NPRO
H & P Capital Investments LLC
Issue 34
April 2008
Commercial Notes Do's and Don'ts
by Tom Henderson
hp apt2

For those who have taken my apartments class, you know the importance of DSCR (Debt Service Coverage Ratio). The formula for DSCR is as follows.

Property's Total Annual Income
(Assume Full Occupancy)
- Property's Total Annual Expenses
(Include Vacancy, Taxes, Insurance :Do Not Include Debt Service)
= NOI (Net Operating Income) Banks refer to this as FUNDS TO SERVICE DEBT

NOI divided by the annual debt service (Principal and Interest Payments) = DSCR

This formula allows lenders to determine if the property will generate enough income to service the debt. A DSCR of 1 is a break even at best. Anything below 1 means the buyer is going to have negative cash flow. Is it any wonder lenders want a DSCR of 1.25 to feel secure

For example, if a property has a NOI of $50,000, and annual debt service of $50,000 (P+I), this would be a break even. In other words, a DSCR
of 1, which is not a good situation to be lending money on. If anything out of the ordinary happens that costs money, the property will not support itself. This means the buyer is going to have to dig into his/her pocket, not fix the problem (more vacancies), or not be able to make your payment.

By the same token, let's look at a property with a NOI of $50,000 and a debt service of $40,000. If we divide $50,000 by $40,000, we come up with a DSCR of 1.25. In this situation, there is room for unexpected expenses, and still have money to pay the debt service.

If you sell your property using owner financing, you should use a DSCR as a criteria also. You do not want to sell your property where the odds are great the buyer will not be able to make his payments. Make your note accordingly.

A case in point. A note seller brought me a note where the payor put very little down. The seller inflated the price of his 8 unit apartment. Now to add to his problem, he charged 12% interest. To continue with our analogy, with a NOI of $50,000, the debt service was a whopping $55,000. The seller was flabbergasted when I explained to him that this was a foreclosure in embryo. "Are you receiving payments regularly?", I asked. "He has always been a month late. But he always pays", was the reply. The seller just now realized his buyer was late because it took him two months to get enough money to make one month's payment. It then can to light that there were now three vacancies. We did not even get into deferred maintenance. I suggested he immediately get with his buyer and recast his note.

Had the seller known about DSCR, he would have known his buyer would not be able to make his payments. Note buyers will also look strongly on DSCR. Next to having root canal work done, taking back a property with high vacancy, with deferred maintenance is my least favorite pastime.

Here are some Do's and Don'ts when selling your apartments or commercial property.

1. Be sure to get credit information on your buyers. (Even if they are an LLC or a corporation)
2. If an LLC or corporation, have your buyers sign a personal guaranty for the note. This is often a separate document. Although gurus will tout non recourse and no guaranty, if you want to sell your note, your buyers are going to have to be personally liable on the note.
3. Be sure to have "assignment of rent" clauses. If your buyer stops paying, you want the authority to collect rents to pay you off.
4. Demand 20% or more down. (If you want to sell your note)
5. If you inflate your property's value, do not inflate the interest and terms also. The inflated price is "interest" enough. Make the note easy to pay. You might have difficulty in selling your note at an inflated property value, but you will enjoy a long, healthy cash flow. (Be careful of imputed interest. Ask your accountant)
6. Look at your buyer's DSCR. If it is not 1.25 or more, chance are you are going to be taking the property back at some point. If the DSCR is in line, you definitely going to get a better price than a break even DSCR.
7. Remember, just like residential notes, the more down payment you get, the more money in your pocket. Low down payment, low credit scores and low DSCR will not translate into selling your note.
8. In your contract, separate the price of the building, the land, furniture and goodwill. This will keep the note buyer from having to "guess". When we have to "guess", guess whose side we favor.

These are just a few tips on owner financing your commercial property. Feel free to contact me if you are selling your property using owner financing. We can go more into detail on how to achieve your goals, and avoid traps.

If you know of anyone who has a Note to convert to cash, contact me for professional pricing.
Remember, I will pay referral fees at the least, and will also split my profits if you would like to "co broker" a Note with me.

Copyright H&P Capital Investments LLC
All rights reserved

Tom Henderson-Note Investor
Buys Your Real Estate Notes
note deal

Remember, I pay referral fees on Notes If you would like to
"co broker" a Note with me, I will split my profits with you.

ONLINE NOTE QUOTE
Tom Speaks: Owner Financing Seminar in June
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Tom will be giving his comprehensive seminar on "How To Get Rich with Notes and Owner Financing" in June. The details are being worked out. Contact Tom next week for exact times.

Tom is also giving presentations to local Realtors on how to use notes to increase sales. As usual, Tom's no-nonsense approach is being well received. If you would like Tom to speak at your real estate office, please contact us to make arrangements for time and place.

Note Professor Notebook
by Tom Henderson
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GUARANTEE! You will learn at least one new usable concept to increase your profit in buying or selling notes and real estate.

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Tom Henderson
H&P Capital Investments LLC