Note brokering instead of balloon for seller-financing deal?

Question

Is this a thing?

RE investor approaches property owner about seller-financing.
Owner is on the fence. Cash now is more attractive for them than passive income.
So investor suggests a balloon option at, say, 5 years.
Owner likes the compromise and the deal ensues.

But what if instead of the balloon, which is a less convenient position for the investor, the note was promised to be sold at 5 years with the investor serving as the broker? (Or maybe the investor could find a different broker who would find a note buyer.)

In order to net the same result for the seller, the terms of the loan would likely need to be structured differently so that the seller received the desired amount upon the discounted sale of the note.

I understand there is risk involved for the investor here since there is no guarantee of being able to sell the note. But perhaps the investor is willing to bear the risk and pay more in the long run to avoid coming up with the balloon in the short term.

Or perhaps this could be an option in the deal instead of replacing the balloon all together, effectively making the balloon an exit plan should the note not sell.

My 2 questions:

1) Are there any ethical, legal, or practical limitations to this from the note investing/brokering side? Is this even a thing?

2) I know there are a ton variables to consider with the note structuring, but what differences might you expect to see, generally speaking, in the note terms between these two scenarios to make the deal possible?

This is all hypothetical -- it came to me while up with a sick kid at 3am -- but I appreciate any insight our experienced note investors are willing to provide to ease my overly tired (and thus oddly creative) mind.

Jeremey J. · Answer

Thanks for trying to help figure this out. I apologize if I have been confusing. I'll try to clarify a little:

While the idea for this situation stemmed from my thinking about a real potential deal on the horizon, the scenario I proposed was an exercise for my brain trying to utilize the selling of a note as a tool in structuring a creative financing deal.

As someone new to the notes realm, I got stuck trying to understand what a note investor may want to see in order to invest in such a deal.

I was also curious to see if and how other note-savvy investors use their knowledge of note structuring/brokering/buying/etc. to aid in putting together creative financing opportunities for RE deals.

Again, my apologies if I wasn't clear.

Jeremey J. · Answer

Thank you, @Chris Seveney for the feedback.

You said,  "For the owner, not sure why he would want that as he wants to get his $ and no guarantee note would sell (and definitely would sell for less than balloon price)."

Yes, I definitely see this. I was hoping to find out how the note could be structured in such a way that is a win/win for both parties:

• Seller needs the note structured in such a way that will help him sell the note and still get what he wanted out of the property.
• Investor is willing to pay more for the property over time to avoid the balloon.

It's probably just matter of playing with the financial calculator long enough to see what numbers make something like this work.

But this is more about my brain trying to grasp concepts in how notes are valued and constructed than it is about dollars for an actual deal.

Question - Is there an obvious method to structuring a note in this way to help both parties achieve their goal -- i.e., making the note marketable for the seller to get a good price for the note?

You also said:

"...if you were going to attempt to broker and sell the note for a fee as the borrower that would appear to be a conflict of interest"

Yes, this seemed logical to me. But does that mean it's against the law? Or is it just shady business? I'm not interested in breaking the law or doing bad business.

But I am interested in finding out how creative one can be within those boundaries, and I get the feeling that a lot of note holders don't really know selling their note is an option until they run across some marketing from a broker or buyer.

Question - If it's not okay for the investor to broker the note he's paying on, what is a legitimate way for him to approach the seller about being able to sell the note (or part of it) as an option to land the deal?

Marco Bario · Answer

I'm glad you asked, as this is one of my favorite topics...

Money today is worth more than money tomorrow.

Let's say a seller loans $100,000 at 8% for 15 years (180 payments). The monthly payment will be $955.65.

Before receiving any payments, the seller immediately sells their ENTIRE loan to an investor who wants a 12% yield. The sale price would be $79,626.52. That's a 20% haircut and a reduction of over $20,000. Over the next 15 years, the buyer of the loan will receive payments totaling $172,017. Not bad.

