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Agreement For Sale vs. Vendor Take Back Mortgage (VTB)

DonnaMcGuire

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Q&A from our student forum:
What're the difference between AFS & Vendor-take-back mortgage, practically and technically? Any particular consideration when using one over the other? Thx.

Both are forms of seller financing. The basic differences between the AFS and VTB are:

1. Technically: with the VTB, title changes into the buyer's name and, with the exception of your payment to the seller under the VTB, that's all the connection the seller still has with the property. With the AFS the seller's name remains on title and to the world at large he is still the owner.

Practically, with the AFS you have to work with the seller to set up your payment under the AFS so that it goes to an account from which where the seller is typically making his mortgage payment. ( not all sellers have underlying mortgages but most do). There is more admin stuff to do in making sure that the right insurance policy is in place, that the AFS buyer's address is the one for tax notices, condo/strata corps if any, insurance and mortgage renewals .

When you look to close out your AFS, its trickier because if you are the one buying and the property is worth more, you can't finance based on the increased equity but only on your purchase price. Some buyers have had to use a bridge lender to acquire title, hold for 3-12 months and then re-fi based on the increased equity. If you have found a third party buyer, then you have to work with the seller to put together a contract between them and the ultimate buyer making sure that you get your profit.

One or the other?

AFS is preferable in the low equity-no equity situations. Sellers are more comfortable, easy to explain and often no point in doing a VTB as there is no equity. Plus, in most VTB situations, there is an underlying first mortgage and when title changes, you have to deal with that underlying mortgage unless you are getting your own new first plus the VTB.

Overall, the AFS strategy takes a bit to learn and then implement, it is usually not smooth sailing on the admin side but the ability to get control of properties for little or no money down often (but of course not always ) makes all the effort worth it.
 

Sherilynn

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One thing you neglected to mention, Donna, is if people want to learn the ins and outs of AFS (and other creative strategies), they should consider attending Barry McGuire's "Rapid Cash Program" in Vancouver in September. :)
 

Matt Crowley

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I bought Barry and Donna's Deal Ready Docs a number of years ago and it was a good product on real estate contracts. Legal is one area you do not cheap out for real estate.

One thing I would add to above is that both strategies are very advanced strategies and not for beginners. AFS can get you into a lot of trouble if the buyer or vendor are not experienced.

AFS are a very uncommon tool to use in land development because you can't get easily get financing or permit approvals on something you don't own. Typically a VTB works a lot better because you can defer a large "profit-for-the-vendor" payment for a number of years once you have achieved rezoning and development approval. By that time, you should have a take-out loan and development funding available from a bank to develop.

With AFS, your enforceable rights get a lot more messy. Questions about interest registration and lender covenants (between the vendor and lender) come into question. When you are dealing with $300,000 - $500,000 AFS purchases with little initial down, you may not be able to afford to enforce your right (eg. hire a lawyer and pay for an expensive court battle) if you can't afford the initial down payment.

In my own opinion at least, AFS should generally be avoided. It will really only work with very sophisticated parties with strong asset management. The nature of an AFS means you need to develop or operate without requiring any changes in zoning or significant permitting. Your claims to ownership are...well...ambiguous. It will be tough to go to any bank and request funding because of this AFS interest.

The problem with sophisticated parties is that both parties expect to make a profit. The vendor is only going to deal with a "weaker" buyer if that buyer can pay a higher price to justify the risk of not selling the property outright. The buyer can only afford to pay a higher price if they can find a way to add value to the property that the seller has been unable to develop or was unwilling to discover. If the seller was unable to develop that higher use, you have another problem of trying to convince the seller to allow you to manage the redevelopment; and if you can convince them it is a good idea then why would they go with you instead of just refinance and do the redevelopment themselves? Alternatively, if the seller was unable to develop for financial reasons that suggests they have a low equity position in the property and you probably should not be doing an AFS with them in the first place. AFS only makes sense if the seller has lots of equity stored up in the property...it starts getting really dangerous when you have a vendor who is financed to the hilt. (This is because you do not have the same financial diligence rights as a bank). At the same time, the vendor needs to ask the buyer why the buyer should be allowed to future promise-purchase when they can't afford to buy the property now. The vendor has to be aware that the buyer needs to raise the value of the property, but how is it that the buyer claims to be an expert at raising property value but can't afford to purchase the asset that it needs to perform it's area of expertise? When you start looking at these questions, if is not really a great mystery why these contracts are not used very often. Historically, AFS contracts were used for farm purchases.

