Selling my rental in Texas on a wrap-arbitrage play

[Benjamin Maughmer]

I smell an opportunity. 

The property and financing - Bought my 1st rental property (2019 new construction 3/2 with a 5 year home warranty) which I paid  20% down at 139k and refinaced in 2020 108k at 3.75% on a 20 year note resulting in a $646 monthly mortgage payment and renting @ $1535 per month resulting in a cash flow around $250 per month after PM fees Taxes and Insurance.  Current zestimate is $225,600. (I know that’s not totally to be trusted but is adequate for my question) Great equity as the loan is currently around 97K

The current situation - The tenants are breaking the lease and leaving. I was planning to sell next year anyway and put the equity into  two rentals using a 1031 exchange. Current interest rates and pricing make this strategy look thin to me from a purchasing and cash flow perspective at this time. So instead of paying for a make ready and putting new tenants in for 1 year it’s seems prudent to do a make ready and sell.

Given that I have a 3.75 mortgage rate it appears that selling with a wrapped mortgage could result in getting my initial investment (about 30k) back and more.  If sold for 225k with 25% down from the buyer and using a minimum 8% interest rate with a 30 term I would get $56k down payment and the mortgage payment to me would be about $1239 a month. So  $1239-$646=$593 per month arbitrage cash flow for 30 years.

I do plan to hire a quality real estate attorney to guide the transaction and make sure all is on the up and up. I am aware of the due on sale clause. 

It seems strong… But I have never done this and am sure I am missing something… looking for BP advice. Shoot holes in it. Pat me on the back and guide me. :) I know this is not the easiest way and there are more moving parts and risk but I am very much considering this approach and look forward to, and am grateful for,  any BP wisdom to flow my way. 

BM

[Wendy Papasan]

Warren Buffet says "Best time to sell a good asset is...Never." Why sell a cash-flowing rental? 

[Benjamin Maughmer]

Hello Wendy, 

I would like to amplify my original investment. I am seeking increased cash flow so putting the equity in this property to work seems like my option. I dont have tons of income at this time so it would take a while to save up for another down payment. This seems to get me there faster and takes advantage of the low interest rate in my favor. If I had ten or twenty of these and had tons of cash I would not consider selling it as I am in my current situation. 

[Michael Smythe]

You would violate the Due on Sale clause in your existing mortgage.

[Wayne Brooks]

@Benjamin Maughmer No one is going keep an 8% mtg for 30 years.

[Benjamin Maughmer]

@Michael Smythe I did take that into consideration and did some research on that topic. You are right in that my current lender has the right to call the loan if they choose. I have read and spoken to many who say this is very rare. As long as the lender is getting paid regularly they don't have a great reason to call the loan. If they did call the loan I would need to be ready to repay it for sure. That would be accomplish by structuring financing with a first mortgage at 76% LTV and a second mortgage at 14% of the LTV (the other 10%) was the down payment. If the loan gets called I would sell the first note to cover the called loan and the second would remain and provide cash flow at 14% of the number in my original post.

@Wayne Brooks You are  correct in that it would be unlikely that the buyer would not refinance after a period of time.. I am pretty sure that period of time could be predetermined in the form of of a pre-payment penalty or ballon payment laid out in the financing terms to ensure I was covered to pay of the underlying loan. It is often the case that buyers who are seeking owner financing can’t get a loan through a bank for whatever reason. But, to your point, that does not mean they wont be able to qualify in the future and refinance out of the owner financed deal. It something for me to consider and do some math to determine th minimum amount of time I would need the loan to be active to make it worth giving up the 3.75 mortgage on cash flowing property.  

Thanks to both of you for your observations. 

BM

[Rick Pozos]

I dont know where you are, but bigger cities like San Antonio there are all different types of buyers. Some people will pay 10% to 15% down payment and 10% interest rate. They will keep the loan for 10 years or 15 years and then probably pay it off cash.

You mentioned selling off the first and keeping the 2nd. That is a great way to do things. It gets rid of the first with a bank and now the owner of the first knows there is a 2nd who you know and can talk with if need be. The only problem is the discount that you are going to have to take on the first. But it sounds like a great backup plan.

[Benjamin Maughmer]

@Rick Pozos thank you for your input. Yes I saw that 10% is a norm on this scenario and will adjust my number to reflect that. Do you know what the typical discount would be on selling the first if it came to that. I understand that 76% LTV is a good marketable note and there are probably a multitude of variables as well. I know there will be some discount but have net gotten to that part of my research.

[Jay Hinrichs]

Quote from @Benjamin Maughmer:

@Rick Pozos thank you for your input. Yes I saw that 10% is a norm on this scenario and will adjust my number to reflect that. Do you know what the typical discount would be on selling the first if it came to that. I understand that 76% LTV is a good marketable note and there are probably a multitude of variables as well. I know there will be some discount but have net gotten to that part of my research.

jsut run it in the PV in your real estate calculator  investors are going to want 12 to 15% return so the longer the term the larger the discount on this type of paper..

[Rick Pozos]

I would keep the 1st at about 10% higher than your loan. So if you owe 100k, keep the wrap mortgage 1st at 110k so if you have to sell the first you can take a discount and maybe still make $1000. With the first at 10% you should not have to take too big of a discount. Also, the first is going to be at about 50% LTV if you have to sell. That is pretty secure for a note buyer.

[Benjamin Maughmer]

@Jay Hinrichs thank you for that input!

@Rick Pozos I appreciate you showing me that perspective with regard to what size to make each of the notes and why.