If you follow the real estate market and the trends that the media reports,  you may want to check out www.voiceofthehomebuyer.com.

This is a real estate blog that says it does a lot of independent research. Their conclusion is that the media is hyping the recovery in housing, and they question if we are truly in a recovery or, is another bubble in the making.

One of their concerns is that housing has been driven by investors. Most importantly, they cite Data Quick as saying that investor activity is focused on the lower end of the home price market. Throughout the United States, the median cash price was $205,000 in 2012. In California, my home state, 32.4% of all home purchases last year were cash buys – more than double the annual average for the past 20 years. Here is the question “voice” asks:

“When the investors move out( because the investment is no longer worth the risk), will organic homebuyers across the country have the capital and the credit to pick up the slack and keep recovery on track?”

Time will tell.

Also, “voice” points out that baby boomers own 66% of all owner-occupied housing in the United States. How can they not have an impact on our housing market as they retire, downsize, and their heirs eventually deal with settling their estates? What will be the true effect on housing, inventory, pricing, etc?

“Voice” provides interesting and stimulating reading. Maybe even a contrarian point of view. They have me thinking and asking more questions than I did previously. See for yourself at www.voiceofthehomebuyer.com

Have you seen Pawn Stars on the History Channel? The show is about a family owned pawn shop in Las Vegas.

The show fascinates me in two respects. First, a guy can walk into the shop with an item he wants to sell. If the owner is familiar with the item, he may rattle off its history, show a lot of knowledge about it, and ask the guy how much he wants for it. The negotiating begins.

Second, let’s say a customer walks in with a rare item. The shop owner may know a little about it but not enough to make a cash offer. So, he calls in an expert to examine the item and give his opinion as to its value. Sometimes the item is rare, sometimes it is a fake.

Case in point. Guy walks into the shop with a Wanted poster for John Wilkes Booth, the man who assassinated President Lincoln. He claims it is an original and he is asking $33,000 for it. The shop owner is excited, knows this is one of the most iconic documents in US history, but is it real?  He calls in an expert.

The expert comes to the shop armed with an original Wanted poster. He says it is one of four known to exist. Value? $100,000. He examines the customer’s document and explains the differences between the two.  He says the customer has an early reproduction. Value? $100.

Little bit of a spread bewteen $100 and $33,000, huh? Buyer beware.

Again, I am fascinated on two fronts. The pawn shop owner never knows who or what will walk into his store. Yet his knowledge and experience allows him to negotiate with many customers about many different items and at the same time, protect himself from being taken.

Secondly, what does he do when confronted with an item that he may desperately want but knows little about? Instead of relying on his instincts or allowing his emotion to carry him, he calls in someone who knows more than he does. This way, both the owner and customer can hear what the expert has to say. Sometimes he will give a  high value on the item that will be pleasing to the customer, and the owner now knows its true value. Will he offer to pay market value? No. He has holding expenses and hopefully a profit to account for. Sometimes they make a deal, sometimes they don’t.

It seems to me it would be real easy for the owner to be hustled if it were not for the experts he relies upon. They are indispensable for him to stay in business.

The note business is pretty similar. We have to rely on third party experts to determine the true value of a property, to determine the credit worthiness of the payor, for title folks to search out the chain of title on the property, etc. Once this due diligence is complete, then the “true value” of the note can be determined, and the buyer can part with his cash.

Due diligence is to the note buying business what expert opinions are to the pawn shop owner. Good for both parties.

The Standard & Poor’s/Case-Shiller Index tells us that the 20 largest cities in the United States had home price increases of 4.3%, comparing October 2011 to October 2012. The real estate bust was pretty severe in the Western states, and the recovery seems to be stronger here.

San Francisco and Phoenix are both up 22% from their bottoms. The Los Angeles area is up 10.5%  from its bottom while San Diego is up 12.2%. In California, inland areas are lagging behind the gains posted in the coastal regions, according to Case-Shiller.

This is great news for the housing market, the economy and our country.

However, for those of us who are in the business of buying seller carryback notes, some of our experiences don’t jive with the media reports. We will make an offer to purchase a note at a certain price, then have an appraised value of the property come in substantially lower than the sale price. This is certainly happening with properties that were sold at the peak of the market in 2007 and the years following, but we see it with properties sold within the last 12 months. It is very frustrating for buyer and seller.

