In his "Fact and Comment" column in the June 24, 2013 Forbes magazine, publisher Steven Forbes warned about the continuing collapse in commodity prices, that will only get worse.  According to Forbes, this is due to the Federal Reserve pulling back from its quantitative easing programs, which will cause interest rates to rise.  

 

As a result, investors will flee commodities such as gold and oil for interest bearing instruments, such as Treasury Bonds.  This will make private mortgage notes even more appealing to passive investors with a long term approach.  Private mortgages notes are loans from individuals or a group of investors to finance the purchase of a property.  While individuals finance the purchase of a single property, that is very risky.  It is far better for investors to join with others in a pool of capital to fund the purchases of a wide variety of properties.  That provides diversity in the private mortgage investment portfolio, which is always better.

The returns on private mortgage notes have already proven to be strong.  Shaun Cohen, President of EquityBuild Finance, the funding arm of EquityBuild, a real estate investment company, reports a high annual return for its private mortgage loans.  That certainly beats the 2-3% that can be earned from Treasury Bonds.

The return from Treasury Bonds is expected to rise by Forbes and many others, however, due to Federal Reserve policies.  Since 2007, the Federal Reserve, under Chairman Ben Bernanke, has acquired trillions in Treasury Bonds and mortgage-backed securities to recapitalize the global financial system in an effort to keep interest rates low.  That was done through three quantitative easing programs.  Quantitative Easing II consisted of the Federal Reserve buying $700 billion in Treasury Bonds from November 2010 through June 11.

Quantitative Easing III, still in place, is an open-ended program that has the Federal Reserve acquiring $85 billion each month in Treasury Bonds and mortgage-backed securities.  Recently, there have been concerns that Quantitative Easing III will be truncated.  As a result, interest rates have increased with commodities falling in price.

That makes private mortgage notes much, much more appealing to investors.

Private mortgage notes benefit from higher interest rates.  As an interest bearing asset, like a Treasury Bond, a private mortgage note becomes more valuable when rates rise as it can charge more.  The cost of funds for private mortgage notes is low, as the capital is contributed by investors.  So the yield becomes even higher as interest rates surge due to the mortgage rate increasing.

There can also be provisions to gain from higher interest rates after the loan as been made.  A private mortgage note can have floating rate terms that increase the payment when interest rates rise.  This flexibility is a very alluring feature of private mortgage note financing, too.  If held in a retirement account such as an Individual Retirement Account (IRA), the investment income and capital gains are tax free.

When commodities fall due to interest rates rising, private mortgage notes increase in appeal.  The language of a private mortgage note can be drafted so that the investor is protected, no matter what happens in the economy.  For the passive, long term investor, private mortgage notes are rewarding no matter what the future brings.