Purchase price … how important is it?
Investor · United States · Member since 2020 · 202 posts · 284 votes
Purchase price … how important is it?
Most Popular Reply
Rental Property Investor · Raleigh, NC · Member since 2016 · 393 posts · 995 votes
3yQuote from @Sean Bramble:
When using creative strategies to buy-and-hold (subto/ seller finance, hybrids), how important is purchase price?
Most people commenting about how vital purchase price is, are thinking in terms of normal real estate transactions. However since you specifically stated that you are in creative financing, then purchase price is largely irrelevant.
Terms are often way more important than price when dealing in the creative financing space. Think of it this way, if a home has a fair market value of 200k, why would anyone pay 210 for it? Well, you could get a mythical 100% LTV loan from the bank at 8% prevailing interest rate and pay somewhere in the neighborhood of $1463 per month not counting taxes and insurance. OR, you could sub2 the deal at 210 and take over the payments on the loan that the seller obtained a year or two ago when rates were 2.5%. Now your monthly payment is only $829 per month, a savings of $634 per month.
That's right, I overpaid by 10k for a house, but am saving $634 per month and will quickly come out way ahead and am cash flowing massively right out the gate. In addition no bank will give you anywhere close to 100% LTV for a rental property, but with creative financing that is relatively normal to carry the entire amount allowing you to scale infinitely fast, you are only limited by the flow of deals you find. Now obviously you still don't want to offer more than you need to in order to secure the deal, but this was just a hypothetical example to illustrate that overpaying isn't the end of the world if the terms are right.
From reading a decades worth of BP posts, I know @Account Closed is another legit source of information when it comes to the creative space, and I think he primarily does lease options but there are many different routes you can take.
29 Replies
- Real Estate Agent · Orem, UT · Member since 2021 · 98 posts · 80 votes3y
I'd say it definitely matters still. I don't ever plan on selling my investments, but purchase price does affect a number of metrics that I look at including the ROI, Cap Rate, and DSCR. A rule of thumb is that you should never pay over market value or what someone would spend if buying the place as a primary residence. This is because most Primary Residence buyers have an emotional aspect of their decision, making them pay a bit more. As investors, we can be much more systematic and thus shouldn't buy properties over market value.
This is just my opinion obviously, and I understand why someone might pay over if they have sufficient cash flow. I just don't think I would do it.
- Investor · United States · Member since 2020 · 202 posts · 284 votes3yMakes sense ... definitely limits your exit options when you pay over market, which helps if your underwriting is off/ rents change over time
Quote from @Garrett Christensen:
I'd say it definitely matters still. I don't ever plan on selling my investments, but purchase price does affect a number of metrics that I look at including the ROI, Cap Rate, and DSCR. A rule of thumb is that you should never pay over market value or what someone would spend if buying the place as a primary residence. This is because most Primary Residence buyers have an emotional aspect of their decision, making them pay a bit more. As investors, we can be much more systematic and thus shouldn't buy properties over market value.
This is just my opinion obviously, and I understand why someone might pay over if they have sufficient cash flow. I just don't think I would do it.
Anyone else have a contrarian perspective?
- 3yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
If you're never going to sell, then it doesn't matter since you're going to lose more money by keeping houses that are gaining in equity.
However, if you do plan on keeping your equity moving as it builds, so that your equity is buying more PV as it moves, then it does matter...to an extent. The purchase price impacts the loan payment, and thus reduces your CF, and increases the DP too.,...and don't think that a higher DP will offset that...it doesn't. The higher the cash (DP, negative CF, adding monthly to the principle, ...) you pay, in any form, just increases what you are paying for the property.
There are ways to control all of this by the terms you establish when buying. The best deals are not found, they are made. They are a combination of the lowest cost to the REI (the cash that comes out of their pocket), and the terms of how someone/something else pays for the rest.
