Borrowing our way out of Debt

July 19, 2019 By Dave Franecki

Today I cam across this article title,” The Three Ds of Doom: Debt, Default, Depression”. Without sounding negative, it certainly makes one think about the current economy. Everything appears to be booming, at least here in the greater Phoenix Metroplex. But………..what is under the covers. What goes up always comes down. It is a fact of life. Now apply this to the niche business. It is the paper side of real estate.

In the very near future, Capstone will be launching a Utube note training series on buying Notes. One of the topics as part of the due diligence series will be a deep dive into Investment to Value and Loan to Value. Another words, what is the note buyers safety net in the event of a downturn. How to minimize the pain in your portfolio. The only way I know is to have an EQUITY SPREAD. For instance, if a note has a $100,000 unpaid loan balance (aka UPB), what is your risk tolerance. What safety net do you require? The Capstone safety net is an Investment to Value (ITV) not exceeding 65% and a Loan to Value not exceeding 70%. Some say this is too big a filter. I guess time will tell. Anyway–moving on to the article.

The Three Ds of Doom: Debt, Default, Depression

July 17, 2019

“Borrowing our way out of debt” generates the three Ds of Doom: debt leads to default which ushers in Depression.

Let’s start by defining Economic Depression: a Depression is a Recession that isn’t fixed by conventional fiscal and monetary stimulus. In other words, when a recession drags on despite massive fiscal and monetary stimulus being thrown into the economy, then the stimulus-resistant stagnation is called a Depression. Read more

AUGUST PHX NOTE INVESTORS FORUM MEETUP

July 15, 2019 By Dave Franecki

The August 7th Note Investors Forum Meetup focus on:

TOPICS: Several New Case Studies
Where Does a New Note Investor Begin

Bring your questions, This will be an interactive meeting.

The Next Note Investors Forum Meeting will be
Wednesday, August 7th 11:30am-1:30pm
La Famiglia Restaurant, SE corner of Dobson & Guadalupe, Mesa

Ask about Partnering and/or Coaching on Note Opportunities

TRUSTS | NOTES | REAL ESTATE | IRAs – NOTE INVESTORS FORUM

August 26, 2018 By Dave Franecki

A CONUNDRUM of Confusion and Questions?

Join us Wednesday September 5th 11:30am.

Lunch at the Note Investors Forum Meetup

Topic:

Trust Basics For Notes & Real Property
What Every Note & Real Estate Investor Needs to Know

Why trusts should be utilized in the Note/Real Estate Arena.

We’ll drill down into what works & does not work.
Practical hands on application for a ROTH IRA

Location: La Famiglia Restaurant, SE corner of Dobson & Guadalupe, Mesa, AZ

PARTIALS SIMPLIFIED–A BRIEF OVERVIEW OF A PARTIAL TRANSACTION

September 27, 2017 By Dave Franecki

Today an IRA administrator questioned -requested an explanation on the sale of a partial. He said he had never seen this type of transaction before. Neither had his compliance officer.

They were confused and requested a simple explanation which follows.

All of the following statements are true:

Partials can be difficult to understand.
Partials can be simple.
Partials may be a safer note investment than selling a full note.
Partials are a conservative tool which is perfect for a ROTH IRA
Partials are a great tool to grow ones’ ROTH IRA if one is selling the front payments and keeping the tail, in affect an annuity for the future.
When one is selling a Partial, you are recouping your initial investment and the tail is effect “free” future cash flow.

“Bob” is buying 3 partials–funding the last purchase of 125 payments(blue) for $18,900.

My entity is keeping the remaining payments –gold(the tail).My entity is assigning all the payments to him as evidenced by an allonge which keeps this transaction SEC compliant.

This is a great deal for Bob, because I will always be in the deal protecting the remaining payments(gold).

After Bob receives his payments, the remaining payments will be reconveyed to my entity as evidenced by a Reconveyance of Agreement for Deed which references the Purchase and Sale Agreement.

In the event of an early payoff, default or if Bob opts to exercise the 60 month buy back provision the following chart –the Entitlement Schedule –Schedule B illustrates how that scenario will be administered.

