Convertible notes are a useful tool for hard-to-financing projects such as large real estate projects or undiscovered property opportunities that are not fit for investment but may be suitable for use as a down payment.
Their popularity should not be lost of healed when it comes to this article: this article is about Convertible Notes in General, not the bendable kind. We will go into more detail later!
The purpose of this article is to introduce you to how to use bendable convertible notes for financing hard-to- Finance real estate projectsetta.тт
Bendable notes are used in multiple ways, including as an alternative method of obtaining equity finacrç¹³¹³¹³n ²œŒequity in a project ¶œŒequity in an asset ¶őŒequity in debt ¶¶¶¶¶¶ššššššşşşşşususususußßßßÜÜÜüüüüüüüü ÜÜäääää ßëèèèèèææææææ őñññóóóóóóôôôôôôâââââååå ãðïïïïîîíîíî ‘‘’””””””>has one or more properties that would require significant renovations or expansions, where equity can be obtained through either renovation funds or additional property acquisitions.
Who should use convertible notes?
Most notably, convertible notes are useful for financing hard-to-finance projects such as large real estate projects that require heavy use of financing.
Many times, the only solution is to raise additional capital through a capital increase or loan, which is not an easy process for someone looking to gain fast cash.
With the right project, the right convertible note investor, and the right lender, you have the potential for quick and easy financing. The investor can easily just take off their request to take out a lot of debt when it is completed, which saves both parties from having to deal with extensive paperwork and stress.
In order for a project to be considered hard-to-finish real estate property, it must be unoccupied for at least a year and not be in good financial shape before it is started. If this type of property were to start operating, then the person applying for the note would need money in order to start working on it.
What should be included in the terms of the convertible note?
A convertible note has two parts: the debt and the terms of conversion. The term of the note should be reported as debt, and the terms of conversion should be reported as taxes, benefits, or incentives.
Some common tax incentives include property R&D capital expenditures, forgivable loans for short-term housing needs, and donation credits. Without these benefits included in the note, your potential lenders would be unwilling to lend you money.
If an investor were to convert their note into an equity interest, they would need to include tax treatment for any gain that was made during conversion. If a converter wanted cash without having to go through a new investor agreement, those who provided funds had to make sure that they were receiving some benefit from the project.
As stated before, it is important to properly report this debt on your taxes so that it receives full treatment.
What is the conversion price?
When a buyer desires a certain property but it is not in their friendly neighborhood, they can use convertible notes as financing. This is known as limited or restricted lending due to the radius of the property you want.
Limited loans may only be obtained for very specific properties and in very specific areas. They are not an available method of financing for most people due to cost and restrictions.
However, with the right lender, they can be an excellent way to acquire real estate investment property or take control of a property you do not feel comfortable owning alone.
There are several ways limited loans can be obtained. The first is through an appraisal process. When a seller desires an accurate value for their property, they can request an appraisal from the county assessor and researcher.
Should there be a cap on the conversion price?
When a note is converted, the new owner has to pay off the previous owner at a certain rate for the length of the note.
This conversion rate is called the conversion price. The conversion price for notes such as this one is low, but it can get high fast.
A very common use of convertible notes is as an initial funding source for hard-to-financing projects such as rental properties or occupied properties. Participants in the project can offer their convertible debt as a base to start negotiations with potential investors.
Should there be a discount offered if the investor converts their notes into shares?
Some investors like to convert their convertible notes into shares of stock in the company they invest in. This is a nice way to receive a small discount on your investment, and in some cases, help with financing the project.
In order for this to work, the investor must have at least some degree of control over the company they are investing in. Also, there must be a suitable amount of stock given the investors investment amount.
Mostly these companies look for people with solid finances and control over a project so that they can get their product out soon. If you think you would be able to control a project if you had some stock, then offer yourself for work!
If someone were to invest money into your project and wanted to buy some stock, I recommend talking with them first so that they can determine if it is what they want or not.
Can there be multiple convertible notes issued for one property?
While it is possible to have multiple convertible notes issued for the same property, they must be issued as separate certificates of interest in the same project.
If a developer were to issue two or four notes on the same project, the two or four investors would each need to buy their notes from separate developers.
This is to ensure that if one investor defaulted on their note, it did not affect the other investors who had their second and third notes paid off. It also helps protect any equity partners on the project from overextending themselves by issuing more debt.
If a developer wanted to proceed with another type of debt, such as a private loan or bank loan, they would have to notify both the holders of the first set of notes and let them know what new debt they want to take out.
What are the tax considerations of a convertible note?
Most people think of a convertible note as an alternative to a loan in hard-to-finance projects where the amount of loan required is prohibitive. A convertible note can be arranged as a loan, but it requires more consideration than a standard loan.
The note has the potential to be reissued and then forgiven, making it look more bankable than a standard mortgage. However, if the project does not work out, the owner can always reissue the note and take advantage of its forgiveness.
As with any liability that could be rewritten at any time, there are steps that need to be taken in case of emergency.
What should be included in the business plan for a real estate project using a convertible note financing structure?
When using a convertible note financing structure, the business plan includes detailed information on how much money the project will need to raise.
This information can include selling securities, taking out a loan, or even applying for a TAR (Troubadour Acceleration Program) loan. The TAR is similar to a bank loan except it comes from a non-bank source.
The difference is that the TAR does not require an additional balance to be paid off before the property can be sold, and can even grant forgiveness of the note if revenues meet expectations.
If you are interested in applying for the TAR, check out this link for more info.
