question about example in Unity of RE & Paper - Posted by Bob Smith

import · March 13, 2006, 4:12pm

Posted by David Butler on March 19, 2006 at 11:07:39:

Hello Bob,

Nice to see you digging deeper, but again - you want to be sure to keep your mind wide open to the fact that deals don’t happen in a vacuum. The circumstances of each individual deal, including time, location, economic factors, objectives of the respective parties, and other “influencing factors” are always present in the equation for every deal ever closed - regardless of the structure!

Also helpful to realize early on what successful note finders and investors learn to recognize quickly. We really don’t explain to anybody “…what is in their best interest to structure a transaction…” in any particular way.

Instead… we endeavor to find out what the parties’ objectives are; offer the possible solutions we see as being viable alternatives - and let them then explain to us why it is in their best interest to do a deal structure in any particular way!

Again, like all things - the numbers must be subjected to analysis, and also to meeting objectives of the parties to each side of the deal.

But, assuming for the moment, just one scenario:

Hard-Money loan @ 100% LTV, with points rolled in, interest only, all due in one year (not always easy to get for many folks, but easy enough for enough folks that we’ll use that structure here).

So… with our $60,000 HML, with points rolled in (using 3% here); we’ll have a total loan balance of $61,855.67, with interest-only monthly payments of $773.20 @ 15%; with a total 12-month cost of $10,360.87 ($8,505.20 interest, plus $1,855.67 in points).

Going the seller-financed route, we give the seller a note for $66,000, paid interest-only at $550 per month at 10% interest; with a total 12-month cost of $12,050 ($6,050 interest, plus $6,000 in note premium).

In the above scenario, the “spread” in costs is $1,689 between the apparently cheaper HML, and what turns out to be the more expensive seller-financed note, in terms of total costs. But now several things to consider:

In THIS scenario, seller’s objectives are moot - he winds up with his $60,000 cash at closing, either way.

We’ll assume too that we’ve met the note investor’s objectives as well, in that he is willing to accept an ROI yield of 19.30% on this particular deal. Given the relatively short time frame, this compares somewhat favorably to the HML’s 17.13% APR (effective rate) for the LOAN SCENARIO described above.

So RE buyer/Payor’s objectives are what’s left here. One obvious potential “benefit” on a short term basis is that the seller-financed note AS DESCRIBED IN THE ABOVE SCENARIO is payable at $550 per month; versus the $773.20 monthly payment described for the Subject HML. Is this $223.20 savings in monthly holding costs a benefit for you on THIS deal? Maybe, maybe not! Only you (or the rehabber if it isn’t you) can ultimately that.

But keeping in mind that Mike wrote his course for a broader audience, it could very well be that this particular deal structure described above is just the ticket for another rehabber. Or a variation thereto, as Mike pointed out in his initial response.

Same thing for a novice just starting out who might be facing an HML in HIS AREA - where the best he can do on an HML is say, $50,000, with 5 points, 18% interest payable monthly and all due in six months.

What if THAT HML requires that points are paid up front? What if the buyer/Payor is not comfortable with only having six months to repay the HML? In fact, what if he knows that only having a six month fuse on his particular deal could blow the whole thing up in his face? What about any other “what if’s” you can think up?!?

As I touched on briefly in my previous response - and in much depth in many related types of posts where we address the need for identifying the objectives of the parties (as have Mike, John Behle, Terry Vaughan, and other contributors over the years) - skilled usage of seller-financing is simply one more tool in your CREI and/or note-finding toolbox.

The circumstances of each deal, and the objectives of the individual parties to THAT deal, at THAT point in time - dictate what structure the deal is going to take at the end of the day.

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

David P. Butler

import · March 13, 2006, 4:12pm

question about example in Unity of RE & Paper - Posted by Bob Smith

Posted by Bob Smith on March 13, 2006 at 17:12:47:

There’s an example on pages 41-42 about using discounted paper rather than hard money to acquire fixer property. Looks good for the paper buyer, especially if the note is paid off early, but what’s in it for the payor? The total financing cost looks significantly higher than, for example, hard money at 15% and 3 points, and some of the stated demerits against hard money apply equally to the paper deal (the discount is effectively a large prepayment penalty, the 1 year balloon means it’s equally short term, and the example buyer came out of pocket to fund repairs). Plus, a table funded deal like that looks likes a usurious loan should a delinquent payor contest foreclosure. I’d love to convince a rehabber or several to finance his deals as described, if I could show him why it’s in his best interest.

import · March 16, 2006, 2:45pm

Seller financed Terms Vs Hard Money - Posted by Michael Morrongiello

Posted by Michael Morrongiello on March 16, 2006 at 15:45:56:

Bill;
Most hard money lenders are SHORT TERM, expensive lenders who also require a prepayment penalty if their loan is paid off early. So the actual cost of their funds is not always 15% + 3 pts…

The example you refer to in the Unity of Real Estate & “Paper” study course provides an alternative. Its simply a starting point to negotiate the financing.

You can structure the financing with the property seller who would SELL their property to you and then also FINANCE you at a far LOWER interest rate. Often where more time is given on the financing (perhaps a year or longer), and with NO points and NO prepayment penalty - These are real benifits for the property buyer, especially a buyer who is not looking to quickly flip the property fast but may wish to put a tenant in their property and take advantage of longer term capital gains tax treatment upon resale of the property.

