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An Explanation of Equity, Cash and the Discount

 Palm Springs Desert Area Homes, Condos & Real Estate 

How to Shrink the Discount and Net Close to Full Price

(Note: This short story explains the difference between cash and equity. The difference is called the "discount" and is always present in some form. We also explain how the Simultaneous Note Purchase Program can be used to minimize the discount.)

Last year Mr. Seller, bought a $100,000 house with $100,000 cash that he had in a bank account. What happened was that his stake in the cash market was converted at full value into equity in the real estate market. But now Mr. Seller wants to go sailing. He wants to buy a $100,000 yacht. So he wants to sell his house and get his $100,000 cash out right now. Let’s look at his options. 

The first thing he might do is take the deed to his house over to his bank and say: "Mr. Banker, last year I took $100,000 out of my account with you people and bought my house for $100,000. I want you to take the deed to my house and give me back a cashier’s check for $100,000."

Mr. Banker explains: "Mr. Seller, the $100,000 you have in your house is equity. Your $100,000 equity is not the same as $100,000 cash in our bank. Equity is not cash. Think of it like this: Real Estate may be a solid investment but, by the same token, it is not a liquid investment. You can’t buy groceries with it or pay doctor bills with it, or, for that matter, cash it in. In fact your options are limited. Here they are: 

1. Find a motivated cash buyer for your real estate equity.  There are full-price buyers out there. But it might take you two to six months to find one and another couple of months to close the deal at your full asking price. It’s going to take a long time, even if everything goes well. Besides, the buyer is probably going to beat you out of your price anyway. In any case, by that time you will be so fed up with the whole process that you will spend money on a realtor as well. So, you see, there is a time-value dimension (discount) and a cost-of-sale dimension (discount) to the cash-equity equation. By the time you have paid a realtor and negotiated the price and terms and depending on market conditions, you might cash out somewhere in the mid $80,000s. And don't forget that during this time you will likely have continued to make your house payments and maybe incurred other expenses." 

2. Borrow on your equity. Our bank will refinance your house and lend you $80,000 cash on it. Your $100,000 equity will not be converted into $100,000 cash but at least you will be able to make a significant down payment on your yacht. Of course, you will have to pay interest on your bank loan in the meantime. On the other hand you would still own your house, although your equity in it will be reduced to $20,000."

3. Offer your house at a price no serious buyer or investor could refuse. To get an immediate all-cash sale, you must discount your equity. If you put your house on the market at a discount for, say, $70,000, you will get all kinds of buyers lining up to buy it – all cash and right now at that price. Of course you would lose $30,000 equity in your house but that is the discount you must accept to sell your house and cash out right now. The discount is the difference between the cash you want right now and your equity right now. The discount is what it takes to convert your equity to immediate cash."

Mr. Seller does not like any of these options but, fortunately for his sailing plans, he has come across the Simultaneous Note Purchase Plan. He finds out that there are a number of possible outcomes ranging from acceptable to outstanding. This is what he has learned, tailor-made for his situation:

Step 1: Advertise - "Wonderful Home. Owner Will Finance. Low Down. No Banks Required. $100,000." This will bring you a flood of motivated buyers who can’t get regular financing. And you won’t need to pay a realtor. And you can demand the full appraised price.

Step 2: Enter into a contract and take a cash down payment for as much as you can get. It should be at least 5% of the appraised value, In this case $5,000. The amount of down payment he collects is important. The more you get the better your cash-out position. Also the buyer stands to obtain a better interest rate. This is because the note purchaser sees a greater commitment on the part of the buyer.

Step 3: Create a note for $80,000 and sell it to your note purchaser for a minimum of 90 cents on the dollar. You might get as high as 95 cents on the dollar but we will be conservative. The $80,000 face value of the note is simply calculated on the basis of 80 per cent of the $100,000 appraised value. The note purchaser likes to see his investment protected by the other $20,000 equity. It’s a kind of cushion and makes the investor feel comfortable. At 90 cents on the dollar your cash proceeds from the sale of the note are $72,000. At 95 cents on the dollar your cash proceeds from the sale of the note are $76,000.

Step 4: Enjoy a successful outcome. Here are a couple of possible outcome scenarios. 

Scenario 1.

An acceptable outcome could be that you get $100,000 for your house but have to carry paper to clinch the deal. However, you are relieved to have sold the property and got it off your hands. At least you can go sailing. Here is how this outcome looks:

 5,000 cash down payment

15,000 second mortgage 

72,000 cash proceeds from note

92,000 total

Scenario 2.

A better outcome could be that you get $100,000 for your house but you get all cash. Here is how this outcome looks:

20,000 cash down payment

72,000 cash proceeds from note

92,000 total cash

Let's now consider the REAL discount you have taken and the second mortgage:

The Real Discount: The difference between the $80,000 face value of the note and the $72,000 price paid for the note is $8,000. This translates into only an 8% real discount on your $100,000 equity in the house. By the way, this is approximately what you would otherwise pay in real estate commissions alone, assuming you got the full appraised price. If you were to realize 95 cents on the dollar for your note ($76,000), this real discount would be reduced to only 4%.

The Second Mortgage: If you take back a second mortgage, you simply make the remaining part of your equity in the house portable. You take the equity with you in the form of paper. This paper actually earns you money at an interest rate higher than you could get at a bank and, in time, the buyer will pay off the note at full value. Many sellers like this arrangement for tax and other reasons. However, if you do not want to hold the paper, you can sell it for cash. But be ready to face a discount below the face value of the note. Carrying back paper and holding it may not be an ideal outcome but it sure beats sacrificing the equity the paper represents. And it helps you sell the house.

Now look at the discounts you have BEATEN with a Simultaneous Note Purchase:

The time-value discount: Because the program accelerates the sale of your home, you have got your money out sooner. Money now is worth more than money in the future. Also you have avoided continuing house payments and other expenses. The Simultaneous Note Purchase program can save you months.

The cost-of-sale discount: You avoid paying real estate commissions. You also avoid paying negotiated incentives for the buyer, such as loan points.

The price erosion & negotiated price discount: Because "Owner Will Finance" is such an effective marketing tool, you create maximum demand and can always demand full appraised price. 

E-Mail Tony

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Palm Springs Desert Area Homes, Condos & Real Estate are to be found in the Coachella Valley cities of Palm Springs, Palm Desert, Cathedral City, Rancho Mirage, Indian Wells, Bermuda Dunes, La Quinta, Desert Hot Springs, Thousand Palms and Indio. These are the cities that form the Greater Palm Springs Desert Area and are home to some of the finest living and the best resort real estate in the world. If you want to sell or buy homes, condos, or real estate anywhere in the Coachella Valley,  this site will provide the little known information you need and the solutions you seek.