A Piece of the Action  - Cash Flow Notes and Partial Purchases

The hidden real estate paper market (cash flow note business) is exploding. 

For this reason, it would be wise for those in the cash flow note business to focus on this market for the next several months in order to increase his/her income.

One of the real miracles of the private paper (cash flow note) industry is the possibility of purchasing or selling only apart of the cash flow note! This maneuver is known as a partial purchase, or a "partial," and refers to a transaction in which the owner of a private mortgage cash flow note sells, and a buyer purchases the cash flow note, less than the entire indebtedness owned by the seller.

Using the partial technique, you can have your cake and eat it too – in fact, you can eat your cake and wind up with more cake! How is this possible with a cash flow note?

First, a mortgage note, no matter how the cash flow note is structured, represents a stream of payments that are due sometime in the future. It can be a fully amortized cash flow note with 360 equal payments.

It can be amortized on a 360-month basis, with a balloon lump sum payment due in 180 months. It might be interest-only payments due monthly, with the principal balance due in 10 years. It can be 10 annual payments or 20 semiannual payments.

Each one of these payments has a separate value, determined by the time it is to be received. Remember: a dollar to be received in the future is worth less than

a dollar received today.  This is the key factor in the cash flow note industry.

Secondly, you can buy or sell any portion of a cash flow note -- the first 12 payments, the last 12 payments, half of each payment, a  balloon payment, part of a balloon payment, etc. When dealing with cash flow notes it's just a matter of using your imagination, and coming to an agreement.

Let's illustrate, using a $25,000 cash flow note, fully amortized over 180 monthly payments of $268.65 at 10% interest. What is each of those future payments worth today, if you require a 14% yield on your investment?

After a couple of clicks, and a few whirs of my trusty financial calculator it tells me that

the first payment is worth $265.55. In other words, $268.65 to be received 30 days

from now will yield 14% on $265.55 invested in a cash flow note today.

The second payment won't be here for 60 days. To earn 14% on the second payment,

you would pay only $262.49 today. What is the third payment on your cash flow note worth?

It's worth $259.46. The 10th payment is worth $239.23. What is the 36th payment worth?

By itself, the 36th payment is worth $176.95 today. Put another way, if I invested

$176.95 in a cash flow note today at 14%, how much should it be worth in 36 months. You know the answer -- $268.65!

Okay. So what would I invest in a cash flow note today to receive all 180 monthly payments and earn 14% on my money? Click, click, whir.…whir…. my trusty calculator tells me I would invest $20,173 for that stream of payments.

Now, what if this same cash flow note was payable at $268.65 per month, with the balance all due in 10 years? In this instance, there are two different cash flows notes --120 monthly payments and one balloon payment.

To earn a 14% yield on my money, what would I invest today for each

of these cash flow notes? My calculator says I would invest $17,302 today to earn 14%

on the 120 monthly payments.

How about that balloon payment? According to my calculator, that balloon

will have a balance of $12,644. But I won't see any of that for 10 years.

Hmmm.  Back to the calculator. It looks like $3,143 invested in a cash flow note today, at 14% interest, would be worth $12,644 in 10 years. So I guess that's what I would pay for just the balloon payment.

If I bought the whole cash flow note, then I would pay $20,445 ($17,302 for the

monthly payments and $3,143 for the balloon). On the other hand, if I buy just the

120 monthly payments for $17,302 and the seller keeps the balloon for $12,644, he

gets $29,946 for his $25,000 cash flow note!

I'm not sure, but it looks like our seller just ate a big slice of his cake, and wound up with a bigger cake!  Wonder why there is so much interest in cash flow notes?

What if I only had $10,000 to invest? Well, if the seller only needs $10,000 right

now, I can buy the next 49 monthly payments of the cash flow note of $268.65, and earn 14% on my money. The seller gets the $10,000 he wants today, and in 49 months he starts receiving his cash flow note payments again. At that time, his cash flow note will have a remaining balance of $21,368.

Let's see -- $10,000 today and $21,368 in 49 months. Hey, did we just turn that

seller's $25,000 cash flow note into a $31,368 cash flow note?

What a deal! 

And just about the time I receive the 49th payment, the seller tells me he

wants $11,500 for the down payment on a shiny new car, but he also needs

the monthly note payments to cover his car payments. How can we make that work?

Piece of cake! I'll do a reverse partial.  Now the seller gets cash and the payments, and I'll wait for what's left. Let's see -- we've used 49 payments, so there are 71 payments left,

plus that $12,644 balloon. The seller needs 36 payments to cover the car loan. That leaves 35 payments on the back end.

The cash flow note is well-seasoned now, with a good payment history and more equity cushion in the property. I can live with 12% on this new investment.

To earn 12%, I give the seller $5,522 for the last 35 payments. I also give him $6,238 for that balloon.  So, the seller gets $11,760 for the reverse partial, plus another $9,671 he receives from the next 36 monthly payments.  That's $21,431 total for his remaining $21,368 balance!

Hey, his cake just grew again!!! Add in the $10,000 I paid for the first 49 payments and the seller got $31,431 for his $25,000 note!

As for me, I got a part of the cash flow note with only $10,000 invested and earned a 13% average return over 10 years on a well-secured investment. More importantly, using partials gave both the buyer and the seller enough flexibility to meet their objectives, and they were able to complete a successful, win/win transaction!

Marie Antoinette was right – if you're short on bread, eat cake!