The Inns & Outs of Paper
As the first quarter of 2017 draws to a close , I want to share my excitement with you: excitement that stems from all of the opportunities we have before us, excitement about the market conditions creating the “perfect storm,” and, finally, excitement to be able to share some of the techniques I’ve learned over the past 25 years (in the finance arena) to help you put together more deals and more important: more profitable deals.
When I originally was asked to write this blog, I considered the shortcomings of others I’d seen, mainly, too much “fluff” and not enough “meat and potatoes.” So, notwithstanding the mixed metaphors, I vowed that this would be different. Sure, we’ll discuss generalities, but we’ll also discuss specifics. We’ll learn various techniques, but we’ll also use real-world examples, and walk you through, step-by-step, how to implement them. And finally, we’ll cover strategies that are specific to today’s marketplace, rather than those that are “old and cold;” (those are the ones that still look good on paper, but simply aren’t applicable to today’s real estate game).
Over the next few months, you’ll learn everything from how to supplement your real estate income by buying existing mortgages to creating your own. We’ll discuss using defaulted paper as a way to control real estate, and the availability of certain conventional mortgage programs that will give you alternative ways of putting together deals. And throughout this series, as in real estate, you’ll learn the benefits of ownership vs. control, and the advantages of doing the deal for yourself, rather than representing others (the old RE Agent vs. RE Investor Theory – one of them makes a lot more $$).
Are you ready? Then let’s get started!
In this two-part article, we’ll look at a technique that will benefit you in several ways: First of all, when you buy a property, you’ll be able to put cash back into your pocket! Second, when you sell using this technique, you’ll open it up to a wider array of potential buyers, ones who will have less closing costs, and won’t have to jump through the hoops of conventional financing! Even better, (and this is number three), you won’t have to worry about those annoying lender requirements like provable income and chain of title!
The technique is called a simultaneous closing, not to be confused with a double closing. For many of us, a double closing is where one buys a property, and then sells it, all at the same time. Call it a “flip” if you will; the bottom line is that the property changes hands twice at the same closing. A simultaneous closing, on the other hand, involves two steps:
Step 1 is where the property is sold, and the seller carries back a mortgage (owner financing). In Step 2, that newly-created mortgage is sold to a third party, whose cash is then used to pay off any underlying liens, closing costs, profit, etc. Please note: THE PROCEEDS ARE HANDLED THE SAME WAY AS THOSE FROM A TRADITIONAL LOAN. And…the closing procedure is also similar.
And while we’re on the subject, please note another very important item. There must be at least THREE separate parties in this transaction: a buyer, a seller, and a note buyer. (Remember this, and you’ll never again confuse refinancing a property with a simultaneous closing.) The MUST be a sale of property, there MUST be three separate parties (and now that you know the rules, I’ll talk, in a later column, about how to bend, not break, them!)
How does this help you?
Let’s look at a real world example: John, a Florida attorney, wanted to buy a $200K house from Jane. He wanted a no-qualifying loan, no-money down, interest rate below 10%, and didn’t want to have to state any income or assets. To make matters more complicated, John had marginal credit, so he didn’t qualify for a no-doc loan with a traditional lending institution.
Jane, on the other hand, provided the saving grace in this deal, because she only required $50K down, and was willing to receive the rest in payments over time. Granted, John didn’t have the $50K, but here is where we (my company) came in. We simply guided Jane in creating a $55,000 1st lien note that we purchased at the closing table for a discounted price of $50K. She carried a 2nd lien for $145K.
John didn’t have to jump through the hoops of conventional lending, and got the terms he wanted. He paid two payments every month: the 1st lien payment came to us (because we purchased the note), and the 2nd lien payment went to Jane. He got into his property for no money, and his closing costs were minimal. Jane got her $50K, and monthly payments. We (my company) got a high-yielding investment.
Sound simple? It really is, once you understand the nuances of both seller financing and the secondary lending market. Mortgages are bought and sold daily; banks sell in large amounts (pools), and private sellers sell individual notes. The net effect, however, is the same: cash is exchanged for the right to receive cash flow. The only difference in the private-seller market is that sellers don’t have to sell the whole note. Instead, they can sell a portion of the note (called a partial sale), which opens up this technique to even more uses!
Oh, and one last thing: Could John have put money into his pocket at closing using this technique? You bet! However…this article has limited space, so you’ll need to wait for the next installment, where we’ll also discuss how to create a note (either to buy or sell a house) for maximum profit!
Until then…happy investing!
