Investment Banks and other lender categories are generally wealthy for good reason. The interest income they garner from a loan, if securitized and structured properly, is an almost risk-free example of true “passive income”. Why should lenders make this money when the income is a available to a property seller?
One of the first questions I ask ownership when discussing a possible sale is … “what is/are asset(s) current mortgage(s)”. The answer to this question can be worth hundreds of thousands and in some cases….millions of dollars in additional “sale proceeds” to our Seller Client. Why and how?
There are many tentacles of seller benefit.
Higher selling price…
A “seller note hold” will increase the size of the buyer pool. Demand increase will increase Value and, in turn … increase the selling price of an asset.
Interest Annuity Income…
Many say that owning real estate is a “passive income” investment…until they own real estate. Even if you hire a management firm there is still effort needed to a degree that does not fulfill a reasonable definition of “passive”. Holding a note might be a truer example of passive income for a seller. Might be best to provide a recent example to illustrate.
Recently we closed on a small asset assemblage in Essex County. The sale price was 2.8 million. Buyer came with 800k in cash and seller held the note on the 2M. Note was for 5 years, interest only at 7.5%. This equates to a before tax interest income annuity of 100k per year or 500k for the term of 5 years. It can be construed that the property did not really sell for 2.8M …. it “sold” for 3.3M. The taxes on the annuity may vary depending on who/what entity actually receives the monthly payment and for what purpose. This 100k a year is not much less than the NOI received during ownership and there is no liability of ownership and no management.
Ownership liability and property management ….
As a property owner, if you have not already, you will inevitably be the defendant in a law suit brought by a tenant. Often the outcome of a suit is not predicated on the logically evaluated validity or support of the suit.
What is your Vacancy Rate and Credit Loss? In some areas of the state, mostly contingent on tenant base type, a tenant can begin to believe that they should not have to pay rent or at least act like they believe this. The eviction remedy can take time and ultimately is a cost without arears recovery.
What is the tone of your municipal and state regulatory environment? Over the decades we’ve done quite a bit of work in Montclair, NJ. Not long ago Township passed rent control legislation. TWG provided pro bono consult to the opposing organization. An element revealed from our analysis and contribution was that cumulative property value was reduced by over $600,000,000 stemming from rent increase confines and or prohibition. It can be construed that this is a redistribution of money… from property owners to the/a tenant base.
Generally, investment property ownership is a very good piece of business …. but it does have challenges that can arise in a degree, frequency and number … devastating or removing benefit.
Most believe capital gains tax consequence is onerous. Tough to argue with this. Holding the note means that the seller does not receive full sale proceeds at closing so does not get taxed on what they don’t receive. There are many ways to structure how sale proceeds and interest on a note are received and when … but the bottom line is that the note hold is at least a great liability deferment and, in some cases, a tax liability reduction.
A seller might charge a point on the note but generally financing fees and costs of a seller note hold are much less than those of a conventional lender. These savings are shared by the buyer and the seller.
A seller has the ability to abate or delay when payments might begin. This gives the buyer an opportunity to get into the property, set up systems, possibly make a couple of improvements, etc. This is a huge advantage and savings to the buyer; the seller shares in this savings. Conventionally, the number of months of delay of payment commencement are put on the back end of the term.
So why doesn’t every seller hold a note on an asset sale?
We hear a variety of reasons:
- I don’t want to deal with the management of receiving payments
- I want all proceeds now and don’t care about interest income
- We haven’t found the right buyer as yet
- We’ve identified a replacement property and want all proceeds for the 1031
- Overwhelmingly, the biggest reason or concern stems from the possibility of buyer default
Risk and risk mitigation is a part of any piece of business. Properly underwriting the buyer and securitizing the note will greatly reduce risk. Conventional elements of underwiring would be performed, however, there are a series of less conventional protections that can be structured that all but remove risk. In fact, it has been said, that if properly structured, a buyer default is or can be a considerable benefit to the seller holding a note.