Although a note that is performing can remain in the joint venture though its entire term, there may be circumstances where one JV partner may want to sell out his/her interest or buy-out the other partner. Below is a general description of how we would determine the note’s value to establish a fair purchase/sellout price.
Partner Buyout:
As far as a buyout, the JV agreement has various terms in section 8.0.3, but basically either partner can propose to buy out the other for an agreed price. The purchasing party can pay all cash or 4 equal semiannual installments over a 2 year period upon mutual agreement. As far as a guideline for valuation, generally that would depend if the note is performing or non performing, the remaining term of the loan payments due and the value of the home.
For an example, lets look at a note with a $50K purchase price, on a home worth $110K and the unpaid principal balance (UPB) of $100K:
- If non performing it would be the Cost Basis of the note at the time of purchase. So if we bought a note for $50K and had an additional $500 in holding costs/expenses, then the purchase value would be $50,500. In this case the manager would be buying out the partner since the partner funded the deal, or we would be selling it to a third party to liquidate at par.
- When we get the note performing then the purchase price would be the current value of the note, minus the Cost Basis (purchase cost + expenses – any income to the partner), divided by 2.
- So in the above example lets say we own the note for 15 months and started collecting $665/month in P&I payments at month #3. Of that payment, $570/mo. is the interest portion, averaged over the first year. Each party is entitled to 50% of the interest portion of the payment and the funding partner gets 100% of the principal portion.
- So, we’ve collected $6,840 in interest in the first 12 of 15 months of ownership. The funding partner received half of that amount, $3,420 + the full principal portion of $1,015 = $4,435. The new cost basis for the funding partner is then $50,000 + $500 (initial expenses) – $4,435 = $46,065.
- Now, what is the value of that now-performing note? In our PE fund, we us a 10% yield as our basis for valuation. On this example, with a remaining UPB of $98,985 and 348 remaining P&I payments of $665/month, the sales price for those future 348 payments at a 10% yield would be $75,346. (less any sales/transaction costs)
- The equity would be the sale value minus the partner’s current Cost Basis:
$75,346 – $46,065 = $29,281
- Based upon that calculated value, then the partner buyout cost would be 50% of the equity or $14,640.
- At that point the partner purchasing the asset is entitled to all of the remaining 348 term principal payments of $98,985 and interest of $132,541 or a total of $231,526!!
- If the borrower sells or refinances the loan then the remaining UPB is paid off. The profit would be a capital gain of $52,920 (UPB – Cost Basis). This would be an approx a 87% ROI
Regarding ongoing expenses, they vary depending on the loan, but assuming a performing loan with taxes/insurance escrowed, it would be $30/month for servicing. Also for the JV, we can assume an annual cost of perhaps $200 for tax filing and issuing a 1099 to each JV partner