S.E.C. Real Estate Observer

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The recently well attended S.E.C. meeting in Carefree, Arizona, was the epitome of a selfless collaboration of problem solving professionals. The treasure trove of experience, knowledge and creativity highlighted a most productive marketing session. The years of work, education and building a systematic and principled Society of Exchange Counselors foundation, coupled with an arsenal of creative talent, is just what the doctor ordered in these times of economic uncertainty. So it is, that the tools honed and fashioned by the S.E.C.s, are an antidote to the real estate crisis we face today. As our new President Tom Langel referenced, “It is our time.” The meeting was full of participants highly motivated by the quest for solutions to their people related property problems. As anticipated, many problems were associated with the lack of “market financing.”

Obviously most conventional lenders are presently weak kneed and scrambling for dollars to capitalize their balance sheets. I must emphasize that there are still some small and medium sized banks, local in nature that remain in good standing but in general most are suffering. When a bank works on a 5%-10% net worth margin, more or less, it is easy to see why they get paranoid when the value of their assets decreases by 20%-30% overnight creating a “negative net worth”. Ironically, these are the same banks that require 30%-40% equity, personal guarantees, your kid’s trusts, your dog and everything else you own, to make a loan to you. Who is selling who? Maybe we should interview our banks to see if they are worthy of our good credit.

So where does financing come from with this topsy turvey lending environment? It is my opinion that investors, individuals, and unconventional lending sources tend to migrate to borrower capital users and needs by filling the void left by inactivity of the conventional lending crowd. They look and seek the capital user.

It is reasonable to assume that not everyone is going to be lining up at your office door to entrust their money to you. Then how do you tap into the money resource? There are several methods but for the sake of this article I wish to focus on one concept that has provided benefits over the years. The formula is what is referred to as the “Discount Sale-Buy Back-Lease Bank Formula.” This Formula is described with many other useful formulas in a comprehensive formulas book available through the Society website.
Let’s set the stage.

You (or your client) own a $1,000,000 appraised commercial land parcel, which is free and clear. You have an opportunity to acquire another property, which has a killer upside, but you need $500,000 cash in 30 days to take advantage of the opportunity. Your local bank is on a slow morphine drip and your 25 year liaison with your loan officer ended when he got laid off. So where do you go?

You scramble to find other conventional sources, but you come up short. You decide, as a last resort, to attend a local marketing session in the hope of finding a solution. A local broker happens to pitch a client who is running out of time on his 1031 and needs to place $500,000 immediately. A big tax awaits the client if a substitute property is not found quickly. The broker describes the owner as picky and wants a safe position, cash flow, and a little upside.

You approach the broker with an offer. Here is how it works.

1. You agree to sell your $1,000,000 property to the Broker’s client for $500,000 with the proviso that:
   1. The client agrees that you can lease the property back for three years for what is in effect an 8% annual return rate (the “Lease Payment”); and
   2. The client agrees that you can buy the property back within the three year lease term at a buy back amount equivalent to 105% of the purchase price cumulative each year.

Effectively the 8% monthly return in the form of the “Lease Payment” coupled with the buyback return at 105% of the purchase price gives the client an annual yield of 13% interest. Obviously, this is a good rate of return and gives the investor client a highly secure position in the property. More importantly, if you default he gets a $1,000,000 property for $500,000.

Now this may sound a little expensive and maybe risky, but let’s analyze. If you go the conventional thieves temple (bank…if one is even lending) you would have to pay $10,000-$15,000 in lender related costs inclusive of appraisal, environmental, lender legal and the list goes on. Secondly it would take them 60 – 90 days just to approve the deal and get an appraisal. The timing alone puts your 30 day killer opportunity at risk.

However, the advantages are no loan committee, no credit minion located in a padded room in the basement of the bank purveying your last 20 years of tax returns and the intrusions go on, inept and slow responses, and bureaucracy of the ill fated “loan committee” approval. So in this context, does it appear reasonable to take this faster route to achieve your goal of accruing a new profitable deal?

A caveat is noted here; if you can’t be assured of making money on the new deal, then don’t play the game. Also be wary that you must be able to meet the timely lease payments you have just created for yourself.

Let’s look at some possible variations of the Formula:

• First it can also work in a situation where you need to pay off a $500,000 loan secured by the same $1,000,000 parcel. Basically, look for investors who want good returns and safety typical of the previously described example. The new investor buys your property for $500,000, which allows you to pay off the loan. You follow the same lease back and buy back arrangement as described in the earlier example.
•  This is also a great tool to use when a lender (a $500,000 loan) secured by the $1,000,000 property you own, is willing to discount its mortgage to say $400,000. Again by obtaining the investor to acquire your property for $500,000 you use the proceeds to pay off the discounted $400,000 mortgage. The extra $100,000 could be escrowed for future lease back payments, taxes etc.
• Lastly, if the investor says “Hey I will give you the $500,000, but you have to take a $200,000 free and clear commercial lot as part of the deal.” You agree to sell your $1,000,000 land, as before, for $700,000 to the investor. The investor 1031’s into your land with the $200,000 commercial land parcel and cash in the amount of $500,000. Here is where an adjustment in the rate of return may be applicable. By contrast to the cash, the land has no return. The cash has an effective return of 13%. So $200,000 at 0% blended with $500,000 @ 13% produces a blended rate of return (lease back amount) of say an estimated 10%.

Again, the S.E.C.’s have developed a refined approach to handling people related problem solving by using innovative techniques applied to real estate. There remain many “coupled” formulas, which piggyback on the “Discount Sale-Lease Back-Buy Back Formula.” Again, the way to find alternative financing is to think “outside the box” of conventional approaches. “It is our truly our time.”

Stephen D. Barker, S.E.C., Chairman of the Board and Chief Executive Officer of Catellus Group, LLC, a Michigan and North Carolina based corporation, has specialized in all facets of commercial investment real estate including development, rehabilitation, management and finance.