A Simple Strategy Made Real

by | BiggerPockets.com

You’ve got $150,000 plus fix-up cash, and you’re rarin’ to go. You’re goal is to acquire a home to fix up, and without using debt. Problem is, you’re in a $200,000+ market. What to do? Before we begin, the seller you’ll need to find will have to want income, and not have any debt on the property. Let’s get goin’.

Finding the Property

You locate a property in need of some fix-up. The seller will agree to a value of around $225,000 or so. They’re in their 60s and don’t mind the idea of considering a note as payment in full. The reason they’ll do this is cuz you’ve located a couple notes totaling that rough amount. It pays 10% interest, is fully amortized for 30 years, and has decent equity behind it, secured by a single family residence. So far, so good. When the seller realizes the income from these notes will far surpass anything he’d be able to negotiate on his own property, he perks up. After all, the monthly payments on the notes you’re offering add up to almost $2,000 monthly. (roughly $1,975) If he carried back a note on his property the most he’d get would likely be 6% — around $1,080 a month — barely over half of what you’re offering. He’d need 20% down in order to carry himself to feel secure. Therefore, not only would the amount of the note be less at the beginning, but the interest would be far less also.

A Scenario to Consider

You make the deal. But wait, there’s a fly in the ointment. Since you only paid $150,000 for the $225,000 note, you’d be makin’ a sizable profit IF you’re credited for a sales price of the same amount. Taxes would be owed, for sure. What to do? Here’s the way we’ve dealt with this problem over and over. The seller will very likely have no objections to lowering his sales price to $150,000. Why would he care? IF he was gonna be potentially liable for any gain, sellin’ for the reduced amount would lower that gain by $75,000. Also, it wouldn’t change the fact that he’s gettin’ a note with the face value of $225,000 and payments based upon that amount. He’s happy — and you’ve arranged to acquire a $225,000 home for your $150,000 in cash. But that’s only the first step, acquisition.

You then break out your fix-up cash and do your thing. When you’re done you have a couple options. You can choose to keep it and rent it out for the long haul, or sell it for the profit your hard work has earned. On the other hand . . .

Why Not Have Your Cake and Eat it Too?

Let’s say you now have a $300,000 home. (more or less as you prefer) It’ll rent for around $1,500 monthly. What if you put a new $175 ,000 loan against it — 4.5% for 30 years, fully amortized? Your monthly payments would be about $887 or so. You now have your acquisition and fix-up cash back. The loan is not even considered a taxable event. (Later you might hafta deal with what’s known as ‘loan over basis’, but probably not. In any case, it wouldn’t be a big deal.) You now have the option of keepin’ the house as your first long term investment property AND retaining the ability to begin the search for your next flip.

Will finding sellers willing to take a note be difficult? Oh, yeah. Can they be found? Absolutely, been there, done that, back in the day. The motivation for those kinda sellers haven’t changed. They know the place is beginning to fall apart. They want out, and they want income. But in the end, here’s why this strategy will work. They realize they can’t generate the income you’re bringin’ to the table with your note. Not even close. It’s incredibly appealing — and pardon the expression — a genuine win/win. In fact, though I don’t have time now, there’s a very simple way to structure this transaction during acquisition that will result in the seller being able to receive installment sale treatment. In other words, if it was a tax issue to him, installment sale status would allow him to pay taxes on any capital gain only as it was received in the monthly payments — NOT all at once as in a cash sale.

The seller gets much more income than he could’ve generated by carrying back 80% or less of the sales price. The interest would’ve been much less than the note you brought to the table. He has the option, if needed, of paying any capital gains taxes over a period of years, not all of it next April 15th. Again, he wins, you win.

Actually, you win twice cuz you now have the option to rinse ‘n repeat if that appeals to you.

About Author

Jeff Brown

Licensed since 1969, broker/owner since 1977. Extensively trained and experienced in tax deferred exchanges, and long term retirement planning.


  1. Jeff your posts give me joy!

    I am old guy, learned notes before the St Germaine Act of 1982, and your post here is just awesome. I have learned there are 30% of residential homes that have no loans, 100% equity, I am pretty sure that is still true.

    What don’t you just call this, “Mr Seller, Let me Show You the (more) money! With notes!”

    Installment sales with primary residences for free and clear properties are just awesome.

    20% cash down,
    good interest rates,
    underwritten buyer/borrower,

    create a 1st and a 2nd, say 85% 1st, and a 15% second,
    after 6 – 12 months the 1st is seasoned,
    sell a partial 60 payments on the front end to a note buyer for slight discount,

    and get….

    20% of value cash up front
    20% in 6 months (partial sale of 1st 60 payments on 85% first)
    No payments for 60 months on 85% 1st but payments on the 15% 2nd for 1st 60 months
    After 60 months and seasoning of 6 months, you get both full 1st and 2nd payments.
    And pay IRS tax as you receive the money, not in 1 chunk! (IRS Installment Sale)

    Thanks for the great note article!


  2. Brilliant, the whole thing relies on the seller not adjusting the value of the note for risk. The reason you are getting 10% on a note is that the party paying on the note has a higher risk of default than your average joe. In fact, they have probably already missed a few payments such that the note-holder is willing to sell it to you at a discount. Thus, the risk-adjusted value of the note is $150,000 – exactly what you paid for it.

    If the seller believes the note is worth $225K and not $150K then you have just proved the “greater fool” theory. Awesome!

    • Jeff Brown

      Not really, Steve. The note already has an 80% LTV first position. It is a performing loan. If the seller must foreclose they’re a home worth more than $281,000, free ‘n clear. If they took a 20% down payment on their property instead, and carried the different at a lower rate, how are they better off?

      The security for both loans are the same 20% down payments. As far as why anyone might pay 10%? There are a number of reasons, mostly due to the most recent economic cycle. But remember, they put at least 20% cash down. Typically these notes are in the face value range of $50-100K or so. The house payments, PITI, would be around $1,000 +/-. In other words, completely affordable. In California the payments on the median home would be 2-4 times that amount, so we don’t find those high interest notes there.

      Make sense? We don’t ever invoke the greater fool theory in our business — ever.

      • Thanks for the reply, Jeff. I understand why someone would take a note for 10% and I understand the seller has a cushion of 20% equity if the note taker defaults. It’s a great return for the seller if performance on the note (or notes) holds up (or the costs of foreclosing on the note taker are minimal).

        Can you explain why the owner of the original note (or owners of the original notes) would sell you $225K in fully performing loans for $150K? Presumably they have given the note takers $225K in cash in exchange for the notes at 10%. Why are they taking a bath?

        • Jeff Brown

          Sure — Most of the time the owner of the note that was sold had carried back the note themselves, not loaned hard money. Also, again most of the time, there was a lotta profit in the sale of the home used as security for the note. They usually set out to carry their own paper with the idea of selling the note for a discount. These kind of notes are not rare as most folks think. Many of these notes are generated by flippers who build the discount into their business model.

  3. Thanks for the clarification, Jeff. Amazing that flippers would want to sell their notes at a discount to you so you could effectively sell them at full face value to another party. Nice work if you can get it!

  4. Thank you for your post! I have been looking into investing in real estate but was confused about where to begin. I will definitely keep these things in mind. Keep the great info coming.

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