I. BASIC ECONOMICS
a. Gross Rents – Operating Expenses – Debt Service = CASH FLOW
b. But taxable income is different from Cash Flow
i. Gross rents – Operating Expenses – Interest Part of Debt Service – Depreciation = Taxable Cash Flow.
ii. Interest Deductions: For tax purposes, you subtract only the interest part of the debt payments from the gross rents. The closer you get to total amortization, the less you can deduct because the interest portion is decreasing.
iii. Depreciation: also for tax purposes, you deduct a standard depreciation value.
1. Commercial property: 39 year depreciation scale (1/39th of the cost deducted per year)
2. Residential property: 27.5 year depreciation scale (1/27.5th of the cost deducted per year.
a. Equity of Redemption (Rule Against Clogging)
i. Old Rule: Regardless of desire of Mortgagor, equity of redemption could not be traded away. No clogging for any reason.
ii. New Rule: No provisions made at the time of the mortgage that limit Mortgagor’s equity of redemption upon default.
1. Made at time of mortgage” clause: Court’s sometimes allow agreements made after default where parties agree to convey property (and thus the equity of redemption) in lieu of foreclosure. Subsequent contracts)
2. They also allow options for lender to acquire an equity or interest in property (made simultaneously with mortgage) unless condidtioned on occurrence of default. (Option to buy contract)
III. MORTGAGE ALTERNATIVES
a. Determining if a mortgage was created or not: Ask whether it was intended as a security or a conveyance in real property?
i. It does not matter what the parties intended to create, a mortgage or something else. It matters only if they intended the property to serve as a security for a loan. If so, it is a mortgage.
ii. Mortgage vs. Conveyance of Absolute Deed
1. Mortgage, not a conveyance if
a. Agreement to reconvey is entered into at same time as mortgage
b. Price paid for the conveyance is far below the fair value of the property.
2. Flack v. McClure
a. Six factors to consider in determining whether an equitable mortgage exists:
i. Whether a debt exists
ii. The relationship of the parties
iii. Whether legal assistance was available
iv. Sophistication and circumstances of each party
v. The adequacy of the consideration
vi. Who retained possession of the property.
IV. KEY TERMS
a. Wrap Around Financing: Combination of seller financing and ???
b. Due on Sale Contract:
c. Installment Land Contract:
d. Net-lease: Landlord applies 0 gross-rents to operating expenses. Leaseholder pays all expenses, property taxes, and utilities.
Real Estate is good as collateral:
Does not depreciate in value (little, if any)
Not moveable. You can reach out and touch it.
Ease of verification of ownership. Title searches.
Downside to Real Estate as collateral:
Balloon Payment: Your payments are calculated as if the loan term was 25 years, but the loan is due in 10 years. At year ten, you have to pay the remaining principle and interest. Terminology: Amortized at 25 years, but due in 10.
Better rates the shorter term. Lender doesn’t have to cover the possibility that rates will rise.
Adjusted rates: ARM = Adjustable Rate Mortgage.
Can be anything the parties wish to agree on.
They can go up or go down.
If they go up, you may enter negative amortization or at the very least, no amortization. You just pay interest and never pay down the loan.
Typical purchase of real estate:
Buyer puts down some amount of money and then borrows the balance from a lender (mortgage company, bank, savings & loan).
Total Equity purchase: You collect investment partners; everyone invests a share and you buy it outright.
Buyer takes over the property subject to the loan.
Assume the loan. You actually take over the loan.