All Forum Posts by: Dion DePaoli

There is a forum here on BP designated to notes and cash flow:

https://www.biggerpockets.com/forums/70-tax-liens-...

Well this just got messy.  

So there are two subject properties?  So they need to be capitalized separately or together.  Probably wise to keep them separate unless you take equity in the company.

So interest is being converted into equity - mezzanine financing.  This approach begs the question is treating this capital as debt capital to be converted the best way or should you just buy shares of the company which owns the project and be in the operating agreement?

There are different ways to structure this. Buying into the LLC which owns the projects. That comes with its own set of ownership interests, voting rights, etc. Might be a way of gaining good control over the project. Then again, that may not be of interest to the other party.

Additionally, you can be a stand alone partner on title and take a carved out split of equity through Tenants In Common title. The current lender would have to approve you joining title, which they shouldn't mind if you are bring more capital to the table. So TIC would be he gets X% and you get Y% of net proceeds as two separate owners of the same property. Well properties in this case.

Or you can set up mezz debt, as the original idea in the thread.  Originate a loan which accrues interest and then that interest is converted into equity upon sale at some conversion rate which is considered your payback.  

The key here is keep it simple.  You want controls in place to manage your capital exposure.  You also want remedies upon project default, if that were to ever happen.  You are going to want to  get legal counsel involved in this to protect your interests.  

Bare in mind, the broker has an incentive to want you to do the deal as they probably get paid when it originates.  You don't get paid until it completes.  Those two ideas are not exactly aligned.  

Well how long until he finishes the project and how do you plan on distributing the funds to him?

If the loan amount is large you may want to have draw downs at certain construction milestones upon inspection.  This limits your exposure to a default and flight on the project.  There are title companies and inspection companies who can help conduct the draws and inspections.  

The loan will be in second position since he already has a first position.  It would be wise to review the current security instrument from the other lender.  Attaching another loan to the property, assuming that is your plan opposed to making an unsecured loan, is important.  The first lien may have clauses which require permission to be granted.  The loan could carry a deferred interest which means what is actually due on the note will be greater than the loan amount due to interest being paid upon sale or completion.

How will you be handling the interest accrual of your loan?  Is the borrower to make monthly payments.  Will you set up an interest reserve?  Will you defer interest payments?  The answers to these are what you negotiate and what the project is and how it will be managed.  

The obvious question is why is the project already over budget?  Chances are the first lien wanted to see a financial plan and capacity to ensure the project could be completed and they get paid back.  So it seems likely there is a cost over-run which now requires the borrower to seek more money.  I would dig into that to understand the risk of putting good money on top of bad money.  

These are just some ideas that can go into your inquiry.  Really what you should do is describe the deal a bit more.  Loan terms are relative to the risk and you didn't really describe enough of the deal or risk to understand what may or may not be warranted. 

This is an idea rooted in a fruitless waste of energy.  You will never be able to buy your own loan.  NEVER.

You are not going to find a qualified counterparty to buy the note for you.  What would even be in it for them anyway?  Loans owned by the big institutions will require big institution trading partners.  Neither will be interest in a call from you.  Chances are that your loan is pooled into a security trust and there are numerous bondholders plus specific administration and servicing instructions - none of which include selling a one off loan out of the portfolio.  Also, consumer loan servicing portals are not designed to handle reverse inquiries for loan purchases in any of the big servicers.  

The whole "pennies on the dollar" is a gross misrepresentation of the real world secondary market pricing.  Discounts are applied to loans for a reason.  There is no reason in this thread your loan would be in need of a discount other than negative equity.  The point here is the notion that loans simply trade for huge discounts in the secondary skips over the why.  Discounts are relative to the loan defect.  Discounts are not handed out like Halloween candy.  Wherever you see a loan discounted someone lost money since it takes 100% of the principal (most of the time more) to actually fund the loan.

I didn't listen to the podcast.  I glanced at the title to see if it is one we have discussed before.  It is not.  Be careful what you take away from the podcasts by those claiming to note experts.  There are practices at large which the experts don't approve of and that can get you into trouble.  

In relation to the blog:

Never seen or heard of a loan purchase agreement having the word "receivable" in it. Not all that big of a deal but receivables are not real estate notes. In addition, purchase and sale contracts do not typically contain a description of the note. What happens if you buy more than one note at a time? Generally assets are attached to the contract as an exhibit in a referenced schedule of assets. The seller and buyer both make representations and warranties. Some contracts have more and some contracts have less. The parties can negotiate their own. There are other important ideas in the contract none of which have to do with the asset description like interim servicing period and administration along with sunset or buyback clauses.

