A fellow investor talked with me recently regarding his real estate dilemma. He owns a multi-family residential property that he wants to sell. He’s tired of tenants and toilets and the headaches associated therewith. So he’s decided to move to cash and seek a better investment elsewhere.
His problem is that the duplex won’t sell.
I reminded him that the potential market for buyers of a duplex was fairly thin, even though the income could more than pay for the property over time. To make matters worse, few lenders have any interest in providing financing for multi-family homes unless the owner occupies one side. Even then, the rate is unattractive.
Finally, I brought up the idea of offering seller financing to a qualified buyer with a substantial down payment at closing. He recoiled. “You mean ME be the bank?”
Just as we imagine that humans are right-handed, most of us have been programmed to reject the idea of seller financing. But in some cases, it can be a perfect solution.
Here are some advantages:
1. Shorter marketing time
Properties marketed with Seller Financing will draw a greater response rate and typically sell more quickly than properties requiring conventional financing.
2. More buyers
After the recent real estate meltdown, FNMA, FHLMC, FHA & VA (the secondary market makers of home loans) tightened their approval process at all levels. Recently, we have seen some easing on loans for owner-occupants, but multi-family properties are different. Seller held financing enables a greater number of buyers to purchase and finance a home.
3. Fast settlement
Without all of the complicated barriers of a conventional mortgage lender, a seller financed transaction can close in as little as two weeks, possibly sooner. Most conventional loans get bogged down in “underwriting,” and no one can talk to anyone in underwriting. Under seller financing, you act as the underwriter.
4. Boost selling price
The seller will likely receive an offer that is closer to full market value for a property when providing financing. In today’s market, seller financing is a sales concession. In the specific case of my friend, I believe he might get as much as $50,000 more for the property when seller financing is offered.
5. Greater borrowing flexibility
Existing non-owner occupant loans are quite restrictive. But under seller financing, the seller has complete flexibility when it comes to the buyer’s credit history, down payment, debt to income ratios, and other underwriting criteria.
6. Fewer costs
Many of the fees charged at closing are simply profit points for the lender or originator of the loan. With seller financing, a buyer can put the money they save on origination fees, points, underwriting fees, mortgage insurance premiums, and junk fees towards the down payment and build more equity. Alternatively, the seller can competitively charge settlement costs of up to 3 percent and require a specific attorney for closing.
7. Interest income
The seller is able to collect long-term interest since they are essentially acting as the bank by extending terms to the buyer. This feature is valuable even in the case of a short term loan. However, on a shorter term note, such as a five year balloon, interest income is still considerable.
In the case of my friend, if he sold for $400k requiring a 25% cash down payment, the INTEREST INCOME of 6% per annum over five years with interest-only payments added to 3% closing costs and interest income from the escrow account might add up to $90k + 9k + 1k = $100,000. That’s very close to a return of 7%. I dare my friend to find any other secure investment with a yield anywhere near for the next five years. And that doesn’t include the higher selling price, which is hard to prove.
8. Installment sale method
When an income property is sold at a gain, there is an opportunity to delay a portion of tax due by employing the Installment Sale Method (Refer to IRS Publication 537, Form 6252 and check with your CPA for further details). That delayed tax portion can earn money for the note holder (in interest) so long as it is not realized (received). You are keeping your money at work longer before sending it to Washington forever.
9. It’s a safe asset
The balance of the purchase price is collateralized by the property. If the buyer stops making payments the seller can take back ownership of the home. The state of Georgia has one of the fastest foreclosure turnaround times of any state, typically less than 90 days from default to forced sale date.
10. And yes, it’s a liquid asset
We often think of home loans as non-liquid, but these instruments are negotiable. Lenders buy and sell them every day. If my friend needed cash for some reason, he could sell the note and security deed on the open market. Only a series of massive rate hikes would make this note unattractive, and remember, it’s only for five years.
Atlanta native John Adams is an author, broadcaster and investor. He is also a property owner. He answers real estate questions on radio station WGKA (920am) every Sunday at 11:00 AM. For more real estate information or to make a comment, visit money99.com, where you will find an expanded edition of this column.
