How Much is Seller Financing Worth?

Question

So I have come across a "deal" in which seller financing is an option.  However, I am not sure about the numbers, and would like to post it to the BP community for some guidance.  The seller is straight forward, and wants to make money, but I am not sure which of us needs to budge.  There are 2 duplexes for sale and I have inquired about purchasing both in order to start my portfolio as well as provide the current owner to move on to retirement.  One of the properties was purchased prior to 2008, and the other was purchased in 2010 as a foreclosure.  I will do my best to set the stage and present the numbers as accurately as I know them...

I am located in northeastern connecticut where things are still considered a buyers market.

I would rate the neighborhood as a rising c

The properties (as described by the owner) are turn key with new everything besides one furnace and water heater. (I personally think that he has over rehabbed both)

Both are fully occupied with month to month rentals

Both properties have a combined gross rental income of $3,200

Tenants pay heat and electric and are on separate meters.

Landlord pays water and sewer

The current owner is looking for a minimum of $245,000 for both properties, before considering seller financing.  I said that I could do 1,000 monthly payments for 245 months and he was hoping for more.  Either additional down payment or increased monthly payment.  My thought is this...

The 50% rule, which I conservatively changed to the 60% rule (including property management) leaves me with $1,280 for monthly payments, which doesn't leave me with much room for an increased monthly payment while maintaining a positive cash flow.

The 2% rule puts the value of this property @ 160,000 (I would pay a little more for the newer appliances, kitchens, roofs, furnaces etc.).  The mortgage calculator tells me that in order to have the total payments equal $245,000, the selling price for conventional financing on a 20 year 3.5% loan would be $176,000. I am comfortable paying that for the seller financing and the fact that I will own the property outright in 20 years, but would not be comfortable doing much more.

This seems like a fair deal for both of us in my opinion, but I am a newbie and would love to hear what advice you all have for me.

Thanks,

Jacob

Ned Carey · Answer

The 2% rule may not be the most appropriate for your area. More importantly does it meet you criteria as an investment.

If I understand your numbers you are looking at est $280 a month positive cash flow. Divided by 4 units that is $70 a unit. That is pretty weak. it should be more like $100 min. I would want $150-200. That slim margin puts you are risk if something goes wrong. An eviction or major repair could cause you real problems.

So part of the equation is you personal cash reserves. Would you have money if something goes wrong before you can build up cash?

Maybe you can negotiate a better deal. You can real creative with financing. You could have the right to skip a payment if the property goes vacant in the first year, or other creative clause. Right now what is on the table is no interest payments! So that is great for you. Maybe add a balloon payment in 5-10 years at which time you can refinance him out. Also maybe just add more payments.

245 payments of $1,000 each is the same as paying  $155k at 5% interest!!!!   With your offer you are making $1280 a  month, but $1000 of it is equity.

I would analyze this deal carefully. When are taxes due? What are the other actual monthly expenses? The 50% rule assumes putting aside money for Capital expenses. So do a budget and see how fast your reserve fund can grow. Keep in mind you should get credit for the security deposits the landlord is currently holding. Depending on your state law as to how those funds are held that may give you some reserves.

Luis Melendez · Answer

hey jacob great job getting out there and even finding a deal for a potential owner finance. they are hard to find but they are out there so thats great. i think if you can get in at 200k thats a little less than an 8% cap its not a bad deal. you will have about $116 per unit cash flow managing yourself which is not bad. Turn key so low maintenance.  And bonus is seller financing so off the books. but i wouldnt go more than that.   That would be your STRIKE price so start at 10% below that(which you already had in mind at a $174k purchase) and make sure you do your best on educating the seller about why seller financing would be beneficial to him. he would ultimately get way more for the property. his capitol gains is spread out over 20 years or whatever you negotiate and worse case scenario if you do default he keeps your deposit and gets the properties back via foreclosure. All he does is collect his money every month. Also im not sure but does he have mortgages on these properties? Cause if so you would have to do a subject to or wrap around mortgage which i have never dealt with personally so you may want to get some advice on that. also how much did he buy them for? If hes looking for a minimum of $245k to even start negotiations you need to figure out why. Whats his why factor?

Jeff B. · Answer

Some may not like this but IMO,

• seller financing is a good way to get into buyer's remorse.

Why? Because you and the seller can make anything happen and that's the problem.  You want it and he'll sell it to you - - but that doesn't mean it will be profitable to you down the road.  Qualifying for a loan, especially a commercial loan on a MFU 5+ keeps you in the black and miles away from buyer's remorse.

