lower down payment vs. lower price & rate, what should I go for?

Question

Hi BP friends, I have a situation here and I would like to get your opinion on this:

I am negotiating on a property with a seller in the Central Valley.  After a few rounds of negotiation, the seller gave me 3 choices:

1. 450k purchase price, put 300k down, and the seller finances the rest at a 5% interest rate for 10 years. I have tried negotiating on a lower down payment with 450k, but the seller needs 300k for a 1031 exchange.

2. 470k with 50% down payment and the seller finances the rest with 10yr 5%

3. 470k purchase price, with a conventional loan (I am looking at 7.5% with 25% down 30-year fixed for investment).

The property is an SFH but converted into 3 separate units and currently renting at above-market rent to daycare. According to the number provided by the seller, I will be cash-flowing either way, but around 1k more with option 1.  Essentially my question would be: should I put more cash down (around 80% of all my cash reserve) and lose the opportunity to buy in another area (hopefully a primary in the Bay area and house hack) in the near term for a lower purchase price and interest rate?

Alternatively, I can walk away and use my cash to invest in a fixer house in the bay at a B to B+ location but probably need to put all my cash in for down payment and rehab. Hopefully I can rent out 2 rooms to help with mortgage but I will still have a negative dscr in this scenario.

Would love if you can share your thoughts here!

Daniel Schiff · Answer

Option 3- which is about $135k down and leaves you roughly $225k cash ($300k was 80% of your reserves so I am assuming $360k cash on hand) Keep your powder dry and take the option to use other people’s money as long as the deal really does cash flow for you and pay for itself. Make sure to do due diligence on the property and cash flow- 1-2 years bank statements and receipts / cancelled checks. Confirm the application process that was used and credit worthiness of tenants; ensure they have solid income/careers to ensure their work/industry doesn’t put your cash flow at risk. make sure to know how long that cash flow is in place before needing to rent or renew, and if any capital investments are looming (roof, HVAC, etc) that would detract from you cash flow and success. IE get proof your rent will be stable and remain in place and not become a maintenance money pit. Your cash reserve will ensure you can ride out any uncertainty if the market or economy sours, and if fed reduces rates in next 2 years you can refinance to a clean, lower rate loan.

With you cash you will have flexibility for other RE and not be 80% tied to one property.

DUE DILLIGENCE is your key here (act as if you are an underwriter and eliminate risks). Without provable facts walk away.

Greg Scott · Answer

Given what you wrote, the seller appears to be playing games with you.

If the seller "needs" $300K for a 1031 exchange, then option #2 makes no sense because he gets $235K and therefore cannot do a 1031 exchange. One might argue that the added $20K in purchase price makes up for that.

But, if that is the case, then #3 makes no sense because the seller would get $470K.  Some might say the benefit of #1 and #2 is that the seller can defer some of the capital gains because they are offering seller financing.  However, if you are doing a 1031 exchange, ALL of the capital gains gets pushed into the new property.

I'd ask a lot of questions around these issues.

Alex Olson · Answer

Sounds odd. I would skip this one and move on to a cleaner deal.

Wang Windy · Answer

Hi Daniel, thank you for your detailed response. I am concerned about the above-market rent, and I do think that's a risk. And it is selling at a higher price compared to other properties in the area with an adu and garage. Do you think that's a problem?

Bradley Buxton · Answer

Also check that the property is actually zoned to be a business and especially a daycare and are they permitted and insured. With 3 buildings can you rent out as separate units?   I agree with the other that there is a lot of due diligence here to be done with the math and the operations.

Becca F. · Answer

Where in the Central Valley? Would you continue renting the property out to the daycare? Or eventually turn it back into a SFH rental?

My opinion is that Bay Area properties have great appreciation but the negative DSCR is a factor. I also considered the Central Valley - Turlock was recommended by my local realtor but the negative cash flow of at least $400 a month wasn't good in my situation. I don't know very much about the Central Valley but if people earning Bay Area salaries are commuting to Modesto, etc I think it could be a good investment.

I'm not a big fan of putting more cash down and you mentioned using 80% of your cash reserve. I think $300,000 down is large downpayment and tying up a lot of money (without know the rest of your financial situation). From a buyer perspective I would go with option #3. If you do option #3, are you in a positive cash flow with monthly payment or at least break even? I haven't done any seller financing so I can't speak to options #1 or 2. Putting in all your cash reserve for a Bay Area property and rehab...hmm....I would be cautious. I prefer to have at least 6 months cash reserves per property plus another $10,000 per property but I know everyone has different risk tolerances.

Those are my thoughts but I have different goals and financial situation than you. Good luck!

lower down payment vs. lower price & rate, what should I go for?

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