Dawn Rickabaugh - Note Queen

Def.: Trust - confident expectation of something; hope.

Many luxury residential and commercial sellers don’t have a lot of trust in the real estate market. Recently, as if rattling a sordid skeleton, a local high-end Realtor squeamishly confided, “Nothing’s moving right now.”

Though conventional financing is more attractive than ever, jumbos ($625,500+) are sporting a healthy 7%+ rate, and they’re tougher to get. Many buyers, who could easily afford a high end property, can’t qualify for a jumbo loan . . . stalemate.

Now, while I probably can’t help you with a stale mate if you’re married to one, I can probably figure out how to help you safely close a high end real estate transaction.

But isn’t seller financing risky? What if the buyer quits making the payments?

Trust issues:

1. How do we trust that the buyer will keep making his payments? If he defaults, it will take us at least 6 months to get the property back, during which a normal 10%-20% down payment cushion would probably evaporate.

2. How do we trust that the bank won’t accelerate, or ‘call,’ underlying loans? Having to replace a nice 6.75% fixed $1.7 mil loan would represent an unacceptable financial risk and destroy the investment objectives of any buyer.

"The best way to create trust is not to need any."

Developing trust:

We can put a property into a land trust, with an associated document ‘transfer system.’ Using the land trust transfer system, we achieve two important objectives (which is why I call it Seller Financing on Steroids):

• If the ‘buyer’ defaults, we can evict him according to tenant law, instead of having to foreclose = possession of the property in 60 days rather than 6 months, mitigating the risk of a small down payment (small is 10% or less on conventional, 20% or less on jumbo)

• We prevent the bank from being able to ‘call’ the loan, as the trust system works within federal Garn - St. Germain guidelines.

Seller financing is a powerful tool that can help us close more transactions, restoring trust in today’s market. With the Trust Transfer System, we can expand seller financing techniques to those situations where there might not be a lot of equity, but there is good underlying financing that can be left in place.

Putting Seller Financing on Steroids is a great way to close more high end real estate transactions . . . trust me!

Related Reading:

• I need help putting my deal together, can you help me?
• Seller Financing and Land Trusts - Secrets of Liquidity After PTSD in the Real Estate Marketplace
• Investor’s Business Daily and Rickabaugh Have a Chat About Seller Financing

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The quick answer to this question is "As much as possible." The more money someone puts down, the more protective equity you have, and the less likely they are to default. It's called, "Having some skin in the game."

There are good buyers out there who do not have 20% or more for a cash down payment. Does that mean that you shouldn't do the deal? Maybe, maybe not. It all depends.

There are many factors that are unique to each individual situation. That's why people pay me to go over their particular situation and look at it from all sides, understanding both the risks and rewards and best ways to mitigate risk.

If someone doesn't have a 20% down payment, you can reduce your exposure by using the land trust transfer. That way, you don't have to foreclose to regain possession of the property if the buyer defaults. It also allows you to defer any capital gains.

FYI, here are some typical Loan-To-Value (LTV) Ranges required by note buyers (which is also why many note holders end up selling a partial):

• Owner-occupied single family home: 70% to 80%
• Non-owner-occupied single family house: 60% to 70%
• Owner -occupied condominium: 50% to 70%
• Multi-family apartments: 50% to 70%
• Commercial property: 60%
• Urban land with utilities (to the property): 50%
• Rural land (non farm): 50% or less

Two things may be learned from this list:

1. The type of notes preferred by note buyers: Owner-occupied homes are the most desirable in general. History has proven them the most stable. Notes secured by land usually have the greatest risk.

2. Real estate values fluctuate both up and down over time, even in good areas. A note holder's best protection against loss is protective equity established at the time he acquires a note. An owner with a substantial equity who is paying on a note will be motivated to protect his/her equity position.

Related Reading:

• How We Can Help
• I Want to Sell My Note

Recently, LA Times writer Peter Hong published an article about the new interest mortgage interest rates:

Mortgage rates fall, but many borrowers will have trouble qualifying - Low seasonal demand and high borrowing standards make a rush of new loans unlikely.

". . . Jumbo mortgages, those over $729,000, carry interest rates just under 8% and remain very difficult to obtain, Lazerson said. Because Fannie and Freddie can't buy jumbo loans, the rates on them are unlikely to be affected by the Fed's plan."

The jumbo loans needed to purchase luxury residential properties, as well as the mid-sized commercial properties, are going to continue to be very difficult to get. And it's showing.

The high end properties just aren't moving, and they won't unless we can bridge the financing gap.

I know a lot of agents that will say that the higher end clients don't need help with financing . . . they have great credit and income, or maybe they're all-cash buyers. I don't doubt that that's true for some, but it's definitely not the case for all.

Seller financing is going to be an increasingly important tool for closing the more expensive properties. When there is existing financing that needs to be left in place, we are having great success using the Equity Holding Trust Transfer System to protect both buyers and sellers.

