Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
Quite often I hear people talk of seller financing as more of a last ditch resort when disposing of property that one might not be able to sell any other way. I'm sure that many of you have come across these kind of deals.
I have been a buy and hold investor for many years and through various means now have several paid for properties that have substantial built in gains. At this juncture in my life and business, I will be doing 1031 exchanges to build better cash flows and look for better opportunities for appreciation.
I have considered seller financing now, but don't see that as being quite as advantageous as exchanging properties. When I near retirement though, it may make sense to use seller financing as a way of deferring gains recognition. This type of sale would be treated currently as an installment sale which could be quite beneficial. I have a number of properties that between appreciation and depreciation recapture would yield large gains if sold traditionally.
I know that some of you have considered this strategy. I would appreciate hearing your thoughts, opinions, laughter, etc. Feedback is a great way for everyone to learn.
Loveland, CO · Member since 2008 · 1k+ posts · 123 votes
16y
Dan, it's an excellent idea IMO, one that I used and I've been happy with it. However everyone's situation is different.
Rich wrote; .
1. "Once you move out of owning, your future gains from principal reduction, tax benefits and possible appreciation stops instantly."
True, but in my case I owned everything free and clear, and lived in TX where appreciation isn't much of an issue. Since about the 1980s or so whenever someone says "tax benefits", they really mean LOSSES.
2. "Instead of tax breaks, you become taxed, taxed and taxed. First on the gain from sale, and then the income you receive."
See above regarding "tax breaks". Yes you do pay taxes, but you pay taxes on the rent you receive as well, moot point IMO.
3. "Most likely, you'll also lose equity from cost of sale, and commissions."
I've NEVER paid a commission on any seller financed deal I've done. When you ADVERTISE the benefits correctly you'll have your choice of buyers.
4. "You can continue exchanging up forever and change basis and grow your future estate."
That's OK if you're interested in an "estate". I have no interest in leaving an estate. I plan on ENJOYING what I've worked for.
5. "Just re-fi and get your money out to live on,,,tax free!!"
OK, to get access to MY OWN MONEY, I'm going to pay, points, closing costs, fees and then interest to get what I already own. And then have the hassle of my overworked wife writing checks each month. No thanks.
Once I knew that I didn't want to spend the rest of my life in Houston, or be a long distance landlord (IMO there does not exist a reliable, trustworthy property manager) I decided to sell my 16 rentals on a seller financed basis.
As the leases expired I gathered comps from agents and advertised as follows; 3/2 in Running Rat Estates, owner will finance with $2,000 (sometimes as high as $5,000) down.
By and large I was selling for 12-15% OVER COMPS. I generally charged about 1 1/2 to 2 % over the prevailing interest rate. I prepared the documents and charged for it. Closing was handled at my bank, they don't charge for notary service.
I've gotten a few of them back, but always resold at a higher profit and started the clock over.
The downside is that over the years some buyers have refinanced and some have sold so my income has dropped from $130K/year to about $45K. Although I did receive the balance on the sale and reinvested those proceeds.
I looked on this as my own "bond fund" or as my wife says a "FrankieMAE" fund. I've always adjusted the rest of my holdings to reflect this.
Note Investor · Pasadena, CA · Member since 2009 · 849 posts · 544 votes
16y
In your situation I think the biggest difference between the two strategies is this:
With a 1031 exchange, you're still a landlord.
With a seller financed sale, you're now a payee.
Of course, if you've gotten to the point where you pay a property manager or company to have your headaches for you, then I'd say keep exchanging and keep cash-flowing.
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
16y
Yes, it is possible to leave behind a substantial inheritance. We are at a point that we need to consider how we handle our estate.
I fully intend to continue exchanging and building up existing real estate while purchasing new real estate. The cash flow and freedom outweigh any management issues.
There does come a time though when freeing up additional cash for retirement may also make sense. Outright selling property with sizable gains means paying substantial taxes. It also may mean that it may be necessary to park the money into another investment. Structuring a seller finance deal could mean distributing the gain recognition over several years while obtaining a decent return based on the mortgage.
It would still be necessary to qualify the purchaser, insure suitable terms and the ability to adjust the interest rate periodically to current market rates.
