non-performing loans and two, BeQuest Funds, which is focused on mortgages purchased in the secondary mortgage market space. BeQuest Funds is more of a longevity, annuity play. 

So, I understand business from both sides. But some hedge funds’ objective is to buy, double their money and sell off smaller pools downstream to more retail buyers. For BeQuest, it’s always been a longevity play. We’re cash flow investors, so what we want is the monthly income from the borrower’s payments. We want to keep it through the duration of the term 20-30 years.

So you’re actually servicing the loans as well?

We have a third-party licensed servicer that we use. However, we piggyback off of the servicer if there’s any need for communication with the borrower. The licensed servicer collects payments, issues out loan account statements and issues year-end tax forms. We also have an internal asset management team that monitors the performance of the notes in both the non-performing state and the performing state.

Yeah, that makes sense. If you look at BeQuest from an investor’s eyes, they’re always concerned about risk. What happens if the loan you acquire goes back into default? What’s the risk of that happening?

BeQuest Funds: What’s the Risk Involved?

There’s about 160 mortgages that currently reside in BeQuest. The pool itself sits at a 90% collectability percentage. It’s a healthy pool because we’re buying them after they’re seasoned — after they meet the underwriting criteria. 

With that said, we’ve never foreclosed on a loan within BeQuest. When a borrower stops paying, whether they’re on the hedge fund side or on the BeQuest Funds side, that’s our area of expertise. We have a number of different ways that we connect with the homeowner, and we have legal needs if we need to. We monitor the performance of these mortgages on a daily basis, it’s part of the KPIs within the company. So, we’re on it. If someone is slightly behind, we’re picking up the phone and reaching out.

Do interest rates have any impact on the performance of the fund? Or does it not matter because it’s really the price that the fund is able to acquire a note at? Is that more along the lines of how the returns are generated?

How Do Interest Rates Impact BeQuest Fund Performance?

The annual preferred return is 9%. We’re buying these mortgages at a 12-13% yield, so that’s all fixed. Where inflation may come into play is it affects the US dollar. There’s a lot of money in circulation right now — everybody knows inflation is here. So, at some point, individuals may look for riskier investments so they can meet their yield criteria. 

Or, if inflation got to the point where it exceeded 5-9%, then that puts the fund in jeopardy because we’re locked in with what we purchased the loans at and what we pay the investors monthly. But I think by the time that would happen, the stock market would crash and a lot of other variables would negatively affect our economy.

How’s the fund structured? Is it a rolling fund where you’re accepting investors at any time? Or do you have specific points where you open and close investing?

Creating Generational Wealth With Alternative Investing

It’s an evergreen fund. This particular fund launched in February of last year, so there’s only $7 million assets under management right now. It will be capped out at $50 million. So, we have about $43 million to go. 

There’s no expiration date, hence the name BeQuest. It’s a legacy play. It’s something that myself, my partner and the investors are looking to pass down to future generations as a source of income. So really, we’re long-term players. 

In terms of what will happen when we cap out at $50 million — which we anticipate doing in about two to three years — we’ll launch an additional fund.

How has the impact of COVID-19 affected the landscape? I know the fund is relatively new, but did you see any variability in people paying or not paying their mortgages?

Did COVID-19 Affect The Real Estate Note Investing Landscape?

When COVID-19 came, we thought we would see our collectability percentage go down to 75%. 90% is the industry standard. If we think about the investment devaluation at 62%, we can absorb some deficiencies — such as collectability issues — and still be “okay.” So 90% is the threshold. We never want to go below that. But we were thinking about 75%. 

We actually converted some of the processes. We went from looking at performing mortgages, collectability percentages and delinquency buckets on a weekly basis to a daily basis.

We found two things:

1. Collectability ranged from 92-93% all year — throughout COVID — and is sitting at 96% now.
2. A lot of what was in the media was not reflective of what we were seeing. 

People were actually valuing their homes more! After all, they were home everyday, staring at their walls and floors. There was more of an appreciation for where they lived. As a result, we were receiving payments accordingly.

That makes sense. I know you mentioned you have a preferred return of 9%. What happens if something changes in the market and no longer can you purchase these for 80 cents on a dollar? Or the purchasing price goes down?

The Investing Period: How to Use Real-Estate Note Investing for Long-Term Gains

So real estate notes have an inverse relationship with a housing boom. So, we’re seeing our recession now, actually. There’s a limited supply of mortgage note inventory, and prices are really high. When the market turns — and it will at some point — there’s going to be an increase in inventory and a decrease in pricing.

But, BeQuest Fund has an 8% annual preferred option with a one-year lock-in. If someone is concerned about inflation, they can come in at 8% and only lock in one year.

One of the questions I always get is how long is the investing period? What’s the normal, or average, period of time?

One option we have is 8%, that’s a one-year lock. The other option is 9% at a four year lock-in. Half of our funds come from self-directed IRA funds. Generally those people opt into the 9% option, as they want long-term gains. But there’s people that are using real-time funds who want to come in for a year and test the waters. 

At the end of the day, whether someone comes to BeQuest or to some other solution, everyone in the marketplace should be thinking about inflation and adding additional flows of income. This way, they’re able to absorb the hits… because they’re coming, it’s just starting.

