There is no doubt that obtaining a bank loan is very difficult in today's economy. As a result, more and more real estate investors are seeking seller-financing. That option doesn't always work when the seller has a near-term need for the cash, unless they are aware that the secondary market for real estate secured by promissory notes is currently robust.
What that means to sophisticated investors is they can educate sellers about the secondary market, with a plan for the seller to finance the purchase and quickly sell the note for cash on the secondary market. These are not hard moneylenders. These are investors looking for secure investment alternatives away from Wall Street.
There are more than 77 million baby boomers ready to retire but have seen their retirement accounts devastated by the stock markets repeatedly over the past 20 years. They are terrified that if they leave their money on Wall Street, it will completely disappear. They have moved it into saving accounts and money markets paying 1.5% interest. The interest rates are so low they don't keep up with inflation. Real estate loans paying anywhere from 6% to 12% are very attractive to these people.
This secondary market has been around for many years. Historically, seller-financers have been reluctant to use it because private lenders demanded big discounts to purchase the notes. Today, these discounts are significantly minimized or eliminated when the note is structured to be highly sellable. Also, the large influx of new money into the market means these secondary market investors are now competing with each other for the best notes.
The time value of money is a major consideration to the secondary market. Inflation means that the monthly payments they will receive in the future will have less purchasing power. The way this is partially offset is by structuring the note for the shortest repayment period as possible.
The interest rate is a big concern to these investors. Right now, the low Federal Reserve interest rates work in favor of real estate investors. Because private lenders earn more than the 1.5% that savings accounts pay is the reason they want to hold real estate notes without becoming landlords.
However, it's possible for the interest rate to be too high. There are state usury laws that must be complied with. Additionally investors know that the higher the interest rate the more likely the borrower is to default. It all helps keep interest rates in a range that real estate investors can afford.
A third important consideration is the relationship of the cash out refinance loan to the real estate securing it. You need the note to be in the first lien position. Also, the lower the loan to the value of the property the more attractive the note becomes. Secondary market investors also like to see a solid history of payments being made. You maximize the attractiveness of the note with a combination of a high down payment and having the seller hold the note for a period of time to season it to show a reliable history of payments.
A well structured note that investors will ask little or no discount to purchase includes:
Of course, a loan having the opposite characteristics is going to be nearly impossible to sell.
Selling promissory notes on the secondary market is generally limited to sophisticated sellers. Your average homeowner isn't going to want to become involved with this financing option. Your best opportunity is with commercial sellers and experienced residential investors.
Author bio: Brian Kline has been investing in real estate for more than 30 years and writing about real estate investing for seven years. He also draws upon 25 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest in the Olympic Mountains with the Pacific Ocean a couple of miles in the opposite direction.