Real Estate

Don’t Chase Cash Flow! Use THIS Metric to Analyze Your Deals


How important is cash flow when analyzing real estate deals? Many rookies zero in on this familiar figure when crunching the numbers, but there’s another metric that is FAR more important: cash-on-cash return. This simple but powerful equation can help you determine whether an investment property is worth buying!

Welcome to another Rookie Reply! Many rookies struggle to analyze deals when starting out. Fortunately, Ashley and Tony are here to show you exactly how to calculate your cash-on-cash return on a property. They discuss when to use lines of credit to help fund deals, as well as how to pitch seller financing options that make sense for both sides. They also talk about the home appraisal process and, finally, whether an offer on a property can ever be TOO low!

Ashley:
This is Real Estate Rookie episode 308.

Tony:
And I just want to define really quickly cash-on-cash return, because we’re talking about this as a metric. But for those that aren’t familiar with that metric, cash-on-cash return is a fraction. In the top of your fraction, you have profit for the year, how much profit did you generate over a 12-month timeframe. And in the bottom, in your denominator, you have your cash invested to acquire that property. So for us, on the short term rental side, that’s your down payment, closing costs. And we typically try to enroll any startup costs into that as well. But typically it’s your down payment in your closing costs, and then that top number is your profit.

Ashley:
My name is Ashley Kehr, and I’m here with my co-host Tony Robinson.

Tony:
And welcome to the Real Estate Rookie Podcast where every week, twice a week, we bring you the inspiration, motivation, and stories you need to hear to kickstart your investing journey. And today we are back with a Rookie Reply episode. And as always, I love to get into the nitty-gritty of these. Most episodes on Wednesdays, you guys to hear from amazing guests. On Saturdays, you get to hear me and Ashley blab for, I don’t know, 30 or 40 minutes about all things real estate investing. But we talk about a wide range of topics today. We talk about how to submit offers as a rookie and when is an offer too low and how do you kind of navigate those situations, which is a very important conversation. We talk about cash flow requirements, like how do I know what I should be looking for as a new investor in terms of what kind of cash-on-cash return makes sense? And we also define what cash-on-cash return means for our rookies that aren’t familiar with that phrase.

Ashley:
Then we touch on appraisals and how to get an appraisal done for your property and what are some of the steps you should take and really think about before you go and order your own appraisal. And then we talk about seller financing and how to do the math on seller financing. And we give you guys a couple tips and tricks to consider when discussing seller financing.
I want to give a social media shout out today to @TheFinanceDiaries. So I came across Stephanie’s account by using the hashtag #realestaterookie. If you guys are not already following Tony and I on Instagram, you can follow me @wealthfromrentals, and Tony, @tonyjrobinson. We’ve been going through and selecting somebody to give a shout-out to. So if you want a shout-out, make sure you’re following us and using the #realestaterookie hashtag. So Stephanie has been sharing about her personal finances and she was also sharing a rehab property that she recently did that’s going to be a rental. So she shared some before and after pictures that caught my eye and she talked about how she wanted to make the property into a clean, safe, dry, and structurally sound property for somebody to rent out from her. So a big shout out to Stephanie.

Tony:
All right. And before we jump in, I just want to give a shout-out to someone about the username of We Are Note, this person left us a 5-star review on Apple Podcast and the title says, “You are saturating my sponge.” This person says, “I’m the new real estate investor. Haven’t secured my first deal yet, but hopefully will this year. And I’ve learned so much from your podcast. The information is concise and relevant and easy to listen to and understand. Thank you so much and keep up the great work.”
So for all of our rookies that are listening, from the bottom of both mine and Ashley’s hearts, if you can take just a moment wherever you’re listening, whether it’s YouTube, Spotify, Apple Podcasts, leave a review, leave a comment, let folks know what you think about the podcast. The more reviews and comments and shares that we get, the more folks we’re able to reach. And the more folks we’re able to reach, the more we can inspire with the message that we have to share here at the Real Estate Rookie podcast, which is what we’re all about. So please take a few minutes, make that happen, and lighten up someone’s day with some good real estate investing tips.

Ashley:
Okay, Tony, let’s get to our first question. Today’s question is submitted by Vantage Surfboards.

Tony:
Love that name.

