Dawn Rickabaugh - Note Queen

I recently received this email:

“Dear Dawn,

I saw your recommendations in the Tribune article on waiting for Recovery. My question to you is should we sell our home now or next year?

We bought this home 7/2007 for $950,000. We have spent $150,000 plus. The last project is to have the outside of the house painted, which is scheduled for July.

We have been told that we could probably sell for $950,000.
The lot is about ¾ acre, the house is about 2500 sq feet.

We realize we are losing money and our proposition 60 taxes. But the lot has proven too much for us. We would expect to buy a replacement home for about $850,000.

Our property taxes will increase ($6,000 to about $11,000 a year). We will look for the same size house, but a smaller piece of property in the same city.

If we wait, replacement house prices could rise and the property taxes could also rise. We do not have a mortgage. We are retired.

Thanks so much for any help you can give us.”

First off, it’s encouraging that they have a realistic view of the market and the value of their home. Too many sellers these days would insist that the value of their home is $950K + $150K = $1,100,000.

This couple seems to understand that the market doesn’t care how much you put into it. The market is just the market. A stock is worth what Mr. Market says it is, whether you’re making money or losing it.

[But wouldn’t it be great if the government would step in and make sure we don’t lose money in the stock market any more? Maybe they could set up a special fund and buy GM shares at $30 a pop for anyone who paid that much or more for them . . . it’s only fair]

And then those property taxes . . . it makes my stomach churn to think of this couple losing their Proposition 60 base year value transfer.

If they could somehow manage to become ’severely and permanently disabled’ they could transfer the tax basis one more time . . . but, um, that’s probably going a little too far.

The market is not going to be better next year. Of course, I could be excruciatingly wrong, but I don’t buy the ‘green shoots of recovery’ story.

If you can wait 7-10 years, maybe, but in a year we’ll still be unwinding, and things could be the same . . . and they could be much worse.

What happens if interest rates have a sudden change of heart? Jumbo loans are already difficult for many people to qualify for.

So back to the couple at hand.

Because they own their property free and clear, they have more options than the average seller. If they are willing to offer terms, they could get top dollar regardless of market conditions.

My guess is that they could easily inch up to $1mil if they agreed to finance a buyer who just couldn’t qualify for a conventional loan for some reason.

They could:

• take a $250K down payment,
• carry a $750K first at 7.5%,
• due in 5, for a
• monthly cash flow of $5,244.11

(If they wanted to preclude the possibility of foreclosure, they could put the property in a land trust first. This would also preserve the existing tax basis on the property just in case they ever got it back again).

And if they have other cash reserves to buy their replacement property outright, then they’re set, because cash is king, and they should be able to get the lowest possible pricing.

But what if they don’t have $600,000 sitting around to polish off the cost of their new home?

What if they could find someone with a nice 5.5% fixed and ask them to leave it in place?

• Purchase price $850K,
• Down payment $250K,
• Take over the existing financing at $600K (or less), for a
• Monthly liability of $3,406.73 plus taxes and insurance, so $4,000 (for an overall positive cash flow of about $1,200 per month).

If the replacement property is also in a land trust, then the existing loan cannot be accelerated by the lender, and the existing tax basis (probably lower . . . $6,000?) could also be preserved to give this couple the equivalent of their Prop 60 base year value transfer.

I call the title holding (land) trust “Seller Financing on Steroids.” Especially in the jumbo markets, this strategy is empowering buyers and sellers and putting deals together where they otherwise wouldn’t be possible.

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Yes! It’s very common for business owners to carry a portion of the sale when selling a business, and frequently, the note can be sold after 6 months of seasoning (this can be less in certain circumstances).

People selling business notes need to understand that typically, there are significant discounts involved, so if you’re not prepared for a 20%-50% discount (depending on all factors involved), then you’d be better off waiting out the term.

To set up your note and transaction ahead of time so you have a note worth as much as possible, you’ll want to consider hiring me to help you put your deal together.

The basic info I’ll need to start working on your business note:

• type of business
• location (city & state)
• sale date
• how note created (seller carryback?)
• sale price
• down payment
• original note balance
• interest rate
• term
• payment amount
• lien position
• payor onwership structure
• payor credit rating (D&B if applicable)
• personal guarantees
• value of hard asset collateral (tangible and intangible)
• value of intangible ’soft’ asset collateral
• goodwill value
• if real estate included (zoning factors, usage, operation history including NOI past 5 years, any other liens and their rate/term/balance, debt coverage ratio)

These are the documents I generally need to get started and that help me put together the above:

• copy of the note (front and back, or allonges) - be sure you keep the original note handy
• copy of the security agreement - you’ll need the original
• copy of the purchase agreement if purchase-money note
• copy of the bill of sale
• copy of closing statements related to creation of the note
• copy of the appraisal, if any
• copy of the payor’s original credit application and credit report
• documentation of payment history

Additional documentation requirements before closing (where applicable):

