Purchasing with no money down when the seller has 100% equity

13 Replies

So I'm looking for some advice on how to negotiate this deal.  I have come across a seller who has no mortgage on their investment property, lives over 2 hours away from the property, and is fed up with renting, and just wants to sell and move on.  They have no mortgage on the property, and would entertain seller-financing.  

For me - I would like to buy and rent it to somebody for the cash flow.  I do not have a lot of cash reserves, and can not afford to carry a mortgage on the property.  I would like to try and negotiate a sale contingent on me getting a renter in their before purchasing.  I like very close to the property and would have no problem showing it to tenants and screening tenants.  I am trying to hedge my risk as much as possible.  

@Daniel Karbownik

Boy, everything is negotiable, but you'd be hard pressed to get someone to agree to that. If you can't cover the mortgage you'd be worse than a tenant not paying rent because they would have to foreclose. I might suggest you grab a buddy and scrap together 5 grand as a small down payment and safety net, because if you don't have the reserves for 1 mortgage payment you are asking for troubles. Such as furnaces, mold, and tenants not paying rent. My thoughts anyway.

If it is free and clear, you look at at an Installment Sale.

You want to stress to the seller the advantage of a private first mortgage over being a landlord.

IRS Links

http://www.irs.gov/taxtopics/tc701.html

http://www.irs.gov/pub/irs-wd/0931001.pdf

http://www.irs.gov/pub/irs-pdf/p537.pdf

http://www.irs.gov/publications/p523/ar02.html

What I do:

Offer more than comps for sales price

Structure the note payment so I can get a good cash flow.

Everything is negotiable.

The payment can survive the death of the owner-seller in a trust for a charity or family members upon death.

I use the term "annuity payment".

"No more tenants and toilets, own a cash flow, not a rental property with headaches like maintenance and legal issues like possible evictions and being sued by tenants."

@Bill Gulley  

Medium banner reiskills 997   copyBrian Gibbons, REISkills | [email protected] | 818‑400‑3046 | http://MyREISkills.com

Daniel, it's done all the time, rare, but done.

First question, do you have other assets? Equity in any other property or have personal property that has value? If so, offer additional collateral. If you give a security interest in your residence you need to check with your state as to Dodd-Frank issues.

Brian's points are pretty much what you need to play on, change from being a landlord to picking up a check as a note holder at his mailbox.

Check on the possible appreciation of that property, at a reasonable rate, you will likely need 25% equity before refinancing, so any balloon payment you build in needs to allow time for you to save and establish equity.

Use a note and deed of trust (mortgage), use the sale price as your loan amount (PV) and then enter the payment you need, enter the term such as 20/25/30 years and compute or solve for the interest rate, if it's negative or under say 4% it's back to the drawing board, you're trying to find the rate that fits the needs. If you must use a stated rate, like 7%, then solve for the note term (n) that meets your payment to allow it to cash flow. It could be 40 years, but then you can work in a balloon payment.

It's imperative that you not over pay for the property, financing 100% means no equity and you can't start off in the hole trying to establish equity to refinance later on. Don't ever get into a seller financed deal that can not be refinanced in a reasonable amount of time! People die, become incapacitated and others step in to manage.

From that angle, offer to pay for note servicing by an institutional or registered mortgage servicer, this take all the note management issues off the back of the note holder, it can make them feel more secure, so understand servicing.

Another matter is his rents, he could hire a manager at 10% probably and he wouldn't need to fix toilets or landlord it. That can mean you may need to meet or beat his alternative. That means your cash flow may be limited initially and you'll need to force appreciation through higher rents later on. It's all negotiable. Just saying, don't get greedy.

Unlike his management alternative, you'll own it, improve it, cover repair costs, insure it, cover the taxes, so selling can have the advantage.

You might also pick up an investor, give your cash flow away for awhile and then buy out the investor, this can go into partnerships or secondary financing with a private lender, you don't want to use a hard money lender for a rental at a high loan to value, even if you could obtain it.    

