A few days ago, a gentleman man called me about selling his real estate note (as our business is buying owner financed notes). He had managed to run up credit card debts of over $140,000, and finally decided that it was time to start paying that down. He hoped that selling his note would relieve him of much of his debt burden.
Unfortunately, while the note and the associated property on which it was hypothecated had some positive features, there were far more negative issues that had to be addressed. The buyer of the property had weak credit, the down payment was small, and the interest rate on the note was below market. We were still able to make an offer to buy part of his note in spite of the challenges, but could have helped him create a much safer and more marketable note if he had called us prior to the original sale of the property. He, like so many thousands of banks over the last few years, needed to think through the risks of his note (loan) and understand the best- and worst-case scenarios ahead of time!
No one with any knowledge of the real estate market can doubt that banks (and others) did a terrible job of understanding the risks of certain types of lending during the early and mid part of this decade. Now that banks have slammed the door on many potential borrowers, private financing has picked up some of the slack. Some principals (buyers and sellers) understand real estate finance and have done a good job of creating their notes, but many more have made significant mistakes when setting them up, much like the fellow described above.
Allow me to share my opinion on the latest news affecting real estate. There has been a lot of press during the past few weeks about how housing prices seem to have bottomed out, as values and home sales have managed to creep up slightly on a month-to-month basis.
My opinion is that these headlines are nothing more than a "head fake." Although there are areas of the Midwest and even pockets in our state of California that have stabilized and are trending upward, they are the exceptions rather than the rule.
Why do the current economic conditions and my instincts tell me that property values are in for another dip? Well, here are a few reasons:
1) Unemployment is still going up (already at record highs in California) and is not likely to top out for at least another year. Plus, there are millions of people who are underemployed or have been forced to take wage cuts. If people don't have the money now or are concerned that they soon won't have ready cash if they get laid off, why would they buy?
2) Consumer confidence is way down, and our state and federal politicians have not shown that are able to solve the market problems. The money that the feds are throwing at the problem is not a long-term solution, and only delays the reality.
3) Banks and even some private lenders have delayed foreclosures for their own business reasons or because the government has made them do so. When these moratoriums end, nearly all experts agree that there will be another huge wave of foreclosures hitting us.
4) To date, most of the problem with defaults was with the sub prime market. When a boatload of residential Alt-A and prime borrower loans adjust over the next couple of years, not to mention all of the escalating problems with commercial real estate, there will be yet another tsunami of foreclosures. Most Option ARMs nationally are under water, and over 50% of Option ARMs are in California!
5) Housing prices are still too high relative to incomes. When potential buyers are nervous about the market, they are less likely to part with a high percentage of their income, which will keep prices down.
6) Most of the increased home sales seem to be at the low end. While some of these buyers are first-time homeowners, my perception is that it is mostly investors who are bidding up the prices on many of these homes. Many of these investors will get burned (how lucky are investors who bought a year ago feeling now!).
7) Interest rates have nowhere to go but up. While they will probably stay low for the near-term, they will begin to bump up at some point, which will make payments even higher for potential buyers.
In general, the fundamentals of a housing recovery are missing and it is beyond me how we can expect housing prices to stop falling for the next year or stabilize for at least a couple of years beyond that. While prices probably won't plummet to the degree that they have over the last three years, especially at the low end, some sort of decline is likely going to happen. Commercial properties and land are heading in the same direction.
Banks, despite receiving billions of dollars in government bailouts, are still not loaning to most borrowers. I continually hear stories about buyers with 700-plus credit scores and cash for a substantial down payment getting turned down for loans, especially if they are self-employed.
Owner financing is often the best and sometimes only way to sell a property. Owner financing is defined as the sale of a property from a willing seller to a willing buyer, with no bank involvement. The buyer gives a down payment to the seller and signs a note stating the amount of the note, the interest rate, when payments are to be made, etc. Most of the documents used- deed of trust, settlement statement, title policy, and so forth-- are the same as those used for a typical bank-financed transaction, with an attorney or other qualified professional drawing up the documents. A property owner receives cash upfront from the down payment, can look forward to receiving monthly payments over a long period of time, and can delay taxes on their gains. Owner financing is not a good option if the property has little equity or is "upside down" on their mortgage.
In a previous article, I listed several characteristics of a note that is strong and minimizes risk (fortunately, we do come across some very good notes). These characteristics apply whether the seller is planning to keep the note or if the person wants to sell the note. More or less in order of importance, the key points are:
1) Obtain a good down payment, meaning at least 10% for a house in a relatively stable market. For other property types like commercial, land, mobile homes, and houses in more volatile markets, a 20% down payment or higher is better.
When we are evaluating a note for possible purchase, the most critical piece that we look at is the amount of equity in the property, as good equity suggests a lower likelihood of the payer defaulting and a better chance of us recovering our investment if they do. We also have an appraisal done on the property to ensure that the sales price is in line with the property's true value.
2) Sell to a buyer that has a good credit score. A FICO score of above 600 is sometimes acceptable, though a score of 680-plus is much better.
3) Make sure that the documents are properly prepared. This means making sure that the note and deed of trust are of even date, the note is clear about payment amounts, a mortgagee title policy is completed, etc.
4) The terms of the note should show an interest rate that is comparable to market rates. This means at least a 6-7% rate for a house sale, and a higher rate for other property types. Be sure that the term of the note is at least three years but no more than thirty years in duration. A note that amortizes, even if there is a balloon payment at some point, is slightly better than an interest-only note.
5) Additional items that are advantageous vary with the property type. Notes on houses and mobile homes are considered safer if they are owner-occupied rather than rented out or empty.
Vacant land should have power, water, and sewer or septic either on the property or close by the property line. There must be access to the property via public roads or via easements over private property.
Selling a Note
There are many reasons why people desire to sell their notes. Among the most common are a desire to raise cash to pay off debts, divorce (so that they don't have to deal with an ex-spouse), settling of estates, and a desire to do other investments. If you or your client wants to sell a note, there are several options for doing so.
Although the note holder can choose to sell the full note, he or she can usually come out further ahead by selling just some of the payments. With this latter option, called a partial, the note holder sells an agreed upon set of payments now, with the expectation that the person will continue to receive the monthly payments in the future. For more details on partials, call us or visit our website.
And finally, as in most areas dealing with money, be certain that you are dealing with a qualified and experienced professional. In California and some other states, a note broker must be a licensed real estate broker. You can verify that the person is licensed and has no complaints by checking with the California Department of Real Estate. Also, consider a Web search on Google and check websites such aswww.BBB.org andwww.ripoffreport.com.