Quote from @Martina Pollard:
Hi everyone,
This is my first post, so apologies if I should've tagged something different.
My husband and I live on the east side of the Salt Lake Valley, and we’ve been exploring ways to achieve financial independence and build wealth through real estate investment. While we've done extensive research, we understand that nothing compares to the real-life experience of owning property and being landlords.
Here's our situation: we currently live in a duplex and are considering buying it from our landlord. Our idea is to continue living in our unit and have our next-door neighbor (attached unit) pay us rent, which would help cover our new mortgage. Our long-term plan is to eventually move out, rent both units, and buy a house of our own. From there, we'd look into repeating the process with other multi-family or single-family units.
A bit about us: I work in corporate marketing, and my husband works in corporate accounting. We have no current plans to expand our family. We’ve looked at some of the figures, but we can’t find an easy way for this property to produce positive cash flow.
We’ve mentioned our interest to our landlord. He’s older and prefers to be the “bank,” a method he has used for several properties he previously rented out and sold. However, we haven't provided any hard numbers or a formal proposal yet. We’d appreciate your advice on the following points:
- -Drafting a Proposal: Is it worth drafting an official proposal with a commitment to a certain down payment to show our seriousness? Do you have any tips on how to convince our landlord to sell to us or that we’re serious about this?
- -Alternative Options: Should we move on and look for other properties to purchase instead of this duplex? This would be our first mortgage, and we're wondering if it's wise to pursue this specific opportunity or find another one.
- -Homeownership First: Would it be better to first purchase a home of our own, get some experience being homeowners, and then start the process of renting out properties? Essentially, should we take this step-by-step approach rather than jumping straight into being landlords?
We’re looking for any advice, personal experiences, or tips that could help us navigate these decisions. Thanks in advance for your insights!
@Martina Pollard
Hi Martina,
On the surface, this sounds like a great opportunity. It looks like your seller wants to seller finance the deal to 'be the bank' - which can be great - maybe you can negotiate a better deal on interest rates than what is currently going on in the regular market - which would be awesome.
As for which home first - I would definitely go for the duplex you are already in. There is no reason to buy your own first for experience purposes - and the fact you already live there makes it 'owner occupied' if you end up going with traditional bank financing - which will give you better rates, and access to more programs.
So with an owner occupied house and traditional financing you can put as little as 3.5% down on a property to purchase it. If it were a straight investment property - you are looking at least at 5% on some newer programs, and often upwards of 20% down on an investment property. Your interest rates are often higher for a non-owner occupied home than for a personally owned home as well.
So if you end up doing seller financing - it is your opportunity to try and get either a better rate, or better terms than you can get with traditional financing. So hopefully that gives you more ways to negotiate your deal with your seller. You can look at your personal financial situation and figure out your shortcomings and pitch it to your seller. It's a blank canvas as to terms (at least until he states what his are.) Maybe you want / need to put less down on the property. A regular bank might say, "We require 20% down, and that's the way we do it." A seller finance deal you might be able to negotiate, "We'd like to put 5% down and do interest only payments the first year, and then start regular payments." You can also try to negotiate things into your sale. Like if the AC's on the 2 units were 25 years old, but somehow still running - you may not want $10,000 in AC replacement expenses the year you buy your property. So maybe you negotiate those repairs into the deal to avoid that?
There is really nothing hard about being a landlord (in general). But you are having to interact with people - and hopefully you do that with the same respect you would want if you were the one renting, versus buying. You also become responsible for making sure your tenant has a livable space - keeping all the major systems up and going - so hot water heater, AC, the roof, electric, plumbing, etc. Managing one duplex is really no different than if the whole thing was your house - just that there are usually 2 of everything. Two refrigerators, two ACs, etc, and also the tenants.
