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Real Estate Rookie
How to Structure Seller Financing (Get a 5% Interest Rate!) (Rookie Reply)
00:32:10
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- [00:00]
A
What if the bank says your equity doesn't exist, your Airbnb turns into a money pit, and your very first investment deal needs seller financing at 5% all at once.
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B
Today we're solving three rookie dilemmas that could unlock six figure upside or sink your savings if you guess wrong.
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A
This is the Real Estate Rookie podcast and I'm Ashley Kerrick.
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B
And I'm Tony J. Robinson. And with that, let's jump into today's first question. So this question comes from Jonathan and he says, I recently purchased a home with a hard money loan and I'm nearly finished with the renovations. I plan to live in the house. The value of the house has gone up significantly due to partially cash invested and primarily due to sweat equity. I'm being told by my mortgage broker that the only valuation that would be looked at is the original purchase price of the house because I haven't owned it for more than a year. It Is this a quote unquote, find a different lender type of issue, or are there laws about this? I basically want to make sure I can access my equity. I'd like to take as much as I can without paying a penalty in the form of PMI or a much higher interest rate. Are equity lines different? Can I take a regular mortgage and get a new equity line immediately after for 85% of the new value? Just trying to understand options here. And while I'm not new to home renovations, the financing part is new to me. All right, so a couple of things here, and we recently talked about this in a different episode, but there's something called a seasoning period on a home purchase. And different banks, depending on how they operate, have different seasoning periods, but typically what you see is somewhere in the 6 month to 12 month range. Now, I'm not sure if like, you know, like Fannie and Freddie have guidelines on this. I would assume that they do and theirs are probably more strict. Um, but oftentimes you'll see that a lot of banks or credit unions, local banks, can, can do it within six months. If you attempt to refinance or tap into that new value in less than six months, then yes. Oftentimes they'll only appraise it at the purchase price or sometimes purchase price plus cost. Right. So you can't really tap into the equity that you've built up. Ash, have you seen anything different in your investing experience?
- [02:17]
A
Actually, the live in flip that I'm doing now, I bought it with private money. I used my line of credit to do some rehab to the property to make it livable and get it somewhat up to my standards. And I actually refinanced after 30 days. So we at least got the appraisal after 30 days of the renovations things being done. So I'd only owned it that 30 day period and the bank did the refinance with me and they took the appraised value of the property. This was a very small loan, local bank and I can't remember for sure but I'm pretty sure I ended up choosing the portfolio loan option where it's actually an in house loan with that local bank where it's not, you know, a government backed alone. So that could make a difference on it. But you could and I don't know, it didn't say in this question if this was going to be a primary home or if it's a rental property. But you could also go to the commercial so side of lending for a bank and refinance. That way you're not going to get as great of terms but could be some kind of financing. You hold on to property for a couple of years where they usually do not have a seasoning period. And they could also do like an appraisal off the, the income based approach, a DSCR loan too. I've also done that where I've refinanced in a short period of time to pay back hard money and there was no seasoning period there. So I think the, the problem might be just looking at traditional loan types and you know, expand more into other loan products.
- [03:53]
B
Yeah, and as you mentioned, a term that I think is, is like worth just defining a little bit further. But you said portfolio loans. So oftentimes when you get a mortgage, that mortgage is not actually staying with the person who you sign all of those documents with. Many times it's getting resold on what's called like the secondary market. And sometimes those get resold to institutions like Fannie Mae and Freddie Mac that are kind of like quasi government agencies. And they buy up a lot of mortgages, right? Like lots and lots and lots of mortgages. But they also have very strict guidelines because there's this government aspect to them. So you think about like an FHA loan, right, Or a lot of conventional loans get resold to Fannie and Freddie. The other kind of pool that buys these are like institutional investors, right. I think like the big private equity firms or insurance companies or things like that, they'll buy up a lot of these loans as well. But then sometimes you'll see banks not resell those loans and they simply Keep those loans on their own books. And they're the ones who are servicing the debt, they're collecting the interest, and they're just going to hold it for 30 years because they want to make their money work. And when you see banks that have this portfolio loan option, they typically have more flexibility because they're not worried about making it fit the box that it needs to fit to be able to be sold to Fannie or Freddie or some of these other institutions who have their own rules and guidelines. They get to make it the guidelines themselves. So he asked the question of, is this, you know, just go find a different lender type situation? And seems like maybe the answer is yes.
