Building to Seller Finance/Lease to Own

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Building to Seller Finance/Lease to Own

Joel G.
Real Estate Investor · Sunnyvale, CA · Member since 2014 · 65 posts · 20 votes

First...after a 1 year battle with Cancer my mother passed away...another year has gone by getting our lives back together, kids graduating college, etc. Many of you offered kind wishes and it was well appreciated. The struggles that our family went through have given us even more appreciation of life and the time we have. Thank you to all our friends in the BP community.

That said...we are ready to get busy again. However, I believe I need a refresher....

We still own the rental in Las Vegas ($400+ cash flow/$90k equity) and a house in Sunnyvale, Ca with approx. $250k in equity. We have 401Ks that have approx. $300k, and better than avg credit. 

We are willing to sell, utilize, finance....whatever...to reach our goals.

So....

I want to self contract (GC) a new home in Texas (where we plan to move this year) and then sell it by owner/lease to own.

I can build a small 3/2... ~1500sf ...non-descript...rental ready home for $75k cash (my cost to build including my lot)

Appraised value being approx $150k. (ballpark but VERY close for area to which we are planning to move)

With these givens...

**Can I finance 75-80% of appraised value to capture cash? ie. finance $120k (80%) - $75k cost = $45k cash out 

**Or am I limited to % of build cost? i.e.  Finance $60k -$75k cost = $15k in deal (no cash out)

If cash out financing....

**How long do I have to hold...or rent...property...before I can sell it to avoid regular income taxes and treat the property as an investment vs build to sell...or is it an "original intent" thing?? 

**Does selling on a "lease to own" get us around the holding period for a sale? Or does it even matter?

**I have read that "due on sale" clauses are always present in financing but seldom exercised on performing notes...does a lease option side step that as well?

So (in my head) the plan would be...

Build.....$75k

Refinance...$120k (80% ltv)

Cash in my pocket...$45k

Sell...$150k

Seller Finance...$135k with $15k down pmt (10%) with favorable seller terms 

Results...$60k cash in pocket....small cash flow with no maintenance issues...~some~ tax avoidance?...

The further thought is to use the $60k cash....do this process again BUT this time...pay cash for the project...$15k out of pocket to build...SKIP the bank financing...sell for $150k...take 10% down ($15k)... now my out of pocket is zero...and with favorable seller terms have a substantial cash flow and no govt. involvement?? This would also limit the number of financed properties that seems to be such a problem for budding investors.

That's it. Lather. Rinse. Repeat. 

Six months building time per home...5 years = 10 homes (no land speed records, but moving along)

So....please tell me the parts I have forgotten, ignored, underperformed. Given our resources should we be building multiple homes at once? (That would be a new experience for me...multiple projects going at once...but if it made sense...I'd be willing to make it work)  Are there strategies we should be considering that we have not thought of? (I'm sure there are many)

Anyway...thank you in advance for all of your thoughts on this situation...and thank you again for all the well wishes through our family struggles. 

We look forward to reading your thoughts.

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Bill Gulley
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
9y

Sorry to blow your plans, but contractors building new homes are barred from seller financing (rent to own) under Dodd-Frank, best to sell to an investor on a note and deed of trust to lease it.

Texas has specific rules on installment contracts, better see an attorney there. :) 

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  • Joel G.
    OP
    Real Estate Investor · Sunnyvale, CA · Member since 2014 · 65 posts · 20 votes
    9y

    I forgot to add...I am using an iPad...and am unable to see all the different categories in which to post this message.

    If this post would better fit a different category...please feel free to repost it there or re-classify the post to better serve the BP forums. 

    Thanks again!

    0Reply
  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    9y

    Sorry to blow your plans, but contractors building new homes are barred from seller financing (rent to own) under Dodd-Frank, best to sell to an investor on a note and deed of trust to lease it.

    Texas has specific rules on installment contracts, better see an attorney there. :) 

    2Reply
  • Mike ReynoldsPro Member
    construction · Nacogdoches, TX · Member since 2011 · 2k+ posts · 1k+ votes
    9y
    Originally posted by @Joel G.:

    I forgot to add...I am using an iPad...and am unable to see all the different categories in which to post this message.

    If this post would better fit a different category...please feel free to repost it there or re-classify the post to better serve the BP forums. 

    Thanks again!

