Two articles by
industry investors:
Updated
SIMULTANEOUS
CLOSES...Reality Strikes
By Judy Miller
One
of the most frequently asked questions we hear is about structuring and
processing a Simultaneous Close, where money to purchase a to-be-created note
is brought to the table at the close of escrow on the original sale of the
property. The process is not actually "simultaneous"
since the Assignment of the note occurs after the documents in the buy-sell are
themselves recorded. It really is "A Moment Right After"
Close. However, it's close enough in application, if not in definition,
for us to call it "simultaneous" as long as we understand the
important distinction for legal reasons. This process is also referred to
as "Table Funding."
We
must first take into account some basic observations and considerations at the
outset of one of these proposed transactions. Because so much time and
effort goes into simultaneous deal structuring that never materializes into
revenue, the goal is for all of us to take the blinders off and work smart.
First, an agreement must be reached on basic terms between the buyer
(prospective payor) and the seller of the property whereby the seller is
agreeing to create and carry a seller-held note with the intention of selling
all or a portion of the note. You may be asked to review the proposed
terms already tentatively agreed to between the parties. Or you may be
asked to provide feedback about the saleability of the proposed note. The
parties can then predetermine how much cash will be available to the seller if
the note is sold.
How
much CASH the seller will receive at closing is usually the pivotal sticking
point. You will be giving feedback about the note’s marketability based
upon the proposed terms of the deal. If you have a flexible buyer and seller
this may be a back and forth process whereby you are trying to satisfy both the
needs of each of the parties to the buy-sell and the requirements and
predilections of the proposed note purchaser. This is an art, not a
science.
It
is reasonable to assume that, if a buyer could qualify for a new mortgage in a
timely fashion, the seller would obviously be better off receiving full payment
of the sales price of the property rather than carrying back a note he is now
going to have to discount. "If he could, he would."
Therefore, it is understandable that we make certain assumptions merely on the
basis of his willingness to consider this type of financing. As a result,
unless other reasonable explanations exist, we can expect to see blemishes in
the credit of the buyer/payor, or he has not lived in the area long enough to
qualify for a new mortgage or credit is good but he is debt-heavy, etc.
Conversely, on rare occasions we have seen scenarios where credit and down
payment were just fine and the seller is still willing to discount the note,
i.e. the sale price. This may be because the process can go much more quickly.
Other
reasons for a seller to carry paper he/she is willing to discount include: the
property has been on the market a long time and this method will open the door
to more potential buyers, the seller is moving out of town and needs to take
the first offer (which may be one for little or no cash with poor payor
credit), the buyers are long-term tenants of the seller, or a real estate
professional advises a naive seller to accept the first offer that comes along
so the real estate professional is paid a commission fast, but the offer is
detrimental to the seller's best interests due to unfavorable terms or poor
payor credit. We are also seeing more often where note brokers are
approaching real estate professionals and/or sellers and offering to bring
money to the table as an effective means of drumming up note business.
This is a worthy approach if the seller is truly motivated to move that property.
The problem with this method is that the seller must be motivated enough to
take a discount in order to move the property or else everyone involved
is just spinning their wheels. Without serious seller motivation to move
a property, there will be no deal. It is important in a discounted cash
flow situation to determine the true motivation of the seller in order to
decide whether, from the outset, you can make any deal work or whether
you are just wasting your time.
In
addition, in my experience many residential real estate brokers have a
difficult time understanding what we note brokers do. Commercial real
estate brokers deal with the high-ticket items where conventional financing is
not as available and therefore are more likely to be receptive to learning the
concept and applying it to their transaction. We explain to them that "we
buy wraps", and they then comprehend the possibilities.
Another
sensitive area for our attention is that the note broker is probably not
licensed as a real estate broker and therefore must not be giving any real
estate advice. Giving advice is the function of a real estate
professional. In the case of a "For Sale By Owner" property,
the thin gray line between creating a deal and giving real estate advice must
be carefully delineated, and error must be on the side of caution. The
Broker is merely advising that, if a note between the prospective buyer/payor
and seller is structured in a given way, he/she could pay "X" dollars
for the note being created between those parties, subject to a funder’s due
diligence review. It is "OK" that the note we are
purchasing is being executed at the closing of the property sale.
Another
often asked question is, "What fundamentals of the deal do we need to know
in order to create a deal structure?" There is no real mystery in
the fundamentals of evaluating a Simultaneous Closing Note Structure. We
use the exact same fundamentals for any existing real estate note pricing, only
we recognize that there is no seasoning on the note. In a proposed
transaction, we look at the credit of the payor, the amount of the down
payment, the face interest rate of the note, the length of the note, how
realistic a balloon payment term is, if any, and the type of property being
secured.