The IRA Administrator has executed the following docs:

Purchase Agreement
Reconveyance of Agreement for Deed which will be recorded and is subject to the Purchase and Sale Agreement. This doc puts everyone on notice and guarantees the return of the note to me after Tom has been fully paid for his investment subject to the entitlement schedule

Bob will record the Assignment of Contract for Deed to protect himself and will have the original note and the allonge(transfers the note) which will be archived by the Servicier and distribute the 125 payments to Bob. In the event of an early payoff or if the purchaser wants to exercise his 60 month option for an early buyback, his administrator as a road map for future reference.

The IRA company rep understood this transaction when explained in plain English. Additionally he received the following Partial from our NoteHolder’s Handbook–Note Holders Handbook_Partials.

A partial is one of the safest ways to invest in notes.

The IRA Administrator thanked me for providing a “Great explanation!”

Seller Financing – A Solution to a Bad Partnership & a Negative Cash Flowing Property

April 24, 2017 By Dave Franecki

Recently I meet a new real estate investor at AZREIA (Phoenix Real Estate Investors Club). She shared with me how seller financing literally saved her from a poorly performing duplex in Kingman, AZ. What follows is her narrative – with my comments.

I currently hold a note on a Duplex in Kingman AZ. This note came about as an accidental solution to a really bad problem property. It is a very short term note with 5% interest(VERY LOW INTEREST RATE) and a balloon. The note has been extended once, and there is an option to extend it again.

I originally acquired the property in August 2014. My investor and I paid cash for the duplex. It was in very bad repair and needed a full rehab. We had originally intended to rehab it and rent it out. We had a lot of issues with the property, many problems with contractors, problems within the partnership, and tons of money issues. We couldn’t get it finished, and it was just sitting vacant and getting vandalized. It was a huge headache for me, a source of serious stress, and a huge money pit. I drove back and forth to Kingman many times to deal with the property, contractors, solve problems, etc. My partner and I fought about it all the time for two years. After a year I wanted to sell it and get out, but he did not. It was a good property. We just could not agree on any aspect of the property. We both had completely different rules for our investing and very different ways of doing things. After almost two years of butting heads and losing money I’d had enough and was desperate to find a way out.

We owned one other property together that I also wanted out of. Both were good properties but it was technically the partnership that I wanted out of. He did not want to sell the other property either. With the help of a local note investor in structuring a buyout contract, I acquired the duplex solely as part of my partner’s buyout of my share of the other property.

I immediately put the duplex up for sale. I was a very motivated seller, but I did not want to discount the price very much because it was a very good property in a good location in downtown Kingman. We had already put 15K into the rehab so one side was really close to being rent ready. The other side still needed full rehab, but it could have cash flowed or at least broken even with just the one side rented.

Very quickly my real estate agent found me an investor buyer who wanted to live in the finished side and slowly rehab the other side until she could rent it out. She was willing to pay full asking price but wanted seller financing and was going to refi within a short period of time. She was willing to put down the amount I asked for (about 40%) which took care of my partner’s buyout of the other property and the small private money loan on the duplex for rehab costs. In September I wrote a $37K note for 6 months at 5% with a balloon due in March of 2017. The sale of this property as a seller finance turned this disaster of a property into an easy, stress free cash-flowing asset.

In March, my buyer was not able to refi and cash me out. Rather than foreclose, I extended her loan. I charged her a fee to extend her loan. She could not pay the fee up front so I added it to her monthly payment. The property now cash flows at a net of $435.50 every month and I do nothing except get a deposit into my bank account. (AKA – Mail Box Money) Taking a note on this property not only turned a disastrous and extremely stressful negative cash flow property into a stress-free income-producing asset, but the new owner is happy because she lives there and works on the property. Eventually her renters will pay her more than she needs to cover her payment to me, or she can sell it. The work she has done so far has increased the property value by quite a bit, so if she sells it she can cash me out and still have a profit.

This is an incredible story with a heart warming solution.

