EP6: Understanding Lien Positions with Rob Lee

Foreign. Welcome back to another episode. My name is Mundo. I am your host and I am here with my good friend Rob again for part two. We're talking about a creative finance structure known as the Morbi Method. And we are going to talk today all things about the Mori Method as a follow up from our first conversation. And I think specifically, Rob, you wanted to talk about second position liens, is that correct?

Yeah, yeah.

Awesome. Awesome. Well, welcome to the show and let's, let's just go ahead and dive right in. Cool.

Yeah. So I guess maybe for, for anybody who might be watching or unfamiliar with like positioning in a structure like this, where we're looking at, you know, you have to go get cash from a bank, so you're borrowing from an institutional lender and then you're also having. The seller is carrying a note where we're talking about positions. Right. We're talking about first, second, sometimes even more positions in a deal like this. So do you, if, if you wouldn't mind for a minute, maybe just get into what that exactly means?

Yeah. So there's, in this type of creative finance structure, there's all different sorts of ways you can do it. You can do just a promissory note. So that is a scenario where you create a promissory note and really that's it. There's nothing recorded against the property. So if you have a loan, a first position loan, where there are terms in your agreement that say you can't take on any subordinate debt, any sort of second position liens without the first position's approval, I don't see it in a. I guess it's kind of hit or miss. Sometimes I see it in the. More in the mortgages. Sometimes I don't see anything mentioned in there, but let's say it is mentioned where you can't take on any additional liens without their permission, you're technically in violation of the loan at that point. Which would be similar to like a sub 2 transaction where you're technically, you know, you have sold the property. So the lender does have the right to invoke the due on sale clause. And now whether they actually do it, chances of that are very, very rare. They just want to get paid. Or unless you really mess something up on insurance, you're probably going to be fine. Right. It's the same situation here. You know, can they call the note? Yes. Like, what reason would they have to do that? Like, why would they even care? Right. Are they getting paid timely? If the answer is yes, they probably don't really Care. Now, if you pick up the phone and, you know, start broadcasting, hey, I got this second lien position that I already did. Can I get your permission? Now? It's probably not going to go very well as far as that conversation, but.

You'Re talking about calling the institutional lender, correct?

Yeah. So again, it's all about risk tolerance, right? So if you are just getting a promissory note and there's no recorded mortgage, or depending on what state you're in, also known as a deed of trust recorded against the property, you're not in violation of any of those terms because there is no recorded lien against the property. You just have a, you know, a silent promissory note. You have a payment obligation to the seller. Now, the downside of that is if you have a operator who is a bad actor and they know what they're doing as far as intentionally not recording a lien, I could theoretically go and sell a property outright without paying off that obligation. You know, you could just go and ghost that lender. You know, you got a promiser.

You know, you're talking about the seller now.

Yeah, the seller note. You got a seller note, you could ghost them and just say, hey, you know, come and find me. Right. I mean, obviously that's not something I would ever do. But there are, I could see scenarios where there could be a bad actor who would do that. And if you think about what happens when you enter into a transaction, you know, that's done at a title company, first thing they're doing is running a title search. Well, if you never recorded a lien on the property, no one knows that promissory note exists. So title company's not going to catch that. They're not going to say, you know, they're not going to pick up the phone and call the prior seller and say, hey, did you know this guy's selling the property? They would only do that if there was a recorded lien against the property. But if there's not, they're not going to do that. So that's, that's kind of scenario one where you have a silent note. From a buyer's perspective, it's in my best interest to have that type of scenario. You know, I have no intentions of playing, you know, that bad actor game whatsoever. But from terms perspective, with my first position, it protects me the most. Now, the more common scenario is what you were initially asking about in the second position leads, where you have a recorded mortgage or a deed of trust, again, depending on the state. That's also with A promissory note. So the promissory note really lists out all the terms of the obligation in a lot of detail. And the. The mortgage or deed of trust, it's really just the instrument, the. The piece of paper that's recorded against the property that says, hey, there is a payment obligation to this property, to this person. Right. In this case, it would be the. The prior seller and whatnot. Sometimes it, you know, it could very. It definitely will probably say the dollar amount. It may not say the terms. It may not say the maturity date or the interest rate. It's usually a very broad, loosely crafted document that just says, hey, there is a recorded position on this property, and it's just meant to stop anyone from selling the property outright without addressing that lien.

Right.

