Been a while since I’ve posted here. I could use some help on analyzing a multi property deal I am considering. I received a call from an older woman wanting to sell all 12 of their rental properties. Her husband recently passed away and she is overwhelmed with running the rental business. Her husband did all the work.
Here’s what I know. The properties are in decent condition in ok neighborhoods. The seller owes 300K on the properties. The total assessed value for all properties is 560K. I know this number is meaningless but the seller keeps talking about selling them for the assessed value. I would need to convince her that I won’t be able to buy them for the number she is thinking. Total taxes are $11,596/yr. Total gross monthly rent is $7288.
I could use some help in analyzing this deal. We currently have 11 rental/contract properties but I don’t feel like I know everything about analyzing deals. Especially one this large.
How should I work through this to determine if it would be a deal. Any suggestions would be appreciated!
Don’t fall in love with the idea of this deal…
The seller has more on her mind than just selling this portfolio. It represents her husband’s life and work. Of course, she wants the most possible.
I would sit down with her and do a ‘yellow pad’ analysis with her. Check out my blog if you don’t know what I mean.
Show her what she’d get conventionally, by listing her property.
This assumes you’ve already seen each property, so you can list and deduct repairs, etc.
And of course, it’s gonna take months to sell, and investment houses don’t sell for the same prices as houses being sold to end/users. That’s just a fact. I mean if we’re gonna pay retail anyway, why not buy from an amateur, that we can work over more profitably, than an investor?
Empathize with her about the hard work of maintaining and landlording over rentals, as it were.
Of course, you want to see her Schedule E for these houses as a negotiation gambit.
She tells you that she only spent 3% on maintenance, and her tax return says otherwise. Sure, honey.
Did I mention that all sellers lie? I don’t care if Mother Theresa is liquidating this pile of junk, don’t trust her a second with the numbers.
Meantime, just like you negotiate a bulk discount, you want a bulk price on buying all these houses at once …and saving the seller all sorts of grief, delays, hiccups, and more negotiating.
BTW, if you’re the first person to negotiate, you’re probably screwed. Sellers often need to get bloodied up first, before they get real. You may be too early. I don’t know. That doesn’t mean you won’t get a second bite at this apple. Just saying.
If this were me, I wouldn’t get too excited, until the seller started agreeing with me over the expense and pain of managing these hell holes.
Otherwise, the overhead on these things IS going to be 50% of market rents. And that’s the number you want to negotiate from. Why?
Because any other, smaller, number turns this into a negative cash flowing gamble at the get go.
Of course, too, single family investing IS an appreciation play, most times. Unless your rent/price ratio starts climbing about 2%. Then it’s about cash flow, and whatever else is just frosting on the cake.
That’s all I got for this moment.
P.S.
To me, today’s NOI is $43,728. Work off that number, at the current GSI.
Then ask, how much more rent can I get? How fast? Can I cut costs somewhere?
Is the seller willing to give me better financing than the bank, in return for a higher price, but better cash flow for me, or not? If not, I want a better price.
Thanks for your analysis javipa! I’m just talking out loud here because I haven’t been inside the properties yet. What if I could by them on contract from her for 10K down, for 375K, at 5% interest amortized for 30 years with a 2 year balloon payment. Is that a stupid play? Am I in the ballpark? My monthly payment to her would be under 2K with a NOI of $3644/month.
At first blush, even at $500k, this is:
8.75% CAP
1.46% Rent/Price Ratio
With an average rent of $607/mo, at $41,666 per door.
Frankly, on a string of older rentals (built in the 1950’s?), I would want to be at a 11% CAP (minimum), but in no case lower than the market CAP. That is if 65-year old rentals in this market can be purchased at 13% CAP, then it makes no sense to pay for what you’re not getting.
Of course, the financing terms can turn an overpriced lemon into lemonade, and that’s something else to talk about.
That said, I have no idea how old these houses are, or which way the economic/demographics are trending, or what the comps say.
At least the seller has a starting point on price. The issue is, what do the comps say? I mean, if you can buy the same houses at a 2% or 3% rent/price ratio, then this is a turd purchase at $500k.
Regarding the seller financing offer…
I would couch the offer as a safe, secure way to achieve an income stream, from an experienced, reliable, successful investor such as yourself.
Think ‘annuity’ vs. short-term financing. Short term assumes the seller is prepared and willing to pay a bunch of capital gains taxes in two years, or whatever. Why go short-term? And just two years? What’s the point. That’s a very short fuse, and a lot of loans to refinance. I don’t like it. Seven years, or forget it. Unless I get more discount.
