In selling commercial property part 4, we discuss what’s possible, and finish up with a sell financing a property sold with a dangerously low down payment. Included is a short discussion on why different investors will pay more or less taxes than others on this exact scenario.

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Transcript:   We’re getting to the fourth installment now of one of my clients selling a commercial building in New York for $1.25 million with a silly low downpayment of only $100,000, and we’ve been discussing the structure of that note. Today, let’s talk about how that note payment might be received by the seller in terms of what his liability could be to the IRS. Here’s what happens. Every dollar you receive, especially on an amortized note, has three sections to it, and there’s a formula to decide how two of those three sections add up. The first one is interest. That’s easy. Interest received is taxed at ordinary income rates for the vast majority of the time. If you receive $10,000 in interest for a year, it will be a lot more in this case, but if you did, that’s like getting a raise of $10,000 at work. Same tax, right? Now, what about the principle inside of each payment that’s amortized? We know that every payment you receive has a little bit more principal than the payments received the month before, and that’s how you pay those things off. That part of the dollar that is not interest, that is to pay down the principal balance of that loan, was divided into two parts, one is return of capital and the other is return on your capital. There is no tax liability whatsoever on return of capital. That just means you got your original downpayment or whatever or however you bought it back. If you put $200,000 down, there’s a formula and you come up with it and you get it back. That’s not taxed. The other half of that principal paydown you got in each payment is return on capital, and as long as you qualify for long-term capital gains treatment, and in this case they do, it’s taxed at 15% instead of ordinary income. We like that because you’re just paying each year on the value received, and since it’s spread out over 10 years, not only are you only paying give or take 1/10 every year, although that’s not really true, but roughly speaking, we’ll work with that. There’s no balloon payment. There’s no gigantic tax liability in any 1 year, and that can be really good planning over time because you have to plan for those liabilities. What many people don’t know, and this is a red flag, you always need to address with your attorney and/or your CPA. Many times, you can incur tax liabilities due to the way your sale was structured when you really didn’t receive all that much cash from the sale, or you receive no cash from the sale. You can still owe up to 5 or 6 figures in taxes, and people wonder about how that can happen. It’s just about your basis. The basis doesn’t have to do with, “Well I paid this much and I sold it for this much.” It’s more complicated than that, and the formulas for computing adjusted basis, especially when somebody has maybe handled more than one tax deferred exchange for that equity over time, and there’s domino after domino of deferred capital gain, that’s where you can get into a problem, where maybe you didn’t sell the property for that big of a gain, but because your adjusted basis was about $0.37 over a happy meal, you still had the tax liability. That’s something you want to really red flag and make sure that it’s not laying there to trap you.

In Selling Commercial Property Part 3 we continue to explore the options available for this particular owner financed property.

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Transcript:   We last left the seller of our New York City commercial building for a million and a quarter, wondering if maybe there’s another way to structure the carry back loan that he’s going to do with the buyer. One of the ways that he can do it, instead of structuring it for a ten year amortization, no balloon, is to maybe charge more interest. Instead of four percent, maybe charge six percent but amortize it for 30 years. This will save the buyer some money on a monthly basis but it will also mean that in roughly ten years, they will have over 900,000 dollar balloon payment. As a seller, and that’s who I would represent here, we’ve got to look at what are the downsides to this approach. Right away, I don’t care if you’re selling the property for market now and it’s a decade down the road, the bottom line is you’re going to be owed 930, 940 thousand dollars in ten years. What will the market have done? In ten years, that value could have doubled, could have gone down 30 percent. We don’t know that. There’s nothing like being owed almost a million dollars and the property not be worth almost a million dollars. That’s where the buyer, if they wanted to, could just walk away. Now, that’s an unlikely scenario, but it is not rare, so don’t push it off and say, “Well, it’s not going to happen.” You definitely have to think of that. The way you look at it is this. Let’s explore a couple of different approaches. If they know they’re going to get 900 and some thousand dollars, ten years down the road and they realize that in ten years all three of these partners selling it will be retired, they may be in a better position tax-wise. Now, they may not but it might be something that they can consider restructuring as it gets closer. Usually when you restructure so as not to incur a tax liability as a note holder, usually the note payer doesn’t object, because that’s 900 and some thousand they may not have to come up with. Let’s talk about how the seller’s going to be treated tax-wise. Let’s save that for next time.

