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Real Estate Rookie
Deal of a Lifetime? How to Structure a Win-Win Seller Financing Deal (Rookie Reply)
00:24:10
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- [00:00]
Ashley Kerrick
Today we are going to go over getting started. What options do you have available to you as a rookie investor? We'll also go over purchasing a property from family, including how this deal has seller financing wrapped into it. We go over what's the best way to structure. This is the Real Estate Rookie podcast. I'm Ashley Kerrick.
- [00:22]
Tony J. Robinson
And I'm Tony J. Robinson. And with that, let's get into today's first first question.
- [00:27]
Ashley Kerrick
So today's first question is from Trevon in the Bigger Pockets forums. I am a new investor who is in the process of buying my first rental property. I have gotten a pre approval letter from the bank for a mortgage loan. Seeing that the interest rates are high right now, it's looking like my room for profit is limited. Is now a good time to go through with this or take the capital I have and try to invest it into another real estate deal? I am located in Georgia. Just a quick background on myself. I started in the Airbnb but didn't own the property, AKA Airbnb Arbitrage. Therefore, I didn't have much valuable insight as to what investment options I could make. So I would love some input from experienced investors on the right moves to make. Thank you in advance. Okay, so to kind of summarize this here, this is an investor that has some capital. They want to buy their first rental property. They're saying profit is limited, as in their cash flow, because their mortgage payment is going to be higher because their interest rates are high that they're looking at. So I think the first thing I want to recommend is do you actually know that? Do you actually know that the cash flow is limited on the deal? Have you been analyzing deals going through? Analyzing five a day, 10 a day, just to go through and see what the, the mortgage payments would be on each of them and what you could rent them out for and what the cash flow actually is because there are still deals out there even with paying, you know, interest rates now, high interest rates compared to a couple years ago when you could get an interest rate for 3%. But that doesn't mean that there aren't deals out there. There's definitely more room for negotiation when buying the deal. So you can get most of the time a deal for less than he would have, you know, two years ago when interest rates were a bit lower three years ago. So don't get caught up on not buying just because interest rates are high right now. Who knows when interest rates will be back down to 3, 4%, if ever, right? Yeah. Yeah. And that is A really big opportunity costs that you would be missing out on. Not getting a deal now, waiting to time the market perfectly. I'm under contract on a deal. The deal is still going to work even with current interest rates.
- [02:51]
Tony J. Robinson
Yeah. Couldn't have said it better myself, Ashley. I think a lot of new investors are anchored right now in the 3% interest rate environment that we saw for a brief moment in time. So much so that they're passing up on deals today because they're hoping that those 3% interest rates will come back. But everything that we're seeing from, from just like a macroeconomic level, nothing's pointing towards rates at any point in the near future. Getting back to what we saw, you know, in, in that time frame coming out of COVID So the, the goal isn't do I wait for rates to come down. The goal is how do I invest today in a way that still allows me to achieve my goals, knowing that the higher interest rate is a real challenge that we have to overcome or maybe an obstacle that we have to navigate. I, I think the, the thing that I would want to get clarity on is, is what are you actually trying to optimize for here with this first deal? Are you trying to optimize for cash flow? Are you trying to optimize for long term appreciation? Because maybe, you know, maybe you're a teacher and you love being a teacher and you're, you're just trying to buy some real estate to help supplement your retirement. Maybe you're a high paid executive who hates his job and wants to leave as soon as you can. So you're really optimizing for cash flow. What is it that you're optimizing for? And if it is cash flow and you feel like it's really slim on this deal, and again, to Ashley's point, how many deals have you actually analyzed? But if you feel like it's slim and that's what you're optimizing for, then yes, by all means, don't pull the trigger on this one. Go search for something else. So I think a lot of it comes down to, hey, what are your goals? What are your motivations? What are you optimizing for? Because if the question is, is there a better deal out there, probably it's just taking the time to actually go out there and find it.
- [04:39]
Ashley Kerrick
We have to take a quick break, but when we come back, we're going to talk about how to acquire property from an aging family member. We'll be right back.
