Has anyone purposefully overpaid?

Question

Has anyone encountered a scenario where it made sense to overpay? Sounds strange, but let me explain with a hypothetical situation.

- Large MF property is for sale (several million dollars).

- The property is in decent shape but is old and needs moderate attention/maintenance. Property has strong financials/occupancy (long term tenants). Rents are significantly below market level. Other value-add opportunities present.

- Buyer does not have the capital for a significant DP, but sees this as a good opportunity and wants to be creative.

- Buyer purposely offers significantly more than what is asked (the spread being the equivalent to the down payment on the larger amount that is financed). Buyer asks seller for a seller concession equivalent to the down payment to be paid at closing.

- Seller gets the full asking price. Buyer gets the property with practically no money down (closing costs are wrapped into mortgage). Agent gets a higher commission. The buyer's task from there is to manage the property properly albeit with the higher debt responsibility.

Buyer, seller, and (especially!) the agent are happy - everyone wins. Has this been done? Plausible?

Thanks! - Jonny

Jeff Greenberg · Answer

Lender says no and appraisal would need to come in for the higher price.   I believe there would need to be some mortgage fraud in here to make it work. Lender calls note and buyer goes to jail.

I am not a lawyer, but just playing along here.

Michael Le · Answer

@Jonny Reck

An asset might be 'worth' what someone is willing to pay for it but that does not mean that a bank has to loan you the money to get it. If you want to plop down cash for that property there is nothing preventing you from doing so. The bank has just as much libertarian freedom to deny your loan as you do to pay cash or find someone else willing to lend to you.

That said, I don't think it's necessarily mortgage fraud. Freddie Mac does not allow your rehab to be rolled into the loan but I had heard of someone paying more for a property with a seller credit and using that credit for the rehab. I asked one of my mortgage brokers about this and they said it is possible as long as you are clear with the lender about it. But you run the risk of the lender changing their mind near the end of the application period and messing up the entire deal.

Chris Mason · Answer

People do this all the time on the residential side, but not for the down payment. Just closing costs.

Tom Mole · Answer

@Jonny Reck, I hear you saying basically that you "feel" this would be a good deal even at a higher price point. In my experience feelings are tricky devils. They talk you into deals that may be no deal at all. Once the good feeling wears off you're left with a nasty sinking feeling.

Rather than search for clever ways of making your project work, why don't we just take a look at the numbers. Let's this by the numbers:

1) Why is the seller selling?

2) What is the property worth in its current condition with all it the problems, attributes and circumstances?

3) Why are the rents "significantly below market level"?

4) What is the NOI (Net Operating Income)?

5) What is currently owed on the property?

6) What do you expect to do with this property?

So, what is the seller planning to do with the proceeds? How long has he held the property? Could you assume his existing financing? If he has no plans to use the proceeds immediately and would be willing to carry back a mortgage for the difference between the price and what is owed, you may be able to make this work.

In order to make the seller finance option work we will want to know about the NOI. In its current condition would this property have a positive NOI? That is, would the gross income cover the gross expenses (all of them, including capital expenditures, vacancy, etc.) and still have money left over? If so, there could be a way to make this work.

Would the NOI cover the the assumed financing with money left over? The remainder after paying the existing mortgage is all you have to pay the seller carry debt service, so there has to be enough. AND this must be based on the current gross income, not the projected new rents! If this is the case, then there may be a way to make this work.

Once you've figured the NOI and subtracted the existing mortgage what is left is pretty much what the seller is getting on the property right now, but right now he's dealing with the property management and all the risk. You would be taking all that on and you need to get paid for it. You'll need to subtract the amount that you need to make in order to be willing to get out of the bed in the morning. If there's anything left, you may be able to make this work.

Could you structure the terms with the seller such that the amount remaining would pay the debt service to the seller? That means playing with the price, interest rate and term of the loan in order to get the monthly payments down to a point where it can be paid from the money remaining at the end of each month. If you can get that payment down below this "magic number", you'll actually cash flow. In that case you succeeded in making is work. Everyone wins and everyone is happy!

• Gross income - gross expenses = NOI
• NOI - 1st mortgage debt service - the amount you need to make = "magic number"
• "magic number" - debt service on the seller carry = cash flow

Over time the seller will make more money by carrying back the second, so you could in theory offer a lower price. Also, if the seller would carry for a longer term and/or at a lower interest rate, you could get the payment down to or below the "magic number".

As @Jeff Greenberg points out do not try to put anything over on anyone in the transaction. To do so may end up with you in front of a judge explaining that orange not really your best color and how you may like a different serial number for a name. Everyone would NOT be happy then.

So, to answer your original inquiry, yes, it is possible and it has been done before, but really it's pretty complicated and risky. If you analyze the numbers in a straight forward manner and find that price is the only objection, you might still be able to structure the deal to a close. "But I still don't have the down payment!" This can be tricky, it's true, but you might want to bring in a partner with experience in this area or someone who could put up the money for a piece of the action.

I like the way you're thinking. Keep looking for ways to create opportunities and you shall. Just be sure to do what you did this time and check with the folks on BP before you leap into anything.

Cheers!!

Tom Lafferty · Answer

Totally agree with @Jeff Greenberg.  With the prices seller are asking (and getting!) these days, its starting to negatively affect the LTV's buyers are able to get.  I tried to get a deal recently for which the lender offered 80% LTV, with a max loan amount of $9.6M based on historical numbers.  The property ended up trading for a price that caused the LTV to be reduced to about 74%.  So for your scenario, the property would have to appraise high enough to cover your "spread," which is pretty unlikely.  Somehow appraisals have still magically been coming in at exactly what they need to in order to get deals done, but no way they'd be several million higher.

I'm not a lawyer either, but yes, that sounds like something that could get you into some ugly situations legally.

Christine Kankowski · Answer

The property would have to appraise for the higher amount.  The credit would have to be disclosed to the lender, who would have to agree to a 0 down loan.

Without those 2 things, it could be mortgage fraud.    Look up Hendrix Montecastro- in jail for doing this.

Luka Milicevic · Answer

Account Closed On owner financed deals i will overpay all day, every day!

Account Closed · Answer

Thanks everyone. We can chalk this one up as "don't do it through conventional lending unless you look flattering in orange jumpsuits"!  I appreciate everyone's thoughts and feedback. This is one amazing value-add resource that BP provides

Account Closed · Answer

@michael le - you're very right! Banks have total freedom to approve or deny at their discretion. My thoughts were more toward the federal requirement for appraisals to be made and the influence/power the appraisal carries in the acquisition process. I can't help but 'feel' (@Tom Mole!) that instead of being available as a helpful tool that gives clarity to the buyer, the appraisal is more the determinating factor for value (as opposed to demand). Maybe more opportunities for deals could be made without the power appraisals have been ascribed by regulators? Just thinking. Your thoughts? Thanks - Jonathan

Account Closed · Answer

Also, just wanted to stress that full-compliance and adherence to legal standards is valued here. With that, persistence is equally valued ("persistence pays..."). Persistence is how I was finally able to convince my wife to marry me!

Has anyone purposefully overpaid?

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