- 3yHenry ClarkPro MemberDeveloper · Member since 2020 · 4k+ posts · 4k+ votes
Purchase price is always the key. You make your money going in.
With that said. I’m willing to pay more if there is extra land or to corner a market. We do self storage. If I’m in houses would still pay a little more if I can do ADUs and if it is in the same area of my Team.
In your personal file you mention buying all over. Realize it’s the fad to invest out of state and all over. I wouldn’t. Pick a place or two where you can develop a team. Put that to the test where you currently live. Want you to call a plumber, electrician and a HVAC person and tell them you have to get something fixed in the next day or two. See how much “pull” you have.
NYC. I would pick a train path out of NYC. Pick the town or area you want. Use this for both your STR, MTR, LTR. Your value will remain stable or escalate due to location near the rail. Always pick better school district areas. Basically increase the odds for success. Do arbitrage.
- Investor · Austin, TX · Member since 2021 · 9k+ posts · 5k+ votes3y
Purchase price is not as important as cash flow when you are nothing out of pocket. You know you can't sell the property any time soon for gain, you're going to want to make sure cash flow exists.
- Member since 2022 · 1k+ posts · 1k+ votes3y
If you are in a high property tax state, and those taxes are determined by your purchase price, then it certainly does. Lots of California buyers in the last few years have locked into their property taxes at a high price that they will have a hard time shaking. Whereas if rates go up and purchase price dips, there's a chance to lock your taxes in at a lower price and hope to REFI later.
- 3yTheresa HarrisPro MemberMember since 2019 · 15k+ posts · 11k+ votes
It is important to get a good purchase price as it has knock on effects-mortgage payment, cash flow, etc.
- Investor · Scottsdale Austin Tuktoyaktuk · Member since 2021 · 4k+ posts · 4k+ votes3y
Quote from @Sean Bramble:
When using creative strategies to buy-and-hold (subto/ seller finance, hybrids), how important is purchase price? In theory, purchase price only matters when you sell, and I’ve heard of many investors being willing to pay over market value bc the terms they negotiate allow them to cashflow very well … but there must be a limit to how much you should be willing to pay? What are your rules of thumb, and most importantly why?
Well, let me give you the numbers on an actual deal and you decide . . .
I bought a 4 bed 2 bath in Mesa AZ with a value of $225,000 for $225,000 using Subject To. I put $100 down. I took over the seller's payment. Monthly payment was $1,027. I paid $500 to have the property cleaned. So, I was into the property $600 and I would start making payments the following month.
Within two weeks I sold the property on a Lease Option for $250,000 and a lease agreement payment of $1,950. They put down $25,000 on the Option Fee.
So, I got $25,000 cash up front and $923 cash flow a month (for $11,076 yearly) for a total of $36,076 on my $600 paying full price.
Plus I got the tax write offs.
There are many more of these that I've done in three different states, Washington, Arizona and Texas.
I don't know how to calculate ROI on these but I'm pretty sure it's been worth it. ;-) - 3yV.G JasonPro MemberInvestor · Member since 2022 · 3k+ posts · 3k+ votes
Quote from @Account Closed:
Quote from @Sean Bramble:
When using creative strategies to buy-and-hold (subto/ seller finance, hybrids), how important is purchase price? In theory, purchase price only matters when you sell, and I’ve heard of many investors being willing to pay over market value bc the terms they negotiate allow them to cashflow very well … but there must be a limit to how much you should be willing to pay? What are your rules of thumb, and most importantly why?
Well, let me give you the numbers on an actual deal and you decide . . .
I bought a 4 bed 2 bath in Mesa AZ with a value of $225,000 for $225,000 using Subject To. I put $100 down. I took over the seller's payment. Monthly payment was $1,027. I paid $500 to have the property cleaned. So, I was into the property $600 and I would start making payments the following month.
Within two weeks I sold the property on a Lease Option for $250,000 and a lease agreement payment of $1,950. They put down $25,000 on the Option Fee.
