Last week I spoke at the annual REI EXPO, and found it to be very educational. As I mingled and talked to novices, as well as experienced professionals, I discovered that note myths die hard, if they die at all.

My separate conversations with an experienced title company closer and a knowledgeable real estate attorney are a case in point.

After explaining that I purchase owner financed real estate notes, both the attorney and title company closer mentioned they might have clients interested in selling their notes. Both explained that since the notes were paying "above average" interest ranging from 10% to 14%, their clients would demand either full value for their note, or only a meager discount.

This was wake up call for me as it reminded me of all the myths about notes that even professionals cling. Although many real estate professionals are quite knowledgeable in their related fields, they lack knowledge in notes investing. Those who have been following my newsletters, or taken my workshops can spot their mistake immediately.

Note Axiom: YIELDS ARE TARGETS ONLY. You will not know your true yield until you are actually paid off. This brings up probably the number one note myth held by professionals, novices and even experienced Note Buyers and educators.

MYTH: Notes are discounted because of time value of money.The title company closer and real estate attorney were trying to convey that since the notes contained interest rates of 14%, the time value of money concept would dictate the discount would be slight or even zero. This would be true if notes were discounted because of the time value of money. However, like all investments, notes are priced in accordance to the risk the Note Buyer is taking relative to other investments.

Let's re-examine these risks:

Interest Rate Risk: Possibility that a fixed rate debt instrument will decline in value as a result of a rise in interest rate. (Similar to INFLATION RISK)

Collateral Deterioration and Devaluation Risk: Possibility the collateral of a debt will deteriorate or be devalued in price

Repayment Risk (Credit Risk): Possibility the borrower will not pay the obligation as promised

Liquidity Risk: Chance you will need immediate cash and not be able to convert for a price at least the amount you paid. Affected by interest rate and devaluation risk.

Risk-Adjusted Discount Rate: The rate necessary to determine PRESENT VALUE of an uncertain stream of income. "Risk Free" rate (Treasury Bill or CDs) plus the premium adjustment to account for the risk involved.

I gave my One Minute Note Buying Workshop to both the title company closer and real estate attorney by asking a couple of questions. "What are the payors credit scores", I asked. "Not good", was the reply, "but they are paying on time". Next I inquired, " What is my yield if I am forced to foreclose, incur major repair expenses to make the property marketable, and the real estate market declines or there is no financing available to sell the property?" I then explained the risks involved in purchasing notes, and why notes are discounted. I was amazed that I got "deer in the headlights" look from both of these very knowledgeable professionals. I would not object to using either of these professionals in their field of expertise, yet their lack of knowledge of note investments speaks volumes on how taking back notes, or investing in notes is misunderstood.

Encounters like these are not out of the ordinary. The risks listed above are valid no matter if you are investing in notes or stocks, but you would be surprised how the risks of any investment are overlooked or just plain ignored.

Conclusion: Notes are discounted because of the risks involved in purchasing notes. Do not let high yields blind you to the risks involved. If you take back a note with a 14% interest rate, you will not know your true yield until you are paid off. I will close with an investment axiom all wise investors are aware:

Yields Are Targets Only. Beware of the risks involved.

If you know of someone who has a Note they want to convert to cash, remember me. I do pay referral fees.

Got questions or comments, be sure to contact me at It is from your feedback that I get topics for my news letter.


Tom Henderson
a.k.a. THE NOTE PROFESSOR
Copyright © H&P Capital Investments LLC
All rights reserved

If you have not attended a Note Professor "How To Get Rich with Notes" class, be sure and purchase the Note Professor Note Book manual to enhance your knowledge of creative real estate financing and note buying and selling.

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By popular demand, THE NOTE PROFESSOR NOTEBOOK is now available in easy, downloadable E- book form for a the low, affordable price of $39.95. Other products are also available, including HOW TO MAKE OBSCENE PROFITS with SMALL MONEY, and GUIDE FOR SECOND LIENS. There is also a FREE download of CHECK LIST FOR OWNER FINANCING. Simply go to the NOTE BUYERS STORE. I can think of nowhere that you can find such information packed products at such incredibly low prices. We are still working out the bugs, so if you have any problems, be sure to contact me.

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Quantitative Easing, or the Federal Reserve "pumping up" the economy, is in the headlines again.

Remember that "quantitative easing" is nothing more than the Federal Reserve creating money out of thin air. The Federal Reserve has indicated it will "pump up the economy" by $45 million a month to purchase mortgages, as well as another $40 million a month to continue its "Operation Twist Program" (named after the dance, if you can believe it) which does a shell game of selling short term Treasuries to purchase long term Treasuries. All in all, this translates into $85 million a month increase in the money supply. When the money supply increases with no corresponding increase in production, this results in the declining value of the currency, which causes prices to rise. An increase in the supply of money with no corresponding increase in production is actually the definition of "inflation". The currency inflates.

One of my subscribers asked me why inflation has not risen given the fact that Quantitative Easing I, QE II, and now QE III seems to be a permanent part of "the recovery". Good question; because if cause and effect are valid and "inflation" has not risen in light of the Federal Reserve's printing money, this would indicate the definition of inflation is wrong. So why the discrepancy? Why has inflation NOT risen.