Ashley:
If you make surfing boards, please sponsor me. But the question is, “When submitting an offer on an investment property, how low of an offer do you generally ask for? For example, if a home was selling for 275,000, what price would be too low of an offer that it would be a waste of time?”
Okay, so the first thing that I see here is he says or she says, we’re just going to say he for now, whoever Vantage Surfboards is, is selling the home for 275,000. So this must be the asking price of it. I think it’s very important to differentiate that because just because a property is listed for a certain amount doesn’t mean that that’s what it’s going to sell for in a sense. I’m sure this person understands that, but I think getting into that mindset of just because a price or a property is listed at a certain price doesn’t mean that’s what you have to pay or even close to pay to that. Tony gave us an example a couple months ago of it was that property where you kept going back and forth over months and you got it for what? $100,000 less? Or what was that amount?

Tony:
It was originally listed for almost $400,000. We closed on it for 293,000. And then ended up making $40,000 on the flip because we got a price that made sense for us.

Ashley:
So right there, what Tony just said is the key. What price makes sense for you? And so I guess it depends on how much you actually want to profit on you. So where I would start with that as to like, “Okay, yeah, you could go on this $275,000 property and you could offer 100,000 and maybe that means you’re going to make $100,000 on flipping it.” But also you want to be competitive because there could be somebody else putting in an offer that’s higher than that. And so you want to find that sweet spot as to a number that makes sense for you as in what is going to be worth your time to acquire this property, to rehab this property, and then to sell this property again. So Tony just said that, for him it was a great deal, he made $40,000. Okay, so that $40,000, Tony explained to us why that was a great deal. Why $40,000 made you come to that price point?

Tony:
Yeah, I mean, we just have a minimum number on our flips that we want to profit and we usually don’t touch anything if it doesn’t at least get around that number. So we did our analysis, we said, “How much do we think we’re going to spend on the rehab? What are the ARVs that we’re looking at?” And we used that to kind of back into, “Okay, what is the maximum allowable offer that we have on this specific property?” And I knew what the number was, and it was actually 300,000.
So we got it for a little bit lower than what we wanted. But through our negotiation we were able to get it down. But basically, I saw what it was listed for. It was like almost $400,000. I submitted my offer, like 305,000 or whatever it was. They said no. It was still listed a few months later. They came back to us after it had been sitting stale and said, “Hey, would you take it for 350,000?” We said “No again, our offer’s 300,000.” They came back again and said, “Would you do it for 315,000?” We said, “No, we’ll do it for 300.” And then eventually they ended up accepting that offer.
So I think that we’re at a time in the market cycle where a lot of buyers have dried up. It is a bit more of a buyer’s market right now in a lot of different places. So I don’t think that there is an “offer” that would be too low, right? It’s like, “Okay, what is the offer that my analysis says makes the most sense?” And that’s kind of why I put my flag in the ground, my stake in the ground and say, “This is the highest number that I can go with.”

Ashley:
Yeah. So there is no offer that is too low. Yes, you may insult the sellers, but there are people out there that are going to tell you that, “I got the best deal because I submitted that low offer” where sometimes if I submit an offer and it’s accepted right away, my initial reaction is, “I offered too much.”
So I had this property that was listed at… It was a pocket listing actually. It hadn’t even gone on the MLS yet. And then an agent brought it to me and said, “If they get an offer before it gets listed, they’re probably going to take it.” And so they were going to list it for 159,000. I offered 150,000 and they took it right away. And even though that was $9,000 and it made my numbers work, $9,000 less than what they were asking and it made my numbers work, I still had that reaction of like, “Oh, I offered too much because they accepted it right away and didn’t counter.”

Tony:
I also think, Ashley, like so many new investors, they get hung up on this idea of like, “I don’t want to insult the seller.” But say you even came with an offer that was so incredibly low that the seller didn’t even bother to respond to you. I don’t think there was a number that’s so low that if you came back the next day with a full price offer, they would say no to you, right? So say that I offered them a dollar today. I say, “Hey, I want to buy your property for $1,” and they would laugh, they wouldn’t even entertain that. But if I came back the next day at full price, they would entertain it because that’s the number that they’re looking for. So I don’t think for the vast majority of sellers that you can come with a number that’s so low that they would bar you or ban you from ever making another offer on that property again. So I think we just need to let go of that fear of insulting the seller and just know it’s a numbers game and they know that.