The promissory note is what actually lists out all the details, all the terms, what the interest rate is, what the monthly payment is.

Right.

If you're late, you know, this is what happens. This is what a default is. And. And sometimes the mortgage will have, like, hey, this is what a default is. So you have to make sure you're not crafting a promissory note and a mortgage with two different terms. Like, they have to match. Right. So if you happen to be, like, reusing a template, and then you have the title company or maybe you prepare your own promissory note, and the title company is preparing their deed of trust or mortgage, you got to make sure that everything matches. Because they could be using a template, and you could be using a template where. And when I say template, meaning, like, they just crank this out all day long. Right, Right. If they make a human mistake and have some terms in there that don't align with your promissory note, that's something that you want to be careful about. Like, they could have, like, default language and say, every mortgage we have has these same terms, and those terms may be, hey, a default is after 30 days of no payment. We can get the property back. Like, I don't know, whatever. Just an example. And your promissory note may not have that. So you really want to make sure in your final review that everything is in a alignment from both the promissory note and the deed of trust.

Of course. Yeah, yeah. And that makes sense. Talk to me about the implications of position and why that matters.

In what respect? So I. I guess to take a first stab at that question, Y. Your first position is pretty important. Right. They're first in line. If the deal goes south and they need to enter into a foreclosure position and let's say you're in second position and you have a property that, you know, let's say the purchase price is $500,000 and you got a mortgage for 300k and you have a second position for 200k. If you're in second position and the deal goes south day one, you're not getting your money back, like your full amount of money back, because when the first position forecloses, they're going to have fees involved with that related to attorneys. You know, the attorneys always got to get paid. Right. They're the ones making the most money.

Right.

You got court fees and all that stuff. And, you know, let's say that ends up being 20, $30,000. Well, you're, you're going to be, you know, when it trickles down to the second position or third or whatever you got going on, you have to take that into consideration of what your level of risk is because by time it comes down to your churn, you're not probably not going to recoup all of your investment until the property has like, appreciated. Now, if it's one year down the road or two years down the road, there's likely enough appreciation in that scenario to where, you know, you'll probably be covered at that point. But that is, you know, a consideration. Mm.

So with that in mind, when you are. Because really all of these very specific details, a lot of times a seller, you know, you, you mentioned like recently you're working with a finance, someone who's been in finance for a long time, so they might understand some of this much more clearly. A lot of sellers really, like the very specifics can oftentimes just confuse them. But they, they. A lot of times in my experience, you know, they understand the difference between first and second position. I know there was a deal or even third position there, there was a deal where I was working with a lawyer and we were going to wholesale it and I found a buyer who was interested, who was looking to mori method, more method to deal. And the buyer just could not get past being in second position. Like the buyer was like, yes, the terms I like the we, we had pretty much come to, for all intents and purposes, agree in agreement in principle, but he couldn't get bass being in second position. And it was multiple properties, it was three properties that he was looking to sell. And, and that was really my first experience with this barrier that, that can exist in these type of deals. And so I wondered if you had any suggestions or insight to someone who sees the incentive of this type of deal with getting a lot of cash up front and still carrying a note and the incentive of carrying that note with terms, but, you know, ultimately can't get past being in that second position spot.

Yeah, no, I think one scenario that I've pitched in the past, and I haven't had anyone take me up on it until recently, I won't dive too much into that at the moment, but being a member in the LLC is one way to solve that problem. So, you know, the LLC that you're buying the property in, they're the one taking deed and they're the one taking title. Right. So in a roundabout way, that seller would still be retaining ownership and control in the property. And then it really comes down to the operating agreement and what is listed in that operating agreement to make that seller feel more secure versus a traditional second position lean. So when I was describing that second position lean day one, there's some risk. You know, overall, I don't think there's. I guess it's relative to the deal, but as long as there's a path to a positive equity spread, I don't think second position is. Is really a bad position to be in at all. But you'll get into situations where the seller just can't get over it. You know, I've had times where the agent. I couldn't get past the agent because they were like, oh, no. I lived through 2008 and I saw all these deals go bad, and you just can't even get to the point where you can get it in front of the seller.

Yes. I think that's probably the biggest for a lot of people who can't. They foresee a scenario where what if you. You don't really hold up your end, if that makes sense, and take care of the property, and that forces some depreciation in. In value or. Yeah. Some unforeseen, you know, economic.