     What if you opened a solo K and borrowed 50k and spent 25k of your own money? That way your excess income on capital gains could go back into it as a contribution. Provided you use the company that holds the solo to build the house. 

    I think this may be permitted. I am sure someone may come along and say for sure. 

    0Reply
  • Brian Gibbons
    Investor · Sherman Oaks, CA · Member since 2008 · 6k+ posts · 3k+ votes
    9y

    @@Brian Eastman

    @Dmitriy Fomichenko

    0Reply
  • Brian Gibbons
    Investor · Sherman Oaks, CA · Member since 2008 · 6k+ posts · 3k+ votes
    9y

    attorney Texas Rent to own

    Www.lonestarlandlaw.com

    0Reply
  • Joel G.
    OP
    Real Estate Investor · Sunnyvale, CA · Member since 2014 · 65 posts · 20 votes
    9y
    Originally posted by @Bill Gulley:

    Sorry to blow your plans, but contractors building new homes are barred from seller financing (rent to own) under Dodd-Frank, best to sell to an investor on a note and deed of trust to lease it.

    Texas has specific rules on installment contracts, better see an attorney there. :) 

    Thanks for your reply.

    Exactly why I was asking...I figured Dodd-Frank would come with n there somewhere...just couldn't remember how or where.

    Does the fact that I own the home outright make any difference? Or does it come down to a workmanship issue to protect the buyer?

    Also, thanks for RE Attorney advice...we will definitely seek one out prior to starting any project. We just wanted to see if there was even a starting line with an idea like this. 

    Thanks again for the reply...Happy New Year!

    0Reply
  • Joel G.
    OP
    Real Estate Investor · Sunnyvale, CA · Member since 2014 · 65 posts · 20 votes
    9y
    Originally posted by @Mike Reynolds:

     What if you opened a solo K and borrowed 50k and spent 25k of your own money? That way your excess income on capital gains could go back into it as a contribution. Provided you use the company that holds the solo to build the house. 

    I think this may be permitted. I am sure someone may come along and say for sure. 

    Hi Mike...Happy New Year! And thanks for your reply.

    We looked into opening a business in Texas using the ROBS program and a business loan. It seems to be a very tricky thing (for me anyway) with IRS as far as paying back the investment vs taking salary for work performed. Maybe that's just for a business vs a RE to investment...I'll have to look up not that more...thank you for the idea.

    Also, would setting up the Solo K preempt the Dodd-Frank rags that were mentioned in the previous post? Probably not...but worth asking...if for no other reason than to remove as an option. 

    Thanks again for your help!

    0Reply
  • Joel G.
    OP
    Real Estate Investor · Sunnyvale, CA · Member since 2014 · 65 posts · 20 votes
    9y
    Originally posted by @Brian Gibbons:

    attorney Texas Rent to own

    Www.lonestarlandlaw.com

     Thanks for the link and search idea. 

    Given the basic parameters I mentioned before...could we cash out refi and the hold to rent? 

    It would still put cash in our pocket, but the maintenance, tenants, etc would be our continued responsibility.

    If we did that...build-hold-rent...would there EVER be a point that we could seller finance the property? Seems like we would cross a line somewhere where it become ok...or maybe not...I don't know.

    Next stop...the link you sent! Thanks again!

    0Reply
  • Justin WindhamPro Member
    Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
    9y

    @Joel G.

    Setting up a Solo 401k wouldn't affect the legality of your business transactions. It would just provide a place for your earned income to be sheltered from taxes if you choose to contribute them to the plan.

    @Mike Reynolds

    You would not have to take a participant loan from the Solo 401k in order to be able to contribute to the plan, but you could. What you describe would be permitted since you can use loan funds for any reason until they are repaid to the plan.

    1Reply
  • Joel G.
    OP
    Real Estate Investor · Sunnyvale, CA · Member since 2014 · 65 posts · 20 votes
    9y

    So...after some quick reading and a few searches...

    I cannot find out WHY seller financing is not allowed if you are the GC. 

    I am not arguing the existence of the rule...I am saying that I cannot find the reason for the rule in the first place. 

    I'm sure it goes back to the RE crash...but I can't find any articles that say..." the reason Dodd-Frank doesn't allow contractors to seller finance is ABC and XYZ" 

    Again...not arguing the existence of the rule...it's there...just trying to understand the reasoning is all.