But, let say the note holder sells the first 60 payments and retains their right to receive the remaining 120 payments. The investor wants 12% so he pays $42,961.38 for the next 60 payments. If he'd purchased them at par (8%) he'd have paid $47,131.26. The purchase discount is less than 9% and the price reduction is about $4,200. That's a lot less than 20% and $20,000.

What just happened? Presumably, the note holder received a cash down payment when he sold the property, plus $42,961.38 for selling 60 payments. In 5 years the note holder could sell another partial, sell all remaining payments, or sit back and let you pay him/her $114,678 over the next 10 years. Win/Win?

You say your seller isn't note savvy, so I'd bring an investor to the table who plans to purchase the partial and has input into how it's structured.

See how much fun banks and Wall Street have been having all these years? This is why I love notes and seller financing.

PLEASE NOTE: The above is for educational purposes only. I am not an attorney, financial advisor, or mortgage loan originator. It's always recommended you seek input from licensed professionals.

- Marco Bario

Marco Bario · Answer

I love seller financing because there are almost as many options as your creative mind can imagine.

First, a question: Is your goal to generate a broker fee in 5 years, to acquire property via seller financing, or both?

In the scenario you imagined, the note holder would hold an asset (a promissory note and mortgage/trust deed) which he'd be entitled to sell at any time. That is unless language in the note limited his/her scope in selling.

Three other options:

• The note could be sold to a pre-identified investor immediately. Best for the seller if you provide a good down payment and/or an interest rate where the note can be sold at or near par. 
• Create a 1st and a 2nd. The seller can sell the 1st and hold the 2nd for continued cash flow. Other ways to mix this scenario up also.
• Create a note, sell a partial. If the note were structured for 180 payments, the first 60, the last 120, or other combinations could be sold at any time for lump sum cash to the seller.  Partials can limit the discount taken by a seller as well.

I could go on, but drilling into what each party wants and needs becomes the key to finding the best solution.

- Marco

Chris Seveney · Answer

@Jeremey J.

So if I understand this correctly - you want to acquire a property via owner financing then in lieu of a balloon have it be language of selling the note?

For the owner, not sure why he would want that as he wants to get his $ and no guarantee note would sell (and definitely would sell for less than balloon price).

Also if you were going to attempt to broker and sell the note for a fee as the borrower that would appear to be a conflict of interest

Jeremey J. · Answer

@Marco Bario

Absolutely fantastic. This is exactly the kind of thing that piqued my interest in notes to begin with.

But I'm still just learning, and you don't know what you don't know.

Running scenarios helps me visualize how all this can work, so thank you for taking the time to put that together.

Bringing a note investor to the table at the start seems like excellent advice.

Chris Seveney · Answer

@Jeremey J.

Why not get a bank loan after 5 years to pay the borrower off?

Jeremey J. · Answer

Thank you, @Marco Bario.

My hypothetical scenario did stem from thinking about a potential deal we are considering, so should it actually play out in real life, the primary goal would be to acquire the property via seller financing.

My guess is that this particular seller may not be privy to note buying and selling. So I was trying to think of a way to make the seller financing more attractive to them by providing this option.

The investor generating a broker fee for a note he was paying on seemed too good to be true, but would be a nice consequence of creative thinking if that's a legitimate thing to do.

Thanks also for supplying those other options for structuring the note -- that's the kind of experienced expertise I figured was out there somewhere!

Question -- could you elaborate on your comment:  "Partials can limit the discount taken by a seller as well."

Do you simply mean since the total discount of the whole is spread out over the partials that the seller wouldn't have to take as big a discount if he sold some of the payments and kept the others? Or is this a nuance of partials that the relative discounts are smaller than on selling an entire note?

Wayne Brooks · Answer

There is of course no guarantee whaat price the note would sell for at the 5 year mark.  It would never sell at par unless it was a very high interest rate.

Note brokering instead of balloon for seller-financing deal?

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