How to Create A Note for Maximum Profit
In our last installment, we met John, a Florida attorney who wanted to purchase a $200K home. The seller (Jane) needed $50K down, but was willing to take the balance in monthly payments. And to complicate matters even further, not only did John not qualify for conventional bank financing, but he didn’t have $50K either! THAT’s when we learned about “simultaneous closings” – the creation and simultaneous sale of seller-financed mortgages used to circumvent the traditional lending route.
You may also remember that our example concluded with the fact that Jane (seller) ended up carrying both a 1st and a 2nd lien – she sold off the first at a slight discount to generate the $50K that she needed in cash, and she held on to the 2nd for monthly cash flow. To be more specific: Jane carried a 1st lien for $55K and a 2nd lien for $145K. She sold the 1st for $50K, and kept the 2nd.
Did Jane take a discount when she sold the 1st?
Absolutely! But you’ll notice that while she sold the note for only about 90 cents on the dollar, her actual discount on her $200K home was only $5K! That equates to about a 2.5% discount on the entire property – one that is normally absorbed by sellers in either negotiations, or Realtor fees. And, she received two major benefits for that 2.5%:
- Her house stayed on the market less time, because more buyers qualified to buy her home than if they had taken the route of traditional financing.
- Because she was willing to concede and offer seller financing, she was able to be firm on her price and get full value for her home.
Think about it…for you, the real estate investor, it’s a great deal! As the seller, you get the benefits outlined above. As a buyer, you have the ability to generate a down payment, avoid conventional financing and all of its rules and fees, and even better – there are times when you can even put money back into your pocket at closing!
No, I didn’t stutter – this is a GREAT tool to reimburse you for part or all of your down payment, your closing costs, and sometimes, even put some money in your pocket to rehab the property. Here’s how it works:
Going back to the previous example, you’ll see that the note buyer (in this case it was iFam Fund – go figure!!) purchased a $55K note for $50K. Please note: regardless of the eventual sales price of the note, John is still obligated to repay the entire $55K. So…
What if the note was created for $60K, and purchased for $55K? Remember, John is obligated to repay the full $60K, but in this example, Jane (seller) only needs $50K. Where does the other $5K go? In John’s pocket! In a way…he is borrowing the money to reimburse himself for his closing costs. And, because it is borrowed, that $5K that he receives is tax-free.
Now you may be thinking, “Hey Bob! This sounds like a pretty good deal for John, but what about the seller? Is she going to want to take a $10K discount?” [[SPECIAL NOTE: Even though John is borrowing $60K on the 1st and $140K on the 2nd, Jane is only receiving $50K now, and a 2nd lien for $140K. In other words – she took a $10K discount.]]
She may, or may not…but here’s a couple of very convincing points. First of all, the $10K discount to her only represents 5% of the property’s sales price. Second, if you add up all of the payments that she will receive on the 2nd lien, they will more than adequately make up for the small discount.
That’s all there is to it! Well…kinda’…
You see, the important thing to remember is that ANY time you are structuring a note for either the purchase or sale of a property with the intent of selling that note at or after closing, it is IMPERATIVE that you first check out the structure with your note buyer. Note buyers (and there are several across the country) buy notes based on their yield – as such, a note with a low interest rate will sell for less than an otherwise identical note with a higher interest rate. In this case, the needs of the seller and the buyer are opposed: the buyer wants a low payment and interest rate, resulting in the seller getting less money for his note. On the other hand, if the seller wants to sell his note at a higher price, the buyer must accede to a higher payment (which makes the note worth more).
The best way to avoid all of this hassle is to go over the note’s structure and terms with your note buyer BEFORE you consummate the deal. I can’t tell you how many times some well-meaning seller has agreed to carry paper at a ridiculously low interest rate, only to be shocked at the low, low, low price he is offered for the sale of his note.
Now then – do you think you understand the basics? In short – buyer and seller create owner-financed 1st and 2nd liens; seller sells the 1st lien at the closing table and receives cash; he retains the 2nd lien for cash flow. Seller sells property more quickly, buyer doesn’t have to qualify for conventional financing, has less closing costs, and can often put money in his pocket at closing.
NEWS FLASH: Come to my Paper Power Workshop this coming June 3-5, 2017! We’ll go over this in-depth, with plenty of real-world examples. Better yet, BRING ONE OF YOUR DEALS: We’ll structure it on the spot!!
To learn more about “Paper,” call Bailey at 800-567-6128 to get registered for Bob’s 3-day event this coming June.
Bob Leonetti is a nationally recognized author, lecturer and trainer with over 2500 platform hours. An active real estate investor, he has been involved in the mortgage and private note industry since 1992, taking his start-up company, Success Financial Services Group, public in 2000. More recently, he is the co-founder of Investors First Asset Management (iFam), a hedge-fund formed to facilitate the purchase of seller-financed notes and distressed real estate assets.