Landlording vs. Seller Financing

36 Replies

I'm currently in the Dallas - Ft. Worth market - I haven't been investing long (since 2009), but recently I've been turning my rentals into paper via seller financing. Many of these properties have mortgages with less than 20% of equity, and one is paid off. I can make $200-$500/month in cash flow by converting (or wrapping) these properties, put a 3rd party loan servicing company in place, and NEVER have to deal with tenants again. 

Example - I had one property left in Austin. $150k principal balance, 3.5% fixed interest, $1050 PITI, $1350 rent. Property taxes were on the rise and eating my cash flow. I decided to wrap this mortgage as to not have to deal with tenants or the increase in property taxes. I sold the home for $205k (market value was $195k), $15k down, 6% fixed, 30-years... I now am cash flow positive $450+.

I'd like to hear why others (not just DFW market, but Atlanta, Phoenix, Nashville, Memphis, etc.) choose to be long-term landlords and deal with tenant screening, repairs, vacancies, etc. (with or without a property manager). What are the positives and why do you choose to be a landlord? What are your concerns about seller financing and turning into the bank?

I like your business model as an exit strategy @Mark Allen .  Dodd-Frank and the Safe Act has added a few layers of risk to the lender on owner-occs, but for someone wanting out of the LL thing, I like it and have done it before as well.

For me, it's taxes and lack of control being the big barriers.  I've turned a highly tax-advantaged, passive income investment into interest (ordinary income) cap gains, and dep recapture.  

There are also a lot of headaches inherent with wraps (how do we split up the 1098 bank interest or deal with insurance and DOS issues to name a couple). I also no longer own the asset and need to foreclose in case of default.

If exiting during a soft or stagnant market, I will consider SF I am sure.  In a frothy seller's market like now, I would rather 1031 and delay  (or forego entirely) the tax hit and reset depreciation on my older properties. 

To reduce management headaches almost entirely on my houses, I offer 2-yr lease options to well-qualified, ownership-minded tenants. The almost readies. I then sell conventionally and need no magic at tax time.

Good idea and good discussion!

@Mark Allen Thanks for raising this question. Being a fairly new investor and examining the plethora of exit strategies, I've wondered this same thing because it seems like a no brain-er. I've asked around to get a better understanding, and the response I usually get is 2 part:

a. They generally buy and hold for the long term so once paid off you see higher and ongoing Cash Flow that can be passed on to your Estate or Cashed out when ready for retirement. (note: most have strategies to pay off loan well before 20 or 30 years) 

b. They simply don't wish to relinquish control of a property that they still technically own.

IMO both are great strategies... It really just depends on the personal needs and goals of the investor, as to which would be a better fit for him/her. 

Hope this helps... I'll be watching closely to see others' opinions on this topic. 

Best,

Will G

Promotion
Baselane
All-in-one Financial Hub for Rentals
Still using Excel to manage your rental finances?
Simplify rent collection, bookkeeping, banking, reporting, and taxes. Less stress, higher ROI.
Learn More

@Mark Allen

Glad to see another DFW resident being successful as in investor.  I would have to agree with @Steve Vaughan on his bullet points, unfortunately, in Tx I would stay away from lease options.  I enjoy being a small business owner due the tremendous tax advantages that you can take.  Last year I deducted the total cost of a  Ford F350 and Travel Trailer using section 179 and ended up paying pennies on the dollar of my rental income.   I don't think this is possible when you are a note investor.   I find that in any business you want to get to a point of working on your business and not in it.   As a landlord that means:  not going in person to collect rent, not taking maintenance calls, not having to evict, not having to screen tenants but having the processes/people in place in order to do everything for you.  I currently only have 2 notes but if for some reason I get tired of landlording,  I do see owner financing as one of my exit strategies. 

Best of Luck!

Mark, do you worry about having too many mortgages in your name at some point preventing you from  getting another?

For me, I don't do seller finance because I buy my houses in cash, but more importantly you miss out on the appreciation on the property. 

Originally posted by :

b. They simply don't wish to relinquish control of a property that they still technically own.

Unless you're selling w/ a contract for deed, you don't technically still own the property when you seller finance.    Also, when you lease a property, you are relinquishing control of that property (subject to the lease terms, of course) during the lease.

Originally posted by @Mark Allen :

@Steve Vaughan @Will Gandy Great feedback! 

Another downside - I lose my leverage to borrow against the equity in those homes after sold/wrapped.

 If you finance it and sell it right, you'll have a negative net investment at time of sale and will have already gotten all your cash out of the deal and made a healthy profit.

Wow I don't think I ever seen this side of the coin laid out like this. Do you have any other properties that are structure as seller financing? OR this one in Austin is your only one? 