    I'll do a search here on BP as well...I can't  possibly be the only person who has wondered...and asked why...this rule exists! Lol.

    0Reply
  • Joel G.
    OP
    Real Estate Investor · Sunnyvale, CA · Member since 2014 · 65 posts · 20 votes
    9y
    Originally posted by @Justin Windham:

    @Joel G.

    Setting up a Solo 401k wouldn't affect the legality of your business transactions. It would just provide a place for your earned income to be sheltered from taxes if you choose to contribute them to the plan.

    @Mike Reynolds

    You would not have to take a participant loan from the Solo 401k in order to be able to contribute to the plan, but you could. What you describe would be permitted since you can use loan funds for any reason until they are repaid to the plan.

    Hi Justin.

    Thanks for the explanation. Does sheltering the income in the 401k...preclude you from taking some of that income now...for living? 

    Probably taxed...of course it would be, what isn't...but I mean...are there any rules saying that we cannot take a salary from part of the proceeds? 

    There are some strange rules on that using ROBS financing for a business depending on how much "stock" the IRA owns...using certain business entities, percentages, etc. definitely using an attorney...lol.

    Does any of this affect cash out refi? I mentioned it in the original scenario, but no one has commented on whether that is allowed...at least...in the way I proposed it.

    Thanks again for you help. Happy New Year!

    0Reply
  • Joel G.
    OP
    Real Estate Investor · Sunnyvale, CA · Member since 2014 · 65 posts · 20 votes
    9y

    Well...

    https://clintcoons.wordpress.com/2013/10/16/seller...

    This link goes to an article that describes the situation I originally proposed almost identically...BUT it still doesn't clear up the WHY this regulation exists for builders.

    I have read multiple articles now...and done multiple searches...and this is what I have found:

    In Dodd-Frank....the builder - "involved with construction of" - seems to have originally had the intent of deterring timeshare developers who were acting as seller/financers and using deceptive practices to lure would be owners not contracts that they knew would never...or eventually not...perform.

    The 1 unit rule and 3 unit rule seem to be in there as a go around for builders willing to develop other entities etc and then seller finance that way...so confusing...and so little written or discussed...on my topic anyway...that I can find.

    In BP search...I found several articles discussing Dodd Frank...but none from my perspective....or maybe I just don't know how to search anymore.

    At any rate...I will continue to search...and will gladly report back what I find.

    If you have any other ideas or suggestions please feel free to chime in!

    0Reply
  • Justin WindhamPro Member
    Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
    9y

    @Joel G.

    Since the investment/business activity would be outside of the retirement account, you could keep whatever funds you wanted to live on. Yes, that would be taxable (unless other tax deduction apply) as you would only get the 401k tax deduction for the portion of the profits you decide to contribute to the plan. Yes, the ROBS structure is a more involved setup with additional rules since the 401k would own the business in that scenario. The Solo 401k is much simpler and in this example, is really just a place to shelter any income that you contribute to the plan. It's not designed to be a business finance structure, although some do use it that way by taking a participant loan from the plan for up to $50,000.

    As far as the cash out refi, I don't think there is anything specific that would prevent you from doing so on your properties, it's just that the approval guidelines and loan terms would be subject to the lender you use. You might want to reach out to a lender or two to get more familiar with those guidelines.

    Happy New Year!

    0Reply
  • Joel G.
    OP
    Real Estate Investor · Sunnyvale, CA · Member since 2014 · 65 posts · 20 votes
    9y
    Originally posted by @Justin Windham:

    @Joel G.

    Since the investment/business activity would be outside of the retirement account, you could keep whatever funds you wanted to live on. Yes, that would be taxable (unless other tax deduction apply) as you would only get the 401k tax deduction for the portion of the profits you decide to contribute to the plan. Yes, the ROBS structure is a more involved setup with additional rules since the 401k would own the business in that scenario. The Solo 401k is much simpler and in this example, is really just a place to shelter any income that you contribute to the plan. It's not designed to be a business finance structure, although some do use it that way by taking a participant loan from the plan for up to $50,000.

    As far as the cash out refi, I don't think there is anything specific that would prevent you from doing so on your properties, it's just that the approval guidelines and loan terms would be subject to the lender you use. You might want to reach out to a lender or two to get more familiar with those guidelines.

