BiggerPockets

A couple thoughts/questions...

In your example, the investor puts up $57,500 to cover the purchase, holding costs, and rehab costs MINUS half the down-payment.

That means that if the buyer can't refinance out of the investor's loan, the investor is earning $382/month on his $57,500 cash outlay, for a cash-on-cash return of less than 8%.

Considering that most lease-purchases and owner-financing situations don't result in a refinance, the investor's upside isn't very good.

What happens if/when the buyer trashes the house, stops paying, and you need to foreclose? Who pays the additional rehab costs necessary to get the house back into selling shape?

If it's the investor, then his potential profit has just decreased tremendously. If this happens more than once, the investor could end up losing money!

What risk are you incurring in this whole thing? You're doing a rehab that could likely be flipped (albeit for a lower profit), so there is no risk there. And you're not putting up any money once the investor comes into the picture, so there's no risk there. The investor is taking all the risk.

Not trying to dissuade you from pursuing this business model, but expect your money guy to ask these questions, and have some good answers ready...

Great questions:

Jon: This is what I have been doing for the last 4 years using your business model. It has afforded me a nice lifestyle and income during that period of time and I do not intend to stop doing it that way. I don't need a partner for this method as I have a nice cash standpoint and can get the loans all day long from my local lender.

So then why would I need a partner? Well I only have so much cash and my lender will not allow me to sell the houses via owner financing. I could lie to her and do it anyways but that just isn't going to happen. So I am forced to take on a money partner if I want to move forward with owner financing. I am just not in a position to tie my money up for multiple years. If I had 500k+ in the bank I would definitely consider it though. But still I would be limited a few deals. I am ready to do 20 deals or so next year using this method.

JScott: Using my math yes the investor gets an 8% return on their money with a beautiful back end return. And yes you are right the ratio is probably low that the buyer actually refis out of the loan. You say I am not risking anything. That can't be farther from the truth. I am risking something very valuable and that is my time. I am bringing to the table what the money partner doesn't have. They might not have time, the knowledge, the expertise, and maybe more importantly the ability to get started.

Besides an 8% return secured by real estate is not bad. Better than some 5% CD and a CD doesn't have a back end potential.

You make a great point asking what if the house gets trashed. This is certainly possible that this could happen. Part of the expense or possibly all of it would be covered by a new down payment from the next buyer. The rest would have to come out of pocket and it will just be something me and a potential partner will need to discuss.

If I had it my way I would much rather just get a loan from someone that would be secured by the house. They wouldn't be my partner they would just be the lender. That way they get the return they want and I am in full control. I would WAY rather do it this way. I just have a feeling a potential investor would like it this way instead.

No one is risking 60k. They are completely collateralized by the house. The house is not going to just magically disappear over night and be worth zero. In truth they are risking nothing if you look at it this way. Even at wholesale rates they would get 60k for the house. And as Jon pointed out you could always retail the house on MLS to a conventional buyer and make a profit.

Another way to look at this. We could sell the note after it has been seasoned for 6 months or so and probably get 70-80% of its value. Not the greatest return I understand but still a decent profit.

The only risk they are taking is if they have another option to make a greater return on their money.

I'm sure you can find people who would be happy with an 8% return. And, if the buyer pays you off in three years, the IRR on this investment is 17%, which is quite good. Trouble is, the longer the buyer takes to refi the worse this deal gets. The investor's upside is limited to half of the $35K back end, less principle paydown. After 10 years the IRR is down to 9%.

Selling the note for 70% of its value after six months would net $66,500. Less the $60K that's coming back to the investor (based on your original example, the $60K is still owed even after the down payment), that's only $3250 each. Much better to sell quickly.

If you sell this property after six months to a conventional buyer, even at $90K, both of you net $15K. Do it twice per year and you're each making $30K. That pays much better than this seller financing approach.

Having an investor fund these deals looks like a great deal for you. Once the buyer's in place, you're collecting $382 a month with zero risk, plus you have a payday coming on the back end. I can see where some folks might go for this, since, as you say its much better than bank interest.

I was typing my reply and totally missed Vikram's reply. The 80/20 split does improve the situation, but doesn't eliminate the time penalty. The longer this deal lingers, the lower the returns. Is there a balloon on the seller financing to limits the downside?

Just like you feel that the lump sum payment to the investor on the backend should be motivation enough for him to take some risk and accept a relatively small return, I would think the same incentive should apply to you.

If the back-end payoff isn't enough to keep you motivated, why should it keep the guy who has all the money tied up motivated?

Just playing devil's advocate...

In my personal opinion no one in their right mind would do the deal under your original terms. The only fair way I see for both sides is the 20-80 split. You dont deserve your return any faster than the moneyman. I would stick to rehabs instead of the method you are proposing. JMO

Michael, I have to agree with G Simpson and at the risk of stating my opinion twice, I think you should consider the principal and profit separately.

Look at it this way. The investor has put $60K in capital and you have put your time and knowledge into the deal. The end product is $100K worth of an asset. Thus, your labor plus the investor's capital has added $40K in value. This is the total profit from the investment and this is all there is to split.

Your idea of each of you getting half of the $100K means that the investor gets back $50K after putting $60K into the deal and you get the other $50K. I am definitely an investor with the kind of money in the bank that you referred to earlier, and more. And I would never consider the deal you are suggesting for the simple reason that you are taking all the profit plus a part of my principal. The idea of a partnership is for the profits of a venture to be split, not for one party to take the entire profit plus a portion of my capital and for me to get what's left.

Think about it this way. If you financed the sale at 9%, why is the investor getting only 8%? Because you are taking the entire profit from the venture and then some!

I am sure you did not look at this this way and there's no harm in brainstorming ideas to find ones that work. I like your overall concept but think it needs some tweaking to make it worthwhile for an investor. Play around with the percent of the monthly payment until you find a sweet spot that works for you and for your investor.

Michael, when you split the monthly payments equally, that's the same as splitting the loan equally and that's the same as splitting the value of the property equally. It does not account for the capital and profits separately.

Try to look it like the investor would.

Total outlay 60,000.00
"We would split the down payment and each get $2,500"

Return from downpayment 2,500.00 (where does he get repaid the other 2,500.00 of his money?)

Outlay still remaining 57,500.00 (no return on investment yet)

We would split the Principal and Interest Payment $764($382 each per month).

No matter how many payments are made before the traditional financing it reduces the principle by what is not interest so the investor is recieving only 4.5% interest plus a portion of their principle.
While you are recieving some of his principle plus 4.5% interest.
This effectively reduces his interest to 4.5% and he loses part of his principle because when the loan is gotten by the buyer, the new loaner will not give your investor the amount of the principle you took by taking half of the payments (principle plus interest).
The more payments this buyer makes before getting that traditional loan the more you take in half of his principle paydown.

On the back end if the buyer ended up getting a traditional loan we would cash out $35,000 minus the principal he had paid down. We would split this amount evenly.

By splitting this amount evenly the investor never recovers the principle that you claimed by taking half of the monthly payments that were made. Not to mention the half of the downpayment that you took.

So far the investor sees you taking half of the downpayment.
Half of the monthly payments which will always include some principle paydown so you are taking half of that priciple paydown.

At the end the investor gets the 35,000 cashout minus the principle paydown (which you already took half of) and you propose to split this evenly?

In this type setup, depending upon how much downpayment you get combined with how many payments you split it is VERY possible that the investor never even gets his initial investment back.