• copy of the UCC-1 financing statement
• copy of any UCC search done by Buyer prior to sale of note
• lease (or assignment of lease) documentation as well as landlord approved sale and landlord verification rent is current
• fire/hazard or EPA liability insurance policy Declaration page showing you as “Loss Payee”
• evidence of down payment (must be cash out of pocket, not financed)
• bill of sale, covenant not to compete, bulk sales compliance or waiver
• business/corporation/liquor/gambling license(s) and proof sales tax was paid
• franchise agreements, if applicable, and proof that fees are current
• payor’s operating banking information including bank name, address and account number
• copy of the check from a past payment
• financial information (financial statement) on payor and description of payor’s previous experience in this type of business
• if note seller is a corporation, Certificate of Secretary of Corporation showing that the person signing the documents is/are duly qualified to act on behalf of the corporation
• copy of Dept of Corporations Certificate of Status showing the corporation is in good standing
• note seller’s books, corporate or proprietorship tax returns for 2 years prior to sale
• note seller’s operating bank name, address and account # (if a simultaneous closing)
• social security numbers for note seller and payor, or tax ID# if corporations
• pictures of business and location map
• any previous names of the business when note seller owned it
• equipment leases, if any, plus name and address of lessor on any open leases
• authorization from note holder (note seller) to pull credit or D&B report on their behalf
• names, addresses, phone numbers, fax numbers, account number of: seller, payor, landlord, franchisor, escrow agent who closed the sales of the business, underlying lien holder(s) to be paid, insurance agent, appraiser of business, account servicing agent)

Potential fees that the note seller MAY be required to pay in order to sell:

• UCC search fees
• credit report fees
• appraisal cost
• corporate records search fee
• legal research cost
• background investigation cost
• field research cost

Let’s get started! I’d love to work with you to ensure that you get the best price and the best service with someone you can trust. You can email or fax documents to (626)451-0454.

And don’t worry . . . the documentation requirements can seem overwhelming, but my associates and I will be here to help you every step of the way.

I recently received this email from someone who saw a post from last year: Seller Financing and Mobile Homes in Parks, and wanted to know if her mobile on 2 acres of land might be eligible for the land trust transfer technique:

Hi!

I have two acres with a mobile home on it in Perris, California, not on a permanent foundation (hence not eligible for bank financing), which I’ve owned free and clear as my primary residence for around thirty years (hence don’t need to worry about capital gains.)

I have found a way to buy a new home without needing immediate cash from the sale of this one. Am asking $142,500, willing to carry back. However, a current potential buyer who has only $15,000 to put down, willing to make payments @ 6% amortized over 30 years (no balloon), presents the issue (for me) of worrying about foreclosure costs should he default.

In my financial position, selling him the house for $15,000 down would be the same as giving it to him. Should he default, I could do nothing about it (I’ve not seen foreclosure costs for less than $30,000.)

Your website had a similar case (albeit for much more expensive property) wherein the seller owed nothing, the buyer put little down, selling As Is but using a “two party trust” which would allow the seller (if necessary) to evict rather than foreclose.

Questions:

1. Is this an option for me? I wouldn’t necessarily need a buyout of any or all of the loan; just the security of not having to go through the much more expensive process of foreclosing should they default.

Yes, the title holding (land) trust transfer system would work for you.

2. I haven’t been able to find anything online that discusses California law re: eviction in this type of transaction. If someone fights eviction, that can still run upward of $20,000. How would the two-party trust fit within California law, and protect me from high eviction costs?

If the resident beneficiary defaults and fights eviction, then they will forfeit their beneficial interest in the trust. Most people wouldn’t want to jeopardize their initial investment, especially if it’s in excess of 10% of the purchase price.

3. Your consultation fees would be….?

Read here about the costs associated with the trust, and the documents I’ll need to get you going.

4. It’s my understanding you wouldn’t be interested in purchasing all nor a portion of the note until the buyer (if the deal goes through) has demonstrated reliable payment behavior. Correct? As I said, it’s not a necessity, but I’m willing to look at the option.

If you choose not to use the land trust, and just want to set up a traditional installment sale (a note secured by a deed of trust), you will need to let the note season for at least 12 months before trying to sell it.

To sell for minimum discount at that time, you will want help putting your deal together. It’ll make all the difference in the price you’ll get for your note if you ever want to sell.

I recently consulted with a couple who are renting a home in Pasadena. They own a home in Tujunga, but instead of selling it when they moved last year, they decided to rent it out, even though it represented a negative cash flow of $500/month.

Why not wait to sell until the market ‘recovers?’

Their loan broker referred them to me when he realized what they were trying to accomplish would be impossible through conventional means.

Given the economy, and the fact that his wife was struggling to build a new business for herself, they wanted to refinance the home (now investment property) so they could pull out $20,000 to put in savings for a rainy day. It would also help subsidize the negative monthly cash flow.

They bought the home for $250,000 and refinanced to a loan amount of $315,000 when the value exceeded $600,000 at the top of the market.

Loans can be hard enough to get for owner occupied dwellings, but investment property cash outs are even harder. And, of paramount importance is the fact that the value had dropped to $450,000 . . . or so they told me.