The Seller got her price for the property.
The Seller dissolved was able to disolve a negative partnership due to a very hefty 40% down payment.
The Seller turned a negative cash flow into a positive cash flow
The Seller reduced stress in her life. As she put it so well, ” It was a huge headache for me, a source of serious stress, and a huge money pit.”
The Seller no longer has to commute from Phoenix to Kingman to handle landlord issues.
The Buyer is fixing up the house for the seller. In the event of a foreclosure, the Seller is way ahead
The buyer was able to occupy one side of the duplex and rent out the other half which is paying her mortgage and…she still has a profit.
The real estate agent received a full commission and…………..got a quick sale.

Trump Already Moving To Dismantle Dodd-Frank

November 12, 2016 By Dave Franecki

WASHINGTON, Nov. 11, 2016 — Donald Trump has taken the first step to fulfill his campaign promise to “dismantle” Dodd-Frank and the Consumer Financial Protection Bureau. He is considering one of the leading critics of Dodd-Frank on Capitol Hill, Rep. Jeb Hensarling, as Treasury Secretary.

Mr. Hensarling last year laid out a blueprint for replacing Dodd-Frank that many observers view as a starting point. In an interview Thursday, he said the Trump team’s statement “is music to my ears,” and that he planned to make the bill, dubbed the Financial CHOICE Act, his top priority next year.

He said he had spoken with Mr. Trump’s team about the matter in the past, adding: “I think they like the thrust of the legislation and many major components of it.”

As for the prospect of him taking the Treasury slot, the Texas lawmaker said he would “certainly have the discussion” if the Trump administration comes calling, “but I’m not anticipating the telephone call.”

The transition team’s blueprint on the president-elect’s website states that the Trump team “will be working to dismantle the Dodd-Frank Act and replace it with new policies to encourage economic growth and job creation.”

The president-elect has tapped Paul Atkins, a former Republican member of the Securities and Exchange Commission and longtime Dodd-Frank critic, to recommend policies on financial regulation. An aide to Mr. Atkins, who heads a financial regulation consulting firm, referred requests for comment to the Trump transition team, which couldn’t be reached.

Mr. Hensarling’s bill is built around a trade-off: Banks can free themselves from various regulations, such as tough stress testing, as long as they maintain capital equal to at least 10% of total assets and high ratings from their regulator.

That would immediately help many small locally focused banks that tend to be better capitalized, but not necessarily megabanks with sprawling international operations that generally have capital levels below that level.

In the interview, Mr. Hensarling said he would try to convince Mr. Trump’s team to support his approach instead of their campaign-trail promise to reinstate the Depression-era Glass-Steagall law separating traditional lending from investment banking.

Mr. Hensarling’s bill also would make other significant changes, such as requiring that many financial regulations be subject to cost-benefit analysis for the first time and tying the budgets of regulatory agencies, including the CFPB, to congressional appropriations.

The CFPB has enjoyed a high level of independence by getting its funds from revenues insulated from the legislative process.

It is possible Senate Democrats could seek to block GOP efforts they view as overreach, but lobbyists and congressional aides are optimistic that some moderate Democrats up for re-election in 2018 in states that voted for Mr. Trump will be inclined to compromise. Republicans also may come under pressure to change the Senate rules to ease passage of controversial legislation, but it is far from clear they would make that move.

Our take:

The proposed Seller Finance Enhancement Act – HR 5301…, an amendment to the Dodd/Frank legistation is way over due

This bill rolls back some of the excessive regulations of Dodd/Frank by allowing Seller Financed transactions to expand from 3 in a rolling 12 month period to 24 in a year.

While this is not a massive change, it will provide significant relief for the vast number of real estate investors who choose to seller finance property.

Dave Franecki

The housing bubble is getting ready to implode: The scariest chart in real estate shows an impending correction because you can’t afford to buy a home today.

September 11, 2016 By Dave Franecki

As Posted in mybudget360

“Definition of economic bubble: A market phenomenon characterized by surges in asset prices to levels significantly above the fundamental value of that asset.” We are definitely in another housing bubble. First, most Americans can’t afford to buy a home without utilizing artificially low interest rates and even then they are stretching their budgets like spandex. Second, home prices are surging in the face of stagnant household incomes. That is the biggest sign of a bubble. The underlying asset in housing is moving up even though incomes are not. So what is driving prices up? Speculation, flipping, investors, and what we would categorize as fickle money. This is the ultimate sign of a housing bubble. Homeownership is near a generational low because most households are living month to month unable to buy. If you want to see the housing bubble in one chart look no further.