Ashley:
And I think an appropriate way to follow up with that as putting in the offer, they have made it clear that they’re insulted by it or whatever, is just kindly let them know like, “Okay, if you ever want to reconsider or maybe there’s some negotiation here, please contact and reach out to us. We’re very interested.”
I have an example where a property I looked at, I put in a very low offer compared to what they’re asking and they didn’t counter it and they’re like, “No, we’re not even going to entertain that offer” and I just was like, “Okay, whatever” and I didn’t follow up. I didn’t do anything with the property. It sat for sale for a little bit longer. I didn’t follow up again where I should have, and it ended up selling less than what my offer was. I was kicking myself like, “Oh my gosh, why didn’t I keep in touch?” It was on the MLS so I could have just had my real estate agent do it, like, “Hey, just ask the seller’s realtor, like ‘Hey, do you think there’s room for them to come down to this offer now that it’s been sitting for 100 days or whatever it was’.” Yeah, so my mistake there.

Tony:
So Vantage Surfboards or whatever your real name is, don’t be afraid. Do your analysis. Use the BiggerPockets calculators. Understand what your maximum allowable offer is. And whatever that is, put that number in. Like Ashley said earlier, the 275,000, that’s just their listing price. And a listing price isn’t always a good representation of what a property is actually worth. And you’ll have agents that’ll attest that too. Sometimes you have agents who put up a list price that they don’t even feel comfortable at, but because the seller was adamant about, “I want this number,” even if it’s not rooted in reality, that the agent’s still going to listen at that number. So the listing price, when I’m analyzing a deal, I don’t even account for that. I don’t have anywhere on my analysis where I say, “What is the listing price?” All I put is, “What am I offering?” And that’s how I analyze my deals.

Ashley:
And that’s why I also love to meet with the seller’s agent at a property. If it is an on market deal, is seeing if there’s a chance to get the seller’s agent there because they’ve talked directly to the seller so they can answer some questions for you that my agent has no idea. They’ve never seen this house before, they’ve never talked to the seller before, where I can pick the brain as to like, “How much wiggle room is actually here as to why are they selling?” And you can find out some information as to… Or one way to even put into your contract, some kind of negotiating technique as to like, their mother passed away, they don’t want to clear out the property. So maybe if you put into your offer, they can leave everything and you’ll dispose of it for them. That might be something to just them be like, “Yep. You know what? Your offer is less, but we don’t want the headache of clearing it out. We’ll take that.” And I’ve had that happen to me before.
Or saying that the tenants can stay and I will take care of resigning their lease or get getting them out of the units, whatever that is, they don’t have to worry about that, where maybe other offers were like, “No, we want the place vacant.”And especially if someone’s going to house hack that property, they would definitely need one unit vacant, where if you’re an investor you can kind of deal with the tenants that are in place.
Okay. Our next question is not from Vantage Surfboards, but from Elizabeth Jane. Elizabeth said, “Do you have a minimum cashflow requirement to meet on a single family home before putting in an offer? If so, what is your requirement? Thanks.”
So Tony, you kind of just talked about this in your last question that for your flips you have a minimum amount that you want to target for flips. And what about short-term rentals? Do you have a minimum amount of cash that you’re looking for?

Tony:
I do, yeah. But before I give my number, I just want to say everyone’s number is going to be different because everyone’s motivation for investing in real estate is different. I know some investors, I have a student in my program and he’s a CFO, super high income earning guy. When he’s buying his short-term rentals, he’s not necessarily worried about getting a solid cash-on-cash return. His biggest concern is, “I want to offset my income as a CFO for this company.” And I have other students who are like, “Hey, I want to…” You guys met Olivia a few episodes ago. Olivia’s goal was, “I want cashflow. I want to generate that quickly.” So I think a lot of it comes down to what’s your personal goals. And if the goal’s tax benefit, you’re going to have maybe a lower cash-on-cash return and you want more expensive properties and markets where you can get better tax benefit if you want appreciation. Maybe you’re looking at markets where you can get that good year-over-year growth. And if you want cash flow, then that’s what you’re focused on.
So I think everyone’s goal going to be a little bit different. Us personally, we typically don’t even offer on a deal if it’s not at least a 30% cash-on-cash return. That’s kind of like the floor in our business. I can say last year our worst deal was a 40% cash-on-cash return. So we’re still kind of above that threshold. But for us, it’s 30% on the short-term rentals that we buy. What about for you guys in your business?

