SELLER FINANCING NOTE 101
By Joe Mueller
Have you ever read a book about real estate investing where they referenced the purchase of a property and mentioned seller financing note? Maybe you have heard the terms ‘Land Contract‘ or ‘Contract for Deed,’ but you weren’t really sure what they exactly meant. I have even utilized what is known as ‘Articles of Agreement for Deed.’
Years ago I believed that seller financing did not exist, especially in our ever-growing and appreciating Chicago market. Now I use it constantly as a way to acquire and control property and find it to can be one of the most lucrative ways to buy any type of real estate.
A Land Contract, or Contract for Deed, can be explained as easily as it sounds. It is an agreement between two parties for the purchase of a piece of real estate under certain terms defined by those parties. That may sound a lot like a normal purchase contract, but the key word is ‘terms’. The important factor of a sale utilizing ‘Articles of Agreement for Deed’ (these titles can all be used interchangeably), is the terms of the purchase.
SELLER FINANCING NOTE
For example, you want to buy a residential 4-unit brick building on the south side of Chicago for your next investment. However, this building is vacant and in such bad shape that you may need to borrow money from a hard money lender because your regular mortgage officer won’t lend on properties they would consider unacceptable or uninhabitable. The problem is that you don’t have the capital required to handle the high interest payments usually seen in hard money situations. The margin may also be too small and you want to squeeze every penny from the holding budget you have planned for the project.
What’s another option? Short-term seller financing note. In other words, the seller holds the note for a short period while you utilize your funds (however you choose to obtain them) to rehab the 4-unit and get it rented out and performing optimally. At that point in time you refinance the property, payoff the seller’s note, establish a new lien on the property with your bank, and even payback yourself with non-taxable funds you receive at the closing of the refinance. Sound interesting? This is very possible in any locale, any market, and any downturn or upward trend.
Many sellers can agree to this type of situation out of shear desperation, or just to stop worrying! Sometimes a family death, pending foreclosure, or nuisance tenants can drive a seller to want to rid him or herself of the burden of a property, and that’s what the determining factor of the sale is. Another situation may be the benefit of selling the property for more money than the current market would normally command for that real estate, or even the saturation of a certain type of real estate in one area, resulting in difficulty selling under normal circumstances. The situation may be that in order to sell, the owner may need to lower the price to below what the other properties are going for just to get showings. Let me explain more what I just mentioned.
SELLER FINANCING NOTE
Mr. Smith has owned a rental property for a few years in the suburb of Addison, Illinois. When Mr. Smith bought his property, which is a 6-flat apartment building, he really didn’t seem to think it mattered that there were several other 6-flat buildings within a few blocks, even feet, of each other. As a matter of fact, he thought that may make it easier for him to find tenants because it was an area of many rentals. He also thought that when a potential tenant was looking for a new apartment, they potentially could just drive down the street looking for ‘FOR RENT’ signs, expecting there to almost always be a vacancy in an area so populated with apartment buildings. Not an unusual train of thought.
Fortunately, that normally was the case. Some tenants would even move from building to building after the word would spread that certain landlords would take better care of their tenants or had lower rent than the apartment in the building next door. Mr. Smith always had reasonable rent and took good care of his building, so he never had many vacancies over the course of his ownership.
Though Mr. Smith loves the extra income, he is getting older and doesn’t really enjoy the excitement of owning his building anymore. So one day he decides to sell. He hires a self-proclaimed local expert in commercial real estate, Realtor Ron, to list his property for sale. After a few months and no offers, Mr. Smith is frustrated because another tenant has moved out and he still has no takers for his property. So he questions Realtor Ron. Realtor Ron tells him that the problem is that there are five other buildings for sale on the same block, and none are selling. In addition to that, most have been on the market for almost a year, and only one has gone under contract, and that was because the owner lowered the price from $599K to $539K. Mr. Smith is very upset to hear this and tells Realtor Ron that if this property doesn’t sell within the next two months, he is canceling his listing.
Realtor Ron is now afraid of losing his potential 2.5% commission, and decides that perhaps it is time to call in a real expert in real estate, Expert Joe.
