Remember this – if you sell a property and carry back the note –  lots of things can happen in the future. But, odds are, that one of the following will probably occur:

1. You will hold the note to its maturity.

2. Your buyer will pay off the note early.

3. Your buyer will stop making payments and you will foreclose.

4. You will sell your note for cash.

3 of these 4 is a good thing; no-one wants to face the stressful situation of a foreclosure. All you can control as a seller of a property is to do enough due diligence so that you feel very comfortable about your buyer. You need to understand his financial situation, his job status, his connection and commitment to the neighborhood, whether extended family may be living close by. The more you know the more comfortable – or uncomfortable – you will become about your potential buyer. You can then measure  how strongly you feel about his ability and desire to make the required monthly payment next month, next year, etc.

At some point, your interest in your note will end, and if you have done most things right, hopefully it will end happily. If you never do another note in your lifetime, remember that the one time you do, you want to do it right. Just like your life on earth, you will be “visiting” with your note for a relatively short time. Do your homework, talk to folks like me, and learn from our experience and mistakes.

Kenneth Harney of the Washington Post has an article about home equity, citing reports from the Federal Reserve and real estate analytics  firm CoreLogic. Here is some data:

Home equity soared in 2013 by $2.1 trillion to a total of $10 trillion. The high point was $12 trillion in 2005. 4 million homeowners country wide climbed out of negative equity last year. Close to 50 million people own homes in the United States, with about 6.5 million of them in negative equity positions. 12 million home owners were underwater in 2009. That’s a huge drop! The states that had the highest run up in prices during the boom – particularly Nevada, Florida and Arizona –  still have the highest percentage suffering with negative equity, 30.4%, 28.1% and 21.5% respectively.

It’s the “lower” end of the market carrying most of the negative equity. Just 8% of  homes worth $200,000 or more have negative equity; 19% of homes under $200,000 report negative equity.

CoreLogic says having positive equity in your home is one thing, but do you have adequate equity? Or, are you “under-equitied”? Under-equity means you have mortgage debt in excess of 80% of your home’s resale value. The less equity you have, the less financial options you have – such as refinancing or obtaining an equity credit line. About 21% of all mortgaged homes nationwide are “under-equitied”, and 1.6 million owners have less than 5% equity.

My personal experience in talking to holders of owner carry back notes in different states is that home equity has made a strong comeback. Many are in fact “under-equitied”, but good equity exists where it was absent just a few years ago.  As always, sellers willing to carry a note need to construct strong terms to protect themselves. A healthy down payment goes a long way to providing that safety net.

Do you know a Millennial when you meet one? If you are selling a home and willing to carry the note, let me introduce you to a good prospect as a potential buyer of your home:

Age   – 33 and younger

Income – $73,000+

Home he will buy – 1800 square feet

Price – $180,000

This “picture” of a Millennial was described in a March 11, 2014 report released by the National Association of Realtors. NAR reports that 78% of first time home buyers are Millennials, the largest group since the baby boomers. The pie chart for home buyers looks like this:

31% – Millennials, age 33 and younger

30% – Generation X, age 34-48

16% – Younger Boomers, age 49-58

14% – Older Boomers , age 59-67

9% – Silent Folks, age 68-88

Lawrence Yun, NAR’s Chief Economist, said “given that Millennials are the largest generation in history after the baby boomers, it means there is a potential for strong underlying demand. However, the challenges of tight credit, limited inventory, eroding affordability and high debt loans have limited the capacity of young people to own.”

What does this mean for you as a seller of a property? Opportunity!

So, if you meet a potential buyer that fits this description, the odds are you have a solid prospect for a seller carry back transaction. Using NAR’s averages, let’s assume you are asking $180,000 for your well kept 1800 square foot home. Here are some possible negotiating terms:

Sales Price – $180,000

Down payment     Note Amount          Interest rate              Monthly Payment, 30 yr Am.