- [04:46]
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- [05:22]
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- [06:13]
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- [06:43]
Ashley Kerrick
Okay, welcome back. This next question comes from Matt in the Bigger Pockets forum. I could use some community input and how to handle a sticky family situation. I have a family member with two eight unit properties in central Philadelphia. Each property is worth about $2 million today and mostly occupied. The family member has had the buildings for decades and managed them on his own, but he is 80 years old with health declining, cannot properly manage them anymore. Each Property probably needs 200 to $400,000 worth of work for deferred maintenance, repairs and moderate upgrades. He would like me to take them over for him. He was willing to sell at a discount with or without a seller note to put them into a trust with me as a beneficiary as long as I agree to take over all management responsibilities, directly or indirectly. He wants some cash either in a lump sum or annuity in the form of interest and principal payments or continuing to receive majority of income. I live in Washington D.C. and have a busy career, so I assume I'll need to have a local minute manager. I'm a novice with no real estate experience. If I do not take on the properties, he will sell them within the next 12 months to an unrelated party and I will never receive any portion of the proceeds. I don't mind putting in some time and effort, but I want to make the best decision for all involved. I have about 250,000 in cash and 1.4 million equity line of credit at 6.5% interest. What should I do? That's actually a pretty good interest rate for a line of credit. I just got a notice the other day that my line of credit rate was, had just changed as 7.75 I think. But it's also very, a lot smaller line of credit for I think 100,000, not 1.4 million too. So that could definitely make a difference in what the interest rate is too.
- [08:26]
Tony J. Robinson
Yeah, and he's got a quarter million just cash that he can go deploy as well. So I mean sit in a really good position. But Ash, I mean, I don't know, I don't, I don't really see a lot of like challenges here. You know, this feels just like a lot of opportunity to make it a win win for both parties involved. I mean in the question he very, very clearly stated this family member is open to either a lump sum or ongoing payments in the future, potentially seller financed. If I'm in this situation, I think the first thing I'm going to do is just offer exactly that, hey, you know, uncle or whoever this person is to you. I'll buy it at this purchase price. I'm going to ask for no money down that way I can take the cash that I have and put that into the, you know, 300k of deferred maintenance. But then I'm going to pay you at a fixed interest over the next, you know, whatever time frame you guys agree on and that's how you'll get your steady cash flow without having to actually worry about managing this property. So is that something, something that you're interested in that. That's where I would start, Ash. I Don't know. Are you looking at it differently?
- [09:28]
Ashley Kerrick
I just went back and reread it and I missed this one word it said or it didn't register. I don't know if I actually read it. But he says he is willing to sell at a discount with or without a seller note or to put them into a trust with me as the beneficiary as long as I agree to take over all management responsibilities, directly or indirectly. So basically he has two options here where he can buy them at a discount right now, have full control of them, right. Reap the benefits of them, or he can inherit these properties but has to take over management responsibilities until that he becomes a beneficiary of the trust. So basically when this family member passes away. So I actually think I would go for the long term play. I think I would put them into a trust. I would hire the third party property management company and I would do asset management and oversee that and I would do that little work to inherit $2 million worth of property. And I mean say he lives another 10 years, another 20 years. Is making $2 million over 20 years worth it? And plus the properties will hold, hopefully appreciate even more over the period of time. Plus two, I don't know a ton about trust. I know a little bit, but also too, a lot of times when you put a property into a trust, when you become, when the trust like actually kicks in, you become the beneficiary, you take the, the tax basis becomes what the value of the property is when you inherit it. So say like right now the properties are worth 2 million or say, you know, he bought them however long ago, there's probably great, a large amount of it's already depreciated. So if you hear the grandfather was to sell them, he would pay all these capital gains tax because there's just, you know, going from 2 million to say he bought them for even, you know, half a million, however long ago or whatever, he'll pay capital gains tax on that. And then you have this new tax basis that whenever you sell the properties, you bought them for 2 million and then you know, you sell them for 4 million or whatever. But like if you have them in the trust and in 10 years he passes away, your new tax basis is going to be whatever they're valued at when the trust kicks in. So now say they're 10 years later, they're valued at 3 million and you go and sell them for 3 million, you're going to pay $0 in taxes on the property. Now this is not all trusts, there may be like nuances and things to that, that, that may happen. But like, that is one situation where this could be a big benefit to you, but also to the family member too, where they're not going to pay capital gains tax selling it to you. And then he did mention seller financing was an option and that of course would offset some of the capital gains. But I think I'm not taking ownership. I think I'm going the trust route and I'm going to do the work as the asset manager to oversee that. The property manager is doing their thing. The only concern I have is that the properties do need work that 200,000 to 400,000. So I would also try to negotiate that you would lend your fam, that family member, the money to do that from your line of credit, and then they pay your line of credit back. So you set up some kind of payment plan where it's coming out of the profits, you're lending them the money and you're, you know, say you're making six or you're getting charged six and a half percent, maybe you charge seven and a half percent and you make one percent off of it. But knowing that these properties are going to be yours and you want them taken care of, but you don't want to have to dump in $400,000 of your own money and sit and wait, which could be, you know, even 30 years till he passes away. Hopefully he lives that long, you know, So I think like doing it as you're lending the money to fix them up and then he's paying you a percentage, you know, every month of principal and interest payments out of the cash flow of the property every month.