An "Assignment of Mortgage" is NOT the "security instrument". The mortgage or deed of trust is the security instrument. The mortgage/deed of trust is the instrument given by the borrower to the lender which secures the loan. Ergo..."security instrument". An assignment of mortgage transfers the legal ownership of the loan and some equitable ownership. AOM's are not one size fits all in regards to language or format. Different counties will have different requirements to the format of the AOM and those must be followed or the recorder will reject the document.

An allonge is an endorsement to the note. Endorsements transfer equitable ownership of the loan. Think payments. Like any other endorsement, such as the one on the back of a bank check, "Pay To The Order Of" grants the named party the equity to receive the payments from the instrument. Endorsements can be anywhere on the note at or below the signature line or on the back page. That said, generally allonges are not on the back page as digital imagining of the instrument often didn't include images of the back of the page. Note endorsements are still used today and in many ways a smarter method of endorsing the note as an allonge is another piece of paper in the file which can be lost. When an endorsement falls onto its own page it is called an "allonge".

A party can have legal ownership of the loan but assign equitable ownership of the proceeds by obtaining an AOM in their name and giving an endorsement to another entity. This is how one might pledge a loan. An endorsed party doesn't have legal authority to direct or control the loan and would not be able to enforce remedies within the security instrument or through law without the AOM'd party.

Land Contracts and Contract for Deeds are not hybrid notes. They are "installment contracts". They are not a note at all. An installment contract is where possession is granted to an asset but ownership is deferred until full payment. When buying an installment contract the buyer needs to be given the deed to the property, just like any other landlord-tenant real property transaction. Review of the installment contract plus normal real estate review is important to understand the provisions of conveyance mandated by the installment contract upon full payment by the vendee. Do not purchase Contract for Deed or Land Contract and expect to treat it like a note and mortgage/deed of trust. They are not the same.

The implied idea of the article is a little misleading. A contract for purchase and sale, an assignment of mortgage and an allonge are all important documents involved in a loan sale. However let's remember that none of these items are presented in the beginning of a trade. These are all transactional documents. These all come post due diligence and in general the contract will get approved first, the AOM second and there is not much to approve with an endorsement it just needs to be present. In general we can't talk about "important documents to have" and not talk about the note itself. The rest of the documents are meaningless without the note or a lost note affidavit present.  As such I can imagine making a list of "must haves" and not listing the actual note. 

@Jay Hinrichs

Offering to pledge a note as security to obtain another note is by definition a security.  The resulting note is not secured by real estate.  Yes banks do it but they have legal departments to do things right. 

In addition do not overlook the solicitation of the partial as weighing heavily on the classification of it being a security.  In your setting you went to the bank for financing and offered your notes as collateral.  In a street level sale of a partial the issuer would have to solicit for an investor to buy the partial.  In order for that to happen the issuer is holding himself out to the public trying to find a partial note buyer.  

@Patrick Desjardins in regards to evidence I would point to some legal ideas and cases that coincide with note participations.  

The first idea is just because an underlying asset is not considered a security the sale of a piece of that asset is not exempt from being a security.  Specifically courts have found partial loan sales to be securities when going before the court:

Lehigh Valley Trust Co. v. Central National Bank of Jacksonville, 409 F.2d 989 (5th Cir. 1969)
"This agreement also is clearly within the statutory definition of a security as that definition includes 'any certificate of interest or participation in * * * any of the foregoing (note, stock, etc.)."

In addition a participation can be found to be a security if any of the following are true:

1. An unfixed interest rate on the loan or an equity kicker built into the return on the loan;

2. An unsecured or minimally secured loan

3. A borrower without accessible or preservable cash flow or net worth with which to repay the loan;

4. A lead bank which has:

a. sole or primary and virtually exclusive access to borrower information, and

b. primary or exclusive control of loan administration and enforcement upon default;

5. A lead lender which has greater sophistication in lending than the participant; and

6. A purpose involving a new, unique or speculative venture rather than a relatively risk-free venture

Further, in general fractional interest sold are considered securities.  Partials can be seen as a fractional interest in the note depending on structure of partial "sale" or participation.  

I believe in one of the other threads I also pointed out that real property sales can be seen as a security such as some of the condo development and conversion sales that took place in the mid 2000's.  The same ideas which supported those sales being seen as securities included marketing the investment for income production and cost-free nature of ownership due to the rental pools.  The point there is the method of marketing weighted heavily into the viewpoint of treating those like securities.  

There is not a huge body of law around partial real estate note sales and interpretations, I will admit.  Nor do I claim to be aware of all legal cases around or about the asset.  That said, the public idea of partials is they are not riddled with the risk of being found as a security.  That said, there is a longer list of reasons why it either is a security or can easily be found to be a security than the list of reasons it may not.  

