I am again receiving several note quote requests where there are short term balloons and the note seller is expecting to sell his note as if the note was actually going to be paid off in a short period of time. To clear up this misunderstanding, we need to revisit an article I wrote in July 2008. Looks like history is repeating itself.

It is time to dispel another myth about balloon notes. A guru is trying to sell his/her get rich quick program by telling new investors they will get more money for their property by offering the buyer low interest owner financing, in order to make the payments exciting. The guru then instructs the investor to combine the low interest rate note with a "short fuse" balloon. Now the guru says to wait for some seasoning and then sell the note. According to the guru you will get "top dollar" for your note by following this procedure.

I want to emphasize this balloon note myth because in the past month, I have been contacted by three note sellers who have sold their property with a 5 year or less balloon, and insisting their note is more valuable because the Note Buyer will be getting his/her note investment back in a short period of time .

One note seller who contacted me only yesterday even had his calculator out, telling me exactly how much his note was worth according to this guru's teachings. His arguments were valid if, and only if, you assume the balloon is actually going to be paid off when the balloon becomes due. It took me a while, but I finally convinced the note seller the error of his reasoning.

Let's look at an example. Not only will you get a chance for a little calculator practice, you will also learn HOW "short fuse" balloons are perceived by Note Buyers in the real world.

I am going to address only the "crunching of numbers" for balloons, and assume the property has equity, and the payor has acceptable credit. Let's also assume the seller has $100,000 note @ 7%, amortized over 30 years, with payments of $665.30, with a 5 year call/balloon. The note seller comes to me exactly one year after the note was created and wants to sell his note. Here is what the note looks like.

N = 48
I/Yr = 7
PV = $98,984.21
PMT = $665.30
FV = $94,131.76

The note seller insists that if I buy this note and want to achieve a 10% yield, his note is worth $89,434.72. (Simply substitute 10% yield for the 7% and solve for PV) This is where the guru's "teachings" do not reach from the podium to the pavement. While his math is correct, the note seller errs in thinking yields are determined when notes are created or bought. NOT TRUE. Yields are realized when notes are liquidated, not when they are created or bought. This concept cannot be stressed enough.

I ask the note seller, "What happens if the payor cannot refinance when the note is due in 4 years? Do you really think the payor will be able to refinance in 48 months"?

"No not really, but no problem", exclaims the note seller. "You merely extend the note". (of course 'no problem' for this note seller, he has his money. But for me, the Note Buyer, extending a note presents another set of issues, but for now I am addressing only the math.)

"Great!", I say. "We are on the same page. And how many times will I have to extend this note"?

"As long as it takes", snaps the note seller.

"We are still on the same page", I calmly replied to the note seller.

As a Note Buyer, I will have to assume a note with a "short fuse" will have to be self liquidating, meaning the note will have to be extended until the balance is paid off. Since he had his calculator in front of him, I asked the note seller to use his own assumptions that the note will have to be extended indefinitely, and for me to achieve a 10% yield.

"Enter these figures into your calculator, and I will abide by its findings. Fair enough"? I asked. The note seller then entered 348 into N (number of months left on the 30 year amortization) 10% into I/YR, PMT remained at $665.30, with 0 in FV. Now solve for PV.

Next I heard only silence. I knew the figure he was looking at was $75,390.06. Reality was beginning to set in.

"I was not expecting this much of a discount," pleaded the note seller.

"How much money do you NEED", I asked.

"$25,000", the note seller quickly replied.

"I can get you very close to your goal. I can offer $23,965 for the right to receive the next 47 payments. You can then keep the last payment and the balloon". (There is a reason I did not buy the full 48 payments before the balloon. This is another topic) "If your payor can refinance, then you come out way ahead. If your payor cannot refinance, you can extend the note, but call me first. I will help you structure your note to give you maximum value".

"I'll get back to you", sighs the note seller.

He did say he had similar offers for the entire note, and mine was higher. The difference was I took the time to explain "why" all the offers for the entire note were lower than expected. Why was the note worth only $75,390.06? Because the note had a below market interest rate, and did not take into consideration that Note Buyers would consider a short term balloon to be a self liquidating note.