The scariest chart in housing

Home prices are up a stunning 34 percent from 2012. That is an incredible increase but this is not being driven by families buying homes. It would also be different if household incomes were going up. They are not. Take a look at this chart:

This might even be scarier than the years before the last bubble. Why? Take a look at the chart. From 2002 to 2008 housing prices and incomes went up together (but of course home values were already on an upward trajectory). The bubble hit and both home values and incomes went down. All of this makes sense. In 2012 housing prices and incomes went up. But that jump in income only lasted a brief period. Now, you have home prices surging 34 percent yet incomes are stagnant. That is a big problem.

You can even see this problem between new home prices and new homes sold:

New home sales are in the dumps yet prices are moving up dramatically. Most of this is speculation and of course the financial sector in our economy is thriving on the backs of the middle class. But are we in a bubble?

“Bubbles are often hard to detect in real time because there is disagreement over the fundamental value of the asset.”

This is where we stand today. We are in the bubble. It is hard to assess value because people are disagreeing on whether this is a bubble or not. But take a look at commercial real estate values as well. This is definitely a bubble. You need to continue to have speculative money flowing in to keep values at their current levels.

Will the housing bubble pop this year? Bubbles can last longer than most people think. But there are already cracks in the system. You saw the market briefly correcting this year. Suddenly stocks are up on low volume and current prices are still overvalued. The same can be said for housing. Low supply, low demand, yet prices are going up. The Fed is completely afraid to raise rates knowing that it has no other option but to keep rates low. This policy move has made the middle class a minority.

Here is a good summary of where we are going:

“(The Sovereign Investor) I see one of two scenarios at play. Which one do you think will ring true?

Homebuyers continue to fork over more dollars to buy properties while we sit with stagnant wage growth, stagnant economic growth and low-wage jobs being about all that’s created.
We are on the edge of a bubble larger than the one we experienced less than a decade ago as housing prices race back down to where it is affordable and sees demand from new buyers.

The Federal Reserve is held accountable for this fiasco. If it goes forward with a rate increase in the near future, it will be us who pay the price of another bubble.

There’s only one action to take if you ask me — lower your exposure to the industry.

In stocks, that’s homebuilders and mortgage originators. Avoid them at all costs. In your personal investments, that’s being prepared for another real estate shock.

These prices are unsustainable and due for a correction.

Once that happens, opportunity awaits you to pick up houses and housing-related stocks on the cheap.”

You have been warned.

If the above is true, and we believe it is, seller financed notes should be purchase at no greater that a 70% Loan to value or no greater than 65% investment to value

Capstone Capital USA

The housing bubble is getting ready to implode: The scariest chart in real estate shows an impending correction because you can’t afford to buy a home today.

Lopsided Housing Rebound Leaves Millions of People Out in the Cold

August 12, 2016 By Dave Franecki

Homeownership rate continues to decline as credit issues, student loans and high prices lead more to rent

http://www.wsj.com/articles/lopsided-housing-rebound-leaves-millions-of-people-out-in-the-cold-1470852996

The housing recovery that began in 2012 has lifted the overall market but left behind a broad swath of the middle class, threatening to create a generation of permanent renters and sowing economic anxiety and frustration for millions of Americans.

Home prices rose in 83% of the nation’s 178 major real-estate markets in the second quarter, according to figures released Wednesday by the National Association of Realtors. Overall prices are now just 2% below the peak reached in July 2006, according to S&P CoreLogic Case-Shiller Indices.

But most of the price gains, economists said, stem from a lack of fresh supply rather than a surge of buyers. The pace of new home construction remains at levels typically associated with recessions, while the homeownership rate in the second quarter was at its lowest point since the Census Bureau began tracking quarterly data in 1965 and the share of first-time home purchases remains mired near three-decade lows.

The lopsided recovery has shut out millions of aspiring homeowners who have been forced to rent because of damaged credit, swelling student loans, tough credit standards and a dearth of affordable homes, economists said.

