V.I.P. Trust Deed Company
“What is the Current Discount?” I truly wish I had a dollar for every time I have been asked that question over the past 27 years. My response is usually, “That’s like asking a jeweler how much diamonds cost these days”. Obviously, a diamond is priced based on size, color, clarity, etc. If one has two flawless diamonds of the same size, they would still have different prices based on color or whatever (my wife knows far more about diamonds than I do).
For the sake of this article, a discounted trust deed usually occurs when a seller carries back a note and deed of trust – lets say in the amount of $100,000. If the seller wishes to sell the note, the investor or broker will buy the note at a DISCOUNT based on the buyer’s pre-determined yield expectations. Therefore, a $100,000 note may be sold for $50,000 to $99,000 based on the following article. If you understand the bond market you will see that discounted trust deeds are similar to discounted bonds in many ways.
There is absolutely no way to answer the question with a note and deed of trust, as trust deeds are discounted based on interest rate, term, monthly payments, property location, position (first, second or third), borrower’s credit, and equity. As an example, if two sellers carryback a first trust deed on neighboring identical properties with the exact same down payment, the notes and deeds of trust are saleable at a discount based on the other variables mentioned above. As an example, if both notes are for $80,000 with a payment of interest only for three years, a carryback at 6% would be sold at a larger discount than the next door carryback at 9%. Therefore, if you are structuring a transaction with the intention of selling the seller carryback, keep this guide in mind. A higher down payment, a high interest rate and, as importantly, a short term, will result in a small discount. Conversely, a low interest rate, long term and low down payment will combine to produce a huge discount.
Let me be even more specific. Let’s assume that an investor wishes to yield approximately 12% on his or her investment. A first trust deed is offered to the investor. The buyer has good credit and substantial down payment. If the face interest on the note is 10% and the due date is one year, the discount would be slightly under 2%. A 2% discount would earn the investor a 12.13% yield. If we use the same figures and change the interest rate to 8%, the discount would be approximately 3.75% to yield approximately 12%. Don’t forget, I said the term of the note is extremely important. If the interest rate is 8%, but the term is five years, the discount to yield 12% (per annum) is exactly 15%.
By now I’m sure you’re “getting my drift” and realize that discounts are figured to YIELD a certain desired rate. An investor may want a yield of 12% on a first trust deed and 14% on a second. To use the above examples, the discount on a second trust deed with the same terms would be approximately 3.75% discount on the 10% one year note, approximately 5.5% discount on the 8% note and approximately 21 ½% discount on the 8% five year note.
I hope I haven’t bored you with all of these figures and I hope you get my main point. Discounts vary based on the quality of the note, with interest rate, and note terms being extremely important. If the borrower insists on a low interest rate, i.e. 6%-8% make up for that with a shorter term (six months versus one year). On the other hand, if the borrower insists on a ten to fifteen year carryback, make certain that the interest rate is higher with, perhaps, interest increases every few years.
Many sophisticated sellers carryback a first and second trust deed. In those instances the first would have a higher interest rate and the second would have a lower interest rate. In this way the buyer would average a market interest rate. The seller would be able to sell the first trust deed at a low discount and retain the second trust deed.
Peter Rosenthal
VIP Trust Deed Company