The
seller almost always wants to get "all of his money out of the
deal." How can he if there is a low or no down payment, a 7.5
percent interest rate, a non-owner occupied rental property with a 30-year
straight amortized term, with bad credit? Yet we are shown these
scenarios often and are asked how we can get the seller all of his money!
On
the subject of sales price, often we see a seller attempting to cleverly add
onto the price the dollar amount he/she expects to lose in discounting the
note. This will not fly if the value is not in the property. The
price of the property is not the deciding factor in these transactions.
The required and actual interior and exterior full appraisal will be the sole
guiding determination of value and not the sales price. Also, we often
see where a seller had purchased the property at a low price and rehabilitated
it, that is, put money into remodeling and now has it on the market for a
higher price. For example, if a seller borrowed and purchased the
property for $35,000 and put $10,000 cash and sweat equity into the property
and now has a buyer at $60,000, can we help him? We have to look at all
the same factors and see if we can come up with enough money on our purchase to
take out the underlying first lien of $35,000 and provide the seller a return
on his $10,000, let alone a portion of his profits. If the credit is bad,
it's not going to happen. We cannot put enough money into this
purchase to take the seller completely out. "Investment to
value-wise", we will be limiting our investment to perhaps 50 cents of the
sales price, or $30,000 maximum, which is not enough to take out the first lien
let alone the seller's profits.
Matters
start looking up from there as factors such as credit, down payment, equity,
face interest rate, etc. improve. However, it is not likely that
more than $48,000 or 80 percent investment to value, will ever be funded on a
residential note created in this fashion. Since the seller has $45,000
hard cash in the property, will he take what remains of the funder's $48,000,
or $3,000 residual cash now? "Remains" means the funder might
pay you $48,000; however, you have to pay all costs and make a profit from the
proceeds, so it is likely the buyer, at best, could see his $45,000. It
is likely he will accept this amount only if he's gotten a good down payment
and/or he's satisfied with taking his profits out in a second mortgage that is
created at the sale. On his second mortgage he will be receiving monthly income
and showing confidence in his chosen payor by "sharing the risk".
The
issue then becomes one of structuring, combining the recipe for this cake
between buyer's ability to pay and seller's motivation to sell at a
discount. For example, if the payor can only afford $600 per month,
this must be considered as a primary point when setting up the scenario.
Additionally, if the payor has very little or no money down and bad credit, you
would expect the face interest rate to be high. However, if, when the
face interest rate is high, the credit is bad and the note is amortized over 30
year, the monthly payment comes out to be $800 per month or $200 more than the
payor can afford, we have a problem. The payor cannot afford $800 per
month payments. Creating an interest only note for five years with a
balloon is not going to solve this problem because no one is going to have
confidence that the payor can pay that balloon when due. Creating a
note with a low interest rate will mean the seller is going to take a big hit
in the valuation of the note. Therefore, mixing this cake batter is,
again, an art not a science. The main ingredient, as in all note deals,
is once again, bottom line, seller motivation.
Traditionally, when buying an existing note on a transaction where there was
little or no down payment, bad credit, and no seasoning, a funder will
obviously limit its investment more so than in a seasoned or greater equity
note. The same goes for Simultaneous Close deal structuring,
There is no difference. Each of these factors in combination with each
other dictates the recommended terms of the note as well as how much cash will
be available to the seller. And remember, the funder in a Simultaneous
Close is also looking at a non-seasoned note.
The
amount of cash the seller wants from the deal is also in play.
Typically, it is the seller who will find you to broker cash for this
transaction, although we have also worked with purchasers who are looking for
ways to make a deal work for a house they don't have enough money or credit to
purchase straight out. We must prepare the seller for the discount or the
fact that he/she may be looking at a multi-staged payout, which is a series of
Partials, in order to get his/her money out of the property. We remind
them to add the down payment to the amount of cash they will be receiving, plus
the dollars we will subsequently pay for the payments we are
purchasing. If this just isn’t enough cash, the seller can and will
wait for a better offer.
If
we see that the payor has poor credit, we’ll want to keep the monthly payments
affordable and our investment lower. We might then structure payments amortized
over 360 months with a 60-month or 180-month balloon. Then we only
purchase the payments, leaving the seller to collect the balloon.
As
a funder, we at American Note purchase Simultaneous Close Notes. We help
brokers structure the transactions in order to make the notes created
marketable. When a potential note is submitted to our company for pricing, we
like to see the following information (to make it possible to provide you with
a reliable offer):
A Worksheet with your best outline of the deal terms proposed between the
parties, representative of the ability and needs of each of the parties.
The respective payor information in order for us to look at credit.
Credit is such a major factor that any pricing you are given that has not taken
credit into consideration is not to be relied upon and isn't worth the faxed
paper it's printed on.
Any information you have about the motivation of the seller.