In selling commercial property part 2, we continue the discussion of the ins and outs of how sellers might better protect themselves when providing seller financing to buyers, especially when the down payment is far too low.

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Transcript:   Where we last left our intrepid seller of a commercial property, negotiating the carryback he was going to secure by his old property. Now the guy was only going to put a hundred thousand dollars down. There’s no way to make that secure by changing the wording in how we describe it. A hundred thousand dollars down on a million and a quarter property is not safe. What you have to do is what I suggested to this guy. You need to check with your real estate attorney and the state you’re considering doing this but you can have what’s known as a land contract. We don’t need to talk about that here except for one factor. The main difference when you do this is that when the sale closes the buyer is not granted what we call fee title, fee simple. It’s not like you buy my car, you give me the money we agreed upon, I give you the pink. You don’t get the pink in this transaction. What the note says inside the land contract, or contract of sale, they call it different things in different states, is you get equitable title so your equity is safe. You start out with a hundred thousand down, that’s your equity. What it does say is if you do these three things, when you can verify those three things have been accomplished then the seller will grant you actual title. In this case I’m recommending that the seller not grant a real title until the loan is paid in full and that will be in ten years. That makes up for only getting the hundred thousand dollars down. If done right, not all the time because it depends on the laws or whatever state, if the loan goes bad, and let’s face it a hundred thousand dollars on a million and a quarter that the odds of that have increased. If the loan goes bad, they can then sometimes even avoid foreclosure, they just take the property over using the land contract and whatever is required legally in that state. They may not even have to go through the foreclosure process formally, okay? The other thing that happens is this: the buyer may say why on earth would I go through these hoops? Let me give you the best reason. They were going to be paying the payments on the underlying five hundred thousand that is on there by the seller’s father. Even though that interest rate is only 3 1/2, the payments are quite a lot because it was amortized for twelve years. If they do it my way, the sellers of the property can sell it this way. If you do it my way where you’re paying 4% amortized for ten years on the million one fifty, it’ll be about six hundred and fifty to sixty dollars a month cheaper than if I just carried a hundred and fifty thousand second and you assume the first. Once they look at that what that really means is they’re saving just short of seventy-nine hundred dollars a year in cash flow by doing it that way. Why wouldn’t you do it that way? They’re already a tenant in the building. In this case they’re taking the most square footage of any tenant, which means they’re not going to benefit from the rent they would have paid so this transaction is actually going to increase their cost of doing business no matter what it is. By cutting it by six-fifty or more per month, we’re actually helping them quite a bit, which I think will be very attractive to them. Next time we’re going to discuss what if they structured it differently and maybe a little bit more traditionally.

In Part 1 of a brief 4 part series, we discuss a case history of how, when selling commercial property, a seller can impressively increase their return when providing seller financing for the purchase.

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Transcript:   Today we’re going to talk about a question I answered for a client about how to structure a sale of a commercial property they’ve owned in a small partnership for years. He bought it from his dad who carried back about a half a million dollars at the family rate of three and a half percent. Now, the payments are amortized over an original twelve years so that payments are relatively high. They’re going to take a very small down payment, only a hundred thousand dollars, which their real estate attorney said he doesn’t feel comfortable with. My comment was he doesn’t feel comfortable because he has a three digit IQ on a price of a million and a quarter. That’s okay, sell it to the tenants, take the hundred thousand dollars down. His question addressed what to do with the note that they’re going to carry back for the difference. What I told him immediately was you don’t want to carry a traditional second position note secured by the building. You want to do what’s known in the business loosely as a wrap around note. In principle it means exactly that. It means instead of them carrying back a note on the difference between a million and a quarter, minus a hundred thousand dollars down, minus the five hundred they owe their dad, instead of having the note be that amount the note would be just the difference between a hundred thousand dollars down and the remainder of the whole price, including dad’s five hundred. What they would do, they would construct a note using a real estate attorney and that note would be for a million one hundred fifty thousand dollars. It would include, inside that note, the five hundred thousand dollar first position note that is secured by their dad on the property. Now, the way we do that is this. You structure the note as if the seller is lending the entire million one-fifty. The payments are structured on that. In this case it’ll be four percent interest amortized over ten years, no balloon payment whatsoever. We’ll talk about that later. What will happen is this, they will get payments that will come directly to them. The buyer will not be responsible, in any way, for making the payments on the dad’s five hundred thousand existing note. The sellers, my client, will take the money from the first payment and take enough money out of that each month to pay the five hundred thousand dollar payment. Now, that note, that five hundred thousand dollar note, has about eight and a half years to go. The note they’re carrying back on the property would have ten years to go by definition. What’s going to happen is by doing it this way, wrapping around, and we’ll get deeper into that later, the seller’s, my client, will be able to get the equity gain themselves on that five hundred thousand. What are they doing? They’re paying three and a half percent on five hundred thousand. They’re being paid four percent on a million one-fifty. Now, normally that loan would’ve only been six hundred fifty thousand and then the buyer’s, the tenants that are buying it, would’ve just paid two loan payments, one of them six-fifty that the seller’s are carrying back and the existing five hundred thousand note that the seller’s owe their dad. By doing it this way they’re making a spread of a half percent on that amount of money, and simultaneously they’re getting four percent on a million one-fifty instead of four percent on six hundred and fifty thousand dollars. We’ll continue this next time.

