Chapter 13 HOW TO MAXIMIZE YOUR USE OF PYRAMID FINANCING Flashcards
1
Q
What is the goal of pyramid financing?
A
To shift equities to purchase property and obtain new financing that may exceed the actual cost of the property.
2
Q
Define pyramid mortgage.
A
A creative financing method where equity is used as security for down payments or investment funds for more property.
3
Q
What is a primary pitfall of pyramid financing?
A
The potential to over-leverage your investment.
4
Q
What is one reason for using pyramid financing?
A
To create a ‘free and clear’ purchase to allow new financing.
5
Q
How can pyramid financing make another property more saleable?
A
By offering a soft second mortgage on the property being sold.
6
Q
What is a benefit of obtaining cash from a pyramid financing transaction?
A
Cash can be used to fix up the property or for a second acquisition.
7
Q
Fill-in-the-blank: Pyramid financing works best in a ______ economy.
A
rising
8
Q
What is a significant risk associated with pyramiding?
A
Getting too deep in debt too quickly.
9
Q
What type of financing works best in a rising economy?
A
Pyramid financing.
10
Q
What is a common structure of a pyramid financing deal?
A
Using equity from one property to secure financing for another.
11
Q
True or False: Pyramid financing is similar to a blanket mortgage.
A
True
12
Q
What is a key advantage of using pyramid financing over conventional financing?
A
It allows for more creative structuring of deals.
13
Q
What is an example of a situation where pyramid financing may be beneficial?
A
When a seller is motivated and willing to hold secondary financing.
14
Q
Fill-in-the-blank: The pyramid financing technique allows you to maximize the amount of ______ you owe.
A
debt
15
Q
What might motivate a seller to accept a pyramid financing offer?
A
The promise of higher cash down payment.
16
Q
What is an example of a property type suitable for pyramid financing?
A
Office buildings, apartment complexes, or other investment properties.
17
Q
What should you ensure when using pyramid financing?
A
That your plan is sound and you understand the marketplace.
18
Q
What is the significance of a loan-to-value ratio in pyramid financing?
A
It helps determine the risk level for lenders.
19
Q
What is the relationship between interest rates and the success of pyramid financing?
A
Lower interest rates compared to the property’s income potential enhance returns.
20
Q
What is one reason sellers prefer pyramid financing over second mortgages?
A
It may provide them with better security and cash flow.
21
Q
What does a pyramid resemble in terms of structure?
A
A blanket mortgage without the cross-collateralization effect.
22
Q
What is a potential benefit of combining a pyramid with a blanket mortgage?
A
It can provide additional security for the seller.
23
Q
What is a necessary consideration when structuring a pyramid financing deal?
A
The accuracy of property values involved.
24
Q
What is the maximum amount Ryan can borrow from a local lender for the purchase?
A
$175,000
25
What is the balance amount that Ryan is covering with a second mortgage?
$75,000
26
Why might the seller drop the price of the property?
The amount of cash down is more than the seller expected
27
What benefit does the seller gain from not holding a second mortgage on their own property?
The seller feels relief from not financing 100 percent of the transaction
28
What is the 'greener grass' concept in real estate transactions?
The perception that other properties or deals appear better than one's own
29
What is the monthly payment Ryan offers to the seller for the second mortgage?
$435.50
30
How long is the term for the second mortgage Ryan proposes?
120 months (10 years)
31
What total amount will the seller receive over the term of the second mortgage?
$127,500
32
True or False: Ryan's offer includes giving the seller a choice between cash and the second mortgage.
False
33
What should Ryan avoid doing when presenting his offer to the seller?
Making comparisons between cash and the second mortgage
34
What are three critical questions Ryan should ask himself before proceeding with a property purchase?
* Is that property within my comfort zone?
* Will my investment in that property move me closer to my goals?
* Can I afford to lose whatever capital I will put into that deal?
35
What is the advantage of using a second mortgage on a different property?
It avoids existing mortgage limitations to secondary financing
36
How can using a second mortgage reduce debt service?
By moving some financing to a less expensive source
37
What is one example of a potential savings in interest by using a second mortgage?
Saving $3,500 in interest on the first year
38
Fill in the blank: Ryan’s strategy can be considered a _______ investing technique.
cashless
39
What is one benefit to the buyer when using secondary financing?
Increases yield on cash invested
40
Why is it important for Ryan to control the property before closing the deal?
To ensure he can conduct necessary studies and investigations
41
What must Ryan include in the purchase agreement?
Terms and conditions that protect his interests
42
What is the IRS rule regarding taxable gains from the sale?
Allows sellers to spread the tax on gains over the period of time money is received
43
What is the goal when presenting a purchase agreement?
To negotiate the terms and conditions until the seller agrees.
44
What is a due diligence period?
A period during which you can inspect and investigate the property.
45
What happens if you find issues during the due diligence period?
You have the unilateral right to back out of the deal or renegotiate.
46
True or False: It is critical to let the deal expire.
False.
47
What can happen if a seller is a novice regarding the time needed for approvals?
They may not understand the realities and could hinder the negotiation.
48
What is a potential benefit of using the pyramid technique?