Expert Joe visits the property several times with a few different potential buyers. After a few weeks, he presents an offer for the full price! Realtor Ron and Mr. Smith are ecstatic to hear that an offer is coming in, and for the full price! But Expert Joe tells them that there is one condition he wants them to be aware of–the buyer is requesting ‘owner financing’ for the deal for the term of three years. After Realtor Ron receives the offer, he reviews it with Mr. Smith. The offer stipulates that Buyer Bob does wish to purchase the apartment building for the full asking price of $599,900. In addition, Buyer Bob wants ‘articles of agreement for deed’ to be created by the seller’s attorney, and for the terms of the agreement to be as such:
Buyer Bob agrees to provide Mr. Smith with a down payment of $29,995 (5% of purchase price), and will make monthly payments of $3,848.04 ($569,905 amortized over 25 years @ an interest rate of 6.5%) until a balloon payment is due after 36 months.
Expert Joe informs them that his buyer will either refinance or sell the property within that timeframe, paying off the remainder of the loan.
Mr. Smith is somewhat perplexed by this offer, but gives it some serious consideration. He realizes that the property at full occupancy would generate $5,000 in gross income per month and that would be sufficient to insure that he would get his payment every month. Not having to manage the property anymore would be quite beneficial to his social life and plans for the future and he didn’t really need all of the proceeds from the sale of his building right away. After a few days, he agrees to the terms of the offer with one change – Buyer Bob must provide at least 10% of the purchase price at the time of the signing of the articles of agreement for deed. Buyer Bob agrees, knowing that any bank or financial institution would require at least a 20% down payment for a commercial property purchase, and he had plans to utilize his additional funds in the bank to acquire another apartment building in the area, also via seller financing.
Mr. Smith and Buyer Bob close the first part of their transaction at Mr. Smith’s attorney’s offices in Lombard, and Expert Joe and Realtor Ron agree to accept half of the commission upfront, with the remainder being due at the second closing when the seller-financed note is paid off. Mr. Smith walks away with a nice check for 10% of the purchase price minus half of the Realtor fees due, and moves to Tahiti.
After two years or so of ownership, Buyer Bob talks to his commercial banker and finds out that his bank is offering a special low interest rate for current customers. He decides to refinance the building he bought from Mr. Smith. Buyer Bob has experienced some great success with his building and is considering converting to condos at some point in the next few years. But first he must pay off the seller-financed note provided by Mr. Smith, who he contacts in Tahiti via email. Mr. Smith flies back to the states for the closing and receives the balance of his money. More funding for the casinos in Tahiti he and his new lady friend have been spending most of their free time in!
While this situation may seem to you as highly unlikely, I assure you that these types of transactions are commonly occurring in ANY market, in ALL parts of the country. Though the terms may be different depending on each property and situation, these opportunities can be excellent building blocks for potential owners of a future real estate empire. Just apply the same concept to any number of the situations that property owners face.
I recently purchased a 19-unit apartment building in the south suburbs under similar circumstances. The owner had owned the building for several years, and had a very low loan balance on the property. He was busy focusing most of his time on some new projects he was developing in another area of northern Illinois and had let the property maintenance and occupancy fall by the wayside. At the time of the initial closing, the property was 69% vacant. Most, if not all banks, would not even touch this type of situation because it was essentially a potential loss every month for the purchaser. I negotiated a one-year, seller-financed loan and am currently working with my management company to fill the vacancies in the property. Once we are operating at a normal range of occupancy, I plan to refinance the property and pay off the owner, still leaving me with a pre-tax cash flow of over $2,000 per month, and none of my money locked up into the property.
Stay tuned for the next issue of IWP! and my next article, Seller Financing 102…
For more information regarding seller financing, contact Joe Mueller, Owner and Managing Broker of the TANIS Group LLC, at his office: 847-594-4215 or via email: jmueller@tanisgroupllc.com. The TANIS Group LLC is a Residential and Commercial real estate brokerage based in the suburbs of Chicago and works primarily with investors. Joe has been investing in real estate for over eight years and specializes in working with commercial real estate purchases and sales. Joe also maintains a Google group entitled The Strategic Investor’s Group which anyone can join by visiting www.google.com and clicking on ‘groups’ and searching for the Strategic Investor’s Group.
