With a rental you own the property and collect rent. With a note you own the debt and collect loan payments, and someone else owns and looks after the property. A note is less work and pays no more than its terms, while a rental is more work and can grow in value. Which one is safer depends on the particular note and the particular building.
The same house, two positions
Picture one house. The landlord holds the deed, finds a tenant, fixes what breaks and keeps whatever rent is left after costs. The note investor holds a lien on that house, a recorded claim that secures a debt. The owner of the house makes a fixed monthly payment to the investor, and maintains, insures and pays tax on a home that belongs to them.
| Rental property | Private note | |
|---|---|---|
| What you own | The real estate | A debt secured by the real estate |
| Who pays you | A tenant under a lease | A borrower under a promissory note |
| Repairs, taxes, insurance | Yours | The borrower’s, though you check they are paid |
| Vacancy | No tenant, no rent | Does not apply. The payment is due either way |
| Payment amount | Can be raised at renewal | Fixed by the note |
| Rise in property value | Yours | The borrower’s. It strengthens your security and leaves your return unchanged |
| How it ends | When you sell | When the last payment is made or the loan is paid off |
| If they stop paying | Eviction, then re-let | Workout or foreclosure |
| Bank financing | A standard bank product | A specialist loan, harder to find |
Where a note is the lighter load
A note holder has no roof to replace and no tenant calling at night. A servicer, the company that collects loan payments, takes in the money and sends it on. The person living in the house owns it and has their own money in it, which gives them a reason to look after it that a tenant does not have.
The income is also known in advance. The note states the payment, the due date and the number of payments left, and that schedule holds for as long as the borrower performs. A rental’s net income moves with repairs, vacancies and tax bills. You can read such a schedule on real notes if you join the buyer list.
Lighter still leaves work to do: choosing the note, watching taxes and insurance, and making the decisions if a payment is missed. Count those hours before you decide whether note investing is passive enough for you.
Where a rental has the edge
- Growth. If the property rises in value, the landlord keeps the gain. A note holder is owed the same balance whatever the house is worth.
- Inflation. Rents can be raised over time. A note payment is fixed, so it buys less as prices rise.
- Control. A landlord can renovate, change the use or sell when the market suits. A lender has no say over the property unless the borrower defaults.
- Permanence. A rental can pay for decades. A note runs down to zero, and an early payoff hands your capital back whether or not you have somewhere to put it.
- Financing. Borrowing against a note is possible through a narrower set of lenders. See hypothecation of a note.
When the payments stop
A landlord’s bad outcome is a tenant who stops paying and damages the unit. The fix is eviction, repairs and a new tenant, on a property the landlord already owns and has seen inside.
A note investor’s bad outcome is a borrower in default. The fix is a workout or a foreclosure, a legal process run by an attorney under state rules, and it may end with the investor owning a property they have never been inside. At that point the note investor has become a landlord or a seller of real estate after all, which is among the risks of note investing.
The note investor is protected by the price paid and the equity behind the lien, the landlord by the condition and location of the property. Both sets of protection are fixed on the day of purchase.
Tax treatment is different
Rental income and note income are generally reported and taxed in different ways, and a rental owner may be able to claim deductions, such as depreciation, that a note holder cannot. How that works out depends on your situation, so read how income from notes is taxed in outline, then ask a CPA before you compare the two after tax.
Choosing between them
If you want control and are willing to manage a building, a rental fits. If you want fixed payments and would sooner be the lender than the owner, a note fits. To test your answer, take one sum of money and work out the net rent on a rental it would buy, then set that beside the payment schedule and price of an actual note. Count the costs on both sides, including the due diligence and servicing steps in the investor guide.
Related questions
Is a note safer than a rental property?
Not by default. A note removes repairs and vacancies but adds the risk of default and foreclosure, and it has no share in any rise in the property's value. Which is safer depends on the price paid, the equity behind the lien and the condition of the specific property.
Can a note investor end up owning the property?
Yes. If the borrower defaults and the investor forecloses or accepts a deed in lieu, the investor may take title. From then on they have a landlord's or a seller's responsibilities, including insurance, upkeep and tax.
Do I need less money to buy a note than a rental?
It depends on the note and the property. Notes come in a wide range of balances, but a loan to buy one is harder to find than a rental mortgage, so plan on paying the whole price in cash. A rental bought with a bank loan needs the down payment and closing costs up front, plus a reserve for repairs.