Seller Financing – How to Buy a Rental for Above Market Value

A house is worth what someone is willing to pay for it. However, what we will discuss today is how it's possible to make more than “Market Value”. Our strategy for this will be to utilize seller financing.

The following case study will help you figure out how to price different offers for your home. Additionally, you can download our simple calculator that we utilize in order to test out a few different offers. We then send this offer letter that is provided to the home sellers. We will even cover some 0% interest seller financing and ways to help you close that deal.

Choices increase conversions. Period. Even if you aren’t able to close the 0% seller financing – having it as an anchor helps to keep the interest rates low during the negotiation period.


What is Seller Financing?

Before we dive into the advantages and the math behind seller financing, let's first get on the same page.

Seller financing is when the owner of the house acts as the financier and lends the buyer the money to purchase the home. Simply put, seller financing is when the seller decides to loan money to the buyer. Both parties agree to terms such as interest rate, repayment schedule and consequences of default payments. In essence, the home owner works as the bank.

For this case study, we will be evaluating a property at: 123 Solar Ave.


Home Value

Let’s take a look at an example. Let's assume that our best buddy 'Made-Up Mark' owns 123 Solar Avenue free and clear. What we mean by free and clear is that he doesn’t have a mortgage. Even if he did have a mortgage, there are still ways to work with financing options, but we’ll get into those options in future articles. Mark would like to sell his property, so let's help him out.

Mark would like to sell his home but would love to avoid paying a ton of taxes from the sale while also selling his home for above market value. Or maybe, he is willing to sell his home and maintain his cash flow.

Or, maybe you’re a fantastic negotiator and were able to convince Mark to consider seller financing. It's not a tough sell as it’s a pretty darn good option if the circumstances are right!

Now that you’ve had the conversation about seller financing, Mark has some reflecting to do. The seller may not be ready to negotiate terms right now, but at least the thought has been planted.

Mark can now decide what he is willing to accept with regards to price and terms for his sale. For this example, let’s say that the comparable properties to Mark's home show that 123 Solar Avenue is worth $100,000 on the market.*

*Notice, this is an actual property, but the address and owners name have been changed for confidentiality – otherwise, this is exactly how a seller financing thought process would flow.


Why Consider Seller Financing?

Let’s re-analyze this scenario: Mark has a home with a lot of equity (ie he owns his property outright or owes very little more on his mortgage), so most likely, his name is on a bunch of lists from places such as Listsource, a place where you can buy lists for marketing campaigns, and therefore he probably gets a lot of mailers.

Direct mail marketing is a cornerstone of finding these potential leads but don’t for a second believe that your campaign stands out or is unique at all if you are using stuff from websites like YellowLetters.com.

 

 

Granted, these techniques are effective, but they’re costly. Remember to keep an eye on the cost per acquisition and the average profit as you grow in order to make sure that future growth is sustainable.

Back to the point at hand.

Mark has called people who “buy houses for cash” but they all seem to be offering him around $70,000. As you can imagine, this is very aggravating to our best bud Mark. He talked to a realtor and was told that he could sell the property for $90,000 within a few months time. However, Mark wants to sell quickly.

This is where investor Phil Hinkie from Move In Philly enters the story. Mark had reached out to Phil after watching a quick webinar on how to sell a home for above market value.

Luckily for Mark, Phil Hinkie specializes in analytics and can help Mark review some of his options. Below, we are able to take a look at Phil Hinkie’s summary page that he sent over to Mark. We’ll dig into what this stuff means - remember being armed with information allows you to give the seller choices and choices equal conversions.


Advantages of Seller Financing

 

Before we dive into Phil Hinkie’s numbers, let’s review why Phil Hinkie would be interested in buying a home using seller financing.

First off, Phil Hinkie is able to buy more homes when he uses this type of financing compared to when he buys a home that is funded by the banks. Most banks will have a limit that a homeowner can only have somewhere between four to ten property mortgages.

Second, Phil Hinkie knows that creative real estate deals can help both parties. Mark’s primary goal is to sell his property for as much as he can, but Phil Hinkie is flexible on price as long as the terms allow him to purchase the property and continue to cash flow. In order to do this, Phil Hinkie has to run an analysis of the property and determine how much he can spend each month on his mortgage and still generate cash flow.

Phil Hinkie has determined that if he can buy the property and have a monthly mortgage of less than $1,000 a month then he will be able to make money on the property as a rental. Let’s also assume that Phil Hinkie would like to pay as little out of pocket as possible with a maximum down payment of $5,000.

