August 31st, 2013 categories: Seller Financing
This is exactly the kind of thing I hate to see… someone preying on older people who have a lot of equity, and not a lot of sophistication. In Virtual Coffee Q&A this month, I talk about a recent consulting client (an elderly lady with a husband with Alzheimer’s) who contacted me just hours before she was to sign a contract with a buyer.
He was offering her full price just 48 hours after her property hit the MLS, and the ‘nice title lady’ explained how everything would work, and she felt good about it, but just to make sure, she wanted to talk to me. After she did, she canceled the deal.
He was offering her full price, $820,000, but he would be making NO down payment. He would be putting a $420,000 first HML (hard money loan) on the property, and asked her to carry the remainder of her equity in a 2nd for $400,000. He said he would pay it off within 120 days.
All of the risk was on my client, the seller.
If he was so inclined, he could collect vacation (VRBO) rental dollars for 4 months while stiffing the 1st HML (private lender – who was probably a friend of his), and just before turning over the pre-signed Deed-in-Lieu, he could strip all of the furniture out of the property. To get possession of the property and keep it, my sellers would have to bring the HML guy current to the tune of $15,000+, re-key the property, and repair any damage.
When we suggested we switch to a lease-option, the guy who was so keen on getting her property suddenly couldn’t put it together when he needed to come out of pocket, even with a paltry 5%, to control this $820,000+ asset.
I told her she could proceed with the offer originally submitted if she asked for 3 important modifications to the agreement:
- Ask for additional security. I wanted her 2nd position note secured not only by her own property, but by other property that the buyer owned… property with substantial equity.
- I wanted him to sign a personal guaranty for the note that was to be signed by his LLC. It is all too easy to strip an entity of assets. If he defaulted, I wanted it to affect him personally.
- Approve the rate and terms of the hard money loan, as she could potentially inherit it. I also suggested that the first loan be pre-paid for 4 months at close of escrow, so that there wouldn’t be back interest, late fees and other penalties acruing while she was waiting for the balloon to mature on her second.
I will discuss this in detail in Transaction Review & Calculator Practice on September 3, 2013. Owner financing is a great tool and I believe in it 100%, but there are things you definitely have to watch out for.
October 11, 2013 – email from my client:
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I’ve had a couple of email inquiries about the use of owner financing (with the subsequent sale of the note) for high-end properties, and oddly, I was just interviewed by the Wall Street Journal who was covering the topic, inspired by a $29,000,000 listing where the seller is not only willing to offer terms, but creating a financial incentive if the prospective buyer will allow him to be the bank. More on that below…
Certain questions seem to fill my inbox in small, orchestrated groupings, as if there’s something in the air that makes several people have a certain thought or question all at the same time. Lately, it’s been the issue of how reasonable it is to expect that the secondary market for jumbo owner carry back notes provides a meaningful exit strategy for high-end home sellers.
Most of the notes I buy and/or broker are under $100,000, so I had to call around to a couple of larger note buyers to try and get my finger on the pulse of it, and I would greatly appreciate and encourage others to share with me if they’ve found different answers, or know of someone willing to drop millions at a time for an owner carry note… I can imagine some large hedge fund being able to absorb them, but I don’t personally know of any.
From what some of my peers in the industry have shared with me, they’d be willing to drop as much as $1,000,000 on a single note, as long as the underwriting was water tight… solid appraisal, large down payment, sterling credit.
That helps if the home sale is $2mil or less, but a seller of a more expensive home might need to leave quite a bit of equity in the deal until the buyer/borrower is able to refinance, or sells the property.
For some sellers, this is absolutely desirable, like for the guy mentioned in the WSJ article, who was actually willing to reduce the purchase price by $3mil if the buyer would allow him the privilege of being the bank.
Here’s what the seller was willing to do:
- Purchase Price: $26,000,000
- 60% Down Payment: $15,600,000
- First Note & Deed of Trust: $10,400,000
- Interest Rate: 3.8% (fixed)
- Term: 360 (30 years)
- Monthly Payment: $48,459.56
Why would he do this? My guess is he’s looking at other investment vehicles and deciding that all things considered, he’d rather have his $10mil secured by a property he knows intimately, rather than be exposed to the risks of mainstream investments one has less control over…. and, I’m supposing there could be a rather relevant capital gains issue there, as well.
I’ve had two buyer consulting clients recently who were looking to acquire high-end properties with terms offered by the seller, but in these two instances, there has been a rather significant bank loan that needs to be leveraged. The sellers have had as little as 25% equity (there was a 75% LTV note held by an institution), so we were exploring the various deal structures that would meet the needs of, and best protect, all parties (and the existing financing… which in one case was at 2% fixed after a successful loan modification).
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It was enjoyable to spend the morning with several people over “Virtual Coffee.” Although I confess, I’ve switched to drinking tea made of freshly juiced ginger, lemon, honey and cayenne… delicious, and doesn’t leave my stomach feeling sour.
The topics covered included: investing in notes, land contracts for sale, how owner-financed deals in New Jersey might be structured, as well as a lot of discussion as to how I can restructure the community to actually function more like a community, without soaking all of my time.
I definitely want the space to grow into something that allows members to build connections between themselves, and support each other, and probably do deals together. With education and support, and a common ethical framework from which to operate (which I hope I’ve instilled), we can all do a lot more business and create more solutions on all levels.
So, yes, I’m in the midst of an overhaul for the community, so please stay tuned, and if it’s right for you, I hope you’ll consider becoming a part of it. In the meantime…
Here’s the link to the call:
If you want to be added to the Virtual Coffee email group, please click the link above and follow the instructions, and after the next Virtual Coffee Q&A (that happens once a month) you will see that you are added to the list of parties interested in owner financing and notes.
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