Wider spread with 3 percent down, or thinner spread with 15 percent down?

Question

Working through a wrap on a small three unit and I keep landing on 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 me almost 3,700 more a year. B hands me 39k more at closing and gives me a buyer with real skin in the deal, which matters when I'm the one still writing the underlying check if they stop paying.

There's a second layer. Version A's buyer has almost no equity, so if values move down five percent they're underwater on a note I hold and their incentive to keep paying gets thin. Version B's buyer would have to walk away from 49k, which is the strongest default protection I know of that doesn't require a lawyer.

And there's a third layer I keep going back and forth on. The bigger down payment reduces the wrapped balance, which reduces the balance the spread is earned on. So I'm effectively buying safety with yield. On a 30 year note held to a five year balloon, A is maybe 18k more in cumulative spread and B is 39k more up front, which arguably says B wins outright on cash timing alone. Then again B's cash is in my hand now and A's is contingent for sixty months.

Which one would you write?

luis_carrera · Answer

You've already answered it in your own third paragraph and then talked yourself back out of it. 39k in hand beats 18k spread out over five years that depends on a buyer with 3 percent equity staying employed. I'd want to see one more number though, which is what your cumulative spread looks like 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

Three unit changes this for me. A buyer with 10k down on a small multifamily is one bad turnover away from missing your payment, and small multifamily generates bad turnovers on schedule. Ask what their reserve looks like after the down payment clears, not just what the down payment is. On my first four unit I had 6k left after closing and the roof cost 9k in month five, and I was the owner, not somebody's wrap buyer. I'd take B and I'd want to see the reserve statement.

Wider spread with 3 percent down, or thinner spread with 15 percent down?

3 replies