As for the concerns over the “table funding” and potential usury issues -if that truly is a concern for you, simply let some time elasped between the actual property sale closing and the seller taking back their Note and THEN selling it to you if that is a concern of yours. That amount of time could be the next day, a few days, a week, after the 1st payment is paid, etc. -its up to you and your comfort level. Its going to be hard for a borrower to cry foul when the file is closed with a Note signed, and then several days later that Note is transferred claiming usury was involved.

Best to your success;
Michael Morrongiello

import · March 18, 2006, 1:21pm

Re: Seller financed Terms Vs Hard Money - Posted by Bob Smith

Posted by Bob Smith on March 18, 2006 at 14:21:05:

>Most hard money lenders are SHORT TERM, expensive
>lenders who also require a prepayment penalty if
>their loan is paid off early. So the actual cost of
>their funds is not always 15% + 3 pts…

True, which begs the question: why would a property buyer do the note deal with me at 22% yield instead of going the simpler, easier to understand route of hard money? Even if the face rate is low, the total cost of the financing is as high if not higher than hard money.

import · March 18, 2006, 3:26pm

Re: Relieving the Pain! - Posted by David Butler

Posted by David Butler on March 18, 2006 at 16:26:29:

Hey Bob,

Mike did such a thorough job of discussing the advantages I couldn’t resist pointing out the mistake you are making here - one that many folks tend to make for some reason.

Not sure where you are getting your 22% number from. If I am a property buyer, and I give the seller a note for say, $75,000 at 7.5% interest - regardless of payment schedule or term - I will never pay more than 7.5% interest on that note… no matter what else happens (unless I agree in writing to do so).

And, I get the seller-financing at no points, and no garbage fees (saving me about 4% of the loan amount closing costs).

So as the payor - that’s what’s in it for me, in addition to the other advantages typically available to CREI who know how to use paper in relation to the well-known “Dealmaker’s Creed”… “I’ll pay you any price you want, if you’ll let me name the terms”.

The thing is, if the seller wants/needs cash (for whatever reason) at closing, or shortly thereafter, he try to sell that note to get the cash - and he’ll likely have to sell that paper at a discount.

Now, the seller may have to sell the paper at a price low enough to the note buyer to give that note buyer a 22% yield - but that doesn’t change anything for the Payor. And frequenlty, experienced CREI payors find a way to get in there and pull that discount out for themselves one way or another.

In the meantime, why would the seller do such a deal? At this point, we don’t know why. And probably a third of the deals that are done using seller financing, are done without us ever knowing the absolute true reason(s) why the seller agreed to do the deal that way.

Many more deals aren’t done because nobody bothers to even TRY and find out what the seller’s motivations (read NEEDS) really are - so they can figure out a way to help the seller meet his needs, while allowing the other parties to the deal (property buyer and/or note buyer) to also meet THEIR needs!

Most deals aren’t done just so somebody can see how creative they can be. They are done to relieve somebody’s pain. Many times, it takes a creative solution to provide the “pain killer”.

That’s Mike’s point, and his explanation of why you want to consider it is on the money!

Hope that helps, and best wishes for your success!

David P. Butler

import · March 18, 2006, 10:42pm

Re: Relieving the Pain! - Posted by Bob Smith

Posted by Bob Smith on March 18, 2006 at 23:42:26:

In the example being discussed, a rehabber has an opportunity to purchase a fixer property at a large discount for $60k cash. The rehabber will supply from his own funds the cash necessary for repairs. The rehabber instead offers to purchase the property for what is essentially a $66k note @ 10% interest no points with a 1-year balloon, said note to be sold to a paper buyer on or shortly after closing for $60k cash. Since the paper deal is a substitute for traditional hard money, and that discount constitutes a huge prepayment penalty making the total financing cost quite high, the obvious question is why do it? I ask partly because I want to understand a mindset, and partly because I’d love to participate on the paper buying end of the transaction if only I could explain to the rehabber why it’s in his interest to structure the transaction that way.

import · March 21, 2006, 4:14am

Re: Relieving the Pain! - Posted by John Corey

Posted by John Corey on March 21, 2006 at 05:14:03:

Bob (and others),

You have to do the math for both situations. Look at the numbers. Only the difference between the HML and the discounted note matters when you are trying to save a bit of cash.
Then look at the conditions. Can both sources of funding work? Is there a HML that is ready and willing to perform at the LTV needed? What about a note buyer. In one example presented the difference was under $2,000. That is not a large sum of money if one finance source is a slam dunk and the other is shaky. You may find that you can get a better LTV with the discounted note compared to the HM. As someone who provides HM loans I have a pretty conservative LTV. Maybe the note buyer has a different set of criteria so we are comparing two similar but not equal options.
The HML will definitely be for 12 months of less in almost all cases. Maybe the note can be held longer (lower interest rate so less desire to refi) or other ways that the note has a different value to the investor.

I think the decision depends on ones ability to do the math (to compare the costs) and the ability to negotiate the terms that best fit the situation. Then there is availability (HM is tapped out, note buyer are not interested, etc).

People are not completely rational. Some like option A just because that is the one they know. Others fear option B because it seems scary as they do not understand how it works. BTW - Good that you are asking as asking to have something explained is a great investor trait.

Death from a car accident is more likely than from a plane crash but people fear a plane crash more. They are not easy to compare and one statistic is not the full picture.

John Corey

PS. The biggest issue is making sure there is so much profit that you have options as to which route you take.