Reserves?

Question

A property owner is looking to sell his property to me. he's retireing,  I got all the numbers worked out, applied the 50% rule and get a cash flow of about 2700 a month.

I'm 23 years old and dont have cash reserves for the unit. What If I save every dime from the cash flow. To save up a cash reserves account.

The property is worth about 600,000 I'm offering to buy it sub 2 
0 down 
800k monthly payments of 3200 a month
ballon payment at end of 10 years of 416,000
at which point all refinance and I'm going to save at least 120000 from rents to have refinancing money and down payment and all that fun stuff

So to clarify my question, how much would I expect a management company want for a cash reserves account, and would they be willing to accept a portion if I agree to save every dime until I get my reserves account to an acceptable level?

Jon Holdman · Answer

I have spoken to management companies to requested you keep a specific amount of money on deposit with them. That's to cover any repairs they would have to make.  Others just deduct any repairs out of the amount your due from the rent, or bill you for the repairs if they exceed the rent.

I really caution you against the screwy payment scheme.  You're potentially going to run in to truth-in-lending issues, tax issues, and you may leave yourself in a bind if you have to sell.  You're assuming you can hold onto this for 10 years.  The listing price is only $600K, and IMHO its only worth about $500K.  If you "buy" it for $800K with $3200 principle only payments (that IS what you're implying with the description above, no interest at all), and are forced for whatever reason to sell after, say, two years, you still owe $723K on a property that's only worth $600K.  Where do you come up with the $123K?  You probably don't, so you get stuck with a $123K debt you can't pay and your credit is trashed.  Offer the guy his full price, $600K, but with 100% owner financing at 6% and 30 year amortization and a 10 year balloon.  That makes your payment $3600 a month, leaving $2400 in cash flow.  Not a great deal, cash flow wise, but not horrible, and it gets you into a property you can't really afford.  It does leave you with a $502K balloon in 10 years, but short of getting this guy to accept a very low or zero interest rate, that's where you'll be.  If he won't go for a deal like this, he's unlikely to go for the inflated price and interest only payments.

The more realistic way to state your proposition is that its 4% financing of the $600K price with a 25 year amortization and a 10 year balloon.  With those terms, the monthly payment is $3,167 and the balloon after 10 years is $428,156.

Jon Holdman · Answer

This is an unusual way to structure the deal.  You're structuring it at $800K purchase price with 10 years of principle only payments.  That is, an interest rate of 0% and the equivalent of 20 years and 10 months amortization, with a balloon after 10 years.  That's about the same payment as a 2.5%, 30 year term loan, though the loan balance after 10 years would be $597K, not $416K.

You're not paying any interest with these terms, so you'll have no interest deduction.  That will have some effect on your tax situation.

Best to call some property management firms in the area and ask the reserve question.  This sort of thing is all over the map.  I think this is the 29 units you discuss in another post.  For that, I would want to have about $10K in reserves.

I'd also be sure you know exactly what needs to be fixed right away.  If the seller and listing agent say "nothing", they're lying.  Even if its filled, there may be issues when the change of ownership occurs if there are any sort of inspections or requirements for new certificates of occupancy.  I'd call the building department for the city or county where its located and ask what may happen if you buy a multi-unit like this.  I had a call from a BiggerPockets member a few months ago looking for money.  Here apartment building had been red tagged by the building department and they had forced all the tenants out.  She had the violations fixed now, but was out of cash to hold onto the property long enough to lease it up.

Richard Warren · Answer

Regarding paying â€˜no interestâ€™: the seller may think they are getting away with something by treating it as a long-term capital gain rather than interest.  He is mistaken.  The IRS has something called â€˜imputed interestâ€™, they will assume that a portion of the payment is interest and tax it accordingly.

:cool:

Anthony Larson · Answer

I was confused about who holds the cash reserve account, for some reason i thought i read in a property managemnet book that the management compnay holds that money. I double checked and i think I was wrong, its money the investor has to hold onto incase all heck breaks lose, and you have reserves to fix property, hvac, roof high expense items

sorry to confuse you.

Brian Haskins · Answer

I'm confused why your management company would need you to show cash reserves. They usually just want to get paid a percentage of the monthly rent. Can you explain a little bit?

Brian Haskins

Anthony Larson · Answer

inputed interest, thank you, I knew there was terminology for it but couldnt remember what it was.

Richard Warren · Answer

:cool:

Anthony Larson · Answer

no its not a typo, its a set amount of interest im going to pay over 10 years,

interest saving about 90000, that came from a amortization table I made out. If i went the more tradition way,

600000 
120000 down 
7.5 interest
interest paid after 10 years 
339363.49

Anthony Larson · Answer

yes this is the property, the 20000 extra is interest ties into the purchase price.    
I want to talk to an attorney, and see if I can apply the interst expense this way

200000/12/10 + 1666.66  a month in interest

unconditional yes, but its my way of thinking outside the box...

Anthony Larson · Answer

plus my monthly payment is over 150 dollars a month less

Reserves?

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