Ashley:
Yeah. And I think of that as something we need to make clear as to if someone says, “I have $100 cashflow per door” and someone else says, “Well, I have 300,” okay, you can’t go and look, “Oh, well that person who has 300 has a better deal” because you have to look at how the property was purchased and how it is financed. So that person could have put in a $20,000 down payment and they could have it amortized over 40 years their loan where their mortgage payment is a lot smaller so they have more cash flow where the other person could have done a BRRRR where they pulled all of their money out and they have none. So I think what Tony’s talking about is the cash-on-cash return is a way get better metric to compare apples to apples when looking at properties than actual cash flow. Unless the properties are being purchased the same exact way.
So if you’re looking at three different deals and you know you would have to buy each deal the same way, then yeah, you can look at the cash flow that way. But as to comparing especially to other people, I think the cash-on-cash return is a way better metric. For long-term rentals, I am looking at at least 15% cash-on-cash return for a long-term rental.

Tony:
And I just want to define really quickly cash-on-cash return because we’re talking about this as a metric. But for those that aren’t familiar with that metric, cash-on-cash return is a fraction. In the top of your fraction, you have profit for the year, how much profit did you generate over a 12-month timeframe. And in the bottom, in your denominator, you have your cash invested to acquire that property. So for us on the short term rental side, that’s your down payment, closing costs. And we typically try to enroll any startup costs into that as well. But typically, it’s your down payment and your closing costs, and then that top number is your profit.
So say that you invested $10 into a property. Over the course of that year you got back $1, that’d be a 10% cash-on-cash return. That number holds true if I invested $100 and got back 10 or if I got back $1,000 and got back 100. If I invested a million dollars and got back 100,000, that would be a 10% cash-on-cash return. So as you’re kind of analyzing these deals and thinking about it, make sure you’re setting up your framework and that fraction the right way. Cash investing on the bottom, profit for the year up top.
All right. So our next question here, this one comes from Osahan Abi. Osahan, I hope I got your name right there, but Osahan says, “Is it a good idea to use a line of credit as a down payment for an investment property and then use the cashflow to pay back the line of credit? If not, please explain why.”
I’ll give my quick take on this first because I actually haven’t used… Actually, I did use a line of credit once to buy a property. But yeah, so I’ll give my take and I’m curious to hear what your thoughts are. I typically only like to use lines of credit if it’s a short term source of funding. I personally wouldn’t want to tie up my line of credit into something where it’s like a down payment on a house that I’m going to be holding for 30 years. But if I’m doing it for a BRRRR or a flip, I feel like in those senses I know I’m going to be out in a few months and I can pay back that line of credit relatively quickly. Those are the situations where I typically like to use short-term debt like a line of credit. What about you, Ash? How does your use of lines of credits vary from that?

Ashley:
Yes, I’ve never used one as a down payment for an investment property. I have used it to pay for a property in full to partially fund it where I’m going to go and refinance it. Maybe I’m using part of my own cash and then part of the line of credit or I’m using the line of credit to fund the rehab. But as far as me going and getting a bank loan and purchasing a property where the down payment of that 20% or whatever amount, it is, it’s coming from a line of credit. So now I’ve purchased this property, I have my mortgage and I also now have that line of credit payment.
So here’s where I would say go for it. Say let’s use a rental property for example, long-term rental property. If your rent can sustain and can cover the payment on your line of credit… But remember usually typically a line of credit payment is interest only. So you want to make sure that you’re paying back some of that principle payment of that money that you borrowed too. So factor that in as to that you’re making a payment back.
Sometimes a bank will actually take your line of credit and roll it into a 15-year term loan for you if you need to and actually amortize it for you. And you can kind of lock in an interest rate. My one business partner did that on his house. He had a line of credit and then actually rolled it over into a loan that was amortized over 15 years and he could lock in that interest rate instead of having a variable interest rate. So if your cash flow can support having those two payments and your other expenses and you’re still cash flowing or breaking even or depending on what your strategy and your goals are, then I say yes, go ahead and go for it.
The next thing is if you are going to go and refinance. So with the BRRRR strategy, it’s typically recommended to buy with some kind of short-term funding, because if you go with a bank financing to purchase property, you go and do rehab and then you go and refinance with the bank again, you’re paying closing costs twice. But if the numbers work and that’s your only way to get into a property, then go ahead and do it. So then when you go and refinance, you would pay back your first lien, that mortgage on it, and then you would go and you would pay back your line of credit on the property and then make sure that you have enough to pay those two off.
So I think if you can cover the line of credit payment with your cashflow or if you can go and refinance within a short period of time, which I would say would be 12 to 18 months at the most for doing the refinance process. But it’d really just be like how long can you carry on that payment. And if it makes sense to you that you want to pay that out of pocket, factor that into your number. That’s still affecting your finances. If you’re saying, “Well, you know what? I actually have a great W2 job. I just haven’t saved and I want to buy now instead of saving for the next six months, so I’m just going to pull off my line of credit,” well if you can take your cash and you can throw, throw, throw at that line of credit, that might work for you then too over the next six months and you can pay it off that way and you just want to take action now.
Maybe you have the perfect deal that it has come up. But make sure you have a plan in place to pay back that line of credit. Because if you do use it for another property, say that line of credit is on your primary residence and one day you decide you want to sell your primary residence, hopefully you’re not maxed out when you’re not 95% leverage on your residence and now you can’t sell it because you still have that line of credit that’s not paid off and then your primary mortgage too.
So those are just some things to think about. I would say definitely don’t say no to using your line of credit, but think about what your exit strategy is to pay off your line of credit or to pay for those monthly payments.