First thing is to present the idea of seller financing and deferring the gains on the sale. After that is established that he will carry it, then work on the right price and do your due diligence on the property. No reason to incur expenses and waste time in doing the property side first if he won't finance it. Good luck :)

Medium logoscopiccroppedblue2Bill Gulley, General Real Estate Academy | https://generalrealestateacademy.com

@Bill Gulley  thank you so much for your response.  I have read multiple books and countless articles, and your post added a ton of insight into concepts I have read about over and over again.  Thanks to your post, I believe I may be able to structure this deal as a win-win for the both of us.  Thanks again - I will post a reply here when I have an update.  

@Brian Gibbons   @Bill G.  I have to thank you guys as well for this information also! Most of my leads that I've been getting recently are Free & Clear and I've been looking for clarity and ways to convince the sellers that there are benefits to carrying a note!

This is what I was looking for!

Thanks!

@David Martin  

I'd read the links above and read Bill Gulley's post

Free and clear houses represent over a third of the houses that are available for sale

Some money now and some money later works well, and you don't have to give "money later" a payment schedule, could be due and payable in 3 to 5 years from now

Dodd Frank in the safe act does not apply if you're not living in it

Medium banner reiskills 997   copyBrian Gibbons, REISkills | [email protected] | 818‑400‑3046 | http://MyREISkills.com

You guys are welcome, I have found that the best lead for a seller financed deal is the old and tired landlord, hands down! Many of these types have held properties for years, 20 years +, that means the have a low basis and half or more of that price will be a taxable gain. SF defers taxes as that gain is received with cheaper future dollars.

They are also accustom to the monthly income, while they get a smaller check they have no maintenance, repairs, leasing activities, no cleaning up after a tenant, no phone calls about a leaking toilet, no liability, that is certainly worth something......no, they can take a real vacation! Then, show them the interest income, you can compare that to any depository account they might use.  It's not that hard to show the benefits of a SF deal.

Next are empty homes that were owner occupied, estate properties, properties that are not marketable or that need repairs, a lender may not accept the property as collateral and SF can solve the problem.

Usually, owner occupied sellers are moving to another home, that means they want cash as a down payment into the next place. It can certainly be done, but few take a high LTV note. :)

Medium logoscopiccroppedblue2Bill Gulley, General Real Estate Academy | https://generalrealestateacademy.com

@Bill Gulley  

 Would you mind clarifying a few points for me? One of the things you said in your original post struck me as super important and should be stressed again - to NOT overpay for the property. As as I started to work some numbers, it became clear how imperative this point really is.

If the plan is a balloon payment by means of refinancing with a bank, that will go down the drain if the property under-appraises at that time and you don't have the equity you thought you had. So, can you speak a little more to how to hedge against that? Do you order independent appraisals in a seller-financing deal? My property in question is a condo in a Sandy-damaged area on the jersey shore. Prices are all over the place depending on the current condition and amount of damage from the storm. The seller is asking $190k, but 2 comps recently sold in the same complex inside of 6 months ago for $112k and $116k. One of them was an estate sale trying to sell quickly, and the other was a bank-owned. My potential property had some damage, but has been completely renovated since the storm. Any insight on how to handle this?

Also, I was wondering who actually holds the deed in an installment sale like you have mentioned?

Thanks for your time and insight Bill

Originally posted by @Daniel Karbownik :

@Bill G. 

 Would you mind clarifying a few points for me? One of the things you said in your original post struck me as super important and should be stressed again - to NOT overpay for the property. As as I started to work some numbers, it became clear how imperative this point really is.

If the plan is a balloon payment by means of refinancing with a bank, that will go down the drain if the property under-appraises at that time and you don't have the equity you thought you had. So, can you speak a little more to how to hedge against that? Do you order independent appraisals in a seller-financing deal? My property in question is a condo in a Sandy-damaged area on the jersey shore. Prices are all over the place depending on the current condition and amount of damage from the storm. The seller is asking $190k, but 2 comps recently sold in the same complex inside of 6 months ago for $112k and $116k. One of them was an estate sale trying to sell quickly, and the other was a bank-owned. My potential property had some damage, but has been completely renovated since the storm. Any insight on how to handle this?

Also, I was wondering who actually holds the deed in an installment sale like you have mentioned?