Do you know a Boomer nearing retirement? Are they fearful of what that new chapter in their life might be like? For Heaven’s sake, use the buddy system and show ’em where the rest of their options are hiding. Too many Boomers are serving a life sentence, not enjoying the retirement for which they worked so hard.

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Transcript:   Today let’s talk about the buddy system. Let me start out with some interesting numbers. Since January of 2010, and it will go through the whole year of 2030, 10,000 Boomers, of which I am a proud club card holder, will retire, or at least reach 65 every day. Ten thousand. Everyday. From January 1, 2010 to New Year’s Eve 2030. Show of hands, how many of you think of those people are going to retire well? If you go back through all the insurance industry number, and they have the most reliable numbers, it’s worse then the 80/20 rule. Five percent retire exceptionally well. Another 5% live, and retire what we would call comfortable. Another 10% behind them don’t have financial worries, but they’re not members of the cruise of the month club, and the rest, they’re just making it, if that, or they’re relying on family, or they’re moving in with family. Who knows. One of the reasons that has happened more, and more … This is my professional low purpose personal opinion, is that they’ve relied so heavily on the 401K program at work. I want to take an example. I talk to these people 1,2, or 3 of them every week for the last few decades, and it goes something like this. “You know, my buddy next door, we’re best friends. We watched each other, the family grow, we’ve helped each other add family rooms. We’ve done a lot of things, and I’m looking at him, and he says, ‘You know what? I have $300,000 in my 401K. I’m retiring next month, and I’m so scared I don’t know which way to go.'” When he retires, and he’s got $300,000 what’s he going to do with it? The people at work in anticipation of his retirement had a meeting with him, and said, “Because he should be,” and I agree, “Risk averse,” he’s only going to make 4%. Maybe a little less, maybe a little bit more on his $300,000. Well, let’s say he makes 5%. That’s $15,000. He’s getting more than that in Social Security, and it’s taxable. If he’s getting say $25,000 year in Social Security, $15,000 from his $300,000, that’s $40,000. He lives in a state that has an income tax. Eighty percent of the states have it. He’s getting taxed on the federal part, you know, that’s not much of a retirement. I understand he may, or may not have paid off his house because if good old Charlie next door hasn’t paid off his house, and he’s doing $40,000 before taxes, he’s got a real problem. He’s not going to be his buddy’s next door neighbor for long. What can he do? What he needs to do is find out all the pages on his options menu for which he’s been unaware. He doesn’t know that he can buy discounted notes. For all he knows that’s too risky. They don’t know, and we’re all fearful about those things of which we’re ignorant. My purpose today is to let you know that just because you only have a 50, or 100, or 200, even $500,000, you’re retirement is not going to be that cool. $500,000, and the insurance charts say that you’re going to live 20 years. Well, what are you going to do? If you’re like my Grandpa, you go out every year on the 1st of January, and you look underneath the tomato plant where you keep all your cash, and you pull out 1/20th of that $500,000. You don’t want to be too healthy when you’ve got 2 years to go. How sad is that?

It’s an innocuous sounding question, isn’t? “What are your retirement income expectations?” Yet, it may be THE most important question you ever ponder when speaking about retirement income. The reason? Most folks frame their answers based upon false assumptions fed to them for decades.

