Another method of earning profit from real estate is through seller financing. This is a variation of the BRRR method. How does it work?
In a previous post, I explained the BRRRR principle. Essentially the BRRRR principle is Buy, Renovate, Rent, Refinance, and Repeat. Although this principle is sound, it is not for everyone. You may not be cut out to be a landlord, or you just may not have the time to manage a property on a daily basis.
A variation on this principle is the BRSF principle, which means Buy, Rent, Sell, and Finance. This method was popularized by Mitch Stephen. The underlying principle is to sell and finance a property to buyers who would otherwise not qualify for mortgage financing. Let’s take a look at how it works.
The first step is to find a suitable property to buy. The ideal property is either a lower priced home or a mobile home. The property should be in reasonably good condition with little or no renovation required.
The property can be purchased with a hard money loan or paid with cash. If obtaining a hard money loan, the terms should be interest-only for a period of 5 years.
Once the deal is closed, the property can be prepared for rental. If the numbers justify it, you might want to make some minor improvements such as a fresh coat of paint.
The property is offered for rent and prospective tenants are given the option to buy it with a small down payment.
This is the most important element. The sale price is substantially more than the price paid for the property, sometimes double.
The interest rate is relative to the interest paid on the hard money loan. For example, if the interest rate on the hard money loan is 8%, the financing will be offered at 10% amortized over 20 years.
Let’s look at the following example:
The property is purchased for $30,000 and sold to a non-qualifying buyer for $55,000. You, the seller, could choose to hold the note for the several years and continue to pay the interest on the hard money loan. You would enjoy a positive monthly cash flow of $599.33 per month.
In this example, the note is immediately sold to a note buyer and realizes a gross profit of $25,000. I have not included closing costs or taxes in this example.
- Provides an opportunity for a buyer who cannot otherwise qualify for traditional financing.
- Ideal for investors who do not want to be landlords.
- Provides great cash on cash return.
- No appraisals or credit checks required since the seller is financing the purchase.
- The buyer will likely make improvements to the property which will increase market value and reduce default risk.
- Should the seller choose to hold the note longer term, there is a higher risk of default.
- Potential legal liability if the deal is not structured properly.
It is extremely important that the buyer is required under the contract to utilize the services of an RMLO, or Residential Mortgage Loan Originator.
In the event that the buyer files a lawsuit against the seller for unfair or illegal practices, the liability will fall upon the RLMO.
This type of seller financing only works when the monthly mortgage payment plus insurance plus property taxes is less than the market rent for a comparable property. In many communities, it is cheaper to own than it is to rent, but the buyer has to be able to qualify for the financing. Most people would rather pay $1,000 per month on a mortgage than $1,000 on rent.
In our previous example, the buyer’s monthly payment would be $766.00 per month. If the market rate of rent for a similar property is $850.00 per month, the deal would be attractive.
It is a simple task to determine if this method will work for a subject property.
- Check with the municipality to determine the annual property taxes.
- Determine what the market rate of rent is for comparable properties in the area.
- Work the numbers backward to see if the deal is profitable.
Let’s look at the following example:
The potential profit on this example is $18,000 which looks very attractive.
The Bottom Line
This method of seller financing can be extremely profitable if structured properly. However, It is only viable with lower-priced homes or mobile homes.
If you have purchased a mobile home park where the mobile homes are owned by the seller, this is a great method to dispose of them profitably. Read my post on Investing in Mobile Home Parks.
Should you choose to hold the note for an extended period of time, make sure you have sufficient reserves to cover the servicing of the hard money loan and the costs of potential foreclosure proceedings.
The information provided here is for educational purposes only and is not to be construed as professional legal, tax, or financial advice. Every situation is unique and you should consult with an attorney, tax accountant, or financial adviser to determine the best options for your personal situation.