    Happy New Year!

    That's great to hear Justin. 

    Thanks for taking the time and effort to respond! I am continually amazed at the knowledge...and the willingness to share that knowledge...found by members and participants here at Bigger Pockets! 

    Take care and feel free to express any other ideas you might have about our situation.

    0Reply
  • Lance Adams
    Investor · Austin, TX · Member since 2016 · 11 posts · 2 votes
    9y

    Hi Joel,

    I am curious where in Texas you can build a 1,500sf 3/2 including the lot for $75/sf?  I'm not doubting you, just interested.

    0Reply
  • Joel G.
    OP
    Real Estate Investor · Sunnyvale, CA · Member since 2014 · 65 posts · 20 votes
    9y

    Hi Lance,

    In the small towns outside of DFW...we have found plenty on lots that can be had for $8-12k. 

    That price tag is also a little misleading (not intentionally so)...in my wife's family...who will work for beer and pizza...there are 2 carpenters...a licensed plumber...a licensed electrician... and a building inspector. All, of who, will share in the fruits of our labor...only on a delayed basis.

    So we are definitely in a unique situation...however...I have never understood why that is so...

    I met a carpenter in San Diego once who was working on a restaurant interior...he shared with me that he had a regular job and that this was sideline work (on a Saturday). 

    He agreed to do a job that would normally have cost the owner around $20k for no cost up front (except the cost of the materials) but after the place opened he would receive % of of sales for the next 5 years...this would amount to around $400-500 per month...around $5-6k per year and somewhere around $25-30k to complete the transaction. 

    He charged a premium for his service for delaying the payout...he admitted to me that he was "just an average" carpenter...but that this job would only take him about 4 weeks...working nights and weekends...moonlighting from his regular job.

    He told me that he normally would have only been paid around $10-12k for the work he was doing....but that the owner...who was coming out of his own pocket for this work...was happy to have delayed the payment and therefore did not mind paying the premium...nor did he mind...paying a further premium (in the form of a percentage of sales)...to be allowed to pay out for the work performed.

    Everybody won...he was payed VERY well for the work he performed (albeit on a payout plan)...the cash strapped owner was happy about the arrangement...he got to payout for the work over time and IF his doors closed, the deal was off...BTW, the restaurant/bar is still open to this day 18 years later...

    The real kicker...was that the carpenter shared with me that this was the 14th project like this that he had done in the last 2 years...and that although most of the jobs were much smaller than this one...they were all paying him something every month...at about TRIPLE what his normal rates would have been for each project.

    My question is...why are we ALL not doing business like this? 

    Lol...I just realized I climbed up on a soapbox for something you didn't even ask about...my bad

    Sooooo...uhh....Small towns outside DFW with help from family to keep costs down.

    Sorry to drone on. Happy New Year! Thanks for your question.

    0Reply
  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    9y
    Originally posted by @Joel G.:
    Originally posted by @Bill Gulley:

    Sorry to blow your plans, but contractors building new homes are barred from seller financing (rent to own) under Dodd-Frank, best to sell to an investor on a note and deed of trust to lease it.

    Texas has specific rules on installment contracts, better see an attorney there. :) 

    Thanks for your reply.

    Exactly why I was asking...I figured Dodd-Frank would come with n there somewhere...just couldn't remember how or where.

    Does the fact that I own the home outright make any difference? Or does it come down to a workmanship issue to protect the buyer?

    Also, thanks for RE Attorney advice...we will definitely seek one out prior to starting any project. We just wanted to see if there was even a starting line with an idea like this. 

    Thanks again for the reply...Happy New Year!

     The issue is with newly constructed homes, contractor sales. You don't have an exemption as a builder/contractor. Yes, workmanship, the issue is that you'll have contractor warranties for the first year, you shouldn't be holding the note and deed of trust or an installment contract sitting in one seat while sitting in the lender's seat.

    Doesn't matter at all about you having any encumbrance. 

    Make sure your TX attorney is familiar with Dodd-Frank, usually a finance attorney will be more aware than others.  

    Good luck :)

    1Reply
  • Joel G.
    OP
    Real Estate Investor · Sunnyvale, CA · Member since 2014 · 65 posts · 20 votes
    9y

    Thanks Bill.

    I figured that the work product probably had something to do with it...just wasn't making that connection.

    0Reply
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