With a VTB, you have ownership and can rezone, pull permits, and develop. Lenders are a lot more familiar. Commonly used by land developers.

When would I use AFS? Only in dealing with a family / friend purchase of one of my properties to formalize the sale and allow me to keep "control" of the asset during the sale. Even then... I would probably just prefer to sell to someone else using a typical AREA contract. There would have to be extraordinary circumstances to motivate me to use this contract.

Just my two cents.
 
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Sherilynn

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In my own opinion at least, AFS should generally be avoided. It will really only work with very sophisticated parties with strong asset management. The nature of an AFS means you need to develop or operate without requiring any changes in zoning or significant permitting. Your claims to ownership are...well...ambiguous. It will be tough to go to any bank and request funding because of this AFS interest.
While I agree AFS would not normally be suitable if you plan to do any development requiring permits or additional financing, AFS works quite well to purchase single-family residential for rent or lease option. There are a lot of sellers with little equity, or large mortgage penalties, or who must sell quickly, making a conventional sale less attractive. And there are others who like the idea of getting a bit more for their property in the way of a higher price or interest payments, and are therefore willing to carry the financing even if they have substantial equity.

AFS is great in both of those situations.
 

Matt Crowley

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And there are others who like the idea of getting a bit more for their property in the way of a higher price or interest payments .

Yes...assuming an inflating real estate market it can work fine. To my knowledge, rent to own doesn't work in a flat or declining market because the tenant-buyer is going to end up upside-down with their option monies.
 

Sherilynn

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Yes...assuming an inflating real estate market it can work fine. To my knowledge, rent to own doesn't work in a flat or declining market because the tenant-buyer is going to end up upside-down with their option monies.
I'm not buying properties for more than they are worth. I am paying below appraised value but perhaps more than the net proceeds the seller would get selling on the open market.

The property I am currently buying is a perfect example. Fair market value is about $364k. The seller would pay $17052 in realtor's fees, $2000 in mortgage prepayment penalties, and carrying costs of $2100 per month while it is on the market. Let's assume it takes 2 months before a buyer takes possession. Even selling for full market value, the seller would net only $340748.

Instead, I'm paying $352500. The seller gets an extra $12000 and I buy a property with low money down that has an LTV of 67%, meaning I get faster mortgage paydown. (Seller's unpaid equity is payable in 3 years.)

Now I can rent the property, or sell via RTO. Since I have almost no cash in the property, I don't need to inflate the price in order to make excellent ROI. In fact, I could sell the property for what I paid for it, get zero cashflow, and get excellent ROI on mortgage paydown alone.

Everybody wins.
 

Matt Crowley

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Everybody wins.

You are a seasoned pro at this Sherilynn...not everyone can actually make this happen. Most will fail.

At the end of the day, you are still trusting a vendor with poor cash management to make the payments on their mortgage and not end up in a similarly precarious financial situation. Yes, it sounds exciting and win-win but these can fall apart very easily.

A big problem with buzz words "win-win" is that a fair win-win is often not really considered. I'm not saying this in reference to you Sherilynn, it sounds to me like you have made a number of fair deals. But realistically, the vendor's hands are now tied for the next two years and probably can't purchase another home. It's a "win" because they didn't go bankrupt (in the best case scenario) but on the other hand, they are trapped into renting. And for some rent to own business that will go out of business due to poor management and lack of patience for the longer-horizon profit, the vendor ends up in a situation where they do not know about the party "renting" their house. Are they are "party" in the contract between the now-defunct rent to own company and the tenant-buyer continuing to live in the home? Does the vendor have rights to evict if the rent to own company goes belly-up? What about the tenant's option money? Ugly, ugly situation.

Sure it sounds like it works well. And in theory, it can. In my opinion, I do not think the AFS generally balances the different parties interests and combining it with an RTO is very dangerous. It could leave a vendor in a terrible position if the strategy is performed by an undedicated investor excited about the ROI...and not realizing this isn't really a home run strategy. None of them are. This is one strategy you have to do a bunch of times to make a business out of it. Like any business you start, you are basically going to make a bit better than minimum wage when you start at it and it isn't until you become a pro that you start making more money at it.
 