Property Manager · Passaic, NJ · Member since 2008 · 369 posts · 83 votes
16y
I myself have been pondering this same issue. From my experience I am seeing advantages & disadvantages to both. Funny thing is that I began in r.e. with seller financing. My former employer and mentor moved away 15 yrs ago. Rather than sell his property he gave me opportunity and himself a fixed retirement; sold some of his assets to me and held the paper on an installment sale basis. One property I purchased at 1.5M he structured the financing at 9.5% for 32 yrs. It was a no money down deal with interest only payments for the first 2 yrs and full amortization the remaining. This gave me the chance to bank some cash for reserves and capital improvements. Thru the years many have said to me you could refinance, you're paying too much in interest. Although true, we made a deal and I am honoring that deal. We have both benefited. He has a secure retirement he was seeking until I sell, avoided capital gains, paid no commission or closing costs.....I now have a property worth 3.3M. I am at a point now where I must make the same decision as the kids are not interested in real estate.
My point here is you really must feel comfortable with your purchaser or alternatively, be sure that you have adequate protection in place to take back title to your property in the event of a default, be able to immediately appoint a rent receiver etc. I've seen several buyers of seller financed properties just strip a building and leave a seller worse off than when he started.
I do work for another gentlemen that sold his assets during the boom in 2005 and did 1031's of course into higher priced properties. He did avoid the taxation by this method; however, the 1031 properties were also bought during the peak, have depreciated, suffer vacancies in the current market, and are at this point negatively cash flowing. Was the gain on avoiding capital gains worth the loss created by the current market conditions and overpaying on the 1031's?? I guess I won't know this answer for a few more years.
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
16y
I have done quite well over the years with my buy and hold strategy. I fully intend to continue investing for another 10 to 20 years. I have probably got a 2 million dollar gain built-in to the properties we currently hold and when you add back for recapture of depreciation that amount would grow.
Over the course of the next 10 to 20 years, I'm sure that amount will grow considerably.
Seller financing is one possible exit strategy when I retire. It offers a way to potentially spread gains over several years and would yield some interest income as well.
I do not plan to have much if any single family properties at retirement, these I will convert into multi-family units. I'm building a team to assist me in managing my properties now and possibly in retirement. My children are not really interested in RE, but my grandchildren might be.
I'm also looking into creative ways to use a business to assist in my retirement planning. I would love to here some of your thoughts regarding retirement strategies.
Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
16y
Charles- I reached your point in time YEARS ago. I'm not a fan of selling with owner financing and you can find a lot of my posts, threads and even info in the Meet The Investor section here on BP. Here are some of my reasons and thoughts.
1. Once you move out of owning, your future gains from principal reduction, tax benefits and possible appreciation stops instantly.
2. Instead of tax breaks, you become taxed, taxed and taxed. First on the gain from sale, and then the income you receive.
3. Most likely, you'll also lose equity from cost of sale, and commissions.
4. You can continue exchanging up forever and change basis and grow your future estate.
5. Just re-fi and get your money out to live on,,,tax free!!
6. Set up an irrevocable trust for passing estate to grand kids(it works well) and you can even purchase a combination of cheap insurance polices to cover the estate taxes. (my wife made me buy these so estate would not be diminished by transfer.
I just see zero benefits from the proposed owner financing. You'll have same amount of hassle as you had as a landlord. As one who owns multis, sfrs and most other types of RE, Mgmt will lessen your involvement and still be cost effective.
I'm out of country and will be out of internet availability for awhile, so not able to reply after today for a week. Lots of posts and info on here to back up my feelings. Good luck. Rich
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
16y
Thanks Rich for your insight. Retirement is years down the road, but I want to develop a plan of attack well before then. I appreciate your sharing your thoughts. I'll check out your previous posts.
Have a nice trip look forward to sharing additional thoughts in the future.
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
16y
Seller financing does pose different risks. A taxable income stream is created, even though gains are deferred. There is risk that for some reason the purchaser will fail to make payments. If a buyer fails to make payments it can be time consuming and costly to resolve the issue.
A good contract and making sure that the buyer is credit worthy seems a must before doing any seller financed deal. Important to minimize the risk of loss.
Can anyone tell me about there experiences with seller financing?