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Transcript:   Everybody talks to me about their expectations for retirement income, whether it’s five years from now or 35 years from now. I talk to all ages. One of the things that I notice is that a lot of them repeat what they’ve heard from various financial advisors, whether it’s a 401k guy at work or maybe their neighbor who might be a financial planner of some sort. Those guys, they know what they’re doing. One of the things that has always bothered is when these advisors tell people about not to worry about income taxes and retirement because they’re going to be at a lower rate. If you’ve been investing since the 20s, 30s, or 40s age brackets and you’ll retire at 65, 66, and you’re going to go down in tax rates, what we’re you doing wrong? I’ve never understood that. Let’s get specific. If you have a family, whether it’s one or two working parents and they start out, and we all experienced this cycle, we’re learning whatever industry we’re in, we start getting better. Sometimes we switch industries. That happens more these days. We used to have one or two employers our whole life. Now, we’ve got people now in their 30s they’re already on their third employer because that’s just the new nature of the economy. Over time, they begin to make more and more money. They understand that their lifestyle doesn’t have to keep increasing with it, they save more and more and they begin to invest because they understand the dynamics of investing for retirement. How they invest for retirement really begins to show itself as being just extremely important. Are they going to do the stock market? Are they going to be in bonds? What are they going to do that’s going to give them enough money to retire on? If we have somebody who, by the time they’re 40 years old, is making somewhere between 75 and 150,000, clearly that’s more than the median 50,000 household income for the country. They’re not living up to their eyeballs, so they’re saving money, which is why they have money to invest. If they’re going to invest for 25 years from that point on, they’re 40, they’re going to retire at 65, they’re saving and they keep making a little bit more money every five or ten years, they can look back and say, “I’m making more money now,” and they’re saving more. They invest in real estate. They invest in notes. They maybe got themselves EIUL with a David Shafer here on my staff. What ends up happening in about 25 years is they’ve compounded all those investments and they haven’t relied on the stock market or some kind of fund, they’re not subjecting themselves to these huge cyclical and sometimes pretty stealthy drops. Now, I understand. Real estate has it’s on bubbles, this that and the other, but in real estate and especially notes, and I’ll address that, but in real estate, even when property goes down in value, you have to understand, there’s a false assumption that that’s deadly. You’re not getting to retirement with the biggest of net worth that you can create because you’re going to be spending your net worth in retirement. You’re not going to spend your net worth. You’re going to spend the yield on that net worth. If you have a property that might have been worth half a million dollars when you’re retired,

When I’m talking with folks thinking of becoming clients, and mention my team, I make sure getting to know my team happens sooner, rather than later. They’re as close to bullet proof as I’ve seen.

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Transcript:   I think it’s about time we talk about the team—and the teams actually—that are behind what makes my firm run so smoothly. First of all, let’s start at the top. I have a couple, Matthew and Karen, who not virtually, almost literally, run my firm. They are in charge of IT. They’re in charge of making sure everything works, not only on the website, but they’re coordinating everything to do with how we deal with clients, that everything’s going smoothly. If there’s a problem in communication in email, we have our own server thanks to them, so we’re not reliant on some other server. It’s all because of them. When the events that we do come off without a hitch, that’s Matthew and Karen. Without them, I am face down in the water. That’s the only way I can say it. We brought them on a few years ago, and my life ever since has been so smooth, I can’t begin to tell you. What they have allowed me to do is what I do best. From the time I get up in the morning and have my first conference call until I’m done at the end of the day, all I do is talk to people about things that only I can do in the company. Because of Matthew and Karen, I get to do that. I figure they’ve allowed me an extra 10 to 15 hours a week, if not more, to do exactly what I do best. And the benefit, of course, falls down to my clients. That’s the best thing I can say about those guys. As far as in Texas, I have teams in three major markets, soon to be four; so in the Dallas/Fort Worth area and San Antonio/New Braunfels and Austin. Each area has a different local professional management firm that takes care of our clients. Now, they don’t just take care of our clients. Because we have the benefit and luxury on our side of volume, they service our clients just as well as any other client off the street, but generally speaking, for a 20 to 35% discount. When my clients call and invoke the BawldGuy name, all of a sudden, things start to move a little more quickly, if necessary. They do everything they do for everybody else not only for less money, but they want to make sure that at the end of the day, my clients, my staff and me are left smiling. We have the same title and escrow company for everything we do in Texas. I often call my teams in Texas the 27 Yankees, but I’ve had to fire my way into that status. We didn’t start out with this title and escrow firm, but now we use them for everything all over the state. And the next problem that they have caused in an escrow or a title will be the first. When I go there, lunch is always on me. I love them. They are the most efficient, professional, and solution-oriented group of people I’ve worked with in the business since I’ve left San Diego 11 years ago. I have a lender. I went through half a dozen lenders in Texas before I found Chad Emerson. Chad Emerson sets the bar. I had a guy in San Diego I worked with for just short of 20 years, and Chad Emerson is the 40-something version of that guy. All he does is investment loans. Now, lenders will always tell you, “Oh, yeah, I have investors that buy one to four-unit properties all the time.” Well, let me tell you, they’re fibbing. If you really look at their closings in any 12-month period, I can almost guarantee you, giving you 5-to-1 payoff odds that 80% to 95% of their closings are for owner occupied buyers. Chad, on the other hand, this year, will not close ten owner occupied loans, and he does literally hundreds of loans. This guy is absolutely the gold standard.