Assuming I knew what the seller paid for each of these houses, and there was appreciable capital gains, so I could negotiate intelligently, I would say something along this line to frame my seller financing offer:
"Mrs. Widow, you have a lot of equity that is liable for capital gains taxes, isn’t that right?
If she says no, you’re doomed.
Assuming she says ‘yes.’…
Mrs. Widow, capital gains is a 20% tax on your gains, and is probably higher than your current income tax bracket of ten or fifteen percent. So, if I paid you all cash for your houses today, you will lose about 20% of your gains to the IRS. That money is gone, and can never be reinvested again.
However, if I made payments to you instead, you would only have to give the IRS a fraction of that money; do it at a lower rate; and over a longer period of time.
It would be more profitable for you to keep more of your capital gains, as long as you can, rather than give it up to the IRS now, wouldn’t you agree?
Seller agrees.
In that case, Mrs. Widow, I propose to pay you “x” dollars a month, for the rest of your life, no matter if you get sick, go in the hospital, or what. Does that sound good to you?
Seller agrees.
Great, and when you pass, you want your heirs to continue receiving those checks, so you can control how, and when, they receive their inheritance money, wouldn’t you agree?
Seller agrees.
Good. So, here’s the agreement that says I will pay you “x” dollars a month, for the next four hundred and fifty-and-a-half years, or whenever I croak, and begin taking a dirt nap, whichever comes first.
Seller signs.
**** The seller instead asks,
How much are we talking about per month?
What happens if you die?
What happens, if you get in a crack, and stop paying me?
How do I get my houses back from you?
You will have already pulled out your credential book, and showed her what you own, how long you’ve owned it, and letters testifying that you’ve stayed out of trouble ever since your unfortunate incarceration for elder abuse; stopped cheating on your wife for a whole month; quit the cult that skims money off flower sales at the airport three months ago; and that you’ve stopped molesting the community goat. Otherwise, you’ve demonstrated what a reliable, trustworthy, and honest person you’ve been, for at least the last few weeks.
Seller says, OK, that’s all I needed to hear. Where to I sign?
OR
The seller wants “x” payment on $500K, or you can take a hike.
Fantastic …you trade off, whatever it takes to give the seller what she wants, and you take the rest…
OR
Offer her a no-down, principal-only payment, payable monthly, amortized for 40 years (since annuities ‘need’ to go as long as possible, not as short as possible), or however many years you expect her to survive, and then see what happens.
That would be my starting point;
No interest,
Principal only,
30/40-year amortization (or whatever makes the payment profitable, and tax-liability-free for her, etc.).
I know that if Mrs. Widow makes less than $38k per year, she’s unlikely to pay Federal taxes, anyway.
That all said, if you’re the only person bidding on these houses, I would make an offer well below where your top limit is (wherever that is), and fill the front porch full of crap, that you can trade off, and then let the seller beat you to a pulp, so she can equity strip herself blind.
Even then, you want a short fuse on the offer, to discourage her from shopping your offer. After all, it’s unlikely you’re the only one she’s called to unload this deal.
You know, forget her dead husband’s legacy. He’d still be alive if he weren’t farting with these hell holes anyway …the way he was doing it… Just saying :anon
Wow! That’s why I posted in this forum! I really appreciate the time you’ve taken to work through this–you’ve given me quite a bit to think about! Now I need to start looking at these properties. Most of these are older homes 1911, 1918, 1910, 1900, 1943,1934, 1915, 1920, 1914, 1949, 1920. It has to be about the cash flow!
OK, really? 100+ years old? Well, without a shadow of a doubt, you’re looking at greater than 50% overhead, if these haven’t all been re-plumbed and rewired within the last thirty years in copper, or better (NOT pvc!)
At this age, you’re apt to experience multiple avalanches of surprises, just from age, if nothing else.
Not to mention that these houses probably offer obsolete dimensions and features, which make them more difficult to rent.
Things to watch for:
Antique circuit systems and breakers.
Under-powered electrical systems, with rotted, braided insulation, that has served as rat food, with electrocuted rat carcasses embedded in the walls and rafters…
Galvanized (rusted) pipes.
PVC “upgrades” which is a two-syllable word for leaks and breaks.
Lead drain pipes (Impossible to service today).
Extreme settling.
Dry rot in remote places.
Mold.
Asbestos in ‘everything’
Extra small bathrooms.
Kitchens where standard refrigerators are too big.
Obsolete built-ins that don’t function.
Hidden “re-muddling” work behind paneling, wallpaper, etc.
