How Does Note Effect Purchase Price Here? - Posted by Wayne (MD)

Posted by David Butler on March 23, 2001 at 15:47:49:

Hello Wayne,

You’re very welcome! Hey… that was part of my point - you didn’t say $290,000 FMV “after” $20,000/$30,000" repair work - that was one of the references I made to “… information not provided…”, :wink:

My kudos by the way for understanding the difference between “transaction value” and “cash equivalent value”, which in itself is a primary element in the very often incorrectly used term “fair market value”.
You are absolutely correct - the concept is very elementary… surprisingly, very few note brokers even have a grasp on it - and even fewer investors.

For the benefit of others who might read this dialogue, it might be worthwhile to point out that the current economic definition of “Fair Market Value” agreed upon by agencies that regulate federal financial institutions in the U.S. is…

"The most PROBABLE price which a property should bring in a competitive and open market, under all conditions requisite to a fair sale; the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:

  1. buyer and seller are typically motivated;
  2. both parties are well informed or well advised, and
    acting in what they consider their best interests;
  3. a reasonable time is allowed for exposure on the open market;
  4. payment is made in terms of cash (U.S.D.), or in terms of financial arrangements comparable thereto, and,
  5. the price represents the normal consideration for the property sold, unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.

(cited from the Uniform Standards of Professional Appraisal Practice, The Appraisal Foundation 1998, p. 163)

So, as you can see by items 4 and 5 above, yes, notes MAY be a discounted price factor. Doesn’t appear to necessarily be the case in your daughter’s situation however. Let’s assume for a minute that the home is worth $290,000 AFTER spending $30,000 to fix it up? What is it worth, in the open market TODAY, in its present condition. Possibly only $250,000; possibly less. In some markets, a rehabber may be the only market for such a property. If that’s the case, wholesale value by definition, would be the FMV. And wholesalers, by definition, work on a profit basis.

So, his value will be based on yet another accepted valuation concept… “Investment Value”. He might decide that he needs to make $20,000 on a deal like this, plus a cushion for the “risk factors” related to holding period, changes in work orders, marketing costs, etc. So, he budgets $20,000 for that. Now our $290,000 FMV is down to an investment value of $210,000 - and if the majority of rehabbers operating in that geographic area are roughly of the same mind, that “investment value” is then the consensus “FMV”… before we ever get in to discussing whether or not any financing concessions are being made (including possible concessions related to a note).

Now to the main point. A note creation by itself may or may not affect the cash equivalent value - it MAY or MAY NOT, affect the purchase price “considerably”.
Today, I can go to the bank and get a new second mortgage for, roughly 95% CLTV, IF I AM QUALIFIED, for about what, maybe as low as 9.5%, plus an average 2 points, plus UW, Processing, and several related junk fees - for a fully amortized 180 months.

If I offer you the same deal to carry back the second, and offer 10.5% for a 15 year note… on an APR basis, we have met the definition of FMV on a cash equivalent basis. Subsequently, if the sale of your property was later used as a “comparable” by an appraiser, no downward adjustment would likely be made for “financing concessions”; even though such a note would likely be discounted heavily in the private secondary markets, due to the high CLTV.

On the other hand, if your buyer came in with a 650 credit score, paid 20% cash down, had a 40% DTI, took over a 7.5% 1st mortgage that was at 60% LTV,and gave your daughter a 2nd mortgage for 20% of the balance, at 10.5% amortized over 60 months; chances are good that your daughter could get fairly close to 95% par (face value) for that note in the private secondary market… in which case, it still did not affect FMV.

As you can begin to see, there are many factors that can come into play, before reaching a conclusion on values. “How much is that doggie in the window?” To know whether the price is “fair”, I have to know all about THAT doggie… and have a fairly decent idea about the average prices paid for similar doggies. What if the owner wants $300 for his doggie, and I only want to spend $250. If I can get an almost identical doggie around the corner for $250, this owner gets to keep his $300 doggie - or he sells if for $250. Conversely, if I can’t find another satisfactory doggie, or I have to have THIS little doggie, I am going to buy a $300 doggie, or I get to keep my $250. I guess it’s a question of “who wants the dough, and who wants the doggie?!”, right :wink:

You may find it very helpful to have a good look at our NOTE GRADING/PRICING GUIDELINES, at:

I think for your purposes, you will find this both very helpful, and possibly provide some of the “eyewash” you are looking for to share with your daughter.

Hope this helps, and best of luck in structuring a safe and sensible deal.