Tony:
Something else to consider too, and this is true from my line of credit. I assume it’s true for all, but your rate is also variable. The one line of credit that I have, it was through my E*TRADE account and I was able to pledge my stocks as collateral for this line of credit. When I first started using that line of credit, my interest rate was ridiculously low. I think it was less than a percent when I started using it.

Ashley:
Tony, you have to talk about that because that is one of the best ways to get a line of credit. Can you talk about that, is your stocks as collateral?

Tony:
Yeah, let me expand on that. So if you have a brokerage account with an E*TRADE or Fidelity, I think all the big brokerages offer this service. But if you have stocks, you can actually pledge your stocks as collateral and your brokerage will give you a line of credit, so basically a loan that you can use to go out and do whatever you want with. So for me, I had a decent amount of stocks that I’d gotten from my job.

Ashley:
I think you have to have at least 100,000 though. I think there is a minimum. I don’t know exactly what it is.

Tony:
I do think it varies from broker to broker.

Ashley:
Oh really? Oh.

Tony:
Because I think at E*TRADE, I think it might have been 30,000 bucks or something like that was all you needed. So it varies from broker to broker. But basically it works just a traditional line of credit. So you move your stocks out of your general account into your line of credit account, they then say, “Here’s how much stock you have. Here’s how much line of credit we’re willing to give you.” And again, just a usual line of credit, you only get billed if you draw against that line.
Now on the flip side, they want you to maintain a certain amount of equity. So say you have $100,000 worth of stocks, maybe they’ll only give you 60% of that. So they’ll give you $60,000 in a line of credit. Say that the market shifts and your $100,000 drops down to 55,000, now you have to come out of pocket immediately to pay that $5,000 difference to keep your line of credit kind of above board. So there is some risk I think associated with a line of credit in that sense. But if you have a big enough amount and you’re keeping a really healthy margin in your equity, even as the market kind of ebbs and flows, you should be able to move forward without having to come out of pocket for it. Like I said, it was a really, really low cost way for me to purchase one of our properties.
But now rates have gone up quite a bit. And that was the point I was getting at, is that with these lines of credit, they’re not fixed. It’s not a fixed rate like you get with a traditional home mortgage. These are going to go up and down as the market shifts. And what we saw over the last couple of years is interest rates have gone up tremendously, and that same thing happens on these lines of credit. So you could go one month from paying sub 1% to 4, 5, 6, whatever that percentage is that brokerage feels is fair. So just something else to consider because maybe like you said Ashley, if your rent covers the payment at this super low interest rate and then rates double or triple over the next couple of months, now you have to make sure that you’re still able to cover that difference as well.

Ashley:
For that, what did your interest rate go to? Do you know what it is right now?

Tony:
I got to check. I don’t really use that line of credit as much anymore, but I mean it’s probably like 8% or something like that. I don’t know. Something a lot higher than what it was. It was literally below 1% when I first opened it up. It was crazy.

Ashley:
Yeah, crazy.

Tony:
It was like free money.

Ashley:
Mine is two duplexes as collateral, one of mine. And I know that went offhand has gone from 5.75, I think. It was starting out maybe two and a half years ago and now it’s at 9.25. And then I feel within the last year, every two months I’ve gotten a letter, “Hey, your rate is going up” and it’s slowly [inaudible 00:25:47].

Tony:
Just creeping up, yeah.

Ashley:
Yeah. Yeah.

Tony:
So it is something. And again, I think that’s why there’s a benefit of trying to keep that debt using the short run. That way you can anticipate or I guess adapt to some of those interest rate changes a little bit easier.

