The Installment Sale Can Meet Your Clients’ Needs for Wealth Preservation & Cash Flow
1. The Installment Sale is a proven strategic tool allowing them to effectively defer capital gains without having to do a 1031 exchange or buy an annuity.
Many of your clients are tired of managing property, or their health makes it much more difficult for them to do so, yet the rental income is important for a comfortable retirement. Not everyone wants to do a 1031 exchange into more management intensive property, and/or they really don’t trust someone else to manage it, even it it’s a TIC (Tenant-In-Common) arrangement. You want to be one of the few professionals equipped to educate them on the use of the installment sale. It will not only defer capital gains, preserving their wealth, but it will yield them monthly income that is quite often much higher than they are collecting in rent.
You will be able able to significantly improve the quality of your clients’ lives, and they will come back to you again and again knowing that you always have solutions that met their needs. [If your only reason for steering them away from the installment sale is the potential risk of foreclosure, then consider using the Title Holding (Land) Trust]
2. Trust deeds are one of the safest investments available when the transaction and the note itself are structured properly.
When you recommend that your clients explore the multitude of options the installment sale can offer them, you can feel absolutely confident that you are on solid ground with safe and sensible estate planning advice. The concept and practice of carrying paper is age-old and time-tested with standard underwriting guidelines. Many property owners feel comfortable having their property serve as the collateral for a nice monthly cash flow; because they know the property so well after having owned it for so long. There aren’t likely to be any surprises. The testament to the value of a nicely structured real estate note is this: there are hundreds of institutions and individual investors standing in line to buy that note. That’s how safe investors feel these instruments are. You and your clients will want to include a Note and Owner Financing Expert in a conversation about seller financing as you want to feel confident that you are creating an asset worth holding or selling.
3. With residential real estate, your clients can usually double their monthly income by receiving payments on a note instead of collecting rent.
Let’s take the example of a 3 bed/2 bath single family residence, with a market value of $450,000. Your clients may be receiving $1,400-$2,000 per month in rent. Out of this they need to pay taxes, insurance and make occasional repairs, so we can guess a net income of about $900-$1,500 per month. If they owned the property free and clear, they could sell this same property, take a $45,000 down payment, and carry a note secured by a first deed of trust for $405,000. There would be no taxes, insurance or repairs to consider, so the monthly income they would likely receive is somewhere between $2,560 and $2,832. As you can see, they get some cash at closing, and their monthly income is nearly doubled, hassle-fee. All they have to do is deposit the check each month.
4. The installment sale is NOT just for people who own their property free and clear. Seller Financing can be utilized effectively by someone who still has a loan on their property.
Am I talking about high-risk seconds? No. Although carrying back a second trust deed can be an effective strategy given the right circumstances, many people miss the opportunity to make a nice spread using Other People’s Money. And, in a buyers’ market where financing is tight, offering terms might be the only way for your clients to sell quickly and get their price. What if you were able to show your clients how they could make an extra $300-$700 per month on top of the benefits of deferring capital gains? Do you think they might get excited about that?
If your clients have great financing in place, they may very well want to profit from their ability to borrow money at a low fixed rate. Let’s take the example above, but let’s pretend that they have a $300,000 mortgage at a fixed 5.75% amortized over 30 years. They take the same $45,000 down, but instead of carrying any seconds, they decide to do a wrap, an All Inclusive Deed of Trust. They charge the buyer 7.5% and receive monthly payments of $2,832. The payment on their underlying financing is $1,750, so they have a monthly spread of $1,081. They are making 7.5% on their $105,000 of equity (734), and they are making a 1.75% spread on the bank’s money ($347). That’s $347 per month using Other People’s Money!
But what about the Due-On-Sale clause?
Great question. To prevent any financial institution from being able to accelerate a loan upon transfer, we generally use the Title Holding (Land) Trust. It’s a powerful tool in many regards, especially for residential properties. (It won’t prevent acceleration on commercial properties, we have to go about that differently).
5. Seller Financing is one of the oldest and most trusted techniques in the country for selling real estate and businesses.
It’s only in the last few years of easy financing that the idea of carrying paper got all but lost. The truth is that seller financing has been around for years, and in some areas of the country, seller financing has always been and remains a very popular strategy for disposing of real estate, especially in the market that is evolving today. More than $94 billions dollars of private real estate notes are created each year.
In the current economic climate, more and more people will once again turn to the installment sale to get transactions consummated. Business owners are much more familiar with the idea of carrying paper, simply because there has never been an ample and dependable supply of financing for the purchase of businesses. It is common for small business owners to take 50% down and carry the rest for up to 7 years. The underwriting guidelines are different, but business notes can be bought and sold just like real estate notes. This gives the note holder the option of cashing in when the next great business idea comes along.