Garages too tiny to park anything, but a golf cart.
Narrow driveways.
Overgrown trees with roots undermining structures and sewer lines.
Stumps in the middle of the lawn.
Oddly narrow interior doors.
Out of square windows and doors (worse, shimmed and permanently out of square).
Peeling paint from poor attic/wall/crawlspace ventilation.
Vinyl siding camouflaging 50-some years of sin and death.
Poor drainage, missing/leaking/crooked gutters.
Frankly the era of these houses makes them like operating a specialty property, with all sorts of unique, and peculiar problems, that you don’t see on an even a 35-year old track home.
This will require extensive and detailed management supervision and followup, since one problem can so easily lead to so many others, and do it in a very short period of time. Why? Because these homes have already become fragile properties, if you want to maintain them as vintage. And if you don’t, and start doing ‘home depot’ quality upgrades and repairs, they start to look really ‘unintentional’ in no time, and become extraordinarily unmarketable, if not downright fugly.
I mean, you’ve seen where someone installed a white, vinyl, press board, ‘loss leader’ bathroom vanity in a rental, and the toilet and bathtub were still Mamie Eisenhower, pink? Multiply that by a dozen other things, and then all you’ll really have left is a cheap shelter to offer to the most indiscriminate of renters, and then it really does become ALL about cash flow, and zero anything else.
If you don’t mind dealing at that level of investing, great. For me. Nope. Frankly, there’s just not enough cash flow, even for me, to manage that frumpy of a situation assuming it’s gone the “Home Depot” route…
I tried that for a while in KCMO, and gave up, because it was such a ‘non-profit’ venture, with high management requirements.
I just didn’t have enough of them, and by the time I did, I’d be smoking crack with my renters, chain smoking Marlboros, and probably wearing my pants around my butt cheeks, all prison-gangsta style. But driving a shiny, bagged Caddy, with gold trim.
Never mind you’re often dealing with a wad of dirty, mentally-disturbed clients, who you accept, because they’re the responsible ones that receive disability checks, and most importantly, willing to rent your “Home Depot’d” hell hole.
Yes, older properties come with disadvantages. However, I’m looking for the cash flow and understand the appreciation will probably be minimal. In our area, rental properties are the older homes because of the lower purchase price. I’d be looking at considerable more money for a home that was build after 1950. Of the properties I currently own, only one was built before 1950–my current home was built in 1920. They have worked well so far but I understand there will be more maintenance issues with older homes. Your points are well taken and I like the annuity approach with the seller!
Jay has done a good job of breaking this down, although I have not seen any vacancy factor adjustment and knowing the additional costs of trying to maintain older property I would be looking for something in the 12 or 13 cap rate for returns in exchange for the risk.
Since it appears to pay for itself and appears to provide some positive cash flow the seller has some ulterior motives for selling the property, yes her husband passed and yes it is now on her hands but the reality is this property is providing a tax benefit, it provides some cash flow and the tenants are paying down the mortgage while the property appreciates and the rental market grows.
So somewhere within lies her motive and I would not be afraid to step up and offer what’s owed on the properties $300K (A wrap) with maybe a $10k second on each property as a 5% note fully amortized over 15 years say due in 6 or 7 years so a 7 or 8 year note term.
She would pay roughly $34k in realtor sales fee’s and probable 25% in state and federal taxes on profits from a sale, I think this offer is within $40k to $50k of her asking price, just done creatively. You and her will still need closing costs to make it work. You could offer to pay her closing costs if she is still on the fence ($10.5k) and your closing costs should be around $8.4k.
This property will cover the cost of this transaction for less than the $43,728 NOI projected before and still leave a little cash left over every month.
Or if she wants the income from the notes full term ask her for a subordination clause and then refinance or re-do a blanket loan based on term and rate when it works best financially.
I know you’ve delivered Gold River but I want to make sure I understand how to present to the seller what you are suggesting. Could you break it down for me as to how I might present this?
I really believe the seller is just overwhelmed. One renter owes her over 4K from not paying. She also told me two renters are not paying so she told them she’d lower their rent in hopes they’d pay. That didn’t help her and they still haven’t paid her!
Arrange a meeting with the seller, explain that your a real estate investor and need to buy in a position to make a profit and extend and advance the portfolio position you currently own and manage. Explain that you like her properties and understand that selling them one at a time costs her money in carrying costs, management time and realtor fees at 6% of sale price. Explain to her that you understanding she would end up paying about 25 / 26 percent in state and federal taxes on profits from an outright sale.