Don’t forget that in seller financing the down payment goes DIRECTLY to the seller; in this scenario, we will also assume that Mark is willing to sell his property and only collect $5,000 as the initial payment.

 

Advantages

  1. Flexibility – By using creative financing, you are able to negotiate more and find agreeable terms. This opens up a wider array of potential investment opportunities.
  2. Fun – Finding deals is a lot more fun when you are able to use your creativity and figure out ways to make sure that seller’s get what they want too. Marketing for leads is a lot less fun when you are stuck to one strategy.
  3. Growth – This is a leveraging technique. Instead of leveraging your capital, you are leveraging your creativity to spark jump your growth.

 

Let’s take a look at the summary sheet and see what creativity Phil Hinkie has come up with.

 

 

Let’s take a look at these offers individually.

As mentioned, he has determined that he can pay up to $1,000 a month and still be profitable, so he has laid out multiple seller financing options that allow him to pay $1,000 a month to Mark and still make money.

 

For a quick review:

    • Purchase Price is the agreed upon sale price of the home.
    • Down Payment and Mortgage remain the same from a definition standpoint as a traditional home sale except that the homeowner acts as the bank in this situation.
    • The Interest Rate and Number of Months (Repayment Periods) are both negotiated terms that both parties can be flexible with to make a winning combination.
    • The Monthly Mortgage is a function of the purchase price, the interest rate and the repayment period.

 

Here’s where the math gets cool!

Math is Cool

 

The PV of Payments at Fair Interest Rate is a term for the value, in today’s money, of all of the payments that are due on the mortgage. This is a cool formula to show you how much money you will be getting in today’s money. This helps determine how much the house is actually selling for.

Notice how the home can sell for 40% above market value? AND the investor is still happy? How often do you hear about that?!

The Total Price of the Property is a combination of the Down Payment and the PV of Payments at Fair Interest Rate. This is because the property is selling in today’s market for this stream of cash flow plus the initial down payment.

Knowledge is power and understanding that homeowners and real estate investors can work together thru creative financing to create win-win scenarios helps both parties.

With that said, let's take a look at each of the offer's above to help analyze this offer sheet.


 

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Offer 1: All Cash

 

This is just a standard offer from Phil where he is able to offer all cash. Due to this, he is not willing to pay as much for the property.

This is a typical scenario in real estate. Often when people are advertising that they pay all cash, that really means that you expect a discount for providing the instant payday.


What do I need to know about this option?

 

The loan under Offer 1 is a basic loan that the buyer takes out from a lending institution. Usually, all cash offers don’t mean that you have $70,000 lying around. It may appear as an all-cash offer as the seller, but more likely than not, the buyer is getting a loan from somewhere.

Also, don’t forget that realtors generally take 10-15% in fees and costs before the home is sold. In this case, that equates to approximately $15,000. Those costs really add up quickly.

This will be one of your negotiation tactics in order to help close the deal for a discount.


How Do I Pitch Offer 1?

 

Your lead pitch for this offer should be that this offer is cash. That means that the owner will get paid quickly and hassle-free.

If you are not actually interested in paying cash, and would instead use one of the creative offers below, then you will want to make sure that you phrase this correctly – because if you can get a property at 30% market value then you have a deal on your hands and financing will find you.

You will want to mention something along the lines of:

“Keep in mind, that you will be paying hefty taxes on that income and that you should definitely talk to an accountant about ways to shield yourself from those taxes if this is the route that you decide to go. We will provide you with the cash, but we can’t protect you from Uncle Sam!”

 

Offer 2: $103,770 Purchase Price with 4% interest and $5,000 down over 10 years.

 

This is the first creative scenario that we will be seeing from Phil Hinkie.

In this scenario, Phil Hinkie has offered $5,000 down and asked for a mortgage from Mark (not the bank – remember this is seller financing and not bank financing) with a 4% interest rate to be paid off over 10 years.

Real estate financing consists of three main terms:

  1. Price
  2. Repayment period
  3. Interest rate.

When Phil Hinkie is able to be flexible with regards to the payment period and the interest rate then he can field multiple attractive offers to the homeowner.

In this example, Phil can pay $103,770 in total for the property as long as the homeowner is agreeable to a 4% interest rate that is repaid over 10 years.

You can see the value for both Phil and the homeowner. This is why this financing tool is so useful in getting deals done.

Offer 3: $133,983 Purchase Price with 7% interest and $5,000 down over 20 years.

 

Phil has laid out another creative financing scenario here.

