Creating notes to buy a property - Posted by Jim Beavens

Posted by FJW on November 03, 1998 at 20:39:39:

As far as I know, on a non-owner occupied, over 4 unit multi (commercial), lenders are going to be looking at 60% ITV or Investment To Value to start. Obviously all lenders have different parameters and maybe you can find one that will go higher, but I’m thinking it may be a stretch. Explain that to him and maybe his motivation will go even higher. He will definitely need to find someone to come in with all cash if he wants to move it, or at least qualify to take over the existing. Again Good Luck.

Creating notes to buy a property - Posted by Jim Beavens

Posted by Jim Beavens on November 03, 1998 at 13:45:15:

I posted a couple weeks ago on the Real Estate Forum about a 6-unit property I was trying to buy. It was a long diatribe about how I was trying to assume the existing loan, but the bank turned down my application. We’ve been looking for other financing, but having a hard time finding anybody willing to go above a 70% LTV (local banks seem to be shoring up their lending criteria thanks to some high-risk mortgage companies going under lately).

After reading John’s articles about using notes in real estate, I came up with some possible ideas that I’d like to run by here. I’m interested in getting a feeling for the feasibility of some of these plans (in particular, if the discounts I’m coming up with for the sale of some of these notes are even realistically in the ballpark based on the equity that a note-buyer would be getting in each scenario). I’d like to buy and hold this property, as I like the area, but would creating notes that are attractive to buyers kill my cash flow? (ie, in order to get a decent discount that would get the seller the cash he needs, would I need to make the note amortized over 10 or 15 years instead of 25 or 30, and thus inflate my mortgage payments?). Are these techinques used primarily for flips, or can they be done when buying and holding?

Anyway, here are the details and the options I came up with:

Asking price: $90,000
Existing mortgage: ~$70,000
Broker commission: $ 5,400

Seller needs: $75,400 cash (he’d like as high a price as possible but is willing to help with financing any amount above his cash needs).

I have $7,500 cash for a down payment, plus will be getting credited about $3,000 from pro-rated rents and receipts.

  • Option #1: Find a conventional lender that doesn’t mind subordinate financing, create a 2nd and 3rd mortgage, and sell the 2nd.

Sales price: $90,000
Bank 1st mortgage (70%): $63,000
Seller 2nd mortgage (10%): $ 9,000 -> sell at 70% discount for $6,300 cash
Seller 3rd mortgage (10%): $ 9,000
Down payment (10%): $ 9,000

Cash to seller: $78,300

  • Option #2: Have seller hold all financing and sell the 1st.

Sales price: $90,000
Seller 1st mortgage (80%): $72,000 -> sell at 94%(?) discount for $67,680
Seller 2nd mortgage (10%): $ 9,000
Down payment (10%): $ 9,000

Cash to seller: $76,680

The discount would probably depend on the result of a credit check on me by the note-buyer.

  • Option #3: Use a hard money lender, create a 2nd and 3rd, sell the 2nd.

Sales price: $90,000
Hard money first (50%): $45,000 (refinance in 6-12 months).
5 points for 1st mortgage: ($ 2,250)
Seller 2nd mortgage (30%): $27,000 -> sell at 80% discount for $21,600
Seller 3rd mortgage (10%): $ 9,000
Down payment (10%): $ 9,000

Cash to seller: $73,350 (starting to push it here).

  • Option #4: Lease-option the building (not relevent to this discussion, but I’ve included it in my list of options I’m considering).

I wrote down the above options and faxed it to my broker a few days ago to try and get some wheels spinning, and a couple days ago the seller stopped by the brokerage and took a look at my fax. After about 10 minutes of studying it, his response was, “interesting…”. So he took it with him and is considering some of these options.

The thing I’m worried about now is my inexperience with creating and selling notes. What I’m thinking right now is that if I start with the cash we need, the yield a note buyer would want, and monthly payments that are acceptable to me, then I can come up with the term of the loan (start with PV, PMT, i, and solve for N). Once I have N, then I can use PMT and the face-value of the note PV to find the actual interest rate for the loan. Do I have the math right here? Would including a balloon payment in the loan have any effect on these calculations?

My next question is if I should start looking for a note-buyer right now (on or elsewhere), or if I should simply assume that there will be buyers out there willing to get a certain yield (say 14-16%), and start the paperwork so I actually have something tangible in hand to shop around and sell.

I guess I’ll stop here since I’ve already asked alot of questions, and I’m still not sure of the feasibility of some of this. Any thoughts you might have would be welcome.


Options are viable . . . . - Posted by John Behle

Posted by John Behle on November 04, 1998 at 14:15:44:

Your options are good possibilities if you can find a willing note buyer. Your local area is the first place to look. Give me your location and I might be able to recommend someone. Never create a note without knowing it will sell and at what price. You can always make your offers contingent on finding a buyer for the note once your have a feel for what you can sell.

A balloon or balloon alternative (see Today’s Tip post - above), can make the note more valuable without having to have a short amortization with a high payment.

One of the greatest tools you can have is some local funding sources for notes. Try to find the local sources first, before messing around with the brokers on ANN or elsewhere. Most just broker to the same few funding sources and are limited in their own funding and experience. A local buyer (look for the ads in the paper and talk to Realtors) can go kick the deal and might look at higher loan to value ratios. It may be hard to get the LTV you need in a 6 unit, but at that price - maybe not? You can always give the seller some of his equity in the form of a note on another property you own or create and sell a note on another property to get more cash for the deal. It can be more costly to use discounted mortgages in this way to finance deals, but really opens up your options. Creating and selling a note can result in many more closed deals.

Re: Creating notes to buy a property - Posted by Jim Davis

Posted by Jim Davis on November 04, 1998 at 13:53:11:

Jim I say go with #2 because to me that seems like the easiest way to buy the property without running yourself ragged trying to find financing. Unless you have outstanding credit(FICO of about 650&up)it is tough to find a buyer at 94%.Maybe the broker will take a note in lieu of cash to help the deal.

He’s got the problem, not you. - Posted by FJW

Posted by FJW on November 03, 1998 at 18:58:12:

It sounds like you want the deal more than he does. With that kind of equity, he doesn’t have much to play with. Why don’t you ad one more, better yet, retract all of the other options and offer to L/O for 3 years with 3K consideration, part going towards commission, and a 78K strike. Offer good for 48 hours and move on. Maybe it’s just me, but it sounds like your beating yourself up over this one. Don’t forget the power walking away has. Just how badly does he need to get out of this property and why?

Good Luck

Re: He’s got the problem, not you. - Posted by Jim

Posted by Jim on November 03, 1998 at 20:00:59:

I already got the property under contract, based on the assumption I could assume the existing loan. Even though we know now that won’t happen, there’s still a couple weeks left on the contract, so at this point it doesn’t hurt to look at other alternatives. I’m not really worrying about it at all, and if the seller decides that I don’t have enough to buy his property and wants to let the contract expire, then I’ll move on. What I’m noticing, though, is that as time goes on, he’s getting more and more motivated (he intially wouldn’t carry any financing, but once the bank turned me down he said he would).

In the meantime, after reading John’s articles I went ahead and faxed the above ideas to my broker, sort of as a “what do you think?” type of thing. Little did I know it would end up in the seller’s hands, and he’d seriously consider them. So I wanted to simply ask here if I had the concepts straight before moving on. At the very least, I wanted to educate myself better to approach future deals with some more tricks in my financing toolbox.

Thanks for your reply.