The moral to this story is that notes with short term balloons, will not be priced strictly according to yield, but rather by the reality of the payor being able to refinance. In today's market the chance of this happening is next to nil. The Note Buyer has to assume the payor will not be able to refinance. Therefore short term balloons are bought either one of three ways.

1. Assume the note is self liquidating
2. Buy the payments only, and let the note seller keep the balloon.
3. Buy all the payments and part of the balloon

More importantly, DO NOT BELIEVE GURUS selling get rich quick programs.

The NOTE PROFESSOR NOTEBOOK time proven techniques to bust balloons.

If you are selling your property using owner financing, I can help you structure your note to give it maximum value in today's market. Or if you have a question on your note or a Note to convert to cash, I will be happy to discuss your specifics. And if you know of someone who wants to sell a note, CONTACT ME Remember, I pay referral fees.

Be sure to contact THE PROFESSOR with questions or comments. This is where I get my topics.

Copyright © H&P Capital Investments LLC All rights reserved

If you have not attended a Note Professor "How To Get Rich with Notes" class, be sure and purchase the Note Professor Note Book manual to enhance your knowledge of creative real estate financing and note buying and selling.

"I got your news letter. It was great, purchased your (Notebook) and it was awesome. I used your renter technique and it worked also. I am getting 41% return thanks to your expert advice. I have spent hundreds and not able to do any thing thru other gurus" Gary W. Garland, TX

"It blew me away what a powerful tool notes can be. Lots of great information, worth every penny! Highly recommended."
Jeff C. The Colony/Investor

"Your manual is short and straight to the point, it's rare to buy something today that gives you your money's worth. Thank you" Stephan B. Phoenix, AZ

You will learn at least one new usable concept to increase your profit in buying or selling notes and real estate.
Tom Henderson, author

By popular demand, THE NOTE PROFESSOR NOTEBOOK is now available in easy, downloadable E- book form for a the low, affordable price of $39.95. Other products are also available, including HOW TO MAKE OBSCENE PROFITS with SMALL MONEY, and GUIDE FOR SECOND LIENS. There is also a FREE download of CHECK LIST FOR OWNER FINANCING. Simply go to the NOTE BUYERS STORE. I can think of nowhere that you can find such information packed products at such incredibly low prices. We are still working out the bugs, so if you have any problems, be sure to contact me.

FREE Real Estate
Note Newsletter and Archives
click here to subscribe and view the archives of past information packed issues through 2009. And be sure to forward this newsletter to a friend that would have an interest in Owner Financing and Real Estate NOTES.

Current ARCHIVES (end of 2009-2011)

I have been asked to comment on Dr. Ravi Batra's talk on the economy at recent meeting of a local real estate group. For those who are not familiar with Dr. Batra, he is senior professor and former Chairman of the Department of Economics at SMU and has written several successful books. As Dr. Batra proved, academic credentials do not always translate into sound economic reasoning.

When evaluating Dr. Batra's talk, again I feel like the mosquito in a nudist colony. I know what I have to do; I just do not know where to start. I will begin by acknowledging it was correctly identified how Greenspan triggered this economic downturn by artificially increasing the supply of money and credit after 911. I have discussed this in previous issues of THE NOTE PROFESSOR NEWS LETTER. Batra then goes on to correctly explain how the laws of supply and demand should be the main focus when discussing economic issues. However, from here many of his arguments completely ignore the laws of supply and demand, while at the same time basing his assertions on false economic principles and contradictions.

The major contradiction I am going to address is his proclaiming we need to get back to free markets, where supply will always equal demand, then starts giving solutions to "fix" the economy by having government interfere with the market place. Free markets and government interference are contradiction in terms.

