March 10, 2008
Sometimes Your First Loss is Your Best Loss
Congratulations. You sold your property. You're better off than a whole lot of people right now. Now you are struggling with selling your real estate note at a discount. The first step is to realize you're not necessarily selling at a loss.
We're in the discounted note business. In fact, the secondary market for ALL real estate notes is discounted. Gone are the days of premium pricing, and we won't likely see them again for years, if ever. Many noteholders see accepting a discounted price for their note as taking a loss on the sale of their property. I'd like to try and put this misconception into perspective in the following paragraphs.
First of all, the fact you are holding a note means you sold your property. You're better off than my neighbor, who has been making double mortgage payments as his house sits empty up the street. The house has been on the market for 16 months and the price has been reduced over $50,000 in that time. In addition to the reduction in asking price, he just recently re-carpeted the entire house, and put new paint in every room. Regardless, buyer interest has been limited.
Since you were willing to finance the sale of your property, you likely got close to your original asking price. Buyers will typcially pay a little more if they don't have to worry about seeking out their own financing. If you have to discount your note somewhat in order to sell it, aren't you still better off than my neighbor? Between his payments, taxes, insurance, updated flooring and paint, and his reduction in asking price, his cost to carry this property since he listed it is over $85,000. And he still hasn't gotten a penny to offset all those costs. Even if he ends up selling it for his current asking price, he will theoretically have accepted a huge discount from what he expected the market to pay when he first listed it. What's important in this example is that his asking price right now is still $100,000 more than he paid for the house. Just because he can't get as much for the property today than he could have two years ago doesn't mean he's taking a loss on the sale. That's the double-edged sword of "market pricing."
Something else to consider when mulling over a discounted offer for your note: What are real estate prices doing in your area? Many economists expect property values to continue falling for at least two more years. How much will your note be worth in two years if the property you sold sees a 25% drop in value over that time? Depending upon how much your buyer owes you in relation to the value of the property, your note might not even be marketable in the aforementioned scenario.
The number one question I get asked: Why do investors discount my note? There are thousands of different answers to that question, but this is the most common; investors don't know as much as you do about the property, the borrower, the payment history, the neighborhood, etc. We have to price the risk factor of the "unknown". Did you get a completed mortgage application from your buyer? Did you call their employer and verify how long they've worked there, how much money they make, if there were any threats to their future employment? Did you get copies of their last two years' W-2 statements? Did you get a full interior appraisal done on the property? Did you verify with all three credit repositories that your buyer is a safe credit risk? The answers to these questions, almost 100% of the time: Of course not. You wanted to make it as easy as possible to consummate the sale. At the time, you weren't really concerned about what a potential investor would want to know about all aspects of the sale.
Sure, I'll probably turn some people off with this blog. After all, I'm not saying what a lot of people want to hear. Then again, there is no sense giving notesellers a false sense of reality - that just adds a bunch of wasted time into the equation. Everyone knows that the nationwide real estate market is suffering. And most people expect it to get much worse before it gets better. If we all acknowledge the reality of the situation, we have a much better chance of putting a deal together.
If you are contemplating selling your note but don't really need the money right now, you may well be better off waiting for a few years. If you think you might need the money in the next year or two, you should probably sell now. I've seen offers drop 10-25% from where they were a year ago. The sellers get upset with me, but much to my chagrin, I don't control the markets. Believe me - if I did, we wouldn't be where we are today. If real estate prices continue to drop, which we've already said is almost guaranteed, the market price of your note will continue to drop. That's the harsh reality.
Getting back to the bright side: There is still good news. Talk to us about a partial option, where you sell a certain number of payments now and retain a future stream of payments. That allows for a "cash now, payments later" scenario that many times results in a much more minimal discount to you. Many times, in fact, the total dollars you receive over the life of the loan actually exceeds the current balance owed.
Real estate notes are commodities, just like a stocks, bonds, and pork bellies. Market prices go up and down. Once a noteseller can accept this reality, it's a lot easier to accept a discounted offer for their note. Market pricing is what it is - if we can't accept it, we're likely to get a mouthful of sand whilst our heads are buried.
Make it a great day.
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