© 2011 Cengage Learning created by Dr. Richard S. Savich. California Real Estate Finance Bond,...

© 2011 Cengage Learning created by Dr. Richard S. Savich.

California Real Estate FinanceBond, McKenzie, Fesler &

BooneNinth Edition

Chapter 14Creative Financing

Approaches


Objectives After completing this chapter, you should be able

to: Differentiate between traditional and creative financing

techniques. Identify at least five ways in which real estate can be

financed through ways other than the traditional methods.

Contrast the all-inclusive trust deed to the installment Contract of Sale, citing at least three differences.

Apply the formula to calculate blended interest rates. Name the instruments required to close a sale using the

creative techniques presented in this chapter. List at least six items that must be disclosed under the

Creative Financing Disclosure Act.


Outline Secondary Financing Techniques All-Inclusive Trust Deed (AITD) Installment Sales Contract Lender Participations Sale-Leaseback Open-End Trust Deed Commercial Loan Stock Equity/Pledged Asset Loans Blended-Rate Loans Creative Financing Disclosure Act Imputed Interest


Secondary Financing Techniques

Second Trust Deeds carried by seller

Referred to as “gap loans” Carried back by seller Helps buyer to purchase

home Due in shorter time frame

than first trust deed Buyer may renegotiate the

second Secure a new loan to pay

seller Refinance the entire loan In mid-2009 Fannie Mae and

Freddie Mac eliminated seconds


Collateralizing Junior Loans Use seller-carried note and second dead of

trust as an asset They are pledged at collateral for a loan

through Private parties Mortgage brokers Commercial banks

At a discounted value Seller receives cash


Seller Sells the Second Loan

Instant cash Deep discount Who buys?

Escrow companies Loan brokers Holders of maturing junior trust deed

loans


Broker Participation Broker becomes a lender for part of the

equity Break note into two parts Assignment of seller’s note and trust dead

for the portion of the broker’s interest In default, broker can foreclose


Combination or “Split” Junior Liens

Create second and third trust deeds Can sell a smaller second easier


All-Inclusive Trust Deed (AITD) (aka wrap-around)

Junior deed of trust to original loan Seller will pay off loans from monies received from buyer Used when

In lieu of installment sales contract When existing loan cannot be paid off until later date Buyer wants income tax benefits Seller has overpriced property Low down payment Low interest existing loan Seller firm on price but not terms Buyer cannot qualify Heavy prepayment penalties When severe money crunch hits mortgage market

Cannot be used to avoid due on sale clause


Characteristics and Limitations to AITDs

Can increase the seller’s rate of return It is a purchase money transaction, subject to

encumbrances, to which it is subordinate The buyer become a trustor-grantee The seller becomes a beneficiary-grantor Subject to California’s antideficiency statutes so

buyer-trustor is held harmless should foreclosure occur Legal title is conveyed by grant deed and is insurable

by title insurance In event of default and foreclosure, the seller-

beneficiary follows normal foreclosure procedures


All-Inclusive Trust Deed Equity payoff

Buyer takes over prior loans after seller’s equity has been paid off

Full payoff Buyer continues to pay until entire balance is

paid


All-Inclusive Trust Deed Benefits to seller

Only way to dispose when lock in clause Broader market because seller is willing to carry back No loan fees Higher sales price Defer recapture of equity Retain favorable terms of first Increase net yield No interest rate limitations Know immediately about default Trustee’s sale is speedier Income tax advantages

Similar to installment sale


All-Inclusive Trust Deed Benefits to buyer

Get property not qualified for Larger property for same down payment Only one monthly payment Closing costs reduced Extra long terms can be negotiated No points No prepayment penalties Lower capital gain at resale Grant deed at beginning, not end


All-Inclusive Trust Deed Precautions for sellers

What about impounds? Timing of AITD payments

compared to first mortgage

Limit another AITD upon resale by buyer (due-on-sale clause)

Reserve right to have buyer refinance at later date

Approve leases on income producing property

Precautions for buyers What if seller defaults? Request notice of

default and notice of sale

Set up payments to cover any liens against seller


Procedures in Setting Up AITD

Examine existing trust deed clauses Due on sale Alienation Acceleration

Ascertain outstanding balances, periodic payments and balloon provision

Who collects and disburses payments Spell out default and foreclosure procedures Get title insurance Get insurance coverage


Installment Sales Contract (aka conditional sales contract or land contract)

Title remains with seller Until contract is complete Lawsuit is necessary for foreclosure Significant income tax benefit to seller

Prorate capital gains over life of the note Can be used for any real estate including

vacant land


Lender Participations Participation in revenue of project Equity participation Charge one time fees or points Profit Participation Multiple lenders


Sale-Leaseback(aka purchase and lease-back)

Investor buys property Develops land Sells to major investor Leases back property Could be used for just land, just

improvements, or both


Advantages Seller

Lease payments are tax deductible

Rent is lower than loan payments

Improvements may be tax deductible

Frees up capital Long term leases not

shown as long term liabilities

Cash today, payments later

Could buy back at later time

Buyer Higher yield than loan Appreciation to lessor In default can go after

other lessee assets Lease payments cover

original investment and leave lessor with title

Lessee could pay for repairs, maintenance, insurance, utilities, taxes and operating expenses. (triple net lease or net-net-net)

Could do sale-leaseback with another party for same property


Disadvantages Seller

Long term contract No participation in

appreciation Rent may exceed loan

payments Expiration of lease could

lead to problems Improvements may cost

too much

Buyer Lease payments are

taxable income Rents could go below

market If default, must operate

property May not get depreciation

deduction if only land lease Capital is tied up Only lessor, not creditor in

case of seller insolvency Did lessee develop property

for special purpose? Inflation Is repurchase option below

market?


Open-End Trust Deed Add on to principal

Either until original loan amount Or until fair market value

Not used too much due to seconds


Commercial Loan Personal loan from bank Borrowers of substance Usually less than three years Purchase real estate Finance home improvements Purchase a foreclosure, when cash is

required


Stock Equity/Pledged Asset Loans

Marketable securities are used as collateral


Blended-Rate Loans

Existing loan interest rate Market interest rate on new loan Somewhere in between

(Existing rate X Existing loan balance) + (Market rate X Net new money)

Blended yield = ________________________________

Total financing


Benefits Buyers receive below market rate Borrower qualifies more easily Cash proceeds are greater Seller does not carry back as much paper Lender increases yield on old loans More creative

Could be combo with lender and seller


Creative Financing Disclosure Act

Description of terms of loan Any other financing Warning about negative amortization When AITD, then who is responsible Terms of balloon payments Credit information about buyer Warnings about seller’s role in case of

buyer’s default


Imputed Interest If project >$4,217,500, then interest rate

>9% or applicable federal rate (AFR), whichever is lower

AFR is rate on federal securities with same maturity

Does not apply to seller carry back loans when buyer uses property as principal residence

Changes capital gain into ordinary income


Questions and Comments?

© 2011 Cengage Learning created by Dr. Richard S. Savich. California Real Estate Finance Bond,...

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Transcript of © 2011 Cengage Learning created by Dr. Richard S. Savich. California Real Estate Finance Bond,...