He decided to extend the repayment period in this option. Therefore, he is able to pay Mark a higher interest rate on his loan. Mark is paid $133,983 for a home that’s not worth anything near that, but because Mark works as the bank in this situation he can get a HUGE payday. Phil and Mark are both happy.

Who says negotiating can’t be fun?

By demonstrating flexibility with repayment periods and interest rates, homeowners can get significantly more money for their property. This is because they are not only getting money for the property, but they are also earning interest on their money.

Talk about a WIN WIN.

Offer 4: $129,282 Purchase Price with 9% interest rate and $5,000 down over 30 years.

 

With an extended repayment period like this, Phil has decided to increase the interest rate to an impressive 9%.

As you can see, due to the increased interest rate and the extended period of time, the homeowner is actually getting over $140,000(!) in terms of today’s value of money. Homeowners can easily visualize how much that payment stream is worth by analyzing properties this way.

Closing the Deal

 

Armed with the above information, Mark is able to determine which repayment schedule works the best for him. Mark can counter with different terms at which point Phil will update his numbers and determine viability.

We talked about how real estate negotiations focus around three things when we’re talking about seller financing:

  • Price
  • Repayment Period
  • Interest Rate

A homeowner who understands this can get the most money for their home.

They can also satisfy the buyer and therefore it’s a true win-win. The homeowner will receive more money than their house is valued for. Additionally, both the homeowner and buyer get the benefit of a quick close. Even better, the homeowner gets to avoid a large tax bill and/or paying a hefty fee to a realtor.

The best part about creative financing is that it can be structured to help almost any situation. Homeowners are able to work with investors, especially when both parties understanding the basics of seller financing, in order to create the most profitable outcome for both parties.

Price Is a Function of Repayment Period and Interest Rate

 

When you have a home and you can offer seller financing, then the above statement is true.

And if you’re a real estate investor, or a potential real estate investor who’s just trying to learn more about seller financing, then knowing how to use some excel tools can really help you during the negotiations.

In the above table, we talked about different price scenarios. The excel spreadsheet is available for download and I’ll help explain how you can use it to your benefit here.

 

  • Step 1: Determine the price of homes based on comparable properties. If you need any help with this, then check out this blog post from BiggerPockets, which should help you understand how to run comps effectively;
  • Step 2: Determine Expected Rent based off of rental analysis comps;
  • Step 3: Assume that for an All Cash Offer the purchase price will be 5-15% lower than the neighborhood comps. Your offer of a guaranteed closing with a cash offer, the seller's usually willing to discount slightly;
  • Step 4: Do the analysis to determine what the maximum monthly mortgage can be for a profitable rental. Depending on what your rental goals are, you may have different requirements here. For example, if you want to cash flow at least $200 per month, your formula will be:
    • Rent - Mortgage (Seller Financed) + Rental Costs (Including insurance, taxes, maintenance, vacancy etc..) > $200

If the following is satisfied then you know you will profit $200 a month.

Now you can back into what the mortgage should be by doing simple math:

 

Expected Rent – Rental Costs– $200 (Profit) = Mortgage

 

If you go into negotiations armed with this information, then you will know the maximum amount of money that you can spend on the mortgage each month. What does that do for us?

 

  • Step 5: Determine interest rates and repayment periods that would be enticing to you. Utilize the current interest rates here. If a homeowner sold the house and took the profit and invested it, then what rate of return is he or she looking at? Today, maybe 2-4% if they’re lucky. Remember, those interest rates are secure. Your loan is significantly less secure (although it's still backed by physical property, so it is not a bad investment). Therefore, you will probably pay higher interest rates for that.

 

Now you will want to base your interest rates based on the repayment period. The longer the period, the higher the interest rate will have to be in order to satisfy the homeowner. One example may be to take today’s interest rates and try to use one offer with a shorter repayment period (5-12 years usually) in order to get a low-interest rate.

You can play with the numbers and determine what interest rates and repayment periods work for you based on your specific real estate goals.

 

Appreciation versus cash flow – know your market and always have cash flow.

 

  • Step 6: Price is a function of the interest rate and repayment period. Here’s the fun part! Once you determine how much you are willing to pay each month and you create some estimates for loan terms, you can solve for the price of the house. In order to do this, in Excel, you will go to:
    • Data
    • What-If Analysis
    • Goal Seek

and it will look similar to this:

 

Using our spreadsheet, you’ll be able to present multiple offers to homeowners and increase the number of deals you close. In this example, you will be setting the monthly mortgage to the value that you calculated above. Then, you just solve that by changing the cell of the purchase price.

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