Seller Financing tied to CPI?

Question

Good afternoon BP Community. I have run into a unique (to me) situation and I would like to know if others have encountered this, and/or successfully/unsuccessfully completed this type of transaction.

Background: my clock just started to tic on my 1031x. Last week, I made an offer on a property (5plex, all 2/1), presenting 2 options to the seller, who was looking to get $775K for his property. Rents are 50%+ below market. One is via commercial loan through local lenders at $675K, which requires a minimum of $475K down payment. The other is seller carry at $750K, using $400K down payment, and the rest is seller financed at 5% I/O for 5 or more years.

These terms would allow me to COE with just above break even, but the potential cash flow is $50K. I know the market and have 50 units in the area.  I'm confident the rents can be double or more.

Today, the seller responded with seller carry at $800K, same down payment.

Among other unfavorable, but tolerable conditions, he wants the loan at 6.25% I/O for 10years. This would result at roughly net zero at COE.

Here is my dilemma,  he wants the loan to adjust every 6 months, with the interest tied to any fluctuation of CPI.

I had not heard of this before, but I understand his stance.

My question to those who are in the seller financing world, have you encountered this before? How has it played out?

Note: in the last 24 hours, I have 2 other deals that came in, much more favorable, that i will pursue. However, if the seller financing can still be obtained, I would like to try and grab them all, even if it means I float the costs for a short period using cash flow from nearby properties ($20K/yr max if needed). The upside is $500K in value for a future 1031x.

Please share your thought. Be honest and as critical as needed. I want to hear all points I may have not considered. I can add additional details for those that require it to analyze. These are all off market deals.

Sam Yin · Answer

The properties are worth 1.4M, appraised individually.  There are 3 parcels in total, a duplex, a triplex, and a fairplex. All parcels are contiguous.

I am buying as a bundle, but with a separation clause to allow separate refinancing or individual sales.

However, from a commercial loan perspective,  its probably worth 1.2M. I look at it thay way in case I might want to keep them together and refinance into one commercial loan later down the road.

Conventionally, properties in San Bernadino, CA generally sell for about 200K-250k/door for your average C neighborhood home. That's up to 4 doors. It may reach 300k/door for a B or A neighborhood. When it comes to apartments,  it drops to 150k-200k/door on average.  Thus valuations look different. From a commercial perspective,  with 20% down, the DCR is only 1.16. That's the lowest I have ever done. I generally like 1.3.

In this case, I just closed on 14 homes last week, one block south of this location. This would make it for easy management due to proximity.  Additionally,  when I close those 14 homes, I used commercial financing to wrap them all because they were close to each other. they were valued about 2.5M individually, but I bought them for 1.9M as a commercial package. There DCR was 1.4. All this to say that if I mess up on this new deal, i could potentially wrap them all on a refi later into a 23 home commercial loan.

Your thoughts?

Chris Seveney · Answer

you are paying $1.4M for properties worth $1.2M??

Sam Yin · Answer

Well... in my pursuit of trying out owner financing,  I think I finally locked one down that might work.

I will revive this post... my post... lol

The original one relented and removed the CPI adjustment component of the financing.  But I walked away from it anyway.

I found another that had slightly better terms. Here is the deal:

$1.4M for 3 properties, total 9 unit, in a tertiary market. Actual individual current value adds up to that, at best. If it was to be evaluated as a multifamily commercial, it should be more like $1.2M at best.

The terms is what lured me. It took some negotiations.

20% DP

7.5% I/O for 5 yrs

Zero prepay

Separation clause

Projected cash flow 19K/yr as is with conservative underwriting

NOTE: seller wants a 1% seller finance fee... very cunning...

Actual cash should be around 30K/yr since I operate my own team.

I plan to enter into formal contracts in the next 48 hours and a week later, as a formality. But I'll just button it all up by Friday and wire all the funds because I have a family trip coming and I will not cancel it. I want to come back into town to a completed deal.

Also, I got 100k OPM at 4% to aid my DP. Actual out of pocket is $180K plus some minimal fees... like 11K to seller and $700 to escrow/title. the 180K was from cash flow saved from other rentals income this year, so none of my W2.

Is there anything that I may have missed that could be detrimental? This will be my first seller financing deal. I wanted to give it a try just to see how this would play out for portfolio growth.

I will be using a property inspector. The properties were fully renovated last year and got new roofs.

Sam Yin · Answer

@Chris Seveney

Thanks for that. All good points. I think I was a bit excited to have my first seller financing offer on a property a few blocks from my others, that just happened to come at a time when I need to spend the money. That seller requirement of tying the rate to CPI fluctuations is my sticking point.

Thanks for the quick response.

This is all very fresh and I just submitted a few more offers, an 8 and a 14. If those are accepted offers, I was thinking of countering the above seller finance deal with a rate cap of 8% and lower the DP to under 200K. That could allow me to nab the property by chipping just a little off my reserves, which should recover.

Here is a tad more detail on the property and my mental math. Current rents are roughly $750/month. Market rents are $1800/month and Gov subsidized rents are $2100/month. At $800K for 5 units, that comes to $160K/door. The area is currently trading at $200K/door for this unit mix at $1400/month. Should rent be raised to to $1800, that equals $108K gross. Operating expenses are $30K. The area averages a 5 CAP.

That CPI tied interest is what has me baffled as how that can be made to work. At the moment,  its likely a dud. The seller owns it outright with a partner and this was his CPAs recommendation. He is an investor as well. He has about a dozen properties, totalling about 500 units. So he knows the game way better than I do.

Chris Seveney · Answer

@Sam Yin

Loans are not tied to cpi the are tied to sofr

Some of the reason not to do this are:

1. Sofr goes up and down, cpi almost always goes up

2. Cpi could change how they calculate the rate

3. If cpi goes up 2%, and your loan is 6%, I assume your loan is now 6.12% (not 8%)