By PETER ROSENTHAL, President
V.I.P. Trust Deed Company
September 2001
The concept of an All-Inclusive Deed of Trust or All-Inclusive Trust Deed (AITD) has been around for many decades. In common terms, this is often called “Wraparound.” In the old days the term wraparound was used to describe a “Land Contract,” which was usually unrecorded. Over the years the AITD became much more popular as TITLE was actually passed with an AITD. Wraparound financing was heavily used during the early and mid 1980’s when interest rates were sky high and conventional loans were virtually impossible to obtain. The AITD is still used today by sophisticated buyers and sellers even though many of the reasons to use an AITD don’t exist right now. A look at this financing technique NOW may be very helpful when interest rates “head north.”
A word of caution: using an AITD in your personal situation will have income tax and legal implications. The use of an AITD needs to be discussed with your tax advisor and, as importantly, a Real Estate attorney. Many senior trust deeds being “wrapped” will have acceleration (due-on-sale) provisions and A LOT of thought needs to be given to the responsibilities of both buyer and seller in the event of acceleration.
(Example 1)
A 7-unit apartment building sells for $400,000. The buyer plans to renovate the property and sell it in one year; the existing first is $250,000 at 7-½% (adjustable). Current interest rates (hypothetically) are 9%; buyer puts down $50,000: seller carries back an AITD at 8-½% interest (2 years). This interest rate also adjusts based on any adjustments of the senior trust deed. Win/Win: the buyer ends up with no financing costs and a loan below market rates. The seller ends up with a 2 year-carry back with 9% interest being earned on the $100,000 seller’s equity, but ALSO a 1% PROFIT on the lender’s $250,000 first; i.e., almost $2,500 per year ADDITIONAL interest (declining principal balance).
(Example 2)
Interest rates are still 9% but first trust deed is at 10% with a large prepayment penalty ($10,000) for another year. The sale price is still $400,000 with $50,000 down. The seller’s AITD is still 9% for 2 years and the seller actually loses 1% on the underlying $250,000. If the seller wants to sell now, this is still a win/win deal. The buyer still gets seller financing with no fees and the seller avoids the vast majority of the prepayment penalty. In this example a lock-in provision (cannot prepay), or a corresponding prepayment penalty needs to be used in the AITD to protect against a payoff in less than one year.
(Example 3)
1982 – conventional interest rates are 14%. Any apartment buyer who is foolish enough to take out such a killer loan probably can’t qualify for it anyway. Seller wants to sell, the interest rate on the first trust deed is 9%, and sale price and down payment are the same, this time the seller carries back an AITD at 11-12% and is therefore able to sell the building that would be virtually unsellable (no financing).
(Example 4)
As I stated earlier in this article AITD’s are not common these days due to the fact that plenty of money exists at unbelievably low interest rates. Interestingly enough, though, I just sold (personally) a 12-unit court in Glendale with “seller financing.” I was able to accommodate the buyer’s need for seller financing, and down payment of $100,000. I tailored the AITD for a 1% profit similar to ( Example 1) above.
In closing, let me once again warn buyers and sellers to get competent professional advice before using this tool. Further, this was not intended to induce anybody to violate the due-on-sale clause in an existing trust deed (my attorney will be happy now).
Peter Rosenthal
VIP Trust Deed Company