Rising Interest Rates Make Private Mortgage Notes More Attractive and Dividend Stocks Less Appealing

In a recent column by Wallace Witkowski, a news editor for MarketWatch, a unit of The Wall Street Journal, it was detailed how investors are fleeing stocks that pay dividends due to rising interest rates.Private Mortgage Notes  In his excellent piece, "Why dividend yield stocks are getting dumped," Witkowski reports that, "Dividend rich stocks have lost their luster as Treasury yields have jumped, leaving cyclical sectors like banks and tech to do the bull market's heavy lifting."

 Long story short: When interest rates rise it becomes a "bull market" for private mortgage notes!

Private mortgage notes are the financing provided by an individual or group of investors to the borrowing party that wants to buy property.  An investor can either lend money for a defined real estate transaction or participate with others in a consortium.  By working with a syndicate of private mortgage note investors, there is more diversity in the portfolio of loans.

When interest rates rise, so do mortgage rates.  That is why stocks in the housing sector were hit hard in recent market action, along with the dividend equities that Witkowski wrote about in his article.  But rising interest rates mean that those providing private mortgages can increase the rate they charge, and thus the profits from the loan.  

This is a huge advantage of investing in private mortgage notes rather than dividend-paying stocks: rising interest rates benefit the owners of private mortgage notes.

There is another major feature of private mortgage notes that increase the allure as an investment: flexibility.  As the terms are worked out between the parties, those financing a private mortgage note can set the deal so that it meet their needs and responds to changing personal and evolving market conditions.  By contrast, the dividend from a stock is contingent on the action of the management of the company.  It can be reduced or omitted totally.

But a private mortgage note can have the interest rate based on Treasury Bond yields, for example, so that it rises along with those securities.  There can obviously be a floor rate to protect the investor.  If the party funding the private mortgage note wants to participate in rising property values, there can be a provision allowing for equity participation.  If the lender wants the money in a chunk down the road, there can be a balloon payment clause.  These are all terms that can be agreed to be the parties to the transaction.

For those just looking for yield, there is no comparison between private mortgage notes and dividend-paying stocks.

At present, the average dividend yield for member company of the Standard & Poor's 500 Index is around 2%.  Shaun Cohen, President of Equity Finance, the funding unit of EquityBuild, a real estate investment firm, reports that private mortgage notes have returned an average of 12% for its portfolio.  Historically, real estate has created about 90% over the world's millionaires over the last two centuries.  Over the course of The Great Recession when stocks and bonds plunged in value, rental income actually rose in the United States.  Properly structured, private mortgage notes can benefit the lender, no matter what the prevailing economic conditions.