Request from Seller for Loan Advance on Seller Financing - Math Help
Investor · Member since 2018 · 259 posts · 74 votes
Request from Seller for Loan Advance on Seller Financing - Math Help
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Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
2yYou’re dismissing a 25% return on your $100k? Admittedly it’s over 4 years, so it’s really only a guaranteed 6% return. But that means you have to have a guaranteed return higher than that to dismiss this out of hand, much less say it’s bad for you.
I guess if you want to get greedy or set a bad example if suddenly you need help come extension time or when that runs out. Then sure stick it to them after all they’re the idiots that gave you 0%.
Personally I’d take it partially because it’s a good deal for the buyer, partially because you’re helping someone out that helped you out a year ago. Plus it will help with your refinance. If you feel the need to WIN at the buyer’s expense without taking actual cash out of their hands agree with the option period being extended to 4 years. That will cost the buyer a boatload of money, but not actual cash out of hand.
29 Replies
- 2yNicholas L.Pro MemberFlipper/Rehabber · Pittsburgh · Member since 2018 · 6k+ posts · 5k+ votes
if it's 0% interest, then he's reducing the principal by 25K in exchange for 100K now.
agree it's not a good deal for you, it's like a retroactive down payment.
- Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes2y
You’re dismissing a 25% return on your $100k? Admittedly it’s over 4 years, so it’s really only a guaranteed 6% return. But that means you have to have a guaranteed return higher than that to dismiss this out of hand, much less say it’s bad for you.
I guess if you want to get greedy or set a bad example if suddenly you need help come extension time or when that runs out. Then sure stick it to them after all they’re the idiots that gave you 0%.
Personally I’d take it partially because it’s a good deal for the buyer, partially because you’re helping someone out that helped you out a year ago. Plus it will help with your refinance. If you feel the need to WIN at the buyer’s expense without taking actual cash out of their hands agree with the option period being extended to 4 years. That will cost the buyer a boatload of money, but not actual cash out of hand.
- Accountant · Bryn Mawr, PA · Member since 2023 · 409 posts · 321 votes2y
- Investor · Member since 2018 · 259 posts · 74 votes2y
I'm not sure I'm following your logic. The property cash flows about $45k per year. So this would make the property have negative cash flow for over two years.
In addition, you could think of it as putting another $100k down on the property in exchange for $25k off the purchase price. This would also reduce your annual cash flow.
I don't see how it's a 25% return at all. It's not an independent investment. It's part of the property's overall performance.
- Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes2y
Quote from @Kim Hopkins:
Hello!
Well, this is a brain tickler. So we purchased a retail property at the end of 2022 with seller financing: 5 year term, 30 year amortization, 0% interest. Payments are $2k per month. Three year option to extend for additional $500/month. The entire loan is for $725k, but with the 5 year term, we would pay him a total of $120,000 before the loan is up and we need to refinance (or use our option). We've paid one year, so $24,000 so far.
The seller just asked if we would be willing to give him $100,000 now, and in exchange, he would knock $25,000 off the total loan amount. (Obviously the loan balance would also be reduced by the $100k).
Now, I know this is not a good deal for us, but I can't explain why. And I also can't figure out how to underwrite such a proposal in terms of return. Certainly there would be some break even point where if we give him $100,000 now, and he knocks $X off the total loan amount, then it's a good deal for us. But I don't know what $X is or how to even analyze this proposal.
Thoughts?
Thanks!
Kimso you could extend this up to 8 years. So for giving $100k now you get a 25k reduction. I would say no. IT would need to be close to $100k reduction for me to consider it.
7e investments53 Reviews - Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes2y
Take a mythical $100k you have laying around. (If you don’t have $100k laying around, then his request is moot.). You giving the seller this $100k in exchange for $125k off your debt, means you made a $25k return on your extra $100k. It has zero to do with cash flow and wouldn’t impact it at all, unless you had to borrow the $100k in which you shouldn’t do it unless you can borrow for less than 6%. I was assuming from the way you phrased it you had the $100k.
If you don’t have it and have to borrow it, you figure out what it would cost you to borrow it and you charge the seller that much or more for the money and you’re just playing middle man.
Using your example, YES, I would put down an extra $100k to get a $25k discount on any property I was buying, and it would increase my cash flow not lower it. It would lower your ROE until the 0% period expired, but not your cash flow. You don’t count a downpayment as negative cash flow, it’s an investment.
Here’s another option for you. Assuming you could borrow this money at 7% his 0% loan is worth about $49k per year on $700k. You could give him the $100k to extend the 0% interest for an additional year and the $25k discount. That’s easily a $75k return on your $100k in 5 years (15% annual return) and protects your definition of “cash flow”.
