I’m considering a deal with an unusual financing arrangement. It’s a low-down payment (10%), owner-carry deal, but the owner is very old and is mostly concerned with maintaining his monthly income. As such, he wants a 10-year amortization at only 7%. The rate is low, but the amortization would make the monthly payment quite high – with current income/expenses, the park would NOT cash flow, and I’d be out of pocket each month. That said, there is plenty of room to raise rents; immediately after close, I would proceed to do that and reduce expenses. In other words, I can get it to be cash-flow positive, even with the high monthly loan payment… but not by much (I think I can get it to a 12% cash-on-cash).
On the plus side, I would obviously plan to refi asap once I turn around the park. The proposed deal would have the benefit of allowing me to get equity into the park, such that after 2-3 years, the loan would be paid down somewhat, the value would be up, and so refinancing should be straightforward, as I anticipate a 55% LTV. With more conventional financing – and a much lower loan payment – the park would cash flow beautifully (50% ROI)
Would you take this financing, and effectively defer an real money for 1-3 years to get to a very solid ROI?
I would but there would need to be some decent upside. What is the upside in this deal? Finding somone who only wants 10% down in this hot market and especially in the nw is a bit of a unicorn. Makes me ask what the catch is? Your saying 10 year amortization but are there additional problems? I look at lots deals in the nw and a 8 cap is pretty typical.
Thanks for the reply! So far as I can tell, there aren’t any problems. In fact, it’s a nice park. Not big, though - 41 spaces. The upside is in the under-market rents - I can raise them about 15%. There are also 7 POH that could be sold off. Would that be considered “decent” upside, in your opinion?
I would strongly consider doing this. However, I’d have to be very sure of a couple things:
I can handle the negative cash flow for the duration of the 7% note. If i have plenty of surplus income in my W-2 or other investments this bodes well.
I have a lot of confidence that a bank will lend on it. Sometimes they don’t like things like dirt roads or small towns. Talk to several banks but keep in mind if the economy turns south that lending may dry up somewhat.
I guess for me the main thing would be to get it stabilized and cash flowing better rather quickly. If he isn’t imposing any kind of prepayment penalty, the quicker you can get it to a lower rate and longer amortization the better off you’ll be. As the other commenter said, give it thorough diligence and inspection before purchasing to make sure there aren’t any big “gotchas” you didn’t see coming.
I would probably not do the deal as it appears that you feel you will need nearly 50% cash sitting dead and buried in the property to generate a descent positive cash flow. In effect it is your own money that is generating the cash flow and not the property itself.
The reality of investing is that if a property can not produce positive cash flow with a theoretical 100% financing it will never have true positive cash flow. Paying down a mortgage only creates artificial cash flow.
Cash having a estimated opportunity value of 10%+ will kill any possible true positive cash flow from the investment. Your cash is doing all the work and only carrying a property that is otherwise a poor investment. Why bother having the burden of owning the property.
I would only take a seller finance deal that produced descent positive cash flow with 10% down from day one or walk away.
Belatedly… thank you all for your advice and input. We are now in escrow and starting a nice long due diligence, so I’ll have a lot of time to figure out the real numbers.
Greg, to your point: the issue is that the property would cash flow at a 20 or certainly 30 year amortization – it’s the short amortization that is making the payment higher and skewing the cash flow to negative (now) and flat (once we raise rates and get rid of some ridiculous expenses.) Upon refinancing with more typical amortization length, the park would (will, we hope!) cash flow nicely.
So, here we go. Our first park!
Again – my gratitude to each of you. I’ll try to remember to update you all on how it turns out.
What leverage are you looking at after refinancing. You will need to keep your equity as low as possible in order to create true cash flow otherwise it is only your own cash that is generating a income. Cash flow comes at a very high premium when it is acquired with equity.
Assuming a 10% return on equity every 100K is buying $833/month in cash flow. After you deduct that from your income, plus all other expenses including debt repayment, you are then left with the properties true cash flow. If at that point it has no cash flow there is no point in investing in real estate.
Greg, I have to admit I hadn’t thought of it in those terms, and you’ve given me serious pause. I’ve gone back to the drawing board, and here are my numbers:
$850K sale with $100K down ($750K note)
Due to the accelerated amortization schedule, at the end of 3 years, loan would be ~ $620K (73% LTV), or, put differently, I would have infused another $130K into the property, bringing my equity to $230K, or 27% of original sale price.
So, I think you are telling me: I have to ensure that when calculating my new cash-on-cash post-refi, I use the $230K number, not the $100K figure. That is a great point, and I had not been doing that.
With the corrected numbers, I end up with a 16% cash-on-cash. Too low? Or about what you could hope for here out West?
Note that, by the end of 3 years, I expect to have the value up to at least $1M. How, if at all, does that change the calculus?
Thanks for following up, and pushing me to make this correction!
As your equity increases due to appreciation you must use the new equity value to calculate your C on C returns.
Many investors fail to adjust and as a result end up earning a very low return on their equity.
Cash buyers of investment income properties earn the lowest returns of all investors. It would be wiser to continue to pull equity out of a income property to reinvest rather than have it negatively impact your true cash flow.
High levels of equity will ultimately turn a asset into a liability once the equity is generating all the cash flow and the property is generating zero or negative cash flow.
7% is not low. I recently bought a great park in a big major city (over 1M population) with a 30 year fixed loan at 4% interest non recourse with 10% down payment.