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Sherilynn

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So many points with which I disagree.
1) Not all AFS vendors have poor cash management skills. In some cases, the opposite is true. My current vendor has already purchased his next house and is moving in 2 weeks, hence the desire to sell quickly to avoid carrying costs on a second mortgage. Furthermore, he has paid down his current mortgage by $40k over the past 3 years.
2) I don't trust any vendor to make the mortgage payments. Generally, they are withdrawn from our corporate account. That doesn't work with every bank, so we must allow for adjustments to our SOP's. But under no circumstances am I going to write a cheque to a vendor and cross my fingers he pays the mortgage.
3) Having one mortgage does not prevent all vendors from getting a mortgage on a second property. Landlords are proof of that. If the vendor requires credit, we can easily provide him with a copy of the lease showing the rent being paid on the property. Yes, the lease would be in our name, but this is also the case with my JV partners - they may be on the mortgage but are never on the lease as my company manages our properties.
4) The vendor not going bankrupt is certainly not the best case scenario, nor is it the only opportunity for the vendor to get a win (as detailed in my previous post).
5) People starting in any business need to assign a value to their time. My "minimum wage" is $15k per deal, and has been from deal #1. If the numbers don't work, we don't do the deal.

Another example of a win-win, this time with a desperate seller:
This elderly lady had a nice little starter home in a decent area in South Edmonton. Her husband died a couple of years prior, presumably with no life insurance. She was left with a half-renovated house (and poorly done to boot) and a mountain of debt. She had limited income and couldn't pay the mortgage. She couldn't sell because of the condition of the house. (Not many people would be willing to take on such a big project.) She would soon be homeless and penniless.
We asked her how much she needed to get out of the house. The numbers worked for us and she sold to us via AFS. We took over mortgage payments immediately but let her stay in the house for 2 months while she found a new place. (We reduced the agreed price by the amount of the extra payments.) We put almost nothing down - just enough for her to move. Our contractors renovated the house and we sold within 6 months.
The vendor saved her credit, eliminated her financial stress, wasn't left homeless, and got the money she needed out of the house within 6 months.
I settled for "minimum wage" on this one. ;)
 

Matt Crowley

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I really wasn't pointing at you Sherlynn...

A couple of counter points
If the property was listed at "fair market value" it would, on average, sell by the average days on market. If it doesn't sell, it is most likely that (A) you have a poor Realtor, or (B) you have overpriced the property and it wasn't listed for market value.

2) I don't trust any vendor to make the mortgage payments. Generally, they are withdrawn from our corporate account. That doesn't work with every bank, so we must allow for adjustments to our SOP's. But under no circumstances am I going to write a cheque to a vendor and cross my fingers he pays the mortgage.

No matter who makes the payments, you are still relying on vendor to take care of the rest of their finances. You are crossing your fingers and hoping they don't screw anything up. What if they refinance? It doesn't really matter what they have written in that AFS. It is still an obscure document that is non-standardized and not really generally familiar.

This is usually a vendor-driven business. You find the desperate seller who needs to squeeze more money out of their house than it is worth. Probably the house isn't ideal. You can RTO and sell the house to a person who probably wouldn't have chosen the house in the first place or rent it out. If you rent it out, I would advise the owner to cut out the "investor-expert" and just hire a PM.
3) Having one mortgage does not prevent all vendors from getting a mortgage on a second property. Landlords are proof of that. If the vendor requires credit, we can easily provide him with a copy of the lease showing the rent being paid on the property. Yes, the lease would be in our name, but this is also the case with my JV partners - they may be on the mortgage but are never on the lease as my company manages our properties.

It prevents many vendors from getting a second mortgage. Usually they are better to sell the property at fair market value. No point fitting a round object through a square hole. This strategy is almost always about finding the desperate vendor. Then whatever the house turns out to be you just find a way to work with it.

4) The vendor not going bankrupt is certainly not the best case scenario, nor is it the only opportunity for the vendor to get a win (as detailed in my previous post).

I disagree. If they were willing to sell it for fair market value, they could. Instead they end up with a messy contract that it would be difficult for them to enforce.

Another example of a win-win, this time with a desperate seller:
This elderly lady had a nice little starter home in a decent area in South Edmonton.

