3% down on a 12 unit land contract, but no inspection til signed?

18 Replies

I'm working on a deal for a small 12 unit apartment property. Units are 1bd/1ba 500sq ft. Avg rent is $420. Cash flows $1800/mo at 100% capacity. Seller is an upstanding member of the community with 400 units and growing. We've verbally agreed on a purchase price, a down payment of 3%, and a balloon in 45 months. He had his attorney write up the contract. His agent showed me 3 units. The contract allows for an inspection, but does not give the purchaser an exit from the contract should the inspection be unsatisfactory. I understand my position is not strong in this deal and should the inspection come out well, I'll be walking away with a good deal. However, I'm reluctant to sign on a property without having an exit route should I uncover more repairs than I'm ready to handle. 

Are my expectations set too high for the contract to have a "pending an agreeable inspection" clause? 

Has he told you why he wants to sell? What’s the interest rate on the loan? 3 percent down seems really good deal but the interest rate and location could be a deal breaker.

What’s the asset class? 420 rent is really low generally speaking

I admittedly don't have experience with apartment buildings, but I would 100% want some kind out out clause for inspections. If the remaining units are in similar condition, everything is great - but what if you saw the 3 best units? What about the roof/foundation/hvac/etc?

Maybe suggest a dollar limit? If the inspection reveals more than $10K of deficiencies, you can back out. Something like that.

It's nice that he's a great upstanding guy, but I wouldn't place a lot of money on the line for that trust. And in reality, he shouldn't expect you too.

I’m not sure I️ would want to purchase on a land contract, but 3% down is certainly attractive.

With that being said, I️ certainly would not buy without being able to have an inspection contingency. You said you only saw 3 units. What if the other 9 are destroyed? What if there’s a $30,000 foundation issue? If I️ were you, I️ would be wondering why the seller doesn’t want me to be able to inspect the entire property.

Also, make sure you have a plan w the property. Are you buying at market value? Will you be able to refinance if values go down? Can you create some value since you have very little equity in the deal to start? Just some things to consider.

@Stephen Richardson , how much is being asked (per door)? What should the market value be (per door)? ie. Do you know the commercial market cap rate for the area? (No good can come from just taking the Seller's Agents' word for it).

Of course you can ask for a "pending an agreeable inspection" clause. 

But of course, they can say "no". [Certainly, that'd be a big red flag for me].

Your position is strong, because you can offer your price, or walk away at any time!

I agree, 3% down owner financing is very tempting, but it begs the question: why would the seller be offering this, if he's already getting more than what you'd be paying him per month on average? [Because if he's not, how would it be a deal for you to make money?]

Two answers spring to mind. #1: Lots of already overdue deferred maintenance/cap ex, and/or #2: Vacancy may be (artificially?) lower than usual at the moment, so the seller wants to strike while the iron is hot. [Nothing here suggests he'd be charitable to you]. All the best...

Iwould not do it under those terms

I️ would require inspection of any and all units by licenses inspector and if I don’t like it Ican wall 

Gents, thanks so much for taking the time to respond. This BP community is so cool. You've really reinforced my resolve to get some kind of "pending agreeable inspection clause." 

@Caleb Heimsoth - Thanks for the feedback! He's selling to get better economies of scale with larger properties and with higher rental values. The property class is as low as you can go before beginning to accept section 8. The property is currently 100% occupied and none of the units are section 8. 

@Mike McCarthy - Exactly! I like your suggestion of the dollar amount. Half of the units have been remodeled this year - new flooring, paint, cabinets redone, bathrooms updated. The other half are going to require $1-2k each of updates and that's doing the work, depending on how much work I do myself. So, I'm fine with updates and remodels. Frankly, room to add value is something I seek. BUT - what if there are structural concerns with the roof, foundation, or wood destroying insects? HVAC isn't much of a concern because it's all base board heat + a wall unit for A/C. Setting a dollar amount and limiting to structural might be a good compromise. 

