Exchange Loan Back
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Editor’s Note: This article first appeared in the April 1974 issue of the Real Estate News Observer.
Creative financing is the soul of real estate problem solving. It implies the use of a promissory purchase money note secured by a mortgage on some parcel or parcels of real estate in some degree that is acceptable to both parties of the transaction. At first, you would think the successful degree to which this concept can be employed is limited only by the imagination of the problem solver and the motivation of the property owner. However, the framework of custom often imposes limitations that sometimes hold us back. We never know what the market will produce in the form of solutions, and the best solutions are infrequently conventional, so we need a method that will produce the most flexibility in the minds of our clients and that will give us a reasonable approach to the market with the widest margin of public acceptance and as few limitations as possible.
When thinking creatively to solve a real estate problem, you usually will find that your client is resisting every solution that you offer when the solution that is offered requires that he accept notes and mortgages to complete an installment sale or to balance equities in his favor for an exchange of real estate. He will continue to resist as long as you wait until the last minute the offer is made before you explain the advantages of the offer and prepare him to make the concession he must make in order to dispose of his property. On the other hand, he will not resist when you warn him ahead of time, at a time when his mind is clear on the advantages and disad-vantages that can result from this method of financing a transaction.
That is why it will be prudent for you to program your owner from the very beginning by reviewing hypothetical situations which will include some form of creative purchase money notes and mortgages as part of the solution to his problem. When these ideas are presented to him in the form of a “Verbal Proof Story” (a technique that is explained in the Harding Seminar), he views the incident as an objective third party. You are not trying to get him to make a personal commitment for an unknown quantity, and you have eliminated a threatening environment that makes him uneasy.
At an early point in the chain of Counseling events, I try to determine what kind of cash is available to the owner. Using the Harding method for accomplishing this, I determine the financial strength the owner can demonstrate to solve his problem.
This method is practiced to determine how many cash dollars can be generated to solve the problem that has been presented, and the items of information discovered give me ; the confidence to present solutions that require that my client will be willing to “bank” any proposed transaction that will solve his problem.
“To bank” is a term that is used in Florida, which means to loan money. When an owner takes back a purchase money mortgage, he does, in effect, loan that amount of purchasing power to the buyer. However, to go one step further, you ask the owner to loan “hard” dollars, and literally be the banker in the transaction …taking a note for the amount with terms agreed upon, and secured by a mortgage or Trust Deed on the property to which he just gave up title. This becomes a very effective and efficient tool for the solution of exchanges that require dollars under a “crowded” dollar market, or a market in which an institutional charter will not permit “hard” dollar loans on certain properties, such as vacant land.
Other exchange counselors have used this technique from time to time, and it has become known as Harding’s Exchange Loan-back formula. One owner (usually one who would be reasonably wealthy) exchanges his Free and Clear Property with another owner who needs dollars. The owner who needs dollars agrees to make the exchange, as long as the wealthy man agrees to loan back “hard” dollars on the property upon which the wealthy man is giving up title in the
exchange.
Here is a real-life example from a case in the file where a very wealthy man helped solve real estate problems by offering to loan thousands of his own dollars in return for a note and then permitted the note to be secured by a mortgage on the property he was giving in the exchange. The interesting part of this example is the fact that Mr. Wealthy produced the dollars for the “loan back ” by borrowing them from the bank, using certificates of deposit for security (CDs).
The exchange loan-back is a special form of creative financing in the finest definition of the term.
WARNING: The client must be prepared for this during the counseling session. It will not work when you wait until you need the dollars.
In this solution there was a WEALTHY, qualified client who had no immediate need for DOLLARS, but could benefit from a tax-deferred exchange, and the following was employed to supply DOLLARS where no institution loan could be made.
Example:
Andrews was a wealthy man with $50,000 in DOLLARS resting in CDs with his local bank. He also owned a piece of vacant land in the path of progress with a market value of $100,000, which would be taxed at the full capital gains rate if he took advantage of the market and sold.
A proposed tax-deferred exchange would give him the buying power to reinvest in a $450,000 Warehouse with a $350,000 1st mortgage balance of $100,000 equity.
Bradford was a builder who owned the warehouse, and he needed to build more. He liked the land owned by Andrews, but needed to transfer ownership in the warehouse in order to buy land.
Solution:
Counselor suggested that an exchange be made, “equity for equity,” with Andrews agreeing to loan $50,000 to Bradford with subordination privileges in the event Bradford decided to build another structure.
Results:
Andrews borrowed $50,000 at 8% from his local Bank pledging the (CDs) for collateral,
their rate of interest _______ 6%
Cost of $50,000 loan ______8%
Net cost of CD loan ______2%
Andrews loans the $50,000 to Bradford and gets a note and 1st mortgage on the vacant
land at the rate of _____ 9%
Total gain for Andrews on bank move ________7%
Assume the cost basis in the vacant land to be $10,000, Andrews produced a tax-deferred exchange that gave him a new cost basis of $360,000, for a brand-spanking-new depreciation schedule.
Bradford takes the vacant land and $50,000 cash in his dealer corporation that owned the ware-house, and…pays the Banker in GREENBACKS.
