Imagine you’re a ninth grade boy, in your parents’ dimly lit basement, about to lock lips for the first time with the cute girl who lives next door. She slowly leans in toward you. With sweaty palms, and a racing heart, you nervously press your lips against hers…
And then your worst nightmare happens: your braces lock.
Well that wasn’t exactly what you had in mind when you imagined your first real kiss.
But at least now you’ll have a little experience if your dreams come true with the sexy senior cheerleader at the big school dance this weekend.
As a newcomer to private lending, it’s tempting to go straight for the uber-hot cheerleader of private lending: a Shared Appreciation Mortgage. But is this wise? Or should you maybe consider cutting your teeth on a simpler deal or two before setting your sights on a S.A.M.?
What is a Shared Appreciation Mortgage and why does everybody want it?
With a S.A.M., you agree to lend to a borrower at an interest rate below the prevailing market interest rate. Why would you want to do this? Because in exchange, you are entitled to a share of the profits when the property is sold, or upon termination of the mortgage. This share is known as the contingent interest.
Seems like a win-win situation for everyone involved, doesn’t it?
However, by participating in the appreciation of the property, you the lender are taking on an additional risk related to the value. Whether or not this is a favorable trade-off depends on the state of the current housing market. If the property’s value decreases, the borrower is still on the hook for the outstanding principal, but if the borrower sells the property for a loss, the contingent interest is zero.
So the question you have to ask yourself is, are you ready to take on this risk?
How do you know if you’re ready to pursue a S.A.M. borrower?
If you are just getting started in the private lending business, now is probably not the time to hyperfocus on a S.A.M. deal. If you have a hefty mortgage to pay every month, mouths to feed and a child attending one of the most expensive private colleges in the nation, you’d be wise to get some experience with smaller deals.
How do you get experience?
Just like looking for your soulmate, you wouldn’t sit on the sidelines waiting for the perfect man or woman to fall into your lap, would you? Of course not. You’d frequent your local watering hole on Karaoke night. You’d ask your friends if they knew anyone right for you. You might even sign up on a dating website. So why wouldn’t you do the same with your business?
You had to swap saliva with your next door neighbor before you could try your luck with the cheerleader, didn’t you? It’s no different with a S.A.M.
Even if you have successfully closed deals, you have to know not every deal is going to be a S.A.M. For example, if you are only funding 65% of a deal—and this doesn’t include all or a portion of the repair costs—then you probably aren’t taking on enough risk for a borrower to want to split the profits with you.
Think you’re ready to take the next step with a S.A.M.?
S.A.M.s are not found; they are created. Learn when a S.A.M. is appropriate. Sharpen your negotiating skills so you can show a borrower the benefits of doing a S.A.M. deal with you.
Don’t think your broker’s going to feed you S.A.M. deals either: unless you want to starve like a whimpering puppy, waiting for table scraps. These deals normally result from finding borrowers on your own, and explaining you’re interested in a being a long-term funding solution. This isn’t a one night stand. Tell the borrower you would like to help them drastically increase their profits over the next 12 months, and mean it.
You should always strive to work with experienced borrowers, but this is even more important in a S.A.M. deal. You don’t want to fund a newbie for repair costs just to find