S.E.C. Real Estate Observer

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The most disappointing issue for us old “true exchangors” (before cash-out was available on either end) is that listing postings don’t provide enough information about the intent and circumstances of the owner who wants to change current ownership. Although some state laws and professed broker ethics suggest that such private information is detrimental to the “Seller” and should not be exposed, complicated people – motivations are usually not solved without the transaction creators being fully aware of each participant’s true objectives, all tools available for the process, and the real estate equity in question (i.e., additional items, credit, talent, partners, flexibility, family geographics, etc.). Listings that show a lack of client counseling result in the listing broker not knowing what flexibility the client may provide to a possible transaction. These listings are generally passed over by exchange brokers who don’t want to “shoot blanks.”

A way of suggesting transaction possibilities for a client without disclosing secrets might be to have the broker offer alternative transaction suggestions that he or she wouldn’t shirk from presenting to his client. Examples: “Although all clients would like ‘a clean deal,’ I would present proposals to partner him in a transaction that provides the following benefits:_________; a proposal to have my client add his collectibles, some cash, a note he owns ($_____ payable _____, etc.); a proposal to transact only part of his unwanted equity to solve part of his objective, a proposal to lease/option his property as a way of getting out of management; a proposal that requires that he bring in a partner with signature or more cash than he personally will contribute if the end result is _____________; or any transaction that would get him off the existing loan, and so on.”

Sometimes, regardless of the client’s motivation, the equity he thinks he has is (in current market terms) nonexistent. That motivation can still be the basis of a transaction that would delight him (because counseling discovers the other contributions available toward a solution). Weaver and I used to teach a formula called “Backside Benefits.”

Backside benefit examples:

A client came in who was tired of paying on a promotionally sold lot in a recreational development where the market value was likely less than the existing loan he’d already been paying on for some years. We had another client with a duplex who was unable to keep the existing loan current and was about to lose it. The encumbered lot was offered together with small cash and assumption of the existing duplex loan (the negative cash flow was not a problem for the new owner). The encumbered lot was gifted back to the lender (in California, purchase $ lenders cannot pursue personal liability).

A very prolific early S.E.C. deal doer, Jim Reed, used to have lots and land all over the United States that he would offer in trade for most motivated equities, such as eaters, unwanted personal property (usually with wheels, not working, etc.), geographically unacceptable or high-talent-required equities, over-encumbered properties, and so on, and he always wanted “$200–$1,000 cash today, so I can pay my hotel bill and get gas to get home” plus a small carry-back note with small monthly payments against the lot or land being traded in. The note was the “backside benefit” or usually the whole benefit of the deal.

I witnessed a proposal made to Jim Reed at a Sacramento Exchangors Meeting in the late ’60s where Billy Moon (another prolific deal doer in Sacramento) offered two new encumbered duplexes in a suburb (that were eating) for Reed’s parcel of land. Reed said, “I accept the proposal, but I will only take one duplex.” Moon got only half the backside benefits hoped for.

I was new and naive in exchanging and acquired a 1927, 27ʹ cabin cruiser, docked in Sacramento, from Billy Moon by just signing on a new 5-year loan I had to apply for against the boat. What was his backside benefit? (We named it The Sour Owl and brought it to Sausilito and syndicated it with friends to help amortize the loan). After years of little use, it sank at the dock and contributed mightily to one’s doctorate from “Hard Knocks U.”

Every auto (boat, plane, furniture, etc.) dealer offers to take a trade at too high a value or offers 0% financing, and so on, to get the backside benefit of an employed payor on the purchase note that he can hypothecate to his bank as his “backside benefit.” How can you use such a perspective in your transaction-causing business?

Don’t “turn up your nose” at questionable equity. Counseling will tell you whether your client will add something to cause a transaction. Most REO transactions during the late ’80s with the S&Ls that were mostly negative net worth (according to their regulator) would make deals that would get them paper for their REO real estate that could be out of the “written up assets” category. Challenged by other brokers who claimed that institutions would never take “you-can’t-find-it land” in remote Oregon, I proposed a deal to an S&L to take 10 new houses it had foreclosed on. I offered 160 acres of land + a first loan on each of the 10 homes signed by dentists of good credit. The loan amounts were 75% of their book basis, and the regulators would be at least a year discovering the questionable value in the 160 acres far removed from the county of the S&L (and from everywhere). So they got 75% in “admitted assets” and 25% in “discover later,” and neither of us has seen the land as of today. It was an important change in their net worth at the time, based on the regulator’s rules. I kept the lot under each house and leased/optioned it to the dentists to keep their home on, and they only had to pay closing costs to own the managed 100% financed tax shelters. After occasional negative cash flow over 5 years, they each cashed out in a better market and made big cap gains, and the IRS helped out along the way. The leased lot owner exchanged some, kept some, and was very happy with the results of his 160 acres.

Note: The above example also illustrates the not-often-enough-used joining of various entities’ assets to acquire a proposition—from which each of the various entities can later separate successfully. The “out-of-the-box” thinking process that eases such solving evolves from the “stone soup” mental process of causing transactions. Even when cash is plentiful, this knowledge and counseling is still relevant for your clients today.