- [13:58]
Tony J. Robinson
It's a really good point, Ash, and I think I, I overlooked that part of the question as well. I, I do feel like it, it maybe also comes down to what this person's strategy is going to be with the deal. Like if they also plan to hold it for the rest of their lives, like, like, you know, this family member did, then yeah, keeping it through the trust actually might be a better option, both from a, a, a tax perspective and I guess even almost like an asset protection perspective. Right. But maybe that is the, the right play. But if, if maybe, you know, his goal is, hey, I want to buy this and then maybe 1031 in the next five years into something bigger and instead of 28 units, I want to go out and get like a 50 unit somewhere. Having actual ownership and control that asset might be more important. So as with a lot of the questions that you know, that we try and answer on the rookie replies. Maybe a little bit more context around this person's goals and motivations would help. But I, I, it's clear here that both of these paths I think offer some, some benefits. It's just what aligns more with, with what it is you actually want out of this deal and what makes the most sense there. I actually don't know. Ash, if there is debt on a property that's in a trust, when that person passes away, what happens to that debt? Does it just automatically get rent reassigned to whoever owns that trust?
- [15:24]
Ashley Kerrick
A lot of times the trust has to sign so like whoever's the executor of the trust, they have to sign to get the debt. So if the property's already in the trust, I know that like the executor of the trust has to sign for the debt. So the debt is also in the name of the llc, it's in the name of the trust and then usually the personal guarantor. So like it would be the family member at this time, you know, guaranteeing the debt on a personal level. So the, the trust would already be part of the debt. I don't think a bank would lend on a property that was in a trust without making the trust sign on the loan docs either. I used to work for an investor where I would, he had stuff in trust and that's how it was always done. The bank would make the executor of the trust sign for the loan to. I don't know how it works. If you have debt on the property and then it's transferred into the trust and then the person passes away and then you become the beneficiary. That I don't know, I know for the investor I worked with, he would have big insurance policies so that life insurance policies that are trust owned. So in that circumstance the insurance policy would kick in and that would be used to pay off the debt on the properties. But I don't know if that was like something that the bank required to have once it was, you know, put into a trust. So because like a, a trust like your, your deed usually still says like your LLC or whatever and that's what the bank looks at. So I don't know. I, I'm definitely not a trust expert. I've just seen things and they could be wrong and they could be right. I, I have no idea. Just.
- [17:09]
Tony J. Robinson
You are not our resident trust expert today we, yeah, we, we interviewed Brian Bradley and you know, guys, don't, don't quote me on this. This was like probably a few hundred episodes ago. But he talked about asset protection, all the different layers and maybe we need to bring him back to give us like a refresher on trust and when to use them and, and questions like that. Like what happens if I buy it on my personal name that I transfer to a trust and then I pass away? Like what happens to the debt? Because the reason why I asked that question, Ash, is because I think it does give us some insights into what the person who asked this question should be doing if they want to keep it in the trust to make sure that that process goes as smoothly as possible once, once that family member passes away.
- [17:49]
Ashley Kerrick
But your questions and I think too like make sure you have it in writing as to what your roles and responsibilities are as the manager. So like do you get to make decisions? Because what if you're, you know, you're the family member? I think, you know, like he's getting older and older and he can't make sound decisions. You know, like maybe he's just not there all anymore but like he still is the owner of the property. You also don't want to get into a decision where he's saying, no, I'm not spending, you know, $50,000 on a new roof. Like it's fine. And then there's like leaks coming into the tenants apartments and you don't want to put your own money in to fix it when you don't own it. But so I think like be very clear as to what do you have control of and like what happens in these certain circumstances when there is, you know, a capital infusion that needs to be put into the property too. Okay, we're going to take our last break and we'll be right back after this.
- [18:54]
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- [19:30]
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- [20:41]
Ashley Kerrick
Welcome to our ugly home.
- [20:43]
Resimpli/RentReady Advertiser
Reddit is back for a historically hideous season. It's our 100th ugly house. This place is mayhem. That is impressive. And if these walls could talk. Do you cry a lot?
- [20:55]
Tony J. Robinson
I do.
- [20:57]
Resimpli/RentReady Advertiser
They'd have a lot to say. What in God's name is this pit? Don't get too close.
- [21:03]
Ashley Kerrick
No, no.
- [21:03]
Resimpli/RentReady Advertiser
You've seen the show. I'm scared of that. Ugliest House in America Season premiere Wednesday at 8 on HGTV so you're about.
- [21:12]
Ashley Kerrick
To make a trade based on a friend's text.
- [21:15]
Resimpli/RentReady Advertiser
But which u do you listen to.
- [21:17]
Ashley Kerrick
Is it we could buy a house in Tulum get optioning those options.