- 2yHenry ClarkPro MemberDeveloper · Member since 2020 · 4k+ posts · 4k+ votes
I would do it for the return on Equity today. A sure return. Realize you can get a better return. Unless you do the following, then its a great deal.
I would also ask him if he is willing to take a second position over the 5 or 8 year term. Is this non-recourse or personal guarantee? Does he have another assurance of payment. Otherwise, this assets value is tied up for the 8 years.
- Investor · Member since 2018 · 259 posts · 74 votes2y
Quote from @Chris Seveney:
Quote from @Kim Hopkins:
Hello!
Well, this is a brain tickler. So we purchased a retail property at the end of 2022 with seller financing: 5 year term, 30 year amortization, 0% interest. Payments are $2k per month. Three year option to extend for additional $500/month. The entire loan is for $725k, but with the 5 year term, we would pay him a total of $120,000 before the loan is up and we need to refinance (or use our option). We've paid one year, so $24,000 so far.
The seller just asked if we would be willing to give him $100,000 now, and in exchange, he would knock $25,000 off the total loan amount. (Obviously the loan balance would also be reduced by the $100k).
Now, I know this is not a good deal for us, but I can't explain why. And I also can't figure out how to underwrite such a proposal in terms of return. Certainly there would be some break even point where if we give him $100,000 now, and he knocks $X off the total loan amount, then it's a good deal for us. But I don't know what $X is or how to even analyze this proposal.
Thoughts?
Thanks!
Kimso you could extend this up to 8 years. So for giving $100k now you get a 25k reduction. I would say no. IT would need to be close to $100k reduction for me to consider it.
@Chris Seveney
Interesting. Do you see how to understand the math at all? For example, why would you consider it for $100k? How did you come up with that number? - Investor · Member since 2018 · 259 posts · 74 votes2y
@Bill B. Thanks for expanding on your thought process. I'd also like to hear what @Nicholas L. has to say on this logic, since the 2nd and 3rd BP contributors seem to have opposite interpretations on whether or not this is a good deal. :)
@Bill B. Yes we do have a mythical $100k lying around. The property doesn't, but we do.
I should have said cash on cash return (or ROE as you call it) instead of cash flow. ROE increases as a function of debt when the interest rate is low - 0% being an example of "low" obviously. So if we had this proposal from the beginning - $100k extra down (i.e. $100k less debt) for $125k off the loan amount (total of $25k off the purchase price), it would lower the LTV substantially and therefore greatly reduce the ROE for the entire 5 year period. I don't see why you say "yes" you would take that option.
- 2yNicholas L.Pro MemberFlipper/Rehabber · Pittsburgh · Member since 2018 · 6k+ posts · 5k+ votes
i think everything comes down to your goals. a good deal for person A might not be a good deal for person B. for me, the whole point of seller finance is is to put as little down as possible, even if that means paying slightly above market. so for me, his offer is not a "good deal," because it now requires that bank loan-like outlay of cash.
i guess if the loan term were shorter it might make more sense - like just 2-3 years of payments. if that were the case, you'd be coming up on the time to refinance anyway and you'd get your 100K "back" sooner. but, you're just (i believe) only about a fifth of the way into the initial term.
that's my thought process FWIW.
if he needs cash, maybe there's a win win in here somewhere else? like, you up the monthly payment (assuming it's covered) in exchange for something?
- 2yDon KonipolBusiness MemberInvestor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votesAll the brain power spent on recalculating ROI, etc. is meaningless. This is a SEPARATE investment. Since you are not paying interest, we eliminate interest savings on principal balance reduction from the equation. Invest $100k now and get $125k (in the form of less payoff) in 4 years. You’ve made 25% over 4 years.
Quote from @Kim Hopkins:
@Bill B. Thanks for expanding on your thought process. I'd also like to hear what @Nicholas L. has to say on this logic, since the 2nd and 3rd BP contributors seem to have opposite interpretations on whether or not this is a good deal. :)
@Bill B. Yes we do have a mythical $100k lying around. The property doesn't, but we do.
I should have said cash on cash return (or ROE as you call it) instead of cash flow. ROE increases as a function of debt when the interest rate is low - 0% being an example of "low" obviously. So if we had this proposal from the beginning - $100k extra down (i.e. $100k less debt) for $125k off the loan amount (total of $25k off the purchase price), it would lower the LTV substantially and therefore greatly reduce the ROE for the entire 5 year period. I don't see why you say "yes" you would take that option.
