Better Focus: An Example

In my previous blog entry, I explained how I was now going to concentrate on acquiring properties Sub2 and either rent them out or sell via seller-financing. The following is a true-life example on why this is so powerful. You might recall that my very first "deal" from my bandit signs was from a person who wanted me to take over their property with no consideration. The post is here. At the time, my focus was more on buy-n-hold, and if that wasn't possible, flip via a RE agent. Looking back, this would have been a good candidate for seller-financing. Here were the figures:

Description: 1997, 3/2, 1,100sf
Repairs: ~$1,000
ARV: $87,500
Existing Loan: ~$87,500 balance with 2yr lock @7.25% and 2yr prepay penalty

As you can see, I would be negative right off the bat going the retail flip via RE agent route. After commissions, closing costs, and whatnot, I'd be in the hole big time. Buying to hold and rent would have been equally a disaster. However, with seller-financing, I could turn this bad deal into a good deal. Since we are selling without using traditional financing, the pool of buyers is a lot bigger. People who have bruised credit and couldn't qualify, or even people with good credit, but who have just moved or gotten a new job, are excellent candidates. Since you are able to offer the buyer the incentive of not having to go through traditional financing, the terms are now flexible in your favor. In this particular case, I could add a premium to both the sale price and the financing. For example, the ARV is around $87,500. I could boost this figure up to around $94,900 - about an 8.5% increase. For terms, I could offer 2% or more above the going rates. Since the underlying loan has a 7.25% rate, I'd boost the rate to about 8.5-9.5%, so that I can add monthly cashflow. Also, depending on the situation - and because I'm the "lender" - I can ask for a 2yr balloon, 5 yr balloon, 15yr w/no balloon, or whatever. Since this particular property has an adjustable rate based on the LIBOR, I'd like to add a balloon of no more than two years. I'd also like to add at least a one year prepay penalty of my own to recapture any money in case the new owner decides to turn around and refinance. Therefore, my terms would look like this:

Sale Price: $94,900
Downpayment: $5,000
Loan Amount: $89,900
Loan Terms: 9.125% w/2yr balloon and 1yr prepay penalty

I'd gather $5,000 up front to use on other properties, marketing, or whatever. Since the existing loan has a current monthly payment of $603.73 and the new loan term to my buyer has a monthly cost of $731.46, I'll be making about $127/mo in positive cashflow. True, I'll lose out on the interest rate reduction and other tax benefits that go along with owning the property, but this is about turning a property that originally had no promise into something that cashflows! Plus, in two years when the owners refinance, I'll get a nice check for the equity difference (~$3,500). So, in two years, my net profit would be:

$5,000 downpayment +
$3,500 equity check +
$127/mo for 24 months =

$11,565 !!!

For a deal that had no promise!

Now, of course, there are a few drawbacks to doing this. For instance, what if the buyer doesn't live up to their agreement, and you have to foreclose? Or, what happens if the buyer quits paying? Or, a miriad of other scenarios. I figure it might happen, but if you carefully screen your buyers, it should lessen the chances a great deal.