What to do? Many note buyers will opt to purchase only a part of the note, not all of it. Why? This lowers their capital investment as a ratio of the current property value, thereby minimizing the risk. It also allows the seller to get some cash now, then recoup the balance  of the payments due under the note when the buyer has received his share. Good for both parties.

As always, sellers who may be creating seller carryback notes today should not be lulled into complacency by the reports of recovery. Sellers should protect themselves by demanding a decent downpayment, checking out the credit history of their buyer, requiring a higher than preferred risk interest rate, and use a 3rd party to service the account. Both parties will be better off in the long run with this prudent approach.

The folks who track these things estimate that more seller carrybacks are being created now than ever before, about 1 in every 50 transactions. A seller offering to be the bank happens because conventional financing is difficult or unobtainable for the buyer, or, as happened in the 1980’s, interest rates are in the 18%-20% range. Seller carryback fills the void in these situations.

We have been experiencing an unusual marketplace for several years now. High unemployment, low interest rates, record defaults and foreclosures, low property values, low credit scores. Some big time buyers of seller carryback notes have been hurt badly by these events, to the extent of being out of the business altogether. The end result is that we have a lot of seller carryback notes with fewer buyers chasing them. Many of these notes are not marketable, as I have discussed ad nauseum in previous Blogs and my Newsletter.

Buyers are cautious.  Buyers are picky. They don’t want to invest their capital in a  poor or borderline  note. They want to purchase the best of the available pool. That means a note that shows a good downpayment, a property that has maintained its value as much as possible, timely and seasoned payments, and a good credit history for the payor. Absent these qualities, an investor will move on to the next note.

The market is what the market is.  Note sellers need to realize this. The best way for a seller to protect himself is to find a reasonably solid buyer and construct strong terms in the note. If selling the note will be the best option, the seller must make that note attractive to an investor, who has many other notes he is looking at. Is this particular note better than the others? If not, the seller will hear the two words he dreads:

“I pass.”

A balloon payment is a single payment due at the end of a partially amortized loan.

Let’s say you are considering a seller carryback sale with a  $100,000 note at 8% amortized over 360 months. The monthly payment is $733.76. You don’t like the idea of waiting 30 years to get your money. Your buyer thinks he will be in a position to refinance a few years down the road, so you would then be able to get your money earlier rather than later.

If you and your buyer agreed to the same terms, but you would get a balloon payment in 7 years, your buyer would still pay you $733.76 monthly, and then have a single payment to you in month 84 of $92,477.94. At that point, you have been paid off, you are out of the note.

What is good and bad about this arrangement?

The good is obvious – as a seller, you have your cash in 7 years rather than 30 years. You don’t have to worry about your buyer making or not making his payment next month. Plus, if you have another business or investment opportunity, the balloon payment might be a great source for the cash you need.

Your buyer may benefit as well. Let’s say that interest rates 7 years from now are higher than today. How about 6%. The buyer could refinance the 7 year balance of $92,477.94 for 240 months with a monthly payment of $662.54. That’s $71.22 less than he was paying you, and for a shorter term. The fact that you demanded a higher interest rate in your promissory note actually helped your buyer in the long run.

Here is the bad. Sellers and buyers are misusing the balloon payment provision in their negotiations. I have talked to sellers who know nothing about the credit history of their buyer, but will then agree to ridiculous terms. What’s ridiculous? How about no downpayment, 3% interest only payments for 3 years, a balloon payment due after 36 months. If the seller does not know who he is dealing with, does he have a buyer or a renter? Where is the commitment from the buyer?

This example may seem exaggerated to you. It’s the truth. I have seen countless other arrangements that are not as bad as this one, but close. If the buyer cannot come up with the balloon payment when due, what is the seller going to do? He has 2 options – foreclose or extend the terms of the note.  To most sellers, neither option is attractive. He could have avoided either possibilty by being more business like in the beginning, by knowing his buyer and demanding terms that were realistic and protective of him and his buyer. If the buyer would not agree, find another buyer. The housing woes we have had for several years now have caused some desperate sellers to sell their property to the first person that comes along, and then agree to terms that will get that person in the property. Potential disaster awaits.

