Seller Financing: How can I make this deal happen?

Question

I have the chance to buy 3 multi unit properties owned by a seller who wants to retire. The seller is willing to do seller financing with the following terms:

35% Down, 7% Interest, 7 Year Balloon

The asking price and rent rolls are as follows:

Property 1 = $63,999

Unit 1: $550

Unit 2: $550

Total Monthly Income: $1,100

Property 2 = $349,999

Unit 1: $400                                  Unit 7: $450

Unit 2: $450                                  Unit 8: $450

Unit 3: $430                                  Unit 9: $450

Unit 4: Empty ($450)                      Unit 10: $450

Unit 5: $410                                  Unit 11: $350

Unit 6: $450                                  Unit 12: $450

Total Monthly Income $5,190 + $150 (Coin Laundry) = $5,340

Property 3 = $239,900

Unit 1: $550

Unit 2: $550

Unit 3: $550

Unit 4: $550

Unit 5: $550

Unit 6: $450

Total Monthly Income:   $3,200

I will have about $60K available pending an SFR that I am selling but that does not give me the total downpayment the seller would like which is about $225K. How could I structure an offer that takes advantage of the seller financing offered given what I have available   in cash? Would it be reasonable to offer 10% down to the seller?  Could I borrow part of the 35% down payment that I don't have from a private or commercial lender?

Any help on this would be greatly appreciated!!

Aaron Mazzrillo · Answer

Way too much down, way too big of a loan based on your cash situation, and way too short of a pay back period. How do you intend to come up with almost half a million in seven years? That's $60K per year you'll have to save to be able to pay this seller off. The bigger question here is, how much of a discount are you getting on the retail value of these properties? Based on the rents, it sounds like the prices are good, but I live in California so I have no idea what your market is doing.

Why not eat the elephant one bite at a time? Take down the least expensive property and once you get control of it, work on shoring up the financing. Then, move on to the next. If you're getting a decent discount, maybe sell them one at a time until you are left with one that you have paid off considerably.

As a buy and hold investor, I want to keep everything I get a 'Yes' on from a seller. Only problem is, I run out of cash. Every once in a while, I have to drag something out behind the woodshed and harvest the equity.

In this situation, I might sell off the two most expensive properties and use the profits to be left with the least expensive free and clear or mostly paid off. You'd hopefully still have a large chunk of your operating capital so you can stay in business.

Another option, if you're getting a significant discount, is to find a partner on the deal. You might be able to raise the entire down payment from a partner and still retain 25-50% of the deal. Just depends on your negotiation skills.

Here is what I would and have done;

Find a fellow investor and it doesn't have to be someone in real estate. You split the deal 50/50, but you guarantee that person a 6% return on their cash invested off the top. She puts up the down payment of $229,000 and you pay $1,145 per month on that.

Using the very conservative 50% rule, you take a nominal management fee for doing the work, and split all the cash flow 50/50 but you have to pay the 6% regardless. There should be plenty of cash available every month and if you do a good job which you will because you'll be a partner, you should be able to pocket at least $1,000/month.

$654K purchase price. $229K down. $425K 1st at 7% = $2,500/month

GSI $9,500

10% taxes, 5% insurance, 10% maint, 10% mngmt, 10% vac, 5% learning curve

$4,250 net

- $2,500 interest pmt on seller's 1st

$1,750 cash flow to split, but partner gets 6% guarantee

- 1,145 partner guarantee

$605 cash flow to you just for putting the deal together PLUS the 10% management fee. Conservatively, you'll be pocketing around $1,500 a month if you do your job. That's not bad income for 14 units and no money down. Of course, there are escrow fees and all that jazz so maybe you have your partner put up $240K.

When I was doing deals like this, I also included an acquisition or finder's fee for putting the deal together. So, maybe the partner puts up $250K and you use $10K to line your pocket and pay the 6% on the $240K.

It's late. There might be some slight miscalculations here or there, but you can iron out the details. I've done a bunch of deals very similar to this and even with a few hiccups here and there, they still all worked out well for both myself and my partners.

Krystof Bartos · Answer

Does he have a kinds? Give him 10% down and 25% share of profits. You will handle all management etc and he will get profits, appreciation etc. Or you can change it to 10% down +45% share +45% loan or something like that. Seller will protect the downside and gets potential to upside.

Don Konipol · Answer

The numbers look like they can work, but you need to evaluate the true vacancy history, the tenant turnover, the real expenses, any deferred maintenance, property condition, and if neighborhood is stable, on rise or in decline.

Many investors are concerned only with the numbers. This is half the equation. We need to understand what this investment will look like after we purchase, in three years, in five years, in ten years.  I have seen many investments where the current numbers didn't make sense turn into goldmines as demand changed, neighborhoods became hot, new facilities built.  I have also seen investors take losses on properties purchased with initial high cash flow.