Exactly. Yeah. I mean, in that scenario, we're definitely not talking about me because I always perform. But if I was abducted by aliens, so.

So. But even that's a big part of it, right? Like, how much is that a part of your conversation, building that credibility? I mean, is that a lot of times that can just come from an initial conversation if you just sound like you know what you're talking about. But sometimes, like, does that ever happen for you where they really. They, you know, they're like, okay, well, I see the incentive. I can handle being second position, but I gotta trust you.

Credibility is critical on those. On the phone calls. I never that that's my main core focus. I never leave the initial conversation without them knowing that I'm credible. And it's very intentional. I have stories to tell. One example, I was talking to another agent and I actually it was, it was like 6:30, 7:00 o' clock at night. And I was planning on leaving the office that day around 5:30 and the tenant texted me for another property, said that he was already two or three days late on rent. And I was like, hey man, you gonna pay rent this month? What's going on? And. And he was like, yeah, I'm gonna pay it next Tuesday. And I was like, that's not gonna work, bro. If he wanted to move into another one of my units that I had an eviction on. So that unit was going to be, it's gonna as of Tuesday, so tomorrow it's going to be vacant. And it was a two bedroom. This guy's in a one bedroom, he really wants to move in. And if I don't move him into the two bedroom, I'm then going to have two empty units. Because it's just a matter. He's been asking me for like three months, hey, when are you going to have a two bedroom available? When are you going to have a two bedroom available? I already knew this two bedroom was starting to not perform and it was just a matter of going through the whole, you know, court process of evictions. So I told him like, look, hey, if you want to move into this two bedroom, like we can't be having this kind of conversations every month where you're paying rent, you know, 10, 15 days. Yeah, that's just not gonna work, right? And I think it was because he travels for work. Like he's in construction and he goes and works in Ohio and so he's gone for like a week at a time. So in his head he was like, oh, I'll just pay him when I get back. In my head I'm like, dude, what's going? Like, I need the cash, I need. You got to pay the mortgage, right? And so I was like, hey. Like he basically said, I can do it today, right now, I can head your way or you're gonna have to wait till next week. So I was like, I guess I'm gonna sit here and wait. And so I was. The point of that story is I was talking to the agent. He finally came. It was like around 7 o', clock, I was still at the office and he started walking up to me and he started talking to me and it kind of like Interrupted the conversation I was having with the agent. Well, once the guy left and I got the, the rent because the guy pays in cash only, which is, you know, not ideal. It is what it is.

It is what it is.

So I told that story to the agent.

Yeah.

You know, instead of just like, hey, why is this guy interrupting me? And then just dismissing it, I, I made it a point to bring that up and, and I told him this story of I have this eviction here that I'm dealing with. I'm moving this guy into this one. This is why, you know, I told him, hey, meet me here.

Right?

Yeah, it really fed in nice to a couple minutes later in the discussion where I asked, hey, so why is the seller, you know, why is he selling? And you know, it was kind of more of a tired landlord situation. And then I kind of fed back into that story. I was like, oh, so you don't want, you know, he doesn't want to be in a parking lot, 7 o' clock at night collecting cash from your tenant that's, you know, he's late.

Yes.

I assume he doesn't want to do that. Like, so just stuff like that. And just every time I hear something in the conversation from the agent, I'm, I'm pulling on those collective stories and experience and all of that's building credibility in their head of like, this guy's a reputable guy.

Yeah, yeah, yeah, for sure. Yeah. I, I think, yeah, there's a ton of power in the experiences. There's a ton of power in the stories. This. Do you have a suggestion for someone who might have a lot of experience with conversations, but not, not a, not a larger portfolio? Not 10, 15, 20 doors, you know, maybe one rental? What, what about somebody who knows what they're doing and is like, this is something that can happen and I know how to execute it. But when it comes to that, like, that conversation, what are some other ways to kind of establish that credibility without those tangible experiences?

I mean, the easiest thing is to, to bring in someone that does. Right. To have a partner that does or tell a third party story of your partner, like of a story, you know, you and I are partners on a deal or going to be partners on a deal. Right. We may not be right this minute, but technically we, we have entered into a business arrangement. You know, you could use stories of, you know, me, right. You could say, hey, my business partner, you know, dealing with this or whatever that comes up that you think would make sense. And someone like myself, I mean, you know that you could call me, text me and I will jump on the phone with whoever you need me to jump on the phone with and we can, you know, provide that level of credibility on the call.

