Good or Bad Owner Financing Apartment Deal?
Hello BP Ninjas,
I'm looking at a 10plex renting for 500 per unit fully occupied (zip 36303 AL). Seller wants 500k with 10% down on owner financing. Term will be 30 year but balloons at 3 years if I dont find my own financing through a bank. All the commercial lenders in town want 20 year amortized schedule with 20% down (which I dont have), and if I did the mortgage would be too high.
These are the numbers. Under the 50% rule by $200. So after 3 years I will only have about 30k to finance with.... yet 20% down on the remaining 450k will be 90k... which I dont have. I need some advice on how to negotiate this better or evaluate the deal and find out my max offer.
Also should I get a lawyer involved and set up LLC for this?
You have nothing allocated for repairs and reserves (capital expenses such as roof, water heaters, hvac, etc). I also think your insurance figure is low, I don't see how proper coverage for property and liability on a 10 unit would be only $100/month.
Using the 50% rule on a property with $5000 in gross monthly rents you would end up with $2500 after expenses. Subtract out your $2696.98 mortgage and your cash flow is -$200 so you'll lose money every month you own it. Not a deal.
Thanks @Patrick L.
I'm going to continue to evaluate this deal at least for practice, I met with the property manager yesterday and some of the units currently renting for as low as $425 and there are couple section 8 who have been there for years and problem free. Insurance quote came out to $200 from State Farm.
I agree with you that this is no deal, once I have all the numbers I can find the max offer I can make which will put the property above the %50 rule.
Are all utilities metered separately and do tenants pay them? The price is way too high for the rents it collects unless the rents are significantly under market rent and you can raise them.
@Eddie the water and electric are on the tenants, I'm still waiting on the rent roll and management costs from the property manager. I agree this is way too high.....
So what monthly cashflow would you deem acceptable? I know I need to at least be above the 50% rule but once there what kind of number coming back into my pocket would be considered a good deal to you?
The owner doesnt want to carry the loan very long and is talking about an adjusted rate after 3 years... problem is that unless I can make 90k in 3 years I wont be able to refinance with the bank... and the banks here wont do more than a 15 or 20 yr loan.
$50K (per unit) for $500 in rent is too much. There may be some other play here, but its only going to be cash flow positive to the extent you put cash into the deal.
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The owner is offering those terms because the property is grossly over priced.
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And, you won't have enough equity in 3 years to refinance, you'll likely need to be at 75 % LTV if you're lucky most likely 70%.
Always talk to your bank about the exit loan requirements before you do a seller financed deal!
So, it appears, not only is it overpriced but the seller is taking a down, getting you to manage, taking payments, then taking it back, the rinse and repeat scam. Balloon in 10 years, at least 5 years if you have room to improve adding value, otherwise, walk! IMO :)
Originally posted by @Wayne Brooks:
The owner is offering those terms because the property is grossly over priced.
Yea.. This.
One other point. A 3 year balloon is NOT good. I would always ask for 10 and hope to get 7... MAYBE consider 5. But not 3.
A 3 year ballon could be fine if you had the cash for a commercial loan to begin with (25% down). However even if you had 25% down available and went with the 10% down deal the seller is offering you would need to make sure your value is accurate. If you didn't properly value the deal (or manage it properly in the first 2 years) then you could be in for a world of hurt. Let's say you bought it for 500k with 10% down. You are not going to amortize the loan at all during the first 3 years to build up any equity (22-23k @ 5% & 30 year am).
- 500k with 50k down for a 450k loan.
- After 3 years call the loan amount 427k
- If the property appraises low...let's say 350k at a 75% LTV refi you would need to come up with 165k (427k-262k). Value is the key part of this.
- As it's already been pointed out the deal doesn't cash flow either.
Like @Wayne Brooks pointed out the property is probably way overpriced. Just because you can get into a property doesn't mean you should. A lot of seller financed deals don't pencil out right now based on where we are in the market cycle. Low interest rates, high rents, lots of capital in the market, and hungry buyers make most seller financed deals over priced right now (for multis).
