Contract for deed deal - Good one?

Question

HI BP,

This would be my first deal.  We are looking for mainly rental units but willing to do a couple flips a year is our long term goals.

Our mentor we met recently is VERY experienced nice older gentlemen.  First deal he knows the owner for many year and his kids and the potential buyer/renter.  We would be the person buying and doing the contract for deed and giving him some wholesale cash etc.

He mainly wholesales now but does it all.

Here is the deal right as of now:

Price: Hoping to get it for 100k but could be higher depending on negotiation

Current Tax Value: 125k

Rent/payment: We are trying to get him to pay 1200 a month

Property needs about 30-50k of work on the inside.

Comes with about 4 acres and a shed.

Down Payment: We would like to get 20k down (still in negotiation)

Strategy: We would use our cash to buy with a balloon in 5-7 years

Our money will have about a 4.25% cost to using most of it unless we use 50k from our IRA.

The Money: So assume 100k at 4.25% = 355 a month interest.

If he also pays insurance that is our only other cost then correct?  If so we cashflow 845 a month

When we take a loan against it for 100k and use the 20k down we pay 735 a month and cashflow 465 a month until he buys it from us.

The rest of the story:

He is a mechanic and this is on a major highway so he operate the business from here.  He recently went through a divorce so he needs some time to clean up his credit.  Older guy that is a little rough around the edges.  He seems to have a pretty strong business.

The risks:

This guy bails and I am stuck with trying to rent or do a contract for deed on the property

He trashes the place even more then leaves and we have to put 50k into a property and hope we can flip it and probably break even or rent it out and we probably break even.

The agreement will be written so current renter/buyer in the home will have ALL responsibility for the property and if he defaults will need to give the property back and lose all down payment and other payments.

My Questions:

1. I don't know contracts for deeds, is this a good deal.  Is my mentor correct on this?

2. Is there too much risk for 4-500 a month

3. Can I refinance in 6 months? (I have a good income, job, and 800 credit score)

4. Did we factor in all costs?

5. What other risks am I not thinking about?

VERY THANKFUL for ANY TIPS

John Leavelle · Answer

Howdy @Jeremy Karja

Contract for Deed.  AKA Land Contract or Seller Financing.

First.  You need to establish the current Market Value of the property based on recently sold comps.  Not tax assessments.  Determine your ARV since you seem to be planning major renovations.  Again use recently sold comps.

$30K - $50K seems to be a little high for just inside stuff.  What are you planning?  That much Rehab will cause problems with tenants.

Spending $130K  - $150K for a property Valued at $125K is not a deal at all.  You need to get good numbers.

What is the current rent?  Do you know what the Rental Market rates are for the area?  What is the demand like for rentals?  In other words, is there a good pool of renters?

This is basically a BRRRR type strategy.  Alternative financing to Buy the property, Rehab it to force equity appreciation, get it Rented, then Refinance out, using a conventional loan, of the original loan, Repeat the process.

Let me jump to answering your specific questions at the end of your post.

1.  Seller Financing (Contract for Deed) can be very beneficial.  They make it easier for buyers who have a difficult time qualifying for conventional loans.  They speed up the purchase process.  They can be very flexible in terms.  Do not allow the Seller to dictate all the terms.  It is a negotiation between you and the Seller.  Be sure to have your Real Estate attorney review any contracts before signing.

2.  Normally having positive Cash Flow of $400 - $500 per month is a very good thing.  However, I am not sure of your calculations.  Your numbers are all over the posting.  Which makes it difficult to analyze.  When you provide data for using to review please keep in concise and all together.  Like this:

Purchase price $100,000

Down payment $20,000

Loan $80,000

Mortgage payment $355? $735? (Interest only? 4.5 APR / 5 - 7 years) balloon payment

Rehab $30K - $50K

ARV $125,000?

Cash required $50K - $70K

Monthly Rental income $1,200

Expenses???? (Not provided)

NOI = Income - Expenses

Cash Flow = NOI - Mortgage payment =. $845? $465? Not sure how you get these numbers)

3.  Yes it is possible to refinance from 6 - 12 months after the property has been Rehabbed and placed into service.  They call it seasoning.  Since the property has a current tenant it might start from the closing date of the acquisition loan.  Shop around to find the best deal for you.  I strongly recommend you get prequalified for the Refinance loan prior to purchasing the property.

4.  I do not see any expenses listed.  You should account for Vacancy, Property Management, Maintenance, CapEx, and a few other possible miscellaneous expenses.

5.  Lets whittle down the above information before looking at what additional risks there are.

Have you used any of the BP calculators?  Try using the one for BRRRR.  I think it will help you clarify your information.  Then post a link to it here.

Jeff Filali · Answer

@Jeremy Karja Post the ARV and comp numbers and we can all give you better feedback on if its a good deal.

Need to know the ARV based on recent comps.  I do a lot of these type deals, do not get caught up in good terms to cause you to make a bad decision.  Its either a good deal or its not, there's no in between.  You make your money in real estate BUYING CHEAP, the rest of the numbers are just details.  Treat every deal just like a cash deal to evaluate the numbers.  You should buy every deal like you have the cash to buy it, and negotiate with that power.  Negotiate the price first, before negotiating the terms.

It sounds like you may be confusing CFD with Lease Option, because you post Buy/Rent and Rent/Payment.  If its a CFD, you're acting as the bank, and carrying a note on it for the buyer.  Their payments must be set up on an amortization, and cannot have a required balloon payment.  If its Lease Option, you can be much more creative and less regulations.

You need to check your state laws before doing a CFD.  Some states have specific laws.