6. For your clients that prefer to sell their properties FSBO (For Sale By Owner), being familiar with the installment sale and seller financing strategies can give them the competitive edge, the BOFS, they’ll need to sell quickly for top dollar.
Most people realize the value of using the services of a good real estate agent in today’s market, but occasionally, you have clients that are fairly sophisticated and just don’t need or want an agent. If these clients are flexible and open to the idea of offering terms, they will have an edge that can more than compensate for lack of exposure in the MLS (not to mention that they can get MLS service for a very low price).
Adding “Owner Will Carry – No Bank Needed” to any advertising will attract a much larger group of interested buyers. In today’s lending climate, there are people with cash, but not the credit needed to secure reasonable conventional financing. Offering terms arms your client with bargaining power and they are much more likely to get their price. In fact, depending on the property, being willing to finance all or part of the sale may be the ONLY way to sell in this market!
And carrying paper DOES NOT mean that they cannot walk away with cash at closing!
7. Seller Financing can be used to quickly and inexpensively sell any property for full market value regardless of market conditions.
When an escrow is not dependent on third party lending, the transaction is simplified tremendously. It’s common for these types of transactions to close in 7 days. So, when your client decides to offer financing and gets lots of offers, he can close 4 times faster than if he waits for the buyer’s financing to come through. The Seller can use the installment sale to close the deal and then either keep the note as a nice trust deed investment, or sell it immediately for instant cash. Let’s go back again to our example. Your client sold their free and clear property for $450,000. They took a 10% down payment, and amortized a note over 30 years with a 5 year balloon. Here’s how it works:
- Sales Price: $450,000
- Down Payment: $45,000
- Note Amount: $405,000
- Amortized over: 360 months (30 years)
- Balloon Due In: 60 months (5 years)
- Interest Rate: 7.5%
- Monthly Payment: $2,831.82
- Balloon Amt: $383,200.52
An investor comes in and buys all the monthly payments for the next 60 months, plus half of the balloon payment:
- TD Investor Gives Seller: $249,733.04
- Buyer’s Down Payment: $45,000
- Half of Balloon (in 60): $191,600.26
- TOTAL: $486,333.30
- Closing costs & commissions: $24,000
- TOTAL to Seller: $462,333.30
That’s more than the original sales price of the house! The seller carried paper to get the deal done, and still walked away with cash at closing.
8. Notes can be held in a trust and greatly enhance the quality of an inheritance for future generations.
Many clients, although they would like to, won’t sell their investment properties because they’ve put them in trust for their children or grandchildren. What they fail to realize is that a trust deed can be held in trust the same way property can. The trust simply receives the note payments on behalf of the beneficiary. The nice thing about a note is that is doesn’t need any management! Especially if you have a note servicing company handling the note, which I highly recommend. Not all beneficiaries are interested in managing property. They usually have time to deposit a monthly check, however. And, if the heirs ever need cash, they can sell a portion of the note. They cannot sell 1 room of a 3 bedroom house, but they can sell a few of their note payments quickly and with ease.
9. Notes can be created in a multitude of ways to meet the needs and financial objectives of the note holder.
- What’s the minimum amount of cash that the seller absolutely needs?
- What’s the maximum amount o money the buyer can put down?
- What is the credit worthiness of the buyer?
- How long does the seller need or want to carry?
- If there’s a balloon payment, what is the exit strategy?
- Will the seller have regular needs for larger sums of money?
- Do they need to buy a new car, or pay for medical expenses?
- Will the seller need stepped-up payments to keep up with inflation?
There are many factors that can be manipulated to come up with a creative, unique solution that meets the needs of all parties concerned. Carrying paper is one of the most flexible, adaptable tools available in the disposition of real estate.
10. Well-constructed notes can be sold for minimum discount at the point of note creation or at any time in the future.
A note secured by a deed of trust or a business is an asset that can be bought and sold rather easily. The sale of a note is not as different from the sale of real property as you might imagine. Many of the same principles apply, and even some of the same paperwork. The amount of discount required to sell any given asset is related to the amount of risk it represents. The relative risk of any cash flow is usually determined by evaluating the four following factors:
- Protective equity
- Credit history of Payor
- Payment History
A note with 50% protective equity and a 800 FICO many sell for 90 cents on the dollar, whereas a note with 5% protective equity and a 550 FICO will require a steep discount, perhaps 65 cents on the dollar (if it can even be sold at all). As of this writing, there is almost no institutional buying of notes where the Payor’s credit score is below 600.
