Posted by Brent_IL on January 23, 2004 at 23:40:42:
Except for the past two years, prices are pretty stable here also. For decades it?s been about 2% to 4% appreciation a year. I don?t really get that much of a discount off of the market value. I?ll usually pay the seller?s asking price, or slightly more. It?s the rest of the terms that create a low present value of acquisition. Twenty years ago, I learned from Ray Como that the only reason I wasn?t getting zero interest financing from property sellers was that I wasn?t asking for it.
Working with the seller, I work down the expenses until we get to the monthly NOI. In this area, it will not be more than one-half of 1% of market value. I tell the sellers that this is how many dollars your monthly NOI will buy as a mortgage payment. They won?t sell that cheap, but now all that?s left is to talk about terms or for them to throw me out. Since I talk to must-sellers, they aren?t going to throw me out. If the sellers want more up front, I point to the NOI. If they say the monthly payment is too low, I might shorten the term, but the interest rate stays at zero. If I agree to higher payments with higher interest, I?ll mess around with the interest allocations so the loan payoff is much less than perceived.
The outcome is that a large discount off market value isn?t necessary to create something that?s salable. I used 15% as an example of the discount rate associated with a high LTV deal. It was picked from air. Remember that the partner’s participation is less than 60 months most of the time. I?ve paid 12% to non-working partners since 1979. In the interim, short-term interest rates have gone from 20% to 1%, so the discount rate offered on the cash flow won?t make or break a deal of this type.
Some reasons I don?t keep the cash flow are:
Habit. I didn?t start out that way. I had to sell cash flow off because I had no money to close the deal.
I haven?t internalized all of the benefits of receiving a steady monthly income that I convey to my sellers. In my mind, money talks, BS walks; Cash is King; et al. If a house or two has trouble, I can cover it. Should the real estate market head into an abrupt 20-year decline, me and all partners will have trouble. The cash will still be there to pick up the pieces.
Many times the ?cash flow sale? is structured as a loan out of a trust. Capital gains rate is preserved.
I think a real estate market correction is inevitable. Builders are building because the interest rates for construction money are low. Demand for the house is optional. I think that as record foreclosures continue to come on the market, any weakness in the economy and a rise in interest rates will start a trend toward lower selling prices. The time to buy is when the majority is selling. Cash helps.
One of the reasons that I haven?t been doing too much lately is that I no longer believe that I will automatically be able to cover the take-out for the passive partner by selling the property if the R/B can?t get financed in two or three years. I?ll take a chance personally, but I don?t want to involve too many others right now.
Newbie has to make a decision in 1.5 hrs: HELP!! - Posted by REI_newbie
Posted by REI_newbie on January 23, 2004 at 14:37:24:
After going to a couple of REI seminars, reading Carleton Sheets and an REI book by Peter Conti & David Finkel, I’m about to make my first deal, but I need some advice.
The seller has to move due to illness in the family (in about 1 - 1 1/2 months), so he is offering his 4BR, 1.5 Bath SFH for $189900 in a NW Suburb of Chicago. I got a CMR from the agent that I’m working with and 2 similar homes sold for 215K. The home is is good condition.
Does this sound like a good enough deal?
If it is, what would be the best exit strategy?
1)Rehab & Flip?
2)Lease Option OR Rent to own?
3 Buy it as owner-occupy(I am still renting), move in and
get a home equity line of credit in 6-8months?
Re: Newbie has to make a decision in 1.5 hrs: - Posted by Brent_IL
Posted by Brent_IL on January 23, 2004 at 15:14:02:
Depending upon your ability to finance, you might be able to rent or L/O and hold. Acquisition is too high for a wholesale flip. L/O would work if you can handle the risk.
So, you?re at 88% of market value. I?d do it to flip the financing, but I wouldn?t get all excited about this deal. The important thing is to speak with the seller to find out what he?s thinking. He has to move soon. You?re the solution to his problem if you can agree on the way that you pay him for his equity. For quick cash, I?d want him to go about 10% lower or more if he wanted to close in a week. If he wants his price, try a subject-to or a re-fi and subject-to with a deferred down payment.
You have to find out what the seller needs in the form of cash to be able to structure the deal.
You say that the house is in good condition, but then the first exit you mention is to rehab it! Does the house need work or not?
If it does need work then this is probably not much of a deal. (I wouldn’t really know, I’m not a rehabber) However if it is in good shape and you get it for say $180k, this would be a solid installment sale/rent-to-own deal, assuming those comps hold up.
You would sell it for around $235,900 with $8-$9k down, and generate a healthy cash flow with a 3 point mark up on the interest.
Posted by Brent_IL on January 23, 2004 at 17:06:56:
It?s short hand for purchasing under one set of financial terms and reselling on a different set of term. Any value added is in the financing and not in renovation or rehab.
For example, FMV = $100,000. Buy at %90,000 with 10% down and zero interest for 30-years with a call in five years. Sell on CFD at $110,000 with 100% financing at 11.65% APR, buyer contributes 3% toward closing costs and has a balloon in three years. The monthly spread is about $877.00. In 36 months, I owe the seller $72,900. My contract buyer owes me $108,542. My annualized ROI on the $9,000 is over 127%. It?s not quite that great because maybe the place needed paint and carpeting, but it?s still good.
We can take it one-step further, and package the whole thing to yield 15% a year to a passive partner. If we want to pay less, we can mix-and-match deals to reduce the guy?s risk, but let?s use 15% for this example. A non-working partner who bought the deal at a discount rate of 1.25% a month will pay slightly over $48,000. We paid $9,000 down and $5,000 in refurbishment and incidentals, so we get paid $34,000, at closing, of shortly thereafter.
Maybe not legally, but in every other sense we are at risk for the duration. I?m not quick as quick to discount-off this type of deal as I was in the past.
Brent, I’m curious, why do you sell off all this great financing you seem to be getting for yourself?
I’d prefer to bring a passive partner in, stay in the deal myself, and collect that beautiful cash flow.
Frankly a 12% discount on this type of deal would be fantastic in my market, but maybe Chicago is different? I always forget that my market seems to have much more stable prices than a lot of other markets, so big discounts are next to impossible, at the same time you don’t need a huge discount to protect yourself either.