Yep.

So I think it's just partnering with good people.

Yeah.

I think that's really what it comes down to and have to. To build that credibility.

Yep.

And I think for people that are new, if you're in a, like real estate community, like sub two, I mean there's a lot of value and it is, I mean it goes light years beyond a normal person who's just doing things on their own. Like, there's so much. Even if you haven't done a deal, I mean, there's like 40 hours of Zoom training focused on real estate a week. Like even someone who hasn't done a deal, but they've taken the time to do the work, there is a ton of knowledge that translates into experience in some way. It's not like you're just starting brand new.

Right.

So it's kind of leveraging those experiences. You can even leverage failed experiences. Right. You know, if you're new and you've worked on trying to get 10 deals and 10 of them failed, you can talk about those 10 deals. You know, you don't necessarily have to go into that they failed, but you can draw from those are all real experiences that occurred along the way.

Yeah.

So I mean that's, that's, that's what I would recommend. Either partnering with someone or drawing upon, you know, get real creative about the experience that you do have and really pull the strengths out of those experiences and highlight that in conversations. But you probably need to do, you know, if, if you haven't done or someone hasn't done a ton of deals and you need to be creative about how you're presenting that you should probably just do some role playing with yourself of like, okay, if I'm an agent, I don't trust this person on the phone. What questions am I going to ask? What are my answers? And just rehearse that over and over and over again. You know, if you, if you've done a ton of deals, like, you don't need to do all that. Like, it's just part of your experiences. Like, I'm never going to forget when I had to meet this guy at 7:00 at night and collect cash because he wasn't going to pay me until the next week. I won't forget that, you know, because I was irritated that I had to do that. It's in my head of Course.

Yeah, no, and I, I, I, I love that. I think that's exactly where someone in that position has to go. You know.

And.

Ultimately in my experience with morbi method deals, I, I feel like this, this, this is the, that potentially can pause, pause sellers but they're like in my, with my conversations and I'm trying some new language and some, a little bit of, of new tendencies and these new approaches. For example, you know, you and I talked about one time like, and I don't know that this necessarily means you're hiding anything and I don't know that it even means that you're intentionally being like you know, shady or deceitful or anything to the seller. But you, you present things especially when someone isn't super familiar with the concept. You present things in stages and levels. And so like even bringing up note position like that's not something that to necessarily talk about immediately or, or right away. And I know, I know other people say that's like one of the first things they talk about and I'm sure either way can be depending on, you know, how you phrase it and what you talk about can be effective. But yeah, even something like that where just kind of layering the different conversations around what to talk about with this type of deal.

Yeah, I don't ever bring no positions up at all. I just, I always let the seller, they're going to be the ones that push back. You know, I'm not gonna, I'm not gonna negotiate against myself I guess is what I'll say. And if they want to push back and say hey, I need second position or I need to be this and that, that's just a negotiating chip. It's like, you know, if you look at things like a scoreboard of who's, you know, getting concessions in a deal. You know, I always like to feel like I'm winning and I always want, I always want the seller to feel like they're winning. I don't want to come in and just be just so heavy handed that it's just all on my side and the seller's getting nothing. If that, I'm not saying that scenario won't ever happen, but if it does happen, it's because the seller has no more chips left and they're in a bad situation and they need me to come in and help them. And by helping them out of the situation, that is a win for them. Right. In that scenario I'm going to come with like my best and final like hey, this is not the greatest scenario for me. As far as like a entry position, equity position, whatever, maybe the deal, barely. Cash flows, whatever. These are the terms I need, take it or leave it kind of thing. You'll have some of that sometimes, but usually, you know, I won't mention things like no positions, I'll let them come back. So that way it's, that's a win in their column. Right. So hopefully at the end of the day, when we're done with the transaction, done negotiating, there's a couple wins over here for the seller. There's a couple wins over here for, for me as the buyer. And we can come together and both be happy about where we're at with it.

Yeah, well, I think let's, let's, let's reconvene because there's, there's a deal right now somewhat in my backyard here that the seller is open to financing with a higher down payment. So we're trying to put it together, we're trying to structure it. It's a, it's a four unit all, all one one. About 2,000 square feet. So I'm actually four single family homes.

Or is it like a little complex?

It's one house.

Okay.

Very large house. And there are four, four units in it. All one bed, one bath. Yeah. So wait, I sent the LOI on Friday and we'll see what the response is today from the agent and, and the seller. So maybe our next conversation is an update on, on where things are at with that deal.

