How To Invest in Debt: A Complete Guide to Alternative Opportunities

Introduction

Debt Is Rampant—Let’s Make Money

Our Debtor Nation is facing a real problem with excessive debt. As of the end of 2016, the official debt of the United States government was $19.3 trillion, which breaks down as:

•   $59,508 for every person living in the United States

•   $154,407 for every household

•   106 percent of the US gross domestic product

•   553 percent of annual federal revenues.

It took decades to get ourselves into this situation, which will not go away any time soon. I have yet to hear of any politician with a concrete plan to address the debt crisis. Most won’t even mention it. There is nothing that we can do as individuals to solve this problem, so, as private investors, we seek ways to profit from this situation. This book will introduce you to ten opportunities to invest in debt. These investments are not widely known or promoted. They are often purchased at deep discounts, and the debt is often secured by valuable real property. Our leaders in Washington, DC, have loaded us down with lemons, so let’s learn how to make a profitable lemonade stand.

Through my twenty-five-year law practice, I have represented a variety of large and small investors who have profited from investing in various forms of debt. I have learned the advantages and disadvantages of each option, and I distilled a guide for ten ways to invest in debt, either directly or indirectly. These investment vehicles are unusual. They can provide a valuable hedge against stocks and bonds, which move with the economy. These alternative debt investments often perform better when the economy is struggling—contra other investments.

Most people have not even heard of these opportunities. There are very few books on these subjects, and they are not typically discussed on televised investment programs.

•   Tax Liens

•   Peer-to-Peer Loans through internet sites

•   Defaulted Credit Card Debt at a Discount

•   Defaulted Mortgage Notes

•   Performing Mortgage Notes at a Discount

•   Sheriff’s Sales

•   White Knight Rescues of Preforeclosure Properties

•   Buying Foreclosed Properties

•   Life Settlements & Viaticals

•   Mortgage-Backed Securities

Each chapter in this book will introduce you to a different way to invest in debt. I’ll explain how each investment vehicle works and tell you everything you need to know to participate in these opportunities. This book is not intended to promote these investments. I’m not selling any consulting services or webinars. I will lay out both the good and bad aspects of each concept and leave it up to you to decide which are for you.

Is This Stuff For You?

Some of these investment opportunities are not for everyone. They work well for a certain type of person with an entrepreneurial spirit, a stomach for risk, and a high level of self-motivation. In my experience, the most successful investors in these vehicles have run their own small business or have experience investing in real estate. Others may very well succeed with no real estate or small-business experience, but be honest with yourself. If you have always been a nine-to-five employee, and never got around to investing in real estate or even picking your own stocks, then the more complex investments may not be the place to start. Don’t worry, we will also cover a few debt investments that don’t require any specialized knowledge or work at all, such as peer-to-peer lending, mortgage-backed securities, and life settlements. There is something for everyone.

This book does not promote any miracle investments or easy money. Some of the investment opportunities discussed are more like small businesses themselves than simple investments. In order to generate returns that are higher than average, an investor must find a way to gain separation from other investors. To beat the general market, an investor must gain an advantage over other investors and over the market itself by adding one or more these factors:

   Luck

   Risk

   Work

   Specialized knowledge or ability

Anyone can get lucky and pick a winning stock once in a while, but luck is not consistent, and you can’t do anything to improve or manage your luck. In order to obtain consistent higher returns, investors gain an advantage through hard work and by developing an advanced knowledge and ability to manage risk. For example, anyone can hit a lucky basketball or golf shot once in a while, but if you want to consistently win at basketball or golf, you can’t rely on lucky shots. This common-sense rule applies to investing as well, so if you want to consistently win financially, then you must put in the work and gain a specialized knowledge and skill that most others don’t have. Learn to recognize opportunities that others don’t see.

Risk and reward go hand in hand. Investments with high potential rewards always carry higher risks. You must be willing to take risks and also be capable of assessing and managing those risks.

