Often note holders sell their property with an underlying lien. Instead of carrying back a second, the property is sold via a wrap note, or contract for deed (CFD); also called a land contract. Both the CFD and wrap note have their own issues with structure and legalities, but in this issue I addressing only the number crunching.

To refresh your memory, a wrap note is a form of financing where instead of taking back a second, the property seller will create a "wrap note" where the underlying note will remain in place, and the wrap note will "wrap around" the underlying lien. The property seller will now hold a wrap note instead of a first lien. When the property buyer makes the wrap note payment, the wrap note holder will take that payment and pay the underlying note. The remainder is the wrap holder's profit.

If there is not enough equity between the wrap note and the underlying note, the wrap note holder will be disappointed in the final outcome of the note sale.

For example, a property has a value of $100,000 with an underlying lien of $70,000 at 5% with 20 years remaining and payments of $451.97. The property was sold for $100,000 with $10,000 down and the property seller carried a "wrap" note of $90,000 at 8% interest for 20 years with payments of $752.80. In this example the borrower would pay the wrap holder $752.80 a month on the wrap note, and the wrap holder would pay the underlying lien of $451.97.

The remainder of $300.83 is the profit the wrap holder receives. (The wrap holder actually enjoys a yield of 17.49%, but this is a topic for a different discussion.)

The wrap holder needs cash and wants to sell the wrap note. Let's assume that the credit, property and note are acceptable to a Note Buyer. Let's further assume the Note Buyer is requiring a 11% yield. How much would the wrap note be worth? Let's look.

N = 240
I/YR = 11
PV = -72,932.04 (This Is the Amount the Note Buyer Will Pay for the Wrap Note)
PM = 752.80
FV = 0

But hang on. Remember there is an underlying lien of $70,000 that has to be addressed. All things being equal, Note Buyers will require the underlying lien to be paid off so they will have more protection by being in first position, as well as not having the risk of the due on sale clause being activated.

Under this scenario, subtracting the underlying lien of $70,000 from the $72,932.04 from amount paid for the wrap note, the note seller will receive the balance of $2,932.04. If the closing costs of selling the note are factored in, it is not uncommon for the wrap seller to be in a negative position. (Can you purchase a wrap note and leave the underlying in place? YES. This is an advanced technique for later discussion.)

As either a Note Buyer or note seller, you should be aware of how wraps are purchased and address the possibility the wrap seller will have to come to the closing table with cash.

There are many other Do's and Don'ts when dealing in wraps which I discuss in my Advanced Note Class. However, I will address "wrap traps" that I have encountered twice in the last 30 days. Do Not Get Upside Down on the underlying lien with either the size of the loan, the length of the loan, or interest rate.

Two quick examples to avoid. First DO NOT construct your wrap note where the underlying lien is more than your wrap note, no matter how much down payment your receive. I just had to turn down a wrap sale where the wrap note was $168,000 and the underlying was $175,000. This is what I call "a bug looking for a windshield".

Question: What is the wrap holder's position if the borrower sells the property or pays off the $168,000? There is a $13,000 difference that is going to have to be paid by somebody?

The second trap to avoid is having the time period of the wrap note less than the underlying note. Using the above as an actual example, the underlying note had a balloon due in two years, while the wrap note was a straight amortization. See the problem?

A "time trap" which happens more frequently that makes selling the wrap a big problem is having the terms of the wrap note for 15 years while the underlying note has a 25 year term.

Under this scenario, the borrower will have paid off his wrap note in 15 years, but the underlying note still has 5 more years ago. The result is not favorable. The current property owner will have to make payments for 5 years more than contracted, or the wrap seller will have to make payments for 5 years, yet have no payments coming in. Not a good scenario, is it?

Wraps can be very lucrative and advantageous. Just be aware of how wraps work, whether you are buying, selling, and more importantly, if you plan to take back a wrap note as an exit strategy for selling real estate. Act out of knowledge; not ignorance or fear.

If you have questions or comments, be sure to CONTACT ME I get the topics for my newsletters from your input.