David P. Butler

How Does Note Effect Purchase Price Here? - Posted by Wayne (MD)

Posted by Wayne (MD) on March 20, 2001 at 12:55:27:

I posted the following on the main board, and then it occurred to me that this really is the place for this quesiton. The key point here is the note. I know the way the thing is structured has a profound effect on the actual sales price of the house; I simply am not educated enough yet to decipher that effect. Any help you can give me will be very, very appreciated.

My daughter and her husband have been presented with a purchase offer from a neighbor who also is a mortgage broker. For reasons that go far beyond those of simple business analysis and principles, I would greatly appreciate independent third party opinions of the following purchase offer facts:

?Effective Sale Price: $242,500?

?Seller to take back and hold a second mortgage in the amount of $48,000 @ 8% annual
interest, paid annually, due and payable in 48 months from day of closing.?

?Effective sale price will be increased by an undetermined amount to cover buyer settlement costs and to provide for funding for renovations to the property; adjusted sale price, no matter the amount, will not affect your net proceeds.?

Fair market value of the house is approx $290,000. Amount estimated for fix-up $20,000-$30,000 (my personal estimate). The purchaser does not indicate just how much the ?adjusted sales price? will be.

Thanks very much for your input.


Re: How Does Note Effect Purchase Price Here? - Posted by David Butler

Posted by David Butler on March 22, 2001 at 16:00:08:

Hello Wayne,

I’m not sure I follow the question here in your header?
But, I can see plenty of issues for concern.

Actually, several issues that should be discussed extensively, come to mind - a good deal of which appear by way of information that has not been provided… but that’s too much ground to cover thoroughly at one sitting. So, for a short little jumping-point, I’d like to start with the obvious, especially because I am seeing so much of this over the past year.

You indicate the property has a FMV of $290,000. The definition of FMV being what it is, why is your daughter even looking at an offer for $242,500??? More to the point, why are they even looking at taking a discount of nearly 20% on the FMV, AND carrying back a 2nd mortgage, AND carrying back the 2nd at what may very well be a below market interest rate, AND soft terms??? (although you didn’t clarify if he is talking interest only paid annually, it sounds like it is).

The answers to those questions may explain whether the deal is right for them. And it very well could be, up to a point. However, jumping off a sinking ship is one thing… giving up all the life rafts seems to be overdoing it, unless the whole dang thing is crawling with rats!

Ignoring that nonsensical clause you described with regard to the “floating” ‘effective sales price’, the implications of that clause bring in to focus, a whole series of practical considerations.

If I am going to hold a 2nd note, I definitely want to know what kind of 1st position loan the note is going to sit behind. If I am going to hold a 2nd note, I definitely want to be sure that I am going to get my money out of the deal. If I am going to hold a second note, I must be in a financial position to be able to step in and cover the costs of a foreclosure and making up the monthly payments on the first note, in the event of any default on either of the loans. If I am going to hold a second note, I definitely want to see some hard down payment out of the buyer, and I want to see it now… and I want to know where it is coming from. Finally, I want to see a credit report. Then I want to put all this together, and see how risky this thing is going to be to me, and my $48,000. I may not be in a position to take this kind of deal, even if I wanted to.

Now, if I am already in default, and three months behind, and have no other offers, and am going to lose the house anyway… well, maybe parts of this deal make some sense. But that “effective sales price” clause doesn’t. Still, for now, I don’t want to drive all around that course, without having some understanding of what lies behind the other issues I have brought up.
But for what it’s worth, I hope I have helped at least a little bit so far.

David P. Butler

Re: How Does Note Effect Purchase Price Here? - Posted by Wayne (MD)

Posted by Wayne (MD) on March 23, 2001 at 06:49:13:

David –

Thank you very much for your thoughtful response. And I quite agree with what you have said.

With regard to the offering price of $242,500, don’t forget that the property needs $20-30K put into it to bring it up to market value. That narrows the margin conisderably, especially in light of the amount of time needed for the rehab work.

The question in my header refers to the note itself. I know from elementary note study (very elementary) that these particular terms in effect discount the purchase price of the house considerably. I simply cannot find the example I need to show my daughter. Notes are powerful negotiating instruments and often are misleading. It is sort of like offering someone a $50,000 junk bond as a down payment on a $300,000 property. I can buy a $50,000 junk bond for a couple of thousand dollars. Return is high; risk is high. I think the bottom line is how much is that note worth on the open market if she and her husband make it?

I quite agree that the softer the terms (and these are very soft) the higher the price should be.

Thanks again.

Wayne Carpenter