You can end up with cash in your pocket after a property purchase.
49
What is a downside of using the pyramid technique?
You may end up with more than 100% of the purchase price being debt.
50
Fill in the blank: The pyramid technique allows you to use _______ from one property as acquisition capital for new investments.
[equity]
51
What does pyramiding allow you to do with your existing properties?
Retain ownership while acquiring new properties.
52
What is the 'greener grass syndrome'?
The belief that holding onto property demonstrates its value.
53
What is one way to purchase two properties at the same time?
Get control over one property and then use it to springboard into another.
54
What must you show to a local lender when attempting a double transaction?
Your plans for improving the properties and their future value.
55
What are the key elements of Blackburn's first transaction?
* Assumed the first mortgage
* Provided a second mortgage of $30,000
* Invested $8,000 in improvements
56
What was the value increase of the duplex after improvements?
$140,000.
57
What did Blackburn do with the cash from his bank account?
Invested it into improvements for the duplex.
58
What is the total equity Blackburn had after his initial transactions?
$127,000.
59
Fill in the blank: Pyramiding is one of the highest leverage forms of _______.
[financing]
60
What is essential to ensure when undertaking pyramid transactions?
That the income from each property covers the debt service.
61
What did Blackburn do with his remaining cash after acquiring the six-unit complex?
He used it for renovations.
62
What is a potential risk when using the pyramiding technique?
Increased liability if personally obligated to the debt.
63
What should be done before attempting additional pyramid transactions?
Ensure there is income to support the new second mortgage.
64
What strategy can be beneficial for distressed property owners?
Finding motivated sellers willing to relieve themselves of their properties.
65
Fill in the blank: Blackburn's long-range plan was to build as much _______ as possible.
[equity]
66
What type of building did Blackburn convert into a miniwarehouse?
An old industrial building
## Footnote
Blackburn put all his remaining cash into renovations.
67
How much was the second mortgage Blackburn offered on the warehouse complex?
$75,000
## Footnote
This mortgage was secured by a six-unit apartment house.
68
What was the existing mortgage amount on the industrial building Blackburn assumed?
$325,000
69
What strategy did Blackburn use to get the bank to extend his loan?
He got them to extend the loan by the amount of interest for one year and put a one-year moratorium on principal payments.
70
What did Blackburn present to the bank to support his loan extension request?
A detailed pro forma prepared by his accountant showing expected revenue growth.
71
What was the increased value of the warehouse after one year?
$550,000
72
How much cash did Blackburn invest in remodeling the larger industrial complex?
$100,000
73
What was the asking price for the larger industrial complex Blackburn purchased?
$1,025,000
74
How much did Blackburn need to borrow from the bank for the larger industrial complex?
$750,000
75
What were the terms of the land lease for the industrial complex?
Annual payments of $20,000 on a land lease, subordinated to a first mortgage not exceeding $750,000.
76
What was the fixed price for the land that Blackburn could purchase within 20 years?
$275,000
77
What was Blackburn's total net worth at the end of the financial picture presented?
$550,000
78
What are the two major factors to keep in mind when approaching pyramiding?
* Pyramiding is highly risky.
* The property should have potential to substantiate the risk.
79
List the six key steps in building a strong pyramid.
* Review your goals
* Outline your risk equity and/or cash
* Substantiate your equity by appraisals or pro forma
* Look for property that has not reached peak income potential
* Make an offer
* Ensure the new property supports new pyramiding by carrying a secondary loan.
80
Fill in the blank: The quickest way to do your own appraisal is to visit every similar property listed by real estate brokers until you find one or more that have recent _______.
professional appraisals
81
What is a good source for properties available for pyramid buying?
Local exchange group
82
What is the first step to effectively present an offer in pyramiding?
Have all the data about the security on the property being used to leverage up in the pyramid.
83
True or False: It is advisable to begin the presentation of an offer in a negative mood.
False
84
What should you do if the seller initially rejects your offer?
Don’t become defensive; it is normal for a seller to be skeptical.
85
What are the objectives of the pyramid for the seller?
* Make the property more salable
* Reinvest the equity into more real estate.
86
What are the factors that indicate whether pyramiding can aid a sale?
* Seller's equity presents a problem
* Seller cannot or will not hold purchase money financing
* Conventional financing market does not offer effective refinancing
* Seller wants to reinvest in more real estate.
87
What is the first step the seller needed to realize to move ahead with his plan?
Most of his equity
88
What was the determined value of the property based on an NOI of $25,000 and a 10 percent capitalization rate?
$250,000
89
What was the annual debt service on the maximum loan of $187,500 at a constant rate of 12.07 percent?
$22,631
90
What was the cash flow remaining after deducting the annual debt from the NOI?
$2,369
91
What amount would the seller receive if the investor wanted a 10 percent return?
$203,190
92
True or False: The seller was ready to reinvest.
True
93
What was the price of the three-acre tract of land the seller was interested in?
$210,000
94
What was the cash amount offered to the owner of the three acres in the structured offer?
$10,000
95
What was the interest rate on the first mortgage for the three acres?
8 percent per year
96
What type of financing was used to help sell the retail complex?
