I like to Overpay for Rental Properties. That’s Not a Typo. Hear Me Out.
I like to overpay for rental properties. That’s not a typo. Hear me out.
By Daniel Hart
All too often we fixate on one metric alone; sales price. It’s the measurement that we’ve been conditioned to use as an indicator of our success or failure. We all want a great deal, and for many of us a discounted sales price is our goal, but should it be? Sometimes, yes, but “it depends”.
The sales price does not always need to be a concern. At first read this may sound ludicrous. How could the sales price not matter? Well, it might matter to a seller, but it doesn’t necessarily need to matter to YOU. So, let’s give the seller what they want. In exchange, let’s get what WE want.
Here is an example of a real deal (one of many similar deals, not just a one-time lucky deal) that I actually closed on, and still own today:
A seller, Mr. Coleson, called me from my motivated seller direct-mail marketing. He invited me out to look at his property on Big Tree Lane, which was vacant and rent-ready (often rare with motivated sellers). What really surprised me about Big Tree Lane was that it was a 5-bedroom house. In a lower-middle income neighborhood this is a rare find, and I knew the rents can be substantial on the higher bedroom count houses, at least $ 1,100 a month in this case, so it certainly peaked my interest.
The county tax value was $ 101,000, and that is exactly what he wanted. By listening to his needs, it was apparent that this figure was very important to him, and any negotiation was going to need to be structured around this need. There was one big problem though. At the time (2010), the market value was closer to $ 50,000. Yikes! But, maybe that’s ok.
One important question I always ask is: “If we can agree on a sales price, would you CONSIDER taking your equity in monthly installments?”
I always insert the word “consider”, because motivated sellers want to appear cooperative, and who wouldn’t at least “consider” an option? Even if a seller does not want to take their equity in monthly installments, they still usually say that they would at least consider it. If my question was “Will you take your equity in monthly installments?” then more often that answer is a flat-out NO.
So, as you might have guessed, his answer was “Yes, I would consider that”. He was open minded to terms (a.k.a. seller financing). This opened the door to further discussion about his needs. Some of the information I needed to acquire from him, preferably not suggested by me as a seller prefers that it is their own idea, is a ballpark of an acceptable payment amount, and a down-payment (if even requested). A down-payment (or even monthly payments) are not always necessary! Anything can be negotiated, but I have much more success when monthly payments are discussed. In this deal, the seller did state that he would want to receive at least $ 2,000 at closing. The amount was small enough that I didn’t feel it was even worth negotiating.
I asked Mr. Coleson what kind of payment would be acceptable to him, and he said, “Can you do $ 600 a month?” I said “I am sorry but I need to keep it no higher than $ 400.” He said “Well, could you do $ 500 a month?” Once again, I said “I apologize, but I really need to keep the payment to a maximum of $ 400 a month.” In truth, I had more flexibility, but in negotiation you should often “ask for more than you expect to receive”.
After that he said “Well, what ELSE could you do?”. That was an interesting question. He knew there was still some value to be gained from his side of the negotiation. He wanted something, but he was not sure what. What could I give him? I already hinted that I would agree to his above market value sales price, and at this juncture we both knew the payment would likely stay at a maximum of $ 400.
I made a suggestion and said “How about I increase the down payment to $ 3,000?”. I was certain he would object, but he immediately agreed! I expected that to be a starting point of more negotiation, ultimately ending in a much larger down payment, but for some reason a $ 1,000 increase was enough to meet his needs.
He was previously asking for an extra $ 200 a month, and then an extra $ 100 a month, which over many years FAR exceeds the extra $ 1,000 at closing. I will never understand why he agreed to the extra $ 1,000, but I can assure you it was not for lack of intelligence. Many times, a seller will do things that we ourselves would never do, so we cannot let our own expectations influence the negotiation. Therefore, it never hurts to ask for what we may not expect to receive.
Normally, I would not even bring up the topic of an interest rate, unless it is asked by the seller, but he did express the desire for interest, so it needed to be addressed. I asked if we could keep the payments “principal-only”, and if he would be willing to accept payments for 10 years. He agreed! It’s good I asked!
That meant we now had a tentative deal for 10 years of 0% financing. Every $ 400 payment would directly equate to a $ 400 reduction of the principal balance. With an (estimated) $ 1,100 a month in rent, that was some significant cash flow, but what about that over-payment? To pay double the market value must surely still be a mistake! Think again.
After I closed on the deal, and received the deed, I rented the property for $ 1,110 a month. When factoring in taxes of $ 100 a month, insurance of $ 35 a month, a 10% vacancy allowance of $ 110 (never forget vacancy!), and a 10% maintenance allowance of $ 110, that equated to a monthly net income of $ 355, or $ 4,260 a year. Not too shabby for $ 3,000 out of pocket! In fact, that return on investment equals 142%.
When we look at the numbers, the cash on cash return is well over 100%, which is of course easy to measure, but the value of the 0% financing may not be so obvious. At 4% interest, about what a bank might charge, on a $ 98,000 balance, that is almost $ 4,000 a year saved, but let’s get back to that sales price. That is, after all, what you came here to read about.
I paid double the market value of the property, but only on PAPER. I bought the deal for the TERMS. With the full balance due in 10 years ($ 50,000), I can likely extend the terms with the owner, refinance with a private lender, or even a bank (yuck!). However, should a situation occur in which I am unable to fulfill those terms (which is not a situation I take lightly) I would have still earned approximately $ 51,120 over those ten years.
Should all forms of extension or refinance fall through, the seller could take the property back, and I would not be liable for the remaining balance owed, since it was not actual money lent. At that ten-year mark I did pay the balance in full, and today the house is rented at $ 1,225 a month (slightly under market, as that prevents vacancy, but is a topic for another day), and is worth about $ 250,000. Now, I didn’t count on any appreciation, but it certainly is icing on the cake.
It is worth noting that some of the conversation with Mr. Coleson was with more technical vocabulary, only because he was an existing landlord with investment experience, but I always try to avoid technical vocabulary and keep the conversation as basic as possible. When most sellers hear complicated financial vocabulary, they begin to feel overwhelmed. Keep it simple. E.g. “I will buy your property for $ 100,000, pay you $ 2,000 at closing, and then $ 400 a month until paid”. That simple agreement is a 0% interest deal! Big words do not impress sellers, they only serve to confuse and intimidate them while feeding our own ego.
So, is overpayment a viable strategy? In my opinion, the answer is a resounding YES!
Daniel Hart, Owner of Hart Homes and author of The Real Estate Roadmap (available on Amazon) has been investing in New Jersey and North Carolina real estate since 2004, and has purchased over 100 properties, almost all using creative financing strategies to create passive income. He is a former board member of the Metrolina REIA in Charlotte, NC.
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