Yeah. So going back to the second position liens and all that to kind of wrap that discussion up, you know, you can, I can see a way where being a LLC member in the deal would give seller more comfort and security versus second position. Right. If you go back to that scenario where there's, there's no equity in the deal and second position is kind of like, hey, I know if I have to foreclose today, I'm going to lose money. I'm not going to recoup my full security investment. Having more control in the llc, you can structure the operating agreement in a way that says, hey, if you don't perform and you don't meet this obligation, I'm taking this property back. Right. I'm taking ownership of this entity which owns the property. In that case, I don't have to go to the title company, I don't have to sign the deed over because I already am on the deed. Right. As the seller, I'm an owner in the LLC that owns the deed and has title to the property. So it's really becoming a business dispute at that point where it's like, hey, if you're not performing, and let's say the buyer is 51%, I'm saying, hey, you can write it however you want to. I'm saying, hey, you're not performing. I'm 51% now you're out.

Right, right.

Or you're at 20% and I'm the majority until we get this stabilized and then build back trust and you show me that you can, you know, pull your head out of your butt and get this thing turned around or, or whatnot. Right. There's more control in that scenario, being a member in the LLC as opposed to going through the foreclosure process. You know, being a member of the llc, you can take control of the bank account. You could say, hey, all the funds. I'm controlling the funds, I'm controlling the bookkeeping. Like, you have a lot more flexibility as opposed to a lien holder. You're not involved in the deal. Like, you're not in the operations. You know, there's a different relationship level of, hey, I'm your business partner, versus, hey, I'm your lender, if you think about that type of conversation. I'll be right back.

I gotta get the door.

What time you get to school? Early. Early. Got these fine young gentlemen waiting out here for two to.

All right, sorry.

I like it. You podcasting at school. All right, well, you might get some.

You might get some language in the background.

Yeah. I assume we gotta wrap up soon, but, you know, it's a different kind of conversation of having a business partner involved and the level of engagement in the property versus a lender. I'm not calling up, you know, rocket mortgage and saying, hey, just so you know, you know, the property's doing pretty well. And they're like, why are you calling me like, just pay the mortgage and leave me alone? Right. Like that's what they would say. But your business partner wants to know all that information. Right? So someone who wants to feel more connected to the deal and have more sense of security that, like, you're gonna get more of a heads up if the deal's going south, being involved in it versus being a lender. So I think that's an attractive play for a lot of people that are savvy.

Yeah, yeah. One of our, you know, I, I think going back to the deal that we. We were taking a look at in Detroit, right, With that seller, I. I don't know if we ever. We kind of got there, and I don't think the numbers ultimately worked, just period. But you know that I. That's the one experience I've had where that might have been a more attractive way to. To enter in to the deal. But going back to that now, you're really looking at truly like a partnership.

Yeah.

In a way.

Is that. Do you. Have you talked to that owner recently?

I. I did. I did reach out to her, and she actually said, let's hop on the phone. So she basically said she's. She's reconsidering, like, not. Not necessarily selling as she was expecting to, but I think she's reconsidering, like, what to do with the property just in general. So.

Yeah, well, I'm gonna be talking to some lenders over the next couple of days, so I'm gonna. I'll ask some questions. I. I'll throw in a. In there, like, hey, tell me about the difference between your underwriting in this type of deal that I'm presenting and a 10 unit commercially.

Yeah, yeah, because that one as, you know, like, that was a huge, huge property. Six units, you know, but one parcel. One parcel in the city.

So wait, remind me, how many units again? Total?

6 total.

I thought it was more. Oh, when we talked about.

They were large. They were large units. Remember, like, like two. Two of the units had three beds and were about a thousand square feet, and then the other four were two beds and close to a thousand square feet. I mean, the total square footage in the Property is around 6,000 square feet. So.

Okay.

Large property. Yeah.

Okay.

So, yeah, I do. I need to get. I need to get on the phone with her and give you. Give you a little update, see what's going on.

Cool, man. All right, well, I know you probably got to go. Well, I appreciate you coming on the show again, talking through some of the lean position stuff like that. So we'll. We'll have another conversation once you get further along in your loi process and kind of go from there.

Yeah, I can't wait. I can't wait to give you an update. Hoping for the best.

All right. Thanks for joining today, man.

Always.