- [21:26]
Resimpli/RentReady Advertiser
We could lose everything.
- [21:29]
Ashley Kerrick
Or let's do a little research, get.
- [21:33]
Resimpli/RentReady Advertiser
Your head in the trade and make the investment decision that's right for you.
- [21:36]
Ashley Kerrick
Learn more@finra.org TradeSmart okay, let's jump back in. Our next question comes from the BiggerPockets forums and it is from Jade. We're new to real estate and I'm looking for advice for more advanced members. I'm a registered nurse and my husband has a plan to get an apprenticeship in carpentry. So our first option is we would move to California and live in an apartment. Our main house, which is in Wisconsin, would be rented out as a long term rental. I work as an RN and my husband wants to get an apprenticeship so Option B, we would buy a five to six bed house somewhere, doesn't matter where, and live with three other people who would pay us rent and we would live there with them. And we can do the apprenticeship and I can be an RN while we get into our corporate housing business. We just don't know if buying a house in the next few months is going to be worth it. With the market. What do you guys think and where would be a good area to invest in a five to six bedroom house in the usa? The options, I love this. Like you know what, we're going to move where it makes the best deal. We had Austin Wolf on before on an episode and he literally did that. He analyzed markets and he moved to a market. His job was remote just because it was. He wanted to live there and house hack for a year. And after a year after he house hacked he moved back to where he had lived before. He missed his girlfriend I think he said. But he literally did this and I think that is such a cool thing to be able to do to set yourself up financially by moving to the right place. The first option was moving to California. I think that I'm going to say that this would not be the best market and especially like tax wise and.
- [23:21]
Tony J. Robinson
Well that was my follow up question is like why California? They didn't really mention like what the motivation was to go to California is because you feel that both of you will end up making significantly more money in your jobs. If you were to go to California is because you're from there and you want to get close to family. Like what is the motivation there? And they also said actually if they do the California move that they would rent out their current home in Wisconsin. But I guess the other question is if they go out and buy a five or six bedroom somewhere else, are they doing the same thing with that property in Wisconsin or are they selling that property to help fund that next five or six bedroom purchase? Because if, if in either way you're going to turn the property in Wisconsin to a rental and I felt like that kind of changes things because then it's just okay, well where can we go to actually make the most money and you know, net at the end of the day have the most money in our pockets and if it's staying in Wisconsin and being an RN and you know the carpenter apprenticeship, then just stay there, right? Because you know that market, you combine that market again. But if you're, again if you're going to California because it's like we can make significantly more in our line of work than we can say in Wisconsin, then I think it makes sense to go there. So I guess just some clarity on what they plan to do with that house in Wisconsin. If they, if they want to buy that five or six bedroom would be helpful as well. The other part of this question was like, what market should they focus on? And if we had a nickel for every time someone asked, what market should I go invest in? Guys, the truth is 20,000 cities in the United States. There are plenty of cities across the country where it makes sense for you to invest. The goal isn't to find every single one because that would be impossible. The goal is just to find the cities that actually match what it is you're looking for. So we want good population growth, you know, maybe, you know, low, low, low crime, good schools. Those are the benchmarks, you know, job diversity. Those are the benchmarks of markets that tend to do well for traditional long term rentals. So if you can get that in Wisconsin, then just stay there, right? Because again, you know that market, you've already purchased there. But if you're not seeing those signs there, then yeah, by all means you can go somewhere in the Midwest, you can go somewhere in the Southeast like Google. Best places to invest. And I'm sure everyone's done a list on what that looks like. So I think I would spend less time necessarily worried about the actual city and just more time focused on what are the criteria that we're focused on. And just filtering cities through that to see if they actually match because there's a good chance you could just say where you are and it works out fine.
- [25:46]
Ashley Kerrick
Well, thank you guys so much for joining us today on this week's Rookie Reply. I'm Ashley, he's Tony. And we'll see you guys on the next episode.
- [25:53]
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- [26:47]
Tony J. Robinson
If you're watching this, we want you to apply to be a guest on the Real Estate Rookie Podcast. That's right. Ashley and I are looking for amazing stories just like yours to be a part of our Real Estate Rookie Podcast. Now look, you don't need to be an expert. You don't need to have done thousands of deals. Even if you've done one deal, your story could help inspire the next listener.
- [27:05]
Ashley Kerrick
As a rookie investor. Especially if you just got your first deal. It is all fresh in your minds and you are the best person to tell your story. Give your experience on how you got it done to help someone someone else get their first deal.
- [27:18]
Tony J. Robinson
So head over to biggerpockets.com guest if you want to be a part of our show. Again. That's biggerpockets.com guest and we'd love to have you on.