0% Seller financing - for WAY MORE than the property is worth? 🤯

66 Replies

Ok so this is probably not going to be an easy read, and i primarily write this down to make sense off my own thoughts, but i thought why not let a few of the great BP minds participate and maybe together find a satisfying answer to the following “Problem":

I have an offer to purchase a 2006 SFH that's owned free and clear with a current market value of ca 350k in a great neighbourhood in Las Vegas, Nevada (8/10, 9/10, 10/10 rated schools, low crime, nice amenities, walkable, views, etc)

Seller offers it for sale for 435k - 85k over market value, asking for 20% (87k) down & 0% interest for 17years - essentially charging ~4% interest on the current market value up front 😳

My general thinking is this: 

If i were to buy the same home at current market value of $350k with a conventional mortgage at 20% down with 4%, with a 15 year term, i would have paid $90k in interest, so the real cost of the house (all other things aside) after 15 years would be $440k. With a monthly PITI payment of ca $2300 it would likely cashflow negative

With a 17year term, i would have paid $106k in interest or $456k total.

(with the more common 30yr amortisation, the interest would be $200k, so real cost of $550k, but lower PITI of ca $1,600 it would break even / slightly cashflow positive)

The seller offers it for $435k at 20% down, with 0% and 17yrs - essentially charging the interest upfront or a 100% pre-payment penalty, and with a PTI payment (no I, yey..) of ca $2,000/month it would be breaking even at best.

This should automatically disqualify the deal in most investors eyes (including mine) right? 

But i feel, there is more to it. 

  • I intend to use it as my primary residence for a year or so, and rent it out afterwards. I won't be able to qualify for another regular owner occupied mortgage at a reasonable rate until the next tax return. (so for another 6 months) 

  • Buying this, would enable me to buy something now before my second child is born and convert my current home to another rental, which would likely add ca $600 to my monthly cashflow. (Is this convenience worth locking myself into a 17year commitment? (100% prepayment penalty, remember?)

  • Breaking even would mean owning the same A class property for 87k invested. Nice Piggy bank, property would be paid off by the time my first kid turns 18, talk about a college fund. AND rent`s tend do go up over time, right?

  • Even if it cash flowed negative, lets say $300/month (worst case) for the duration of the loan, this would equal ca 61k over 17years - plus the 87k down = 148k invested, to own another paid off property in an A class neighbourhood in Las Vegas, NV.

  • The payment is fixed for the duration of the loan, and every payment goes to 100% to the principal. After 5years, i would have already paid the loan down by $100k+ 

  • Appreciation: I don't want to gamble on the future value, but historically prices have been going up, the average appreciation of Las Vegas in the past 20yrs was 3.45% - the population is growing, tons of jobs created - however the city is surrounded by mountains, so there is only so much dirt left to build on. I think it`s fair to calculate with 3% appreciation, which would bring the value at the end of the term to $580k. My return (assuming only breaking even on rents and not adjusted for inflation) would be $493k
  • After 30 yrs, this property would have appreciated to $850k and brought in $720k in rents, for a total return of $1,48M.

Opportunity cost: What could my 20% down get me alternatively?

87k is a lot of money - i could for example buy a C class BRRRR property in in the midwest cash, that rents for $900-1000/month.

After 17 years, this would equate to 204,000k over the same time period (not adjusted for inflation), assuming the same 3% rate of appreciation would bring the property value to $143k. The total return on my 87k invested (again, all other things aside) would come out to: $260k. 

After 30 yrs, this property would have appreciated to $211k and brought in $360k in rents, for a total return of $484k. 

🤯

If you made it until here AND are not completely confused, i would LOVE to hear your thoughts. What am i missing? Would you do the deal? Why / Why not? Thanks in advance for your 2 cents!

My apologies for the incoherent string of thoughts - I'm a (over)thinker not a writer :P

Best, Stephan!

Don't try to over analyze a bad deal and try to rationalize ways that it could theoretically work out.  That is a massive 25% price markup, essentially limiting your exit strategies for many years to come, additionally a 17 yr payment schedule means your monthly payments will be too high to cashflow, and also reduces the positive effect of not having any interest because you are repaying the loan so quickly.  While I have bought properties for over market value because they were owner financed at 0% interest, this isn't one of those deals.  

@Bob Daniels

thanks for the reply and your insight! I generally agree and always prefer Cashflow, however if dont "need" the cashflow now, why would it not be enough to break even in your opinion? What downside am i missing - besides beeing locked in the deal?

After ca 5 yrs i would have paid off more and owe less than if i purchased same Property at market value with a regular mortgage, would that not be an argument FOR the deal? 🤔

Have you tried using IRR and net present value? They might help you calculate all this.