But you’re right, this return is NOT attractive. Some people buy property for a 6% cash flow return, but anticipate at least as much in appreciation. My minimum would be to invest $100k for a $50k additional principal reduction. However, since I can delay the payoff 3 additional years, I need more of an incentive. If the seller really really needs the money, offer him this, $100k now for a $200k reduction in principal. - 2yHenry ClarkPro MemberDeveloper · Member since 2020 · 4k+ posts · 4k+ votes
How much was your original downpayment or did they do 100% financing?
- Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes2y
@Kim Hopkins
Internal rate of return
If I understand it correctly you could have 7 more years before you would have to pay off the loan. Paying $100k extra at a 12% return during that time would yield you around $100k (actually higher but doing this in my head). So you could keep $100k and invest it during that time and turn it into $200k
If you take the $25k reduction your $100k you don’t have to invest is only saving you $25k. That’s a bad deal.
That’s how I spitballed the $
7e investments53 Reviews - Member since 2020 · 351 posts · 329 votes2y
I think it's very, very likely you end up taking the option (it ends up being about 1% interest rate) So you'll make 25k over 7 years (because that is how long the equity will be tied up). your total return on just this portion will end up a little less than 3.5% (on a very illiquid investment). As you mentioned, your IRR will lower on the house as well. It depends on appreciation (yay nonlinear calculations) but you'll probably end up down another 2-3% yoy as well.
If you are trying to build goodwill/repay a favor with the buyer maybe you take the deal and add another two years to the option. Maybe you can structure the deal so that some of that 100k goes towards future payments e.g you make no payments for the next 50 months. - Investor · Member since 2018 · 259 posts · 74 votes2y
@Don Konipol Noted. Agree to view it now as a separate investment. When you say you would do it for $200k off the balance, do you mean $200k in place of his $25k, so a total of $300k off the balance (the $100k we're giving him now plus the $200k extra)?
@Chris Seveney I love where you're going with this, and the IRR, but I'm not sure I followed your spitball, but I'm trying to recreate what you said below with a calculator. :)Ok, here's what I've got so far based on everyone's observations.
- Best way to view this is to compare the returns to if we invested $100k in a property. And to view it as a completely separate investment from the property itself.
- Since it's a separate investment, we'd continue paying monthly loan payments for the term of the loan on the property (i.e. there is no pause in loan payments even if we advance him the $100k).
- The deal should include an agreement to put the extra 3 year extension into effect at the same current monthly payments of $2k/ month. That gives a total of 7 years left on the term (instead of 4).
- If we invested $100k in a property at a 10% annual cash on cash return (or ROE, whatever you call it), that would be $10k per year in cash flow. Over 7 years, that's a $70k return.
- At first pass, this makes you think asking for a $70k return instead of a $25k return would make this an acceptable agreement. But it doesn't:
- First, it doesn't have any tax benefits of a real estate investment (cost seg, interest, etc.). I'm spit-balling those at an extra $5k per year in returns. So $15k / yr x 7 years = $105k. So now we're up to asking for a $105k additional reduction of principal instead of $70k or $25k.
- But that isn't a correct comparison either, because with this deal, we'd be waiting 7 years to get the $105k instead of getting $15k per year with a real estate investment. With the real estate investment, we could then take that $15k each year and reinvest it as well, making a 10% return on those cash flows.
- I think the right way to fix the above is an IRR calculation. (What @Chris Seveney was saying, I think?).
If I take the IRR of the real estate investment with $100k investment in year 0, and $15k per year cash flows with a return of equity in year 7 (assuming 0% appreciation I might add), I get a 15% IRR.
Conversely, with this arrangement, if I assume a $100k investment in year 0, $0 cash flows for 7 years, and a return of $X in year 7 and I set the IRR to be 15%, then $X needs to be about $270k.
Conclusion: That means I need a $170k return on my $100k, instead of a $25k return. To say it another way, I would offer him $100k now, if he reduces the principal balance by $270k in 7 years. That's a big gap.
Does this analysis sound correct?
- 2yDon KonipolBusiness MemberInvestor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votesNo, if the lender gave me a $200,000 total deduction ($100k additional) that would be a 100% return over 4 years so to me a “no brainer”. Somewhere between $50k - $100k is a deal I’d take. BUT, it really depends on the OPPORTUNITY COST of your funds, and that’s a number unique to you. For example I can invest my capital all day in real estate loans at earning me about a 14 - 15% return. And since reducing my own debt may be arguably less risky, I should accept the same return on this deal.