Hi @Zzigmunt Smigaj I have always had a simple rule of thumb that you always want to may sure you have owner financing out a minimum of five years. - (it still goes by way to quickly). Ways you can get there are to have extensions in place that will allow you to add a year or two to a contract with a lump sum principle payment. In essence you are buying some time but also working to get to that magical 75% LTV # with a principle payment. Also don't forget to insert a clause that allows you refinance the owner finance balance with a 75% LTV loan, based on an appraisal, with the owner agreeing to carry any amount above the 75% LTV. This would be a carry back 2nd or even secured by another property such as a sgl family home until the loan is seasoned some. Give yourself multiple options because the truth be told no one has a crystal ball when it comes to the future of REI.
Build from within, learn everyday.
Paul
I agree that 50k per door is probably too high without knowing more but wanted to add that once you start increasing in size, the 50% rule is more of guide than a rule. I see 10 units operating at 35% expense ratios all the time and that includes replacement reserves and management fees.
I also don't really think in terms of the 50% rule because there are so many other factors involved. Your 35% expense ratio is common for bank underwriting however just because that includes a replacement reserve number ($250/unit) doesn't mean that number is correct based on capital improvements needed. I understand inspectors will extrapolate capex needed over a period of time however they are usually off. Newer properties with higher rents definitely run more efficiently than C class, older, lower rent properties however capex is still needed over time. They can definitely run closer to 35% however not for a $500/month rental (and not for 10 units).
WOW thanks everyone! @Derek Carroll @Chris Winterhalter @Paul Palmer @Mark Whittlesey @Bill Gulley
Real eye opener! I'd like to get all the financials and create a offer that will actually be considered acceptable on both price and financing terms... but I don't think the owners will accept so at this point its mostly just an exercise to help me evaluate what a good offer will look like.
Gonna walk on this one. I think my liquid cash can be used to obtain several other more solid single family homes in better areas.
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Originally posted by @Paul Palmer:
Hi @Zzigmunt Smigaj I have always had a simple rule of thumb that you always want to may sure you have owner financing out a minimum of five years. - (it still goes by way to quickly). Ways you can get there are to have extensions in place that will allow you to add a year or two to a contract with a lump sum principle payment. In essence you are buying some time but also working to get to that magical 75% LTV # with a principle payment. Also don't forget to insert a clause that allows you refinance the owner finance balance with a 75% LTV loan, based on an appraisal, with the owner agreeing to carry any amount above the 75% LTV. This would be a carry back 2nd or even secured by another property such as a sgl family home until the loan is seasoned some. Give yourself multiple options because the truth be told no one has a crystal ball when it comes to the future of REI.
Build from within, learn everyday.
Paul
Good point Paul. If any such note is to be devised it really needs to be done by an attorney skilled in financing. What this is is a future commitment to modify the note or to provide future financing. It won't be just a clause as the terms must be stipulated, you could save a lot by saying 'like terms" but it's not that simple either.
Future obligations must have a time set, usually less than one year. Going beyond one year will not be enforceable as any lender has the right to underwrite the loan based on current circumstances. You simply can not force a lender to agree that he will, under any condition, loan or advance or modify a new loan in five years.
A better way to address the matter is to agree to subordinate the loan in the event all amounts can not financed, that too won't be short, but it's not requiring a new loan as much as reinstating the existing loan allowing another lender to take a superior position.
If anyone thinks of getting creative you need a skilled attorney in financial arrangements not just an RE attorney as a note, while a written contract, it has different and specific aspects that can not be changed at will. :)
would owner be willing to balloon in 3yrs at$275k and carry a second for balance.
Why not? Get the bear share after 3yrs of payment and allows you to refinance. Alot can happen in 3yrs.
Thank you everyone! I've learnt a lot more than expected in this post and have some good followup questions for the attorney. I'm just getting started in this business and will take everything said here seriously, it will help me create my strategy for owner financing on these larger properties.
Update... so the property manager never got back to me after several attempts on my part to follow up and get some of the operating costs. As of now I've decided to not pursue this property.
I'm about to deploy with the Army to Kuwait for the next year but plan to stay involved with BP to learn as much as I can. If anyone has any properties for sale I'd love to run the numbers for practice and learn about what kinds of areas you are all investing in.
-Cheers!
Zig
ALWAYS FORWARD! HOOAH!
I disagree with what these guys are saying, I wouldn't walk away from this deal....I'd RUN!
There are plenty of good ones out there, just keep looking.
Just for "negotiation practice"...Zig, offer them $200K, 10% down, seller financing (same terms). Most likely they will not accept the low ball offer.
What if they accept the price? Then put it under contract and do your due diligence. It might become a deal if the price is right.