Real Estate Investor · dc, Washington D.C. · Member since 2008 · 392 posts · 89 votes
16y
For some other perspectives, you really should check out some of Dawn Rickenbaugh's and Bill Exeter's content on seller financing, notes, and exchanges. Marc Faukner and Donna Bauer has some great content on seller financing and notes; and Wendy Patton has some great content on lease-options and seller financing.
Although selling with seller financing might be a "last ditch resort when disposing of property" for some, it's not a last choice for others (myself included). Seller financing is much more versatile when combined with note buying/selling, and I learned from Dawn and Bill that one can combine them with exchanges to much more.
Keep in mind that one can structure the seller financing so that the title transfers at closing, or sometime later (as in the case for a land contract or a title-holding trust). One can also structure the seller financing so that the seller retains the depreciation and interest deductions (also for land contracts [most states support this--but some don't]). One can also structure the seller financing with an interest rate with adjustable or stepped rate (ie which is kind of like--but not exactly--built-in appreciation). And the list goes on.
Although the income (ie the payment spread) is taxable, I wouldn't necessarily say that one created another taxable income stream. After all, one would still be taxed on the income from the rent, so the income stream is essentially transformed (from rent to mortgage payments).
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
16y
Thanks Dory,
It's great to have a resource like this where you can learn from the experiences of others. I like to examine all of the tools in my box. There can be many creative ways to do an option, seller financing or employee other tools. Some are circumstantial being in the right place with the best alternative.
Loveland, CO · Member since 2008 · 1k+ posts · 123 votes
16y
Dan, it's an excellent idea IMO, one that I used and I've been happy with it. However everyone's situation is different.
Rich wrote; .
1. "Once you move out of owning, your future gains from principal reduction, tax benefits and possible appreciation stops instantly."
True, but in my case I owned everything free and clear, and lived in TX where appreciation isn't much of an issue. Since about the 1980s or so whenever someone says "tax benefits", they really mean LOSSES.
2. "Instead of tax breaks, you become taxed, taxed and taxed. First on the gain from sale, and then the income you receive."
See above regarding "tax breaks". Yes you do pay taxes, but you pay taxes on the rent you receive as well, moot point IMO.
3. "Most likely, you'll also lose equity from cost of sale, and commissions."
I've NEVER paid a commission on any seller financed deal I've done. When you ADVERTISE the benefits correctly you'll have your choice of buyers.
4. "You can continue exchanging up forever and change basis and grow your future estate."
That's OK if you're interested in an "estate". I have no interest in leaving an estate. I plan on ENJOYING what I've worked for.
5. "Just re-fi and get your money out to live on,,,tax free!!"
OK, to get access to MY OWN MONEY, I'm going to pay, points, closing costs, fees and then interest to get what I already own. And then have the hassle of my overworked wife writing checks each month. No thanks.
Once I knew that I didn't want to spend the rest of my life in Houston, or be a long distance landlord (IMO there does not exist a reliable, trustworthy property manager) I decided to sell my 16 rentals on a seller financed basis.
As the leases expired I gathered comps from agents and advertised as follows; 3/2 in Running Rat Estates, owner will finance with $2,000 (sometimes as high as $5,000) down.
By and large I was selling for 12-15% OVER COMPS. I generally charged about 1 1/2 to 2 % over the prevailing interest rate. I prepared the documents and charged for it. Closing was handled at my bank, they don't charge for notary service.
I've gotten a few of them back, but always resold at a higher profit and started the clock over.
The downside is that over the years some buyers have refinanced and some have sold so my income has dropped from $130K/year to about $45K. Although I did receive the balance on the sale and reinvested those proceeds.
I looked on this as my own "bond fund" or as my wife says a "FrankieMAE" fund. I've always adjusted the rest of my holdings to reflect this.
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
16y
Frank,
Thanks for sharing your actual experience with seller financing. I don't mind leaving an estate behind, but I also feel that my wife and I should enjoy some of what we worked hard for. Children and grandchildren may not appreciate what it took to build these properties.
There are many decisions to be made before retirement. Part of it is investigating different ways of dealing with the real estate we will have accumulated, part of it will be how to provide something for those we love without creating a dependence.
Seller financing can be a useful tool especially when property is owned outright. I will want to investigate other options as well, while I more fully investigate seller financing as a way to supplement retirement and spread taxable gains over years as opposed to one large taxable event.