All other things being equal, high leverage, like 90%, is a two edged sword.  It can magnify profits, creating a very high return on invested capital.  However it also means higher fixed cost of debt service which magnifies the problems of vacancy loss, unanticipated repairs, utility price increases, etc., resulting in higher risk, less profit margin, and greater stress and worry.

Higher leverage may often result in margins too small to hire a competent property manager meaning the investor will be managing the property herself or managing a revolving door of less than qualified individual property managers.

An investor in any property needs to consider not only how they they will purchase the property with available cash, but also the consequences of investing with high leverage.  Most properties purchased all cash will provide a positive cash flow with little owner involvement, somewhat less at 50% leverage, and very few at 90% leverage.  Market pricing seems to be set up (in general) so that 75% leverage is the dividing line between relative comfort and relative stress.

Jeremy Pace · Answer

@Dante Pirouz do you have the credit and reserves to go to a bank and get a loan for 75% of the purchase price?

Honestly, if the seller won't come down on 35% down, and you have the means to go to a bank, ask the seller to finance the 25% down-payment, so you can get the bank loan.  That way, he'll get a lot more up front.

If you don't have the credit or reserves to go to a bank, you could either negotiate the down-payment lower by sweetening the pot some other way, or get an investor to front you the remainder or the money you need (get a loan from them, make them an equity partner, etc.)

Jay Dewberry · Answer

Hi Dante. I will defer to more seasoned investors and keep an eye on this thread. But from what I've learned, many investors have a Price vs Terms type of thought process. The seller can have one...but not both. If he wants those terms, especially with that 35% down payment, he should yield some on the price...or vice versa. Of course it does depend on the market as well. Perhaps it's justified, perhaps not. Either way good luck. Make sure to still run the numbers many ways in the BP Calculators.

Eric Munson · Answer

@Dante Pirouz - Great job negotiating. Numbers look good. Best of luck with this portfolio.

Joel Owens · Answer

"35% Down, 7% Interest, 7 Year Balloon"

People often ask why would people with 35% down go with owner finance when they could get  a bank loan for less down?

The answer is some people have lot's of money but for whatever reason cannot qualify for a regular commercial bank loan. So in that instance this works for 35% although you try to negotiate less down.

If you can go to a regular bank of course some will allow only 20% down if the debt numbers work with the purchase price. Loan costs are typically higher than a regular seller financed deal. Banks tend to give shorter term loans for 5 years and sometimes 7 years.

7% rate frankly just sucks. Rate should be no more than 5% fixed for 7 years with no annual step ups  and a 30 year amortization. You want to maximize cash flow. You do not want a large debt payment on an older building needing repairs. If some tenants go out and income drops suddenly and you have repairs and make readies to do to the building to get fully performing again the high debt service payment will crush your turnaround efforts.

Sounds like the seller wants to owner finance as they have used up all their depreciation schedule so want to take the income a little at a time.

You have to walk away sometimes. I walked away recently from a 2 million retail strip center 50% occupied. Just could not come to terms with the seller. Their solutions fitted them but to me were not good so I told them thanks,but no thanks.  For whatever reason they had a 15 year amortization schedule on the loan in place which was horrible. Made the debt payment really high and break even. Bank would not change to 25 year amort. like I wanted.

Always say NO to bad or marginal deals. If you don't then when one that does work comes along you will already be strapped with a bad property and debt and the opportunity will go to someone else.

Nathan Diones · Answer

I like Krystof's idea.  How about 10% down, the seller takes a 90% note at a fair rate, 50% of net operating income until the balance reaches 35% as a down? But you get 100% ownership, deductions and depreciation. That way it might only take 2 years or so to pay it off.

Are all the properties debt free or does a seller have mortgages?

Dante Pirouz · Answer

Just wanted to update everyone that we finally have agreement with the seller on the following seller financing terms for the 20 units:

5.7% interest, 5 year balloon, 30 year amortization, $56K down (~10% down)

2 unit property = $55,000

Total Monthly Income: $1,100

12 unit property = $312,000

Total Monthly Income $5,190 + $150 (Coin Laundry) = $5,340

6 unit property = $212,000

Total Monthly Income: $3,200

Thanks to everyone on this thread who has helped me try to figure out this deal! Fingers crossed that everything looks good through due diligence period!

Stan Hill · Answer

You already named the possibility that immediately came to my mind: buy one of the properties you can do with a conventional investment loan and not straining your resources. But I say that as someone who doesn't like partnerships and am generally pretty conservative.

Assuming the duplex is in decent shape in a stable area with good demand for that type of unit, it sounds like a decent buy.

Seller Financing: How can I make this deal happen?

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