How many times have you lost the opportunity to purchase a note because the note seller needed or wanted more money than the quality of the note justified?
If the note seller wants an amount of cash equal to 75% LTV, but the property and/or purchaser supports only a 60% LTV, the deal will probably not be made.
This might be just one of the cases where a Reverse Partial can be structured that will give the note seller a substantial amount of cash at closing and the balance over the next year or so.
Suppose you are negotiating with a seller who holds a note secured by a single family residence in a stable market. The home sold 18 months ago for $75,000 with $5,000 down, 10% interest, and $636.09 monthly P & I. The current balance is $68,980.03, and the note holder tells you he will not take a penny less than $55,000.00. The 18 month pay record is good; however, you discover that the purchaser has poor credit.
You then discuss the note with your investor (if you are brokering), and he or she tells you that the most they can pay is $45,000.00 because of the poor credit risk. You talk about a partial with your note seller and he is not interested. He wants $55,000.00 and will not budge.
How about trying this approach? Ask your note seller if he will accept $43,551.00 cash now and then receive the next 18 months of the $636.09 monthly payments. The 18 payments the note seller receives amount to $11,449.62 and, when added to the buy price, total $55,000.62 to the note seller! The note seller assumes the risk that the payments will be made over the next 18 months, but he is comfortable because of the previous 18 month pay record. The following is a summary of the transaction:
SALE PRICE $75,000
DOWN PAYMENT $5,000
INTEREST RATE 10%
PAYMENT $636.09
PAYMENTS MADE 18
PAYMENTS REMAINING 282
CURRENT BALANCE $68,980.03
CASH TO SELLER AT CLOSING $43,551.00
+ 18 PAYMENTS TO SELLER 11,449.62
TOTAL CASH TO SELLER $55,000.62
NOTE BROKER’S COMMISSION:
INVESTOR’S BUY PRICE $45,000.00
CASH TO NOTE SELLER AT CLOSING ($43,551.00)
NET TO NOTE BROKER $1,449.00
A Reverse Partial can be a particularly useful tool when negotiating the purchase of a note secured by commercial property. Mortgage financing is not readily available for commercial property and does not exist in some areas of the country. Thus many commercial real estate sales are put together using seller-financing.
Suppose that you are negotiating with a seller who holds a note on a well-located office/warehouse building and has a payor with good credit. The note holder sold the property 28 months ago for $400,000 with $75,000 down. The seller financed the $325,000 balance at 10% with monthly payments of $3,136.32. A balloon payment of $273,234.84 is due seven years from the sale date. The principal balance on the note is now $311,565.57. You call your investor and they tell you that they can only pay $190,720 for the whole note because a certain amount of the sale price was allocated to personal property.
You don’t even present an offer to your note seller because you know he is not about to take a discount in excess of $120,000, and he already told you to forget about a straight partial because he does not want to wait almost 5 years for the rest of his money.
How about offering him a Reverse Partial? Your investor says they will pay $133,170.00 now for the balloon payment that is due in 56 months. They will take a full assignment of the mortgage and pass through to the note seller the 56 payments up to the balloon. The payments total $175,633.
You tell the note seller that you will pay $126,500 for the balloon that is due almost 5 years down the road. The total payout to the note seller is $302,133, which doesn’t look too bad for a $311,565 note secured by commercial real estate. It may be one of the few offers he receives at any price. A significant amount of cash NOW, plus the luxury of continuing to receive large monthly payments, is a situation that should be attractive to many holders of commercial real estate mortgages.
The following is a summary of this example:
ORIGINAL SALE
SALE PRICE 28 MONTHS AGO $400,000.00
DOWN PAYMENT $75,000.00
ORIGINAL NOTE BALANCE $325,000.00
INTEREST RATE 10%
MONTHLY PAYMENT $3,136.32
BALLOON PAYMENT IN 84 MONTHS $273,234.84
TODAY
CURRENT BALANCE $311,565.57
PAYMENTS REMAINING BEFORE BALLOON 56
CASH TO SELLER FOR THE BALLOON $126,500.00
56 PAYMENTS TO SELLER $175,633.00
TOTAL CASH TO SELLER $302,133.00
NOTE BROKER’S COMMISSION:
INVESTOR’S BUY PRICE $133,170.00
CASH TO NOTE SELLER AT CLOSING ($126,500.00)
NET TO NOTE BROKER $6,670.00
An additional selling point for the above example is to show the vendor the total cash that will be received from the sale of the property:
DOWN PAYMENT $75,000.00
+ 84 PAYMENTS @ $3,136.32 $263,450.00
+ SALE OF BALLOON PAYMENT $126,500.00
TOTAL CASH RECEIVED $464,950.00
Even when the seller understands the time value of money (which many do not), the realization that he is receiving $64,950 more than the sales price may somewhat counteract the concerns associated with discounting.
