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An introduction to Real Estate Lender Finance (“Note-on-Note Financing”)

March 29, 2024 • 2 min read
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Discover how investing in “note-on-note” financing to real estate bridge lenders can earn attractive returns with two layers of downside protection.

Real estate bridge lenders often utilize a common form of leverage known as “note-on-note” financing to reduce their capital requirements and increase yields on their investments. In the following, we’ll explore what note-on-note financing is, how it works, and the key benefits it offers to investors.

What is Note-on-Note Financing?

Note-on-note financing involves an investor (the “note-on-note” lender) providing a loan to a bridge lender, which is secured by an assignment of the underlying loan as collateral for repayment. Typically, note-on-note lenders advance between 60% and 80% of the underlying loan amount. If the bridge lender defaults, the note-on-note lender can instantly foreclose on the bridge lender, wiping out their entire investment and becoming the direct lender to the original borrower. 

How Note-on-Note Financing works

Here’s a step-by-step example of how note-on-note financing works:

  1. Lender A (e.g., a bank, debt fund, or specialty lender) makes a loan to a borrower, secured by the real estate. 
  2. The Note-on-note investor (Lender B) makes a loan to Lender A, secured by the loan Lender A made to the Borrower. Lender B’s loan is senior and priced with a lower interest rate than Lender A’s loan, thereby increasing Lender A’s yield on the now-subordinate piece of the loan. 
  3. Lender A must pay interest to Lender B, even if the underlying Borrower has defaulted or stopped paying interest on the underlying loan. This provides an extra level of security for Lender B. 
  4. If Lender A defaults, Lender B can instantly  take ownership of Lender A’s loan to the Borrower, without going through foreclosure proceedings. Lender B now owns the loan to the Borrower at their advance rate (typically 60% to 80% of the underlying loan’s principal balance).

Key potential benefits of Note-on-Note Financing

  • Two layers of structural protection: The note-on-note investor benefits from subordinate capital from both the lender and the borrower. Even if the original borrower is in default, the lender is required to continue paying regular interest payment to the note-on-note investor. 
  • Stronger LTV: The note-on-note investor’s loan-to-value (LTV) ratio is lower than the underlying mortgage LTV. For instance, if a property is worth $1M and the lender makes an $800k loan at 80% LTV, the note-on-note lender’s investment at a 60% advance would be $480K (60% of $800k) or 48% LTV. 
  • Simple foreclosure process: At closing, the lender assigns the underlying loan to the note-on-note investor. In the event of a default by the lender, the note-on-note investor is able to instantly foreclose on the bridge lender, wiping out their entire investment and becoming the direct lender. If the borrower pays the entire original principal of the loan, that is retained solely by the note-on-note investor.

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