Advice needed (long post)

[Westernskies]

Just found out about a development that could affect my ER plans, and wanted to solicit some advice from some of you market-savvy folks here on what to do if it happens....

I sold an investment property a couple of years ago on a contract, ~$550K at 20% Down, 6.5%, 15 year note. Has been paying like clockwork. Plan was for us to be able to use the proceeds to fully fund ER at age 55 until 59.5 and ~63 when 401K's and SS could phase in as required.

Just found out through a mutual friend that the buyer is considering a refinance to lower the rate, if so, I'll get paid off early. It's raw land, so I'm not sure he'll be able to beat the 6.5%; I hope not.

I want to be proactive, and have a plan for this $ if I get paid off early. So the question is, what to do with the proceeds? MMA and CD's are out, IMO, they're not paying anything. I'm not completely risk-averse, and have my 401K account (roughly the same $$ amount as this contract) allocated primarily in equities, chasing returns- I have been OK with that in the current market climate because this contract was safely chugging alongside paying 6.5%. My knowledge of individual stock investing is ZERO- my 401K is all invested through my employer-sponsored plan with Federated; self-directed, but with limited fund choices.

Pros- If this contract pays off early, the capital gains will be taxed at 15%, and I'll get a nice chunk of cash earlier than planned.

Cons- If this contract pays off early, I'll lose a guaranteed 6.5% interest income, and 15% to Capital Gains, and get a chunk of cash to try to figure out what to do with.

I'm 53 now, not quite ready to ER, and have been using the proceeds of the sale for living expenses, banking my w*rk compensation for ER, (kind of a trial run to see if we could ER at that income level) No kids, so no college expenses or anything of that sort to worry about, just DW (still happily w*rking for now) and me. I'd like to work a couple more years, probably till 55.


Any and all comments and suggestions are welcome.

Thanks,
WS

 

[Martha]

I took the proceeds from the sale of our home (really a four unit apartment building) and bought CDs. I was too nervous to do anything else. I then invested in two real estate investments with about a third of the proceeds so far. So, I am dribbling it into other private offering real estate investments structured as LLCs. One was a rental development in Arizona and another much smaller one was a hotel in New Hampshire.

One possibility is to wait and see what kind of offer he gets on a rate and then match it.

 

[FinanceDude]

Doesn't sound like a bad scenario either way. Can't blame the buyer for refi, at these low rates. If you get a chunk of cash fairly quick, I would park it in an ING orange account and maybe DCA into some broad based ETF's..........the rates on MM will go up slowly over time, and then you can decide how much to keep liquid............

 

[ERD50]

One possibility is to wait and see what kind of offer he gets on a rate and then match it.

Right. You mentioned you doubt he can do much better on raw land, so if he was able to document an actual offer for you, why not meet it? Sounds like you'd rather have, say ~5.0~5.5% from this 'regular as clockwork' payer than look elsewhere. And he would avoid a bunch of paperwork and time.

You might need to be proactive, if he has already gone through most of the work and put money down on fees he might just continue down that path, then your plans mean nothing. So you might want to approach him. Of course, this might just about guarantee you will settle for a lower rate, but still, if that is preferable to finding another home for the money, you might as well take control of the situation.

I think that is what Teddy would do.


-ERD50

 

[Westernskies]

Right. You mentioned you doubt he can do much better on raw land, so if he was able to document an actual offer for you, why not meet it? Sounds like you'd rather have, say ~5.0~5.5% from this 'regular as clockwork' payer than look elsewhere. And he would avoid a bunch of paperwork and time.

You might need to be proactive, if he has already gone through most of the work and put money down on fees he might just continue down that path, then your plans mean nothing. So you might want to approach him. Of course, this might just about guarantee you will settle for a lower rate, but still, if that is preferable to finding another home for the money, you might as well take control of the situation.

I think that is what Teddy would do.


