Negotiating the purchase of a cash flow is about providing a service to sellers desiring cash rather than payments over time. While providing an essential service, the cash flow industry is also a for profit business. Cash flow brokers earn their profit through fees or spreads resulting from the difference between the price the seller agrees to accept and the amount an investor will pay. But how are these fees determined? Is there such a thing as making too much or too little? While these questions might be considered a “hot potato” they are certainly worth exploring to determine how we will individually conduct our business.
Determining the Fee Amount
Two of the most common questions posed by new brokers are “What is an average fee?” and “How much should I make?” The answer from experienced pros invariably contains the words “It depends.” And it does depend. The type of transaction, the amount of competition, the ease or difficulty of placing the paper with an investor, along with hard costs, overhead costs, and time involved in closing the transaction, are all influencing factors.
After viewing thousands of transactions I would venture to say that the current average fee on a typical $50,000 residential note runs between $2500 to $3200 (or 5-6%) before costs. If you factor costs in the approximate amount of $1100, comprising of $600 for title and appraisal plus $500 for overhead costs, this leaves a net spread or fee of $1400 to $2100 (3-4%). This is a very modest cost estimate and doesn’t take into account higher expenses for commercial appraisals, high premium title report states, a large staff, or expensive marketing campaigns.
These types of fees represent the bread and butter for many cash flow brokers. There are certainly instances where a much higher fee can be earned. A fee in excess of 10% is typically the result of a hard to place note resulting from defects in the title, property, or credit history of the payor. Higher fees are more frequently seen on commercial transactions due to the size, skill, and additional overhead required to close this sort of investment.
How much is too much?
Some might be quick to respond “There is no such thing” or “Take what you can get.”
Others may feel it is a mute issue since today’s competitive market has made it more and more difficult to score a “home run” on fees. While less frequent than in the past, opportunities to earn higher fees still present themselves. The prudent and ethical business person will ponder the question “How much is too much?”
Why care? First, there is the issue of ethics that any professional must adhere to. Second, if we don’t regulate our actions they could be regulated for us. Third, if you fail to determine an appropriate fee structure, it might be determined by your investor. Let’s explore these issues further.
The subject of ethics is often felt to be a personal one. The “Can I sleep at night?” test might work for some. However, to make the test more tangible, it becomes a matter of what a court will deem appropriate or unconscionable. Generally, only a person who feels they were treated unfairly or taken advantage of will seek justice in the court of law. Unconscionable action is defined as unreasonable or unscrupulous actions that are not guided by a conscience.
Unconscionable action can be subject to prosecution and sentencing for the charged party but the more global effect can result in an industry with a tarnished image that sets the stage for ensuing regulation. In reviewing such a case the court will look first to existing statute. Finding a highly unregulated industry, the court may look to what is customary in our industry or an industry deemed similar. They may consider the average fee of a mortgage broker (1-2%) or the standard commission charged by a realtor (6-8%) as a basis of comparison. The knowledge or sophistication of the seller would be another consideration. Someone could take it a step further and make it their personal mission to protect the public from unscrupulous actions by proposing specific regulation. Nothing will bring on regulation quicker than a grandmother in tennis shoes shouting foul play. Regulate your actions or have them regulated by others.
Some investors, realizing the potential for risk, have begun internal reviews on the amount of fees being earned by brokers. At least one investor has an internal policy that if a gross fee exceeds 20% of the amount being paid by the investor it must be reviewed by management for acceptability. A fee in excess of 20% could be justifiable once costs are calculated into the mix. For instance, there are often the same hard costs incurred on a small note as a large note which equates to a much higher percentage on a smaller note. However, if an investor feels there is potential liability in purchasing a note with a high broker fee they might suggest either a) the broker obtain the seller’s written acknowledgement of the fee; or 2) the broker purchase the note himself and age it for a period of 30-90 days prior to selling to an investor. These actions can provide protection to both the broker and the investor.
How much is not enough?
This might be an even harder question to answer than the first. Each person in business must decide on the price of goods or services they provide in order to meet overhead and make a living. This price can be dictated by the cash flow needs as well as competition. When dealing with this issue there are two important items to contemplate.
First, it is misleading to quote an unrealistically high price to the seller (translating into an unrealistically low fee for the broker) just to “bag the deal.” Unfortunately this is becoming a frequent strategy used in competitive markets to take a deal away from another broker quoting a realistic price. Sadly, the broker quoting the unrealistically high price knows they will cut the seller at the last minute yet have a high probability of keeping the deal due to a seller’s resistance to start over. Interestingly, the brokers using this tactic are often the same ones charging what could be considered unconscionable fees.
Second, don’t charge so little that you run yourself (and potentially other brokers) out of business. You are a professional charging for a specialized service. Take a moment to pencil out your hard costs and overhead costs. Once you have deducted these costs estimate the number of hours you will expend on the deal and divide it into your net fee. Basically, this is the price per hour you are working for. If it’s single digits you might as well work at the local fast food joint, at least they provide benefits plus discounts on greasy food, and you don’t have to pay for the food before you sell it. Value your time for yourself as well as the industry as a whole.
For now, fee determination is a personal decision for each independent operator. However, it serves us all to combine a healthy interest in profits with a genuine regard for the welfare of our industry and any role our actions may play.