When
we purchase a Simultaneous Note transaction, we package the entire
transaction. However, in the event you wish to package the transaction
yourself for sale to another funder, here are the basics of what you will
ultimately need to provide:
Name, address, telephone number of Title Company that will be handling the
Title on the file.
Name, address, telephone number of Attorney or Escrow company that will be
handling the sale transaction.
Name, address, telephone number of Real Estate Agent/Broker who is representing
buyer and seller.
Copy of the
Copy of Receipt for funds deposited into escrow/title.
Loan Application/Credit Application completed by buyer(s).
Name, address, telephone number and Social Security number of seller(s).
Name, address, telephone number and Social Security number of buyer(s).
Copy (draft) of proposed note and Deed of Trust/Mortgage.
Copy of Commitment for Title/Preliminary Title Report.
Copy of estimated closing Settlement statement.
Full Appraisal. (We recommend that, based upon the deal structure between
the parties, if you have any doubt about the value of the property, you collect
a deposit from the seller, who is the party with whom you will be entering into
contract, to cover the actual cost of the appraisal. In the event the
appraisal comes in at or above the sales price, you can agree to reimburse the
seller the appraisal deposit at the close of the transaction. You would
spell this out in your contract. In the event the seller balks at
putting up an appraisal deposit, you have to decide if you wish to take the
risk of the appraisal expense. If there is no down payment and poor
credit, please think a lot.)
If the buyer is a Corporation, you must provide copies of the last two years of
tax returns and a Corporate Resolution.
If the seller is a Corporation, we will need a Corporate Resolution.
Putting a Simultaneous Close together takes a lot of cooperation from both the
buyer and seller and flexibility and realistic strategizing by the note broker.
Success with these is based upon common sense.
I
no longer have contact info for Judy. If
I find it I will update this material.
Here is another
one from Mike Morrongiello;
Creating
Marketable Notes
By: Michael T. Morrongiello
The
day has come when savvy entrepreneurs, investors, rehabbers, FSBO's, Realtors,
and other Real Property owners have come to the realization that they can sell
their properties faster by offering owner financing and still get to a
cash position. The advent and acceptance of what often is referred to as a
"simultaneous closing" where a property is sold and the private
seller financed note is also simultaneously sold to coincide with the sale of
the property has become an integral way that many note deals get done these
days.
I
am often asked how can I structure these types of deals to provide for two
things: #1, a saleable note that can be easily converted into cash? and #2, a
minimal note discount from the balance owed?
The
following circumstances surrounding a potential note deal will come into play
when a note investor, including ourselves, is looking to purchase these newly
created notes.
Type
of property, occupancy, new sale or one with a payment history, buyers down
payment, buyers credit profile, buyers credit scores, buyers employment,
stability, and finally the repayment terms of the note.
Let's
briefly explore each of these variables:
1) Type of Property
As
far as the collateral securing repayment of the note is concerned, clearly a
vacant land parcel that has no improvements attributed to it would be
considered far riskier than a mortgage lien on a single family dwelling which
is generally considered to be the easiest type of real estate to finance, sell,
or dispose of. Different types of collateral warrant different levels of
exposure from a funder. Residential type properties are far more acceptable
than commercial properties or land. Within the residential sector there are
varying degrees of acceptance over the actual type of residential
property. A mortgage lien on a single family detached home is far more
desirable than one on a condominium, town home, or mobile home, etc. For
purposes of this article we will focus on the most desirable type of collateral
for an investor in paper and that is the "bread and butter" single
family home. If you are creating paper and you are wanting to maximize the
amount of cash you can receive, then a properly structured 1st lien
mortgage on a single family, owner occupied, detached dwelling is by far the
type most note funders can price aggressively. Meaning; maximizing the funding
exposure and minimizing the discount on the note sale.
2) Occupancy
Statistically
speaking, a payor who lives in his/her home as their primary residence is going
to keep up the condition of their property better and pay more timely on a note
than an investor owner who may be struggling to collect rents, keep up with
repairs, or other bills, etc. This translates into more conservative exposure
levels that are going to have to be adhered to for a non-owner occupant
investor type payor. It is wiser to sell to prospective buyers who are going to
live in the home, feel that they have some emotional attachment to the home,
and are more willing to pay a full "retail" sales price for the home
than an investor.
3) New
A
note that has been newly created where there is no discernable payment history
established creates an aura of uncertainty and risk associated with this
burning question; how will the note be repaid? Often even good credit payors
overextend themselves when purchasing a home and all the extraneous expenses
that go along with home ownership (taxes, insurance, repairs, upgrades,
furnishings, utilities, etc.) A note that has even a few months of documentable
payments associated with it can often lessen many issues surrounding the
burning question. With lesser credit payors, the note may have no alternative
but to be seasoned in order to mitigate the risk and uncertainty and make it
marketable for sale. If you have marginal payors that are going to be paying
you, make sure you have the ability to clearly document their payment history
to you. After a period of time the risk and concern over their credit background
becomes offset to a large degree by their performance on the note.
