Let's recap what we learned in Seller Responded – Making Your First Offer Example P1. A seller responded to my marketing letter which was sent in the mail based on an “educated hunch” that the property was distressed. After speaking with the elderly owner's daughter for the first time I came to the following conclusions:
- I spotted a property that no one else even knows is for sale.
- I’ve determined that indeed, the property is for sale.
- We also note that the asking price of $80,000 is the retail price for that neighborhood.
I decided now that it's action time. Reviewing the numbers , if I set my target sale price at $80,000 and we spend $2000 in fix-up costs, we still have to discount the purchase price significantly from there in order to make a reasonable profit. We do not yet know what the minimum price will be so all we can do at this point is evaluate some of our options.
Making Your First Offer Calculations
Some of the options we can consider when looking to make an offer to a seller include:
We could offer $60,000 on a cash-out sale. That’s a 25% reduction from the original asking price. After fix-up, our gross profit would be $18,000 if we could resell at $80,000 to the new buyer. We would request a 60-day escrow (independent third-party processor such as an attorney) in order to give ourselves enough time to find the new buyer before the escrow was scheduled to close.
Then, our new buyer would obtain new financing thus cashing out our seller and giving us our $18,000 profit. The escrow costs would be paid by our seller, Ida Mae, and by our buyer so none of the closing costs would come out of our gross profit. Escrow would simply pay us our profit out of the new financing obtained by our new buyer.
We could offer an even higher price; say $70,000, with the proviso that the Ida Mae carries back the financing. Our argument here would be that Ida Mae would then receive higher interest than she could obtain from a bank CD at current interest rates. She would have a monthly cash flow that would undoubtedly last her for the rest of her life. We would find a buyer at the $80,000 figure that would also pay us a larger down payment than we would be paying to Ida Mae.
If we structure this correctly, we not only get our buyer to cover our down payment, our buyer also covers our $2000 in fix-up costs plus perhaps another $1000 or two that we immediately put into our pocket. We can simply transfer the seller-provided financing to our buyer, or we can create a wraparound mortgage in which we earn a slightly higher interest and monthly payment than we will be paying to Ida Mae.
If we can obtain 5% financing, we can charge 6% financing to our buyer. If we can get Ida Mae to agree to a $3500 down payment, we can charge a $6000 down payment from our buyer. Using 5% interest and a 30-year amortization schedule, our monthly payment would be $356.99 on the $66,500 mortgage ($70,000 purchase price minus $3500 down payment). Our buyer would pay us $443.67 per month on a $74,000 mortgage at 6% interest for 30 years. Monthly, we would make $86.68 ($443.67 minus $356.99) in addition to the $2500 lump sum up front ($6000 minus $3500). We recovered our $2000 fix-up cost and have an additional $500 in cash.
Summary of Our Offer to Ida Mae:
$70,000 Purchase Price to be paid to Ida Mae
+ 2,000 Fix-up costs out of our pocket
$72,000 Our total cost
$70,000 Purchase Price
– 3,500 Our Down payment to Ida Mae
$66,500 Mortgage owed to Ida Mae at 5% interest, 30 yr amortization
$356.99 Our monthly payment to Ida Mae for Principal + Interest
Summary of Our Buyer’s Payments to Us
$80,000 Purchase Price paid to us by our buyer
– 6,000 Down payment from our buyer
$74,000 Mortgage (wraparound) owed to us by our buyer
$443.67 Monthly payment from our buyer to us (6%, 30 years)
Summary Between What Our Buyer Pays Us vs. What We Pay Ida Mae
$6000 Our buyer’s down payment to us
– 3500 The amount we pay to Ida Mae as our down payment
$2500 Gross Cash to us
– 2000 The amount we paid to fix-up the outside and inside
$ 500 Net Cash to us
$443.67 Payment we receive from our buyer, Principal + Interest
– 356.99 Payment we make to Ida Mae, Principal + Interest
$ 86.68 Net monthly we make on the difference
We could offer Ida Mae her full price under a lease-option program. Here we would offer to lease the property from her for a year with the right to renew that lease four additional times. Then we would find a tenant/buyer who would lease from us at a higher rent than we are paying Ida Mae. Additionally, our tenant would give us an option payment larger than the payment we would make to Ida Mae. As a result, we profit from the difference in the option payment up front; from the difference in what we pay as rent versus what we collect as rent; and finally from a higher sales price than what we’d agreed to pay Ida Mae.
We might offer Ida Mae $1000 for the option but charge our lease/option buyer $5000 for the option, thus making $4000 up front. We’d handle the lease payment in the same manner as we structured the wraparound mortgage in number 2 above. We’d pay $500 per month in rent but charge $700 in rent to our tenant.
We’d start out at a target sales price of $90,000 at the end of one (1) year to our tenant. If the tenant elected to renew the lease/option for another year, a new option payment and a higher monthly rent and purchase price would be established. If our tenant walked away from the deal at the end of the first year, they would forfeit their option payment and we would simply find another tenant/buyer. Recall that we reserved the right to renew our lease arrangement with Ida Mae for an additional four (4) times after the first 1-year period, so we really have a five (5) year lease/option working for us.
Summary of Lease/Option Program
$90,000 Sale Price to new tenant/buyer
– 80,000 Our Purchase Price from Ida Mae
$10,000 Our Profit on the difference
$5000 The non-refundable Option Payment from our Buyer
– 1000 The non-refundable Option Payment to Ida Mae
$4000 Our Profit on the difference
$700 The rent we charge to our tenant/buyer
– 500 The rent we pay to Ida Mae
$200 Our monthly profit on the difference
Of course all of this is speculation since we don’t know as yet what our potential seller will agree-to in price and terms. The advantage of pre-determining our options is that we always have a solution to our seller’s problem. Regardless of what Ida Mae tells us she wants, we have a prepared response to solve her requirements and still make a reasonable profit for our efforts.