Seller Financing????

Question

Hello Everyone,

I have been searching and searching for investing advice and finally I found this forum.. I am so excited. :D

I have been investing for a little over a year now and have purchased 6 properties.  I have sold a few on contract and rent a few.  So here is my question...

Is it ok to cash out at 80% loan to value before I sell on contract?  Is this a good strategy?  Or should I focus on a smaller %?  My main goal when starting with little money was to do this to get back my down pymt while increasing monthly income so I can buy again.  Then after doing the math it seemed safe to cash out higher because the payment I was receiving would still give my $100 per month after all is paid.  I also require a 10% down pymnt and application when I do owner financing.

I have a great relationship with my banker and I just wasn't sure how this looked.  Is this ok to do??????

Thank you for your advice

Brandon R · Answer

Thank you so much Jon!!!  I really needed to hear that.

Brandon

Jon Holdman · Answer

Do realize that the taxes and insurance that are included in your PITI payment are in the 40% or 50% expense ratio.  These expenses aren't unexpected, just sporadic.  It you build a portfolio of 20 properties, you WILL do an eviction once in a while.  Probably at least once a year.  Properties need new roofs, furnaces, sewer lines, and who knows what.  Not every year, but with 20 properties, buying a roof AND a furnace every year is a reasonable assumption.  If you want to be a landlord, you need to account for these expenses because you will have them.
                        
                        So, lets consider your current deal.  
                        
                        As a rental:  Rent is $650/month.  Lets use my optimistic 40% ratio, and allocate $260/month for expenses.  A common rule of thumb is to try to get $100/month in true cash flow.  So, $650 less $260 less $100 leaves $290 for debt service.  At 6.5% for 30 years, that will give you a loan amount of $45,881.  I'd guess the refi costs at $2500, so that gives you your $40K investment back and leaves about $3000 in cash.   Since I'm trying to accumulate good rentals, that's what I would do.
                        
                        I would not be using the financing proceeds from any of the to be paying off debt.  You're converting a car loan that has, what 4 years to go (at most) into a 30 year loan.  Uh, that's just crazy!  You say you owe $9000 on that. At 9% with 48 payments to go, your payments are $224 and total for the four years is $10,750.  You convert that to 30 years at 6.5% and your payment is now only $57/month.  But the total payments are $20,479.  That's a bad deal.  Same for the credit cards.  Pay this sort of stuff out of current income, not the loan proceeds.
                        
                        You do realize all this loan money is taxable, right?  Not right at the moment when you take it, but when you sell these houses.  If your cost is $40K, and you sell for $70K, then, after expenses, your gain is about $25K.  You owe tax on that gain.  At long term rates (which may well go up in the not-too-distant future), it would be $3,750.  If you have an 80% loan on this puppy, you have to pay off $56K.  After closing costs and paying off the loan, you'll net about $9,000.  You'll owe the taxes out of that, leaving you with only $5000.  If prices fall, and you're forced to sell, maybe you only get $60K.  After the closing costs and paying off the loan, you have to bring about $1000 to the table to sell.  But, you still have a gain of about $15,000.   And you'll owe taxes on that gain, about $2,250.  So, with even a fairly minor decline in value, you end up $3,250 in the hole.
                        
                        Frankly, I think when you say you're using the loan proceeds to pay off debt, that you're living off the loan proceeds.  You should just be focused on paying your bills out of your regular income.   Getting rid of debt it great.  I'm trying to do that.  But converting it from short term debt to long term debt isn't getting rid of it.  If you can't afford to pay your bills out of your regular income, and you need the proceeds of these loans to get by, then you really need to re-look at your financial situation.  You're living day to day by borrowing.  You can't keep that up forever (as much as the US Government thinks they can.)
                        
                        If your financial situation isn't like this, and you're OK with refing for the minimum amount and holding this as a rental, I think its a good time to be doing that.
                        
