For those real estate investors who could not borrow from banks and are still looking to leverage their real estate investments, seller financing is a possible consideration. Quick review: in a seller financing transaction, the seller plays the role of the bank instead. The seller will finance your purchase of his or her home. Most negotiations will fall into four major factors:
- selling price,
- interest rate,
- the length of the financing,
- and the amount of the down payment.
As you negotiate in these types of deals, the factors get played around throughout. The seller may consider lowering the selling price, for instance, in exchange for a higher down payment. Or in another example, the seller may consider raising the interest rate if you are looking for a much longer term of financing. Each variables can often be changed depending on your needs and the sellers’ needs. As a result, one should carefully think about which factors are more important than others.
There are different types of buyers as well. You have to consider which buyer you are. Here are a few examples we can look it and see how these four factors play out.
A speculator is looking to capture appreciation in a housing market. Given the events in the last several years, in certain markets there are opportunities to speculate and capture appreciation. A speculator is looking to fully maximizing his or her profit in a short time frame.
So as a speculator, one would pay great attention to the selling price and the down payment amount. Monthly cash flow will play a second fiddle to this venture. The speculator will love to put a low down payment and yet still get a competitive sales price. He or she is willing to pay a higher interest rate or a short term balloon payment to achieve those goals. The speculator may suffer because he or she is not going to get good monthly cash flow, but he or she knows that holding this piece of real estate is a short term play and even a 3 to 5 year negative cash flow scenario may not create a big enough dent to his or her future profit sale.
2.) Long Term Real Estate Investor
The LTRE investors will love to hold the real estate forever. In fact, there are great benefits to holding real estate forever. The rental income is good. The tax benefits are good. And maybe sometime in the future, the value of the home may rise (but for someone who wants to hold the real estate forever, doesn’t that just mean you’d have to pay more property taxes?).
For LTRE investors, one would probably like to have a lower interest rate and a longer term financing. Suppose the interest rate is not too much more expensive than the current market, the investor would probably like to lock down the financing terms and hold it for the duration of the loan (whether it be 15 or 30 years). The investor may even want to pay it off earlier because he or she may not like debt so much. Nevertheless, the investor understands that rent will eventually rise and the investor should be able to earn a big spread on the monthly cash flow. He or she wants the income. And with good patience, he or she will get it.
The selling price may not affect this investor as much. The investor is probably willing to trade a higher selling price for a lower interest rate that leads to a lower monthly payment.
3.) “Will Get Financing Soon” Investor
Perhaps you are an investor who currently hasn’t been able to get financing yet but will be soon. Maybe it is because of a short sale history or maybe you are rebuilding credit. In any case, you want to take advantage of this depressed market before the opportunity goes away. The time to buy cheap homes is now.
For this type of investor, the ideal situation is to lock down a good selling price. You know prices that low won’t last that long. So you want to do whatever you can to get it at the price. So what to give up? Interest rates, down payments, or length of financing. You can give up all that knowing that shortly you will be able to get bank financing soon. So what if for 2 years you have to pay 10% interest? You won’t be paying that forever. You know you can replace it with a cheap loan very soon. Besides, by that time you can get financing the real estate market might have already recovered.
For this type of investor, it is get in, and figure it out later. It is a bit riskier. But watching your real estate market go up 50% while you are standing on the sideline is a tough pill to take.
These are just a few examples. The important thing is to see what kind of investor you are and what kind of factors are important to you. Fight for those factors in your negotiations. We all love to get everything as cheap as possible, but when push comes to shove, you need to understand what to fight for and what to give up.
Photo: Tambako the Jaguar