So, I got $25,000 cash up front and $923 cash flow a month (for $11,076 yearly) for a total of $36,076 on my $600 paying full price.
Plus I got the tax write offs.
There are many more of these that I've done in three different states, Washington, Arizona and Texas.
I don't know how to calculate ROI on these but I'm pretty sure it's been worth it. ;-)Cool, your risk still stands with this new buyer of this lease-option remaining solvent and liquid. How have you protected yourself from this?
- Rental Property Investor · Raleigh, NC · Member since 2016 · 393 posts · 995 votes3y
Quote from @Sean Bramble:
When using creative strategies to buy-and-hold (subto/ seller finance, hybrids), how important is purchase price?
Most people commenting about how vital purchase price is, are thinking in terms of normal real estate transactions. However since you specifically stated that you are in creative financing, then purchase price is largely irrelevant.
Terms are often way more important than price when dealing in the creative financing space. Think of it this way, if a home has a fair market value of 200k, why would anyone pay 210 for it? Well, you could get a mythical 100% LTV loan from the bank at 8% prevailing interest rate and pay somewhere in the neighborhood of $1463 per month not counting taxes and insurance. OR, you could sub2 the deal at 210 and take over the payments on the loan that the seller obtained a year or two ago when rates were 2.5%. Now your monthly payment is only $829 per month, a savings of $634 per month.That's right, I overpaid by 10k for a house, but am saving $634 per month and will quickly come out way ahead and am cash flowing massively right out the gate. In addition no bank will give you anywhere close to 100% LTV for a rental property, but with creative financing that is relatively normal to carry the entire amount allowing you to scale infinitely fast, you are only limited by the flow of deals you find. Now obviously you still don't want to offer more than you need to in order to secure the deal, but this was just a hypothetical example to illustrate that overpaying isn't the end of the world if the terms are right.
From reading a decades worth of BP posts, I know @Account Closed is another legit source of information when it comes to the creative space, and I think he primarily does lease options but there are many different routes you can take.
- Rental Property Investor · Raleigh, NC · Member since 2016 · 393 posts · 995 votes3y
It's actually usually beneficial if the new buyer defaults and doesn't end up buying the house. If this happens he can simply remarket the property and collect another $25k fee and start the lease clock back to day 1. Worst case scenario he needs to evict someone, which is no different than any traditional rental.
Think about how much stress some people put themselves through in order to obtain $200 per door in cashflow with a traditional rental. He is getting nearly 5x that, with no down payment (he actually collected the 25k down payment). All Mike has to do to collect $1k during most months is head to the mailbox each month to collect his big check, and mail out a smaller check to cover the sub2 payment. - 3yV.G JasonPro MemberInvestor · Member since 2022 · 3k+ posts · 3k+ votes
Quote from @Ben Zimmerman:
It's actually usually beneficial if the new buyer defaults and doesn't end up buying the house. If this happens he can simply remarket the property and collect another $25k fee and start the lease clock back to day 1. Worst case scenario he needs to evict someone, which is no different than any traditional rental.
Think about how much stress some people put themselves through in order to obtain $200 per door in cashflow with a traditional rental. He is getting nearly 5x that, with no down payment (he actually collected the 25k down payment). All Mike has to do to collect $1k during most months is head to the mailbox each month to collect his big check, and mail out a smaller check to cover the sub2 payment.I don't disagree with the process of it. He's well ahead most everyone in that regard, it's still a headache to deal with the default process. It's likely if they default, they'll leave the place in a bad position. The cost of that to fix up is unknown. Overall, great deal and I'd do it even with that minute risk but just set aside more cash reserves for the potential headache. I think everyone would do it.
- 3yDan H.Pro MemberInvestor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
Quote from @Jon Martin:
If you are in a high property tax state, and those taxes are determined by your purchase price, then it certainly does. Lots of California buyers in the last few years have locked into their property taxes at a high price that they will have a hard time shaking. Whereas if rates go up and purchase price dips, there's a chance to lock your taxes in at a lower price and hope to REFI later.
