Pros/Cons of originating a note

[Julie McCoy]

Hey all!  I'm new to this topic, though not at all new to BP; you'll usually find me over on the vacation rental forums.  However, I'm looking to begin to diversifying into a more passive asset class, so I intend to be spending more time over here reading and getting to know you all!

My first question pertains to note origination - first of all, I can't seem to find much on the forums about it.  Seller financing is almost always addressed from the buyer side, that I can see; and note investing typically involves existing notes.  I see the rent-to-own/lease-option forum but that's not what I'm wanting to know about, either (though if it's a better forum for this question, just let me know!).

I am interested in the pros/cons of offering seller financing on a property.  In my market (TN Smokies), it is VERY hot, and properties are often sold for cash/above appraised value, because of the value of the cash flow as a vacation rental.  I have a couple of properties I own outright, of a type that is in high demand, and it *seems* like there may be the opportunity to have my cake and eat it too with seller financing - given the market conditions, I could price at a premium, and open up the buyer pool to those who need financing but bypass the necessity of an appraisal/conventional loan qualifications etc.  For the first several years I can see great returns off the front-end interest payments, and possibly sell the note down the line, or buyer sells/refis/whatever and I'm cashed out.

Aside from the necessary costs of making sure I'm in compliance/have tight legal documents, and having to underwrite the borrower, what's the downside here?  I feel like if it's actually a great idea more people would be talking about it, so I'm wondering what the catch is.  :) 

[Jamie Bateman]

@Julie McCoy, I don't pretend to be a seller-financing expert, but my instinct is that seller financing generally works best in cooler markets or in downturns when you really need to expand the buyer pool. And I think those that operate in this niche are generally very good at finding great deals on properties (or note investors who take back properties as REOs), they maybe do some rehab, and then they sell via owner financing to often less-than-stellar borrowers. Not saying it can't work in your market but it seems like a hot market simply does not lend itself to this strategy quite as well (especially with the crazy-low interest rates we have right now).

To me, there really needs to be a very good discount for you at the entry point, such as finding a property at a great price or buying an existing note at a discount (which is typically the case). If you create a note via seller financing (without many points charged up front, etc.), and then the borrower refinances or sells the property, there is not much profit for you at all.

With that said, if you were already planning to sell a property, selling via owner financing can really help spread out your tax liability if there was a lot of appreciation (capital gains). That is one of the main benefits of seller financing.

Anyway, welcome to a great forum! There is a ton of knowledge here.