Dan:
One of the interesting things you can do with SELLER FINANCING is to manipulate the “terms of the sale” and repayment terms so that the tax code provides you as the buyer and the property seller with some benifits.
Your proposed alternative will provide them with more interest however INTEREST INCOME is highly taxable income. Even under the installment sale method of reporting the income from this seller held Note the interest collected is highly taxable.
Now what if you could INCREASE your “basis” in the property by agreeing to a pay a higher sales price - might that have benifits to you down the road when it comes time for you to sell? Higher basis in property = less taxable gain when it comes time for you to sell or exchange.
Additionally in concert with agreeing to pay the higher sales price and $600,000.00 amount to be financed by the property sellers you might have them financed you with little or NO INTEREST (Zero) - therefore the income derived from the seller held installment sale note is pure long term capital gains income and not as taxable as the interest income they might receive under your 13.25% proposal.
Eg; $7,142.86 per month payable over 84 months = $600K
$7,142.86 per month x 12 months = $85,714.29 per year in income which is the repayment of their principal and long term capital gains income. Not interest income. $85,714.29 per year in INCOME is better than $69,213.72 per year in taxable income ($5,767.81 x 12 mos)
Might this provide a Greater > monthly & annual income to these sellers?
I ask these questions only because its in your and their best interest to strike a deal which provides benifits for each of you.
Best to your success;
Michael Morrongiello
Author of the following Home Study courses;
The Unity of Real Estate & “Paper”
&
Paper Into Cash - The Convertible Currency - How to Effectively Create Marketable Real Estate Notes
Motel in my lap, why shouldn’t I accept? - Posted by Dan Smith
Posted by Dan Smith on November 24, 2007 at 02:46:04:
I have developed a friendship with a couple who have owned an 11 unit motel in a great location for ten years and are wanting to sell and retire. They are incredibly emotionally invested in the property after all the work they have put into not only the business but the small farming/big spring-fall tourism based town. There is only one other hotel in town but by contrast we are talking Hilton vs. crack brothel. They have been dropping hints for a year now but just this week sat me down and made an offer with the contingency that I spend some training time under their scrutiny before we all commit. They are by default just as concerned with my success as I am, as they will be carrying a note for the entire purchase price and plan to be spending their retirement in other states that are at least 1000 miles away.
My background is in construction and I am the son of a general contractor so running a business and maintaining the property will be nothing new to me. Taking care of people and maintaining good customer relations is one of my stronger suits, which is of huge importance to the owners and is one of the main reasons they have approached me.
As for the beans; $650,000 appraised value, $600,000 price, $124,000 gross income last year, $122,500 so far this year (projecting $140,000-145,000 total this year). Expenses: $26,000 annual operating, $21,000 all taxes $6500 for one employee 2-3 hrs day janitorial duties. Occupancy: 14-20% occupancy in winter (great opportunity for growth), 65-90% occupancy spring through fall (tourism, hunting, fishing). Room rates: $45-$72 nightly.
The contract is zero down (exception: $4500 closing costs)$600,000 purchase (including their underlying $100,000 8% 3 year remaining term which they will maintain payments on) 15 year note at 8% fixed amt. I will take over after winter so that I have time to save during the high profit months and survive next winter, again they are wanting to ensure my success, and therefore theirs. My question is this; am I missing something here? I understand the commitment of living onsite as they have for ten years, but what are the other negatives? Am I fogetting something on the financial end? Is this the opportunity I see it as? I’m thinking of approaching a friend of the family with some experience in the field and offering a 5% equity for his advice through the first six months, any thoughts on that idea? Someone is wanting to entrust what is essentially their retirement and legacy to me and I don’t want to screw it up. I need a Charlie Munger on this one.
Thanks for reading my book, any input would be great.
~Dan
Where is the upside to this deal? By my figures your total expenses including mortgage payments would be nearly 124k per year.Based upon your figures from last year, you would struggle to break even. Are you willing to put up with all of the aggervation and responsibility for nothing? In order to make any money you would have to greatly increase occupancy in the slow periods and that may entail a great deal of effort. Also consider that in this deal you would be heavily cash strapped and if a nice, new motel opened in the area it could spell the end for you. These people may be your friends, but they are “giving” you nothing but a very low paying job with a ton of headaches.
Dan:
I like the leverage (100%) and the fact they will finance you (which quite frankly they may have to in order to sell such a business and property)
However, you need to recognize which I think you do that you are essentially buying another BUSINESS (which just happens to include Real Estate. Motels especially a small mom n pop type operation are VERY management intensive.
If you are not going to be residing on site and running the operation then you need to factor this into the equation. Perhaps they can finance you at a slightly lower rate to offset cost you will have additionally for management.
I assume they are taking back a 2nd lien for the $500K you will owe them above and beyond the existing liens of $100K.
I would much rather see then WRAP the existing $100K financing and provide you with a $600K wrap around Note to be payable to them.
Re: Nice Leverage but buying a business - Posted by Dan Smith
Posted by Dan Smith on November 24, 2007 at 15:32:00:
Wrap is the plan. As for management they would only go through with it if the plan was for me to live on site and manage it as they do to maintain their awesome reputation, I did not exagerate when I called the place their retirement and “legacy”. And I “believe” I understand what I am commiting to when it comes to living onsite. But thats where the one month of on-site training comes in. I am thinking of throwing them a curveball on terms though, ie;
current----------------------proposed
$600,000---------------------$450,000
15 yrs-----------------------15yrs
%8---------------------------%13.25
$5733.91 mo------------------$5767.81 mo
$21587.04 1st yr int.--------$10192.99 1st yr int.
Luckily they are smart enough to see that the offers are the same essentially provided they are protected by a good pre-payment clause. My curveball actually pays an extra $6k over the term of the loan. Its all semantics really until you look at my expanded options (thanks to the better equity position)in case of financial trouble. They will understand that, and I think he will be happy for the added tax benifits due to the higher percentage of my payments being labeled as “interest”. Even without them gaining anything by going for it, if it was just an equal proposition I think that they would still agree just to feel safer about not having to come back thanks to my equity parachute. Oh, and as for selling they get plenty of offers as high as $900,000 from seattle bean counting doctors and their like at least ten times a year. I’m getting the “he’ll carry on our tradition” discount I suppose.