Builders use paper in many ways.
1) SELL A SECOND
Some builders make it easier to sell homes and open the
market to lesser qualified buyers through taking back a second
after a lower LTV first (with the knowledge and cooperation of
the lender - not in "secret"). Depending on these
notes and the LTV ratios the discounts are usually quite high,
but they cut down on holding costs (expensive with a construction
loan) and marketing costs.
2) TRADE THE SECOND
Builders can take the second and trade it into other
property to be developed (land, lots) or even for materials.
This can happen at face value in some cases or through "Lemonading"
which is the process of adding ingredients together. As the
saying goes, "If life gives you a lemon - make
lemonade". The term lemonading came about where you add
something you don't want in with a nicer package.
An example of Lemonading is adding cash or a note in with a
property that you are having a hard time marketing. So, maybe
the property has a short term negative cash flow and you add
in a short term note to balance the cash flow (in that case
the note is the "sugar").
So a builder might use the note individually in a trade or
as part of a bigger package. That could look like $80,000 cash
and a $20,000 note for a $100,000 parcel of
A builder can also take these notes and go to a bank REO
department that might have some land he would like to develop.
A big win/win. .(See "Overtrading")
3) KEEP THE SECOND
Builders can end up really short on cash flow sometimes. A
note (even a higher risk one - that he created) can balance
out the cash flow or might make a better investment than
whatever else he/she is investing in.
Some builders put notes into their pension funds or other
investment portfolio (like personal - buys the note from his
company). Of course, the pension fund cannot necessarily buy a
note from you or your company, but the note can be created
into the pension fund if you do it in the right way.
4) BORROW AGAINST THE NOTES
Though the notes might demand a high discount to sell them,
they will build the builder's net worth and borrowing power.
That's one of the nicest things about paper. The more you buy
- the better you look. They beef up the overall financial
statement and are also an asset that a banker might loan
against because they will base the loan primarily on the
builder and their credit. It might be possible to borrow more
against the note in this manner than the builder would receive
by selling it. AND - there are tax incentives to borrow
against notes instead of selling them.
5) BUILDER WITH A NICE
Sorry. (It's that Bill and Ray humor that rubs off) I have
a friend who is a long time builder that occasionally just
goes without the banks. He writes his own paper - to "Fannie
Mae" standards and now has several million in his
pension fund. It's also very liquid. If private paper is
documented and collected properly FNMA will buy it.
6) SIMULTANEOUS SALE
Just as investors can buy properties through creating and
selling a note, the builder can do the same. Again, it may not
be as good as going to the bank, but might open things up to
more buyers and result in less holding costs and marketing
costs. The builder could possibly even work out a buy down on
the rate or put aside some cash to buy down the payments for a
7) "BACKSIDING PAPER"
Many builders and developers have a strategy of development
where they fund their deals through selling land, property,
condos, etc. on seller financing with a buyer in place that
generates cash for more deals.
Land Developers have used this for years. They buy the land
- usually with a large percentage of seller financing - and
then divide it and sell it for low down on seller financing.
They then sell the notes to buy more land and do the same.
I had a friend doing this with "Condo
Conversions". He bought a large apartment complex and did
a condo conversion a few units at a time (usually easier with
a stock cooperative "Co-Op"). As one unit was
complete, they sold for a low down on seller financing - at a
much higher price than his cost now that it was a condo and
had been upgraded. The cash then went into converting more
8) PAYING PAPER WITH PAPER
Now, to take it a step further, some developers pay their
seller financing with the seller financing they create -
totally bypassing the discount. I.E. - buy the land,
apartment, etc. with seller financing and as you develop and
sell on seller financing, that is used as full credit to
reduce the existing seller financing.
The builder can also use the seller financing (notes) as
payment for many other forms of debt. I have a builder friend
that became very over-leveraged in a bad market. He used his
banking relationships and knowledge of paper to actually
borrow money from the banks to buy paper and then trade that
out (sometimes to the same bank) to retire his debt. Everybody
wins and he and the bank avoided bankruptcy.
Just a few of the ways to use paper as a builder
About the Author . . .
John D. Behle is one of the foremost educators and
practitioners in the field of discounted paper investment. His
innovative strategies and techniques have shaped the industry.
With over two decades in the industry and an extensive
background in real estate and finance, John Behle adds a
wealth of knowledge and experience to his creative
John holds an National Council of Exchangors "Gold
Card" and an EMS designation. He is also listed in Who's
Who In Creative Real Estate. John Behle is the author of
several hundred articles published in national magazines and
newsletters and of several ground-breaking real estate paper
* The Paper Game Trilogy
* The Paper Game 5-Day Video Training
* Millions Of Mortgages In Minutes