@Darren Budahn - Thanks for responding. I'd be interested in any drawbacks you see in a land contract scenario. I'll be reviewing the contract with my attorney (when/if I get the seller to agree to putting a better inspection clause in the document) and I'm putting together a list of things I'd like addressed before I meet with him. As far as equity goes, it appraised for $390k in 2015 when average rent as $390/mo. I am buying at market value, but since the appraisal will be commercial in nature, value will increase as I improve the 6 remaining units and raise the rent. That said, I'm basing this on the assumption that base employment in the town won't fall out and the rental market with it. 

@Brent Coombs - Great questions! 10% seems to be the going cap rate. This one is around 11% - largely because of the remarkably low down payment. I appreciate the reminder of strength in the "walk away" position. If I understand your "why is he selling" question correctly, my answer would be that he would eliminate the operating costs of the property during the owner financing period and receive market value for the property in 45 months. Lastly, I asked for historical rent records, but their in-house "PM software is not reporting that right now." 

@Michael Plante - Thanks for the affirmation that an inspection is needed!

@Stephen Richardson I had a similar situation with the inspection though the seller wanted the EMD to be hard the moment it was deposited which I was opposed to. So we came to an agreement (in contract and signed) that if specific issues (we had a few - roof, flooring, plumbing stacks because the seller claimed recent work done) are identified during inspection, we have the option to back out and get our EMD. We did find a huge issue which we were not ready to deal with and received our EMD.

Originally posted by @Avi Garg :

Stephen Richardson I had a similar situation with the inspection though the seller wanted the EMD to be hard the moment it was deposited which I was opposed to. So we came to an agreement (in contract and signed) that if specific issues (we had a few - roof, flooring, plumbing stacks because the seller claimed recent work done) are identified during inspection, we have the option to back out and get our EMD. We did find a huge issue which we were not ready to deal with and received our EMD.

EMD (earnest money deposit, right?) hasn't even been mentioned in this deal. This is really good food for thought as I negotiate further.

OK  if I am reading this right he wants the 3% down payment paid up front none refundable.

normally that would be couched as EMD .. subject to inspections.

he owns 400 units you own how many ?  playing devils advocate this screams of someone unloading a property they don't like for various reasons.. tenant base.. property condition.. etc etc.

and sucking you into giving him 3% up front and you lose it if you don't close.. wonder how many 3% he has gotten from others :)

Originally posted by @Stephen Richardson :

Gents, thanks so much for taking the time to respond. This BP community is so cool. You've really reinforced my resolve to get some kind of "pending agreeable inspection clause." 

@Caleb Heimsoth - Thanks for the feedback! He's selling to get better economies of scale with larger properties and with higher rental values. The property class is as low as you can go before beginning to accept section 8. The property is currently 100% occupied and none of the units are section 8. 

@Mike McCarthy - Exactly! I like your suggestion of the dollar amount. Half of the units have been remodeled this year - new flooring, paint, cabinets redone, bathrooms updated. The other half are going to require $1-2k each of updates and that's doing the work, depending on how much work I do myself. So, I'm fine with updates and remodels. Frankly, room to add value is something I seek. BUT - what if there are structural concerns with the roof, foundation, or wood destroying insects? HVAC isn't much of a concern because it's all base board heat + a wall unit for A/C. Setting a dollar amount and limiting to structural might be a good compromise. 

@Darren Budahn - Thanks for responding. I'd be interested in any drawbacks you see in a land contract scenario. I'll be reviewing the contract with my attorney (when/if I get the seller to agree to putting a better inspection clause in the document) and I'm putting together a list of things I'd like addressed before I meet with him. As far as equity goes, it appraised for $390k in 2015 when average rent as $390/mo. I am buying at market value, but since the appraisal will be commercial in nature, value will increase as I improve the 6 remaining units and raise the rent. That said, I'm basing this on the assumption that base employment in the town won't fall out and the rental market with it. 

@Brent Coombs - Great questions! 10% seems to be the going cap rate. This one is around 11% - largely because of the remarkably low down payment. I appreciate the reminder of strength in the "walk away" position. If I understand your "why is he selling" question correctly, my answer would be that he would eliminate the operating costs of the property during the owner financing period and receive market value for the property in 45 months. Lastly, I asked for historical rent records, but their in-house "PM software is not reporting that right now." 

