Purchase price … how important is it?
Investor · United States · Member since 2020 · 202 posts · 284 votes
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?
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.
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.
"It impacts future purchasing power"
Purchasing power - the financial ability to buy products and services.
Please explain how your purchase price on a creative finance deal impacts your financial ability to buy products and services (or more real estate) in the future...
The only thing that affects this ability are your reserves, downpayment, and cash flow. I think you may be missing the point that prices are equivalent to the present value of discounted future cash flows. When you buy seller finance at a lower interest rate than the market interest rate, you are not only (potentially dramatically) increasing cash flow, but you are also lowering the discount rate on your future cash flows. Thus even at a purchase price higher than what comps would call for you can 'walk into equity'. Comparing prices on housing when interest rates are different is like comparing apples to oranges.
To clarify, I am specifically talking about creative finance, the subject of the question at hand. Personally, I don't know of any regretful seller finance buyers haha, maybe some people who bought using a bank loan. Don't get me wrong, there are bad seller finance deals, but every seller finance deal can be a banger with the right terms. Like I said, my business partner just paid $50k above Zestimate for a property in the spring and there aren't any regrets about $500 a month of net net cash flow :)
@Sean Bramble. Please stack two dominoes next to each other. Knock the first one into the second one. Keep doing this by adding another domino.
Or do musical chairs. Keep doing it. Will you ever be the person without a chair?
Your first answer is yes. Creative financing will work with higher purchase price.
The answer to your last question is the limit is when you're the last domino or the person with no chair. As someone mentioned it doesn't matter till you sell. But if you ever sale and the buyer goes conventional financing it won't work if the appraisal is to low. You then have to be the one doing seller financing. You're a banker then, not an REI.
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.
"It impacts future purchasing power"
Purchasing power - the financial ability to buy products and services.
Please explain how your purchase price on a creative finance deal impacts your financial ability to buy products and services (or more real estate) in the future...
The only thing that affects this ability are your reserves, downpayment, and cash flow. I think you may be missing the point that prices are equivalent to the present value of discounted future cash flows. When you buy seller finance at a lower interest rate than the market interest rate, you are not only (potentially dramatically) increasing cash flow, but you are also lowering the discount rate on your future cash flows. Thus even at a purchase price higher than what comps would call for you can 'walk into equity'. Comparing prices on housing when interest rates are different is like comparing apples to oranges.
To clarify, I am specifically talking about creative finance, the subject of the question at hand. Personally, I don't know of any regretful seller finance buyers haha, maybe some people who bought using a bank loan. Don't get me wrong, there are bad seller finance deals, but every seller finance deal can be a banger with the right terms. Like I said, my business partner just paid $50k above Zestimate for a property in the spring and there aren't any regrets about $500 a month of net net cash flow :)
I shouldn't have to explain why the purchase price point will impact your future purchasing power. You realize the downpayment, interest rate, reserves will all be a function of it. I don't know why you keep bringing up the seller finance part, you keep rambling about that it's a really niche area. Purchase price makes a difference in every and all functions of any loan--seller finance or not. I think enough has been said, you're clearly missing the point. It's fine though, I don't think you will ever get it if you don't understand how all these functions impact future purchasing power.