5%, $9000                  $171,000                    10%                                     $1500.65

10%, $18,000            $162,000                      9%                                      $1303.49

15%, $27,000            $153,000                      8%                                      $1122.66

20%, $36,000            $144,000                      7%                                      $958.04

Remember, no matter who your buyer is, you take a risk by offering a seller carry back. The biggest risk? He doesn’t pay you. Can you handle the downside of this transaction as well as a multi billion dollar bank can? Probably not. You must be compensated for this risk. And, that compensation normally comes in your demand of a significant down payment, higher interest rate, and/or shorter pay period.

Be on the lookout for this buyer!

If you are self employed and want to get a mortgage loan, it’s tough going out there. If you have an “unattractive” Schedule C, odds are you won’t qualify.

Briefly, according to a mortgage broker friend of mine, your net profit for the past 2 years is averaged, then divided by 24 months to get your net monthly income. 45% of that figure is the maximum mortgage payment you would qualify for. If you are showing very little or no profit at all, that leaves almost no income left to make a mortgage payment. Decline.

The new lending rules effective in 2014 will make it more difficult for a lot of people to get qualified for a mortgage loan, not just self employed folks. But with a nice rebound in home prices, those of us in the seller carry back business have seen a big spike in activity, and a more attractive pricing experience for sellers. So, if you are self employed and have some cash, ask a seller of a property you want to buy if he would be willing to carry back the note. Offer a strong downpayment – 20% or more -. Run your own credit and give your score and history to the seller. Be willing to pay a higher interest rate because the seller is making an accommodation by taking the place of the bank.

Once the transaction closes and you have made several payments, the seller will probably find an attractive market for this note should he want to cash out. Note prices have risen gently and many sellers of high quality notes are receiving 80%++ for their notes.

Don’t despair if you are self employed. If you find the right property and the right seller, you may not get a bank loan but you certainly can negotiate an installment sale that will benefit you, your seller and the housing market.

The headline of a recent article I read announced Optimism of small business owners falls. Since most of us live in the real world, this is no revelation.

The article quoted Bill Dunkelberg, chief economist for the National Federation of Independent Business. I have cherry picked some quotes:

 “Small-business owners were more pessimistic last month about the economy’s outlook.”

 “Prospects for politicians and policymakers getting it right are low, and job creators are rolling their eyes and shaking their heads, thinking this is certainly not the way to run the largest enterprise in the world(bold is mine).”

 “Manufactured crises in Washington probably would keep consumers and small-business owners pessimistic about economic growth.”

I can watch about 2 minutes of a news show featuring a politician and be totally frustrated. Those of us in business, any business, try to provide a service or product, solve problems, make life better for the customer. If we fail in doing so, no income, no bills paid, no business.

Got me thinking – could we change the rules and have legislators not have full time careers in Congress?  Provide community service for free or very little compensation? You know, like serving in the Army for 2 or 4 years, then you are done. Now, you move on with your life. Simple answer – NO – because they make the rules, and they feed at mother government’s breast until there is no more milk. Feels like we are there right now, doesn’t it? Dry.

To me, the real issue for years has been jobs, jobs, jobs. Solve the jobs problem and America starts moving again. Other problems go away or are minimized. Seems so basic to me. Am I a simpleton? Our career legislators have focused on everything but creating the right environment that Mr. Dunkelberg and the rest of us want.

What does this have to do with notes? It’s all related. People working, making money, feeling good about their present and future, spending money, buying homes – it helps everyone in the real estate industry and the economy at large.

Just needed to vent.

Activity is picking up. More and more people are looking to sell their owner carryback notes. More and more people are creating owner carryback notes.

Industry experts  who track these things estimate that about 1 out of every 50 real estate transactions involves some kind of owner carryback. I can remember giving a presentation to a real estate group several years ago where I said that 1 out of every 400 real estate transactions involved an owner carryback.

How far reaching is this activity? A July marketwatch.com article referred to a 35,000 square foot mansion in San Francisco that has been on and off the market for the past 10 years. Asking price? $29 million. The seller decided to sweeten the pot by putting the home back on the market with this proviso – if the buyer agreed to allow the seller to carry back 40% of the purchase price, the seller would offer a 3.8%, 30 year fixed interest rate and reduce the price to $26 million.

Any takers out there?