All notes are securities.  By law.  Some of those notes are exempt like notes secured by real property.  Selling 'some' of the payments is not selling the whole note.  Selling a note where you guarantee return/yield or principal protection to the partial buyer is going to fall under a security.  Selling something that must be "sold" back is not a true sale.  ...I think that covers most of the notions that I have seen in rebuttals promoting partial loan sales.  

Now, that said, partial loans sales do occur.  Institutionally they are not uncommon.  Street level investors do not measure up to compliance and regulation teams employed or under contract for those types of operations.  Those with proper licenses and proper disclosures will stand up better to legal scrutiny.  That is generally not the common streel level investor.  Nor does the street level investor or casual note investor conversation about partial note sales ever even seem to acknowledge the risk and concern.

So the moral of the story is, treat them like securities and do not bank on the remote chance they 'may' not be considered a security.  As such, street level investors should stay away from issuing them or creating them.    

@Jason Hatfield

For the sake of conversation it is possible that the situation with the mortgagee has elevated to such a hassle that the Seller is second guessing the sale.  It may not be a conspiracy to not sell just a matter of path of least resistance.  For the most part, it will likely not be known.

Whatever the reason the seller is backing away from the sale, the approach you are taking may not be the best to cause the transaction to execute.  The burden of dealing with the disgruntled mortgagee may be overbearing for the seller.  I wouldn't be talking about suing him over the contract which you are not entirely correct on.  

You would have to go after the seller for "specific performance" which is not a common pursuit in residential transactions.  In addition, the "damages" you have to make claim on are very limited at this point and the seller is ultimately not responsible, the mortgagee is stalling the transaction.  That at the least will be the defense that gets raised.

I would suggest a slightly more accommodating approach.  Try relieving the seller of the burden of hunting down a payoff from the mortgagee that is not cooperating for what is a small amount of money the seller will net.  Offer to amend the contract price down to $1,500 or $2,000 and take the property subject to the mortgage.  Verify the payoff number as best you can and give it a haircut that makes it agreeable so you don't pay over the seller's level of equity.  Then as you were thinking originally, you can pursue the mortgage payoff.  Chat with your attorney about any specific language to cover you in lieu of a windfall pay off via a reduced balance or voided loan by the court.  So any reduction in the payoff proceeds is your gain.  The sale should be final and generally you wouldn't need any additional language but just as a cya get legal input.  In addition, I would not make a big point to the seller of there being any potential balance reduction or high likelihood of a void. 

At this point there is no overly compelling evidence that a discount on the payoff will materialize.  So it is a gamble but it is a gamble in your favor.  Obviously this all centers around how many payments we believe the seller made on the loan.  Like I mentioned earlier the Seller would have $2,600 in equity.  You can do +/-$200 on that (to your favor lower).  Essentially what ever you can negotiate in your favor.  Perhaps recognize the seller is fighting for nickels but get him to transact and walk.  You get the idea.  

Then you assume the task of pursuing the mortgagee and clearing title.  Check with the title company and ensure there are not other clouds on title and transact, dealing with any other issues with the seller.  

It just seems to me at this point you can have a good idea of the path to clear title and understand there is a 'potential' windfall albeit after some legal battle with the mortgagee.  However, in the meantime you get the property and can do what you need to do.  It seems to me your desire to gain the property is greater than the seller wanting to tolerate the hassle of dealing with the mortgagee.  So try and take the hassle away.  Stay away from threats of lawsuits and breach of contract that is just going to make the whole thing more difficult than it already is.  The seller doesn't seem overly interested in sending certified letters or causing stir.  He may even be scared of legal implications or fees which he may not be able to afford or simply doesn't want to burden.  Even though those are relatively unfounded.  

Armed with the concepts discussed here then sit back and let the mortgagee hang himself out to dry and capitalize on it as best you can.  I would guess the mortgagee uses up more slack on the rope once he finds you in possession of the property anyway.  Which only serves you better.  Barring dealing with the hassle.    

Good luck.     

 I said that??

Partial loans sales are a bad idea. Selling a partial on a NPN is a very bad idea. Not to mention pretty darn silly.

Delinquent and defaulted loans require capital input and there is low or no return. So I buy your NPN for $100. Spend $20 on servicing and enforcement and you buy it back from me for $144? So you just paid me $24 to do advances on your loan while paying me the exact amount of the advance that you could have made yourself.

Why on earth would somebody do that?  The answer is nobody would this is non-sense.  

Careful on the information you find out there it can be misleading and harmful.

Unless you are buying or selling the whole loan you are playing with a security which requires a license.  Partials are in general a bad idea.