Let's begin where Dr. Batra asserts our economic problem is that supply exceeds demand; and if supply exceeds demand, layoffs result. Dr. Batra does not explain the supply and demand for what? Supply and demand for goods and services are not homogeneous, but that is another topic. I am not going to delve into the fact that supply and demand entail price, and at some price, supply will always equal demand. In other words lower the price and demand rises, and supply decreases. This is called "equilibrium", but is also a topic for another issue.

What I do want to discuss is the assertion that "supply" just increased for no particular reason, and then consumer credit came along and raised demand. This reasoning has the horse before the cart. In fact, it was Greenspan's easy credit policy that gave rise to increasing "demand" as money was artificially injected into the economy. As a result, people were buying all sorts of goods and services on credit, not to mention using their house as a credit card. To keep up with the artificial demand, manufacturers produced more and more goods based on the "false signals" easy credit was giving the market. Hence the reason the supply of all goods and services increased. (I might add, there is only one way I know for all "supply" to rise and that is artificial expansion of credit) So in reality, "supply" did not increase in a vacuum, but rather as a result of the artificial credit expansion by Greenspan. When the credit bubble burst, indeed there was more supply than demand, especially in housing, but supply was not created in a vacuum, but rather triggered by an artificially easy credit policy of the Federal Reserve.

From here Dr. Batra asserts "we", meaning government, meaning politicians and bureaucrats, need to increase "demand" by increasing the minimum wage. Demand for what? Black out! He maintains that a minimum wage does not increase unemployment. This is another example where the laws of supply and demand are completely ignored. Remember, price controls creates shortages. The minimum wage is a form of price control of unskilled labor. Therefore saying the minimum wage does not increase unemployment is in direct contradiction to economic laws. In other words, rather than putting more money in peoples' pocket to spend as the minimum wage was intended, raising the "price of unskilled labor" will have the opposite effect by decreasing the demand for unskilled labor. Hoover and FDR tried this "solution" with devastating results.

What was overlooked was the fact the minimum wage can be raised, but you cannot force businesses to hire. This was part of the reason the Great Depression lasted well over a decade. Why; because firms could not afford to pay the high price to hire unskilled labor, so they did not hire anybody. The people who are hurt are low skilled workers, especially teens. Why do you think there is high unemployment among teens, and especially in minority communities? Because the local mom and pop businesses within the community cannot afford to pay an artificial high price, where the cost of labor does not equal the productivity. In other words, the minimum wage created a shortage of unskilled labor jobs.

Another example of Dr. Batra's engaging in false economic principles; along with overlooking other data, was his assertion that mergers in general cause prices to rise, as well as unemployment. He used the term "monopoly capitalism". Not sure what that is. He used the example of Exxon/Mobile merger, then explained a scenario of at the corner of two busy streets, there was once a filling station on every corner of this intersection. He contends that now there are no gas stations at this intersection because after the merger of Exxon/Mobil, the newly formed oil company wanted cut the supply of gasoline and thereby increase price of gasoline. Bovine scatology. What Dr. Batra ignores is this particular intersection is high priced, prime real estate where a gas station on every corner was not its best and most profitable use. The real demand for a shopping center and retail stores outweighed the demand to have gas station on every corner. Hence the gas stations were gone, and the shopping centers were created. It is that simple.

There is also no mention of the jobs created by retail stores, as compared with keeping four filling stations in tact. What is also ignored is that in this shopping center, there is a major food chain store whose quantity of gas pumps equals the pumps of the four gas stations. In other words, the supply for gasoline, as well as the demand for a shopping center were both fulfilled by tearing down 4 obsolete gas stations.

Add to this that a mile down the street, there are two large discount chain filling stations selling gas at a cheaper price than major oil stations, not to mention there are convenience stores all over the area, with multi pumps selling gas at discounted rates. So far from the supply of gasoline stations declining, the supply has actually risen. Yes, the price of gasoline has risen, but it had nothing to do with the merger of Exxon/Mobile.