@Michael Plante - Thanks for the affirmation that an inspection is needed!

You wrote: "I'd be interested in any drawbacks you see in a land contract scenario" (which coincidentally I also raised as a response question in another thread today), so I googled it and came across the following site:

http://www.ppblawyers.com/benefits-and-pitfalls-of...

Quote:..."Situations not uncommon in the current market are those where the land contract buyer has made all payments, complied with all requirements of the agreement, and paid all property taxes and insurance amounts when suddenly, they have a foreclosure notice on the door. Often the seller has pocketed the buyer’s monthly payments instead of applying them to the mortgage, leaving the home in foreclosure. Such is also the case where the underlying mortgage has an adjustable rate, leaving the seller suddenly unable to keep up with higher payments in the event the land contract payments are less than the monthly principal and interest due on the mortgage. Without protection written into the agreement and proof of payments, there is no guarantee that a buyer’s payment will be applied to the mortgage. This can leave the buyer having complied with every single provision of the agreement and left without the property, as the bank’s first position lien trumps a buyer’s possessory interest".

So, no wonder Darren said: "I’m not sure I️ would want to purchase on a land contract"!

You also wrote: "10% seems to be the going cap rate. This one is around 11% - largely because of the remarkably low down payment". Are you sure you're using the right formula?

ie. "Divide the net operating income by the sale price to get cap rate" does not vary because of deposit amount or funding cost of the balance. You need to totally understand cap rate!

And another thing: On top of every other red flag that we already knew about, you "asked for historical rent records, but their in-house "PM software is not reporting that right now."" 

Don't you agree: This is starting to become beyond a joke?...

@Brent Coombs - I was wondering when someone was going to catch on to their in-house PM software being partially broken. Yeah, the shroud is definitely suspect. They're going to have to shed some light or hang on to the property until someone more gullible comes around.  

@Brent Coombs   I have more than a handful if not two handfuls of time's wakled up knocked on a door of a home I bought at trustee sale ( sherrifs sale out your way) and the tenant shows me the contract of sale they had with the owner.. owner ripped their payments never paid on the underlying and let it go to sale.. now properties get posted so I am not sure how these folks miss it or they call and the sellers says oh its a boo boo don't worry.. pretty sad state of affairs at that point.  I don't buy and hold so I ended up having to ask them to leave with the exception of one couple .. they worked for a company that had a ESOP and then got bought and got 600k large and paid me off. :) pretty nice job working at a grocery store that got bought.

@Stephen Richardson and @Brent Coombs

Good job listening to Brent. I was LOLing pretty hard reading your posts. I'm glad you see the light now Stephen. Glad we are watching each other's back out here, you took it well Stephen and didn't get defensive unlike some other newbies that solicit for help. Good luck and hope the next deal is better - you have the right mindset.

Here's a quick update. Seller is permitting inspections prior to signing. No EMD. No down payment paid before signing. Just a verbal agreement on the contract prior to inspections commencing. It looks like there are some revisions to the contract that need to be made on both ends, so it was probably a legitimate oversight when the contract was drafted. Stay tuned...

Originally posted by @Stephen Richardson :

Here's a quick update. Seller is permitting inspections prior to signing. No EMD. No down payment paid before signing. Just a verbal agreement on the contract prior to inspections commencing. It looks like there are some revisions to the contract that need to be made on both ends, so it was probably a legitimate oversight when the contract was drafted. Stay tuned...

Don't forget to ask: why a "Land Contract"? [If he won't change that, I'd suggest: walk!] 

Originally posted by @Jay Hinrichs :

OK  if I am reading this right he wants the 3% down payment paid up front none refundable.

normally that would be couched as EMD .. subject to inspections.

he owns 400 units you own how many ?  playing devils advocate this screams of someone unloading a property they don't like for various reasons.. tenant base.. property condition.. etc etc.

and sucking you into giving him 3% up front and you lose it if you don't close.. wonder how many 3% he has gotten from others :)

lol yup! There’s this guy in my area, has his hands in almost every apartment in the region, keeps owner financing them to others for  ridiculous prices.. everyone who takes a bite defaults 5-10 years later, he takes back the property and does it all over again.

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