for fun let me show you a deal that will blow your mind. Lay
back and fantasize for a while. Come along for the ride and
see if it jump starts your greed glands. I control the
vertical. I control the horizontal. The deal is real. The
profits are realistic.
At times, I like to show people the potential beyond their
current position. A little like showing you a picture of
Chateau Lake Louise in Waterton, Alberta, Canada - even though
you may currently be driving though the desert in Arizona. Itís
on the road, just some miles away.
If it makes your brain hurt, donít worry, it did the same
for me when I needed to bring in the investors and explain it
to them. Some deals are harder to explain than they are to
understand. Itís easy to know that a deal is profitable
(especially when you get something for free), but sometimes it
takes massive spreadsheet calculations to show someone else
The "Paper Trade"
It started with a standard "paper trade"
scenario. We just had too many deals on the table at the
moment and not enough un-encumbered paper (most of it was
financed at very attractive rates).
The "Paper trade" in itís simplest
format is buying notes at a discount and then trading them at
full face value for real estate equities. I buy a $100,000
note for $70,000 (30% discount) and then use it
as collateral to buy a $100,000 house. I end up buying
the house at 70% of market value. Most of the time the
"Trade" takes the form of using the note (or notes)
as collateral - a term called "hypothecation."
$100,000 Property Value
$100,000 Note used as collateral (Hypothecated)
$ 70,000 Cost of note purchased and used as collateral
$ 70,000 New loan taken out on purchased property
$ 70,000 First loan - new loan from Last National Bank
$ 30,000 Equity - that didnít cost a cent
To get the cash needed, I finance the property for $70,000
and it becomes a nothing down deal at 70% of value with a
positive cash flow.
A "Collateral Rental"
Since we didnít have the notes we needed at the time, and
because I donít like to pass up a good deal, I suggested the
creation of new notes on an investors real estate equity. In
other words, we buy the property using seller financing that
is created against the equity in the investorís property.
This concept is called a "collateral rental." The
investor puts up his equity and has as security the equity in
the house that is being purchased. The investor gets a 3% rate
of return on his un-productive "dead" equity and has
no cash invested. That is not 3% interest, it is a 3% spread
on borrowed money (equity). Little risk is involved, because
the investor has the house as collateral also.
So, the numbers on the deal look like this:
$350,000 FMV of property
$300,000 Sales Price
$ 30,000 Down Payment
The $270,000 Balance is a note to be created against an
investorís property. Terms of the note are 9%
interest, payable $2172.48 per month for 360
months. I execute a compensating note to the investor secured
by the property being purchased for the same amount with a 12%
rate (resulting in a 3% spread). This results in a
payment to the investor of $2,777.25 per month and a
resulting net profit of $604.77 per month for the
investor. Remember, the investor has no cash invested and is
For an added cushion on this deal, to make payments for the
first year (and to make it a 100% free property) we pull $40,000
in cash out of the property with a new loan. We also pull the $30,000
down payment out, resulting in a new first loan of $70,000.
The investorís note is in a second position, but has the
added security of the cash cushion (of 40k) - in the
Now, the long term plan is to acquire the notes to use as
collateral instead of the investorís property. This is a "Substitution
of Collateral" technique. In other words, when
the notes are available, they are used as collateral and the
investorís property is released.
The "LOC Twist"
When checking into the financing, (through our in house
conventional mortgage company) we found a new program that is
an "equity line of credit" with no
points, few closing costs and 9.375% interest - up to 90% LTV
on the property. In other words, the lender is
effectively giving us a credit card to buy notes with and a
$315,000 limit. I like that.
As a note becomes available (at a discount of 30% or more),
the line of credit is used to purchase the note or notes. The
notes can later be used in one of two manners. One is to
substitute collateral to free up the investors property (the
collateral rental) and the other use could be to use the
income from the note to offset the payments. The higher yield
on the notes makes it a profitable deal, along with the
discount in the fair market value. Even after the cost of the
collateral rental, the property will cost below 70% of value
with nothing down and no payments for the first year. Next, Iíll
show you how to cover the payments on the second through the
30th years so that the property is 100% free.
Portfolio Turnover and Improvement
When the paper is purchased and substituted, the investor
will be out of the picture. He received his rent for his
equity (You can rent a rental twice!) and has been paid out
and his property is now unsecured.
We are left with a note of $270,000 secured by $270,000
(or more) in existing real estate paper (notes). As you
may know, the average 30 year note goes about 4.2
years. Letís assume that these notes are long term notes and
according to the 4.2 year number, 25% of the
portfolio will experience the process of
"Refunding". This process is the dread of CMO based
mutual funds, and the greatest reward to discounted paper
In other words, the notes will pay off at face value and
result in a profit to us. Why? The profit comes from the fact
that we can again substitute paper with the previous home
owner that took the seller financing. Letís say one of the
notes in the portfolio is for $75,000 and pays off at
face value. Yes, itís collateralized, but could we take $50,000
and buy another $75,000 note to use as collateral
(substitution). That leaves us a profit of $25,000 to
make payments for year number two. The next year, the same
Those are the "natural" statistics. Portfolio
turnover and enhancement can be over 50% per year when the
portfolio is actively worked. Encouraging payoffs and using
over 117 different techniques to improve notes and enhance
their yields results in extraordinary profits.
Weíre working on an even nicer deal right now. A land
developer puts up his land as a collateral rental for the
purchase of a single family "fixer." The line of
credit (LOC) on the home is then used to draw upon to buy the
paper created as the developer sells lots. A 30% discount on
the created paper leads to a great yield and an eventual
substitution of collateral for the holder of the seller
financing that is created by the purchase of the single family
home. The home is purchased effectively at 70% of value. After
modernization and sale of the single family home, there should
be a profit of over 100,000 dollars with nothing invested
other than some "Brain
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