Promotion
Turo
Turo car sharing
Average $50K/yr with 5 cars
Join thousands of entrepreneurs who have started successful car sharing businesses on Turo.
Learn more
Originally posted by @Jason Hirko :

For me, I don't do seller finance because I buy my houses in cash, but more importantly you miss out on the appreciation on the property. 

What's to preclude you from doing seller finance if you pay cash? I bought my first seller finance house last year w/ cash in my Roth IRA, and it was the best transaction I did last year. Missing out on appreciation? I bought and sold that house in a back-to-back closing, booking a $30K gain on a net $87K investment. How many years do you need to own a rental to realize that kind of appreciation?

As y'all might have guessed by now, I'm a big fan of seller finance. I have the rental thing covered w/ my MF interest and a SFR rental. After experiencing most every strategy in SFR investing, I came to appreciate that my core competencies carried from my pre-RE career are in finance, not construction or property management. For this reason, I'm primarily focused on seller finance going forward. I have no interest in selling anyone on it, and buy-hold may indeed be a preferred methodology for others.

I see lots of down sides to seller financing. (or upsides to landlording if you are glass half full)

  1. Lack of liquidity - Harder to sell a 6% note than a house
  2. Lack of appreciation - While not guaranteed, over the long haul, appreciation is huge
  3. Shrinking equity - Rather than growing equity as a landlord, you are losing equity (though you could reinvest if you are disciplined)
  4. Taxes - You are avoiding property taxes (which are admittedly terrible) but you have acquired income taxes
  5. Servicing - Servicing is not totally free or totally simple
  6. Foreclosure - Lot harder than eviction
  7. Insurance - Rather than just getting it, you have to make sure someone else has it
  8. No Exchange - 1031 does not work with seller financing
  9. No Development - Sometimes development rights or demographics change and it would be great to add another unit or square footage. 
  10. Surprise sale - You are not in control of when this asset disappears because the new owner can sell whenever they want

 Not trying to say it does not have it's place. I think it can be a good exit strategy but maybe not as good for generational wealth. I will be taking a small second lien soon but that is primarily to grease a sale I want to push through. Also, I think my opinion of seller financing will change significantly if we ever get back to 10%+ interest rates. 

Originally posted by @Timoteo Guy :

Wow I don't think I ever seen this side of the coin laid out like this. Do you have any other properties that are structure as seller financing? OR this one in Austin is your only one? 

 I have three in the DFW area currently... All with underlying mortgages. I plan to utilize a seller financing or wrap strategy until the market corrects in DFW. 

Originally posted by @Will R. :

I see lots of down sides to seller financing. (or upsides to landlording if you are glass half full)

  1. Lack of liquidity - Harder to sell a 6% note than a house
  2. Lack of appreciation - While not guaranteed, over the long haul, appreciation is huge
  3. Shrinking equity - Rather than growing equity as a landlord, you are losing equity (though you could reinvest if you are disciplined)
  4. Taxes - You are avoiding property taxes (which are admittedly terrible) but you have acquired income taxes
  5. Servicing - Servicing is not totally free or totally simple
  6. Foreclosure - Lot harder than eviction
  7. Insurance - Rather than just getting it, you have to make sure someone else has it
  8. No Exchange - 1031 does not work with seller financing
  9. No Development - Sometimes development rights or demographics change and it would be great to add another unit or square footage. 
  10. Surprise sale - You are not in control of when this asset disappears because the new owner can sell whenever they want

 Not trying to say it does not have it's place. I think it can be a good exit strategy but maybe not as good for generational wealth. I will be taking a small second lien soon but that is primarily to grease a sale I want to push through. Also, I think my opinion of seller financing will change significantly if we ever get back to 10%+ interest rates. 

 1. I won't originate a note for less than 9.9%, and I'd argue that notes are easier to sell than houses b/c they're more of a commodity, w/ only a handful of factors determining value.   You can certainly close faster on them!

2. I had 34% appreciation in the nanosecond I owned my last seller financed house.   How long will it take you to match that in a rental?

3. Not necessarily true.   If the house has a sub to or amortizing seller financed note at a lower interest rate than the buyer's note, equity will increase over time.

5. Buyers often pay for servicing, and the servicer makes it simple.   Even so, it only runs ~$25/month.

6. True, but cash for keys works for both tenants and SF buyers.

7. That's the servicer's job.

8. No problem, there's plenty of profit on the front end earned presumably for providing financing over the term of the loan.    Having a sale or refinance means you earned it w/o having to tie up your capital over the full loan term, and can rinse or repeat another deal.   Honestly, I wouldn't do seller finance if I expected buyers to pay on the note through maturity; the rate is high enough to motivate them to improve their credit and refinance as soon as they can.

