The question I get asked most often when presenting a partial offer to a seller is undoubtedly, "What happens in the case of default." I explain in detail the different scenarios in my Advanced Real Estate Techniques for the Small Investor Workshop ; however, in this issue I am going to examine in general what happens in the event of a default. While there are several different partial contracts, here I will address the "soft" partial contract I use.

To set the stage, one of the first things a note seller "assures me" is there is no chance of the note going into default because the payors have been making payments in a timely manner. Yet when it becomes obvious the note will command only a partial offer, the note seller's first concern is what happens in the case of default. And rightfully so. In other words, the risk of default ALWAYS exists, and you had better know what options you will have whether you sell your note or not. The scenario I use in my Advanced Real Estate Techniques workshop for the Small Investor will serve as a good example.

To keep this article as short as possible, please accept the math. In this case study, a real estate investor put $50,000 into a house, and sold it for $75,000 and took back a note. After a year's seasoning the real estate investor sold 72 months of a $75,000 note and received $32,145. In year 5, the note defaulted. What will happen? The question the note seller should be asking is "What would happen if he/she had not sold a partial of the note?". Here we are back to the Number 2 Myth note holders cling to. "If I foreclose, I will get the property back without effort or expense, in the same pristine condition as when I sold it." Not true is it?

To begin, the if the real estate investor had not sold a partial of the note he/she would have the expense and HASSLE of going through the foreclosure process. At the least, this is an extra $1,500 OUT OF POCKET expense. What about the insurance expense? Assuming you do not have to evict, which is another expense and aggravation, you will now have the expense of getting the property in "marketable" condition . Those who are landlords know about property being damaged, especially with tenants which have to be evicted. The same is true of defaults. Add to this the probability the house being vandalized. How much money would YOU invest in rehabbing this property? Moreover, WHO ARE YOU GOING TO SELL IT TO if banks are still not lending? So you are left with a property that cost you more time and money and also having to search for a buyer again. Not a good position to be in, is it?

Ah, but what happens if you had sold a partial of the note. In the above scenario, the Note Buyer would have approximately only $7,400 left on his/her partial balance. You, the note seller would immediately be given the option of paying off the Note Buyer $7400 and going through the foreclosure process yourself. Might not be a bad decision if the property is indeed in the same pristine condition as when it was sold.

Let's say, you don't have the $7,400 or you do not want the aggravation or expense of going through the foreclosure process. What happens then. Simple! The Note Buyer pays the expense of foreclosure and goes to auction. The bid price will be the amount of the note, plus expenses. Should the property be purchased at the court house steps, the Note Buyer will receive his/her $7,400, plus the expense of foreclosure. Then you, the note seller, will receive the rest, which should total around $50,000. (Not bad. You received $32,145 for the partial and $50,000 at the courthouse steps)

But let's get real. This is probably not going to happen. More than likely, the property will not be sold at auction for $75,000. In this case, the Note Buyer would put the property on the market for a 90-120 day sale. From the proceeds, the Note Buyer would receive the $7,400 originally due him/her, plus all other expenses, such as insurance, broker fees etc. You would receive the remainder. The amount you receive would be determined by the market price of the house.

Let's take a "bad case" scenario and say the property sold for only $32,000, and after all expenses, you received only $20,000. Your IRR or Internal Rate of Return would still be 9.9%. Moreover, if your assumption that the property will immediately sell for top dollar, comes to pass, your return is more into the 20% range. Not bad for not having to put out any more money or inconvenience, don't you agree?

To summarize, SELLING A PARTIAL of your note WILL INSULATE YOU from having to go through the expensive and time consuming foreclosure process. When selling a partial of your note, of course, it is prudent to ask what happens in the case of default. However, it would be wise to also ask, what happens if you do not sell part of your note and have to foreclose?


Which situation would you rather be in; SELLING A PARTIAL OF YOUR NOTE, receiving much of your initial investment back, as well as NOT having the added expense and the unpleasant, time consuming process of foreclosure. Or keeping the note and not recapturing any of your cash outlay, while having good money chasing bad which adds to your losses and disappointments.

Which would you rather have?

If you have any questions or comments, be sure to contact me In the subject line, write ASK the PROFESSOR. I will try to answer your questions in the next Note Professor issue.

Remember, if you know of someone who has a note to sell, I do pay referral fees and this has been very beneficial.

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Tom Henderson /a.k.a. THE NOTE PROFESSOR .

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Only a few years ago when events like the Real Estate Investor Expo came around, often I would be the only person speaking about seller financing as a means to acquire property, as well as an excellent exit vehicle. At this year's Expo, there will be 8 or 9 speakers talking about seller financing. Each of these speakers has their own take about how seller financing is the "magic bullet" for selling your property. I am sure there will be some good information from all the speakers.

However, when seller financing is the major vehicle to sell your property, what does this tell us about the state of the current real estate and credit markets?

Remember: The price of real estate is directly proportional to the financing available. Keeping this axiom in mind, let's examine what it means when seller financing is being touted as a primary exit strategy.

Let's take an example of your having a house that sells for $100,000 and the buyer is able to obtain financing from a bank. How much cash will you, the seller receive? $100,000, right? What if someone were to offer you $80,000 CASH for the same house? Would you accept the offer? Why, heck no. Why? Because other buyers can obtain financing and you could get the full $100,000, and not have to take a $20,000 hickie. In other words, your house is worth $100,000 because buyers can easily obtain financing to purchase your property.

Now let's take this same house, except banks are not lending, as is the case today. In order for you to sell your property, you are FORCED to seller finance. So you sell your property and take back $100,000 note. However, if you were to sell your entire note for cash, in today's market you might receive only $75,000. (Which is why partials are so popular. You don't have to take a large discount) With this in mind, and someone offered you $80,000 cash for your house, would you accept? Maybe, because $80,000 CASH is more than the $75,000 you would receive for the note. The point is because of tight money and lack of financing, your $100,000 house is really worth only the $80,000 cash offer. We are back to the Number One Myth most note holders believe: "A $100,000 note is the same as $100,000 cash." (Revisit the August 08 issue of THE NOTE PROFESSOR NEWSLETTER You might also check out my Economic Observation from three years ago to see how I did.)

Take the myth that a note is the same as cash one step further and you will deduce that a house that sells for $100,000 and is financed by a bank has the same value as a $100,000 house that sells with seller financing. We know better don't we?

Is it becoming clear that as long as seller financing is being touted as the "magic bullet" to sell your property, that in reality, real estate prices are declining. Does this mean to get out of real estate, or to never seller finance? Heavens, NO. It merely means to be aware that real estate prices are still either stagnant or declining. Do not be misled that getting a "higher price" for your property by selling financing is the same as getting more cash. . Revisit the July/07 issue.

Being an election year, it is difficult to ascertain what the politicians and Federal Reserve will do in the next 12 months. Some say they will "open up" credit, while others say look for Obama to initiate cram downs or debt forgiveness on mortgages to buy votes. I am not sure what to expect. However, I do know that as long as seller financing is the major vehicle for moving property, the price of real estate will remain stagnant at best, or at worse continue to decline.

Recommendations: Buy properties at rock bottom prices with all cash and/or buy with seller financing with favorable terms to have an immediate exit strategy. More importantly, become aware of alternative exit techniques, such as partials or wraps, that will allow you to receive exceptional returns, with the least amount of risk. As long as seller financing remains a primary exit strategy, know how to effectively structure your note to achieve maximum value will paramount to increasing your wealth.

Remember: the price of real estate is directly proportional to the financing available. Seller financing gives a property a different value than does conventional financing.

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

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