-ERD50

I've thought about approaching him, but as you mentioned, it would just about guarantee that I'd take a 1-1.5 point hit on the interest rate. I'm not ready to charge up San Juan Hill yet; will probably wait and see how he does shopping on the open market before offering to modify the terms for him. When we agreed on the rate, it was lower than he could get on land, and high enough to be attractive to me, not sure that this scenario has changed that much. We'll see.

 

[Martha]

I agree that the odds of him getting a lower rate isn't great unless he gets some kind of cash flow from the property.

 

[Aiming_4_55]

6.5% is a reasonable rate.

Perhaps when you have a few minutes, you can call 1 or 2 places to check rates for raw land.

If you find the rates lower, check what upfront fees he might have for the new loan. Based on both, you can understand the chances of him pulling the trigger or the need to approach him with a "deal" (lower interest rate).

I suggest to be proactive... if he mails you a check for the full amount, your options are limited, but having the $$ in hand isn't all bad.

 

[samclem]

Some thoughts:
- The 6.5% feels good right now, but keep in mind that you are still taking risk with that note. It sounds like it still has over a decade to run, and there's a good chance 6.5% won't be so great in a few years. You'll be stuck once rates go up. And, of course, that 6.5% check is entirely dependent on a single person's ability and willingness to pay. Yes, you could get the land back in case of default, but if you wanted the land you wouldn't have sold it.
- If the payoff comes, is there a way to put a chunk of it into tax favored status this year or over time? Have you got any room in your company 401K, can you start a small business for the very nice Solo 401K opportunity, etc? This whole real estate thing sounds like a small business to me . . .
- Asset allocation: Would the addition of a lump sum of additional assets really upset your applecart? Philosophically, I don't know why you wouldn't diversify the new funds according to your present allocation. Get comfortable with that allocation, make it more conservative if need be (to make up for the loss of the steady 6.5% checks) and rebalance every year. If it helps you sleep, set up a cash bucket to cover a few years worth of expenses.

Good luck!

 

[Martha]

Some thoughts:
- The 6.5% feels good right now, but keep in mind that you are still taking risk with that note. It sounds like it still has over a decade to run, and there's a good chance 6.5% won't be so great in a few years. You'll be stuck once rates go up. And, of course, that 6.5% check is entirely dependent on a single person's ability and willingness to pay. Yes, you could get the land back in case of default, but if you wanted the land you wouldn't have sold it.
- If the payoff comes, is there a way to put a chunk of it into tax favored status this year or over time? Have you got any room in your company 401K, can you start a small business for the very nice Solo 401K opportunity, etc? This whole real estate thing sounds like a small business to me . . .
- Asset allocation: Would the addition of a lump sum of additional assets really upset your applecart? Philosophically, I don't know why you wouldn't diversify the new funds according to your present allocation. Get comfortable with that allocation, make it more conservative if need be (to make up for the loss of the steady 6.5% checks) and rebalance every year. If it helps you sleep, set up a cash bucket to cover a few years worth of expenses.

Good luck!

Watch out on real estate businesses, you run the risk of losing capital gains treatment if you get classified as a real estate dealer rather than investor.

 

[W2R]

Since Uncle Mick hasn't chimed in, I just have to say "pssst... Wellesley!" for him.

One year returns 11.69%, 5 year 6.3%, 10 year 6.48%. Supposedly bonds are going to go in the toilet eventually, even though "they" (whoever "they" are) were saying that two years ago. So, that is a consideration, though it hasn't happened yet.

 

[walkinwood]

After we sell our home, we plan to rent for a year - so we have a similar situation.

Where to park a large sum of money safely?

I was thinking that if I can handle a possible 5% drop in capital, then I can take 10% of the capital and invest in REIT, Emerging Markets, Small Cap Value & Large Cap Value indexes and hope for the best. If the equity portion tanks 50%, I take the 5% loss. The rest of the money stays in a CD. (I am far from doing this in practice)

Is that an option for the OP? Has anyone done this? Done any research on it?