Suggest to her your interested in making a creative offer which allows her to sell the property, end her management headaches and essentially make about the same thing she would make on an outright sale without the tax and accounting hassle’s and sell everything in one single transaction.
Let her know your offering a creative deal because these properties (Homes) are old and the condition / management could be an initial struggle.
Her Imagined Transaction - Probable Sold Individually
$560,000 Her Asking Price
$33,600 Potential Realtor Sales Fees
$300,000 Existing Financing Balance
$14,000 Closing Cost on Asking Price
$212,400 Potential Pre Tax Profit
$55,224 State and Federal Taxes on Profit
$157,176 Net Profit
Your Creative Offer
$300,000 Current Loan Balance (12 Homes) Wrapped
$120,000 #12 - 2nd TD Notes @ 5% for x to xx years. ($10,000 each)
The difference is $37,176 dollars. It’s the equivalent of offering her a 93.4% of asking price and taking all 12 homes off her hands.
Explain to her your real estate experience, the fact you currently have 11 properties and your desire to help her while you improve your own portfolio position. Talk about your wife, your children, your hopes and dreams, etc. Make her want to pay you to take her properties. (In Spirit)
Remember for a $420,000 equivalent sale your closing costs are based on this $420k figure.
Now if she doesn’t have the cash to make this work you could suggest a few options:
You reduce the notes equally for you to pay closing costs for her!
You suggest a " Prosper Loan " for the amount of closing costs.
You could take a second on the home with the lowest amount owed to cover her closing costs and place notes on the other 11 houses.
Now if she thinks you should be closer in price you could increase your offer say $500 per note or $6k for the package, or in any increment that makes sense. $13.1k per note is equivalent to a full price offer.
Now sell her on the advantages to doing this:
$79.08 Per Month Per Note = $948.96 Per Month or $11,387.52 Per Year. (On 15 year $10k note @ 5%)
$106.07 Per Month Per Note = $1,272.84 Per Month or $15,274,08 Per Year. (On 10 year $10k note @ 5%)
She will receive this income essentially tax free as this income amount per year will not force her to pay against it as the income is relatively small.
I figure her existing debt on the 12 homes is about $2,100 per month principle and interest.
The maximum you can do and still have the property pay for it is a 10 year note for $10k at @ 5%.
Have you looked at her list of homes and verified there condition and value. You need a BPO on each house or a drive by appraisal on each home to verify your position.
Now you adjust according to her needs, if she wants completely out in 3 years, you adjust accordingly, if she wants income for 15 years you adjust and get a subordination clause in each note allowing you to refinance with a blanket loan for all 12 1st TD’s. You will have to have a minimum 3 year note to be comfortable and able to get refinanced when you meet required seasoning time requirements.
Make sure you set up payments to go through a Escrow / Title servicing account so there is proof to a lender your paying and your assured the mortgage, taxes and insurance is paid on your wrap!
If her motivation is unpaid rents and management / maintenance problems then I think she will take this deal to get out fast. Stress to her you can close in less than 30 days. Work out who pays what closing cost’s and whether she can afford to pay her closing cost’s.
Hopefully this helps you understand my thinking and makes this much easier to take down.
If the seller doesn’t have any money to close, why not just “close” by taking over the existing mortgages “subject to?”
I mean, check the titles yourself. Draw up the deeds yourself. Record them yourself.
Of course, you’ll need an attorney to help you with the documents, administrative rights, Dodd/Frank compliance, and the rest …so that you’re not dependent on the seller to communicate with the banks, insurance companies, etc. after your closing.
But …since you’re not giving the seller a bunch of money, and relying on her numbers and truthfulness, you don’t need title insurance, and otherwise, the cost of closing will be minimal.
Assuming the rest falls in place, the only thing left, is to refinance the existing mortgages after a period of time, depending on how fast you get the portfolio stabilized, and can show a good Schedule E. ???
An issue might be, finding financing that will allow for subordinated liens…
And that might require that you and the seller create temporarily unsecured notes for her equity, until the new financing is secured, and then place the notes back on the properties.
Anywho…
I know you’re not a newbie here, but indulge me for the sake of anyone else reading this…
Be sure you drop a clear trail of breadcrumbs, and keep things extremely simple, for the seller to follow. Creative financing details can overwhelm a seller, and especially one that’s not familiar with industry terms.
Additionally, I never use the term ‘sub2’ or “subject to” with a seller. I avoid (like the plague) using any technical jargon. And whatever I offer, I attempt to couch it in terms that benefit the seller.
