Real Estate Agent · Arlington · Member since 2016 · 162 posts · 100 votes
Has anyone encountered a scenario where it made sense to overpay? Sounds strange, but let me explain with a hypothetical situation.
- Large MF property is for sale (several million dollars).
- The property is in decent shape but is old and needs moderate attention/maintenance. Property has strong financials/occupancy (long term tenants). Rents are significantly below market level. Other value-add opportunities present.
- Buyer does not have the capital for a significant DP, but sees this as a good opportunity and wants to be creative.
- Buyer purposely offers significantly more than what is asked (the spread being the equivalent to the down payment on the larger amount that is financed). Buyer asks seller for a seller concession equivalent to the down payment to be paid at closing.
- Seller gets the full asking price. Buyer gets the property with practically no money down (closing costs are wrapped into mortgage). Agent gets a higher commission. The buyer's task from there is to manage the property properly albeit with the higher debt responsibility.
Buyer, seller, and (especially!) the agent are happy - everyone wins. Has this been done? Plausible?
Lender says no and appraisal would need to come in for the higher price. I believe there would need to be some mortgage fraud in here to make it work. Lender calls note and buyer goes to jail.
Lender says no and appraisal would need to come in for the higher price. I believe there would need to be some mortgage fraud in here to make it work. Lender calls note and buyer goes to jail.
The property would have to appraise for the higher amount. The credit would have to be disclosed to the lender, who would have to agree to a 0 down loan.
Without those 2 things, it could be mortgage fraud. Look up Hendrix Montecastro- in jail for doing this.
Totally agree with @Jeff Greenberg. With the prices seller are asking (and getting!) these days, its starting to negatively affect the LTV's buyers are able to get. I tried to get a deal recently for which the lender offered 80% LTV, with a max loan amount of $9.6M based on historical numbers. The property ended up trading for a price that caused the LTV to be reduced to about 74%. So for your scenario, the property would have to appraise high enough to cover your "spread," which is pretty unlikely. Somehow appraisals have still magically been coming in at exactly what they need to in order to get deals done, but no way they'd be several million higher.
I'm not a lawyer either, but yes, that sounds like something that could get you into some ugly situations legally.
@Account Closed, I hear you saying basically that you "feel" this would be a good deal even at a higher price point. In my experience feelings are tricky devils. They talk you into deals that may be no deal at all. Once the good feeling wears off you're left with a nasty sinking feeling.
Rather than search for clever ways of making your project work, why don't we just take a look at the numbers. Let's this by the numbers:
1) Why is the seller selling?
2) What is the property worth in its current condition with all it the problems, attributes and circumstances?
3) Why are the rents "significantly below market level"?
4) What is the NOI (Net Operating Income)?
5) What is currently owed on the property?
6) What do you expect to do with this property?
So, what is the seller planning to do with the proceeds? How long has he held the property? Could you assume his existing financing? If he has no plans to use the proceeds immediately and would be willing to carry back a mortgage for the difference between the price and what is owed, you may be able to make this work.
In order to make the seller finance option work we will want to know about the NOI. In its current condition would this property have a positive NOI? That is, would the gross income cover the gross expenses (all of them, including capital expenditures, vacancy, etc.) and still have money left over? If so, there could be a way to make this work.
Would the NOI cover the the assumed financing with money left over? The remainder after paying the existing mortgage is all you have to pay the seller carry debt service, so there has to be enough. AND this must be based on the current gross income, not the projected new rents! If this is the case, then there may be a way to make this work.
Once you've figured the NOI and subtracted the existing mortgage what is left is pretty much what the seller is getting on the property right now, but right now he's dealing with the property management and all the risk. You would be taking all that on and you need to get paid for it. You'll need to subtract the amount that you need to make in order to be willing to get out of the bed in the morning. If there's anything left, you may be able to make this work.
Could you structure the terms with the seller such that the amount remaining would pay the debt service to the seller? That means playing with the price, interest rate and term of the loan in order to get the monthly payments down to a point where it can be paid from the money remaining at the end of each month. If you can get that payment down below this "magic number", you'll actually cash flow. In that case you succeeded in making is work. Everyone wins and everyone is happy!
Gross income - gross expenses = NOI
NOI - 1st mortgage debt service - the amount you need to make = "magic number"
"magic number" - debt service on the seller carry = cash flow
Over time the seller will make more money by carrying back the second, so you could in theory offer a lower price. Also, if the seller would carry for a longer term and/or at a lower interest rate, you could get the payment down to or below the "magic number".
As @Jeff Greenberg points out do not try to put anything over on anyone in the transaction. To do so may end up with you in front of a judge explaining that orange not really your best color and how you may like a different serial number for a name. Everyone would NOT be happy then.
So, to answer your original inquiry, yes, it is possible and it has been done before, but really it's pretty complicated and risky. If you analyze the numbers in a straight forward manner and find that price is the only objection, you might still be able to structure the deal to a close. "But I still don't have the down payment!" This can be tricky, it's true, but you might want to bring in a partner with experience in this area or someone who could put up the money for a piece of the action.
I like the way you're thinking. Keep looking for ways to create opportunities and you shall. Just be sure to do what you did this time and check with the folks on BP before you leap into anything.
