Analyze My Seller Finance Bay Area Deal

[Robert Musallam]

Hello BP!

My business partners @Travis Limbocker @Courtney Limbocker and I have found a 6 unit in San Jose that is in need of significant repair. 

Here's the deal:

Sale Price - $1,272,000 - 0% interest for one year. 6% interest after one year if we haven't completed the project yet.

We tried to negotiate a $1.15m buy price with a higher interest rate in order to take advantage of a lower property tax rate after we refinanced out but the seller claimed he'd incur a higher capital gains bill if he did that. 

Rehab - 250-300k 

ARV - 1.7m - 1.9m

Technically Zero Money Down...

Except we'll place 36k in Escrow once we're in contract plus an additional 218k to be held in escrow. This money will come in the form of a HELOC and will be drawn out of escrow as needed to cover our rehab costs. It's a show of good faith on our part to put some skin in the game to have it held in escrow.

Current Rent - $7000 a month

Pro-Forma - $11400 a month + $300 Garage rental revenue

Unit Mix:

Four Studios - Pro Forma $1450/mo

Two 2 Bedroom - $2400/mo

We will explore the possibility of increasing the sizes of two of the studios to one bedroom units. 

Our goal is to refinance out at a higher valuation (We need 1.6M but prefer $1.8m) to pay off the Seller. Pretty much a multi family BRRR.

Monthly	Annual
Revenue
Rental Income	$11,700.00	$140,400.00
Vacancy	-$351.00	-$4,212.00
Net Rental Income	$11,349.00	$136,188.00
Other Income	$300.00	$3,600.00
Gross Income	$11,649.00	$139,788.00
Expenses
Property Taxes	$1,325.00	$15,900.00
Insurance	$200.00	$2,400.00
Property Management	$931.92	$11,183.04
Maintenance & CapEx	$351.00	$4,212.00
Advertising	$0.00	$0.00
Utilities (water)	$300.00	$3,600.00
Heloc	$1,450.00	$17,400.00
Other 2	$0.00	$0.00
Other 3	$0.00	$0.00
Total Expenses	$4,557.92	$54,695.04
Net Operating Income (NOI)	$7,091.08	$85,092.96
Cash Flow
NOI	$7,091.08	$85,092.96
Mortgage	-$6,959.52	-$83,514.20
Total Cashflow	$131.56	$1,578.76

A couple of final things to note:

(1) We're using a HELOC to fund the construction. As a result, we have a significant expense that we must pay off monthly. Once paid, the deal (obviously) looks a bit better.

(2). This is a long term play. While this property may not be pumping out the eye-catching numbers years 1-5, we're confident years 6-20 will be extremely worthwhile. Both in cash flow and appreciation. Seller financing in the bay area is rare. Based on the current state of the property, a lender wouldn't go higher than 40-50% LTV, which means I'd need a cool $1m in cash or private money to do this normally. This deal will allow me to get into a 6 unit property in the bay area, with very little of my own money down and a significant stake in the equity.

(3) The ARV is what I'm most concerned about. I've spoken to two commercial lenders and they've quoted me at 3.5% interest, 5/1 ARM at 75% LTV...only no one can give me the value. Income based approach had me finding properties that have sold anywhere from 1.75m-2.1m.

(4) At the moment, our goal is to self manage but I included the property manager expense because I know we won't be managing it for very long and it's good practice to include it.

(5) I would like to thank the tremendous amount of people all around BP who have taken the time to answer questions for the new investors like myself. I may have completely mis-calculated my deal here, but to me that's not the point. It's because I come into these forums and get educated from the real, on the ground investors that I had the confidence and (half a brain and) the courage to attempt to put this deal together. So, thank you.

Having said that, please rip my deal to shreds and tell me what I'm missing :) 

[Abe Gonzales]

Hi Robert,

This is a good rough calculation. Does your software  program take into account the loan constant? At 6% past year one, you might be looking up to 8% loan constant so that your cash flow can be a bit lower than calculated. Since the rehab costs are calculated based from known inputs, it might be worthwhile to see what were these inputs based from? Again, given existing constraints that contractors and materials suppliers have had to comply, not including possible changes in compliance which can take place by surprise events any given time, (minor material deficiency or contractor's burden however minor of an incident, and that this could be beyond contractor's control) can escalate and could lead to project slowdown up to project cancellation/project shutdown. You may want to also pull out statistics in project cancellation/project shutdown due among other things, State induced strict compliance to the letter, contractor's compliance and liability costs (biggest reason why significant California contractors are put out of business aside from tight competition), it's just next to impossible to earn contractor wages based on economic conditions (that being current prevailing economic depressed consumer wages cannot support re-construction costs or that wages to property modification ratios is not sustainable in long term basis), indicators, and indices (unit labor ratios, material integrity and application ratios, Local, State, and Federal (labor, occupational hazard, environmental) compliance costs, and certain and uncertain risk factors. These and all that can reduce your investment to negative cash flow if not properly guarded. Again, your focus will be on the details in property rehabilitation costs. 

Now, we are only at the first stage. The second stage assumes rental and property appreciation to be positive based from positive outlook from the first stage without looking back the details. While the trend all point to hypermarket in San Jose and the Bay Area at large, still at its center stage, the trend does not account what is happening on the ground. There are significant number of pre-foreclosures happening in every neighborhood every day, and I am certain that a large number of neighborhoods, families are about to face pre-foreclosures everyday as well. You may want to look at nominally employed residents, significant wage to property affordability ratios, depressed wages, quality of current salaried employed in the private sector. Look at the landscape of employment, the public sector to private sector ratio. This ratio will significantly and decidedly determine whether future value of a project is viable or not. I can consider significant employment in the private sector to be troubling because these are the same employed residents who will eventually lose employment in the beginning of the third year of employment. Their useful value will lose steam the first month of employment and will somewhat lose greater significant value the third year. Inversely, significant upswing of local public employment raises troubles in that the local government hires temporary wage workers based partly from Federal subsidy and short-term infrastructure projects (even while some of these wage workers are contractually connected with private construction companies, the life-blood money comes from contracts provided by the city). A long stable indicator would be an appropriate ratio favoring local public sector due to local government's strict adherence to labor wages. Still, by today's dollar value, these wages cannot support long term economic sustainability in the overall sphere of economic activity unless the core economic principle is drastically changed.