One thing tho - interest is tax deductible which means you would be saving at least some taxes so that needs to be in your calculation :)

@Mary M.

i have not, digging into IRR a bit now, thanks for the tip.

As for the interest and taxes, only up to 750k for owner occupied 1st and second if purchased after 2017 - but yeah i thought about that, talking to my CPA next week how that plays out, since i effectively would pay interest up front. but since i would only reside in it for 6-12months that is secondary anyway.

taking any available tax deduction got me in the precarious situation that my income on paper prevents me from refinancing properties or buying a new primary, so working on that for 2020 😅🤞

One major consideration on paying the interest "up front" is that it's in today's dollars and not inflation dollars several years down the road.

That is a huge mark up.  I would be cautious and yes the market has been trending up.  With little to no cash flow that's a huge risk and a No go for me.

What if the market tanks and it's only worth 325k.  Always have some kind of backup scenario.  It's always risky to bank on appreciation. There is no guarantee that will ever happen.  Better safe than sorry.

@John Teachout

is it though? ..i owe the 435k for purchase in todays dollar, the 87k down are gone wether in this scenario or if i bought the same house for market value and with conventional financing.. i also continue to owe the set dollar amount in todays value over the course of the loan, so inflation would actually benefit me (granted my / the propertie's income rises at or above inflation level)

@Brent Paul im not betting on appreciation, im only assuming less than the historical rate - but i agree, there might be a downturn at some point and the property could be worth less - but that doesn't concern me unless i have to sell right? in the long run, i think its safe to say that all properties in landlocked areas in good condition will be likely worth more than what they are today..

“......But I feel “

There’s your mistake .., using feelings instead of logic and numbers to analyze a lousy deal . Are you sure your not a woman lol don’t buy this house ! Your paying way too much

Technically there is no such thing as 0% interest. Look up imputed interest and the irs reasonable rate of return. The irs can look at your deal as a gift since there is no interest being charged and that is a no no. Plus man you should be finding seller financed deals that are still under market!! The idea of paying more for a seller financed deal is more like this. House is worth 200k and your offer is 150 cash or 165 seller financed. NOT house is worth 200 and you pay 240. That **** may work out over your lifetime but definitely not worth the risk to me. You mention having children right now. Trust me, a lot of things change in life when kids come into the picture. 

Folks from the midwest may not understand the west coast housing markets. I would caution against taking advice from those that dont understand those markets :) 

I doubt interest rates are going much lower.  It is likely that they will increase.  For comparison if you did a 4% note over 17 it would cost approximately 130k.  If rates increase to 5 or 6% in the coming years then having a 0% loan sounds amazing.  Is it transferrable, can you sell the property and the note? Also consider the market value is likely inflated by such low interest rates and a rise may decrease value.  Are you taking a standard deduction on taxes, or would you deduct any interest paid?  I'm assuming this would not report to your credit, so that's a bonus.  

@Alex G.

i agree, however - thats exactly my point - don't we all fool ourselfves when we buy a house at or bow market value and pay 100's of thousands of interest for it?

Another thought - would you buy the same house at 24% BELOW market value (350k -24%= 266k) with a 25% down rental loan at 5%?

You would have paid 186k in interest or a total of 452k for the house at the end of the term. your income in the samw time period is a cash flow of ca 500/month or 180k over the course of the loan, and same appreciation assumption after 30yrs (850k) your total return would be 578k, compared to the 1,48M of my initial example 🤯

I dont want to rationalize a bad deal, i have done quite well with my other properties, and love good cashflow as much as the next guy - but comparing apples to apples, if i dont NEED the cashflow, WHY would this be a 'bad deal'? 🤔

@Trey Knight

it would be assumable, i am itemizing and already exceeding the personal home limits for mortgage interest deduction. For rental purposes all associated cost are tax deductable though, im talking to my CPA if the by efficiently upfront payment of interest can be somehow accounted for as what it is. I dont think it can be counted as a gift, if it is 1/4 above market value. Thanks for the insight!

@Charlie John

Im talking to my CPA about this, an argument can be made that paying above market is efficiently paying interest upfront, so no gift and even deductible, potentially as cost of doing business.

You are absolutely right on finding below market deals, however see my answer about a analysis of the same property bought 24% BELOW instead of over market at current rental loan conditions in my answer above - please let me know what you think 🤔🤘🏻

@Stephan Kraus Stephen what you need to do is find more deals because you seem to be fixed on this opportunity because it is there not because it is the best one out there in your reach or possible option , so I suggest not thinking and doing more reaserch

@Diego Aguillon

by no means, we just bought an auction property and are in the middle of rehab, im not fixated on this one but find the math on this one fascinating - did you read the calculation of the deal if it was 24% BELOW market instead? its a few answers above, let me know what you think 🤙🏼

@Stephan Kraus Hey Stephan, 

Honestly, my brain stopped reading after cashflow negative but the nosy part of my brain wanted to read more. 