- [05:31]
A
Yeah, I think another thing too that he called out here was, should he just get that mortgage for whatever amount they'll give him 80% of the purchase price and then get an equity line of credit immediately after? So this was also kind of another question we answered on a rookie reply was about getting a line of credit when you already have a mortgage in place. So he did say he's going to plan and to live in the house, so he'd be able to get a home equity line of credit. But that bank may also, if they already have the seasoning period on the mortgage, they might also have a seasoning period. So to get a line of credit on the property, too. So you might want to ask that question. And then he did say 85% of the new value. Can I get a new equity line immediately after for 85% of the new value? And I just wanted to clarify that, as in say the Property is worth 100,000. We're going to do this for easy math for me and say that he had a mortgage on the property of $80,000. Okay. For that 80%, he got 80,000. So that 80,000. That 85% would only be another $5,000 that he would be able to get in a line of credit. Okay. Because you're increasing. You already have 80% of that is your mortgage. So that means there's 5% left of the new value. So that would be 5,000. Obviously, he had gave us different numbers so it'd be more than 5,000 he could get. But I just wanted to make it clear that you weren't getting 85,000 on top of the actual mortgage you have on the property, too. It's that difference between the mortgage and that 85% that you'd have. And, you know, I've seen people, my one partner got one for up to like 90% of his home equity, the mortgage and then the line of credit combined was 90% too. So I think there are different percentages that banks will offer to, to get those lines of credit.
- [07:30]
B
I think the next step if I'm in this person's situation is I'm just going to find, you know, 100 local banks and credit unions and just call them all and say, here's what I did, here's what I'm looking to accomplish, here's the timeline that I'm looking to do it in. Do you have any options that might fit this? And chances are if you call around to enough banks, maybe instead of you waiting 12 months, maybe it's six. Maybe instead of six months it's 90 days, maybe they say, yes, we'd love to give you a loan today, but I do think that there's value, probably a tremendous amount of value in getting this deal in front of enough people because especially if you've, if you've forced a lot of appreciation, if your all in cost was, you know, $200,000 and the properties now worth $215,000 so it's a small margin, right? So maybe there's less banks interested in that. But if you are all in at 200k but the property is now worth 500k right there, there's a lot of equity there that I think a lot of banks would, would love to partner with you on. So probably is a case of maybe go talk to some more lenders and see if there's someone that's maybe more flexible. And I think the last thing I, I'll add Ash and you know, let me know if, if, if you've ever seen this. But again, depending on how much equity you have, you could also go to someone from a private money perspective. Like if your plan is to, we're not sure how long you plan to live there, but maybe if it's a shorter term plan for you, maybe you only plan to be there for 24 months, then maybe getting a private money note from someone makes more sense. And yeah, maybe the interest rate is a little bit higher, but you're able to tap into that equity today and you get a nice big check and then you can either sell the property in two years or refinance or whatever you want to do to get the cash out. So other options I think around the table for you.
- [09:11]
A
Yeah, and that's a great point too because like if you got that private money loan and even though if you didn't want to sell like after two years, depending on what your closing costs would be. If you have the opportunity to tap into that equity again, you'd be able to pay off that lender. Think about what you could do with that money over the course of two years and that may greatly reset, you know, offset the the cost of the closing costs and things like that too. Up next, your Airbnb isn't printing cash, so should you pivot to midterm travel nurses or lock in a 12 month tenant, we'll dive into that after a quick word from our sponsors.
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- [10:34]
A
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- [12:06]
A
Our next question comes from Erica in the BP forums. Hey everyone. We've been renting our fully furnished four bedroom two bath home as a short term rental near Park Hill which is close to hospitals, but it hasn't been as profitable as we hoped. We're now exploring other options. We were planning to switch to a long term rental, but someone recently suggested trying midterm rentals since the house is already furnished. Before making a decision, I'd love honest insight from anyone with midterm experience in Denver. Is midterm actually a good choice right now for this area? What's a realistic monthly income we could expect for a four bedroom with two bathrooms in this location? Which platforms or companies offer the best commission rates for furnished midterm rentals in Denver? I'd really appreciate any advice or numbers from folks who've done this. Thank you. Right away I'm going to say yes, I would try midterm rentals before I tried doing short or do a long term rental and the reasoning because it's already furnished. So I feel like to go from short term rental to long term rental and then switch gears again to try midterm rental because long term I think you should try out midterm rental too. But also the first thing is really to check your laws and regulations and what the rules are and make sure there's no restrictions or different certifications you need. And usually this goes more on the short term rental side. But just to double check because Denver does have a lot of rules and laws and regulations around the city limits for renting properties. But I the thing I think that I would actually do in this situation is offer all of them. So I would list keep my short term rental listing open for a period of time. I would market it on a place like Furnish Finder and I would put it up as a midterm rental. So like say I have a couple of Airbnb bookings through October and then nothing. I would put the available date for November 1st, put it up there as a midterm rental and then I would also list it as a long term rental for a pretty ridiculously high rent and have that available as of November 1st and I would see which bookings I got. And if I got short term rental bookings further into November, further on, then I would cut out the, I would, you know, change the date when available. But if you don't want to do the short term rentals, you could do this just midterm and long term. And if you get someone for long term that's willing to pay that high amount, then I would just shut off the midterm rentals. The only thing is you got to keep like your dates updated when the place is available or not. But I think that is the route that I would go.