In all, some 200,000 to 300,000 fewer U.S. households are purchasing a new home each year than would during normal market conditions, estimates Ken Rosen, chairman of the Fisher Center of Real Estate and Urban Economics at the University of California at Berkeley.
“I don’t think we are in a normal housing market,” said Lawrence Yun, chief economist at the National Association of Realtors. “The losers are clearly the rising rental population that isn’t able to participate in this housing equity appreciation. They are missing out on [a big] source of middle-class wealth.”
Anxiety about missed economic opportunities is a key driver of the anti-incumbent anger on both sides of the political spectrum that has shaken up the 2016 election season, helping fuel the insurgent presidential campaigns of Donald Trump and Bernie Sanders.

“You have these people who can’t get housing, and it’s turning into this rage,” said Kevin Finkel, executive vice president at Philadelphia-based Resource Real Estate, which owns or manages 25,550 apartments around the U.S.

While economists expected the homeownership rate to begin edging up this year, the rate fell to a 51-year low of 62.9% in the second quarter from 63.4% in the same quarter last year.

The rate could fall to 58% or lower by 2050, according to a recent prediction by housing experts Arthur Acolin of the University of Southern California, Laurie Goodman of the Urban Institute and Susan Wachter of the Wharton School at the University of Pennsylvania.

Long-term declines could erase gains made by middle-class Americans since World War II. Owning a home provides protection against rising rents and has been a key component of retirement saving and wealth creation.

“The default savings mechanism for American households has been homeownership,” Ms. Wachter said. “Today we have historic lows for young households in terms of ownership so they’re not getting on this path.”

That, in turn, can ripple throughout the economy. Homeowners often use home equity to pay for college tuition, vacations or home renovations, all of which help boost consumer spending. The mere knowledge that home values are rising can make consumers comfortable spending money other places, a process known as the wealth effect.

“We’re seeing a divide between the wealth of homeowners and the wealth of renters,” said Nela Richardson, chief economist at real-estate brokerage firm Redfin.

After peaking in July 2006, the Case-Shiller index plunged 27% over the next six years. Since then the recovery has been swift, particularly in markets with strong job growth and limited supply, creating problems for entry-level buyers in particular.

Across the country the recovery has been divided between strong West Coast markets and Texas, which have rebounded swiftly beyond their 2006 peaks, while prices from the Rust Belt to southern Florida may not return to those levels for decades.

Prices in the Boulder, Colo., metro area are 45% above their prior peak, while those in Dallas are 26% above their boom-time highs, according to data provider CoreLogic Inc. Meanwhile, prices in the Saginaw, Mich., area remain nearly 40% below their peak levels and those in Atlantic City are still 38% lower.

In Sacramento, prices have jumped 64% since the beginning of 2012, according to CoreLogic.

Sunny Kenner, a 40-year-old single mother who works for the county government and has rented for years, decided a few months ago she needed to buy before rising prices shut her out for good.

Ms. Kenner, who is looking for a two-bedroom house in the $250,000 range, has been trying for months but twice has been outbid by buyers with large cash reserves who bid $10,000 over the asking price. By the second day a house is on the market, she says, there are usually about half a dozen offers on it.

“The first time I didn’t get one of the houses, of course, I cried,” she said. “The second time I was just numb.” She said she wishes she had enough money to buy when prices hit bottom a few years ago. “I feel like I missed the boat.”

The main reason for falling homeownership, economists say: mortgage availability. Lenders chastened by the financial crisis have been fearful of making loans to borrowers with dings on their credit, student debt or credit-card bills, or younger buyers with shorter credit histories.

“I’m not sure that we’ll see some of those conditions change in any material way in the foreseeable future,” said Tim Mayopoulos, the president and chief executive officer of mortgage giant Fannie Mae, in an interview last week.

“Right now our mortgage finance system is still not working well for lower- and middle-income households and first-time buyers,” added Mr. Rosen.

A dearth of home construction, especially at the lower end, is taking a toll. Nationally, the inventory of homes for sale has dropped more than 37% since 2011, according to Zillow, a real estate information firm. Some of that reflects the clearing away of distressed inventory, but economists said the pendulum has swung toward a housing shortage.