Quote from @Kim Hopkins:
@Don Konipol Noted. Agree to view it now as a separate investment. When you say you would do it for $200k off the balance, do you mean $200k in place of his $25k, so a total of $300k off the balance (the $100k we're giving him now plus the $200k extra)?
@Chris Seveney I love where you're going with this, and the IRR, but I'm not sure I followed your spitball, but I'm trying to recreate what you said below with a calculator. :)Ok, here's what I've got so far based on everyone's observations.
- Best way to view this is to compare the returns to if we invested $100k in a property. And to view it as a completely separate investment from the property itself.
- Since it's a separate investment, we'd continue paying monthly loan payments for the term of the loan on the property (i.e. there is no pause in loan payments even if we advance him the $100k).
- The deal should include an agreement to put the extra 3 year extension into effect at the same current monthly payments of $2k/ month. That gives a total of 7 years left on the term (instead of 4).
- If we invested $100k in a property at a 10% annual cash on cash return (or ROE, whatever you call it), that would be $10k per year in cash flow. Over 7 years, that's a $70k return.
- At first pass, this makes you think asking for a $70k return instead of a $25k return would make this an acceptable agreement. But it doesn't:
- First, it doesn't have any tax benefits of a real estate investment (cost seg, interest, etc.). I'm spit-balling those at an extra $5k per year in returns. So $15k / yr x 7 years = $105k. So now we're up to asking for a $105k additional reduction of principal instead of $70k or $25k.
- But that isn't a correct comparison either, because with this deal, we'd be waiting 7 years to get the $105k instead of getting $15k per year with a real estate investment. With the real estate investment, we could then take that $15k each year and reinvest it as well, making a 10% return on those cash flows.
- I think the right way to fix the above is an IRR calculation. (What @Chris Seveney was saying, I think?).
If I take the IRR of the real estate investment with $100k investment in year 0, and $15k per year cash flows with a return of equity in year 7 (assuming 0% appreciation I might add), I get a 15% IRR.
Conversely, with this arrangement, if I assume a $100k investment in year 0, $0 cash flows for 7 years, and a return of $X in year 7 and I set the IRR to be 15%, then $X needs to be about $270k.
Conclusion: That means I need a $170k return on my $100k, instead of a $25k return. To say it another way, I would offer him $100k now, if he reduces the principal balance by $270k in 7 years. That's a big gap.
Does this analysis sound correct?
Utilizing our compound interest calculator, we find that $100,000 invested today at 15% annual interest for 4 years will result in $175k at the termination. So, if I was willing to accept an annual yield of 15% I’d want a $75k reduction, not a $25k reduction.
$100k reduction in 4 years while an AVERAGE return of 25% is actually a COMPOUNDED return of 19%. (We use compounded returns because that’s what annual interest rate is based on, and we want to compare apples with apples.)
I would be THRILLED with that return. People who are able to invest their capital at 25% with little additional risk would not be happy with that return. - Investor · Member since 2018 · 259 posts · 74 votes2y
Excellent breakdown of your thought process. I believe we actually have the same logic. The only difference is I switched to using a 7 year hold instead of a 4 year hold, based on someone's suggestion above that it might be good to request the 3 year extension option now as part of this proposal.
I was proposing a $170k reduction over 7 years, which is a compounded return of 15%.
So if we're both aiming for a 15% compound return, then it sounds like the answer is $170k over a 7 year hold and $75k over a 4 year hold.
The problem with the 4 year hold is if we decide at the end to exercise our extension option, then we're paying more in monthly mortgage for the extension years AND he's now holding onto our $100k investment and the return for an additional 3 years which greatly reduces our annual compound return. Not sure how we would untangle that.
- Rental Property Investor · Boston, Massachusetts (MA) · Member since 2016 · 2k+ posts · 2k+ votes2y
great posts and working through the math, thank you all. This may be oversimplifying or I may have missed it, but did you factor in the negligible risk rate for your 100K right now?
High yield savings account or CD or treasuries at close to 5%, so over the 4 years you have at least the 25K opportunity cost as a base case...
- 2yHenry ClarkPro MemberDeveloper · Member since 2020 · 4k+ posts · 4k+ votes
Don’t have all the financial numbers so will go with the deal I would have done with the owner.
I would offer your team the following scenarios:1. $100,000 cash outlay
4 years
$25,000 loan forgiveness
No tax
2. $100,000 cash outlay.