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B
Before I even talk about switching gears, I think my first question would be, why isn't this property performing well? Is it internally driven or is it externally driven? Internally driven could be. Are you getting a lot of bad reviews? Right. Are you as the manager, not equipped, which is totally fine if you're not, because not everyone is. But are you as the person managing this, not equipped to actually deliver a good experience to your guests? And is it the review scores that are pulling down your property's performance? Is it pricing? There are a lot of folks who don't understand the nuances of accurately pricing your Airbnb. So it could be that maybe your prices are too high and because of that you're not getting enough nights booked. Or it could be the inverse where maybe you're priced in a way that you're fully booked, but you're not making any money because you're giving the property way too cheaply. So is it pricing that's the issue? And if it's either of those, like, what's, what's like the second layer behind that, are your prices too low? Because maybe you've poorly designed the place and the only way you can get someone to book it is by dropping your prices so low that it, you know, that's the only way people book it if you're 50% lower than all the other properties in that area. So is it, is it a scenario where maybe if you reinvested a little bit back into your design and your amenities that you could get to where you want to go? So those are all of the, the internal forces. And I, maybe one more to add as well is what were your initial projections and how did you land on those? Did you actually underwrite this deal as a short term rental and did you have data points to back up how much money you thought you would generate both in terms of top line revenue and bottom line profit? Or did you just say, man, Denver's a great place. I know it, I like it here. This is a cute house. Let me turn this into an Airbnb, because if there are no actual projections behind it, then how do you know if you're underperforming or, or, or overperforming? So, so those are the internal pieces I think I would try and answer first. And then the external factors are, well, what's happening in that, that Denver market that you're in? Is this a, a trend that's specific to your listing or is there something market wide happening in that market where the majority of listings are seeing revenue dip? The majority of listings are seeing occupancy dip. Because then, you know, it's not necessarily you doing something wrong, it's just the market. And that might be a stronger signal to say, okay, let me transition away from short term because maybe it's not working here, but maybe I can do a better job with midterm or long term.
- [17:39]
A
Yeah, I think that's a, a great point, is really identifying what is going wrong with the property in the first place and then strategizing from there and then also making sure that when you're going to your, if you do decide to pivot to the other strategies is making sure you understand what's involved with operating because those operations are significantly different for each of those different strategies.
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I think the, the other thing that I'd add actually, because I agree with your point of, hey, it's already furnished, let's try the midterm rental out before we get rid of all the furniture and turn into a long term rental. I think maybe one additional layer, you could probably market it simultaneously, but is doing furnished room rentals. So you could midterm rent the entire place or you could just market each room individually already furnished and maybe charge a slight premium above that as well. Because if you've invested the money into designing and furnishing this place, I think it would be best if you could keep those things and not, you know, I mean, as soon as a couch sits inside of your home, it's probably lost more than 50% of its value. So you reselling this, you're not going to be able to recoup what you spent on the furnishing. So if there is a way to still keep those in place while driving additional rental revenue, I think it's something to explore. So I would, I would list it as a midterm rental, Ashley's point of furnish finder. But then also list each room individually as A furnished room rental.
- [19:03]
A
And you could list it as a furnished long term rental, the whole house. I mean, we just did an episode with someone who was buying houses from people getting divorced. So maybe you're one of those people that just got divorced. You know, maybe the other person took the house, took the furniture. You have nothing starting over. So like, I feel like there's also a lot of scenarios where someone could be looking for something that's already furnished because like you said, it is very expensive to buy brand new furniture and it is very time consuming to be on Facebook marketplace to look for used furniture for each piece that you need and go and pick it up and bring it home. Like in, I guess in the example of the property that I have it, we have it listed with the photos from the short term rental listing with all of the furniture in it. And we do not state that it is furnished or not furnished. And I think that leaves it very open ended, as if somebody was looking for furniture, like loved the furniture, loved the design, say yes, for another $150 a month or whatever it would be, we would happily leave the furniture in here. And worst case scenario, they say like, no, we don't want the furniture, we're going to sign a one year lease, whatever. Then you know, we get rid of it. Or we say, you know what, we were not going to charge extra, just take it so you don't have to move it.
