On a wrap, a wider spread with 3 percent down or a thinner spread with 15 percent down

Question

Take a wrap on a small three unit and lay out two versions of the same deal. Version A: sale at 340k, 10k down, wrap balance 330k at 8 percent. Underlying is 218k at 4.125. Monthly spread runs about 690. Version B: sale at 325k, 49k down, wrap balance 276k at 6.75. Same underlying. Monthly spread runs about 385. A pays roughly 3,700 more a year. B hands over 39k more at closing and puts a buyer with real skin in the deal on the other end, which matters for whoever is still writing the underlying check if payments stop. There is a second layer worth naming. Version A's buyer has almost no equity, so if values move down five percent they are underwater on a note someone else holds, and the incentive to keep paying gets thin. Version B's buyer would have to walk away from 49k, about as strong a default protection as exists without a lawyer involved. And a third layer: the bigger down payment reduces the wrapped balance, which reduces the balance the spread is earned on, so safety effectively gets bought with yield. On a 30 year note held to a five year balloon, A runs maybe 18k more in cumulative spread and B runs 39k more up front, which arguably says B wins on cash timing alone. Then again, B's cash lands now and A's is contingent for sixty months. Which structure would the room write?

luis_carrera · Answer

The numbers already answer it, even if the framing talks itself back out of the conclusion. 39k in hand beats 18k spread out over five years that depends on a buyer with 3 percent equity staying employed. One more number is worth pulling though: cumulative spread if the buyer balloons at month 36 instead of 60. Version A's advantage shrinks fast if the note pays off early, and buyers with thin equity are exactly the ones who refinance the second they can.

karen_whitfield · Answer

Down payment is the only underwriting a private seller really has. Everything else is a promise. I've never regretted asking for more down and I have regretted the other direction twice.

renee_dubois · Answer

A three unit changes the calculus here. A buyer with 10k down on a small multifamily is one bad turnover away from missing a payment, and small multifamily produces bad turnovers on schedule. Worth asking what the buyer's reserve looks like after the down payment clears, not just what the down payment is. Take a four unit where only 6k is left after closing and the roof costs 9k in month five, and the owner of record eats that, not a wrap buyer. The lower spread, higher down payment version is the safer structure, and the reserve statement is worth seeing before deciding.

On a wrap, a wider spread with 3 percent down or a thinner spread with 15 percent down

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