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 www.notenetwork.com 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.
Jim