Shared Appreciation Financing

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Topics: Financing

There’s a major difference between sharing EQUITY with another person and sharing APPRECIATION via financing.  The LENDER stands outside all the problems and liabilities of fee title ownership with clear rights to the first profits OFF THE TOP.  The OWNER of a fractional property interest, on the other hand, can become embroiled in all the management, maintenance and regulations and EPA liability associated with income property.

Claude wanted to sell a house to Lana but she couldn’t qualify for the $100,000 loan required to buy the house.  So Claude agreed to sell for the $75,000 loan amount for which she had been approved, and he agreed to carry the balance of $25,000 in a Shared Appreciation Loan.

He wrapped the institutional first mortgage with a 2nd mortgage with identical interest and payments.  This caused his wrap loan to AMORTIZE IN REVERSE, since payments were insufficient to cover interest on the whole $100,000 after taxes, insurance and principal.  The loan also contained language which shared all appreciation in price over $100,000 on a 50150 basis once the $100,000 plus accrued interest had been paid to Claude.

BENEFITS: Claude gets a cash out sale that pays off his old loan, relieving him from loan liability; plus he has a growing equity.  Lana gets her own home, plus homeowner tax benefits, all with lower payments, plus a share of the equity.

FINANCING FIXER-UPPERS

Let’s walk entirely through the alternatives as a single house is singled out for acquisition, fix-up, and sale.  Ron fixes up houses.  He has found a 70 year old vacant house in a neat, older, safe neighborhood that is occupied primarily by retirees.  The house is in an estate, and the 5 heirs don’t want to rent it out, or to carry any ‘paper’.  They just want to take the money and run.  So Ron has to come up with the cash to buy the house.  He needs $35,000 to buy it, and another $25,000 to bring it up to code.  It should sell for $100,000 when completed.  John has money in a pension plan that he wants to keep busy.  Here are some opportunities for you as the financier.

1.    Ron offers the estate $35,000 in the first mortgage at 12% signed jointly by himself and his wife.  John’s IRA commits to buy the mortgage for $30,000 in cash from the estate the day after the closing.  That amounts to only $1000 less per heir and they’ll have the balance of their inheritance just as soon as the title work has been completed.  Ron now has his house, and he has 30 days before his first payment falls due to start getting the house fixed up for resale.  Even though the house will sell shortly, John’s IRA will make a tidy profit with little risk.

John offers Ron a private line of credit with which to acquire houses at 16% per annum with 3 points.  This line of credit is secured by Ron’s own personal residence, and the note is signed by Mr. and Mrs.  Ron with full personal liability.  Ron must use his own money to fix the property up.  But, when it is sold, he can continue to roll the money over into an assortment of houses without having to waste time chasing new money.  For an additional 2%, John offers to accept a single lump-sum payment at the end of one year rather than monthly payments.

Ron gets the sellers to carry back a six month balloon note secured by a first mortgage.  This loan is to be paid off out of the sale proceeds when he sells the house.  John lends Ron the $25,000 in a series of draws pegged to Ron’s fix-up progress.  His loan is secured as above by Ron’s own home and by a wraparound mortgage on the property under repair.  Ron uses the loan proceeds to rehabilitate the house.  When it finally sells, John is paid $5,000.  He agrees to repeat the process so long as Ron has only two houses in the ‘pipeline’ at any one time.

John offers Ron a tandem loan arrangement.  He funds the acquisition of the house as in #1 above, and then he agrees to provide ‘take out’ financing for a qualified buyer who passes the usual job and family stability, and credit screening process.  Here’s how that might work.  Ron sells the house at high retail using seller ‘carry-back’ financing, 2 points above comparable FHA rates, on a loan amortized over 30 years, but due and payable in 5.  Then he resells the note and mortgage to John at 75% of value.  In the above example, out of the total $100,000 price, John will receive $5,000 profit for his initial loan, and $25,000 equity in the mortgage for an out-of-pocket investment of $75,000.

John does all of the above, but he agrees to 30 year terms and/or a lower interest rates if he can share 50150 in any increase in the gross sale price of the house at the time it is sold.

John can do any of the above, but retain a first right of refusal option to buy the house at a price 25% below any price offered by a bonafide buyer so long as the occupant owns the property.  The price John will pay will be the difference between the offered price and the original loan amount.

In the above example, you’ll note that John participated to a large degree in Ron’s profits because he was flexible in his lending policies.  That is something that institutional lender’s rarely are today, because they package their loans and sell them as a more or less standard product into the secondary mortgage loan market.

When John not only provided the initial funding, but also provided a secondary market for Ron’s seller carry-back ‘paper’, he made Ron’s position much more liquid.  By being able to flip houses quickly without the interminable delays of FHA and VA loan processing, and their high closing costs, Ron can easily rationalize giving away 25% of his profits.  By the way, this isn’t idle musing.  For the past few years, I’ve been the ‘John’ who has been providing the financing under the above variety of schemes.

Another thing to note is that no long term financing was offered that wasn’t compensated for with a quicker loan payoff and/or higher interest rates.  This was to protect John from any quick spike in interest rates.  Amore direct route to protect the lender from being savaged by inflation is to index loans.

Learn more with Jack Miller’s Creative Financing Solutions book

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