Thanks for your time and insight Bill

Financing may have an intrinsic value for a buyer, no credit or bad credit, they may think a financing option as being very valuable to them, but intrinsic values do not apply to the value of the car, or boat, or plane or real estate, to the asset being purchased. Just as having a view of the ocean or a lake or mountains, that may be shown as to the general location, but the value of the view is intrinsic, in the eye of the beholder, it is not a value that can be shown in the market for similar properties. The only value that can be justified is the cost of alternative financing.

The property is what it is, you need to stay with the market value concept as that effects you as to the asset held, the appreciation, taxes and future financing. If you pay too much, you're giving up future appreciating, your net worth is skewed, your income as to return on assets is less, depreciation is skewed and it takes longer for equity to be established to support any future refinancing.

Those who advertise seller financing on a property will almost always ask to much, it will be overpriced. I don't recall ever seeing a seller financed deal that was purchased at an asking price that was not overpriced, buyers see the deal as a payment, like they might buy a car and they see owning better than renting (that may not be true financially, but as to desire) an intrinsic value.

Interest only loans in residential consumer transactions are considered predatory lending, few will actually reduce principal to establish sufficient equity. To "hedge" your equity position you need to reduce principal.

Look at an amortization schedule at a loan amount over 30 years, the principal reduction is minimal in year 1 and barely increases in 5 or 7 years.

If you buy at a 90% LTV, in 5 years you may have reduced principal by 5%, you're at about 85% not considering appreciation. Don't count so much on appreciation, the average is said to be 2.4% last year. An appraiser may not see appreciation in the market in a year or 2 and maybe 3 years depending on the area, beyond the time value of money.

If your lender requires 30% equity to refinance, in 3 years you're likely behind in trying to get to that level, only two things to do, reduce principal or improve the value of the property.

Where fix and flippers lose is paying too much for improvements that are not shown in the market adding the value they actually put in or at their cost. You can look to
"forced appreciation" techniques, a book can be written on the subject, but besides a gut rehab, forcing significant appreciation takes time.

Many investors target raising rents, just because you get an idiot to agree to pay more in rents doesn't flip a light switch on the value of a property, comparable rents will still be used in valuation, not necessarily what your tenant is paying as a premium. (This is a trick the "turn key" operators pull, having a high paying tenant to force value through the income approach). Don't bank on it in the short run, your bank won't!

The two sales you mentioned are distressed sales, or could be, quick sales do not expose the property to the open market for a sufficient period of time won't meet the definition of market value.

To comp those, look to the condition of the sales and adjust those values to be most similar to the subject property. My bet is that your subject is overpriced, that's my guess.

If rents won't pay down the principal to the required LTV in time for a balloon payment, you don't have the deal you may think you do. Getting into a property is not hard, really owning it is.

I'd start by educating the seller, as to the value of financing, seller financing should cost no more than bank financing, they will generally want a higher rate which compensates for the costs of the bank loan. What is the difference to a cash sale and your cost of capital? You can consider a cash price without having the cash or making a cash offer, the point is valuation of the property, not the mode of financing.   

The reason sellers get away with overpricing a property in SF deals is because the transaction doesn't require an appraisal (now required in owner occupied transactions under Dodd-Frank). So, if you are serious, make sure the seller is motivated to sell at the market value and get an appraisal!

Last note on seller financing being offered on a deal. When a seller wants a 3 year balloon they are not taking the biggest advantage of financing, the deferred tax benefits, 3 years really isn't long enough to off set that expense. So, taxes are not the issue, the reason is to open  the purchase opportunity to those who can't obtain financing and this too is a predatory lending matter. They are  baiting a buyer into a structured  arrangement that can not be successful under the initial terms set out, equity will not be established to meet the balloon requirement, without going further as mentioned above.

