Stable Future Income Option, Owner Financing For The FULL 30?

Question

Hey All,

I wanted to explore an exit strategy some of you have probably debunked, can vouch for or have at least thought of. This exit strategy stems more from a mindset of getting a consistent return over a long period of time.  Let's assume this option would be applied to just 1 property out of a smaller portfolio of 10 properties.

Traditionally I have read seller financing is geared towards buyers that may have exhausted the amount of loans they can get, maybe there is a lack of credit history or maybe they have a less than desirable credit history etc...

From the perspective of the seller, with interest rates on the rise and no telling where they will rise and fall to over the next 30 years, has anyone entertained or actually provided seller financing options to QUALIFIED buyers at current market rates?  Everything I've read only talks about offering at higher rates and a higher asking price.  What if I wanted to find the best buyer with the least amount of risk for default while getting a long term fair return.

My mindset is, with rising rates, does a collateral backed guarantee of 5-6% sound so bad over the next 30 years on one investment (Assuming rates don't drop back below that and the buyer refinances out)?  Yes, you would probably lose the ability to get a higher asking price but could still dictate down payment amounts.  Yes, you could make more income by going the traditional route but it could be marginal if they refinance out of it quickly and you have a higher risk of default.  I understand a highly qualified buyer can still default and can still leave the house a wreck when exiting but there is definitely a lower risk of that happening.  I am sure everyone's current financial position will play a role on how they respond.  Lets assume the seller would easily live another thirty years and have other properties that he/she would NOT do this on.

Poke some holes in it, I'm just thinking out loud.

Chris Mason · Answer

Why would a seller carry a note for $100k @ 5% when they could sell the house, make a clean break, and just park the $100k in a Wall Street index fund for >5%? The only reason institutions lend @ 5% is because the secondary market loan purchase amounts to a subsidy.

ROI and interest rate are two sides of the exact same coin.

If you really want to lend money out at 5% without any of the pesky modern underwriting requirements, post this fact over on the marketplace and you will have more borrowers than you know what to do with, until you are depleted of money/houses. :) (A non-trivial amount of these people will just be re-lending the money at 10% and 4 points, which is what some people currently already do with HELOC money.)

Dave Foster · Answer

@Joe Trainor, I think if you are looking to provide seller financing to qualified buyers at market rates only then you'll be very exposed risk wise.  There's a reason why hard money is more expensive and conventional is much less expensive.  It is not a function of greed.  It is a function of risk.  The traditional lenders market rates can be lower than private financing because of the levels of risk mitigation between them and borrower default.  Defaults are built into their proformas.  And Federal insurance as well as economies of scale and reinsurance and even the dreaded credit default swaps and derivatives of the last debacle are an example of institutional risk mitigation.

When you go privately you don't have access to this mitigation so your risk goes up exponentially.  Sure, in an aggressive market it's easy to think about providing finance for those qualified buyers who are all expanding.  But you'll be the one left with the properties (or at least the necessity to foreclose on those properties) when and if the next round of "strategic foreclosures" hit.

There's a middle ground that I've used which is short term owner financing through lease options.  Not strictly owner financing since I retained ownership until actual purchase.  But I did it to very qualified borrowers needing to fix credit or to decide if a corporate transfer was going to work out.  The key was I didn't do it long term.  3 years was our max.  And we built in 3 profit centers - The Option price, The NOI from lease, and a strike price for purchase that escalated according to an appreciation factor each of the 3 years.

I would hate to hold a note for 39 years without some of the conventional safeguards.  I felt that 3 years with the up front, ongoing, and back end cash protected me well enough for 3 years.  At the end of the 3 years or whenever the tenant exercised the option we would then 1031 again.

I don't know if that meets your definition of stable.  Honestly if I was looking for stable like I think you're thinking I'd 1031 into a passive commercial placement.  TIC or DST. Laddering 20 year TICS performing at 7% can build up a substantial stable income that doesn't all go dark at any one time.

A syndication with a really strong incredibly experienced syndicator would be nice but the ability to 1031 into them is  rare.

Joe Trainor · Answer

Awesome suggestions and information!  Especially the latter.  I don't really expect to use what I through out but definitely wanted some insightful input on it. Thanks

Joe Trainor · Answer

Thanks for the input!  I probably didn't hammer on the word "stable" enough in the thread, but I was trying to build the discussion around that.

I don't know if throwing the lump sum (or even dollar cost averaging in the short term) in todays market is my definition of stability but to each their own.  Say I did though, and the market tanks in the beginning and I continue to withdrawal at 5%.  Does that greatly reduce the chance that the money doesn't last 30 years, probably.  Even the principal is subject to loss. I know, if its and butts were candy and nuts.......

Is hard money stable?  It can be very profitable but there is a reason hard money gets higher returns.  Rates correlate with risk. You had mentioned hard money rates above.

The question is not stemming from a position of amassing more wealth (even though the ROI from interest would grow the initial investment).  I hear a lot of people saying they want to grow grow grow but have no exit strategies in place that don't include some serious assumptions about where the market will be when it comes time to exit.  If creating more wealth is the main goal then the short answer to the seller financing question should be, lend high and take a larger down payment.

This is just a thought relating to stable, pretty passive, lower risk, long term income while still growing the initial investment on one property.  Please keep in mind there would be other properties to exit and grow wealth with by using the ways you described above.  I guess the best way to describe this option would be, am I creating a hedge from market uncertainty by doing this with a property or two while still building a portfolio?

Stable Future Income Option, Owner Financing For The FULL 30?

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