In CA, if the price of your property goes down you are not locked into the property tax based on the purchase price. You can request a new valuation for tax purposes. It is not a difficult process, but there are also companies that will do this for you for a small fee.
This process was used a lot at the GR. Fortunately there has been no cause to use it in recent times. However, if you purchased near May of this year it may be worth considering as your value may be down (my market is down ~10% since May which is substantial as the 10% equates to ~$100k). This $100k at 1.1% property tax rate would be $1100 which may justify the effort.
- 3yDan H.Pro MemberInvestor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
Long ago I purchased a house with seller financing paying about 5% over market but my rate was 20% less than market. I calculated the amount of time it would take for my reduced payments to recover the over market price. I do not remember what I calculated, but it was short enough that I made the purchase and believed it to have been a win-win. I ended up paying less for the property due to reduced rates. The owner got more for the property than market and got a better interest rate than he would have achieved in many other investment options backed by an asset that he had confidence in (his previous property).
A purchase has to be evaluated on all terms. for a similar reason that the current higher interest rates make some buying values that would have worked at the lower rate no longer work, a reduced interest rate can compensate for a property being purchased above market value. Similarly, low money down can compensate for increased price. For example, if I can purchase a RE with market value of $200k for $220k, for only closing costs (100% LTV) and it cash flows $400/month that purchase would provide outstanding COC and ROI. - Investor · Brooklyn, NY · Member since 2022 · 158 posts · 118 votes3y
@Sean BrambleI don't think you mean to ask if purchase price matters. Of course it does. I think you mean to ask if people are sometimes willing to pay more for a property in exchange for favorable terms, and the answer to that question is yes.
Keep in mind that a lot of this depends on investing strategy. You'll note that a lot of the responses on this thread appear to be from investors who use the snowball method to build their portfolios, relying on the cashflow from their properties to buy future properties.
I personally don't favor that method. I operate in a HCoL place where, even if you got an excellent deal, it would just take too long to snowball into other properties. Additionally, cashflow is taxable; whereas, tapping into your equity via refinance largely is not. So to me equity is much more important than cashflow and I might be more reluctant to give up equity in exchange for cashflow.
I also question those folks who say they'll never sell. Do you have no desire to one day trade up into larger asset classes? - Member since 2019 · 7k+ posts · 4k+ votes3y
Quote from @Sean Bramble:
When using creative strategies to buy-and-hold (subto/ seller finance, hybrids), how important is purchase price? In theory, purchase price only matters when you sell, and I’ve heard of many investors being willing to pay over market value bc the terms they negotiate allow them to cashflow very well … but there must be a limit to how much you should be willing to pay? What are your rules of thumb, and most importantly why?
Strategy changes overtime, for me purchase price extremely matters as I don't want to overbid a house.
- Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes3y
@Sean Bramble
Check how many people 15 years ago did interest only and 80/20 loans and how did they work out for them? People will say bad lending habits and yes many of these people couldn’t afford the homes but this is no different in many creative financing situations.
There are a large number of comments to this post and it’s amazing I did not see one that takes into account the other aspect of real estate called risk. Everyone is basing this on a utopian world where the economy is doing fine and a property cash flows and tenants are perfect etc. That’s not always the case.
7e investments53 Reviews - Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes3y
value matters a lot more to me than price
- 3yV.G JasonPro MemberInvestor · Member since 2022 · 3k+ posts · 3k+ votes
Quote from @Jon A.:
@Sean BrambleI don't think you mean to ask if purchase price matters. Of course it does. I think you mean to ask if people are sometimes willing to pay more for a property in exchange for favorable terms, and the answer to that question is yes.
Keep in mind that a lot of this depends on investing strategy. You'll note that a lot of the responses on this thread appear to be from investors who use the snowball method to build their portfolios, relying on the cashflow from their properties to buy future properties.