Jacob Reilly · Answer

@Robert G.,

Thanks for going through the numbers again.  I think that loose some of my monthly cash flow per unit due to the shorter loan period of 20 years as opposed to 30.  I expect that this will come back to me if I own the properties outright for 10 additional years.  I have already learned a lot from your feedback, and really appreciate the time you took to help analyze the deal.  I am not sure if the owner and I will be able to come to an agreement that will be mutually beneficial, but at least I have learned a lot from this thread.

-Jacob

Brad G. · Answer

The general rules are a good place to start.  However, I suggest using some actual numbers (rent, taxes, etc) while accounting for vacancy, maintenance, etc. to get a better understanding if there is a deal on cashflow.  You should also check the sold comparables in the area to see if you would have some equity.

Robert G. · Answer

You're taking liberties with the numbers and "rules" that aren't really justified.

First of all, the 2% rule is an "ideal".  It isn't achievable in most markets.  I don't expect you'll find many properties that meet it in CT.  Also, it was designed for SFRs.  Not sure how applicable it would be for a pair of duplexes.

Next, the 50% rule already includes property management.  Changing it to 60% is NOT "conservative", it is actually a quite drastic change that will eliminate just about any deal from working.  You've raised expenses by 10%.  Most CAP rates are around 10% or just below.  This isn't a "give or take" 10% industry.  In essence, you just turned an attractive deal (assuming 10% cap) into a break-even project.

Finally, the numbers you've provided for your hypothetical deal give YOU the benefit in every instance.  Seller-financing is a benefit to YOU, which means the property will cost more if you utilize it.  If you can qualify for traditional financing from a bank, and your goal is to pay less for the property, do not use seller-financing.  I see you mention a 20 year loan.  Why not 30?  You also mention 3.5% interest.  That is a great rate on a pair of duplexes.  It'll probably be closer to 4.5%.  You also failed to mention any down payment.  The reason your monthly payment is so large, making the deal look unattractive (because of the small monthly cash flow) is because you appear to be financing 100% of the purchase price.

Honestly, I don't know whether or not this is a "deal".  But I can tell you that you're not analyzing the property objectively.  You'll pass on plenty of real deals using the methods and assumptions you've made in this post.

Lastly, I don't see any mention of whether or not you can add value to the situation.  Are the units rented out at market rent, or can you raise rents beyond the current level?  Can you add storage lockers and charge more?  Or laundry?  Can you appeal the taxes and pay less property tax going forward?  You know what the current owner spends and receives in rent.  You need to figure out how to make the property earn more, or how to reduce expenses.  That is what can make something like this a true deal.

Melissa Gittens · Answer

@Jacob Reilly if you were considering these properties why wouldnt you manage these properties on your own? Are you planning to live in the property? Also The numbers don't look right because that would be mean there is no interested that the seller is receiving. Are you planning to re- finance this in the near future, I have only seen seller financing for a max of 18 months in CT? I dont know any owner who would finance a deal for 20 years.. something just doesn't seem right. if you need help you can give me a call and maybe we can come up with a stronger offer for this deal. Best of luck to you!

Dan Leyden · Answer

Hi Jacob,

If I was the seller I wouldn't consider your offer of a purchase price of $176,000, and heres why:

The properties are for sale for a total of $245,000. Seller financing means you are going to be taking a loan out for $245,000, or what ever you negotiate for the sale value. This isn't the total you will end up paying for these properties.

At 3.5%(which would be a generous rate for seller financing in my opinion) and a 20 year standard loan from the bank will end up costing you a total of $341,016 with a monthly payment of $1420.

Paying $1000 a month for 245 months is like getting a 0% interest rate loan - no one in their right mind would consider that. Why would the seller want to sell you the properties and wait 20 years to get the money another buyer could give at closing?

For a typical buyer here's my calculations.....

Your downpayment and taxes would be needed to really say if this was a good deal, but I'll take a guess.

Put down 20% ($49,000)

Paid $10,000? a year in taxes. No idea what taxes would be up there.

Paid $13,632 ($1136 a month) towards the principal and interest. ($196,000 loan)

Income $38400 a year ($3200 a month)

Insurance $2000?

You would profit $12768 a year. (26% return on your investment(not including added equity due to mortgage payment)

Just doing quick numbers it doesn't sound like a bad deal.

Let me know if I misunderstood what you were trying to ask.

Dan

Jacob Reilly · Answer

@Luis Melendez,

Thanks for the input.  My final offer was $20,000 down and $1,500 monthly for 14.5 years, putting the total payments at $281,000.

I don't think that we are going to come to an agreement, because the seller is very set in his ways.  I have attempted to educate him, but he isn't open to learning about how this would benefit him in the long run, and is quite condescending in our conversations.

Either way, this has been an incredible learning experience for me, so it was not in vain.

Thanks again  to everyone who chimed in and helped with this learning process.

-Jacob

How Much is Seller Financing Worth?

Most Popular Reply