5 Rentals: How would you work this deal?

12 Replies

I had a caller come in via some mailers I sent out the other week and this guy has a fair amount of properties, 20+ I believe he said.  We had a plesant conversation discussing a huge number of things including that this gentlemans kids are not interested in taking care of his rentals, which was one of the reasons he contacted me as he is 72 years old.

I am focusing on 5 of his properties that are in a very similar in size (3bd/2b), built in the late 90s, similar lot size and even the same subdivision.  In the last 90 days, I am showing that the median sales prices for similar homes matching sq feet, lot size, bed/bath and year built at 159,000.

He started off telling me that the reason he was interested in going this route is that he can avoid paying commisions and all the normal fees associated with traditional sales (vacancies, improvements, etc) and wanted to roll the cash into a tax free bond.  Not sure if that is possible but that isn't the question here.  He very much seemed against taxes/commissions even if that means he accepts a lower offer.

He also mentioned that he has thought about carrying a note, I would assume for a short period of time (approx 1-5 years).

I would be very interested in working this into a buy and hold deal for myself, my only problem is I don't have much cash to swing around yet.  Knowing the above information, how would you approach this potential deal?

If there are any details I failed to mention that would be useful, just tag me and I will update.

Thanks in advance for the help!

One thing I missed was that these are all currently occupied @ ~1200/month rent and owned 100% free and clear.

If he owns them free and clear, you may not need much money up front.  

You should offer to pay all the closing costs.  Figure out a monthly payment (interest rate) that you can afford that will let him have something each month with no hassle ... amortize the note for 15 or 20 years, and put a 5-yr balloon on it, you don't want him to have to wait forever.  you want to make sure that you have financing actually lined up for this, so the price you buy it for has to make sense to a banker.

By 'make sense to a banker' i mean you need to make friends with a business banker at your local bank, explain what you're trying to do, and figure out what you need to do in addition to your current plan to ensure that you're able to refinance this deal in the future.

If you're EXTRA short on money at the moment you can always do an installment land contract (or their equivalent in your state) which defers the transfer of the deed until the satisfaction of the contract, which means you don't have to pay transfer taxes up front.

Another avenue that you can approach is seeing if he (seller) would be interested in carrying back a second mortgage.

Let's say each house is 200k * 5 = 1 million.

So what if you asked him to carry the second mortgage of 20% at 5% interest only loan, balloon of 5 years? This for him has positive implications.

He gets 80% of his money at closing= $800k
He would make 5% on his $200k instead of parking in in the bank accruing nothing.
He won't get taxed on the $200k for capital gains until he receives the remainder in 5 years.

For you it would be a positive because you would have to come up with much less to close the deal. Most of the down payment is via the second mortgage.

In 5 years you should could sell a house or refinance and pay him the 200k.

Typing on phone so there may be typos.

@Jeremy Pace @Juan Maldonado

Thank you both very much for your thoughts.  I am going to have to do a little research on these options to fully wrap my head around the process and how I can present this to him as a win-win situation.

Thanks!!

HI DERRICK ,ED REID HERE,I WOULD AGREE WITH THE ABOVE COMMENTARY ON HAVING THE SELLER HOLD A 1ST MORTGAGE IF THE PROPERTIES ARE FREE AND CLEAR,THE SELER COULD ALWAYS SELL HIS NOTE FOR CASH ,I GUESS A KEY QUESTION HERE IS WHAT WOULD MOTIVATE THE SELLER TO ACCEPT YOUR OFFER AFTER YOU CAN DETERMINE HOW YOU CAN MOTIVATE HIM,YOU CAN BEGIN TO STRUCTURE YOUR OFFER,ON E WAY OF COURSE IS TO OFFER HIM BETTER PRICING FOR HOLDING THE PAPER,FEEL FREE TO EMAIL ME ANY QUESTIONS YOU MAY HAVE [email protected] 

  

@Juan Maldonado 

I attempted to send a colleague request and a little message regarding your response but the server was timing out and it did not seem to go through.  Just going to post this right here to see if I am following correctly.

If the 5 properties come in at 150k each we will start with a retail value of 750k.  Assuming that I offer the owner the opportunity to avoid commissions, vacancy, improvement costs, etc and offer 125 for each property and he accepts, we then have the following scenario.

  • ARV: 750,000
  • My Cost: 625,000

From here I would pull a mortgage for 80% of My Cost, which would be 500k.  Because of the fact that I am only financing 80% of the value, I will not be required to put a down payment towards this loan.

For the remaining 125k, the owner would carry a interest only note for 5 years with a balloon due at the end of term.  

