As an article I wrote a couple weeks ago about a potential seller financing opportunity in which I have gotten a tremendous amount of negative comments from, today I have actually gotten an offer close to what I have been looking for. As a result, I would like to further elaborate the math on this deal:
Just a quick recap in case no one read the earlier article, I had purchased a 2 bedroom 2 bed condo in Las Vegas cash for about $65,000 net costs. I am looking to flip the property in a seller financed deal selling for a premium price. In this case, I am looking for a neighborhood of $90,000 with the buyer paying 50% down and I’d carry a 8% loan 30 year amortization with a 3-5 year call. Seems like a lot of people are saying in my previous article that I was crazy to expect a price like that or people would be crazy to buy. But hey, what do you know, I’ve gotten an offer today.
The Offer on my Condo…
A buyer today offered to put down $28,000 instead but is willing to repay the principal of the loan in installments of 5 years at 8%. Meaning at the end of every year he would pay me back a fifth of $62,000 (or $12,400) for each of the 5 years. Would this be a good sale for me? Or should I keep renting the condo until real estate prices go back up to a crazy level again?
It was really a gut decision until I put the numbers together.
So let’s crunch some numbers again.
First, let’s run my returns if I keep the condo rented:
Assuming I don’t sell the property, it runs me at about 7.5% return so far.
But what if I sell it to this buyer?
So I get my $28,000 right back, so my total cash investment once I sell it at $37,000. As you can see, each year I’d get less interest because the buyer would have paid down a fifth of the original principal, which is $12,380.
This is the cash flow I would have received in 5 years (reminder: I do not have to pay HOA, maintenance, property tax and insurance at this point).
Do you know what my internal rate of return (IRR) is? For those who don’t know internal rate of return, IRR is a discount rate which you used to value all your cash flow. It may be hard to grasp so check out this thorough article to learn more. All you need to know is the higher it is, the better.
You know what the IRR is? 32%! You know what that means? Yes, it means it is absolutely an awesome return on your money. I guess the better way to describe this return is that if the cost of your entire borrowing is at 32% per year, you basically break even.
But what if I want to keep my tenant and sell my condo in 5 years to capture appreciation? Again, I can’t say for sure whether the market would go up significantly in 3-5 years although I feel like it would (not only because of a housing market rebound but the reality that the US currency is going to worth a lot less).
So instead of guessing around, I thought, at what price would it be worthwhile for me to sell that would reflect the same rate of return if I had accepted this buyer’s offer?
With some quick Excel calculations, this is the price I came up with… $217,313.81. This is the selling price (this is after all the realtor fees too!) I would have to get at the end of year 5 in order to match the same return I had if I sold it seller finance.
Even I’m not that optimistic. I’m thinking at best around $150,000. But at that price, at the end of 5 years, my IRR is only going to be at 24%. Not good enough.
So as you can see, the time value of money is extremely important and can play a crucial role in determining your return. I did not realize the magnitude of the difference until I started breaking out the investment banking style calculations. The big difference here is due to the fact that I get $28,000 right back from the start (sure I’ve had this property for close to a month now but let’s not get too picky with the numbers).
So to those naysayers, I say “yes” – seller financing is possible and can work. If you can get the buyer to pay large parts of principal back around the beginning you can really boost your investment returns. While most seller financing asks for a balloon payment at the end of three, five, ten, fifteen years etc, I say go for principal pay down in each year instead. Obviously this may not work for many people, but for those who can do that, this would help your returns so much more.
Perhaps BPers are right to think I am a greedy speculator/gambler/crazy guy, I just responded to the agent that I would like 12% interest only instead of 8% since the buyer is only willing to put down $28,000 and not the $45,000 I asked for.
We’ll see what happens…
Photo: kevin dooley