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Updated 9 months ago, 02/28/2024
Complete novice question
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)
I should mention that the strategy would be LTR
@Zachary Petrak
You would need to refinance to a DSCR or traditional loan to pay off the private lender and seller financing.
This important to get the buy price and construction costs correct otherwise you will be upside down and not able to refinance
The other option is to partner with someone and give up equity for them to contribute funds.
How much do you have to contribute toward a down payment ?
- Chris Seveney
Quote from @Chris Seveney:
@Zachary Petrak
You would need to refinance to a DSCR or traditional loan to pay off the private lender and seller financing.
This important to get the buy price and construction costs correct otherwise you will be upside down and not able to refinance
The other option is to partner with someone and give up equity for them to contribute funds.
How much do you have to contribute toward a down payment ?
Thank you Chris! I have about 20k I could put towards. I think the DSCR route would be my option due to high DRI.
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.
- Alex Breshears
- [email protected]
- Podcast Guest on Show #210
Quote from @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.
Thank you so much! I suppose that's why I have read that turnkey may be a better starting point for new REIs. I don't want to wind up under water on my first purchase. My student loans complicate everything with traditional lending.
@Zachary Petrak you could stabilize and perform the rehab while using seller financing if your capital allowed it and then when the property was ready and rented at market rates, you could refinance into a DSCR loan. Before going into this, though I would be very conservative in your analysis of cost to renovate and what you think market rent (along with increases in taxes and insurance) would be so that once you are ready to refi into a longer term loan, your DSCR is rock solid and so is your cash. Ideally you would have forced some great appreciation, too, so that your downpayment for the LT option actually uses the equity you built vs. your cash. Keep us posted as to what you do!
If you are newer turnkey might be an easier option, but watch out how the rehab was done. If you ended up in a property that has low grade materials, you can replace stuff more frequently than expected meaning higher costs than if you had done it yourself. It may be easier to finance a turn key because a lender knows the income it is producing, so look at DSCR loans in that case.
@Zachary Petrak I would disagree with your statement that, "... turnkey may be a better starting point for new REIs.". I would househack over turnkey. Turnkey doesn't really teach you about investing, turnkey is usually in neighborhoods that see very little, if any, appreciation. If you decide to do turnkey be very diligent. Look at the history of the house on Realtor/Zillow/Redfin and see how many times has it sold and at what price. Same for the neighboring houses. Does this house, or others in the neighborhood, keep getting sold at close to the same price?
This is an example of a non-appreciating "asset". https://www.zillow.com/homedetails/785-Dallas-St-Memphis-TN-...
Sold in '01 for ~$10k
Sold in '02 for ~$55k (That's awesome appreciation or an unsuspecting buyer geting ripped)
Sold in '04 for ~$61k (I would suspect foreclosure sale here as it quickly sold again for substantially less)
Sold in '04 for ~$21k (This is probably it's actual value and someone in '02 got ripped off)
Sold in '23 for ~$26k for an appreciation of ~24% over ~twenty years that's roughly 1.2%/year
This is a random house on Zillow: https://www.zillow.com/homedetails/766-Neptune-St-Memphis-TN...
Sold for ~$98k last May and sold again last week for ~$40k. I wouldn't want to be the buyer at got in at ~$98k. (I don't know anything about this house or the buyer(s))
Just a couple of examples to show you part of what my due diligence would be.
I hope this is helpful and not confusing!
Quote from @Richard Elvin:
@Zachary Petrak I would disagree with your statement that, "... turnkey may be a better starting point for new REIs.". I would househack over turnkey. Turnkey doesn't really teach you about investing, turnkey is usually in neighborhoods that see very little, if any, appreciation. If you decide to do turnkey be very diligent. Look at the history of the house on Realtor/Zillow/Redfin and see how many times has it sold and at what price. Same for the neighboring houses. Does this house, or others in the neighborhood, keep getting sold at close to the same price?
This is an example of a non-appreciating "asset". https://www.zillow.com/homedetails/785-Dallas-St-Memphis-TN-...
Sold in '01 for ~$10k
Sold in '02 for ~$55k (That's awesome appreciation or an unsuspecting buyer geting ripped)
Sold in '04 for ~$61k (I would suspect foreclosure sale here as it quickly sold again for substantially less)
Sold in '04 for ~$21k (This is probably it's actual value and someone in '02 got ripped off)
Sold in '23 for ~$26k for an appreciation of ~24% over ~twenty years that's roughly 1.2%/year
This is a random house on Zillow: https://www.zillow.com/homedetails/766-Neptune-St-Memphis-TN...
Sold for ~$98k last May and sold again last week for ~$40k. I wouldn't want to be the buyer at got in at ~$98k. (I don't know anything about this house or the buyer(s))
Just a couple of examples to show you part of what my due diligence would be.
I hope this is helpful and not confusing!