Incidentally, this strategy can also create the possibility for complete deferral of capital gains on luxury residences. The home owner's exemption is $500,000 at most, so anything over that is subject to federal capital gains (that may very well increase to 20%).

If a property seller agrees to leave existing financing in place for a buyer and puts the property in a land trust, their primary residence can become classified as an investment after 12-18 months, and they can elect to do a 1031 exchange into another property once the trust is terminated (has to be completed within 3 years).

If you have a property over $700,000 that is not selling, you should really give me a call before you consider taking it off the market or doing a drastic price reduction. Offering terms will help support your price point. Agents who understand alternative exit strategies will find themselves closing more transactions than their counterparts.

This seller is representative of many sellers of smaller and mid-sized commercial buildings these days:

"Dear Dawn,

I read with great interest the 10/3/08, Investor's Business Daily article that featured your information on seller financing.

I personally own a lake front condo office in Stockton. I have it clear of any loans and lost 3 buyers because of huge finance loan fees quoted, so am now thinking quite seriously about your procedure with me, as Seller, carrying the loan.

Do you offer, for a fee, to setup the carry back situation including how the payments are made and to whom, etc.?

Sincerely,

Tim"

Tim's buyers were scared off by the bank fees, but many can't get decent loans at all. Or maybe they can get a 65% LTV at 11%, but not many buyers have a 35% down payment at the prices that most sellers are wanting for their properties today.

When Tim gets a chance to call me back, here's a few basic guidelines that we'll talk about when structuring a seller carry back transaction:

• Down payment - for commercial property, the standard is to try and get 25% down. Sometimes less is OK if there are other strengths in the deal

• Interest rate - sellers should shoot for 8, 9 or 10%, but to be competitive and support maximum price, sometimes sellers are carrying at 6 & 7%

• Term - amortize over the shortest possible time, over 15 or 20 years if the buyer can do it, and put in a 5-7 year balloon. If they can't make the balloon payment at that point, at least you'll have the opportunity of renegotiating increasingly favorable terms

• Credit score - you want a buyer with a decent credit score . . . not just to make your own investment more secure, but to have a reasonable chance of selling the note down the road

• Capital gains - Tim & I are going to talk about his strategies for deferring capital gains in concert with advice from his own CPA. Should he put in a stiff prepayment penalty? Should he put the property in a land trust for a 1031 exchange option down the road?

• Exit strategy - will he want to sell all or part of the note sooner? Later? How we structure the transaction will reflect his ultimate needs and objectives

If you have a deal you would like to chat with someone about to make sure you put your deal together powerfully and intelligently, feel free to email me.

This is the time for note professionals to shine. Our expertise can make a meaningful contribution to the economy.

I got an email from Kay, who found me as a result of an Investor’s Business Daily interview: Seller Financing Can Seal the Deal in Rough Market. She was thrilled, and so was I, that we only lived 5 miles apart. (It’s always fun when you get to work with people in your own back yard).

She and her husband had an escrow that was falling apart, and they asked me to step in and put it back together. If this deal didn’t close, then they would most likely lose at least another $50,000 on this southbound investment.

Here’s the scoop:

A British buyer had originally made an all cash offer on a $764,000 home. He put down a non-refundable deposit of $24,000, and was willing to walk away from it when the pound dropped substantially against the dollar, virtually overnight.

For him to liquidate enough of his own currency to complete the deal right now would effectively make his purchase price $900,000, and that didn’t mix well with his Earl Grey.

The sellers and I weighed the wrap (AITD) against subject-to and land trust transfer: seller financing on steroids - a technique to prevent the bank from being able to ‘call’ the note on any underlying financing left in place.

Here’s how the sellers made the transaction more palatable for the buyer and created a win-win-win-win-win (2 principals, 2 real estate agents, and 1 note pro):

Buyer made a $194,400 down payment, and took the property subject-to the sellers’ interest-only loan: principal balance $569,600, fixed at 7.25%. By George! Now he could put his focus back on the Breeder’s Cup!

As it becomes economically attractive for him to do so, he will liquidate pounds for dollars and pay off the underlying financing.

(After the holidays, won’t we all wish we could liquidate pounds for dollars?!)

I would have preferred that we had done a wrap (even if the interest rate was at par with the underlying financing). While both strategies are equally underwritten, the wrap would have given the sellers the right to foreclose in the unlikely event that the buyer quits making his monthly payments. Not that they would be willing to soak more money into the investment, but they would have retained more control.

The equity holding trust would have been watertight against potential loan acceleration, but the buyer’s financial strength made it an acceptable risk, so we elected not to try and educate everyone about this particular strategy.

Seller financing saved this Pasadena escrow and made everyone very happy: sellers got to sell, buyers got to buy, and agents made commissions. Now isn’t that some lovely jubbly!

Related Reading:

• Very Scary Halloween Notes: Due on Sale (Santa?) Clauses
• Seller Financing and Land Trusts - Secrets of Liquidity After PTSD in the Real Estate Marketplace