The high end market sees a lot of cash transactions, but creativity and the desire to sell doesn’t seem to have market value boundaries. If you are selling a property and don’t have any takers, maybe you should sweeten the pot and hopefully attract the right buyer. Offer an owner carryback with strong but fair terms for both parties. Meet the fall rush and become a part of it.

Most successful businesses find a niche in the marketplace. They get very good at their niche and this allows them to compete and become profitable.

The business of buying owner carryback notes is similar. Most notebuyers carve out an area they like to operate in. Experience has been their teacher.

As a note broker, my job is to develop relationships with these buyers, discover their likes and dislikes, and then match a seller to the right buyer.

Here is an example of a buyer who has carved out a particular niche in commercial real estate notes that has worked out very well for them over the years. They focus on Class C properties. A Class A property is a big office building in a major city such as Los Angeles or New York. A Class B property is an apartment building or mid size office building. What’s a Class C property?

A Class C property is a church, an auto repair shop, a smog shop, a motel, a gas station, a junkyard. A Class C property may be an older property located in a transitional area. It may have remaining economic life issues. It may have environmental issues. It’s “use” may change over time. Consequently, bank financing may be difficult or impossible to obtain. The seller of one of these properties will typically have to carry some or all of the debt.

Many note buyers will not purchase notes secured by these types of properties, either due to limited experience(usually bad) or a lack of comfort with all the associated issues. Without question, these properties fall into a special niche.

I am fortunate in that I have developed a relationship with a particular buyer whose niche is these very Class C properties. They have been buying these types of notes for years and have an expertise that is uncommon in the note industry. They are always looking for a Junkyard Dog note. If you are the holder of one and looking to sell, help may be available. Contact me and let’s see if your Junkyard Dog can find a new owner.

I have never done business in a pawn shop!

The History Channel has a show called Pawn Stars. Have you seen it? It’s about a family owned pawn shop in Las Vegas. The show fascinates me.

A guy walks into the store with a Wanted poster for John Wilkes Boothe, the man who assassinated President Lincoln. The 12 day manhunt for Boothe was the biggest in United States history. The shop owner gets real excited. He knows this is one of the most iconic documents known to exist. The customer claims it is real and asks for $33,000.

Is this document real? Is it a fraud? Is the shop owner being hustled?

He calls in an expert. The expert walks into the shop with 1 of 4 original Wanted posters known to exist. Value? $100,000.

The expert compares the 2 documents and points out the similarities and differences. He concludes that given the differences, the customer owns an early reproduction. Value? $100.

No sale!

Here is what fascinates me.

First, the pawn shop owner never knows who or what will come into his store. He has to be ready for anything. His experience has taught him a lot, and given him knowledge about people, the items they bring in, and the true value of these items. He will offer to pay the customer based on this experience and knowledge. Will he pay market value? No. He has holding costs and a need to make a profit. The customer has a need to get a fair price. Sometimes they make a deal. Sometimes they don’t.

Second, he must rely on experts at times instead of his own instincts. He can’t afford to take a loss because his cockiness or emotion got the best of him. He does not want to buy something that he should’ve passed on because he finds out after the fact the value is not there. The expert gives both the shop owner and the customer a 3rd party opinion, and sometimes both are surprised by what the expert has to say. Maybe the item is worth way more than the customer realizes, so he is pleasantly surprised and may walk out with way more money than he anticipated. Many times, though, the opposite is true, and the item has little value.

The note business is pretty similar. Due diligence equates to the pawn shop owner’s expert. After an initial conversation with a note seller, a note may appear very attractive on the surface. But, examination of a few documents and a little research may find scars underneath – poor property value, poor credit, unpaid property taxes, poor pay history, etc. In this case, the customer may not have what he thought he had – a very marketable note attracting top dollar. The “differences” will be pointed out, and the parties may or may not come to a resolution that satisfies both.

For the pawn shop owner and the note buyer, Ronald Reagan’s famous quote rings true:

Trust But Verify.

The mindset of many seller ‘s looking to sell their owner carryback note is pretty much like that of a person selling the home he has lived in for 20 years – “My home is the best in the neighborhood.” Translation – I deserve a higher price than anyone else.