But don’t worry, there is a book that guides you through these markets — and you are already reading it! If you are with me so far, then you have what it takes to succeed. Keep reading for the information and skills that you need to set yourself apart, manage the inherent risks, and succeed with these investments.

Market Theory

In each chapter, I include a brief discussion of the theory as to why these investments can produce above-average returns. I know that market theory sounds a bit boring or complex, but a brief explanation helps to understand each investment vehicle, and why it might work for you. I’ll keep it short!

The investments addressed in this book have varying pros and cons, but they all relate to debt, and they all take advantage of being part of imperfect markets. By using the term imperfect, I don’t mean to imply that they are not good investments. These investments have qualities that are far from what is considered to be Perfect Market Competition, and because of those imperfect market qualities, it is possible to gain advantages and earn high profits.

Perfect market competition is purely theoretical. No market is truly perfect, but the theory is useful in comparing different markets. When a market is closer to being perfect, it is harder to achieve outstanding returns. Markets that are further from perfect can generate higher returns because the imperfect aspects of the market create opportunities. What makes a market more or less perfect?

Perfect Market Factors:

  1.   Liquidity—Many buyers and sellers transacting on a constant basis;

  2.   Non-Monopoly—Many small competitors so that no one can dominate the market;

  3.   Information—Complete information is easily available to everyone about the product being sold and the prices paid by others; and

  4.   Easy Access—No barriers to entry into the market such as licensing, specialized knowledge, or large capital requirements.

Again, no market is truly perfect, but the US stock market is an example of a market that is set up to score very high on these factors:

Perfect Market Factors as Applied to the US Stock Market:

  1.   Liquidity—Shares in most large companies are traded thousands of times each day. There are almost always buyers to match with sellers, so anyone can buy or sell any share in literally seconds.

  2.   Non-Monopoly—There are millions of buyers and sellers, and dozens of brokers to trade through;

  3.   Information—Information about publicly traded stocks is regulated and shared openly (despite examples of people who cheat with inside information). The stock markets are designed so that all investors have easy access to information about publicly traded companies, and instant knowledge of exactly what each stock is trading at on a moment-by-moment basis; and

  4.   Easy Access—Anyone over the age of 18 can open a brokerage account with as little as a few hundred dollars and begin to buy and sell stocks from a home computer or phone. No licensing, training, or specialized knowledge is required.

Because of these factors, which are designed to create transparency, fairness, and access, most people find it very difficult to consistently gain outlying results buying stocks. Even highly paid professional fund managers rarely beat the overall market on a consistent basis.

A basic understanding of this perfect market theory is helpful in understanding why the investments discussed in this book can create exceptional results in very imperfect markets. Let’s take tax liens as an example. We haven’t gotten to the chapter on tax liens yet, so don’t worry if you aren’t familiar with them yet; but let’s run them through the perfect market factors as a way to further illustrate how these factors work:

Perfect Market Factors as Applied to Tax Liens:

  1.   Liquidity—Unlike stocks and bonds, tax liens are not sold through a broker. They are generally sold at public auctions in the county or municipality where the property is located. There is no generally accepted secondary market to sell a lien. So if an investor wants to cash out, he or she must go out and find a buyer;

  2.   Non-Monopoly—There are many tax lien investors, so the public auctions can be competitive; but sellers are generally limited to municipalities or counties, so there is a firm limit on when and where an investor can buy a tax lien;

  3.   Information—Some critical information is readily available for tax lien investors such as tax-assessed property value, and photos are often available on line; but there is no public record of prior trades (which stock investors rely upon), and a tax lien investor is not permitted to enter or inspect the subject property, so investors are expected to bid with very limited information; and

  4.   Easy Access—Anyone over the age of 18 can buy tax liens, but most sales are live auctions, so an investor must either travel to attend the auctions or train and pay a bidder to attend an auction. Training and some degree of specialized knowledge is needed.