                        Selling on land contract or lease option may be a good option, too.  That gets you some up front money, maybe a slightly higher rent, and maybe a better tenant.  At least with a land contract, you can get rid of the maintenance, since you're really sold it. But, both of these are really not too much different than straight rentals, so I'd want them to work with "rental math."
                        
                        If your financial situation is such that you need cash now, I'd be just plain selling these.  If you can really turn around and sell this for $70K, then you would net about $64K, even with realtor commissions.  You get back your $40K investment, leaving you a $24K gain.  You will have to pay taxes on that, and may have to also pay SET (self employment tax - social security and medicare), but that nets you real cash.  Even if you end up paying 50% in total taxes, you'll have $12K in after tax income that you can use to pay down debt or pay bills.  Use the $40K to do your next deal. Well, I guess I mean whatever's left after paying off the construction loan and a new construction loan.  
                        
                        With a few decent deals like this, you really should be able to accumulate enough cash to be doing these deals without the construction loan.  If you want to "overfinance" some of the ones you keep as rentals, and use that to expand your business, I think that's OK.  I don't think its OK for you to use those proceeds to fund your lifestyle, or to convert short term debt to long term debt.

Brandon R · Answer

I have a house that I just finished last month that I am advertising for sale with a contract possible with 10% down.  I still have just the construction loan paying interest only (7%).  I have a total of 40,000 (28,000 purchase price including 20%down and 12k in improvements)in this property and the repaired value is $70,000.  I dont want to make a big mistake on this one.  That is why I am seeking advice.  I want to be smart about this. 
 
Should I rent, sell outright, land contract?

Should I Refi it?  At what LTV?  60,70,80%?  Or should I just refi to get my downpyment back?

The initial plan was to refi at 80%, get down pymt back and pay off my wifes car loan (9,000).  I think p/i/t/i would be around 550.00 per month after this refi.  I obviously not been factoring in, what did you say, 40% for unexpected expenses.  If I rented or even sold this on contract my pymt from them would be around 650-700 leaving me again with about 100-150.00 per month not counting the 40% you refered to.

I absolutely love this business and want to continue on.  I really really appreciate everybodies advice.  I am learning.  :)

Jon Holdman · Answer

Rent of $550 and assuming 40% for expenses gives total expenses of $220.  That leaves an NOI of $330.  You say your P&I is $310, so I'd say you're really making $20/month on such a deal.  It seems like you're making more, $145, in the months when its occupied and you're collecting the full rent and only paying the PITI.  But, a major expense or a vacancy and you'll be squeezed.  I can tell you're sensing that's the case from your comments above.

Are you using that $10-15K you get back to purchase more properties?  Or, is that going back to your living expenses.  Doesn't take much for an 80% LTV property to turn underwater, once you consider all the closing expenses.  The first 10% of equity gets sucked up when you sell.  If you're using that cash to buy more, this seems like an OK strategy. If its going to living expenses, I think this is very dangerous. You're living off borrowed money.

Based on what you're saying, you should only have to do three properties like this to get your bankroll for the future ones.  That should give you $30-45K, which is enough to purchase and rehab the next one.  Then, refi it for just enough to get your money back.

What kind of terms are you getting?  I get a payment of $266 on a $40K loan for 30 years at 7%.  $310 seem high, unless you're going with a shorter term.  I'd be more comfortable with a $30K loan on a $550 rent house than a $40K loan.  Be more comfortable still with a $25K loan.

Selling then gives you more flexibility, since you really have put more responsibility on the buyer, and you're collected a down payment.  But, read some of Frank's other posts where he describes some of his owner financed deals that just won't stay sold.

If you could just flat out sell a couple of these, you'd really generate a nice kitty for this business.

Brandon R · Answer

What I have been doing when I refinance is putting back the intitial down pymt for another house and using the rest to pay off debt.  Like last month I paid off 10k in credit card debt. YUCK.