I'm not trying to suggest seller financing is better than rentals, just clearing up some misconceptions.

Great topic! Very informative to see both pros and cons, depending on your situation.

@Chris Soignier

All really good points. Glad you provided some counterbalance. 

1. Totally agree. Higher interest rates make a big difference. Thus my comment about 10% rates at the end of my post. 

2. I would guess that you forced the appreciation in some other way through the purchase or rehab. That works the same if you hold or sell without owner finance. If you are getting more than the actual value, it is maybe related to the risk of the note, not the property. 

3. Only if reinvested as i mentioned, but the forced savings in landlording creates a good balance for me between risk and security.  

5. That is fair, I do not know much about servicing. Just seems complicated from my side. 

7. Maybe this is an impractical concern of mine but it seems like tenants who do not qualify for traditional financing would be more likely to neglect insurance. I guess the servicer can buy it but that seems tricky. 

@Will R. , basically it comes down to different strokes for different folks. Buy and hold is an excellent vehicle to create long-term wealth. I'm a passive in many apartment complexes, soon to be a couple more, and have one SFR rental which is quite honestly too valuable to achieve optimal rental economics. ($350+K market value, 2250/mo. rent)

It seems like many of your concerns or fears are born out of not having a lot of knowledge of seller financing...which is OK, all you need to know really well is the strategy (or strategies) you employ.

I didn't force appreciation at all in my example.   In fact, my buyer's closing was completed before my seller's closing.   I didn't do a thing to the property, didn't buy title or property insurance, and didn't pay any prorations.    Seller financed deals are generally priced based on rent comps, not sales comps, and usually command a higher price vs. an otherwise comparable property w/o financing.   The risk was amply covered by the 10% down payment and 9.9% interest rate.   If I have to foreclose or negotiate deed in lieu of foreclosure, I'll sell it for more next time and collect a bigger down payment => even better economics.   (note that I'm expecting to receive payment for a note which matured in Dec. this Friday.   I could have foreclosed, but chose not to since that's not my goal and I was comfortable that it would be refinanced).

Servicing IMO is easy - b/c I don't do it. The servicer receives payment, manages escrow pmts. in and out, provides reporting, sends my payment to my Roth IRA custodian, and takes care of compliance issues. Also, they PAY THE INSURANCE PREMIUMS out of escrow, so the borrower doesn't really have much of an opportunity to skip paying it unless they want to default on the mortgage.

Again, I'm not trying to debate which investment strategy is better, these are just some of the reasons I prefer seller finance for my single family investing.   I'll continue to invest in MF rentals.

@Chris Soignier

I like your strategy (mainly the 10% interest) but I think I am still missing a few pieces. Are you coming in just as a lender? Are you creating the deal or is someone bringing it to you? What part of the state do you farm these deals in? Are you wrapping a mortgage or is this an un-leveraged loan? What is a normal spread for you between the purchase and sales price? 

Thanks for letting me pick your brain!

@Will R. , just to be clear, I've only done one  SF deal so far.   I'm actively working to raise private money to fund acquisitions of seller financeable properties so I can focus on it as my primary strategy going forward.

I did and will put the deal together, as that's much of what creates the value, and I'm focused on middle/working class neighborhoods in North Texas/DFW area.

I'd love to buy w/ sub to's and seller finance, but those are hard to find these days, so I'm just looking to acquire w/ private money.    I can't really provide a normal spread - the market dictates the sales price, and the motivation of the seller, your negotiation skills, competition, etc. all influence the purchase price.

Mitch Stephen is one of the country's leading experts on seller finance, and he lives right down the road from you in Canyon Lake.    He's a great guy, and if you're interested in seller finance he'll teach you all you need to know.   In fact, his upcoming book is an awesome read on seller financing - I highly recommend reading it if you want to learn all the nuances of this technique from a master of it.

@Chris Soignier I should have clarified... I don't do seller finance on cash purchases because the return isn't high enough for the return I require on my cash. If I had a loan on it and was looking for cash-flow, that would be different.

As for appreciation, I'm not saying you don't get appreciation when you seller finance, but the question was why do you rent. If I'm putting my money into a property to hold as a rental, I'm looking for cash-flow and long term appreciation. If you sell the property owner-finance for 20 years, when that loan is finally paid back, the property is worth a lot more than when you wrote the contract. That's why I rent instead of owner-finance. To me, the headaches are worth it in the long term. Though I do have some things I've owner financed in the past, but those were more lease-option type plays, which I do like as well, in the right situation.