Here’s an arbitrage case study. Though most think the principle of arbitrage is too sophisticated for them, it’s actually a fairly simple concept to execute. Take a look and make up your own mind.

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Transcript:   John and Mary had decided to use some arbitrage for the first time and they refinanced their home and they borrowed $50,000, and they were making $8,000 a year in payments. Now after tax, because you will be taxed on the interest that you receive if it’s not inside an IRA or 401k. Let’s say that they net $6,000. They do okay at work but they’re not huge wage earners. They have $500 a month after tax. They can take that $500, and since they don’t live up to their eyeballs with their lifestyle, they can add their own $500 to that and they can pay that loan off in just over 6 years, 6 1/2 maybe, 77 months. Think about that. In 6 1/2 years, they’ve attempted the time when that note might pay off, just going by the averages, which is give or take, 6 to 9 or 10 years. Look it, it’s random. Just because the average says 6 to 10 years, it could go 2 years. It could go 22 years. There’s no way to know. You have no control. Let’s just say that sometime in that normal 6 to 10 year range, that note pays off. They have cleared their condo. Look at all the options they’ve opened up all because they used a little bit of arbitrage where they borrowed money at way under 5%. They made 10% to 15% with that money. They paid a little tax on it each month. When it got paid off, they didn’t have to pay ordinary income taxes because it’s considered a long term investment so they got treated capital gains, only 15%. When you do that, what that allows you to do is simply add a page of options to your menu when it gets paid off or you get another page on your menu added when maybe the note hasn’t paid off, but because you’ve applied a little bit extra money from your own account to your loan and you’ve added that aftertax monthly payment from the note in addition to that, you’re paying off your home loan way more quickly. That means you can keep it that way, you can sell it, make a lot more money on your net proceeds check. You could borrow a lot more, maybe 2 or 3 times more than the first time. There’s all kinds of options, and the key to take away from this is anything we do, the number 1 goal at first is to create more options for the investor because the investor with the most options wins.

What’s the value of high and low interest rates? The answer is not much when you factor in the points paid to enjoy a lower rate. The lesson here is to do the analysis all the way to the end.

