Bumped Equity

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Bumped Equity

March 1, 2016
Bill Gatten
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BUMPED EQUITY – ‘NOT UNLIKE A SAVINGS ACCOUNT INTO WHICH YOU PUT NOTHING: BUT OUT OF WHICH YOU PULL THOUSANDS OF EXTRA DOLLARS IN A COUPLE YEARS

Let’s say you find a property that is worth perhaps $90,000 to $100,000.

You learn that you can have it for an MAV (Mutually Agreed Value) of $80,000 by making it a fast deal and just taking over the monthly payment obligation.

Let’s also say that the property needs, say, $4,500 or so to cover unpaid arrearages (‘assuming the lender won’t consider forbearance).

In order to make a future profit, ‘you now bump the equity (i.e., increase the current MAV (mutually-agreed value) for your Resident Beneficiary to, say, $105,000 and charge him/her, say, 6.0% to get in (about $6,500). You have now made $25,000 on paper and $2,000 in cash up front, plus a positive cash-flow along the way (‘i.e., ‘in addition to the principal reduction and future appreciation you’ll see over the term of the agreement.

You’re doing great!  Nuthin’ ain’t cost you nuthin’ so far!  But in this case, Nuthin is indeed worth Sumthin!  (‘With apologies to Janis Joplin and Bobby Mc Ghee)

Next, you make your verbal offer to the seller at $80,000, and explain that you are an investor and need to make a reasonable profit (maybe). You explain that since you will have to negotiate with you incoming Resident Beneficiary, with his/her permission you’ll need to put a larger than actual MAV on the offer: ‘i.e., in order to have plenty of negotiating room (‘as is virtually always needed).

Then, ‘when presenting the offer to the Settlor (seller), you show his actual refundable contribution as zero, but show yours as the difference between the acquisition amount (80,000) and the bumped MAV of $105,000. This doesn’t affect him negatively in any way, and could even lessen any tax burden he might have ‘if he will have Capital Gains to deal with (‘upon the trust’s termination).

Now, ‘when you decide to meet with your Resident Beneficiary prospect, he/she sees the higher amount and doesn’t worry about the difference, ‘as he/she will presume that you put in $25,000 in cash (‘unless you tell them otherwise).

The documentation will now show that at the end of the agreement’s term, you and your Resident Beneficiary will sell or refi and give the Settlor (your seller) his equity refund (‘which is zero in this case…‘unless there were to have been some equity for him at start).

At the trust’s termination (‘and that of the lease), you give yourself your $25,000, and return the Resident Beneficiary’s initial non-recurring closing costs (‘i.e., any closing costs that were a one-time expense); ‘following which you and your Resident Beneficiary split the remaining net proceeds relative to your respective percentages of beneficiary interest having been held in the trust: i.e., ‘depending on whether or not the requisite 10% beneficiary interest held by the Settlor during the trust’s term will be relinquished to you or not…’according to your initial agreement with the Settlor.

In certain cases you might have agreed (‘perhaps for added incentive) that the Settlor should participation in profit-sharing at termination ‘proportionately with his percentage of beneficiary interest held (‘although more often than not, the Settlor’s percentage is set to be fully relinquished  at termination in consideration of prompt payments and strict adherence to contract terms throughout the transaction).

Question: So why should the settlor have any beneficiary at all during the transaction’s term?

Answer: 1) So that there is no violation of any underlying lender’s Due-on-Sale Clause (12USC1701j-3); 2) so that the Settlor can have an insurance interest in order to acquire and retain Landlord Insurance Coverage (the tenant beneficiary obtains his/her own renter’s policy); 3) and so that the Non-Resident Beneficiary  will have access to the right of Depreciation for tax benefits (i.e., “Use it or lose it,”  ‘as they say ‘in reference to the IRS’ recapture upon sale, i.e., whether it has been claimed or not).

Remember that bumping the Mutually Agreed Value in this manner by, say, five or ten thousand dollars today doesn’t make the property any more valuable (today), or earn you any more money (‘today): ‘but it does give you significantly more profit at the end of the EHTransfer™, when the trust is terminated and the property is sold or refinanced, and net proceeds are distributed.

Question:  Why would anyone agree to take on the property at more than it appraised value?

Answer: Because they are acquiring a home of their own without needing new bank loan, ‘without standard credit checking; without a normal down payment; and because you don’t care about their credit as much, ‘as long as you have a couple (2 or 3) refundable payments held in the trust’s Contingency Fund for use in case of default and the necessity for eviction.  Inasmuch as, due to the trust, they can never claim having an equitable interest in the property (i.e., the trustee holds all of that), a foreclosure process is never necessary…’just simple, unfettered eviction pursuant to the agreement in the ancillary Triple-Net Lease.

Remember too that the posted Contingency Fund is for the purpose of making any missing mortgage payment; and no matter how much money may be in the fund, a default in payments will result in eviction and termination of the trust (‘if not cured within the allotted time).

Note as well, that irrespective of any amount in the Contingency Fund: ‘in the event of a default, it will likely be yours to keep, in so much as the tenant-buyer will still owe the missing payment/s and all remaining payments on their lease: ‘as well, they also owe any requisite refurbishment and re-marketing expenses.  And also, for any amount still outstanding, they are subject to lawsuit and obligated to pay you, voluntarily nor not, what you are owed ‘should they come into money within the next eight to ten years (‘and depending upon where you live, your lien against them is renewable after that time period).  Note that the defaulting party’s incentive to pay you what you are owed is intensified when they realize that your lien can prevent them from getting credit for buying a house or car, ‘or maybe even getting (or keeping) certain jobs.

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Another way to bump (or “pump”) a property’s MAV is to make your offer at the $80,000 amount, then get the offer accepted in writing: ‘then go back to the Settlor and suggest that for your benefit, the $80,000 be crossed-out and initialed, and replaced with a higher number in order to give you some negotiating room with your incoming Resident Co-Beneficiary (‘you point out that doing so will raise your beginning contribution without affecting his income his tax basis (‘could be a good thing if he has equity).

You then say: “Let’s make it, ‘Oh, say, $105,000; ‘and although I probably won’t get anything close to that, ‘it gives me some room for negotiation.”  Again…you now have the higher MAV showing in the documents and needn’t hide anything from the resident (or the Settlor).

When your Offer to Acquire is accepted by signature of the Settlor, that’s also a good time to have him/her execute the limited Power of Attorney, so that you don’t have to go back to him for signatures later.

That’s it…’ain’t no big deal!  Just keep on bumpin’!

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