Ashley:
Because what does that translate to? Your monthly payment increases. So think about you going from a 1% interest rate to 9% as to what a difference that is in a monthly payment.

Tony:
It’s crazy.

Ashley:
I’m going to do the math on that real quick. So entertain everyone while I Google this real quick.

Tony:
All right, so I’ll just get my last little thought here. So I think if you are in a position where that’s the only course of action that you have and you’ve got a crazy good deal in front of you, it might be worth it to pull the trigger. But like Ashley said, I think you want to make sure you have some reserves set aside to deal with some of these fluctuations because the last thing you want is to be in a position where you can’t pay on that line of credit and now there’s issues that causes this domino effect of issues in your life. So hopefully, I was able to entertain you long enough for Ash to do that math.

Ashley:
I’m ready. Okay, so say you pull $50,000 off a line of credit and you’re going to use it as your down payment and say at the time your interest rate was 4%, okay? So your monthly payment would be $166, okay? Say that it jumped to 9%, which it’s very common right now. That’s what it is. Your payment now is $375. So think about if you were like, “$167? I can cover that.” And now it’s $375? That’s a car payment for a lot of people. That’s a big jump. So even now, think of interest rates keep going up. So say they’re at 9% right now and at 375, and they go up to 12%, that’s $500 a month if it continues to increase. So yeah, that’s a great point as to the variable because your payment will change and will it still be affordable to you.

Tony:
All right. Well I guess let’s go on to our next questionnaire, question number four. This one comes from Damon Hutchinson. Damon says, “This might be a dumb question, but how would I go about getting my house appraised?”
First, Damon, at the Real Estate Rookie podcast, there were no dumb questions. We are here to answer the questions that you feel like you can’t get answered anywhere else. So first let’s just talk, Ash, about what an appraisal is. What is the purpose of an appraisal in real estate?
So when a bank gives you a loan for a home purchase, when they give you a mortgage, banks want to make sure that they’re covering their own butts and that they’re not giving you a loan that’s in excess of what that house is actually worth. And typically, they won’t even give you the full 100% of what the home is worth. They only want to go up to maybe 70 or 80% of what that home is worth. So let’s say that you want to go out and buy a house, and I’m just going to use round numbers here, but say you want to go out and buy a house for $100,000. Most banks will say, “Okay, this house you think is worth $100,000. We will now give you a loan for up to 80% of that. So we’ll give you a loan for $80,000. You come up for the other $20,000.” So I think most of us understand that’s how mortgages work.
But the next step is, and you see a lot of deals fall apart when this step happens, is that banks want to make sure that whatever you’re agreeing to purchase that property for is what it’s actually worth. So they send out an appraiser. An appraiser is someone whose entire job is to give their opinion of value on whatever piece of real estate you’re buying.
There’s different ways to appraise a property, but the most common approaches you see, especially in the single family space, is they use the comp-based approach. They look for comparable sales. So what they’ll do is they’ll say, “Hey, your property on 123 Main street, we’re going to look at 122 Main Street, 124 Main Street, 12,5 Main Street, 126 Main Street, and we’re going to try and find properties that are similar in size and age and functionality to your home. And we want to find ones that have sold recently.” And they use all of those local homes to come up with an opinion of value for your property. And then once they kind of put all that together, they say, “Okay, your house is worth $100,000.” And that happens many times where your appraised value is spot on with your purchase price.
What can happen though is that sometimes your appraisal can come in low. So again, remember our example. Your under contract for $100,000. The bank has already agreed to give you a loan at 80% of what that home is worth. But say that your appraisal comes back instead of it being $100,000, what if the bank says, “Hey, your home is actually only worth…” Or the appraiser says, “Your home was actually only worth $75,000.” So now the bank is saying, “Hey, we’re not going to give you 80% of 100. We’re going to give you 80% of 75.” And 80% of 75 is only $60,000. So that means now you need to cover the gap between the $60,000 loan the bank has given you and the $100,000 that you’ve agreed to purchase this property for. It happens all the time in the world of real estate investing.
So super long explanation, but that’s what an appraisal is. To actually get an appraisal, it’s pretty simple, Damon, if you’re buying a house. Your lender’s probably going to order it for you. You typically don’t have to do anything. If you buy yourself or would just like to get your home appraised, which you can do, just find a local appraisal company and call them and say, “Hey, I’d like to get my house appraised. Can you come take a look at it?” So, different ways to do it.