I personally don't favor that method. I operate in a HCoL place where, even if you got an excellent deal, it would just take too long to snowball into other properties. Additionally, cashflow is taxable; whereas, tapping into your equity via refinance largely is not. So to me equity is much more important than cashflow and I might be more reluctant to give up equity in exchange for cashflow.
I also question those folks who say they'll never sell. Do you have no desire to one day trade up into larger asset classes?
Granted I have zero investment properties today, when I do enter, I do not intend to sell for the most part. I'll sell 1-3 years before retirement probably 75-80% of my portfolio. Keep 20-25% through retirement. That's a very long time away. My strategy is another form of wealth creation, I'm just noticing the cash flow issue in the short given this economy may be a lot worse than I thought. I knew I'd eat some costs up front though, but I think I'll be eating a lot more. - Lender · Member since 2022 · 338 posts · 374 votes3y
You can always order an appraisal to get a better sense of the value
- Lender · Tampa, FL · Member since 2020 · 113 posts · 119 votes3y
Respectfully, @V.G Jason I could not disagree more with your statement that price is critically important.
The fundamentals of finance are that the intrinsic value of an asset is based on its cash flow. In other words, what matters is not price, but that price is supported and justified by cash flow.
So, to the question @Sean Bramble is asking, how important is the purchase price? I would say purchase price matters but is a distraction more than anything else. Is it a bad investment to buy the rights to advertise on a billboard for $10 million? Not if it cash flows $3M a year!
In my opinion as an investor, the critical metric to hit is your cash on cash returns. Therefore, the downpayment and monthly payment become the most important variables to figure out.
The devil's advocate argument I suspect would go something along the lines of "Oh, yea that's great and all, but what happens when you need to sell?!" Simple you sell on creative finance, who wouldn't be happy to buy an asset without having to get a bank loan! You can wrap your existing terms.
Sean, if you'd like I can send you a creative finance deal calculator I created. It might be helpful for you in your underwriting process. A partner of mine paid $50k 'over' Zestimate for a single-family house this spring and it's an absolute home-run cash flow machine. Don't like purchase price distract you ;)
- 3yV.G JasonPro MemberInvestor · Member since 2022 · 3k+ posts · 3k+ votes
Quote from @Jared Prevost:
Respectfully, @V.G Jason I could not disagree more with your statement that price is critically important.
The fundamentals of finance are that the intrinsic value of an asset is based on its cash flow. In other words, what matters is not price, but that price is supported and justified by cash flow.
So, to the question @Sean Bramble is asking, how important is the purchase price? I would say purchase price matters but is a distraction more than anything else. Is it a bad investment to buy the rights to advertise on a billboard for $10 million? Not if it cash flows $3M a year!
In my opinion as an investor, the critical metric to hit is your cash on cash returns. Therefore, the downpayment and monthly payment become the most important variables to figure out.
The devil's advocate argument I suspect would go something along the lines of "Oh, yea that's great and all, but what happens when you need to sell?!" Simple you sell on creative finance, who wouldn't be happy to buy an asset without having to get a bank loan! You can wrap your existing terms.
Sean, if you'd like I can send you a creative finance deal calculator I created. It might be helpful for you in your underwriting process. A partner of mine paid $50k 'over' Zestimate for a single-family house this spring and it's an absolute home-run cash flow machine. Don't like purchase price distract you ;)
Respectfully, you're wrong. I'm saying in all contexts it's important, you're alluding to only in some. It impacts future purchasing power and if you can't understand that reasoning, I won't try any further.
And to the other piece, when you're selling you never want to limit your options. If you have to do seller financing cause your original purchase price was garbage, you need to reconsider how you're buying the asset from the get. Go ask these regretful buyers in the past 6 months if price isn't important.
Join the conversationCreate a free account to reply, vote on answers and follow this thread.