The answer is it depends. On what you would say? Well, there are properties out there where the seller will give you some great terms for you to buy their property. When I say terms I mean seller financing, purchase money mortgages and also called payments over time (sounds nicer in the negotiation). Seller financing is when the buyer negotiates part of the sales price as a loan to the seller. This is where the buyer will owe the seller an amount and will make payments to them until the loan is paid off or when something called a balloon is due. A balloon is a mortgage payment that is due when the balance of the loan has not been completely paid off. For example:
· Purchase Price $100,000.
· Seller agrees to hold $80,000 in seller financing.
· Buyer gives seller $20,000 cash & pays $80,000 in payments over 30 years with balloon due in 5 years.
· In 5 years, the buyer may owe $75,000 and will have to pay that amount in full. The funds can come from selling the property, getting a loan from a new lender or extending the loan with the seller. A good tip is to negotiate the loan extension terms in advance in case it's hard to sell or get another loan.
The $80,000 in seller financing is typically recorded as a lien on the property where the buyer signs a note as a promise to pay the seller. In Florida the buyer also signs a mortgage providing the property as collateral to the debt. This protects the seller in case the buyer doesn’t pay and allows the seller to take the property back. This is similar to a bank loan except the seller is the bank. Hope I haven't lost you, this is just how the title process works. Frankly, you don't have to worry too much on how it is recorded if you have a good title company or attorney handling it. Honestly, even though the gurus promote this as a common strategy to buy investment real estate sellers often won't offer seller financing nor will they accept. However, it should be a tool in your toolbelt to potentially buy more properties with less capital out of your pocket and potentially better terms than banks. Most of the time you will need to negotiate seller financing and educate the seller why they should do it and why with you. If they do offer it be a little cautious about the terms as they could be one sided. Seller financing may sound like something rare in residential real estate and it was a few years ago. However, with higher interest rates it has even become popular for sellers selling residential properties that have no mortgage. Years ago, most properties prior to bank loans becoming so popular were financed through seller financing. Currently it is used commonly in commercial real estate.
Now that you understand what seller financing is let’s get back to our original topic of paying more for the property. If you’re buying a property and the seller is stuck on their price which is higher than the actual market value of the property, there are several options. Walk away or give them their price with your terms. The terms can include full price with low monthly payments with no interest or very low interest. Be cautious about no interest as there could be imputed interest and your seller will be unhappy and we are not in the business of making sellers unhappy. Note, there is a possibility of considering the balloon payment as interest talk to your accountant or tax attorney about that (they should have some experience in advanced real estate transactions). The interest agreed needs to be 50% lower than what you would have paid with a traditional bank loan that amortizes over 30 years. Check out the amortization table on a 30-year mortgage and you will be astounded on the amount of interest a typical consumer pays to the bank—that is how banks make so much money.
More important than the total interest is that the property should positively cash flow. If it is agreed to pay the seller $200 a month the property should be netting after all expenses more than that amount. This sounds simple and is very important to remember. Buyers must be very cautious about negative cash flow as this can send new investors to the bankruptcy lawyer before their career reaches high gear. Imagine a situation of a market turn in which rents go down and the buyer would be even more negative than when they started. If they had several properties cash flowing negatively it will be a deep hole to dig their way out of. Take into account all expenses including taxes, insurance, vacancy, repairs, future capital improvements and management fees. Consider the management fees even if the buyer will be managing the property themselves just in case that needs to change in the future. The manager no matter who it is should also get paid for managing the property as it is definitely work. Last thing is to subtract the mortgage from that figure, if the property is positively cash flowing there may be a deal. If it’s not cash flowing walkway or renegotiate the terms.
There are certain properties in which paying more is worth the risk. They include newer properties that are in highly desirable areas, properties generating a substantial amount of cash flow and when the seller provides a high enough loan to value in which the investor brings less cash to the table than they would have when using a bank. Remember properties in newer areas that are desirable are easier to rent, appreciate faster than other areas and have lower maintenance expenses due to less wear and tear. Multifamily properties generating large amounts of cash flow are highly attractive in this situation. These properties typically generate more cash flow than single family homes and their high amounts of cash flow would allow the mortgage to be paid off faster or would generate substantial positive cash flow. High loan to values offered by sellers combined with the right terms make properties highly attractive especially when using investors. The low-down payment makes the cash-on-cash return to the investors highly attractive as it is based on the amount of cash they put in the deal. Caution, the high loan to value must be accompanied with the right terms of low interest, low monthly payments or both to reduce the risk. Typically, the higher the amount of leverage the higher the risk so be cautious and always remember it is about positive cash flow. Positive cash flow does not matter what the property is worth to a certain degree as long as cash is coming in.
When paying more than a property is worth an important thought to consider is to never ever speculate. This is worth repeating never ever speculate. What is speculating? When investors take risks based on expected appreciation in the future not on sound fundamentals of current values or income. For example, the market is hot it’s worth $90,000 and negatively cash flows. If I buy at a $100,000 today, I can sell for $200,000 tomorrow, next month or next year. This is a big risk to take. What happens is someone will get caught holding the hot potato. The question is will it be you?
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