Hopefully you know your tenants at least a little bit by already living there. But you will have to evaluate them from a landlord perspective going forward. Making sure they make their payments on time, etc. When things go sideways is often when the 'personality' of being a landlord starts to show. Whether it is loud music at night, or "Hey, our car broke down and we won't have all the money this month to pay the rent" - how you handle those situations. Generally speaking I would say you want to be understanding, but firm. You need to develop your rules and policies around late payments; and you have to be able to calmly deal with adverse situations. On the loud music, you have to be able to knock on their door and say, "Listen, the music is so loud we can hear it through our walls and we can't sleep... you're going to need to turn that down after 9pm... or whatever the right answer is to you. Your tenants - as long as they are worth anything- will inherently respect your authority as a landlord. That is something that will take a little adjusting to - that respect! But your tenants should ultimately know that you control their ability to remain in that unit, so if they become too difficult - you just let them know at the end of their lease you will not be offering a renewal if things don't improve - whatever the issues may be. Your lease is a very important document and it should spell out a lot of rights - both for you, as well as your tenant. So definitely make sure to sign a new lease (ie. your lease) even if you take over an existing tenant. You can even just re-write your new lease for their same rate of rent and expiration date, but with YOUR terms and conditions that apply to you being the landlord. This way there is little push-back to get them to sign it (ie. you aren't changing their current rental rate, etc.)
Be sure to consider the thought that there could be a major expense you have to cover at any given time. We have 37 units, and have had to replace 6 ($5,000) ACs in the past month. I've been a landlord for 6 years now and never had a run or expensive items like that!!! (Yes, we knew they were old when we bought them, but you just don't expect them to all 'gang up on you' and break at the same time!) But I don't have a choice - I have to replace them... you can't not have AC in Florida! Had I spent every penny that came in on rent each month, I would be seriously hurting trying to cover that. But since we put plans in place for maintenance reserves, we have those funds set aside and while still painful, at least it is not financially impossible for me to cover something like that. So you too need to develop some reserve accounts - one for repairs, and also one for property taxes and property insurance payments - which are big expenses that are due once a year, but your seller will likely not collect like a bank might escrow for you.
Know that seller financing gives you lots of options to negotiate your deal - but that cuts both ways. You don't know the financial prowess of your seller. Is he going to put something into your contract, or leave something out, that you would want to be there. With that said, I would definitely have a lawyer look over whatever eventually gets drawn up between the two of you. In fact, a lawyer should be the one to draw something up in all likelihood. But regardless, you want to have a real estate lawyer on your side look over ALL the documents that a seller financier wants you to sign. I can tell you that many a seller literally hopes that their buyer's fail as a landlord, as they can collect your down payment, and whatever payments you make before you default, and then they get the house back that they can sell again. They can do this more easily if they write in terms into the agreement that make that easier. So that is one reason why you want someone on your side making sure your purchase agreement is fair both directions, and not exploitive against you.
As to terms - think about your duplex as being fully rented out (even though you will initially live in it). You want to make sure that whatever deal you negotiate if you were collecting rent on both sides, is a good deal as to cash flow. So if your mortgage (principle and interest) and all the other expenses (taxes, insurance, and an maintenance reserve) totaled $2,000, but each side of the duplex will only rent for $1,000 in the current market - that isn't a good deal, right? You are not making a cash flow each month after paying the bills. You are still gaining advantages - market appreciation where the home is increasing in value; tax write offs for depreciation, and your loan balance is going down each month too. But you also want your property to cash flow when it is fully rented out. This is either a negotiation on terms, or price to make that happen. It's pretty easy to tell a seller - "Listen, we really want the house - but at your current terms - the house is losing $200 a month after paying all the bills - we either need the price to be X or the interest rate to be Y for this to be a workable deal."
Or maybe it barely cash flows now and you say, "We get rates are high right now, but we want to be able to do an interest rate reset one time in the first two years we own the property once mortgage rates come down and base it on a known market index. Our commercial loan is based on the 5 year continuous maturity treasury note plus a spread of 2.25%. So if that rate was 4% when our loan reset, we would be paying 6.25% interest. Just know that rates in general are high right now, and if you can negotiate a way to get a lower rate in the future without having to refinance with your seller, that would be a good thing. If not, you can always do a refi down the road. That also goes towards the idea that you don't want a pre-payment penalty after a certain time period if you decide to refinance your deal to get a better rate down the line.
You definitely want to compare the deal your seller if offering to what else is out on the market. This tells you a lot about whether you are being offered a good deal on your place. But be sure to match size and condition of the property to any other properties you might compare it to.
There is much more that can be said - but hopefully that gets you started.
All the best!
Randy