 

[haha]

Is that an option for the OP? Has anyone done this? Done any research on it?

How much research would you need on this? And what could it possibly tell you that would apply to your particular choices for this particular year?

 

[samclem]

Watch out on real estate businesses, you run the risk of losing capital gains treatment if you get classified as a real estate dealer rather than investor.

Thanks, good catch.

 

[walkinwood]

How much research would you need on this? And what could it possibly tell you that would apply to your particular choices for this particular year?

It would be good to see if there was any backward looking research that gave the probability of this scheme generating more than short-term treasuries over short periods of time. I am not holding my breath.

 

[Westernskies]

I forgot to mention the "poison pill" in the purchase contract; two months interest as a disincentive for early payoff within the first five years-so he'll have to factor that ~1% into his refi costs.

 

[Purron]

Some thoughts:
- The 6.5% feels good right now, but keep in mind that you are still taking risk with that note. It sounds like it still has over a decade to run, and there's a good chance 6.5% won't be so great in a few years. You'll be stuck once rates go up. And, of course, that 6.5% check is entirely dependent on a single person's ability and willingness to pay. Yes, you could get the land back in case of default, but if you wanted the land you wouldn't have sold it.

Hey Westie. I'm sure this will bring a smile to your face: I'm ultra conservative. Well, when it comes to taking on risk with my investments anyway

So take this with a grain of salt. I believe samclem has a good point here. The 6.5% you're receiving now is not without risk and you might be happy to have the cash available to reinvest.

I think the economy is showing signs of life and you will have better investment opportunities soon. It might be more apparent here in the DC area, but I believe other areas of the country will revive in the next year or two.

Yeah, I know. Everyone thinks the DC area economy is driven by the Federal Govt. Not so true these days. Most of the growth here is in private industry.

If I were in your situation and received a pay out on this loan, I'd be happy and park it somewhere short term and low risk for the next six months to a year. If the world doesn't end in 2012 as predicted by the Mayans, I'm thinking recovery and some really great investment opportunities.

Best to you and Ms. Westernskies. Look forward to reading your countdown to retirement posts in the near future.

 

[clifp]

I forgot to mention the "poison pill" in the purchase contract; two months interest as a disincentive for early payoff within the first five years-so he'll have to factor that ~1% into his refi costs.

This is a tricky situation. If he paid faithfully for the last few years that means he continued to pay during what is hopefully the worse real estate/financial crisis in our lifetimes, which is a very good sign.

I'd be inclined to match the bank offer unless the refi involves taking cash out even if means losing another 1%. (Please let me know the name of any bank that is foolish info to loan money on cash out refi on raw land, so I can look into shorting their stock). I certainly would only be reactive in this situation. I would think between loan origination cost and the pre payment penalty it would be pretty attractive for him to continue paying you rather than a bank.

A couple of questions. Has he built any improvements? Do you know what his plans are for the property? Finally how much is the property worth now?

 

[Westernskies]

This is a tricky situation. If he paid faithfully for the last few years that means he continued to pay during what is hopefully the worse real estate/financial crisis in our lifetimes, which is a very good sign.

I agree. He now has over 200K out of pocket invested, so the odds of him walking away are pretty slim, IMO... but you never know.

I'd be inclined to match the bank offer unless the refi involves taking cash out even if means losing another 1%. (Please let me know the name of any bank that is foolish info to loan money on cash out refi on raw land, so I can look into shorting their stock). I certainly would only be reactive in this situation. I would think between loan origination cost and the pre payment penalty it would be pretty attractive for him to continue paying you rather than a bank.

I agree. He couldn't find a bank loan at less than 6.5% when he bought it or I wouldn't be carrying the paper, and I doubt he'll be able to find it in this lending climate.... but you never know.

A couple of questions. Has he built any improvements? Do you know what his plans are for the property? Finally how much is the property worth now?.

