california real estate finance bond, mckenzie, fesler & boone ninth edition
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California Real Estate Finance Bond, McKenzie, Fesler & Boone Ninth Edition. Chapter 14 Creative Financing Approaches. Objectives. After completing this chapter, you should be able to: Differentiate between traditional and creative financing techniques. - PowerPoint PPT PresentationTRANSCRIPT
© 2011 Cengage Learning created by Dr. Richard S. Savich.
California Real Estate FinanceBond, McKenzie, Fesler &
BooneNinth Edition
Chapter 14Creative Financing
Approaches
© 2011 Cengage Learning created by Dr. Richard S. Savich.
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.
© 2011 Cengage Learning created by Dr. Richard S. Savich.
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
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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
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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
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Seller Sells the Second Loan
Instant cash Deep discount Who buys?
Escrow companies Loan brokers Holders of maturing junior trust deed
loans
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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
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Combination or “Split” Junior Liens
Create second and third trust deeds Can sell a smaller second easier
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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
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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
© 2011 Cengage Learning created by Dr. Richard S. Savich.
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
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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
© 2011 Cengage Learning created by Dr. Richard S. Savich.
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
© 2011 Cengage Learning created by Dr. Richard S. Savich.
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
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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
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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
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Lender Participations Participation in revenue of project Equity participation Charge one time fees or points Profit Participation Multiple lenders
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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
© 2011 Cengage Learning created by Dr. Richard S. Savich.
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
© 2011 Cengage Learning created by Dr. Richard S. Savich.
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?
© 2011 Cengage Learning created by Dr. Richard S. Savich.
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
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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
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Stock Equity/Pledged Asset Loans
Marketable securities are used as collateral
© 2011 Cengage Learning created by Dr. Richard S. Savich.
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
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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
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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
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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
© 2011 Cengage Learning created by Dr. Richard S. Savich.
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