Most notebuyers are extremely wary of notes with balloon payments, simply because experience has shown that the balloon will not be paid when due.  So, the pricing for the note will ignore the balloon, and assume that it is a fully amortized note.

If you want a balloon in your transaction, a 7 year due date is a safer bet in the current climate.  Coupled with a high interest rate, strong downpayment, and amortized payments, you are doing a better job of protecting yourself should you decide to keep the note or sell it.

As always, call or email me if you have questions before you sell your property.

President Ronald Reagan famously used the phrase Trust But Verify when discussing United States’ relations with the Soviet Union. What he meant, of course, was that while a public declaration by the Soviets might be considered reliable, one should perform additional research to verify its accuracy.

I remember very well one of the first deals I ever worked on in the note business. The concept of Trust But Verify was front and center. This man told me he sold a house that he used to live in and that the buyer gave him $100,000 as a downpayment. He was very convincing in our conversation and I was brand new to the business. My funding source and I were scheduled to meet at the property to look it over, but I received a phone call cancelling the appointment. My funding source said his preliminary research showed this house was a mobile home – not a house. He asked me to request a copy of the closing statement, which the seller provided. There was NO downpayment shown on the statement. I called the seller and he explained that to him, a house was a house and he did not differentiate between a home and a mobile home. He said the $100,000 was given to him outside of escrow. When I asked for a bank deposit receipt or  statement that would reflect this amount, he was silent for a moment, then said he got $100,000 cash and never deposited any of the money!

Ooops! Red flag! Sorry, we can’t help you. Trust But Verify.

This was my shocking  introduction to the note business. A lesson learned.  Occasionally, when I am talking to a seller, I will hear “Why are you asking me all these questions?” Some people are really upset that I am trying to find out as much as they know about their transaction. They feel if I  know the note terms, they should get an offer. Sorry, but it doesn’t work that way.

When you sell a property and offer an owner carryback, there is an element of risk. The more you know about your buyer and the stronger the terms of your note, the less the risk. When a note buyer is considering giving you a lump sum of cash, the risk escalates, and proper due diligence confirming the information you provide is mandatory. Just good business.

Trust But Verify.

Well, 2013 is here. Let’s start the year right, what do you say?

If you will be selling a property this year by using an owner carryback, please consider doing the following to protect yourself and create the strongest note possible:

1. Ask your buyer to run his own credit report and give you a copy. If he refuses, find another buyer.

2. Get the biggest downpayment possible.

3. Use a minimum interest rate of 7%.

4. Amortize. No interest only payments.

5. If a balloon payment is involved, don’t have a due date before 7 years.

6. Use a 3rd party servicing company to collect the payments for you.

A risk always exists when you decide to take the place of the bank and agree to allow your property to be sold by offering  a seller carryback. The biggest risk of course is the risk of foreclosure, with its financial and emotional pain. The stronger the terms, the less the risk. This way you protect yourself as much as possible on the downside. And, should you decide to sell your note, the terms you created will be more attractive to a potential note buyer and help to maximize the cash you receive.

Happy New Year!

In the past few years, because of the tight lending standards in our country,  hundreds of thousands of  people have sold a property they own and financed the transaction by agreeing to be the bank. They agreed to terms with their buyer and “carried the mortgage.” The buyer signed a Promissory Note and promised to pay the agreed upon monthly payment.

This is good because a property exchanged hands. The problem is that the majority of sellers in these transactions are unsure of what they are doing, and don’t fully appreciate the risk that lies behind that “Promise to Pay.”

The biggest risk is that the buyer breaks his promise and stops paying! Now what? If he can’t get the buyer back on track, the seller may be forced to foreclose. Well, how long does that take? How much does it cost, financially and emotionally? How does the seller make up for the lost income?

What about other possible risks? The buyer could lose his job. He could have a serious illness or accident that stops him from earning an income. He could get divorced. A family member could die. A natural disaster could wipe him out. How about the property being destroyed by fire and the seller neglecting to get himself named as payee on the hazard insurance policy? You know how much the seller gets in this circumstance? Nothing !

The list of possible risks is endless. But, hey, the seller may hold the note until it is paid off and never encounter any of these problems. Nobody knows. Most note buyers have encountered all these problems, have learned from experience, sometimes painfully so, and use this knowledge in assessing risk in every particular  note purchase. Most sellers don’t have the benefit of this kind of experience.

