Seller agrees to carry back financing, running myself thin?

Question

I negotiated seller financing with a motivated seller. The terms are good but I am worried I am taking on too much as I already have a deal in the pipeline.

Here is a hypothetical: arv is 200k, needs 30k of repairs, terms:150k purchase price with $500 monthly principal only payments for 5 years then balloon.

There is obviously value in the terms... One idea is to assign the contract. (I assume I  can sell this contact to an investor).  How would I determine the value of the contract? How much would you pay for this contract?

Another idea is to get an equity partner to spread the risk but again, I am not sure how I would structure it

Any thoughts are appreciated!!

Jerry W. · Answer

The terms are great, the price is not so great.  Even if you get it done for $50K and sell it for $200K, with 7% selling costs you are looking at only a $6K profit margin.  That small of a margin can disappear quickly.

Steve Vaughan · Answer

Way too thin for a flip as @Jerry W. mentions.  Would this make a good rental? Would it rent for about $2k per month?

The terms are attractive, but Uncle Sam will force imputed  interest to be paid as far as I know.

If a good rental, find a buy and holder and wholesale it, Joe!

Bill Gulley · Answer

If you already negotiated terms of a deal then why are we speaking hypothetically?

Your price example isn't a deal as Jerry mentioned.

Next, the value in your contract has nothing to do with your financing terms, you can't assign those terms to anyone else, the only value is the equitable interest gained through the sale contract.

Financing does not add value to any real property. The only value between great terms and bad terms is to you, financially as well as intrinsic values, but intrinsic value is not assigned to real property from loan terms.

The IRS will impute an interest rate for tax purposes, selling an unknowing seller into zero interest can backfire on you, what you dream up and present in financing, you're responsible for! Reduce the price and add interest, that's better for the seller too as interest income!

When you partner you give up profit, do things yourself but this doesn't look like a deal to donate any brain damage to. :)

Steve Vaughan · Answer

Sounds good for a buy and hold @Joe Doman.

I don't like the 0 interest part.  Your seller is going to have to report an installment sale.  The IRS will not accept a 0 interest deal.

I am not an expert, but I would pay something.  Discount the price a little for 2% interest or some such.

Our esteemed colleague much more knowledgeable than I in these matters is @Bill Gulley .  Maybe he'll have a sec to chime in.

I won't tag a CPA until Bill has a chance.  Thanks, Bill!

Bill Gulley · Answer

The seller will have imputed tax rates from a no or very low interest loan, they will change annually, he'll not really know until they publish the rate, it's a PITA and causes an unknown tax loss to sellers who are not aware of this, his tax attorney may hit the roof and you'll then have a problem. These can also be predatory lending issues, so my advice, regardless of how great it seems is not to do such a loan.

A financing agreement, note, contract, sub-2, wrap whatever, is a unilateral contract, this is contract law applicable in all states, such a contract cannot be assigned by a borrower without specific consent of the lender. You can sell, but get his consent and allow him to look at his new borrower.   That's with another investor too, any tenant occupant will be a consumer transaction subject to Dodd-Frank and you're not selling your principal residence you're selling inventory as an investor/dealer.

If the seller is really stuck at his price, being a landlord, it's probably overpriced and in his mind he's increasing the value because he's willing to finance it. Just because financing is offered doesn't make a property a good deal and if it's not, walk away. :)

Joe Doman · Answer

wow! Thanks @Billy Gulley, I think I need to look into this a little more deeply..

-I put in the "hypothetical" because I was working out the details when I first posted... I actually offered 3 options, one with interest, one without int, and one cash offer. The seller is really stuck on getting their purchase price and the only way I feel I can get to it and make it benefitial for me, is to offer principal only option. And they seem to be most interest in the prin only option... I'm just trying to create a win-win for both me and the seller.

I was not sure if it was legal to sell a land contract to another investor... knowing that I cannot now, it takes away an exit strategy and makes it a bit more risky... do you know if that is a federal law, or state specific?

The cash flow is very good with the terms mentioned above. After the term, I would be in a good equity position to refi or cash out. I am pretty bummed to hear these tax issues... it might be worth calculating the irs int tax to see how it would impact roi? It sounds like there are other legal issues with this?

Most likely, I am going to renegotiate.

I appreciate the response! Good stuff!!

Joe Doman · Answer

Thanks for the response @Jerry W. And @Steve Vaughan (and sorry for the delayed response).

Regarding the price, the way I look at it, I can get 4.5% in the market place today (30 yr mtg). Using the 4.5% as a bench mark, it would be the same as paying 122K (simple interest), when factoring the principal only terms. (some figures listed below)

Rent is around 2,200 a month. I agree this would be a buy and hold type of deal.. doing a cash out refi at the end of the period would be a good strategy. The more I am looking at it, the more I talk myself into keeping it myself.

150,000

Purchase Price

122,450

Discounted Price (4.5%)

27,550

"interest"

5

Yr term

5,510

"interest per year"

4.50%

Interest Rate

Seller agrees to carry back financing, running myself thin?

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