Analyzing Seller Financing For Rookies

[Stephen Brown]

I thought I'd share something I learned today with the BP community.

Let's say you have a 4-unit that you're analyzing. The NOI is 23,620. You have a local bank that is willing to refinance your deal up to 80% of it's value.

You can purchase this property conventionally for 25% down, $59,050 out of pocket, the purchase price is $236,200 if you buy at a 10% cap rate (NOI/Purchase Price.)

However, if you bought this property through seller financing you can put less money down which will help you scale your portfolio. Let's say you put 10% down, or $23,620.

However, you then realize that you can go to your bank and get your property refinanced at 80% of it's value... so instead of buying the property at full price, you are going to try to purchase it at 80% so that you can get your money back!

So now we see that your purchase price will be $188960 (80% of 236200) and your down payment will be $18,896 (10% of $188960)

With seller financing typically there is a balloon payment after five years, which is where you owe the seller the total amount of the loan at once. To avoid this you want to refinance your loan. Let's say your loan to the seller is for 30 years at 5% interest with a 5 year balloon.
At year five, the seller will have earned only five years of interest plus the purchase price for selling you his or her property. So in total $188960 + $40880 (5 years of interest @ 5%), for a total of $229840.

$229840 is less than $236200. So why would the owner do seller financing here? I guess you'll have to pay at full value instead of 80%.

Or you can buy at a lower cap rate of 9% (NOI/Purchase Price.) and you can raise the interest rate to 6% for the seller.

In this scenario:

The value of the property is $262,444 Your NOI is still $23,620

You want to buy at 80% so you offer $209,600

You still put down 10% as the down payment, so $20,960, but now your loan to the seller is for 30 years at 6% interest with a 5 year balloon

The interest that the seller earns after 5 years is $57,995

The seller will earn a total of $209,600 + $57,995 = $267,544

The seller performs better in this scenario by accepting seller financing than accepting a conventional loan. So the point here is when you're running numbers, you want to present to the seller the scenario that is ideal for you and for him or her. Although you can't really play with the cap rate for a market, you can play around with interest and other terms. You can still buy for 80% of the value! Be creative!