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If you’re unfamiliar with the business of terms deals, the idea of earning six figures on a deal with no money down might sound crazy. But generating this type of profit is fairly common if you can set up terms deals in the right way. Even better, they’re some of the most recession-resistant deals you can make in real estate.
When I say “terms deals,” I’m referring primarily to lease purchases and owner-financing deals. Here’s an example of an owner-financing deal we recently closed that had a total profit of around $200,000. Let’s go through the framework, why this particular deal was so valuable and how you can use these same methods yourself.
The Rural California Property
The property was a rural California home owned by an older, retired couple who wanted to move closer to town. The couple was having trouble selling the house and need to pay some maintenance fees, so they wanted to get rid of it as quickly as possible.
This property was free and clear, so we went for an owner-financing deal, purchasing the house for $617,000 with a five-year term. The simple framework we use breaks each deal up into three paydays:
• Payday No. 1 is the down payment we receive from the tenant buyer.
• Payday No. 2 is the monthly spread, or the difference between what we’re paying to the seller versus what we receive in rent from the new tenant buyer.
• Payday No. 3 is the back-end profit from the eventual sale of the house to the tenant buyer, plus all the principal paydown that accumulates over the course of the term (more on that later).
If you can understand how these paydays work, you can set up any terms deal to be successful and profitable. The key is making sure you have the right documents and legal agreements in place.
Paydays 1, 2 And 3
As a general rule, it is wise to try to get anywhere from 10–20% as a down payment from the tenant buyer. In this case, we got right around 10%, or a $60,000 down payment to create payday No. 1. Some of that is paid upfront, and the rest is paid over the first few years of the term.
For payday No. 2, in this deal, we set the seller up with a $2,300 per month payment, which included $400 in taxes and $1,500 in principal paydown. We were able to rent the home to the tenant buyer for $3,150 per month, creating a profit of $850 per month. Over the course of a five-year term, that’s $51,000 in total.
The final sale price for this home ended up being $659,000, providing a nice back-end profit of $42,900 to start payday No. 3. But this payday also includes the profit from the principal paydown. In our example deal, the $1,500 in principal paydown we received each month resulted in $90,000 in principal paydown alone over the term.
This is the key to maximizing your profit on terms deals: The longer the term, the more principal paydown you can accumulate, and the higher your profit will be in the end. When you combine those two numbers and remove the initial $60,000 down payment, payday No. 3 comes to $72,900.
When you combine all three paydays, the total comes to $183,900. But that’s a bit short of that $200,000 — because there are actually a few other factors at play here that are key to terms deals.
First comes structuring terms deals so that you don’t start making payments until 30 days after you get a tenant buyer in the property. That means effectively getting an extra month’s rent on each deal — in this case, that was an extra $3,150, bringing the total to $187,050.
This particular deal also includes $300 in monthly maintenance fees for the property. This is something that we are able to pass on to the tenant buyer because, after all, they’re going to own the property. As the future owner, they can become responsible for the maintenance.
When you factor that in over the five-year term, that’s an additional $18,000, bringing the grand total to $205,050.
Implementing This Yourself
The beauty of terms deals is that you can set them up with no money down; you get money in your pocket right off the bat and then generate consistent income throughout the length of the term with a sizable payoff in the end.
If you’re ready to begin crafting deals like these for yourself, remember these critical considerations:
• Ideally, find a homeowner who is having trouble selling their home (or simply having trouble selling for their ideal price) and a buyer who isn’t qualified to purchase a home with conventional means right away.
• Structure your deal with three paydays, ensuring you maximize your profit on each.
• Negotiate for the longest term to maximize principal paydown.
• Pass on as many costs as you reasonably can to the tenant buyer.
If you can do all of those things, you’ll be well on your way to generating consistent profit with recession-resistant deals.