Complete novice question

[Zachary Petrak]

I'm in the learn-obsessively phase, but sometimes simple things need explained to me. 

Scenario:

I found a triplex in my area that I'm interested in. The potential seller is someone I know and doesn't do much with the property. The word is that he may be interested in parting with the property. Only one unit is being rented. The other two need rehab, some of which has already been done but the process has halted. 

My question:

If I were to seller finance and then raise private capital for the rehab, how would I pay back the lender loan other than chewing through income from the rentals since I would already be paying the seller on the finance? Especially if the lender wants a balloon at some point? 

 Maybe the property covers enough to pay both, I haven't run the numbers yet as I haven't talked to property owner. This is very preliminary, but it's a basic concept I need to understand anyway. 

Thank you (from a rookie)

[Alex Breshears]

Hi Zachary!

You are asking the right questions now so I applaud you for that! 

What you are really needing is some guidance in underwriting. You need to run the numbers to see if this will pencil out as a deal that gets you closer to your goals for why you were interested in real estate in the first place. Cash flow from rentals isn’t just the money coming in minus the mortgage. There’s going to be a lot more expenses - especially in older properties or ones poorly rehabbed. 

While it sounds ideal to bring on another lending partner in addition to seller financing - as you can see you have to pay the piper at some point. That money has to be repaid on a monthly basis - and whatever balloon payment you negotiate with BOTH lenders. I personally wouldn’t rely on monthly cash flow to “save up” for that balloon payment either. 

I’m going to make up numbers to give you an example - you get seller financing for the triplex for 5 years - your payment is $1500 a month for a wrap mortgage the seller agrees to do. Then you also find someone to lend you more money for the rehab - which you estimate to be $60k for both units. The payment for that is $600 a month, balloon in 2 years. You agree to pay them both monthly payments which total $2100 a month. Your tenant in the first unit is paying $900 a month - I’m leaving out mgmt and repairs - so you have $1200 a month negative cash flow while the property is being renovated and you look for a new tenant. 

A few months later you have one unit done - $900 extra comes in. You have $300 a month loss (again - ignoring mgmt and repairs) - you finish unit 3 in another month - by month 4 or 5 you have all three units renting for $900 a month - so you have $2700 a month coming in with a mortgage of $2100. In this ideal world scenario you have $600 a month extra coming in - which as you can see will not add up to $60k to be repaid in another 18 months.  

That’s where the refinance into permanent debt comes in. You could refinance about 70-75% of the after repair value - which would hopefully pay off lender 1 and lender 2. If not - you are bringing cash to closing just to get out of the loans you already have. Secondly, depending on the interest rate you get for the new loan - a highly leveraged property may not cash flow or cash flow well - so one missed month of rent due to vacancy or a major expense comes up - that wipes out your cash flow for the entire year (or more!). 

This is where solid underwriting comes in. You will be able to see the numbers based on some assumptions. You can also put those assumptions out into the forums here on BP for others to comment on. There are also lots of great videos and information on how to underwrite these deals. Only when you have a solid foundation in underwriting would I pull the trigger on a purchase because as you have seen - it will be a money pit for awhile and if you don’t have the exit strategy to pay everyone back - it won’t be your money pit long because they will foreclose.