Sell Rental and Owner Finance Instead?

Question

I have a rental that I own free and clear. The tenant wants to buy it and owner finance it from me. I am trying to decide what I should do. Opinions wanted.

Details:

Original Purchase price $136,500 Feb 2019 (single family house, about 15 years old, original HVAC and roof)

I net about $12,137/yr renting after taking out taxes, HOA, insurance, maintenance allowance. 8.9% annual return. Single family house. Easy to rent. Had 20 applicants and 3 fully qualified tenants in 1 week.

Tenant purchase price $165,000

Cash down payment to me $24,750

$140,250 financed by me @8.5% interest only. $993/month or $11,916/year

Tenant will not sell or refinance for 5 years (can sell back to me)

Investing the $24,250 will take the net income from the owner financing above the projected annual rent.

I own 3 other rental units and I have one other owner financing deal.

The obvious benefit is not having to deal with maintenance. Obvious downside is no further appreciation or income in 5 years.

What have you done in a similar situation or would you do?

Thanks!

Richard

David Wandel · Answer

@John Terry  I have my attorney draw up the note and mortgage and prepare all the other necessary docs. The note will specify all the terms like interest rate,length,balloons,rate resets,etc. The only time I do interest only loans are on short term loans. I sometimes have automatic rate resets based on the federal prime rate at the beginning of specified year. This is to make sure that I continue to get the return that I want in case interest rates go up.

I would definitely have an attorney that is familiar with real estate notes to prepare the necessary documents. You want to make sure everything is done correctly in case you need to foreclose or want to sell the note down the road.

John Terry · Answer

@David Wandel  Thanks for the feedback. This is my line of thinking as well. It almost sounds to good to be true which is why I wanted to make sure I wasn't missing anything. How do you set up your note so there is no balloon payment? Can you give me an idea of how it is worded? Are your notes interest only?

John Terry · Answer

Thanks for the feedback @Michael Henry. My plan for financing will be interest only. If I did P&I, the payment would be more than the rent. I cant see why anyone would do that.

David Wandel · Answer

When I have a good tenant that wants to buy the house I always sell to them because if you don't you will lose them. They will go find another house to buy.

They have already passed your screening criteria so they should be able to or close to being able to qualify for a loan. Assuming that their rental history shows that they pay on time and they can come up with the down payment I would sell them the house.

If you haven't done any updates you are getting into the time period where cap ex items are going to start popping up. If you sell to them they will be responsible for all repairs and maintenance.

I would probably adjust the interest rate up to bring their payments to the same or just a little higher than what their rents is.

Selling on owner financing is my favorite exit strategy. I still get a monthly income. No repairs or maintenance, and I make money on made up money(the interest on your profit). I don't put balloon payments into my notes. I really don't want them to refi out. At least not in the first 6-7 years.

Your return will be better with the owner financing because you won't have the HOA fees and repairs coming out of your money.

24k is a decent down payment. I would be selling them the house. It will also save you on a turnover. With that kind of down payment they should be able to find another house to buy.

Michael Henry · Answer

@John Terry from my understanding their monthly P&I payment would not be less than their rent payment. So you can adjust the interest rate or purchase price to get to the higher number. The real downside is that you have no idea where the market will be in 5 years. It is foreseeable that we might be in a downturn market and your property underwater wishing you would have sold. On the other hand, if the tenant never refinances out you will look like a genius.