4) Buyer's Down Payment
If
you are presented with two identical notes that are secured by two identical
homes located in the same neighborhood, with the exception that the purchasers
of one home put down 10% of the purchase price of their home in cash, and the
other home purchaser put down little or no cash, everything else being equal,
in which note would you prefer to invest? A down payment of a buyer's hard
earned dollars creates more stability for a buyer. They often will fight, claw,
and scratch their way out of a problem before jeopardizing their initial down
payment they have made into a property. Although most note funders want a
minimum of 5% cash down, 10% is preferable on residential properties. Also make
sure any initial earnest money deposited or down payment money is clearly and
conclusively documented.
5) Buyer's Credit Profile
Prospective
buyers of a property that have demonstrated that they can pay their creditor obligations
timely are going to be inherently a better risk and command more aggressive
pricing for a note that they are paying on than those individuals with a
blemished credit past or present. This is not to say that a so-called
"scratch and dent" borrower cannot still be a good choice. One must
look carefully at the overall credit profile and history to see where the
problems lie. Are there major credit issues like a prior or more recent
bankruptcy, repossession, foreclosure, judgement, etc.? or are the credit
problems possibly related to past medical payment problems? How long ago were
these problems present? Has there been any re-establishment of positive credit?
There is a tremendous amount of increased risk associated with buying a note
that has no established payment history attributed to it. If you want to sell a
newly created note it is advisable to seek better credit quality buyers. As an
alternative as stated above be prepared to accept a larger discount for the
note and a lower level of funding exposure or consider seasoning the note to
establish a track record of timely payments.
6) Credit Scores
Credit
scoring is often referred to as a "FICO", "BEACON", or
"EMPERICA" score. It is generated by analyzing the data in the major
credit repositories for an individual and affixing a score that illustrates
their pattern of credit use. The higher the score the lower the risk associated
with that prospective borrower, the lower the score the greater degree of risk.
Although far from perfect more and more funders are relying on these credit
scores to ferret out potentially problematic borrowers.
As
of this articles writing when dealing with newly created notes or real estate
mortgages one should try to look for prospective buyers who have credit scores
in excess of 600. Sure you can sell one of your properties to a lower credit
score buyer, however you will have to sacrifice a lower tolerance level for any
funding for that particular note or will have to "age" or season the
note obligation for a period of time to offset the lower credit scores and
perceptions of risk.
7) Buyer's Employment & Stability
What
someone does for a living and for how long often illustrates how stable a
prospective buyer may be. If an individual has been going from job to job over
short time periods or has relocated several times over the recent years there
is an aura of extra risk associated with that type of borrower. However
individuals who have some longer-term stability either in working for
themselves or an employer are considered less risky.
8) Repayment Terms of the Obligation
After
carefully scrutinizing the above variables one should have a good feel for
where their prospective buyer / borrower might fit in from a risk standpoint.
Those candidates with less risk should allow you to finance them at a higher
starting (LTV) loan to value threshold for the mortgage which typically will be
in the 85% LTV to perhaps as high as a 90% LTV range as opposed to the riskier
candidates who you might wish to limit to somewhere in the 75% LTV - 80% LTV
range. The same is true with the actual note interest rate or
"coupon" rate. Higher risk means the note should be drafted with a
higher interest rate, typically in the 11.5% -12.5% range. Lower risk can allow
for a lower note coupon rate perhaps in the 10.5% - 11.5% range. The mortgage
and note should typically contain a 30-day default clause, have acceleration
remedies, contain no prepayment penalty, have a late fee provision a due on sale
clause, and non-assumability clause.
Summary
It
is the dynamic interrelationship of all of these variables that will dictate
how you can "tweak" the proposed structure for a deal so that it will
allow you to maximize the amount of cash you can realize along with minimizing
the note discount.
It
makes little sense for you to try to sell a newly created 90% LTV note that is
written @ a 9.5% interest rate to a note funder where the note payor has credit
that is not deserving of that favorable interest rate or higher loan to value
exposure. You will be the one that suffers a greater discount on the sale of
this type of note since its structure was not optimized.
Additionally
experienced funding source personnel or a competent master broker can save you
tons of frustration, heartache, and headache in putting your deals quickly
together in an optimum fashion. Pay attention to the above variables and above
all, be realistic.
Michael T. Morrongiello is operations manager of Sunvest Corp., a
nationwide mortgage investment firm. Michael has 20 + years of experience in
buying, fixing, managing, and selling real estate investment properties. For
much of the last 17 years he has focused on real estate "paper" as a
niche market within the finance industry. You may contact Michael at
707-939-9450 or MikeM@sunvestinc.com.