Brandon R · Answer

Thank you for the help...

Actually I really don't have any of my money in these deals.  I do put 20% down to purchased a distressed/foreclosed property that could be worth on average 60k when remodeled.  I may purchase the property for 20k put 10k into it and only be at 50% loan to value.  At this point I do have my 20% of the purchase price into it and I use a construction loan from the bank to remodel.

Heres the important step I take....

Since the total amount in including down payment is only 30k I have been converting the construction loan to a conventional at say 80% of the repaired value.  This not only gives me my down payment back but usually puts 10-15k in my pocket.

An example of my monthly expenses at a 40k loan would be 310.12 p/i, 75.00taxes,20insurance for a typical pyment of 405.00 or so.  I would then either rent or sell on contract with a total payment due to me of around 550.00 per month +/-.  This gives me on average 125.00 per month on all my properties.  This is typical rent in our central IL area.  Not really expensive.

Is this a good strategy?  Is it a good strategy if I am selling on contract?

Thank you

Jon Holdman · Answer

It concerns me that you're thinking about going to a lower LTV to give you more "margin".  Are this actually good deals?  If you have 30% of your own money in a deal, are you considering the return on that cash?   One way to evaluate a deal is to assume 100% financing, then look at your cash flow after ALL expenses.  Not just the T&I you pay monthly, but all the expenses like vacancy, untilities when its vacant, make ready, tenant damage, legal expenses, lost rent during evictions, maintenance, etc.  Some folks here assume expenses eat 50% of the rent.  I tend to use 40% because I'm willing to manage them myself, for now.  You can't predict the exact expenses because some are very spraodic.  So, subtract off the expenses, figure the P&I assuming 100% financing, and then evaluate the deal.  If its cash flow positive like that, then you have a deal.

If it doesn't, you're "buying cash flow" by putting your money in. You're thinking the property is producing the return, but in reality, its your cash generating the income, and the property is not.

If you have a good deal, then, you can consider the actual financing situation.  One popular point of view is to have as little of your own cash involved as possible.  That said, I'd be careful getting the LTV too high, since its entirely possible prices will fall some more.  You don't want to find yourself having to sell and bring cash to closing to get rid of a problem property.  Banks aren't terribly sympathetic about investors being upside down.

Brandon R · Answer

After thinking more about dates it seems that I have purchased these properties in the last 18 months or so.

Frank Adams · Answer

I like your concept, but have to disagree with your pacing. Be careful that you don't go too fast, and get rid of your outside debt. One way that I found to do this is perhaps sell a higher proportion to retire debt.

Six in one year, from a standing start, can begin to tax your time and energy. I like the idea of lower price properties because (I know this will sound like it contradicts the first paragraph) you can own MORE props, thereby spreading your risk.

One question to ask yourself when evaluating properties/deals is this: What happens to ME if this unit, and every other one quit paying at the same time? Statistically it's rare, but ask people who owned multiple props in Flint MI when GM tanked up there, ask me what happened to me in Houston in the early '80s.

It's not likely that all of your tenants/buyers work for the same employer, but when a large employer or three goes bad, there is a huge ripple effect throughout the local economy.

Frank

Brandon R · Answer

Frank,

Thank you for reviewing my post.  I really want to be as well informed as I can on the investment decisions that I have been making.  I was blessed with a chance to do this and I don't want to blow it.  :)

"I like your concept, but have to disagree with your pacing. Be careful that you don't go too fast, and get rid of your outside debt. One way that I found to do this is perhaps sell a higher proportion to retire debt."

Could you please explain this further?

Is it a good plan to cash out at 80% or lower when I am selling on contract or even renting?  Using the cash flow to pay down debt while getting my 20% downpymt back to buy another property.  Maybe I shoud only go to 70% to get more cash flow and maintaining a more safe margin incase of vacancy, default on buyer/renter or if something major happens that I need to refi to get fixed...?

Brandon