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Transcript:   I have gotten more free drinks and dinners based on the value of interest rates in almost any bet I’ve made. I got into this conversation one time with my favorite Texas lender and we were talking about the difference of and the decision made because of the difference in interest rate options when purchasing an investment property. My people are mostly purchasing one, one to four unit residential income properties. Do they pay 4.75 and point plus whatever or do they pay a quarter point or no points but pay a higher interest rate save five. They don’t know what to do because they hate the fact that they could get four and three quarters which is under five, which is pretty sexy these days. On the other hand that extra point on the property they bought is two or three grand. What to do? Let me make it easy for you. I’m going to tell you why in second but the short answer is take the higher interest rate, keep the two or three grand in your Levi’s. It’s just not worth it, here’s why. Take John and Steve, they buy a couple of duplexes for $290,000 apiece. Floor plan is the same, they’re next door to each other, they we both finished the same day. There’s nothing different about these, they’re clones. They put the exact amount down 25% that means they got the same amount of loan. One of them gets a 4.6% loan, that’s John. Steve got a 5% loan. They’re both going to add a thousand dollars a month to their required loan payment because part of their plan is for them to end up with this property free and clear. Not that they would retire owning at that way but once you get a property for in clear if that’s the best thing to do, sometimes it’s not, usually it’s okay to do that. Now you have more options because you have a free and clear property, right? The investor with the most options almost wins every time. Here is what happens. Let’s take a look at what happens over x amount of time with both of them adding a thousand dollar to the payment but John has four tenths of a point less in interest, then Steve What happens is whether it’s four years, five years, seven years, however many year you want to do almost always usually it’s four to 10. I can do this all day and you can buy me my 18 year old MaCallan all day. Here’s the deal. The difference in amount owed is one month or no months in time passing. It doesn’t seem on the surface that it should be that way but I’m telling you it is. Yet even though John got there the same speed as Steve did, Steve has two or 3,000 in his pocket, John doesn’t have. John’s never getting that money back because as you can see it didn’t make any difference, it just didn’t. The case is where it does make a difference over the long haul for the lines to cross on the chart and it usually has to be so long that it just doesn’t matter. Then you get into the future value of money and then you … And you work your way back and you go, “That really was a whole lot of math for not much return.” Just remember if you forget everything I said today take the higher interest rate, don’t pay the extra fees.

We’ve discerned a significant demand for a relatively hands off method of joining group investments in discounted notes. We’ve decided to supply that demand.

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Transcript:   This is another group investment for you to consider. This is more traditional. What we’re going to do is we’re going to create a sub note fund. This will be for those people who want to buy notes, are not accredited investors. For those of you who have not heard that phrase before, an accredited investor, which is a Securities and Exchange Commission phrase, it’s a legal phrase more or less, it just simply means if you’re single, and you make $200,000 or you’re married and your household income was $300,000, you’re accredited. Maybe you don’t qualify that way. Maybe you have a net worth of $1 million or more, not counting the home you live in. That makes you accredited also. You have two ways to qualify, but these groups are going to be for those, for the most part, who are not accredited, but they have capital in which they would like to invest in notes. One of the things we’re going to do is we’re going to take a bunch of money, and let’s say there’s $1 million in the group. There’s going to be a preferred return. It’s going to be just like the note fund, just like accredited investors get, it will be 8%. That means you put your money and say you put $100,000 in. Every year, you’ll get $8,000. Of that $1 million that was collectively put into the group, we’ll buy somewhere between roughly $1.4 million to $2 million in notes. These will be re-performing notes and they will be exclusively first position re-performing notes. What will happen is those notes will make roughly in the range of 10% to 15% cash on cash, so let’s just use 12%. That $1 million will generate $120,000 a year. You get 8%. That’s your return. Over and above 10%, BawldGuy Inc. will retain that for their share. Everything between the 8% and the 10%, the investors get. In this example, it’s making 12% a year. The $1 million will generate $100,000 a year, 10% cash on cash, to the group, per their ratio of investment. When it paid off, and let’s say we bought $1.5 million, now they’re going to pay off all over the place time-wise. Let’s just say they all paid off at once, which believe me is never going to happen, but if it did, there would be roughly $500,000, it would be less than that because of some principal payback, but for the math, let’s say $500,000. At $500,000, the group would get $250,000, my firm would get $250,000, and that means that let’s say it took 5 years. In 5 years, the $1 million would have generated $500,000 payments and $250,000 in pretax profits. If you look at it that way, in 5 years, they’ve put in a million and they pulled out one and three quarters million. That works for most people, and the reason I say it’s probably going to be for people who are not accredited investors is that they’re not allowed by the FCC regulations to invest in the BawldGuy note file, which essentially will have the same setup except for in return for me running everything, I’ll be taking some of the cash flow and my firm will be taking some of the profits. In the meantime, what you need to look at is what would you be comparing this return to, and what would you be comparing this risk to? Right now, CDs are, if they’re overpaying, they’re doing 1%. Most of the people I know are getting 0.8%. Let’s say you’re making 1%. Well the preferred return on this is 8 times that. You win there. Then you have a built in profit. There’s going to be foreclosures here and there, and that’s where you have the convenience factor.