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Tuesday, May 29, 2012

Making Smart Financial Decisions at the End of Your Days

I spoke with an elderly seller before the 3 day weekend. Her husband left her a single family house she rents out in the high desert, not a particularly secure place to own rentals. I made her a cash offer of $40,000. She said she could not possibly accept such an offer because the house was her only source of income for her retirement. I asked if she might consider carrying a note on the property. After slowly explaining what I meant, she wanted to know what kind of offer I might consider giving her.

I told her I would be willing to double my cash offer price, if she would carry paper and give me terms that allowed the tenant to cover the mortgage, pay all the expenses, and put a little profit in my pocket every month. It is currently rented at $950/month. Let's take a look at the numbers based on the current rent:

Monthly Rent: $950
Monthly Expenses: 40% or $380
Required Minimum Monthly Cash Flow to Investor: $150
Remainder Available for Debt Service: $950 - $380 - $150 = $420
Purchase price: $80,000
Down: $5,000
Principal Balance: $75,000
Interest Rate: 4%
Monthly P&I Payment: -$420
Solve For Term: 272 Months or 22.5 years

If the seller accepts my terms offer, she can collect $420/month for the next 22.5 years without worrying about any loss of income due to vacancy or repairs and she gets $5,000 today to put in the bank providing her with some security for any expenses that might come up. She could also sell the note at any point in the future for an immediate cash payment if needed.

She said she needed to talk to her CPA and financial adviser, so I followed up with her after the 3 day weekend. The seller said she could not accept my terms offer because both her CPA and financial adviser said it is not in her best interest to carry paper at her age. They both claim it would be better for her to sell and take the cash. In this market, her house is only worth about $80,000 out of which she will have to pay commission and sales expenses. Let's assume they eat up 10% of her gross, or about $8,000 leaving her with $72,000 for her pocket. She won't have any capital gains tax or depreciation recapture because she purchased the house new for $115,000.

If she takes the $72,000 from the cash sale and puts it into a savings account, we can safely say that inflation will wipe out any interest she might earn on the savings. If she took that same $420 a month faithfully, her money will last approximately 171 months, or 14 years. More than likely, she will dip into that $72,000 on more than one occasion giving her a lot less than 14 years.

Shortly afterwards, I spoke with an 87 year old seller who owns 5 houses all next door to each other. During the conversation, I heard a clue that he would carry paper. When I asked, he said he would love to carry paper and would be willing to take nothing down. Why do I have two sellers in similar situations, but one is more than happy to carry a note and the other terrified of running out of money? Do you think the CPA and financial adviser really have the first seller's best interest at heart by telling her to take the cash?