In economics there is a Latin phrase cateris paribus, which means "all things remaining the same" or "all things being equal". For example, if demand of a commodity remains the same and supply of the product increases, "all things being equal" the price of the commodity will decline in accordance to the laws of supply and demand.

With this in mind, here is a valuable economic lesson that took me 7 years to learn. When economic events DO NOT follow the laws of supply and demand, or other economic axioms, ALL THINGS ARE NOT THE SAME or ARE NOT EQUAL.

Here is a good example: the supply of unskilled labor is increasing, therefore; the price of unskilled labor should be declining, but the wages for unskilled labor is not declining. Are the laws of supply and demand wrong? No. ALL THINGS ARE NOT THE SAME.

The equations omits there are artificial price controls in the form of "living wages" and "minimum wages" which keeps the price for unskilled labor artificially high and results in high unemployment in minority neighborhoods and among teens. It is not that the laws of supply and demand are incorrect; it is the fact that minimum wage laws invalidates the scenario because "all things are not equal".

Likewise with inflation. When the Federal Reserve has been printing more money than Parker Brothers for its Monopoly Games, why has there not been a high rise in interest rates, as well as a high rise in prices? Let's look.

Why interest rates are not rising is easy. The Federal Reserve establishes the interest rates and refuses to permit them to seek market value. As a result, interest rates are artificially low. In other words, "all things are not equal" and the laws of supply and demand have been usurped. This fact needs no more explanation.

When I explained interest rates to my subscriber, she indicated she understood why interest rates were artificially low, but did not understand why inflation and prices have not risen?

At this point I asked a question that I hoped will clarify the situation. "Have prices risen in the last few years?" "YES", was the reply, "but inflation is still practically non existent. How can this be?"

The answer to this question lies in HOW inflation is measured or defined. Inflation is not measured in the amount of money the Federal Reserve prints, but rather by the Consumer Price Index, or how much prices rise. What is "not equal" is the definition of inflation has changed from "general inflation" to "core inflation". They have slipped a sleight of hand in on us. Because of space restraints in this newsletter, I will be shortening explanations, while still grasping the gist of how the sleight of hand works.

In prior days, a "basket" full of goods and services were priced say 20 years ago which is the base. This "basket" would then be compared to the same "basket" now to determine how much prices increased or decreased during this period. The result will be the inflation rate. However, now instead of the "basket" we used in the past, we have what is called "core" inflation. What is the difference? "Core" inflation does not take into account ENERGY nor FOOD. For government economists, energy and food are volatile to the weather and should not be included in calculating inflation.

While it is true a drought or hurricane can disrupt supply of food and refineries for a short time, it is also true that increasing the money supply is almost always followed by an increase in oil and food prices. I am not going to delve into the price of food increasing because of government demanding ethanol in gas, which uses about a third of our production of corn. Be that as it may, the powers that be have chosen not to include food nor energy in their calculations. It is almost as if they are saying, "if you do not drive or heat and cool your home, nor do you eat, prices are not going up." We know better.

There are several other techniques government economist use in "redefining" inflation. One method is how they will weight certain goods or products in their averages. For example, in President Carter's administration, since house prices were going through the sky, they decided to calculate housing by "owner's equivalent rent". This skewed the inflation rate a bit lower because rents were more stable than housing prices in runaway inflation. Yet if they had used this method the same way in 2005 through 2010, housing prices were going down, while rents remained the same if not climbing. However, there was no "inflation" in housing. In other words, if rents are stable, use rents to determine inflation if prices for houses are rising. If prices for houses are declining, and rents are stable or rising, use housing prices as the measurement.

Another method of cooking the books is called "hedonics". Under this concept, if you purchase say a new car, since your new car has blue tooth or some other improvement, the car price did not actually go up because of the added improvements. Likewise, if you buy a new appliance with extra costs because of government regulations, you can rejoice that the price of your appliance has not risen, and there is no inflation. Never mind, you paid more for it.

Last but not least another method is called "product substitution". You are going to love this one. Let's say the price of steak rises and you start substituting hamburger for steak. They will eliminate steak from the index and use the price of hamburger as if it were steak. Then lo and behold, there is no price increase because the hamburger price that increased is the same as the old steak price.

A study was done that indicated if we used the "basket of goods and services" and used the same method of calculating inflation as we did in the Carter Administration, inflation would be approx 10%. Is it becoming clear that "all things are not equal". We do have inflation, but they changed the definition.

On a real estate note, since QE3 is purchasing mortgage back securities and Fannie Mae notes, there well could be another "jump" in real estate. But this is an illusion, not prosperity. Buying up mortgages with nonexistent money is not the same as producing wealth. You would think politicians would have learned it was just this sort of interference that created the bubble that brought everything down. But then again, we are dealing with a mentality that believes all we have to do to end inflation is to change the definition. However, when you change the definition of a term, "all things are not the same". Hence we are printing more money and inflation has not risen.

If you have a question or comment, please CONTACT ME. It is from your feedback that I get many of my topics.

Remember, if you know of someone who has a note to sell, I will pay a referral fee, or split my profits with you

Tom Henderson /a.k.a. THE NOTE PROFESSOR .

Copyright © H&P Capital Investments LLC
All rights reserved