Ashley:
Yeah. Or if you’re getting a line of credit or any kind of financing on it, the bank will usually take care of doing the appraisal for you. My question would be as to if you’re not going that route as to why you would want to get an appraisal done, is it just out of curiosity how much your house is worth? Because you can be spending 300 to $500 on the appraisal to be done. And that’s a couple hundred dollars, well more than a couple hundred, to your curiosity I guess. But maybe part of the reason is you want to see if there’s any equity in your house to go ahead and go to the bank, I would go to the bank first and I would say like, “This is what I would want to do.” And sometimes the bank will do an in-house appraisal for you first. So they’ll kind of look at it and say like, “Okay. You know what? We do think that there is some equity here, we could do a line of credit.” And you can kind of ask for almost like their opinion on that before going further.
And then of course making sure that you’re approved for the loan too before you go through and pay for the appraisal. The bank will charge you for the appraisal if it’s a mortgage. But I’ve been to a couple banks where if it is your primary residence and you’re getting a line of credit, they will not charge you any closing costs. So kind of watch out for that too. There’s also the loans where you can get the closing costs wrapped in to the mortgage where you’re not paying them out of pocket where they take the appraisal and just add it to your loan balance. So you’re still paying it, you’re just paying it over time or they increase the interest rate or they increase the points you’re paying upfront. Different strategies used like that. Either way, they’re making their money, and you’re paying it somehow.

Tony:
I think the only thing I’d add to the appraisal piece is also understand, and this is for all of you that are listening, that an appraisal is more art than science. You could have two different appraisers go to the same exact property and come up with two different opinions of value. And it’s happened to me multiple times throughout my investing career. I’m sure it’s happened to Ashley as well. Because there’s not a hard and fast rule that’s just like this nationally accepted way to appraise a home. Every appraiser kind of has their own flavor that they put to it and their own perception of the value of a home.
I recently ran into an issue where an appraisal came back low and I talked to my lender, he and I are good friends, and he kind of educated me on how things work in the world of appraising. What he said was that during 2008 in the big meltdown, there were a lot of appraisers who were inflating property values in order to get loans approved for folks that probably shouldn’t had no business getting approved for those loans. So there were some appraisers who were personally held liable when some of these loans went bad. The government was doing their thing and trying to hold people accountable. There were some appraisers that caught in the crossfires.
So ever since the 2008 meltdown, you’ve seen appraisers be a little bit more conservative in their opinions of value, especially in a shifting market like we’re in right now. So if you look at parts of California, different counties are down 5, 10, 12, 15% year over year. And as an appraiser in that type of environment, if you want to really cover your own bases, you’re probably going to be a little bit more conservative in what you think a property’s worth if you see the trend going down like this.
So just insight for you guys as you’re working through that. But if you ever have an appraisal that comes back low and you find yourself in that position, don’t be afraid to challenge it, right? See if you can find comps of your own that support a higher opinion of value. See if you can find holes in the logic that the appraiser used to come up with your opinion of value. Ashley, I know you talked about the whole land piece and how larger parcels are selling at a fraction more than smaller parcels. So just look for opportunities to really point out where you feel the appraiser might have missed something.

Ashley:
And that’s another reason if you are thinking of getting an appraisal to get some kind of bank financing on your property. The bank will not accept the appraisal you go out and get. Even if it is from a licensed appraiser, they will get their own appraisal order. So even if you just got one done, the bank most likely will not accept it and they’ll order a new one anyways to kind of go through their whole process and won’t accept the one you had just gotten done.

Tony:
I think this might be a national thing, but I’m pretty sure lenders actually can’t choose the exact appraiser that goes out and does it. Again, that’s like a 2008 reform thing. But basically, lenders have a panel of appraisers, they submit it and then kind of random choosing. I don’t know how it happens, but one of those appraisers gets sent out. Because I think what was happening before was that lenders and appraisers were buddy-buddies and lenders will be like, “Hey, I need you to get this property to be at this value. I’ll kick you a little something here to make it happen.” So the government’s trying to eliminate that from happening. So typically, I don’t even think you can choose who your appraiser is if you’re doing it for a loan.