An estimated 1 million new households were formed last year, but only 620,000 new housing units were built, according to the Urban Institute. An analysis of census data by the Urban Institute showed that all of the net new households formed between 2006 and 2014 were renters rather than owners.

In 2006 home builders produced 40% more single-family homes than the 30-year long-run average. Last year, by contrast, single-family home construction was still 30% below that mark, according to Census Bureau data.

“We went so many years without building there are in many places in the country a shortage of housing,” said Richard Green, the Lusk Chair in Real Estate at the University of Southern California. “I think that overshadows everything else in terms of normalcy.”

In the early years of the recovery only top earners could afford to buy homes, as new buyers struggled with joblessness or tarnished credit histories, so builders focused almost exclusively on the high-end.

“The entry-level buyer, up until recently, has not been that involved in buying houses,” said Dale Francescon, co-chief executive of Century Communities, a publicly traded builder that operates in four states. “That’s historically where a significant amount of the volume has come from.”

Even as first-time buyers have started returning to the market, many builders have been slow to respond. Building lower-priced homes means finding cheaper land, and that tends to be farther away from job centers on the suburban fringes.

Those areas were the hardest hit during the housing bust, and many investors have been hesitant to encourage builders to return. As a result, builders have tended to focus on ever-dwindling and increasingly expensive land in core areas, pushing up the prices.

Tom Farrell, director of business development for Landmark Capital Advisors, which counsels investors on real-estate projects, said risk appetite is low, particularly outside core markets.

“We’re often saying ’You all want to be in the same spot, and you’re tripping over each other,” he said. “It’s just difficult to get people out to those secondary markets.”

OUR OPINION

This gives more credence to seller financed notes, thus creating even more of an opportunity.

Large investors make the full exit: Big rental investors like Blackstone are now selling properties to current renters.

August 3, 2016 By Dave Franecki

Article from Dr Housing Bubble

Big Wall Street investors stopped buying real estate in large quantities back in late 2014. In many cases big investors had front row seats at banks and were able to buy in bulk and for incredibly low prices not offered to the public. This crowding out of course has caused two major things to unfold: inventory to dwindle and a push up in prices for regular families looking to buy. For the first time in history many things happened in the housing market including nationally falling prices but also a large interest from Wall Street in single family homes. Now with prices near previous peak levels many of these large investors are making the full exit by offering to sell the homes to current tenants, for of course a modest increase. Those bailouts that were geared to helping the public actually created a system that has slammed the homeownership rate lower and has now jacked home prices up once again. Large investors are now making their final play by cashing out.

Large investors cashing out

An interesting story from Bloomberg examines this new trend:

“(Bloomberg) Melissa Suniga and her mother had been renting a three-bedroom Phoenix house for less than a year when their landlord, Blackstone Group LP’s Invitation Homes, gave them the chance to buy it.

Suniga, a 40-year-old childcare worker, used her security deposit and $2,000 she’d saved from her income-tax refund, along with a county grant and a credit from Invitation Homes that together provided her with $10,600 more for her down payment and closing costs. She expects to complete her purchase of the $150,000 house this week.”

The Arizona market is blistering hot yet again. The home in the example above was purchased for $83,000 in 2013 and now is being offered for sale at $150,000. All of this of course depends on the economy not having any minor hiccups ahead:

“Now, Suniga is buying the renovated place for $150,000 with a loan from the Blackstone-owned Finance of America Mortgage LLC. A bankruptcy from more than a decade ago, along with a past sale of a home for less than what was owed on it, had raised flags with other lenders Suniga talked to, even though she’s brought her credit score up to 660, she said.”

Milking it from every angle. This is why over the last decade the U.S. has become a renter nation. If another hit comes about, we can expect investors to line up to pickup these foreclosures and repeat the cycle. Prices and rents have surged well beyond income levels:

There is still maximum leverage in the market. Even in the above example, you have someone that has a tough time getting standard financing and had a bankruptcy in the past. And is now buying a property that has jumped in price by 80 percent since 2013. Has the family’s income gone up by 80 percent? One argument for places like Nevada and Arizona in the past was that with prices being lower, there was just no way that foreclosures would happen in mass. The exact opposite happened with these states being the hardest hit because incomes tend to be lower as well. Incomes absolutely matter when you leverage yourself to the hilt. The homeownership rate is now going to be pushed up slightly with people being squeezed into inflated properties from an artificial market.