- [20:24]
B
But it's convenience that people will pay for, right? I think that's the biggest thing. So you've already got that asset of the furniture, the amenities, the design. So see if you can leverage that first. All right, guys, we're going to take one quick break before our last question. But while we're gone, if you haven't yet, make sure to subscribe to the real estate Ricky YouTube channel. If you're listening to this on Apple podcasts and you want to see mine and Ashley's beautiful faces, then you guys can find us on YouTube @RealEstate Rookie. And we'll be back with more right after this.
- [20:50]
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- [25:19]
B
All right, guys, let's jump back in. So our next question comes from Kyle. Kyle says, I recently found a house in Dallas. It's been listed for 120 days that is 100% owned by the seller. And they're actually open to seller financing. I'm interested in buying the house and renting it out. I have the ability to put down 10%, though there's one big potential downside. There's both a selling and buying agent involved here. And I believe they're expecting 3% each. I've never purchased an investment property before, although I do own my primary residence, let alone done a seller financing deal. Can someone walk me through the thought process I should be using when constructing the offer? I Need the interest rate to be roughly 5% to break even on an interest only loan and was considering a balloon payment in five to seven years. I know that the interest rate is well below market, so maybe this simply won't work. The seller is highly motivated to sell and has already knocked down their price 6% since listing it four months ago. I'm open to all suggestions, advice and criticism. Great question. And I think before I even get into like the anatomy of the deal, let's just talk about quickly what seller financing is for folks in the audience who aren't familiar with it. In a traditional real estate transaction, vast majority of people are going to a bank and saying, I found this property 1, 2, 3 Main street and I need your assistance bank in buying this property. And the bank says, hey, we saw the deal, we like it, we'll give you 80% of the purchase price. You have to come up with the other 20% of the purchase price. That's how the vast majority of real estate transactions work. You buy that property, you give 20% to the bank, they put the other 80% in the seller's pocket and then you make payments to the bank for the next 15, 25 or 30 years, whatever it may be. In a seller financing scenario, the seller is acting as the bank. So the seller owns this property free and clear. So there's no mortgage on it. So let's say that I went to Ashley and I bought her one of her properties on seller financing. I'd say, hey Ashley, I want to buy your house. I'm going to give you and say we agree on a purchase price of $100,000 just for easy numbers sake, I'm going to give you 20% down. So I write Ashley a check for $20,000. So she gets that check today, she assigns title of that property over to me, and then we create a promissory note, basically a promise to repay the other $80,000 and we can set up that promise to repay her in any way that we want. It could be 30 years like a normal mortgage, could be 10 years. You know, with the balloon payment we can set up however we want. So this is what we talk about when we say seller financing. It's where the, the seller is acting as a quote, unquote bank in the transaction. So Ash, what's your, what's your advice to this person here in the, the different factors at play here?
- [28:07]
A
I love this question because I love talking about making offers and seller financing because there's just unlimited opportunity and options here. And so I Think it's great that he already knows, like when he runs his numbers at an interest Only at first 5% is the payment that he can make and still get the cash flow that he wants from the property or the mortgage payment that he wants. So I think it's already great that he already knows that to be able to make this property affordable to him, he can only afford the payment at what is a 5% interest rate with interest only payments. Okay. So knowing that that's what works for you, we can kind of manipulate the other numbers, but also we could also go back back to the interest rate. So it's almost like pulling levers and seeing what works and doesn't work. And the more insight you can get from the seller, I think is also very helpful. So if there's a way to be able to get face to face with the seller, be in contact with the seller, I know that it's probably, you know, not that easy to be, get face to face with them, but if you can get some kind of insight as to what their motivation is. So do they care more about purchase price? Do they care more about how much interest they're paying? Do they, you know, care about how much monthly they're getting when the balloon payment is. I did this one deal before where the person wanted and no down payment, but they wanted $20,000 over like each year end. So instead of giving the $60,000 upfront as a down payment, it was at year end. So it gave me a year to accumulate 20 grand in cash flow. So really was $0 out of pocket. But this, with this thing, I think start with the purchase price as to what they want. Okay. And then looking, you know, you have your interest rate or whatever. So here's my concern with the way this one is structured, that it's interest only. So this means that after the five to seven years, you will not have paid down any principal on this loan. Looking at this property, I want you to be very, very sure that you're going to be adding value, that this is going to appreciate for more so that you can go and refinance or when you sell it and you're not going to be underwater on this deal because you didn't pay any principal down. What I also want you to look at is like, what if you did pay some principal? So amortize the loan over 15 years, amortize the loan over 30 years. There's no rules here like there is in banking. Like you could amortize it over 40 years if you wanted and Propose that. So your payment is lower, you're paying principal, they're making the interest on it, and then in five to seven years or whatever it may be, you're going to go and pay off that balance that owed. So I guess my first thing would to challenge you to not make it an interest only loan because that's a long period of time to not be paying down any equity and I think it makes it a lot more risky of a deal.