To the home seller, it is irrelevant whether his home is, in fact, the best in the neighborhood. He has convinced himself that it is. His strong emotional attachment blinds him from reality. Realtors deal with this all the time.

Most of us have sold a home sometime in our past and gritted our teeth when the realtor suggested a listing price. “What’s he thinking, my house is worth way more than that?” We can relate. Seller price expectations rarely match up with market reality.

There is a similar but different dynamic at work when a holder of an owner carryback note decides to sell his note. Remember, there is no MLS in the world of note buying. When the parties agree to a transaction, it is what I like to call The Wild, Wild West at work. No bureaucracy, just two people agreeing to sell and buy a property based on mutually acceptable terms. No Big Brother looking over their shoulder. A handshake deal.

One of the common issues in an owner carryback sale, especially in recent years, is that the seller will never do another one. This is his first and last owner carryback sale. He found a buyer who for whatever reason could not obtain conventional financing. In order to get the property sold, the owner offered or agreed at the buyer’s request, to take the place of the bank. Many times, this is where the problem begins.

The seller wants to sell and the buyer wants to buy. Unfortunately, the result can be to agree to terms that strongly favor the buyer, and do not offer sufficient protection to the seller against default. These weak terms  will also affect the price any note buyer is willing to pay.

If a seller is doing his one and only owner carryback sale, he may or may not know that a market exists for the possible sale of that note. Regardless, basic business sense would dictate that he should feel secure about his buyer and confident that the monthly payments will be made. The stronger the terms of the note, the more safeguard the seller has created to ensure the safety of the transaction.

What should a note look like that would be attractive to a potential note buyer and make him willing to offer the smallest discount possible, given market conditions? Here is a suggested note structure:

Residential

1. If no real estate agent is involved, ask the potential buyer to run his credit report and give you a copy. Use this information as a basis for your negotiation. If he refuses, find another potential buyer. You would like a credit score of 650+.

2. Minimum 10% Cash downpayment.

3. Minimum 8% interest rate.

4. Amortize the monthly payments. The shorter time period the better.

5. No interest only payments.

6. If a balloon payment is involved, no sooner than 7 years.

7. The more payments received the better. Can sell after 1 payment received.

Use a 3rd party servicing company to accept/monitor the payments. If possible, drive by the property occassionally to make sure it is being properly maintained. Check County tax records to ensure property taxes are paid. Make sure Hazard Insurance is current and you are listed as Payee.

If the property is a commercial building, you should expect a higher downpayment, somewhere in the 30%+ range and demand a few more percentage points on the interest rate.

These are suggested terms. The real message is this – if you agree to act as the bank – you are taking a risk. As the seller, you need to protect yourself as much as possible against the risk you are accepting. Your buyer needs to understand this. Your buyer needs to be committed. The suggested terms add to the mutual level of protection and commitment. The Wild, Wild West does not have to be reckless. It needs to be prudent.

Jeff Foxworthy is a comedian who has carved out a career by making fun of a certain group of people – his own. If you don’t know Jeff’s humor, here is a sample:

YOU MIGHT BE A REDNECK IF…

– Your wife is also your cousin.

– You think Sherlock Holmes is a housing project.

– You think genitalia is an Italian airline.

– You carry a fishing pole to Sea World.

– A seven course meal is a bucket of KFC and a six pack.

– You refer to the fifth grade as “your senior year”.

– You lit a match in the bathroom and your house exploded right off its wheels.

I think you get the picture.

What does this have to do with notes? A lot.

YOU MIGHT HAVE A BAD NOTE IF…

– Your downpayment check bounced.

– Your month 7 payment is due and you are still waiting for payments 1-6.

– The property you sold burned down, and you forgot to name yourself as Loss Payee on the Fire Policy.

– Your buyer told you he and his wife will live in the property. Neighbors tell you 17 people live there.

– There are more cars parked on the front lawn than in the garage and driveway.

– You have no documentation of any kind, and are amazed no-one will buy your note.

I think you get the picture.