A first mortgage of $190,000
97
What was the annual debt service on the $190,000 mortgage after the interest-only period?
$17,613
98
What was the projected cash flow at the end of the interest-only period if the NOI did not improve?
$7,387
99
What is a distant pyramid in real estate transactions?
Where two sellers are involved, each taking the other property as security for a second mortgage
100
Fill in the blank: The pyramid uses _______ in another property as a security for debt.
value
101
What was the total cash required to close on all three properties in the example?
$105,000
102
What is the risk associated with subordinating a land lease?
The landowner risks their position depending on the amount of debt
103
What financial strategy did Brad use to facilitate the purchase of the office building?
Created a land lease on his apartment building
104
What was the annual rent specified in the land lease created by Brad?
$11,250
105
What was the option to buy the underlying land worth in Brad's land lease?
$125,000
106
True or False: The land lease can be a motivating factor for sellers with potential large gains tax to pay.
True
107
What was the minimum cash down the seller demanded from Brad?
$150,000
108
What type of lease did Brad create for his apartment building?
Land lease
109
What was the annual rent specified in Brad's lease?
$11,250
110
What was the option price for Brad to buy the underlying land within the first 12 years?
$125,000
111
How long was the lease that Brad created for the apartment building?
40 years
112
What should be included in a land lease regarding the option to buy back the land?
Option to buy back the land at the same set price established at the start
113
How long should the land lease extend beyond the longest term of an existing mortgage?
More than 35 years or at least 10 years plus the option term
114
Why is it important to have a lease extend beyond the mortgage term?
To allow refinancing of the mortgages prior to the termination of the option to buy
115
What should be specified regarding refinancing during the term of a land lease?
Allow for refinancing but limit the amount to a percentage of the value of the land and buildings
116
What is the key distinction that must be made regarding the document?
It must be a land lease, not a mortgage
117
What should not be included in a land lease to avoid IRS scrutiny?
A required payback agreement to buy back the land
118
What type of index should not be used for rent payment increases?
Cost-of-living index or any index with no known future value
119
What should be avoided in negotiating the terms of a land lease?
Negotiating the terms of the lease itself
120
What is meant by 'sliding the asset' in the context of a lease?
The ability to exchange the leased property for another property of similar or greater value
121
What is a potential tax advantage for the seller when retaining title to the property?
Avoiding capital gains tax at the time of the deal
122
What are the three major problem areas associated with land leases?
* Carelessness in lease terms
* Subordination dilemma
* Time problem
123
What is the 'greener grass theory' in relation to pyramids?
Pyramids work on the idea that moving to a new property will yield better returns
124
What is a critical factor for a buyer in a pyramid transaction?
Control of one property before moving to the next
125
What is the maximum total debt service on a property to avoid excessive leverage?
Not exceed 80 percent of the net operating income of that property
126
What method allows a seller to delay or avoid tax payment on gains?
Installment sale
127
What are the advantages of a pyramid for the buyer?
* Expands holdings
* Low-cost financing
* Establishes good selling terms
* Estate building
* Tax-deductible interest
128
What are the disadvantages of a pyramid for the seller?
* Generates paper, not cash
* Paper may not be secure
* Remote transactions can affect security
129
What is a key risk factor that can lead to the collapse of a pyramid?
Increased debt service exceeding property value
130
What should be taken into account regarding out-of-pocket expenses when acquiring a new property?
Must be accounted for before the transaction is completed
131
What is an installment sale?
An installment sale is any sale where you are not paid all the proceeds of the sale in any given tax period.
132
What tax benefit does the IRS allow for sellers in an installment sale?
Sellers can delay or avoid tax payment on gains from the sale.
133
Which IRS code allows for tax-free exchanges?
IRC Section 1031.
134
What percentage of payments received in an installment sale is considered taxable gain?
The percentage is calculated as the ratio of gross profit to contract price.
135
What is the formula to calculate gross profit in an installment sale?
Gross profit = Selling price - Adjusted tax basis.
136
In the given example, what was the selling price of the property?
$190,000.
137
What was the adjusted tax basis in the example provided?
$85,000.
138
How much was the gross profit in the example?
$105,000.
139
What is the contract price in the example?
$150,000.
140
What was the ratio of gain to proceeds in the example?
70 percent.
141
For each payment of $50,000 in the example, how much would be taxable gain?
$35,000.
142
What is the treatment of interest received on an installment sale?
Interest is treated as earned income, not capital gain.
143
What happens if a seller is relieved of a mortgage that exceeds their basis?
The excess mortgage is considered capital already pulled out of the property and will be taxable at the time of sale.
144
Why should sellers consider including a clause for advance notice of mortgage prepayment?
To anticipate potential capital gains tax implications.
145
True or False: Installment sales are available to every type of real estate transaction.
False.
146
What should sellers be aware of when a mortgage allows full repayment at any time?
Those payments could trigger capital gains tax in a year with other capital gains.
147
What is a potential penalty that can be included in a mortgage for advance payments?
A penalty to cover potential tax payments on substantial capital gains.
148
Fill in the blank: An installment sale allows the seller to spread a large taxable gain over _______ years.
[several]