At this point Dr. Batra asserts something to the affect "we need to return to free markets, because free markets adhere to the laws of supply and demand". Then in the same breath, his "solutions to fix" the economy are in direct contradiction to free market principles. All of his solutions entail government becoming involved in the "free market" in some way. Let's get back to basics. We have discussed in past issues how both supply and demand entail a price. Those who have been following my articles know that price is a language that tells us how much and what to produce. When government distorts price in any manner, it gives false signals to the market. When false signals are given, either price, demand or supply or a combination will get out of kilter.

With this in mind, let's examine one of the "solutions" to our economic woes. According to him, "we", meaning government, meaning politicians, need to tax outsourcing so high as to forbid it. Again concept of free markets has been completely tossed out, while protectionism has replaced the laws of supply and demand. Take his "solution" for example. Using Dr. Batra's example, if a firm outsourced a service for $5,000 that it would cost $20,000 in America, Dr. Batra's "free market solution" is to tax that firm $15,000 to make up the difference. All would seem well at first glance because he has protected an American job. But as Bastiat points out, this is what is seen. What is not seen is the extra cost to the consumer who must pay for the added labor expense, as well as the jobs destroyed because the business does not have $15,000 to spend with his merchants. (Someone please explain how making you pay $15,000 extra benefits you)

For example, say I was a firm that outsourced from India some form of computer technology for $5,000 that would cost me $20,000 in America. Whether I paid the tax or paid an extra $15,000 to the American tech, this service would still cost me an extra $15,000. But I would save an American job and everybody would benefit, right? WRONG!! Did I benefit? NO! I am now out $15,000 that I could have spent to purchase more equipment, supplies, or spent in various other forms. The "saving" of this one job is at the expense of my merchants because I no longer have $15,000 to spend. In other words, the job saved by being taxed is at the expense of the jobs that were lost because I could not spend or invest the $15,000. (I might add that Hoover tried this same "solution" with the Smoot Hawley Act which taxed imports. This was the final straw that sent the economy into a downward tailspin)

Let's take this a step further and examine what happens to the person in India. Remember, we pay for our imports with exports, and since I paid him in dollars, in some way these dollars will return to America in the form of purchasing a good or service. Since the Indian tech no longer has employment, $5,000 will not be used to import a good or service from America. So, again, one job saved is at the expense of the jobs of American exporters to India. Taxing cheaper labor, be it foreign or domestic, distorts the price system and skews the laws of supply and demand.

The same principle is easily seen when government tries to protect the wages of large unions with the same protectionist argument that it will save jobs. But we know better.

To recap, because it deserves repeating; The saving of this one job was at my expense because I am $15,000 poorer, at the expense of the merchants and those who support them who I would have traded with the $15,000 savings, as well as the exporters of goods and services to India. Protection tariffs are a form of consuming without producing are they not? Bastiat's Petition of the Candle Maker fits nicely in this discussion.

The most humorous part of Dr. Batra's talk was his prediction that politicians will miraculously "see the light" that current economic policy is not working, and will turn to free markets. In 2016 we will see golden opportunities as politicians return to reason. His faith in politicians surpasses mine. I see politicians from both sides wanting to hang on to power no matter what happens. It is the nature of politicians. He went on to say "we can fix anything". This is the essence of the problem with politicians and non free market economists. They think they can "fix" the economy, when it was their "fixing" to begin with that caused the problems we are now experiencing. I can only hope that I am wrong and Dr. Batra is right and 2016 will bring us prosperity. I am not optimistic because I know consumption cannot exceed production. Government is continuing to consume more than the ability of the producers to produce. Protectionism is consuming without producing. It appears all the "solutions" are geared to ignoring the laws of supply and demand, which distorts the price system, rather than acknowledging reality that we are in a deep recession because we ignored free market concepts. If politicians would just get out of the way and quit trying to "fix" things, the market will self correct. Moreover, when I hear renowned economists like Dr. Batra promote solutions that make the problems worse, I become more pessimistic. However, there are still good real estate investment strategies. I suggest you go to my July/2009 , which was over two years ago and read my suggestions. (You can also track my "predictions")

If you have questions, CONTACT ME. I will address them in future issues.

Copyright © H&P Capital Investments LLC
All rights reserved