Knowing how you will exit a property is as important as knowing how you are going to buy it. In fact knowing your exit will likely determine if you should buy it, and how much you should pay for it.
I know how to exit a property using seller financing, because of this, I could buy a property at it’s full market value and still make money from it. Please keep in mind that I am not saying that you should necessarily do this, only that it is possible.
If I were to buy a $100,000 house where its true value was $100,000, and I even did something silly like go get a bank loan to finance it, I could make money from it like this:
(Yes real life numbers may be different than this example, but not by much and it doesn’t matter as this is just an attempt to illustrate the concept)
For this example I will assume that I am financing it 100% and with taxes and insurance, the payment comes in at around $1000 per month.
I could resell this home to someone on terms, using a lease option or land contract for $120,000 and have them pay $1,200 per month. They will be responsible for all maintenance and repairs. I would require at least $5000 down and in two years or less they will cash me out by getting a bank to refinance the loan for them.
I would end up with about a $20,000 gross profit plus $2400 in rough cash flow over two years at $200 per month
So I pay full price and still make money on the property.
Before we go on, let me take a few sentances to handle the objections I picture being yelled at the screen.
But in the example you 100% financed it. You can’t do that anymore.
Yes you can.
A bank that feels adequately collateralized will certainly loan you 100%. There are tons of ways to borrow the down payment even if they require 20% down. Please remember that this was an example and the payment in the example is also higher because more is financed. Even if you didn’t borrow the down payment and had to use $20,000 (20%) out of your pocket for a down payment, you are getting $5000 back when the lease option tenants move in, $200 per month gross income (Actually more as your payment would be lower) and $15,000 more on your money when you transfer the deed to them after two years or less. That is 100% (or more) return on your money in two years, pretty respectable even doing it that way. For the record, I consider getting a bank loan and putting 20% down as “doing it the wrong way”
But why would anyone pay more than full price for a property?
I am selling it on terms. I am appealing to the market that can’t get conventional financing right now. The price we agree upon is the price that they pay in two years when they go for conventional financing, and not in today’s dollars.
One point gleaned from this example should be that if you know what you are going to do with the property and what exits you are comfortable with, you will know what you feel comfortable paying.
I wish I had known the importance of the exit when we started buying rental properties.
We started out by purchasing fixer upper homes and turning them into two unit apartments. As, at the time, the rent we can get from a two unit building can support it, but the rent we could get from a single family home could not. The numbers worked out well enough, but in the end what we had created were properties where our primary buyer would be another landlord. There isn’t a huge demand for a home that has two kitchens and two separate entrances. Sure we might be able to find a couple who wants one of their ailing parents to live next door to them, but those couples are rare when compared to the 99% of the other families who just want a regular home.
We were thinking of how to make the property cash flow, but not how to exit it. We have listed one of these homes, but to this day have not sold any of them. As long as they cash flow and are in good shape, we can afford to wait until a local landlord gets in the buying mood.
Single family homes are very flexible. They can be rented, sold outright, or sold on terms to a variety of buyers, some may even be able to be turned into retail or commercial buildings.
An apartment building can only be sold to another investor, and it’s use is usually limited to an apartment building.