Real Estate Financing Tips

Beware Of That Form Note – It Can Bite

by Marvin Levin

Another file from my “Real Estate Mistake Book,” a list of embarrassing mistakes.  Since I started the list in 1959, you will not be surprised to hear that it is a rather long list.

A short time after Paul Menzies and I moved our office to Walnut Creek, we were invited to joint venture the acquisition of the Wimbledon Apartments, a 400-unit apartment project in Portland, Oregon.  In order to justify the price, the seller, a Portland bank, carried back a “hope note” in the amount of $800,000 secured by a third deed of trust on the building.  Our partner negotiated the deal, and he assured us that there would be no difficulty paying that hope note off at a big discount.  We got busy with other things, and did not pay enough attention to detail as the transaction closed.

Although we started with a large vacancy, we were able to attain great occupancy during the coming year.  About 18 months after acquisition, we were ready to refinance and pay off that hope note.  Of course, I was disappointed to discover that we had neglected to put a discount provision for early payment in the note itself.  And, I am sure the reader will not be surprised when I disclose that the lender would not give us one dollar of discount even though the same lender might have agreed to a 50% discount, or better, 18 months earlier.

I am really chagrined to admit what happened.  When our partner asked the bank for a 50% discount, the bank said:  “Well, maybe 25%.”  So, we didn’t put in any provision for any discount, and that oversight cost us $200,000!

A BETTER WAY

It occurs to me that in any “stationery store note form” there are a lot of items that are overlooked.  They are include, but are not limited to, the following:

1. Discount for early payment (referred to above)
   
   
2. A right to purchase the note if the lender proposes to sell it to another party for a discount
   
   
3. A right to recast the terms of the senior note without the consent of the holder of the junior note
   
   
4. The right to obtain a subordination of the junior note if the senior note might be refinanced (although carefully controlled so that the holder of the junior note is not subjected to loss of equity)
   
   
5. A provision that unscheduled extra payments on the junior note result in a reduced subsequent regular payment, reduced proportionately
   
   
6. Instead of a fixed rate of interest, a variable rate with a cap, and/or a floor or no floor
   
   
7. A provision for partial release if there should be extra property described in the deed of trust not necessary for the operation of the main project
   
   
8. A requirement that any notice of default first be mailed to borrower by registered mail in order to avoid the argument over whether a previous payment has or has not been received

So, if you have a client looking for joint venture or an unconventional junior loan, please contact me.