First, I thought ok maybe you can't buy your own home yet, but then I saw that you want to rent your current home to generate another $600 to feed the negative cashflow property.  

Of course, there is no motivation to dissuade you from doing this, I just think it is simply not worth it on a risk-adjusted basis, in my opinion. 

To conclude, a good question to debate on your self-reflective time is WHY is this Seller REALLY trying to sell me this property at this markup price (oh, and the answer isn't the one the Seller told SOLD you). 

Stephan,

I can see why you want to do the deal but one thing you need to factor is what happens IF property values stopped rising and actually goes down?

It happened back in 2008 and it can happen again. Real estate is cyclical.

You need to buy the property right. Buying the property right is the reason I made more money when the Great Recession occured while a lot of investors, specially house flippers...they went from flipping houses to flipping burgers.

The only way I can buy something above market value is if I can create more value in the property AND only if the property cashflows on day 1.

Otherwise, PASS. There are a lot of deals out there.

@Michael Ealy

thank you for your insight! i absolutely agree with you on everything - especially the cyclical market, we may very well be at or close to another turning point, however i think its fair to say that 15, 20, 30 years from now propertie's in general will be likely worth more than they are today, would you agree? Especially in a land locked city like Las Vegas, that is experiencing strong population and rent growth (even during the 2008 recession) - a good healthy cashflow from day one is absolutely my number one goal on any property i buy - i have substantial equity (30-60%) in all my properties and could cut my rents in half and still break even if needed, so my rationelle on this one is: my overall purchase cost are ~ the same as if i bought the same property 24% BELOW market with a 3yr 5% rental loan instead. it would likely cashflow 250 a month, compared to +/- 0 at the initial scenario.

we

In both cases, i own a good condition property in an a class neighborhood, however it is fully paid off in one scenario, and i still owe more than 50% in the other after 17yrs. - from where it will cashflow WAY more than the one that still has a loan.

I understand that there are other deals out there, im not trying to justify this one - im trying to find an answer to: if it doesn't cashflow negative, and im in a position where i dont need $250 of cashflow to cover my bases - WHY NOT? 🤔

This is more a fundamental question, then a "should i do THIS" Dea r not - but it for sure got me thinking about the cost of acquisition of properties in general

@Stephan Kraus , the only real problem I see is if the market tanks and you have to sell.  With a -300/mo cashflow, that could turn ugly.  No exit strategy at that point other than to 'feed the alligator'.  

History from the GFC showed that avg rents fell 10-15% in Phx.  Upper end properties got hammered by even more.  If you feel you can safely afford -600+/mo (worst case scenarios), then it might be ok.  The thing to remember is the rest of your portfolio will probably be getting hammered as well.

Now, with that being said, I don't see a GFC 'repeat'.  There is way too much money/cash in the system looking for a place to invest.  Many investors have refi'd and are sitting on piles of cash waiting for the next downturn.  As a result, it won't happen the same way.  The Fed is ready to run the presses 7/24 if needed with helicopter money.

But all good recessions usually start with some type of deflationary component.  You will need to have enough cash reserves to get thru that part before we get to the inflation that most are expecting.  Just like 2008-12 before everything went 'liftoff'.  ;-)

When you get to inflation, it will always be good to own 'stuff'.  No matter how you got it.  ;-)

@Stephan Kraus

I would not do this deal as it stands.

But I would absolutely counter, you need to see what this guys motivation is to sell. Why is he not just selling it on the open market ? Why not sell it owner finance at 4%?

He obviously wants the cashflow or maybe he wants a bigger down payment ? If you have the cash lower the asking price raise the down and get the payments to a place where they do cashflow. If you can get a 0% loan the pay down is un beatable ..rent it for 5 years get some equity built in then owner finance it to someone else on a 30 year at 6 or 7% or as high as you can. Long term cashflow without the headache of tenants.. No one calls the bank when the roof is leaking .

@Ola Dantis . Your monthly will be around 1800 per month plus taxes and insurance.

Can you afford that is the biggest question. Maybe the $500 cash flow from you present home turned into rental would cover taxes and

Insurance. If your current house payment is 1800 then you get two houses for the same monthly payout. And someone else is paying for one of those. The big negative is the loss of deduction but like you say it’s like putting money into saving but it still takes three years to break even. It’s a coon toss, not all that bad when you look at the 5 year plan. How dies your family feel about all the moving