All Forum Posts by: Kim Hopkins

 Thanks @Jonathan R McLaughlin, and yes, totally agree! That's why I think the counter needs to be closer to $80-90k (versus $25k) which I don't think he'll go for, but I couldn't have determined a number without getting this better understanding so it is what it is! 

Last item to work out on this. I would like to include in the proposal that we automatically get the 3 year extension with FLAT $2k / month payments, instead of the $500/month increase for each year of extension. 

I'm trying to calculate the value of this and factor it into our proposal. We'd defer payments  of $6k in year 5 and $12k in year 6 (the term ends in year 7 so the $18k for year 7 would just be paid in that year along with the rest of the loan balance). I need to somehow calculate what that benefit is to us and deduct it from our proposal to him of the total we want off the loan balance. 

 Sorry, not following. Your option #2 just looks like a better version of option #1, and I think we've laid out why option #1 is definitely not a good option. I don't understand #3. 

 Can you say that again, more slowly? :) 

If I put in the $100k now, it's going towards a note/loan, so I'm guaranteed to get it and the $25k back in the reduced principal on the loan balance regardless of his financial situation at that time. Do you agree? 

What do you mean by "over the 4 years you have at least the 25k opportunity cost as a base case"?

@Don Konipol

Excellent breakdown of your thought process. I believe we actually have the same logic. The only difference is I switched to using a 7 year hold instead of a 4 year hold, based on someone's suggestion above that it might be good to request the 3 year extension option now as part of this proposal. 

I was proposing a $170k reduction over 7 years, which is a compounded return of 15%.

So if we're both aiming for a 15% compound return, then it sounds like the answer is $170k over a 7 year hold and  $75k over a 4 year hold. 

The problem with the 4 year hold is if we decide at the end to exercise our extension option, then we're paying more in monthly mortgage for the extension years AND he's now holding onto our $100k investment and the return for an additional 3 years which greatly reduces our annual compound return. Not sure how we would untangle that. 

@Don Konipol Noted. Agree to view it now as a separate investment. When you say you would do it for $200k off the balance, do you mean $200k in place of his $25k, so a total of $300k off the balance (the $100k we're giving him now plus the $200k extra)? 

@Chris Seveney I love where you're going with this, and the IRR, but I'm not sure I followed your spitball, but I'm trying to recreate what you said below with a calculator. :)

Ok, here's what I've got so far based on everyone's observations. 

- Best way to view this is to compare the returns to if we invested $100k in a property. And to view it as a completely separate investment from the property itself.

- Since it's a separate investment, we'd continue paying monthly loan payments for the term of the loan on the property (i.e. there is no pause in loan payments even if we advance him the $100k). 

- The deal should include an agreement to put the extra 3 year extension into effect at the same current monthly payments of $2k/ month. That gives a total of 7 years left on the term (instead of 4).

- If we invested $100k in a property at a 10% annual cash on cash return (or ROE, whatever you call it), that would be $10k per year in cash flow. Over 7 years, that's a $70k return. 

- At first pass, this makes you think asking for a $70k return instead of a $25k return would make this an acceptable agreement. But it doesn't: 

- First, it doesn't have any tax benefits of a real estate investment (cost seg, interest, etc.). I'm spit-balling those at an extra $5k per year in returns. So $15k / yr x 7 years = $105k. So now we're up to asking for a $105k additional reduction of principal instead of $70k or $25k. 

- But that isn't a correct comparison either, because with this deal, we'd be waiting 7 years to get the $105k instead of getting $15k per year with a real estate investment. With the real estate investment, we could then take that $15k each year and reinvest it as well, making a 10% return on those cash flows. 

- I think the right way to fix the above is an IRR calculation. (What @Chris Seveney was saying, I think?). 

If I take the IRR of the real estate investment with $100k investment in year 0, and $15k per year cash flows with a return of equity in year 7 (assuming 0% appreciation I might add), I get a 15% IRR.

Conversely, with this arrangement, if I assume a $100k investment in year 0, $0 cash flows for 7 years, and a return of $X in year 7 and I set the IRR to be 15%, then $X needs to be about $270k.

Conclusion: That means I need a $170k return on my $100k, instead of a $25k return. To say it another way, I would offer him $100k now, if he reduces the principal balance by $270k in 7 years. That's a big gap. 

Does this analysis sound correct? 

@Bill B. Thanks for expanding on your thought process. I'd also like to hear what @Nicholas L. has to say on this logic, since the 2nd and 3rd BP contributors seem to have opposite interpretations on whether or not this is a good deal. :) 

@Bill B. Yes we do have a mythical $100k lying around. The property doesn't, but we do. 

I should have said cash on cash return (or ROE as you call it) instead of cash flow. ROE increases as a function of debt when the interest rate is low - 0% being an example of "low" obviously. So if we had this proposal from the beginning - $100k extra down (i.e. $100k less debt) for $125k off the loan amount (total of $25k off the purchase price), it would lower the LTV substantially and therefore greatly reduce the ROE for the entire 5 year period. I don't see why you say "yes" you would take that option.

@Chris Seveney

Interesting. Do you see how to understand the math at all? For example, why would you consider it for $100k? How did you come up with that number?

@Bill B.

I'm not sure I'm following your logic. The property cash flows about $45k per year. So this would make the property have negative cash flow for over two years.

In addition, you could think of it as putting another $100k down on the property in exchange for $25k off the purchase price. This would also reduce your annual cash flow. 

I don't see how it's a 25% return at all. It's not an independent investment. It's part of the property's overall performance. 

Hello! 

Well, this is a brain tickler. So we purchased a retail property at the end of 2022 with seller financing: 5 year term, 30 year amortization, 0% interest. Payments are $2k per month. Three year option to extend for additional $500/month. The entire loan is for $725k, but with the 5 year term, we would pay him a total of  $120,000 before the loan is up and we need to refinance (or use our option). We've paid one year, so $24,000 so far. 

The seller just asked if we would be willing to give him $100,000 now, and in exchange, he would knock $25,000 off the total loan amount. (Obviously the loan balance would also be reduced by the $100k).

Now, I know this is not a good deal for us, but I can't explain why. And I also can't figure out how to underwrite such a proposal in terms of return. Certainly there would be some break even point where if we give him $100,000 now, and he knocks $X off the total loan amount, then it's a good deal for us. But I don't know what $X is or how to even analyze this proposal. 

Thoughts? 

Thanks!
Kim