This comparison of the tax liens market to the stock market demonstrates how the tax lien market is far from a perfect market.

So why is an imperfect market a better place to invest? Good question. It isn’t necessarily a better investment for every investor. If you seek a safe and secure investment in which you will get the same returns as the general market, then you should invest in bank CDs or index funds. There is nothing wrong with that safe and secure approach. But imperfections or inefficiencies in a market can drastically reduce competition and can create opportunities for a sharp investor to buy at a deeply discounted price—a bargain. If you seek to beat the market and shoot for some outlying gains, then look for imperfect markets.

For example, if an investor is seeking to buy a two-family house in a particular county, that buyer would have access to photos, recent comparable sales, and other detailed information listed on the Multiple Listing Service (MLS) website. The buyer could walk through and inspect the house. All other potential buyers have the same information at the tips of their fingers, so it is not reasonable to expect to get a great bargain. By definition, the buyer must be willing to pay more than anyone else is willing to offer at that given time. That system is fine if the goal is to reach a fair price. An investor seeking a true bargain, however, is unlikely to find it on the MLS. A bargain hunter must look in imperfect markets to find truly undervalued assets. That is what this book is about.

Most people who invest in the vehicles discussed in this book also hold traditional stocks and bonds. The options in this book merely present an alternative for a portion of a well-balanced investment portfolio. These debt investment opportunities do not typically move up or down with the stock and bond markets. Some tend to perform even better in a bad economy. Personally, I consider these to be a useful hedge against my other more traditional investments, and a way to swing for larger results on a small portion of my funds.

So Why Haven’t I Heard of This?

I’ve heard this question many times. If these investments are so attractive, why haven’t I heard of them? Why hasn’t my broker or financial advisor told me about them? Most people who bought this book probably have at least heard about tax liens or sheriff’s sales, but it is true that most of the subjects are not common knowledge, and the reason is fairly simple.

   No commissions. Most of these investments do not generate a commission or fee, so brokers and financial advisors don’t bother with them. Why should they develop a specialty in an area that does not earn them a fee?

   Specialized knowledge and experience. These investments are not meant for everyone. As detailed in each chapter, these opportunities are not for rookies. Many require a large cash investment, others are restricted to qualified investors with a high net worth and income level. Most of these investments also require some degree of experience, work, and knowledge.

Know the Terms

As unusual terms are introduced in each chapter, I’ll provide definitions that are relevant for the subject matter of that that chapter. These basic terms are more common and relevant to all of the subjects:

Chapter Format:

For the sake of clarity and continuity, each chapter is structured in a similar way. Some of the subject matter overlaps and applies to other investment vehicles, so the repeating format may be helpful in understanding and comparing the different investment options. Each chapter includes a discussion of the following factors so you can easily compare and contrast the characteristics of each investment:

  1.   Overview of Investment

  2.   Words of Wisdom from an Experienced Investor

  3.   Minimum Capital Requirement

  4.   Scalability

  5.   Liquidity—Cash Flow and Resale Market.

  6.   Priority over Other Forms of Debt

  7.   A Little on Market Theory

  8.   What Can Go Wrong? Common Pitfalls

  9.   Common Terms

10.   Source Books, Consultants, Websites and Sellers

You have already taken the first steps of picking up this book and starting to read it, so you are on the right track to exploring these relatively unknown investment concepts. I hope the chapters that follow lead you to new avenues to achieve your financial goals.

1

Tax Liens & Tax Deeds

Make Money by Paying Other People’s Taxes

Income tax, sales tax, real estate tax … everyone hates to pay taxes, but most people don’t know that there is a way to make great profit from paying taxes. This chapter will tell you how to invest in high-yield property tax liens that are secured by first- priority liens on real estate.

High interest and low risk are very attractive terms these days. With interest rates near historic lows and the high volatility of the stock market, many people have been drawn to alternative investments. Tax liens accrue interest at 21 percent or higher, they’re secured by a first-priority lien on