Real estate has been surging in Phoenix:

With this trend it is no surprise that big investors are unloading properties. It is a simple mantra: buy low and sell high. However someone else is buying at this level and it certainly isn’t Wall Street. Why would big investors sell if it is such a great deal to be a landlord in mass? Wouldn’t they just keep buying more rentals or going for more flips? Or do they realize prices are inflated and they don’t want to push their luck? In the end, people are stretching their budgets once again on rents and home prices. And you wonder why people are so angry in a year where the stock market is at a record level and home prices are back near peak levels in many places (higher in San Francisco). Blackstone stock is up 57 percent since 2011 and this will add a nice boost to their revenue.

Large investors make the full exit: Big rental investors like Blackstone are now selling properties to current renters.

Dodd-Frank and Reality

January 15, 2014 By Dave Franecki

The following is an excerpt from The Paper Source

SETTING THE STAGE
The following applies to transactions on or after January 1, 2014.

None of it applies to any seller-carryback transactions where the buyer will not use the property as their personal residence.

Wall Street Reform and Consumer Protection Act

When Dodd-Frank (“The Dodd–Frank Wall Street Reform and Consumer Protection Act”) was enacted into law on July 21, 2010, it said that you could only do three seller carryback transactions a year, and those transactions had to meet certain requirements:

The note could not have a balloon.
It had to have a fixed interest rate for five years, then it could adjust.
You had to prove and document the buyer’s “ability to repay” in accordance with the Qualified Mortgage Rule (QM), which is quite restrictive. That’s the same rule that banks have to use if they want a safe harbor and not get sued for making a loan that didn’t fit the QM.

The Consumer Financial Protection Bureau (CFPB), which was writing the regulations to implement Dodd-Frank, asked for public comments. I told Bill Mencarow about this, and he immediately (and repeatedly) alerted PAPER SOURCE JOURNAL subscribers and everyone else he could think of, urging them to submit their comments.

I also alerted members of Congress and got the National Association of Realtors on board and helped them write their comments to the CFPB.

Because so many people wrote comments to the CFPB —- and THE PAPER SOURCE took the lead — the bureau relaxed the seller financing restrictions. They came out with something that was a lot more relaxed than the Dodd-Frank law was originally.

The CFPB subsequently issued the following regulations. They apply to seller carryback notes created on or after January 1, 2014.

THE ONE PER YEAR CATEGORY
The CFPB broke seller financing into two different categories. One category is for those individuals, trusts or estates who do just one seller carryback transaction a year on a property that has a dwelling that the buyer will use as their primary residence.

Let me repeat that, because there has been so much misinformation circulated about it: this category is for those individuals, trusts or estates who do just one seller carryback transaction a year on a property that has a dwelling that the buyer will use as their primary residence.

For them:

You can have a balloon in your note with the buyer.
You do not have to prove or document their ability to repay.
The note must have a fixed interest rate for five years, and at the end of five years the interest rate can increase no more than two points per year with a cap of six points above whatever you started at. You have to tie it to an index like a T-bill or the prime rate in the beginning.

That’s probably going to affect all but three to five percent of individuals who carry back notes.

Remember that these restrictions only apply to seller-carryback transactions on properties that have a dwelling that the buyer will use as their primary residence. A transaction on a lot or vacant land is exempt, even if the buyers plan to build a primary residence.

If the property has a dwelling, but the buyer is not going to use it as their primary residence — say they’re going to rent it or use it as a second home — then none of this applies, and you can offer seller financing with no restrictions.

Commercial property and multifamily that is five units or larger is also exempt from the restrictions.

Again, the one seller carryback transaction per year category applies to individuals, trusts and estates. It does NOT apply to corporations, LLCs, partnerships or other legal entities. In that case the second category applies (below).