So essentially my payments would be the following

  • Bank: 2,684/mo (500k @ 5% for 30 years)
  • Seller: 520.83/mo (Interest only for 5 years)

Considering the current rents and max occupancy, I would have the following scenario.

  • Incoming: 6,000/mo (Rent Payments)
  • Outgoing: 3,204/mo (Mortgages)

Sometime before the balloon expires, I can sell one or two of the properties to cover the balloon paymet (or refinance, or many other options).

This is fairly close to the 50% 'rule'. Assuming I am interpreting this all correctly, does this seem like a good deal?  When all is said and done, I would only need to find a way to come up with the closing costs - which should be under 25k.

Thanks for proofing!

@Derrick Strope

I think you may be misunderstanding the 50% guideline. Take your rents (6000) * .5 = $3000 in monthly cash. Less $3200 in debt service and you are $200 in the hole every month. 

But 50% is just a guideline. I would suggest simplifying the deal for a moment. Just evaluate 1 of the properties. Add up all the expenses - vacancy loss, property taxes, insurance, maintenance, turn over, capex, management, utilities, HOA, administrative, legal etc...

Rent - Expenses = NOI

NOI - Debt Service = Profit

I think in a conventional scenario this deal doesn't look very exciting. Plus late 90's houses make me think lots of end of life maintenance is about to hit, unless the current owner has been aggressive. Now perhaps with some creative financing this deal can get more intriguing, but that's another discussion.

Originally posted by @Bryan R. :

@Derrick Strope

I think you may be misunderstanding the 50% guideline. Take your rents (6000) * .5 = $3000 in monthly cash. Less $3200 in debt service and you are $200 in the hole every month. 

But 50% is just a guideline. I would suggest simplifying the deal for a moment. Just evaluate 1 of the properties. Add up all the expenses - vacancy loss, property taxes, insurance, maintenance, turn over, capex, management, utilities, HOA, administrative, legal etc...

Rent - Expenses = NOI

NOI - Debt Service = Profit

I think in a conventional scenario this deal doesn't look very exciting. Plus late 90's houses make me think lots of end of life maintenance is about to hit, unless the current owner has been aggressive. Now perhaps with some creative financing this deal can get more intriguing, but that's another discussion.

Brian, thanks for the response.  No, I am with you on the 50% rule which is why I mentioned it was close.  The numbers can still be tweaked and nothing is in stone at the moment, I was just looking to see if the overall process I outlined made sense from an execution standpoint.  I guess I should not have added does this seem like good deal at the end of that outline because my offer prices have not been validated yet by the seller.

If you don't mind, can you expand a little more on this creative financing idea?  

Also it looks like current rates for rental properties in this subdivision are going for between 1200-1400/month based on a 3bedroom/2bath.  My 1200/month is on the conservative side so if we went with the median it would equal 100/month profit.

Ideally, I would like to get more than that out of five properties but again I just wanted to see if the overall process I outlined above was accurate.

In your above scenario I don't see you mentioning property tax.  That is a HUGE part of the equation.  I think you might want to dive in deeper past the initial head-math, and get some real hard numbers.  With real numbers then we can work on something creative that might work for everyone, but without the hard numbers it's all guessing.

@Luke Swab thanks for the response.  The property taxes are 1800/yr for each property.

I mistakenly above asked if this was a good deal, it was a mistake on my part because I have not yet vetted the numbers.

What I was looking for was if my understanding of the process that @Juan Maldonado had mentioned was correct in regards to finanacing with a traditional lender and the owner carrying a interest only second.

@Derrick Strope , your understanding of the process having the seller carry a 2nd mortgage is correct. There are some lenders that may give you trouble as they may want you to have some of your own money in the deal "skin in the game". But talk to them, let them know about your deal structure and find one that is fine with your deal structure. But then again just let them know that its not like they are lending more than they normally would, and what is the difference to them if the 20% is being carried by seller or a family gift to you?

The big things I would highlight to the seller are:

  • Unlike carrying the whole note, he will receive 80% at time of closing.
  • If he's worried about taxes, he gets to differ the capital gains on the 20%
  • Your offering 5% interest only or whatever (%) you negotiate , as long as its better than 1% its beating the heck out of 99% of savings accounts
  • Should you not make payments he would be able to foreclose on you (try not to mention this one, as he would stumble into problems as he holds a lien behind the bank), however in theory he could start foreclosure procedures.

The method described above works, its how our company president grew his portfolio to almost 600+ units.

Regarding your PM, not sure what happened was never received. Keep us posted.

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