The Reverse Partial is a creative way to purchase a note that might not otherwise be sold.
(This article was originally contributed by Metropolitan Mortgage & Securities Co., Inc.)
Learn much more about investing in and brokering cash flow notes and network with the best in the business at the annual Paper Source Note Symposium April 30-May 2 in Las Vegas! Visit http://papersourceseminars.com or call 800-542-2270. Take advantage of super early-bird registration going on right now.
Great information. Thank you!
Great strategy! Thanks
That’s a great creative solution. Thanks for sharing it!
Mike
Why would the note investor be willing to pay the same price and forego the next 18 payments? Presumably if he was willing to pay 45k he will on,y be silly to pay less if he forgoes the first 18 payments??
Good question, Jack This one sort of gets complicated because there is no mention of the yield the note investor was requiring, only the LTV. In one of my courses I have a section on ITV vs Yield that explains this situation in more detail. In a nutshell, the presentation spells out the note investor will want a minimum ITV or Yield, and will offer whichever is advantageous to the investor. In this case the maximum the Note Buyer will pay is $45,000.
This one all has to do with the wonders of compound interest, the time value of money and risk vs reward.
If the note investor wanted a 60% LTV or ITV as I would call it, then 60% of $75,000 is $45,000. At this point yield and pay periods are not considered. When this article was written, I believe the market yield was approximately 11% . If the note investor purchased the remaining 282 payments of $639.09,
at his/her maximum ITV of $45,000 here is what the purchase would look like.
N = 282
I/YR = 16.61
PV = -45000
PMT = 636.09
FV=0 In other words if the note investor paid his/her LTV maximum of $45,000, the note investor would realize a 16.61% yield. This is well above the note investor’s target yield. What happens to the note investor’s yield if he/she offers the reverse partial?
Remember, there are 282 more months left on the note, but the note seller will receive the next 18 payments. This leaves 264 payments. If the note investor’s target yield is 11%, the note purchase would look like this.
N = 264
I/Yr = 11
PV = -63037.92
PMT = 636.09
FV = 0
Now comes the good part. Keep in mind the note investor will not be receiving the $63,037.92 for 18 months, and no payments. More importantly, the maximum the note investor is willing to pay is $45,000 NOT $63,037.92. What does this do to our yield?
N = 18
I/Yr = 22.68
PV = -45000
PMT = 636.09
FV = 63037.92
So a reverse partial increases the yield to 22.68. Notice the seller is responsible for the 18 months of payments, which further reduces the note investor’s risk. In other words, the note investor is purchasing an asset with $75,000 collateral for $45,000 with the expectation of enjoying a 22.68 yield. The question now is merely a risk vs. reward issue.
Jack, in this month’s issue of THE PAPER SOURCE JOURNAL, I cover how to calculate Reverse Partials and Early Payoffs. I will cover in detail at the Symposium in April.
Tom Henderson
http://www.hpnotes.com
Hi Tom – Thanks for the detailed explanation and I am getting closer to understanding it 🙂
I see that after 18 months (period 264) the PV at 11% should be $63,152.82 (not $63,037.92) – why does that turn out to be the FV with 18 periods to go and a PV of $45,000 with the monthly payments of $636 ?
Are you calculating what the yield is for those 18 months ? Should the PMT not be zero then ?
So the yield for 18 months is 22%, then I have a note at a “cost” of $63,152 for another 264 months which results in a yield of 11% – did I understand it correctly ? How can I calculate what my overall yield would be for the 282 periods ?
Thanks
Jack
P.S. Which month’s issue are you referring to ?
and looking forward to meeting you in April !