Ashley:
Yeah. On the commercial side, I know for sure it’s definitely done like that where it’s kind of put out to three different appraisers and sometimes it’ll be like whichever appraiser can get it done the soonest.
Okay, so our next question is from Sarah Lucas. “Can someone help me understand the math for seller financing? Say you are offering $200,000 on a house, you’re going to put 5% down as the down payment and the seller is going to finance the rest. So 200,000, 5% down, that’d be $10,000 as your down payment and you’re going to seller finance 190,000. Meaning the seller is going to be the bank for you. You are not going to have to pay them a lump sum. The bank is not going to have to pay them a lump sum like if you went and got a traditional mortgage. You are going to pay them monthly payments instead of a bank. So the questions here are, “How long do you suggest the amortization for? What would be my monthly payment? How much would the seller be making?” And I’d like to show the seller how much they’ll be making and why would be beneficial to them, which I 100% do every single time I ask for seller financing, is printout the amortization schedule.”
So I actually pulled this up real quick. So I just google amortization schedule calculator. I usually end up clicking on the bankrate.com one. So I have it pulled up here and I put in the loan amount 190,000 and I put in the interest rate for five years. And then for the first loan term I put in a 15-year term. It shows that my monthly payment would be $1,503. It also shows you other information as to when your payoff date would be, the total cost of the loan as to even though you’re doing the loan for 190,000 with interest over those 15 years, you’d end up paying 270,000.
So as to far as the question as to how would I be making money and how much money would the seller be making, I like to highlight and show the seller the total interest paid to them. So in this case, if it’s over 15 years and you’re going to pay to them the whole 15 years, it would be $80,451 additional they are making. So if we go ahead and change the loan term to say 30 years, then your payment is 1,020. So remember the other payment was 1,500, so this is about $500 less. But the total interest now paid to the seller is $177,186 over those 30 years, so the time has doubled. So I think if you go to this calculator report and you plug it in and just play with it and then make sure… I thought there was a question on this, but I don’t think there is in there as to… Or yeah, “How long do you suggest the amortization for?” This is where you’ll want to see what works for your numbers.
So say you can rent the property out for $1,600 a month, so maybe that 15 year, $1,500 mortgage payment isn’t going to work for you because then you only have $100 left to pay your property taxes, your insurance, and all other expenses before your cashflow negative, so that you can go ahead and play with the loan term and figure out which makes sense for your numbers. Where are you still going to cashflow on the property? And that’s where you’re going to then present it to the seller. And then there may be some negotiating from there that you’ll have to do. But I think the biggest thing is to figure out what they want out of this. Why are they saying they want seller financing? Sometimes it may be because they want that mailbox money, they want that monthly income coming in, that steady check, especially if they’ve had rentals and they’re used to that and now they’re selling the rentals and they’ve always budgeted off of what guaranteed income they’re getting every single month.
And so like, “Okay. You know what? I can still hit that. You want $1,000 a month? How about we do it the 15-year term, but we decrease the interest rate or something like that. And then that way I can get you right to the 1,500.” So now you’re paying them less interest, but they’re still getting that monthly amount that they want. So really getting creative and playing around with the numbers will be very beneficial to you. You have to make sure it makes sense for you first though before you actually submit an offer to them saying, “Yeah, I’ll do a 10% interest in a balloon payment in two years and amortize it over 15 years” and then you actually run the numbers, and no, it doesn’t work for you. The property can’t support that.

Tony:
Yeah. I think the only thing I’d add, and you touched on this a little bit at the end there, Ash, but just differentiating or understanding the differences between your term and your amortization period. So your amortization is over how many years are you technically stretching out the schedule of the interest payments in the principal payments? Your term is when is that loan due in full? So what you could say is, “Hey, I want an amortization period of 30 years.” So that means I’m going to stretch out the payment over a timeframe of 30 years. So if I made payments until the very end, at the end of 30 years, it’ll be paid in full. However, you can set your term to be something shorter than your amortization period and say you want it set up to 10 years. So that means you pay as if you were going to pay it off for 30 years, but then at year 10 instead of you making another payment like you normally would, you’d have to pay the loan in full.
Typically, the way you get around that is, I mean if you have the cash saved up, then pay them out in cash. But typically you get around that balloon payment by refinancing the property. So just something to consider, Sarah, is that as you’re putting this together, you can have the amortization be something exceptionally long, three decades, and then have your turn be something shorter to give that seller peace of mind. They’re not going to have to be sitting around for 30 years to get their money back.

Ashley:
Well, thank you guys so much for submitting this week’s questions. If you guys would like to submit a question, you can go to biggerpockets.com/reply and post your question in there. Or you can also leave it in the real estate work Facebook group or you can send Tony or I a DM and we will add it to the list. Thank you guys so much. I’m Ashley, @wealthfromrentals, and he’s Tony, @tonyjrobinson. And we will be back on Wednesday with a guest.

 

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