Wrap-around note when I still owe $180k on the building

Question

I've got a mixed-use building I'd sell tomorrow if the buyer could get a loan. He can't, he's self-employed two years and every bank wants three. He asked about owner financing and my first thought was fine, except I still owe about $180k on a commercial note at 4.9% with a due-on-sale clause in it.

So the structure I keep looking at is a wrap: buyer signs a note to me for, say, $420k at 8%, I keep paying my $180k underneath out of his payments and pocket the spread. On paper the spread is great. What I can't get comfortable with is that I'd be sitting between two obligations with a lender who could call the underlying loan if they notice.

Has anyone worked out what the actual practical exposure is there, and whether an all-inclusive deed of trust changes it or just names it? I'd also want to know how the installment sale treatment works when part of what I'm collecting is servicing someone else's debt.

Rena Expert · Accepted Answer

A wrap doesn't remove the due-on-sale clause, it just puts a second layer of paper on top of it. Your lender's right to accelerate on transfer of title comes from your loan documents, and whether it's enforceable and how it's enforced depends on your state and on the specific language, so that clause needs a real read by an attorney before you price anything. An all-inclusive deed of trust is a documentation tool that describes the wrap and says the buyer's payments cover the senior debt. It doesn't bind your lender to anything.

On exposure, the thing that actually bites is timing. If the lender accelerates, you owe $180k on demand and your income is a buyer paying you monthly over years. That mismatch is the risk, not the spread. People handle it by holding reserves, by getting the senior lender's written consent, or by refinancing into something assumable first. Ask your lender in writing what they'd do on a transfer. Some commercial lenders will consent for a fee and a rate bump.

On the tax side, an installment sale reports gain as principal comes in, and the mortgage you leave in place gets treated as part of the consideration. If the debt you're relieved of exceeds your basis, you can recognize gain in year one whether or not cash showed up, which surprises sellers on wraps specifically. That calculation is a CPA job with your actual basis numbers in front of them.

The part you haven't raised: servicing. Don't take his payment into your personal account and pay the bank yourself. Use a third-party servicer that pays the senior lien first and shows both sides a ledger. If you ever end up in front of a judge, that ledger is most of your case.

dpatel_re · Answer

The spread math on your numbers is $420k at 8% against $180k at 4.9%, which is roughly $2,800 less $1,000 a month before taxes and insurance, so call it $1,800 of gross monthly on paper. Underwrite it against the acceleration scenario instead. If you had to produce $180k inside 30 days, where does it come from? If the answer is selling the note at a discount to a buyer who'll price it at 12 or 14, your $1,800 spread was borrowed against a bad exit.

gregpowell66 · Answer

Two years self-employed is going to be three years eventually. I'd ask what his path off your note actually looks like before you build a wrap for him.

On the building side, watch who's carrying casualty. On a wrap you've got a senior lender wanting to be named on the policy and a buyer who now owns the thing and controls whether the roof gets fixed. I've seen the insurance requirement in the senior note get ignored because everyone assumed the new owner handled it, and then it lapses and the lender has a default reason that has nothing to do with the transfer.

Wrap-around note when I still owe $180k on the building

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