After finishing a course in 1031 Tax Free Exchanges in the early 70’s the first deal put together on this “revolutionary" means of doing business was a “NON Qualifying 1031 Tax Free Exchange" using “pure boot". This was not “like property". A builder had been building homes like crazy and suddenly the market turned south and no one was stepping up to buy the finished homes. The buyers who had just paid top dollar for these new homes and had since moved in would not have appreciated the builder selling the remainder inventory at a deep discount and thereby eroding the value of the entire subdivision on a comparable sales price basis. The builder had been through many building cycles and did not wish to abandon the project leaving the prior buyers in a lurch. He rather, found new buyers, who previously had been turned down due to lack of funds to close, and offered to hold 10% to 20% LTV (Loan To Value) 2nd mortgages. The terms were low and the interest rate was affordable on the second mortgages. With a long history with the local savings and loan, new first mortgages were arranged and underwritten using the tried and true hand underwriting; the only way business was done at that time. Those potential buyers with good job histories, reasonable credit and the ability to repay were able to move into their new homes with little out of pocket as the builder picked up most or all of the closing costs.
This particular builder in addition to building single family homes had on a parallel tract built 10 to 16 unit apartment buildings for investor groups and himself and he was running with the main goal of accumulating long term wealth build up and tax shelter. Being located in a state capital city and a major university meant that newly built rentals were in high demand. Vacancies were few and in some cases, depending on locations, there were large waiting lists. Rents were accelerating in the light of this high housing demand for rentals. The builder offered every tenant in his system the opportunity to own their own home for in many cases a monthly housing expense a slightly higher than they were currently paying with the added incentive of paying little or no out of pocket. The builder made it affordable. Most were held back by the cash investment requirement up front. In less than 60 days all the homes had been sold. All 20 excess inventory homes that had been finished and setting vacant with the interest and expense meter ticking were sold. The homes were scattered among four subdivisions. The builder’s profit came in the form of monthly checks on the 2nd mortgages. A year had passes, most paid on time and genuinely appreciated the opportunity to be a home owner and were working very hard to keep it.
Déjà vu all over again, building cycle after building cycle builders are again in many areas of the country setting on inventory and not knowing what to do. Many builders are tempted to go bankrupt or in some cases run away with the buyers deposits before finishing during these down periods. It is for the builder with moxy to survive.
In this particular case, a listing of a 16-unit apartment building had been taken immediately across the street from a small metropolitan airport. All units had two bedrooms and were bigger than the older complexes in the area. The flight paths were not over the property but it was a super location between the university and the state capital and major employment centers. There weren’t any vacancies. A son had convinced his father, who had proficiency in other investments, to go on the mortgage note with him to provide financial strength to the deal. The son was to do all the management and handle the day to day needs of the property. After being in the property for a year, the son started having marital problems and his business was on the decline. The son moved to another state leaving dad holding the bag. The father was totally out of his comfort zone. The son had no investment in the deal and so he quit claimed his interest back to his father. The wife signed off as well. He wanted out of this situation ASAP. The builder and his agent came calling.
In these days, mortgages were assumable with qualifying. Another savings and loan in the area held this particular mortgage. The listing had been on the market for two days. The builder did an inspection and was aware of the builder’s work that had constructed the 16-unit, apartment building three years prior. First inquires were made to whether the seller (dad left holding the bag) would have an interest in taking 2nd mortgage paper as a down payment on the deal. As it turned out, at the time, the father/seller was a huge discounted paper buyer. He had a portfolio of discounted land contracts in the million-dollar range accumulated over a fifteen-year period. His normal MO (modus oparandi) was to buy land contract first mortgages with a 20% to 30% discount. With face note rates of 8% to 10% at the time, his yields were in the 14% to 15% interest range. At the time the state statue for usury was 11%. Keep in mind if the note payer refinanced or sold the property the yields would rocket up to over 20% plus. He loved notes. Race to mail box each month, “Walla"-checks. He had a ready attorney to write letters and foreclose if necessary, but was able to work out most situations with negotiations or the borrower would quit claim back and hit the road. By being a careful note buyer with good loan to values to protect his investment there was a certain comfort zone.
Now this was a different animal. The loan to value was near the top, but there was “seasoning" of the paper, meaning there was a history of on time payments on part of the note payer. The father, the one holding the bag, was very anxious to rid himself of the property and the day-to-day demands of dealing with 16 separate rental customers. What to do? The father agreed to take the 2nd mortgage paper with a 10% face discount and negotiated a two year personal and business guarantee of each mortgage. It only took 14 2nd mortgage notes to balance the equities in the transaction between the purchase price and the mortgage balance. The builder paid the recording fees and closing costs for all the instruments and assignments. Even the commission was taken in a note form. For a two-day listing and little selling cost involved, this wasn’t bad. Those monthly checks spent very well indeed.
In addition, if one of the notes suddenly went bad, the builder reserved the rights to substitute another 2nd mortgage paper note if the need arose. He would then settle the difference in cash or he would substitute a monthly income stream on another note to settle the delinquent amount and take back the note. It was proven the builder had an excellent credit rating and protected his subdivisions like a jealous lover. If a problem arose, he would intercede and try to resolve the non-payment situation thereby saving the his often used lender a foreclosure on the books and in this case the 2nd mortgage. He would do this by paying the note payer to move and perhaps rent one of his properties and quit claim the property back all the while saving the borrower/buyers credit rating to be used another day. Life is messy sometimes and through illness, divorce or job loss and such non-payment results. Time has proved this builder’s utilization of this winning formula for success by becoming a multi millionaire many times over in up or down building cycles. He always used paper to make a rescue when needed, like in a down building cycle. If he had to take a property back, he would rent it until he used paper again or sold it out right with super term financing.
Today builders and homeowners are again operating in a soft market. The “paper business" is a great way to make deals work. With the advent of corporate note buyers in the market place the deep discounted opportunities can be limited, however, there are still opportunities. If you end up with paper on a deal, hopefully at a discount, many creative practitioners using them at face value to put together purchase and trade deals. There is more than one way to put real estate sales together. If a buyer has a car, truck, semi-truck, semi-trailer, boat, mobile home, motor cycle, vacant lot, gem stones (the appraisals are varied), diamonds, collectibles, personal property loan, business note, judgment award, lawsuit pending on a traffic accident, life insurance annuities, inheritance, business inventory, chattel mortgages on equipment or any number of combinations can be used to make deals work.
Yes it is sometimes sticky, but if you can stay within your comfort zone and two parties agree after utilizing professional appraisers and such, give it a go. The alternative is to do nothing and let the market roll over you like a run away freight train, or you can make something happen. After all, that was how Manhattan was bought, barter and trade. Déjà vu in the market place today. Think outside of your comfortable universe and see an old way of doing new business. Sometimes the deals can be “like kind" property and qualify for favorable tax treatment can be achieved, other times, it will just be “boot" with no tax benefits. Other times it could be both. Déjà vu. Here we go again.
Dale Rogers is a thirty-year mortgage veteran and frequent contributor to the Broken Credit Blog. The BCB is a free website created to assist the general public with information about credit repair and responsible mortgage lending.