Indianapolis Real Estate Note - Yield Calculations
I'm not the greatest at Math so if anyone can help me calculate the yield on this deal it would be greatly appreciated. To me it looks like a good deal. Clause in contract makes Tenant buyer responsible for maintenance, repairs, taxes, utilities, and insurance. You will see in the contract that they are paying $604.40 per month.
The seller sold the property to the tenant buyers on Land Contract. The details are below. He is willing to sell to me for $18,500. If I were to purchase this at $18,500 what would be my yield? Also, what is the formula I would use to calculate my yield so that I can learn something new! Also, does the community see this as a good deal? It is in a C neighborhood/ blue collar in Indianapolis.
Maybe a creative finance guru such as @Aaron Mazzrillo would be willing to lend his expert opinion?
Ben,
Quickly using my calculator it looks like a 25.5% assuming the balloon pays off in November 2016. I based this on a current balance of $24,781 with the July payment already made.
I don't know anything about your market, but I would by cautious about how the balloon payment will be made. Will a lender (conventional or private) in your area be willing to finance the balloon? If you are looking for passive income, validate to pay history and perform enough due diligence you are comfortable payments will continue.
I use an old school HP12C to calculate yields and cash flow. I understand the are apps that will do the same thing and are much easier to master.
Here is what I see:
Original Loan Amount: $29,000
Unpaid Principal Balance (As of June 1)**: $22,997.86
Balloon Due At Maturity: $9,676.17 (Off by -$1,857.22)
IRR***: 24.81%
**UPB - UPB assumes the period payments have been all made on time and applied properly.
***IRR: - Assumes all future payments, including balloon, are paid on time and applied properly.
The note rate is set at 6% as of October 2013. That would be around 2.0% higher than a conforming conventional borrower at around 4.0%. The note is priced moderately well, seemingly. Additional interest has been added to the prevailing market rate to offset the risk of default by the borrower. There is zero information about how the borrower was qualified for this agreement (loan), so we can not properly judge if the risk to interest idea is proper, above or below what it should be.
In general, the Seller collected around $6,002.14 in payments (principal and interest). So, total gross profit for Seller is $24,502.14 (includes OP $18.5k). The discount here is 19.55% (to UPB). Not out of line with what we would expect for Seller Financing, but I am guessing the security instrument here is probably not correctly completed. Is the CFD recorded and what type of deed will the OP get upon purchase? Other terms within the CFD will also need to be looked.
The OP does not mention what the underlying collateral FMV is either by report (BPO or Appraisal) or even a pencil search. That is important to understand. The agreement is in the state of Indiana and a contract for deed can not be used as a circumvention of the buyers equity, or the idea of foreclosure, if you will, unless the property becomes abandoned and in one other setting, more complex than needed here for now. Essentially, the point is, the Vendee (Borrower) is afforded a right to redeem which makes the process look more like a foreclosure (judicial at that). The idea of forfeiture would not apply, so the Vendor (Owner/OP) could not simply evict. Moral of the story, there is risk, more than what is likely being sold by the OP's Seller or understood by the OP on his own merit.
Is this a good deal? My gut says most likely not.
The balloon would require the Vendee (Borrower) to come up with a large sum of money. The loan balance will not be high enough to obtain a conventional mortgage. So there is a barrier to exit. The reasonable expectation would be the Vendor expects to stay in this loan until it is paid in full through monthly periodic payments. This means the contract will need to be remade, which will then cause it to be an extension of new credit, which could also cause it to come under fire of new regulations.
The OP sounds/seems like they are either being sold on the 'Yield', whether by the current Vendor or themselves. There does not seem to be a proper risk evaluation for the asset nor the costs of defending a breach of contract. So, considering that, the only one who wins is the current Vendor/Seller who gets to walk away.
Be curious to know why the Seller/Vendor is selling? Do they do this often?
There have been many Contract For Deed threads here on BP. Land Contracts and Contract for Deeds (same thing) are a dying instrument and really truly should not be used anymore, IMO and opinions of many others who understand them. I have reviewed a lot in recent months and they have 98% of the time been done improperly. They will continue to be used so long as there are investors who purchase them and do not demand a higher standard of instrument such as a mortgage or deed of trust properly executed, recorded and maintained. The point of those who tend to deploy them is to circumvent the ideas that are go with mortgages and deeds of trust. That is a false notion. Courts of laws in most states treat them the same and due to their innate flaws, the owner/holder ends up on the short end of the stick, lesser to those rights and enforcement afforded in a proper mortgage or deed of trust.
I would suggest recalculating the yield if you don't get the balloon but have to extend the loan to maturity. For resources I recommend the 10bii app for the iPhone.
Originally posted by @Bob E.:
I would suggest recalculating the yield if you don't get the balloon but have to extend the loan to maturity.
I did not 100% follow this statement. What are you saying?
@Dion DePaoli it's responses like yours that make this community so great! In your opinion, what are the next steps I need to take to consider this deal?
For example, what do I need to ask for from the Vendor/Seller to determine if this deal is worth the risk?