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B
Yeah, like the one seller finance note that we have right now, it was amortized over 30 years. Balloon payment due at year 10, I believe. And the first three years were interest only. And typically you kind of leverage that interest only period while you're stabilizing the property. Right. So we renovated, we're making operational improvements, we're trying to increase top line revenue and that's how we're trying to drive more value. To Ashley's point though, those last seven years will have paid down a decent portion of the principal as well. So, yeah, I do think there's some value in not doing only interest only during that time frame. But one of the other questions that he asked here actually that I think we should address is the buyer and seller agents and you know, the 6% commission needed between both of them. It's tricky because you've already engaged with the agents and I'm assuming you're saying buyer, agent, maybe you signed some sort of agreement with him saying that they're going to represent you. I think my first ask. Because you also don't want to kill the deal. Right. But I think my first ask is asking the agents if they would each accept maybe a slightly reduced commission to try and get the deal done. Call it like two and a half percent each. So you're not going to percentage point off. There's. And then you said that you're willing to put down 10%. I would either negotiate with the seller. And these are all starting points. Right. Obviously, depending on what the seller says, you can kind of renegotiate from there. But I would as a starting point say I'll cover the 5% in agent fees if I can have a zero down payment. So you're still putting money towards the transaction, but it's going to cover the agent's commissions and you're still saving 5% because you're only putting down 5% to cover their agent commissions. The other option is you tell the seller, hey, I'll give you the full 10% down, but I would ask that you cover the commissions as a seller, which is customary, I would ask that you cover the commissions for the agents. Right. I think you might be, it might be hard pressed to tell the seller that you're not going to give them any cash up front and they're also responsible for paying the agents. Right. Because now they're just like literally writing a check with no money coming in. But I think those would be the two things that I might try and tackle first. Would you, would you approach it any differently, Ash?
- [33:34]
A
Yeah, because I think that's pretty standard. Like even though we had those different law changes about commission and real estate agents, like, it's still, at least in my market, still very standard for the seller to pay both commissions. You do have to like put that into your contract that you're going to pay that. But like a property I just sold, the buyer's agent put into the contract that the seller will be paying their commission as part of the deal, which has been pretty standard. But I mean it could be you could do it so that you're each paying 3% so that it's broken up between the two of you. But yeah, that's a great point that, that's something that's definitely negotiable too. And a lot of the deals I've done recently in the last several years, it has been 5%, not 6% anyways too that I've been paying the agents. I think in summary, the, the point of seller financing as an advantage and opportunity is that it's negotiable. So pick something and start with it and make sure you're on the path of what works for you. And then based on their first response, as long as it's not like never contacts me again, this is a joke. Like you're, you know, and you hurt their feelings because it's such a bad offer. At least get some insight as to why if they say no, this isn't going to work. Get some insight as to why. Is it the purchase price, like they want to sell it for 275,000 or whatever it is. Like, then you can change other numbers to make that deal work for, for you. Okay. As in the terms of the seller financing of what the down payment is, what the interest rate is. So that should be after you submit the offer and if it is denied, that should be your next step is to figuring out what part of that didn't they like. And then kind of problem solve as to how you can make that something that works for them. And then, you know, you move another piece so it works for you. So it's kind of like a puzzle manipulating, you know, the terms of the seller financing so that they work both for you. But don't give up if you get that initial rejection. Figure out what's important to them and tailor the deal that way where it still works for you. Okay, well, thank you guys so much for joining us for this week's rookie reply. I'm Ashley, he's Tony, and we'll see you guys next time.
- [35:55]
D
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