I would also suggest setting it up just like you're the bank, have an escrow account for Taxes and Insurance, that way you know they are being paid.  You will collect a total monthly to include PITIS (Principle, Interest, Taxes, Insurance, and Note Servicing Fees).  There are laws about all of this, limits, and you will need to make sure you're DODD FRANK compliant, may need to use a MLO and Note Servicing Company...unless Trump accomplishes repealing it soon.

Good luck, and hope the deal works out.  Post the ARV and comps for more response on the deal.

Jeff Filali · Answer

@Jeremy Karja It sounds like to me, you're mentor found a sucker (YOU) to fund a deal he is trying to wholesale to someone who doesn't have cash and can't get a loan.

You're saying you can buy it for around $100K and it needs $30K-$50K in repairs, and you can only sell it for $150K-175K.  Forget everything else... Just look at those numbers:

Purchase Price: $100K+

Estimated Repairs: $30K-50K

ARV: $150K-$175K

Based on those numbers-

Best case scenario if you get max ARV and min Repairs:  $175K-$30K ($145K) x 70% = $101K MAO

Worst case scenario if you get lower end ARV and max Repairs $150K-$50K ($100K) x 70% = $70,000 MAO

If I was considering this deal based on the info provide, I would RUN!!  or offer around $65K or less

It would be different if it was already fully updated and turnkey.

John Woodrich · Answer

@Jeremy Karja This post goes all over but this is not a good first investment.  Too many moving parts, too many options for failure, and your mentor has a personal reason for recommending this purchase.  Sure it could work out but there is not enough up side to take on this type of arrangement.  If your ARV is $150k and you purchase for $80k ($100k - 20k) your best case scenario is to flip it at a reno cost of $30k and have a potential upside of $40k (less closing costs, less carrying costs, less construction surprises).  If you aren't experienced in running a rehab I would guess you end up breaking even and wasting a lot of time on this deal.

If the house needs siding, new roof, kitchen, and a lot of interior work $30k is definitely not going to be enough to fix it without sweat equity.

I like the creativity but the moving parts alone make this a no-go for me.  In my experience if he has bad credit it will take a lot longer than a year and a half to build it back up.  Also your idea on making it a duplex is likely not a permitted purpose for that house so you would have to try and get approval from zoning, etc.  This sounds like a lot of work.

John Leavelle · Answer

@Jeremy Karja

I think you are making the right decision since this would be your first deal.  Keep looking I'm sure you will find one that will work for you.  I analyzed over 60 properties and submitted 8 offers before I got my first deal.  Hopefully you will find one that is more simple and straightforward.  Good luck.

John Leavelle · Answer

@Jeff Filali, @Jeremy Karja

I totally agree Jeff.  Too thin and too many variable not in your control.  Definitely a NO Deal for me.

John Leavelle · Answer

@Jeremy Karja

After I sent my comments I reread your post (several times) and realized your were referring to a possible Lease Option deal.

Why is the Seller negotiating numbers with the Renter?  You are the initial Buyer and you should be negotiating numbers with the Seller. You will be the new owner.  You should be doing the negotiations with the tenant/end Buyer.  Do not let others dictate your deal.  It might turn out as a Win-Win-Lose.  Seller wins - Renter wins - You lose.  With the information you have provided there is a high risk of that happening.

Who is paying for the Rehab?

I would not want someone else's current tenant who you are concerned about being a credit risk.

Do you have any exit strategies if you do proceed with the deal?  You need to have a plan with a couple of options just encase things go bad.

I have a lot of other questions.  But not the time right know.

Jeremy Karja · Answer

UPDATE: I am not doing the deal as it is today.

The wholesaler/mentor wrote up the deal with him making 6k... which is not a problem at all.  But my other mentor/friend pointed out that he wrote it up as earnest money going to his company which I guess is a no-no.  Maybe not legal.  Does anyone know this?? He also said he did this on standard MN PA agreement but it was not and my other guy pointed out quite a bit of holes.  So I am not signing the agreement as is.  I may still do an appraisal and get a construction bid done to see if the values are a lot higher and then I may come back in or if they accept 80k plus the 20k I get down from Rick (the contract for deed buyer) cutting my risk WAY down then I might come back in.

But, my other guy said the PA and earnest money issues are red flags and like you guys said the margin is thin but more importantly too many moving parts for first deal.

We wrote up the PAs for the 100k and I think the value is at least 125k but probably 150k and ARV of about 150k maybe more.  But it being on a major highway near construction area it just does not look good if the contract for deed buyer flakes if I can really wholesale it or flip it.

It is hard walking away from 57,000 dollars but like you more experienced guys said.  There are always more deals out there.

Huge thanks again to all who commented, your advice was priceless! @Jeff Filali and @John Leavelle

Jeremy Karja · Answer

@John Leavelle first off, thanks again for your response and knowledge.

Where the middle man comes in is... he is my new mentor, but also a wholesaler.  He set up the deal and just brought me in to be the bank and start teaching me how to do the deals.  It was his idea for a contract for deed.  Then I mentioned my concern about this and he said we could rent it to him with an option to buy as well with less risk but less monthly cashflow.  I think I prefer this over a contract for deed.

There is no renter at all.  Just the seller, the two middle men (me and mentor) and the end buyer if we do a contract for deed.  But the end buyer will be the renter if we do a lease options.

If we do a contract for deed the end buyer/renter will do his own rehab on his own future house with his own money.

Exit strategy if this plan fails is we flip the property after getting him out.  If we got the 20k from him we can use most of that to rehab it then we should be able to flip it for around 150k or worst case 125k.

Or the basement is structured with two egress windows and a start to kitchen.  So i would think with the land I should be able to rent the upstairs for 800 to 1000 and downstairs around 500.  This would be about a 1.5% rule if I can make that work.

Your ideas, questions and concerns are helping a lot.  Thanks again!

Contract for deed deal - Good one?

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