Proof of tenant/buyer payments?
Credit Reports?
What am I looking for in the Deed?
If, I wanted to buy this contract is there anything I could do to lower my risk?
You are correct, the yield is what has attracted me to this deal, I hate to just make assumptions and not take the necessary steps to analyze it and determine properly if it's worth the risk.
Any guidance you can give is greatly appreciated.
Questions for you to answer away from the Seller:
1. What is the real property worth As Is/Where Is right now?
2. Are there any major repairs needed to the property? (Not the cosmetic kind, the utility/functionality kind)
The idea to have about a CFD/LC is that you are purchasing the real property where a major portion of the interest of that real property has already been given away (to the Vendee/Buyer). So let's first remove the idea of the Vendee/Buyer for a moment and figure out, does the property, all by itself, support $18,500 sale price?
Next, we can proceed with the assumption the borrower is not well capitalized to be conservative analyzing the deal further. So any major repair that is foreseeable should be addressed as an administrative/management burden. There is a chance, usually higher than not with these, that the Vendee/Buyercan not afford to tackle any major upcoming property repair. So, in order to preserve the value of the property, you may need to make a repair, now the issue comes into play as to how you recoup said capital expense. You would need to read the rest of the CFD/LC for details, if any, on how the Vendor/Seller can handle such situations. In contrast, what demands can be made on the Vendee/Buyer to make the repair or pay back an advance for the repair?
Bare in mind, a large advance where you may be forced to add to the balance due from the Vendee/Buyer would require a modification of the contract, establishing new credit and could also make the asset less affordable for the Vendee/Buyer.
The chance is possible that you could be found needing to dump $5k into the asset X periods from now. If you do not, the property may be damaged more, say like a roof problem. An under capitalized borrower, one where the simple payment of $604.40 is what is actually sold to the Vendee/Buyer (common method of sale), may not be able to come up with the required money to capitalize the repair. If you can not recover it, obviously it will cut into your return. WHEN and HOW you can recover, in accordance to the Vendee/Buyer's capacity to pay will affect your return.
To further that concern/idea, the total interest income for the investment is around $9k+. Having to repair a roof for $5k, which is not unreasonable, will cut your interest income to maturity in over half. Just like if you get paid off early your return sky rockets, if you experience an expense of magnitude early, your return could be completely wiped out.
It seems to me, you are not thinking of the asset in this manner. You will be the property owner, but you will have handcuffs on since possession and use is granted to the Vendee. As a landlord, you collect deposits to offset some repairs and bifurcate a portion of the rent as reserve over time for larger capital repairs. In that role, it is sort of the devil you know. Fairly straight forward ideas, toilet breaks you fix it, roof leaks you fix it. CFD/LC you do not get to know the devil so well. The Vendee/Buyer will look to you when convenient to be the owner and look themselves when convenient to defend their use/possession. When it is all said and done, a Vendee may simply walk from the property and you may be left will little to no recourse or you may have an uphill battle trying to recover from the Vendee/Buyer in a civil suit.
I hope you see where this is trending. All those paragraphs to give credence to the two simple ideas above. We have not even broached the underwriting of the Vendee/Buyer yet.
To buzz through a couple of your specific underwriting ideas:
Yes. You would need to see and confirm proper accounting of the contract balance and application of the payments.
Yes. If credit reports were obtained, you should be given access. Bare in mind, those credit reports are now out dated since the deal was written in the past. If you seek to pull new credit, you would need authorization to do so from the Vendee/Buyer.
Looking for in the Deed? Well, the property should be ideally sold to you with a Warranty Deed with the CFD carved out. At the least, you would expect a Special Warranty Deed. I would be cautious with any deal that offers only a Quit Claim to grant you an interest. Due diligence here should take you back two owners or more. Many of the ones we have seen are foreclosures that resulted in DIL. As I stated before, most/majority, done improperly and there are some interests hanging out there from the past due to the poor paperwork. In addition, many did not properly pay transfer tax or document tax for either the deed or the contract. You will want to obtain an Owner's Title Policy and you can get the CFD/LC endorsed by some title companies. They will help you with clearing exceptions to title in most cases.
How can you lower your risk? Well, which risk? The common public likes to talk about risk only using it as a buzz word. Identifying which risk you are wanting to mitigate will actually help point you in the direction of how to reduce it. For instance, risk of fraud, risk of default, risk of loss, extension risk, etc. Since many are at play here, there is no easy answer to the question.
I will say this again, you are not simply buying the contract, you are buying the real property and the contract comes with it. In that sense, these deals are more like an investment property with a rental contract. However, these types of deals do not carry the same rights and interests bundled in the same manner that a typical investment property with rental contract carries since a different (greater) interest is given to the Vendee which in the contrasting Investment Property is still held by the Property Owner/Landlord. (That is why I say, it's like handcuffs are put on the Landlord.)
BTW, that misunderstanding (above) alone is probably the Number 1 reason for these deals being done improperly and resulting in a big huge mess.