11. The flexibility and cash flow potential of a real estate note is unparalleled.
Some of your clients may own properties that they just can’t sell. Sometimes mixed use or non-conforming properties cannot qualify for traditional financing. Being willing and able to carry paper can help your clients sell a property that they otherwise might be stuck with. And, the return on these types of notes can be far superior to bonds or bank CDs. As their trusted adviser, you’ll want to bring in a Note and Owner Financing Expert to make sure your clients are protected in the transaction. You want to structure the note to have maximum market value down the road.
12. They can sell a portion of a real estate note to raise quick cash for any reason.
Most people do not know that they can sell part of their cash flow. This is called a “partial.” Let’s say your clients carried back that note up above. Everything is going well and they are receiving their $2,831.82 per month like clockwork. Then, after they receive their 6th payment, their grandson gets accepted to Princeton and needs help with tuition. They want $25,000 cash right away to help him, so they decide to sell a portion of their note:
- Investor gives seller: $25,000
- Investor pays closing costs: $2,000
- Investor gets 10 monthly payments: $28,318.20
- Yield to Investor: 10%
- Note balance after 6th payment: $403,168.17
- Note balance when seller starts receiving payments again: $399,626.66
- Amount of principal reduction while investor receiving payments: $3,541.51
To raise $25,000 of instant cash, the note holder only had to sell 10 payments and when they got their note back, the principal balance of the note was only reduced by $3,541.51 There are so many ways to make the numbers work for everyone involved. Now, what if the seller needed at least $1,400 a month to live on? Then what? Well, instead of selling 10 whole payments, maybe they would sell half of each monthly payment for 23 months. The possibilities are endless!
13. It’s easy to get a Professional Note Appraisal to determine the market value of any notes in their portfolio.
Do you have clients who have notes in their portfolio? Do you think they might want to know the market value of that note? Your clients can get a Professional Note Appraisal on a note secured by real estate. Many lay persons, as well as professionals, are under the assumption that the value of a note is its principal balance. Not so. Just like real property, there are many factors that influence the value of a note at any given point in time. The market value of a note is dependent upon the general economic and financial conditions, as well as several intrinsic factors such as: 1) protective equity, 2) credit worthiness of Payor, 3) payment history, and 4) seasoning. For a reasonable fee, your clients can request a Professional Note Appraisal and know exactly what the market value of their note is at that point in time.
14. Knowing the market value of their real estate notes can decrease their taxes.
Not long ago I was approached by an attorney who was representing an $8,000,000 note portfolio in a debate with the IRS. The IRS has stringent guidelines about how notes are valued for estate tax purposes, but nevertheless, the Professional Note Evaluations I completed ended up saving the client over $200,000 in estate taxes. Just like taxes are paid based on the appraised value of real property, many times taxes can be reduced if we show that the true market value of a note is less than its principal balance. In one instance, my appraisal work revealed that although the note had a balance of $250,000, the deed of trust securing the note was only for $167,000! Therefore, the maximum value of the note could not be more than $167,000 because it was the only security for the note. This saved the client several thousand dollars in estate taxes.
15. A note can and should be serviced by a professional note servicing company to protect the value of their asset.
There are several major and minor factors influencing the value of a note, which we touched on above. A note is not complicated in most instances, but it does require a little maintenance. For instance, the payment history needs to be carefully documented. If the note holder ever wants to sell all or part of the note, the buyer of the note will want to see a copy of the payment history. They will not just want to take your client’s word that it’s been a performing asset. They’ll want to see that each payment was received in full and on time. A note that pays predictably is much more valuable than a note that has delinquency problems. This is where a professional note servicing company comes in very handy. They take care of all the appropriate documentation that preserves the value of the note. Additionally, they prepare all the 1098’s and 1099’s at the end of the tax year, collect any late payments due, and field any problems that may come up. It’s definitely worth the small fee per month that is costs for private note servicing.
Protect yourself and work with a Note and Owner Financing Expert when setting up an installment sale for your clients!
Invite me in to make sure that the payments, dates and other aspects of the note are accurate. Having a Note Specialist involved at the point of note creation helps to preserve the note’s value with an eye on potential sale in the secondary trust deed market down the road. The Installment Sale is a proven strategic tool allowing property owners to effectively defer capital gains without having to do a 1031 exchange.
Trust deeds are one of the safest investments available when the note is structured properly, and they can save your client hundreds of thousands of dollars. If your have clients that are tired of managing property, tired of paying taxes and insurance, tired of low-paying tenants, it’s time you arrange a meeting with The Note Queen. I can help you and your clients explore alternative and legitimate ways of doubling their monthly income, and eliminate all the hassles of ownership.
Discover How Installment Sales can Solve Your Client’s Capital Gains Issues and Meet Their Needs for Wealth Preservation!
Call 626.470.3477 today to discuss how a referral partnership with Dawn an improve the value you deliver to clients. Also, learn how you can schedule Dawn as a featured speaker at your next meeting.