Seller Financed Real Estate Notes
They say “ a rose by another name, is still a rose”- but the same can't be said for real estate notes. The private real estate note industry is made up of several sectors, generally categorized by the type of collateral securing the paper. For example, real estate, mobile home and business notes are all different types of cash flows instruments that are regularly bought and sold in the secondary market place. Various “niches' exist within these sectors, which differentiate them even further. For example, there is no such thing as pure real estate note- there are residential notes, commercial notes ( further broken down into sub-niches such as multi-family residential of more than four units, retail properties, gas station notes, land notes, mixed-use property notes, special use property notes, etc. These notes are also differentiated between senior and junior lien priorities. Different types of risk factors, and collateral assets, exist for each note sector and niche. These differences are reflected in the various grading mechanisms that apply in the individual note segments, the diversity in yield requirements and investment to value thresholds for each sector.
Residential real estate notes are generally tend to have lower discount pricing than similarly commercial real estate notes. When looking for real estate notes secured by single family properties, real estate note buyers generally want to see a down payment of at least 10%, though down payments of 5% is acceptable. (20% is considered ideal). The acceptable credit scores for these notes can range from 500 to 650 or better, but usually credit scores of 550 to 620 supports the majority of the real estate notes that are sold. Maximum IVT (investment to value) levels range up to 95% of the balances remaining on these types of notes.
Real estate notes secured by commercial properties tend to require down payment ranges of 15% to 35% although 25% seems to be the norm. Credit requirements are a little tighter, and investors typically look for credit scores of at least 600+ although a score of 650 seems to be the most preferred. The investment to value threshold for commercial real estate notes ranges from about 60% to 75%, with the norm of about 65% to 70%. Real estate notes are usually non-recourse as no personal guarantees are required. Also, with real estate notes secured by income producing real estate, note buyers will rely much more on the operating history in making a buying decision. The debt coverage ratio can go a long way in making up for other weaknesses in the real estate note, such as the down payment or credit issues. Most other types of notes, including business notes, don't have that luxury!
Business notes are much higher risk than real estate notes. The two factors that help contribute to the risk is the large portion of the purchase price in the sale of the business is based on the expected future earnings potential of the business. No matter how carefully quantified the earning potential might be the real value is not rocket science. In most cases, tangible assets are typically 50% or less in a business note, which creates the problem of pinpointing it's net worth. And unlike real estate, many business assets are difficult to objectively value. The value is further complicated by the lack of effort most business sellers who fail to get an business appraisal. Therefore, business note investors need to offset this misrepresentation of value by wanting to see higher down payments and overall credit ratings from the business buyer.
Down payments are typically range from 20 to 40% for the purchase of small businesses, although the customary target down payment range is 33 to 40%. In addition, business note buyers look for minimum credit scores of 620 or better, with preferred scores of 650 on up. Also investors look for personal guarantees to back up the note. Most of the time, ITV's for a business note are likely to run anywhere from 40% to 65% depending on the type of business, the tangible value collateral securing the note, and several related factors. Although the parameters can be somewhat relative, a well secured and located note of high quality on some land around Lake Tahoe will fetch a higher price, and higher ITV threshold, than a note secured by the Bates Motel.
Residential real estate notes are generally tend to have lower discount pricing than similarly commercial real estate notes. When looking for real estate notes secured by single family properties, real estate note buyers generally want to see a down payment of at least 10%, though down payments of 5% is acceptable. (20% is considered ideal). The acceptable credit scores for these notes can range from 500 to 650 or better, but usually credit scores of 550 to 620 supports the majority of the real estate notes that are sold. Maximum IVT (investment to value) levels range up to 95% of the balances remaining on these types of notes.
Real estate notes secured by commercial properties tend to require down payment ranges of 15% to 35% although 25% seems to be the norm. Credit requirements are a little tighter, and investors typically look for credit scores of at least 600+ although a score of 650 seems to be the most preferred. The investment to value threshold for commercial real estate notes ranges from about 60% to 75%, with the norm of about 65% to 70%. Real estate notes are usually non-recourse as no personal guarantees are required. Also, with real estate notes secured by income producing real estate, note buyers will rely much more on the operating history in making a buying decision. The debt coverage ratio can go a long way in making up for other weaknesses in the real estate note, such as the down payment or credit issues. Most other types of notes, including business notes, don't have that luxury!
Business notes are much higher risk than real estate notes. The two factors that help contribute to the risk is the large portion of the purchase price in the sale of the business is based on the expected future earnings potential of the business. No matter how carefully quantified the earning potential might be the real value is not rocket science. In most cases, tangible assets are typically 50% or less in a business note, which creates the problem of pinpointing it's net worth. And unlike real estate, many business assets are difficult to objectively value. The value is further complicated by the lack of effort most business sellers who fail to get an business appraisal. Therefore, business note investors need to offset this misrepresentation of value by wanting to see higher down payments and overall credit ratings from the business buyer.
Down payments are typically range from 20 to 40% for the purchase of small businesses, although the customary target down payment range is 33 to 40%. In addition, business note buyers look for minimum credit scores of 620 or better, with preferred scores of 650 on up. Also investors look for personal guarantees to back up the note. Most of the time, ITV's for a business note are likely to run anywhere from 40% to 65% depending on the type of business, the tangible value collateral securing the note, and several related factors. Although the parameters can be somewhat relative, a well secured and located note of high quality on some land around Lake Tahoe will fetch a higher price, and higher ITV threshold, than a note secured by the Bates Motel.
posted by Robert Pomerleau | 1:15 PM
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