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“What is the Current Discount?” I truly wish I had
a dollar for every time I have been asked that
question over the past 27 years. My response is
usually, “That’s like asking a jeweler how much
diamonds cost these days”. Obviously, a diamond is
priced based on size, color, clarity, etc. If one has
two flawless diamonds of the same size, they would
still have different prices based on color or whatever
(my wife knows far more about diamonds than I do).
For the sake of this article, a discounted trust
deed usually occurs when a seller carries back a note
and deed of trust – lets say in the amount of
$100,000. If the seller wishes to sell the note, the
investor or broker will buy the note at a DISCOUNT
based on the buyer’s pre-determined yield
expectations. Therefore, a $100,000 note may be sold
for $50,000 to $99,000 based on the following article.
If you understand the bond market you will see that
discounted trust deeds are similar to discounted bonds
in many ways.
There is absolutely no way to answer the question
with a note and deed of trust, as trust deeds are
discounted based on interest rate, term, monthly
payments, property location, position (first, second
or third), borrower’s credit, and equity. As an
example, if two sellers carryback a first trust deed
on neighboring identical properties with the exact
same down payment, the notes and deeds of trust are
saleable at a discount based on the other variables
mentioned above. As an example, if both notes are for
$80,000 with a payment of interest only for three
years, a carryback at 6% would be sold at a larger
discount than the next door carryback at 9%.
Therefore, if you are structuring a transaction with
the intention of selling the seller carryback, keep
this guide in mind. A higher down payment, a high
interest rate and, as importantly, a short term, will
result in a small discount. Conversely, a low interest
rate, long term and low down payment will combine to
produce a huge discount. |
Let me be even more specific. Let’s assume that an
investor wishes to yield approximately 12% on his or her
investment. A first trust deed is offered to the investor.
The buyer has good credit and substantial down payment. If
the face interest on the note is 10% and the due date is one
year, the discount would be slightly under 2%. A 2% discount
would earn the investor a 12.13% yield. If we use the same
figures and change the interest rate to 8%, the discount
would be approximately 3.75% to yield approximately 12%. Don’t
forget, I said the term of the note is extremely important.
If the interest rate is 8%, but the term is five years, the
discount to yield 12% (per annum) is exactly 15%.
By now I’m sure you’re “getting my drift” and
realize that discounts are figured to YIELD a certain
desired rate. An investor may want a yield of 12% on a first
trust deed and 14% on a second. To use the above examples,
the discount on a second trust deed with the same terms
would be approximately 3.75% discount on the 10% one year
note, approximately 5.5% discount on the 8% note and
approximately 21 ½% discount on the 8% five year note.
I hope I haven’t bored you with all of these figures
and I hope you get my main point. Discounts vary based on
the quality of the note, with interest rate, and note terms
being extremely important. If the borrower insists on a low
interest rate, i.e. 6%-8% make up for that with a shorter
term (six months versus one year). On the other hand, if the
borrower insists on a ten to fifteen year carryback, make
certain that the interest rate is higher with, perhaps,
interest increases every few years.
Many sophisticated sellers carryback a first and second
trust deed. In those instances the first would have a higher
interest rate and the second would have a lower interest
rate. In this way the buyer would average a market interest
rate. The seller would be able to sell the first trust deed
at a low discount and retain the second trust deed.
Peter Rosenthal
VIP Trust Deed Company |