For example, “Mrs. Widow, I can help you avoid a huge tax bill, by giving you payments on your profits. Would this be something you would be interested in, or not?”
In this example, I haven’t used the words, ‘equity,’ ‘subordination,’ or ‘capital gains,’ or even the word ‘note.’
Here’s a bad way of asking the same question…
You: “Mrs. Widow, if you allow me to subordinate a note for your equity, and accept payments over a period of time, I can help you avoid paying capital gains taxes on the sale of your portfolio. Would this be something you would be interested in, or not?”
Seller: What’s “subordinate” mean?
Meantime, the “or not” just begs for an objection, which needs to be addressed now, and not after the seller thinks about it, half-way through the contract signing… and after you’ve blown two hours trying to explain what is a ‘subordinated equity position.’
Whoa! javipa and Gold River – it clear you both have a lot of experience and knowledge. Although I’ve been doing this for a while, I still don’t feel like I know a whole heck of a lot! I’m willing to learn though! Gold River, I’ve sent you a PM. I’m hoping we can talk and try go get it broken down even more for me. I have a thick head!
Update on this deal…seller went and talked to her banker about selling properties on contract. He advised her not to do that.
If the deal is good enough, the bank I work with may be willing to loan me the 300K needed to pay off the sellers loan, then have the seller carry a second note with amount and terms we could both agree to. We’ll see. I start to look at the properties today.
You know, this (ridiculously) tics me off, and this isn’t even my deal.
And reminds me of one of the important things I learned from John $Cash$ Locke right here on REICLUB …
Make the seller fish or cut bait, before you ever make your offer. Ask, “Mrs. Widow, if we come to terms today, are you prepared to close today, or not?”
Now, this assumes all the decision-makers are present when you make your offer.
In this case, nobody stipulated to this. So, Mrs. Widow has the freedom to dangle you from a rotting tomato stem, after you’ve spent gobs of time with her, while she shops your offer …with her bank …with Uncle Ned, whose into real estate …and any number of second-guessers to this deal. Pffft.
Creative financing offers cannot be subject to “call you backs.” Either you nail the terms down today, in front of everyone who’s a party to the transaction, or the trail of bread crumbs you threw down for the seller, gets blown all over the place, making it impossible for any third party to make sense of the deal. Anything the seller describes to another party, will get lost in translation, and sound like a deal forged in Hell.
Here’s a better approach:
You: Mrs. W. is everyone, who’s weighing in on this transaction, present, or not?
Mrs. Widow: Yes
You: (Yes, or walk)
You: Mrs. W. if we come to terms on an offer today, are you prepared to close today, or not?
Mrs. Widow: Yes
You: (Yes, or walk)
These two questions undermine a seller’s ability to justify getting a second opinion, and/or second-guess the deal, and/or shop your offer.
In your case, you left all the doors open for the seller to walk away.
I can just hear Mrs. Widow call the bank and describe your offer:
“Hi, Mr. Banker, Do you think it’s a good idea for me to let some stranger take over my loans. You know, the ones you made to me and my husband; and then give him the deed to all my properties, if he promises to make the payments, after putting a second mortgage on all my properties for thirty years, so that it’s a “no down” deal for him, or not?”
If she’s so unmotivated to accept what I would say is a fantastic offer, she’s not motivated enough yet.
Let her baste in her unmotivated juices for the time being. I’m sorry but a half-dozen, old houses, does not for an attractive, cash-deal, at retail make. And certainly not a bulk, cash-sale at $500K. Pffft. And non-performing units? Pffft twice.
Never mind that getting a loans would be more like qualifying for a blanket mortgage, and you would need performance numbers for these for the past three years (at least). And if the numbers weren’t fantastic, and you were still able to get financing, the rates and terms will suck drain water. They might suck anyway, considering these would be considered “D” grade properties at 100+ years of age…
Nonetheless, contact her in a month, with your offer. Write up what you originally pitched, and give her three days to say yes, or no. Then respond accordingly.
Frankly, I don’t think you have any business trying cash her out. She isn’t offering something that begs for cash. And again, what she does offer is a ‘hard sell’ at best.
Here’s an acid test observation: If the seller isn’t trying harder to sell you, than you are at selling him, you’re likely in front of the wrong seller. You always need to care less. Otherwise, you start trying to negotiate with yourself, and possibly turn a turd deal, into a bowl full of the Hershey-squirts.
I think its a good deal, you can easily use this deal as a future investment. If you require a suggestion about this deal then you should talk about with some of professional real estate investors. They know better about this type of deals. Good Luck! :biggrin