Copyright © H&P Capital Investments LLC
All rights reserved
Tom Henderson
a.k.a. THE NOTE PROFESSOR

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It appears that both parties are going to use wealth inequality or income inequality as a platform to gain political advantage over the other. These debates will give us good insight into the lack of economic knowledge, as well as the degree politicians will go to gain votes.

Let's examine wealth and income inequality from a free market standpoint, not a political view.

There are several new subscribers who might not be aware of certain economic axioms. In this issue, the paramount economic axiom we will be utilizing is that there are two and only two ways to organize an economy. One is free markets, where individuals decide what is to be produced and at what price. The other is a collectivist system which uses the force of government to make economic decisions for individuals. Free markets always produce abundance and wealth, where as a collectivist system will always result in shortages, poverty, and eventually starvation.

Far from being an evil concept, the promise of wealth inequality is actually a driving force that produces advancement and progress. Why do individuals get a degree, attend medical school, start a business etc. Is it not the possibility that he/she will accumulate more wealth and comfort than they would by digging a ditch?

With this in mind, no matter what economic system prevails, there will ALWAYS BE WEALTH and INCOME INEQUALITY. The only difference is how individuals acquire wealth.

In a free market society, wealth and income are earned by providing goods or services to others and receiving a profit. The entity that provides goods or services in the most efficient manner will indeed accumulate more income. Those entities which do not operate in an efficient manner will at best stagnate, or worse go bankrupt. In a free market society, when one entity provides a good or service in exchange for payment, both sides of the transaction are wealthier and better off than before the transaction was made. It may appear if one entity provides more products or services than its competitors, it gains at the expense of others because it is accumulating wealth. While it is true the successful entity is accumulating wealth, it is not at the expense of those who trade with it. There is a mutual exchange of values.

For example, when you purchase a computer and pay for a Windows system, who is wealthier from this transaction? Bill Gates for accepting your money or you for owning an inexpensive system to navigate the internet? There was no loser in this exchange, you both came out better after exchanging values? Moreover, those who are professionally associated or employed by Bill Gates also became wealthier, by profiting along with him.Another win-win situation.

Although Bill Gates has become super rich by providing an inexpensive service to the masses, many will say the wealth inequality between them and Bill Gates is evil, even though both profited. The collectivist answer to this situation is to pass laws or regulations as to how much an individual "should" make and to redistribute all that is above an arbitrary figure.

Contrast this situation with a totally collectivist society, like North Korea. Can anybody disagree NK has wealth inequality? Many of the citizens are living in sheer poverty at best, and starving at worst. However, Kim Jong-Il and his cohorts are living in luxury by the use of brute force, not production.

I will briefly point out that America is not living in a free market economy. It is a cross between economic fascism, socialism, statism and crony capitalism. We are at the point where we will have crisis after crisis which will be blamed on free markets, rather than government involvement in the marketplace.

Government programs, no matter how well intended, consume wealth; they do not create wealth. Hence, America has reached the point where wealth can be accumulated, not by production, but by wealth extraction through political favors and programs.

CONCLUSION: There will always be wealth inequality, no matter what system of economics is employed. The difference is in a free market society, individuals accumulate wealth by producing goods or servicesto the masses. In a collectivist society wealth is accumulated by political favor. In a free market society, wealth is accumulated by voluntary exchange, whereas in a collectivist society wealth is accumulated by extracting and redistributing from the production of others. Which society do you think the individual will produce more?

The degree and time a society moves towards a collectivist system and abandons the concepts of free markets is the degree and time a society will decay into tyranny and poverty.

Does this mean to stick your head in the sand and not invest in real estate or notes? Heavens, no. Just be aware of economic conditions around you and act out of knowledge, not out of fear.

If you have a comment or a topic you would like discussed, CONTACT ME It is from your input I get many of my topics.

Copyright © H&P Capital Investments LLC
All rights reserved
Tom Henderson
a.k.a. THE NOTE PROFESSOR

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