1031 exchanges are very useful while you are accumulating income producing properties in retirement I'm sure that I will not want to be on call to take care of property needs. I'm also fairly certain that it would be quite difficult to find a property manager that would be as concerned about efficient management.
Look forward to other peoples thoughts and experiences as well.
Loveland, CO · Member since 2008 · 1k+ posts · 123 votes
16y
Charles,
Another consideration is that you both look younger than us, and as I got older I was less inclined to do work myself. I'm funny about the work that I PAY to have done. I expect that the person doing it, as a professional, should be able to do it at least as well as I can.
By the time we were selling ours my wife had been retired a couple of years and I was selling off part of my company. I thought I was going to work a few more years but I ended up only working a few more months.
I don't regret selling when I did but I would have had more income stream had I waited another year on a few of them. OTOH maybe some of those loans would have gone south in the downturn of '07-'08.
BTW, I'm not interested in leaving an estate because we don't have any kids. Seeing the way many of my nieces and nephews are, the youngest of which is late 30s, had my kids turned out that way I wouldn't be leaving them other than a token amount of inheritance.
One other thing about the long term. Neighborhoods change and with it their desirability and value. Sometimes they go up, sometimes they go down. Cashing out prevents future appreciation but also depreciation.
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
16y
Originally posted by Charles Perkins:
... Children and grandchildren may not appreciate what it took to build these properties.
...
The children just may appreciate your sacrifices and struggles that it took to accumulate your assets - but then they will likely acquire a spouse who would have no clue, and that puts you right back where you are already thinking.
Real Estate Investor · dc, Washington D.C. · Member since 2008 · 392 posts · 89 votes
16y
Originally posted by Frank Adams:
I looked on this as my own "bond fund" or as my wife says a "FrankieMAE" fund.
I loved that line. :cool:
BTW, Charles, I must have had a brain fart yesterday, because I should have also referred you to some of Nick Johnson's posts on seller financing too.
Actually, it's not that hard to find "a property manager that would be as concerned about efficient management," but you might need to interview 30 of them to find that shining star. If you decide to get into commercial at some point, then scale will be a key issue, and it's simply impossible for 1 person to effectively manage several hundred units by him-/herself.
Contrary to popular opinion, seller financing also works just fine even in scenarios where the seller has little or no equity in the target property. Obviously, the terms of a deal with little or no equity should be structured differently than one with the "popular" minimum 30% equity that some recommend. Jason Hanson addresses this issue quite effectively in a post "The 4 Strategies To Make Money From Subject To's". He's the first person I stumbled upon who mentioned anything about simply taking over payments and stretching out the time (for the refi).
Additionally, seller financing isn't just a good strategy for retirement, it's a great strategy IMHO for buying/selling--period.
Furthermore, unless one puts his/her equity to work--via a combination of cross-collateral, a bank loan, and/or seller financing--that equity is simply collecting dust. In other words, that equity doesn't produce any other kind of return.
Originally posted by Frank Adams:
One other thing about the long term. Neighborhoods change and with it their desirability and value. Sometimes they go up, sometimes they go down. Cashing out prevents future appreciation but also depreciation.
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
16y
Frank,
Thanks for the compliments. My wife is retired and I am 50. I have been doing real estate for quite awhile now and don't want to slow down just yet. On the same token, I am getting old enough that I want to plan my exit strategy.
I probably will always be involved in real estate in one form or another during my life. It has become part of my blood. I enjoy remodeling the ugly duckling and seeing them change into something usable and more eye appealing. I also love talking with people involved in real estate.
Steve,
I would love to just give my children and grand children a nice source of income, my biggest concern would be that they would misuse it or come to depend on it and not fully utilize their own skills. So often getting something for nothing goes unappreciated.
Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
16y
Frank-
Replies to your replies
1.Tax benefits aren't LOSSES to me. I own enuff property, with enuff depreciation that my income from other sources is covered and allows me to keep my earnings.
2.Not a MOOT point to me. I have 2 entities- one with F&C properties, one mortgaged to the hilt. If organized properly, and "in the business"you may have your rent and pay ZERO taxes. I've done it for decades.
