Is this a Deal?

Question

Pretty motivated seller wants to sell his old home to move to his new home.  Here are the numbers:

Asking - 200k (way too high)
Owes - 165k
FMV - 170k thru 185k

He has tennants living in the home now but I don't know what they are paying for rent.
Owner/Landlord says the house does not need repairs (as far as he knows)

My exit strategy is to wholesale but can't figure if the tennants will make or break this deal.

Any help will be appreciated. :D

Michael Dorgan · Answer

And what exactly would the sales price be with the 17-18k lump sum?  As far as I'm concerned, that's money straight off the purchase price.  Also, partial interest = reverse amoritization = leverage working against you.  Ok for very short term deals, deadly for anything else.

If, 165k sales price and 17-18k cash brought to the table and you pick it up subject 2 the current loan and the buyer is willing to help pay the mortgage for a bit (if this is what partial interest means), then you have a passable deal.

165 - 18k = 148k / 186k = 80% LTV - the starting point of a decent deal, but absolutely no room for wholesaling profit.  Help on payments and the loan in the sellers name makes the place cashflow break-even so there's the possibility of future rent appreciation and loan paydown for a buy and hold.

The big problem with this is, the deal is not at all clean.  You are leaning very heavily on the current owner and if anything goes wrong, it would look bad in the eyes of outsiders (you 'stole' the property with a QC deed, made the person pay you a 10% fee, then forced him to pay partial rent while you collected all the profits?  Guilty.  Next case.)  Once the seller is out from under the property and his assets are out of the fire, he won't be willing to keep supporting you.

Kevin Oliver · Answer

Well the only way this would be a deal (non-wholesale) is to make it a lease option.  Your seller if he is motivated can either just walk away from the house selling it to you for what he owes.  In turn you could lease option the property to a tenant buyer for 2-3% in option consideration and monthly payments enough to cover the loan.
Secondly you could do a sandwich lease option in which the seller lease options you the property for 1 year with (4) 1 year options and then you in turn sub lease it out to a tenant buyer, with 2-3% in option consideration and monthly payments to cover the original lease payment.   Just some thoughts.

Cliff Bradshaw · Answer

OK, this might be a bad one but I'd be remissed if I didn't ask about how the 17-18K lump sum he promised along with partial interest is not attractive in this scenario.

PS-Actually, this is my first deal and I'm 'sorta' trying to learn as much as possible about why or why it is not a deal, and educate myself on dealmakers and dealbreakers.

Thank you all for your help!

Jon Holdman · Answer

Actually, its easy.  You need to buy it for much less than what he owes.  Two ways to do that.  Either the seller brings some cash to the table or you negotiate a short sale.  Lease option isn't going to get much more than market rental rates, and won't get rid of all the expenses (e.g., vacancy, legal expenses.)   This is just not a deal.  Forget about it and go onto the next one.   This is a numbers game in more ways that one, and one of  those ways is that you have to sift through a bunch of bad deals to find one good one.  Just chalk this up as one more bad one on the way to a good one.

Jon Holdman · Answer

Who is that coming from, why is it coming, and when?

Michael already explained you're several hundred in the hole a month on the current tenant.  But sounds like someone's claiming you're positive by $25/month.  I'd guess all that means is that the rent is $25 a month more than the PITI payment.  That's a LONG way from $25/month positive cash flow.  I think he's claiming that the tenant will end up buying for $185K and you'll have to pay off the $165K loan and you'll net $20K or so.

That's total BS "Flip This House" math.

You'll have to buy this house.  That means a closing.  Since it would be a direct owner to owner subject to transaction, your costs won't be too high.  But hardly zero.  Figure $2000 to be safe.  You're in the hole $400 a month.  Say this tenant buys it for $185K in two years (unlikely, but we're being optimistic here.)  He gets a loan. Now you'll have real closing costs.  No RE agent comission, but still about 2% of the transaction.  That's $3.7K.  The buyer will have closing costs, too.  About the same with a point for their loan.  Plus all the prepaids.  Buyer has to kick in $5K.  No can do they say.  Fine, you say, wanting to be rid of this albatross.  You kick in another $3K.

So, you pay $2K up front, $9.6K to hold it, and anther $6.7K to sell it.  You pay off the loan and net $1700.  And you pay tax on that.  That, my friend, is a bad deal.

Now, maybe you get your rent every month, no hassles, and you don't incurr that $400/month in holding costs.  Instead,you're break even.  So, you net $10K on this deal.

If I'm misunderstanding the deal, please explain.  Because I don't understand you explanation so far.  That makes me think this seller is jerking you around because you're a newbie and trying to make his problem your problem.  There are a lot of people in this business who prey on newbies who don't really understand th math.  They talk fast and try to convince you a crap deal is a good deal.   Don't fall for it.

Cliff Bradshaw · Answer

What (if any) are any other options I have to make this a deal not limiting to wholesaling?  Is there anything he can do to 'sweeten the pot' to make this a deal for any exit strategy?

Michael Dorgan · Answer

Still probably not a good deal.  You didn't mention note terms, rate, time, etc.  An amazingly good 2nd at 0% interest or something may get it close to buy and hold territory, but no where near wholesale land.

Assuming no notes and a sale at 165k with comps at 186k, you are at 89% LTV.  That is risky and won't work unless you are getting good appreciation (not in today's market).  Also, your cashflow is not positive, it is very negative.  If you intend to manage the place yourself, you can only count roughly 60% of the income as yours.  Why?  Mortgage is 1225 (assuming fixed), what about taxes and insurance?  Those may be mostly included in that mortgage figure, but your will be higher.  How about a maintainance fund for when the roof goes bad?  Vacancy allowance?  How about paying yourself a little for dealing with tenants?  That adds up quickly.

Also, are you assuming the mortgage?  If not, you are probably going to end up paying a lot more in interest than the owner.  My back of the envelope calcs show the owner currently paying in the 6s for his mortgage.  You will pay in the 7s or 8s depending on your credit.

Add that all up and I get at least 400 a month negative cashflow or so.

This is not an investor grade deal, this is a retail, give it to a Realtor for a small cash kcikback deal.

Jon Holdman · Answer

Paying $165K for a rental that generates $1250 in rent will never make money as a rental.  Paying 89% of ARV will never make any money as a flip. Michael has it right.  Move on.

If you pay $165K for a property you need something like $2500/month in rent.

For a purchase price of $165K you need an ARV of at least $236K assuming it needs no work.

Cliff Bradshaw · Answer

He owes 165K which is at least what he is looking for. Comps revealed that a similar house across the street sold for 186K in March of this year. The current tennants are paying 1250.00/month rent and the seller is paying a 1225.00/month mortgage. Thanks for helping me on this. Let me know if this is enough info or if you need more and I can ask the seller.  Thanks again.

Jon Holdman · Answer

Not enough information.  What are you paying and what are the terms you're getting?  What's the rent?