This is pretty much exactly my point...you are really ending up working with a desperate seller. It's great that you made this work. But a lot of "well-intentioned" and under-experienced individuals are going to take this magic contract and try and do the same with someone desperate. What if this had turned out differently?

I don't think this contract balances both parties interests very well, which is why I don't use it. It is ugly and difficult to enforce. It is uncommon and was designed for a different purpose. Obviously, credit is due to you for creating good deals for people but generally I think this is an overcomplicated instrument that is not creating enough value to an undereducated buyer or seller, as the case may be.
 

BarryMcGuire

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I read this thread with great interest. Comments as follows:
1. I agree that AFS is not suitable for land development deals and all my experience comes on the residential or commercial side.
2. It is a less known and more complicated strategy so we do not recommend it for any new investors. We think it should complement a buy and hold strategy and investors should only consider it after they have a reasonable amount of buy-and-hold experience.
3. As with all strategies, even buy-and-hold, there is an element of relying on the other party to live up to their end of the deal. Yes sellers or buyers can go bankrupt, yes sellers can try to take the AFS payment and not make their own mortgage payment, yes there are investors who might misunderstand and badly implement the strategy and follow that up making it even worse by not understanding an appropriate exit. Can't argue with the possibility of those things happening. On the other hand, my experience is that if both parties in a contract are trying to make it work and to hold up their end. Investors are better protected if they really understand why a seller is interested in an AFS, that they give the seller what they need, that the deal is fully explained and documented and that each party has competent counsel to advise them. If all of these things are in place, the bad things that can possibly happen are not near as probable.
4. On the win-win aspect Courts have ruled that parties are allowed to make bad deals as long as they understand what they are doing. We teach that win-win should be more positive than this official view. Find out what the other party needs. See if that fits with what you need. Make sure they understand the deal. If there is another solution to their problem other than dealing with you, point that out to them. Do not take advantage.
5.In summary, AFS while not common, has a definite place in the creative real estate strategy lineup.
 

Sherilynn

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Well said, Barry.

SweetZone, I'm sure if you had more experience dealing with such transactions you would see the possibilities of success for both the vendor and purchaser. That is where training programs such as Barry's come into play by opening people's eyes to different possibilities, and to different ways to help solve people's real estate issues.
As it stands, however, we'll have to agree to disagree.
 

alaas1977

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Just a thought here:

In real estate there is always risk, perhaps AFS, etc are more of a risk then say buy and holds. However with risks, often comes great rewards, yet the investor has to enter with his eyes wide open. I myself have taken great risks on properties that the weak of heart would never have given a chance, however we knew going in that we could afford the loss or costs associated and have henceforth been greatly rewarded. One should not risk what they can't afford to lose.

Each person has their own risk threshold, and must be able to sleep at night with the decisions they make.

Lisa
 

Cory Sperle

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Interesting viewpoints on the AFS or "wrap" as I have heard in the past. I must admit I am somewhat traditional and cringe when I hear the words "creative financing" however I am sure AFS has it's place. I had only really thought an AFS applied to commercial where an owner wishes to sell, has substantial equity and is looking at massive mortgage penalties for early discharge and the other party perhaps wishes to put less down on the purchase. I suppose eliminating the middle man, the bank, can be win-win provided there is a level of trust and each party knows what they are getting into. It seems much harder to get out of if things go sideways though.
 

Matt57

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If I was a seller with an existing mortgage at 80% LTV, and I was trying to sell this property to a buyer for a higher price using an 80% VTB, would the existing mortgage holder call my loan due in full when the title transfers to the buyer? How would this scenario play out for the seller?

The buyer in this case has a full 20% down payment ready. Would an AFS make better sense?
 

Sherilynn

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Title transfers when the buyer later cashes out the AFS, so the buyer has his own financing by that point. At the start of (or during) the AFS, it is possible for the bank to call the loan due, but it is very rare. Remember the seller still has legal ownership (title) and only beneficial ownership has changed.
If the buyer has 20%, then AFS could make more sense. In provinces with land transfer tax, RTO may still be preferable to some buyers, especially if they plan to 'resell' the property or assign the contract. Also some sellers feel more comfortable maintaining full ownership of the property and therefore choose an RTO over an AFS.
 
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