When I did the comps, I came out with a market value of $350,000 . . . oops. Yes, there was one new construction that sold for $450K, but several REOs and individually owned properties were selling between $320K - $365,000.

If they put it on the market and sold at $350,000, they’d probably be able to pocket $10,000 and eradicate the $500 a month soak from their bank account.

But, ouch . . . selling at a ‘loss’ is hard to swallow, isn’t it? Wait, but they bought for $250K, so they’re actually up a hundred grand, right?

Nope, that’s not how they see it. In their minds, the property ’should’ be worth $600K, so selling at $350K, they’d actually be taking a $250K ‘loss,’ which, of course, is unacceptable.

I ran some numbers and showed them how they could possibly inch the purchase price closer to $400K if they were willing to offer terms to the next buyer by leaving their (very attractive) existing financing in place.

Using that strategy, they could have pocketed the $20,000 they wanted, and they would have had a positive cash flow of $500 per month. They could also have created an equity sharing agreement that would have let them participate in any appreciation down the road.

In my mind, it made a lot of sense. Most people shouldn’t sustain unnecessary negative cash flow when they’re moving into uncertain economic times, personally and globally.

Ultimately, they decided to do nothing, partly because if they put the house on the market, the tenant might move out a month too early and cost them $1,700 in lost rent.

Hmmm . . . I must be bad at math.

And partly because they, like so many others, are determined to ride the market out until it ‘recovers’ so they don’t have to suffer the humiliation of a loss.

But let me ask you something . . .

When you’ve ‘recovered’ from a hangover after having too much to drink the night before, do you feel all tipsy and high, or do you just feel normal again?

Recovery is not the same thing as re-inflated bubble.

It’s highly probable that some time in the next 3 years this couple will find themselves under water, and not have any exit strategy (save a short sale) if they run out of money to subsidize their ‘investment.’ Bummer.

And even if the price comes back up to $450K, it’ll most likely be the result of inflation and won’t represent real appreciation, because by then they’ll be paying $19.50 for a cappuccino.

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Buying my first commercial building from an owner offering terms several years ago made me an instant fan.

I was reminded that the technique is still alive and well.

Just a few months ago, 5828 Temple City Blvd. sold for near asking in less than 60 days. The listing description went something like this:

“Commercial building for sale. Large lot with approx. 2500 sq. ft. building plus more parking. Currently chiropractic offices. OWNER IS RETIRING & WILL FINANCE 1ST TRUST DEED WITH APPROVED CREDIT & TERMS.”

So why does someone who is retiring think of doing this? Most likely his first objective was to defer capital gains and create a dependable monthly income. His money is probably growing somewhere between 6-8%, and is secured by a property he’s very comfortable with.

I’m thinking he’s glad he hasn’t been exposed to the stock market or to low- yielding CD’s from banks who may, or may not, be in business next year.

Secondarily, it probably helped him sell quickly for top dollar. When conventional financing isn’t required, there are more potential buyers for a property. But that doesn’t mean there isn’t any underwriting involved.

You notice that even though the seller was providing the financing, his ad said,

“with approved credit and terms.”

He’s still looking at the strength of the buyer . . . down payment, credit score, and probably financial statement.

When a seller carries, it’s important that the transaction be structured properly for maximum safety of the investment itself (the trust deed), as well as the marketability of the note if he ever needs to sell it for cash.

The first items usually negotiated between the buyer and seller are:

• purchase price,
• down payment,
• interest rate,
• monthly payment, and
• term or due date (or balloon payment, if any).

A seller should require no less than 10% of the purchase price as a down payment, with 20% being ideal (25%+ for commercial). There is no substitute for protective equity.

The interest rate on a note, in most instances, should at least be the going rate in the market at the time. It can often be a point or two higher. Even with a higher interest rate, the buyer is saving cash at closing by not having to pay points or loan origination fees.

The sellers carrying back a note would want:

1. A due-on-sale provision.
2. A balloon payment due on the note 5-7 years from closing.
3. A late charge of 6% of the payment if it is not made within 10 days of its due date.
4. A prepayment penalty (if early pay-off would generate adverse tax consequences).
5. The buyer to pay all closing costs.

A buyer would want:

1. No due-on-sale provision.
2. No balloon payment. Where will they get the money in 5 years?
3. No late charge.
4. No prepayment penalty.
5. The seller to pay all closing costs.

A compromise would look something like this:

1. A due-on-sale provision will give the sellers some control in the event the buyers sell. They will be able to approve the new buyer.
2. A balloon payment in 10 years, not 5.
3. A late charge of 6% of the payment if not paid within 15 days.
4. A prepayment penalty only if the buyers make additional payments that reduce the principal balance by more than 10% in any given year.
5. Buyers and sellers agree to share closing costs equally.

Related Reading:

• If I Carry, What Happens if the Buyer Quits Making the Payments?
• I Could Use Some Help Underwriting my Seller Financing Transaction
  
• I Want to Sell My Note, What is it Worth?
  

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