4 years$100,000 loan forgiveness
No tax
3. $100,000 cash outlay
2 years
$0. loan forgiveness
Pretax $2mm Longterm capital gain return
Very low risk
Worst case $1mm Longterm capital gain return
Very low risk
This is based on the returns we expect from our investments.
The first two options above are financing options. Option C is a business option. You can adjust to your boots in the ground information and your teams return expectations. The above are our performance expectations in this situation.
Even if your team doesn’t pick option C, they will appreciate you bringing it to their attention.
- Investor · Member since 2018 · 259 posts · 74 votes2y
Quote from @Jonathan R McLaughlin:
great posts and working through the math, thank you all. This may be oversimplifying or I may have missed it, but did you factor in the negligible risk rate for your 100K right now?
High yield savings account or CD or treasuries at close to 5%, so over the 4 years you have at least the 25K opportunity cost as a base case...
Can you say that again, more slowly? :)
If I put in the $100k now, it's going towards a note/loan, so I'm guaranteed to get it and the $25k back in the reduced principal on the loan balance regardless of his financial situation at that time. Do you agree?
What do you mean by "over the 4 years you have at least the 25k opportunity cost as a base case"?
- Investor · Member since 2018 · 259 posts · 74 votes2y
Quote from @Henry Clark:
Don’t have all the financial numbers so will go with the deal I would have done with the owner.
I would offer your team the following scenarios:1. $100,000 cash outlay
4 years
$25,000 loan forgiveness
No tax
2. $100,000 cash outlay.
4 years$100,000 loan forgiveness
No tax
3. $100,000 cash outlay
2 years
$0. loan forgiveness
Pretax $2mm Longterm capital gain return
Very low risk
Worst case $1mm Longterm capital gain return
Very low risk
This is based on the returns we expect from our investments.
The first two options above are financing options. Option C is a business option. You can adjust to your boots in the ground information and your teams return expectations. The above are our performance expectations in this situation.
Even if your team doesn’t pick option C, they will appreciate you bringing it to their attention.
Sorry, not following. Your option #2 just looks like a better version of option #1, and I think we've laid out why option #1 is definitely not a good option. I don't understand #3.
- Investor · Member since 2018 · 259 posts · 74 votes2y
Last item to work out on this. I would like to include in the proposal that we automatically get the 3 year extension with FLAT $2k / month payments, instead of the $500/month increase for each year of extension.
I'm trying to calculate the value of this and factor it into our proposal. We'd defer payments of $6k in year 5 and $12k in year 6 (the term ends in year 7 so the $18k for year 7 would just be paid in that year along with the rest of the loan balance). I need to somehow calculate what that benefit is to us and deduct it from our proposal to him of the total we want off the loan balance.
- Rental Property Investor · Boston, Massachusetts (MA) · Member since 2016 · 2k+ posts · 2k+ votes2y
@kim
@Kim Hopkins can't imagine why that was confusing! Reread it and I didn't understand it :)
I meant that if you did nothing with your 100K other than keep it in a savings account or buy treasuries with it you would earn 5%/year or 20K over 4 years. So keep that in mind when you compare alternatives.
His giving you a 25k reduction of principal is essentially equal to the same amount you would earn in a savings account while keeping the 100K liquid
I think thats what I meant :)
- 2yHenry ClarkPro MemberDeveloper · Member since 2020 · 4k+ posts · 4k+ votes
Option 3 is your opportunity cost. In our business model, those are the returns we would expect in your loan scenario. We would expect a 2,000% return in 2 years. Our normal model we shoot for 400% return in 2 years, with Capital Gains Tax rate. Not one-off deals, can do 1,000 of these deals. Your seller financing and the $100,000 discussion changes the calculation.
Your returns might be lower based on whatever your business model is. Just incorporate your downpayment into the equation as I noted above. Then note or develop for the Seller some form of guarantee (personal, or other unencumbered property) so they take a 2nd lien position or have no lien position on this property.
You're offering your team a Finance explanation and options. I would include a business solution also, include the potential leveraging in this business deal. Your Operations Manager, Controller or CFO would want to look at that option.
All depends on your downpayment on the deal. I assumed the owner did $750k loan but required a $750k downpayment. Adjust to your true downpayment. If you got 100% seller financing, then disregard my option C.
Again, we are talking Real Estate, which to me is leveraging. If you offered me a Financial investment with a 15% guaranteed return on a AAA investment, that compounds annually, I would turn it down every day of the week. Someone will talk about Passive investment. It is a lot of work to find a 15%, guaranteed return on a AAA investment. The work I do is 1 + 1 = 2 type work other than site location, but even that is easy after you have done it.
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