3.Still have the closing costs, and many aren't as smart as you and do pay commission also.(this is minor detail)
4.Different strokes for different folks. I have 6 kids, 11 grand kids and a GST for my grand kids. First one gets' his chunk in June of this year. I was lucky enuff to do both- legacy and travel. And I DO travel a lot, as most on here know.
5.I'm still a believer in appreciation, tax breaks, principal paydown and cash flow as being the 4 benefits in the real estate game. Different estate sizes would make a difference in my strategy. All I can do, is explain past history. My process allows an enjoyable lifestyle, most years ZERO taxes, and an ongoing legacy for future descendants. It works well and I'll stick by by method. I don't mind the re-fi method. It eliminates my taxes. I'll put my lifestyle up against ANYONE as far as my income taxes paid each year.
I was audited in 79&80 and learned how important income taxes were to destoying the dream of creating real wealth. I made it a life long goal to win at that game, and have.
Frank, I can't believe you had to add that "my bank doesn't charge for notary". Isn't that about $5 per signature? That isn't enuff to worry about. Maybe you meant something else.
This is what makes BP cool. Different strategies, mostly proven, posted on BP for folks to decide on. I enjoy the back and forth, but I like my position REAL well. Rich in Egypt till tomorrow.
p.s. Attending a sound and light show tonite at the Sphinx and Giza pyramids!
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
16y
The tax advantages of owning real estate was one of the main reasons I started in real estate. My real estate usually provides a tax savings that helps offset my ordinary income each year. I also have a home office that I use for both my CPA practice and for our real estate business.
I will continue to examine the pros and cons of seller financing as a retirement strategy. Appreciate the different perspective that have been shared and look forward to additional responses.
Real Estate Investor · Pittsburgh, PA · Member since 2010 · 6 posts · 1 vote
16y
Charles,
I've purposed that the current owner be an (investor/limited partner) with his self directed IRA. This way, most of the money that would transfer to the purchase of the property will be directed into the growth of his IRA which I think he has set up as a Roth, My agreement with him if he accepts the offer puts a large amount of interest into his IRA instead of into the repayment of the building.. creative math really.. would something like this work?
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
16y
Self-directed retirement plans are a great way to grow retirement money. Care has to be taken though especially if you are putting leveraged properties into them. There also needs to be enough cash available to pay any expenses. How you invest can make a difference as well.
Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
16y
Charles- on your # 1 , it goes further than this. Not only do you lose the tax advantages, but you create LOTS of new disadvantages.
1.recapture of all previous depreciation
2. sizeable tax consequences
3. loss of several benefits: principal reduction on mortgage, potential property appreciation, tax free cash flow.
I "retired" many years ago. The exit strategy is to set up trusts that pass on to next generations, nearly tax free. I'm able to use the cash flow to enjoy life and do it mostly tax-free. That is important to me. You may always exchange upward to increase tax basis and keep your income flowing tax free. Rich
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
16y
I agree that the taxes are a huge consideration. Both income and estate taxes. There will be both taxable gains and recapture of depreciation. Often poor records are kept of major improvements along the way as well. It is important to consider the consequences of an audit if inadequate support is available to substantiate the increased basis of a property.
Seller financing still seems viable if you have few properties. When you start to have been properties or large commercial properties it is hard to significantly reduce the income tax consequences. So perhaps seller financing as an exit strategy for retirement is better suited for those that have few single family properties.
Estate taxes becomes a burning issue when your intention is to never sell, but to transfer properties after death. I will need to investigate how to minimize estate taxes and who to leave any property with.
My last thought here is that financial planning doesn't stop when one retires. Good planning in retirement can mean more usable income, lower cost transfers to heirs and better peace of mind.
Investor · Mableton, GA · Member since 2009 · 1k+ posts · 465 votes
16y
I must admit that I didn't read all the posts here so I may repeat some. Just to counter some of Rich's point which are all true but...
1. No more property taxes to pay.
2. No more maintenance to be bother with
3. No more managing
4. No more insurance expense
5. No more liability to worry about.
However, two things you do have to worry about:
Default - Foreclosure can be awfully expensive
Inflation - If you, like many of us here, believe that unprecedented inflation is on the horizon, you have to prepare for it. You must structure the loan properly, otherwise, you'll find yourself with pennies in your pocket each month...