Again, these rules only apply to what the CFPB refers to as a residential mortgage loan where the note is secured by a dwelling or residential real property that includes a dwelling.

Most people only carry back a note once in their lifetime, when they sell the big house, retire and move somewhere else. Some might do it a few more times. Even many real estate investors only do it once a year. These regulations are not a huge change for most people.

THE MORE THAN ONE PER YEAR CATEGORY
The second category applies to individuals, trusts and estates that do more than one seller carryback transaction per year when the buyers will use the dwelling as their primary residence.

It also applies to any seller-carryback transaction — even one — where the seller is a corporation, LLC, partnership or other legal entity and when the buyers will use the dwelling as their primary residence.

The note cannot have a balloon.
The note must have a fixed interest rate for five years, and at the end of five years the interest rate can increase no more than two points per year after the fifth year with a cap of six points above whatever you started at. You have to tie it to an index like a T-bill or the prime rate in the beginning. This is the same restriction as the first category.
You must determine the buyer’s ability to repay.
If you do no more than three seller-financed transactions per year you do not have to become a Mortgage Loan Originator (MLO).
* If you do more than three you must become an MLO — or find an MLO who is willing to be the go-between.

Just as in the “one per year” category, these restrictions only apply to seller-carryback transactions on properties that have a dwelling that the buyer will use as their primary residence.

If you have a rental house and the renters want to buy the house to use as their primary residence, and you want to carry back a note with a balloon (and you don’t do more than one seller carryback transaction per year), and that rental property is in a corporation, LLC, partnership or other legal entity, you’re going to have to move the property into a trust or into your personal name. Otherwise, you’re going to fall into the second category which says you cannot have a balloon unless you are an individual, trust or estate.

If you think about it, not having a balloon but being able to do an adjustable rate almost serves the same purpose. Let’s say you start out with an interest rate of 6% on the note and then after five years it goes to 8%, then it goes to 10% and then it goes to 12%. That’s a huge incentive for the buyer to refinance out of the property and pay you off. If they don’t, then you’re rewarded for your risk in carrying that paper; you’re now getting 12% for holding that paper, and there is no balloon.

ABILITY TO REPAY
The second category requires you to determine the buyer’s ability to repay, but the rules and the regs don’t specify any standards for doing it (such as the qualified mortgage standard, a 43% debt to income ratio, etc.). You don’t have to do any of that; you can just ask them if they have a job, can you see a paystub, can you see their tax return (which they may or may not give to you). All you are required to do is to make some good-faith determination that they’re able to afford that payment, and you do not have to document it.

It would be prudent to have some documentation in case there’s a default and the buyer’s attorney says “where’s the documentation?” and tries to create a legal defense against paying you. But there is no requirement that you have to document. All it says is that you should determine the buyer’s ability to repay.

I asked an attorney at the CFPB about how one should determine the buyer’s ability to repay. He said that if you fall under category two you have to determine the ability to repay, but he admitted that there are no set guidelines. You just have to show that you used good faith in determining, for example, that the buyer has a job, his rent was $1,000 per month, but the payment on the note is $900 a month and you think in good faith he can afford this property because he could afford the rental house he was in before.

WHEN YOU’RE BUYING A NOTE CREATED ON OR AFTER JAN. 1, 2014
You’re going to be able to tell from the note if the mortgagee is a private individual or an entity. If it is a private individual, trust, or estate, then ask them to sign an affidavit saying that they have not done more than three of these in a 12-month period and how many of them had balloons. If it’s an entity, an LLC, or a corporation, etc., ask for an affidavit saying how many it has done and how many of them had balloons.

If there is a balloon in that note that you’re buying from an LLC, corporation or partnership, etc., you know there’s not supposed to be one (again, if that note was created on or after January 1, 2014). You’ll have to have the note modified to remove the balloon before you buy it. Otherwise at some point the mortgagor could use the fact that the note was not in compliance when it was written as a defense against paying the debt or foreclosure.

In the Federal Register the CFPB wrote that they relaxed the rules on seller financing because of the numerous comments they received.

Ric Thom

For more information on notes go to performing or nonperforming.