Thanks everyone for your helpful input (and well-received cautions!). I certainly don't want to advocate or inquire regarding anything illegal, non-compliant, or disingenuous.
Some thoughts from a 30,000 foot level: Is this a non-desirable aspect of the RE industry? Perhaps a marker of market inefficiency? An asset should be worth what someone is willing to pay for it. If I (buyer) see a place that I'm interested in buying and a bank is willing to provide a loan and all other matters regarding the viability of the deal are in place (ie, its financially feasible), shouldn't the supposed value be based on that sort of transaction rather than what an appraiser says (which is dependent on his single perspective)? Maybe this is just my free-market die hard libertarian values coming forth, but I can't help but see this as an impediment to maturity and innovation in the RE industry. Apologies for any rambling as I process this. Your thoughts/perspectives are most welcome. Thanks!
Also, just wanted to stress that full-compliance and adherence to legal standards is valued here. With that, persistence is equally valued ("persistence pays..."). Persistence is how I was finally able to convince my wife to marry me!
The fact is that it smells of mortgage fraud, but I wonder what the seller finally gets out of this when it's all said and done.
In this hypothetical situation, it'll probably need the connivance of crooked bankers, crooked appraisers to make it work. And if there are seller concessions involved in this convoluted example when it's all consummated, I wonder what the seller really gets out of it. With the inflated sales price, the seller would probably be stuck with larger capital gains. Obviously, it benefits the seller.
I say this because I've been offered crooked deals during the sale of my rentals. A real estate agent owned a property next to one of my rentals. I sort them out when I was looking for a PM. Then, I sort them out again when I was looking to sell. This is when she offered enter into the crooked deal, or several deals as I have several rentals that I own.
She had several clients with suitcases of cash, undeclared income from owners of cash businesses. We discussed selling my rental, lets say, for $600,000. Tells me one of those clients keeps $100,000 in each suitcase, and he has a number of them. So we can make a deal where I sell him the property on the books for $500,000, and under the table for $100,000. Told me it would two separate contracts, the one for $100,000 for some type of consulting work, and this contract also says I agree to sell him the building in the 2nd contract. When he hands over the cash at the realtors office, this 1st contract is burned.
Told me to think about it, and I told her I need a week to think about it, and I discussed it with my wife. After thinking it through, though I saved a bit on capital gains tax, there's nothing else in it for me, and I have to worry that someone will know I have $100,000 stashed somewhere. I simply told her NO. She didn't know exactly what my problem is, and says her client can give me two suitcases, $200,000 and offer a few bucks more on the real contract. So I told her I want to do a straight deal, and just pay my taxes. I didn't mention I'll have nightmares worrying about robbers breaking down my door at night demanding to know where I have all that cash.
She couldn't get her head around the fact that I want to do a straight deal pay my taxes, and not worry who's following me. After all, I already made a few hundred thousand.
Just thought I give the thoughts of a seller offered a crooked deal.
An asset might be 'worth' what someone is willing to pay for it but that does not mean that a bank has to loan you the money to get it. If you want to plop down cash for that property there is nothing preventing you from doing so. The bank has just as much libertarian freedom to deny your loan as you do to pay cash or find someone else willing to lend to you.
That said, I don't think it's necessarily mortgage fraud. Freddie Mac does not allow your rehab to be rolled into the loan but I had heard of someone paying more for a property with a seller credit and using that credit for the rehab. I asked one of my mortgage brokers about this and they said it is possible as long as you are clear with the lender about it. But you run the risk of the lender changing their mind near the end of the application period and messing up the entire deal.
@michael le - you're very right! Banks have total freedom to approve or deny at their discretion. My thoughts were more toward the federal requirement for appraisals to be made and the influence/power the appraisal carries in the acquisition process. I can't help but 'feel' (@Tom Mole!) that instead of being available as a helpful tool that gives clarity to the buyer, the appraisal is more the determinating factor for value (as opposed to demand). Maybe more opportunities for deals could be made without the power appraisals have been ascribed by regulators? Just thinking. Your thoughts? Thanks - Jonathan
@Account Closed There are a few issues with this train of thought:
Most banks will only allow X% for sellers concessions. They do this on purpose so that:
Lenders in general do not like loaning money to people with no skin in the game. With no money down, what ties you to the property? You have nothing to lose if you just walk away from the property, and then the bank is stuck being a landlord which they are not good at being.
I would try one of these:
As @Tom Mole stated, see if the current owner would hold paper. Or
Get enough private funding to purchase the property in cash.
By doing one of the above, you now have the time to fix the place up, increase the rents, and increase the cap rate of the property, which then you can goto a bank, and get a mortgage on the property, paying off whomever you borrowed the money from. We've just got one issue left....
You need skin in the game! Or you need to find private money that doesn't require that (family, friends.)
This is definitely not a new trick and doesn't work. A lot of banks have limits on seller concessions to prevent this exact scenario. If you try to pull it off without the lender knowing, that's considered to be mortgage fraud and not worth it.
Thanks everyone. We can chalk this one up as "don't do it through conventional lending unless you look flattering in orange jumpsuits"! I appreciate everyone's thoughts and feedback. This is one amazing value-add resource that BP provides