How is Seller Protected if they are in 2nd position?

Question

Hi,

If I buy a apartment doing a seller carry back, how do I explain to the seller how they are protected if they carry a 2nd position note subordinate to the bank?

The example scenario would be if I bought a $1M property, the bank is in first position and covers 800k of the property cost, the seller agrees to cover cost of down payment and covers 200k of the property cost.

Let's say we can no longer make payments on the property and it's foreclosed on. How do you guarantee the original seller that they will also get back most if not all their money. What guarantees they'll be made whole in simple terms?

Bill B. · Answer

If you go under the seller is going to lose that $200k. After late fees, penalties, $80k for realtors, transfer costs, etc etc. With 100% financing the deal should fail and the seller should expect to lose. Especially as that 2nd should be at 8-10-12% interest? If it isn’t a “bonus” situation listed below I wouldn’t do it as a seller, even for 12%.

Either they’d be happy getting 80% and everything you pay is a bonus. Or they already inflated the price 20% so they’ll get market value and what you pay is a bonus. (See a trend?) unless they don’t know how likely they are to lose.

Only way to “protect them” would be for them to have a personal guarantee and for you to be worth well over that amount. And you could still declare bankruptcy and screw them. Do you have over $200k in equity in your primary home? Give that as additional security.

Chris Seveney · Answer

@Jerry Zhang

You cannot

You can give a personal guarantee but then you would have to have other assets.

What could happen and we have seen many times is they go into default and the 20% equity cushion goes out the window due to late fees, accrued interest and legal costs. Typically in these situations the property also is less valuable as well which turns the second into negative equity and wiped out in foreclosure

Evan Polaski · Answer

At the end of the day, you got your answer: you can't. It is 100% a risk to the seller to keep them financial invested in the deal, when they want to sell. More risk = more reward. And to the seller more reward = make the buyer pay more.

I have seen one way this was done on the syndicator review forums. "Seller" allowed a syndicator to "buy" the deal by paying "seller" presumably a lot of money and an agreement to take over all operations. The "seller" never transferred title and the in-place loan remained in effect. "Seller" was able to retain some oversight on operations, since they were still titled owner and on loan.

When "buyer", presumably, couldn't keep property afloat and pay the loan, seller simply removed buyer and took over property again. The seller got to keep the buyer's money that was paid upfront, and was effectively in the same place they were before they sold, except with several million more dollars in their pocket. Unfortunately, the "buyer" was a syndicator, so the real losers were the investors in that syndication.

Joshua Christensen · Answer

There is no such thing as a "guarantee" only the perception of.

if it's a concern in your offer, find out what it would cost to carry a bond or insurance product for the seller. Otherwise, shorten their term and get them paid out in 12-24 months to "reduce" their risk.

it sounds like you are trying to make an offer with this scenario. Personally, I would not create a conversation around this "risk" as that is a sure fire way to increase the sellers anxiety. I' had confidence in my ability to perform.

the seller needs Confidence in Your performance to reduce their risk. Show them how you will perform. Then DO IT.

IF they ask for other assurances, then provide what you can in other means. Risk is relative to every seller and you'll need to answer accordingly.

JD Martin · Answer

Others have already answered the question but the short answer is nothing guarantees they will be made whole. That's why lienholders like to be in first position. You say it's not dangerous for the seller because they're only 20% at risk. $200k is a pretty good chunk of money to lose on a $1 million property unless they paid $50k or something stupid for it 40 years ago.

Depending on your loan structure I'm not even sure you could legally offer a personal guarantee outside of the loan for that money without committing mortgage fraud, as anything that could hinder the ability of the primary lender to recover their principal is supposed to be declared during their diligence period, and any material changes up to the point of taking the loan are supposed to be disclosed as well. I think the only legal way a seller could get that assurance would be to close the loan in 2nd position, and after everything was recorded you sign a new promissory guarantee or other collateral in case of default.

Sarah Vann · Answer

Not so dangerous for the seller - dangerous for the buyer as you are now financing 100% of a property. If cash flow is a concern it's a big one usually

Jerry Zhang · Answer

Not super dangerous, seller is netting 80% of purchase price at close. They only have 20% of purchase price they're risking. Just trying to find out how to secure remaining 20% for seller

Sarah Vann · Answer

Carrybacks are super dangerous.. but... You can set it up so the seller is the member of the LLC that owns the property so that if you are going under then the buyer is booted out of the LLC and seller takes over ownership. Then of course they can catch up on the arrears and sell the property outright. Message me if you'd like some more input!

How is Seller Protected if they are in 2nd position?

How is Seller Protected if they are in 2nd position?

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