Sounds to me like the seller is targeting the payment to move in, probably overpriced and a short balloon sets a buyer up for failure, that may be intentionally done by that seller and then they may not be aware of their offer as it is common. Good luck :)

Medium logoscopiccroppedblue2Bill Gulley, General Real Estate Academy | https://generalrealestateacademy.com

Things to remember a seller would not give away their property with no money down and a full credit report and background check . It would be too easy for someone to walk away if things turn sour. In your case I would only possibly do an lease option and still require a down payment. Holding a note without cash down makes it  unmarketable for the seller

@Bill Gulley  Let's say my seller is asking for $190k.  If I believe real market value is about $167, and I'm willing to put down $5k, and finance the other $162 at fair market rate of 4% with a 10 year balloon payment - a 30 year term on the deal makes the monthly payment a little higher than I need it.  A 40-year term drops it to the range I need it in, but I'm not sure sellers would agree to that.  

So I was doing some reading online and found the following strategy - If I thought the FMV was $167, and they want $190, what about offering $210 at a 0% interest rate. Now, I am giving them $20k more than they want, although it's $40k over FMV, it drops the monthly payment from $167/4%/40yr by about $100, and after 10 years leaves me with just about the same principal balance as the $167/4%/40yr deal.

Any insight on this?  Worth overpaying for the property in this fashion if the financing is excellent terms and actually allows the property to cashflow better month-to-month?  Thanks a lot for your all time and insight into answer my posts

Daniel, as to seller financing......I suggest you read right here and stay off the internet with gurus posting about things they figure out on a calculator and not having a clue beyond that. LOL, No, I don't like that idea from several fronts.

Seller financing.....means the lender is not a lending institution.....means they are mortals! What can happen in 10 years to any mortal? They die, become incapacitation, their needs change causing them to change their mind, they may well attempt to terminate a deal for various reasons......it might not be them, it could be their heirs or administrators.

FMV of 167K, at 2% average appreciation, in 10 years, you'll have a FMV of 199,580!

That means when you try to refinance, you'll be underwater With a 40 year amortization, I doubt your principal reduction will put you at the LTV needed to refinance unless you make additional payments to principal. That means you really won't have a 40 year amortization!

You're giving 10 years of appreciation, possibly more, away to finance the deal.

You do not buy real estate like you might a car, based on the payment you can afford, that is not investing, that's manipulating a purchase with little upside. You're trading cash flow for the increased liability and no equity. Figure in your maintenance, repairs and your management efforts and not benefiting as you should be when investing.

Over that ten year period, if anything happens to you or you need to sell.....you're sunk underwater!

The seller is already being predatory, asking more for the financing which doesn't increase the value of the property......then you're going above making it even more predatory for yourself. Not to mention, now it's your offer, no defense for you later on and the seller will have imputed tax rates with the IRS with a 0 rate interest charge.

Lenders will also impute interest when you refinance at market rates, that is a seller concession, just as allowing rents going toward a purchase price......silly creative financed deals are always adjusted back to conventional norms, to the market to allow equity to be established, it is not what your schedule may indicate as to equity for the LTV, but will be the amount to be paid off and viewed again as to a LTV.

Buying a property significantly over market value can also lead to tax problems for you, you have over valued an asset for depreciation, taking more than is allowed and can become a sham tax filing, now, you're cheating on taxes taking more depreciation than is allowed to a fair market value. Since you made the offer, it may look like you planned it that way!

Not only is that not a deal, it's a bad deal.

Offer the FMV, then interest at 5%, that's probably 4% more than they can get elsewhere. Use an amortization that puts you in an equity position to be able to refinance at the balloon point. If the deal doesn't pencil out to this, then pass, there are hundreds of thousands of over priced properties, buying one is not investing regardless of how you play games with a calculator......it's not a deal. Just say next and move on.....sounds like your seller is a greedy scamster anyway, if they are serious about selling, motivated, they will take close to that offer just mentioned. Good luck :)

Medium logoscopiccroppedblue2Bill Gulley, General Real Estate Academy | https://generalrealestateacademy.com

if the owner wants to sell but isn't in a rush and you have the credit and means for the loan but no down payment... Could you possibly get the owner to sign a contract similar to a wholesale contract but you stretch the terms to 6 months.... He keeps ownership while you maybe even rent out and save up for the down payment.... If you could qualify for a good rate loan with 2% down than the contract should give you time to save up and close on it yourself in 6 months