No improvements, the contract states that he has to pay it off before any construction starts; I didn't want any lien issues in the event he defaulted. As for his plans for the property, he always wanted a working western ranch (evidently a lot more than I did.) Don't know current value, but he apparently had an appraiser out last week (heard about it from a friend of the mailman who was talking with the game warden... It's a really small town...) That's how I know he's considering a refi.

 

[sheehs1]

Westernskies...just some thoughts.
By the time he comes to you...if he comes .... he may already have refinance money arranged and he may have signed on the dotted line with them. Waiting to match him at that point could be a moot point.

Is it possible he could also have an avenue for private financing where closing costs may not be a factor for him..which sweetens his side of the equation? Or are you fairly positive this may be with a bank?

Definitely research bank refinances for raw land to see what he is seeing. Then decide if you want to approach him. You may find he can't do much better than what he is paying currently.

 

[MooreBonds]

Since you obviously don't want to lower your terms unless you have to (but by then it may be too late), why not simply just give him a call to 'shoot the sh!t'? Just see how he's been, yada yada yada...."oh, by the way, heard you had some people working for you on taking a look at the land, etc."....maybe he'll open up and simply offer that he's looking into refinancing.

If he mentions it, you could naievely say "wow....I never thought someone could find a bank willing to lend on raw ground in today's climate", to which he'd probably open up and offer some more info. Throw out a question like "so you really think they'll underwrite it? What kind of a rate are they offering these days on raw ground - back when I bought it, I paid _____% for a 5 year loan..."

 

[samclem]

No improvements, the contract states that he has to pay it off before any construction starts; I didn't want any lien issues in the event he defaulted.

Could this be why he's seeking different financing? He's got a good rate now, I don't know why else he'd be willing to pay the costs.

If you really want to keep the payments coming to you, maybe offer to allow construction if you can see and approve the contract/any financing. Improvements to the land, if done right, could enhance your position (make him more reluctant to walk away). Or, you'd be happy if he did walk away and leave you a nice new drive, shed, well, house, etc with the construction loan secured by his primary residence.

 

[Westernskies]

Westernskies...just some thoughts.
By the time he comes to you...if he comes .... he may already have refinance money arranged and he may have signed on the dotted line with them. Waiting to match him at that point could be a moot point.

Is it possible he could also have an avenue for private financing where closing costs may not be a factor for him..which sweetens his side of the equation? Or are you fairly positive this may be with a bank?

Definitely research bank refinances for raw land to see what he is seeing. Then decide if you want to approach him. You may find he can't do much better than what he is paying currently.

I agree, but instead of cutting the return by ~$400-$500/month I'm thinking I'll just wait him out, who knows, maybe the the next scheduled payment is already going to retire the note? ...Meanwhile, I'm looking at options for investing the cash; with the extension of the tax cuts it just might be good to get this over with now with capital gains at 15% and move on, like samclem and Purron suggested.

 

[sheehs1]

Agree with this too! 15% cap gains definitely may be going away.! Either way it is a good problem to have. I have 2 CD's paying 5% coming due in the next 2 years and will have to do the same. We will see where rates are at that time. Along with the suggestion of others take a look at MAV and EGX. MAV has a 8.7% yield and EGX has a 10.7% yield. As always...."future performance is not guaranteed...etc...etc...etc.."

 

[Westernskies]

Well, looks like this is further along than I thought. Got a call this AM from the bank holding the escrow account letting me know that they had been contacted for a payoff figure. (And wanting to know if I would be waiving the prepayment penalty.).. uuuuuhhhhh, no.

 

[Purron]

Well, looks like this is further along than I thought. Got a call this AM from the bank holding the escrow account letting me know that they had been contacted for a payoff figure. (And wanting to know if I would be waiving the prepayment penalty.).. uuuuuhhhhh, no.

I'm thinking it's a local community bank desperate for loans and looking to beat your rate.

Don't look at it as a problem...it's a new investment opportunity! And in a market looking better and better these days.

Hope it works out well for ya dude.