I’m all about generating more passive income. I know that cryptocurrency, for example, is not going to feed my family. Precious metals are not going to buy groceries. So I invest in real estate notes because it generates hard cash on a monthly basis.

Does it work similar to a mutual fund? If someone doesn’t want to take a distribution on a given month they can reinvest the profit?

Yes. At the 9% option, the fund compounds at 9.38%. The 8% option compounds at 8.29%. Some people just let it ride, especially IRA investors. But either way works.

What criteria do you use when you’re picking mortgages? I know you mentioned owner-occupied homes, but what is some other criteria?

Making Real Estate Note Selections

The average fair market value of a mortgage in BeQuest is $311,000. We like to see a quality asset that’s the collateral for the mortgage. We do have a combination of senior liens and junior liens, but collectively we’re looking to hit below that 65% investment to value ratio. We’re looking for houses in suburban tertiary markets with HOAs. We try to stay away from blighted properties and not-so-good quality products. 

We also do underwriting on the borrower and their ability to pay. We’ll do credit checks and skip tracing to make sure that the borrower is making payments to the other liens on the property, as well as just other people in general. 

So, we’re looking at the property, the borrower and the borrower’s ability to pay.

So you have that information on the borrower?

100%.

Do you look at geographical location, or is it less of a criteria?

Not necessarily. We’re looking more importantly at the property itself, the borrower and their ability to pay. We’re in 34 states. We consider it spreading the risk, so to speak.

What access to what’s going on does the investor have? Do they receive a monthly statement?

We did a survey before we launched the fund, asking participants what they hate about alternative investments. Being “in the dark” was the number one thing. Investors will go nuts if they don’t know what’s going on. So, yes.

We hired a third-party fund administrator that takes care of operating our portal so investors get to see where their investment is on a 24×7 level. They’re able to pull down statements, which are sent to them monthly. We also send out weekly educational articles and emails. We send quarterly statements with financials for the fund. 

Yeah, I’d agree with the survey results, that’s what I’ve experienced from investors I work with. They get nervous when their money is going in but they have no idea what’s happening with it. Even if they’re not going to evaluate and analyze the actual underlying mortgages, just having the ability to see it goes a long way.

Does BeQuest include other types of mortgages, like those on commercial properties, in the fund?

BeQuest Fund is focused on owner occupied residential mortgages. We have another pillar of the business for hard money lending, note pools and rehabbing properties. And we have a third pillar for business notes.

We built those additional pillars in case we realized a slow down on the purchasing and performing of residential mortgages. So if we had a pile of cash sitting in the bank and no opportunities at hand, we have a plan B or plan C. But to date, we’ve seen opportunity after opportunity. We’ve had no slowdown in terms of purchasing these performing residential mortgages.

Earlier you mentioned that there’s a mix between senior lien and junior lien. How do you determine the overall risk of the fund?

Senior Lien vs. Junior Lien

So that’s an interesting question. Most people think that a junior lien is riskier than a senior lien. However, I would argue that the senior lien is riskier. Oftentimes the banks are not selling off high dollar fair market value, senior lien non-performing loans into the marketplace. They’re selling off junk properties that are 50K, 70K or even 20K fair market value. The senior liens that are performing in the marketplace tend to have a significantly lower fair market value associated with them. So the collateral back in the loan is not as strong as well as the borrower that is residing in that home. A 50K home is not going to have the resources and the means to maintain payments over the course of the loan, as much as someone in a 500K property on average. I know it’s all just a rule of thumb. So we see a better class of borrower and a better class of property on the junior lien side. But we’re open to buying both.

I browsed through the content on BeQuest’s website and saw that the fund has no fees. Fees, in general, are starting to get more attention from investors. Can you talk a bit about that, and explain what a preferred return means?

Absolutely. Our no fee policy is significant because, like you said, investors get fee’d to death. There are upfront fees, backdoor fees, fees for everything. 

We said we wanted to offer the annual return — either 8% or 9% — whereby there’s no fees associated. All necessary expenses/money required to operate the fund is going to be on top of what we’re paying our investors.

We take a very simplistic approach. If I say, “Hey, Marc. Congratulations, welcome to BeQuest Fund. You’re going to receive 9% on your $100,000 investment.” So that means you will earn $9,000 over the course of 12 months divided by 12. That’s your monthly payment. You can do the math on that. 

What is Annual Preferred Return?

Now, annual preferred return. There’s currently no leverage in the fund. What that means is as an equity stakeholder invested in the fund, you’re first in line to receive payment. So before anything’s paid, expenses, before I’m paid, my partner, any bank or what have you, you’re paid. So that gives you assurance that the money’s headed your way.

Okay, great. We’re just about out of time. Martin, I’d like to thank you for being on the show. You provided a lot of great information. How best can someone get in touch with you to find out more information on BeQuest Funds?

You can email me at infoatbqfunds.com and we’ll send you a free eBook, or you can visit our business page on LinkedIn: BeQuest Funds.

Great, we will link to that in the show notes. And thank you to everyone who tuned into today’s episode.