Many sellers don’t truly understand the level of risk in their note until things go bad. Or, they may get a better appreciation when they decide they want to sell and talk to someone like me, who points out some of the risks in their particular note. People sell because cash today is worth more to them than non-guaranteed monthly income for years to come. Maybe it’s better use of the money, maybe it is peace of mind and lack of worry.

Risk is relative for every note holder. The key is understanding the risk before it is too late.

Few weeks ago I was watching the TV show The Lottery Changed My Life. If you have not seen it, it shows real people and how their lives have changed after winning a lot of money in their state or national lottery. Some folks handle it real well, for others it’s like misery walked in the door and became their best friend.

I have never bought a lottery ticket. The day after the TV show and out of curiosity, I went to the California Lottery website. What captured my attention was the posting about the California Super Lotto Plus and how the payout worked. It got me thinking about note discounting, and the similarities and differences between the two. Here’s what I am talking about:

According to the California Lottery website, the Super Lotto Plus payout begins at 7 million dollars. So, if you win the 7 million dollar jackpot, you can take a cash option and receive 3.7 million dollars today, or you can choose 26 annual  payments that escalate over time. The Lottery is obligated to deduct federal income taxes at the 25% tax rate. You could pay more if your bracket is higher.

So, if you receive 3.7 million before taxes, that represents a 47% discount from the advertised jackpot of 7 million. Applying the 25% federal tax rate, you will receive 2.78 million. That’s a 60% discount from the 7 million. California applies no state income or personal tax.

2.78 million is a lot of money – but it’s not 7 million!

How does it work with a note? Let’s say you have a current balance of $100,000. You have at least 20% equity in the property, your payor has decent credit (650+), and you have nice seasoning( 12 months+). You will probably be offered $75,000 – $80,000 – a discount of 20-25%.

20-25% is less than 47-60% !

Either way, if you want dollars today, those dollars will be discounted. A dollar today is worth more than pennies paid out every month for the next few years. That’s the concept.

I know the numbers are different and the reward is greater with the lottery. But do you follow me here? The lottery may not be your money that is being played with, but the net result is much lower than the public is led to believe. A professional note buyer, on the other hand,  will be upfront in working with you, and probably give you the most aggressive pricing your note deserves in the current market.

When it comes time to sell your note, try to keep your situation in perspective. Just remember the lottery discount, and be pleased you have a marketable asset generating cash flow that you can exchange for cash.

Let’s pretend!

Let’s pretend that you have a house you want to sell and I want to buy it. There is a problem, though. I can’t get a bank loan. So, I ask  if you will agree to be the bank and work out terms with me. You say okay, we work it out, title company does all the paperwork, the transaction closes and I move into the house.

Let’s say you are holding a $100,000 note at 8% for 240 months. I am paying you $836.44 monthly.

What do you have?

You have a promise to pay – nothing more, nothing less. You have my promise that I will pay you $836.44 every month. You believe I will keep my promise, you think I will keep my promise, and yes, you hope I will keep my promise. But I do not guarantee that I will pay you $836.44 every month. How are you protected if I don’t keep my promise? Your security is the trust deed – you can take the house back if I break my promise.

Now, let’s pretend you have $100, 000 in a CD sitting in the bank at 1% interest.

What do you have?

You have $100,000 cash money!  If you want to go to the bank and take back your CD, the bank will give you $100,000 plus the 1% interest minus a withdrawal fee.

 You had cash in the beginning and you have cash at the end.

Do you see the difference between the two? Most people do. Some people don’t. Some people think their $100,000 note is equivalent to $100,000 cash sitting in the bank. They believe if they want to cash in their note, they should get $100, 000 for it. They believe all risk should be ignored – equity risk, property value risk, interest rate risk, credit risk, etc. They believe $836.44 monthly equals $100,000 cash money.

Sorry, it does not!

One of the biggest challenges in my business is to get some sellers to understand simple truths. If a person has never done a transaction involving a seller carryback, learning these truths after the transaction is completed can be a cold slap in the face. I get it, I understand that.

So, if you are thinking about selling a property and if you may offer to carryback the note, please call me before you negotiate with your buyer. Be prepared with information. Don’t go at it blindly. Protect yourself. Call me.