Follow-up on potential note deal - Posted by Jennifer Minge

Posted by David Butler on March 05, 2006 at 18:39:26:

Hello Again Jennifer,

While you are telling the Seller your plan, you can’t actually do it. HE has to do it. Those are his payments to sell all or part of. A CREI such as your self structures this kind of transaction all the time, including bringing the seller a buyer for the note payments (as I mentioned in my original response), but want to be sure you have a clear understanding of Who has What rights here.

As for the other, you appear to be using some “smoke & mirrors” and confusing yourself in the process.

You write a contract for $320k purchase price, with $64,000 down, and $256k new note secured by property. You then sell off 42 payments from that first to generate the $64,000 for the down payments. No matter how or what you call it, the description and net result I showed your previously describes the real deal.

Let’s take another look using your “funny money” approach here. I am Mr. Seller. I sell you my property for $320,000, with $64,000 down, and a note for $256,000, payable over 240 months. If that note goes full term, I receive $513,909.60 in total monthly payments, plus the $64,000. That’s $577,909.60 in total cash payments to me. And I get a total of $153,934.18 over the next 42 months.

Following your logic here on your deal structure, I would get $64,000 now, plus 198 payments totalling $423,975.42 = $487,975.42. And I would only get $64,000 over the first 42 months! :frowning:

The balloon scenario makes the deal even worse, in that there is limited interest down the road to beef up the numbers, as it is cut-off by early payoff.

Now the tougher part. We all have to make some decisions about our own integrity and ethics in what constitutes fair dealing.

Your last sentence appears to indicate you want to “fool” the seller into accepting an offer that he most likely would NOT accept if you fully explained the differences in his net values, as I did above.

Please don’t take this wrong - many beginning CREI’s get a bit too excited about putting a deal together, and as a result, lose sight of their moral compass.

But generally, those kinds of business practices come back to haunt you one way or the other - and for most folks that kind of approach doesn’t feel that good, over time.

Better to get what you want by solving people’s problems, rather than creating more for them. That’s the classic “Win-Win” type of transaction we like to talk about - and to pull it off, both sides have to come out of a transaction mutually satisfied, based on material facts.

Hope that helps, and again, best wishes for your success going forward!

David P. Butler

Follow-up on potential note deal - Posted by Jennifer Minge

Posted by Jennifer Minge on March 05, 2006 at 10:37:37:


I posted earlier about a seller willing to finance 80% of a purchase if I put 20% down. I was wondering how to write a note to do this. After getting advice from local investors, this is what I would like to do:

PP $320,000
Down $64,000
Finance $256,000
Interest Rate 8%
Terms 20 years
Monthly rent role $3000

Now, this would create a note having payments of $2,141,29/month. At closing I choose to sell off the first 42 payments at a 15% yield, I would collect $69,637.46. From that amount I give the seller $64,000 for his down payment and I pocket the remaining $5,637.46. Now for the next 3 1/2 years, I collect $3000/mth in rent and send $2,141.29 to the note buyer. This will provide a positive cash flow of about $850/month. From that amount I pay taxes, insurance, expenses etc.

Now during that 3 1/2 years do I get to write off mortgage interest on the note or does the note buyer get that tax write-off? I know I would get the tax write-off on property tax during that 3 1/2 year period since I will be paying for it.

Also is a 15% yield a reasonable rate to consider for this deal? Is it too high of a yield :slight_smile: ? The note would be secured against real estate at a 80%LTV.

Thanks for the assistance.

Re: A Good Start! - Posted by David Butler

Posted by David Butler on March 05, 2006 at 15:01:16:

Hello Jennifer,

You are off to a good start, but you have some important issues to resolve - all of which are extensively covered in a number of existing discussion threads regarding “creating notes”, “simultaneous closes” and similar.

But first, some quick points to consider.

Most important concept - if you give the seller a note for all, or part of the purchase price, that seller becomes the note holder (i.e. note owner). Consequently, only HE can sell all, or part, of that note. You might find the note buyer, but you can’t sell the note, as it is not yours to sell!

2nd important concept - as shown in your example, you will have NO EQUITY in the deal. Not a “dealkiller” all by itself - but brings the need for other compelling underwriting variables into play.

3rd important concept - here, you are asking a seller to take back a note for $256,000, then turn around and sell the next 42 payments for $69,637.46?? What’s in that for the seller that makes it attractive? He gets $64,000, but it came out of the note! That immediately discounted his note by $64,000 at NPV 8%. For that, he goes 42 months without receiving any payments, and he simply gave himself $64,000 from his own note balance?

Net result here is that he is not receiving $320,000 for his property. Instead, he is receiving only $64,000 cash today, and a note balance of $235,014.21 that doesn’t start coming to him until 42 months from now.

Worse yet… because he isn’t receiving any payments on that note until 42 months from now, his Net Present Value for that note - discounted at the 8% face rate is he foregoing for the next 42 months - is only $47,701.26!! :frowning:

In other words, the deal you are offering the seller here results in a total NPV of only $111,701.26 to him/her. That’s not a haircut - that’s a scalping! :frowning:

Alternatively - what if you instead offered the Seller both a first and a 2nd position note? Assuming you have no cash for a down payment, the first could be set up at 75% LTV of $240,000; the second for $80,000 - both set at same terms as above?

In that scenario, it is conceivable that you could possibly pull $69,000 or thereabouts out of the sale of 45 months of the senior note, to earn the investor 14.81 yield, give the seller $64,000 - and put $5,000 in your pocket!

Keep in mind however that the typical note buyer is going to want to see other compelling factors in this deal, particularly due to the fact that you have no equity in the property during the early stages.

There are other variables that can be tweaked for creating a successful note sale here - depending on your goals and objectives, the seller’s needs, the property itself, and your credit/income history. These variables also dictate whether or not a 15% yield will be satisfactory to a note buyer.

As to your other question… yes, you take the interest write off because you are making the note payments. Whomever is receiving those note payments has a taxable income for the interest received, and they would pay taxes on that income.

Hope this helps, and best wishes for your CREI here!

David P. Butler

Re: A Good Start! - Posted by Jennifer Minge

Posted by Jennifer Minge on March 05, 2006 at 15:43:51:

As part of the purchase agreement, I will state that I will be creating a note and selling off partial payments to give the Seller his down payment. The agreement will state that I will only start making payments to him in month 43. So hopefully this addresses your first concern that I could not sell off partial payments.

As for the equity issue. I would be doing this as a simultanous closing. I technically would be bringing $64,000 cash to closing. Then turn around and sell the partial payments in the next closing. So technically I would have equity in the deal albeit not for long.

My goal in structuring things is way is to try and convince the seller that he will be receiving alot more than his initial offering price. The Seller will receive 198 payments (240-42) of $2,141.29 for a total of $423,974.74. Plus he gets the initial $64,000 down payment. So instead of getting $320,000 which was the initial purchase price, he would get a total of $487,974.74. This is how I would position it to the seller: “would you accept $160,000+ over your offering price in exchange for financing the deal?”

Another option

We could potentially have a balloon after 5 years so the Seller could get his money sooner. He would still receive the 20% down payment, plus monthly payments for 18 months. So far he has gotten $64,000 down plus $38,543.16 (18 * 2,141.29) for a total of $102,543.16. We would then say we would give him a ballon payment of $247,456.84. This means he would be getting $350,000 in total for a unit with a selling price of $320,000. Hopefully this would make the seller think he is getting $30,000 more than his asking price.