#149 -Making An Offer: Part 1

SW Financial Literacy

Making An Offer: Part 1

I just bought 160 acres of farm ground back in May, so I have a little bit of a problem.

Around five years ago I reached out to 20 absentee landlords in the area, introducing myself and asking them to consider me if they ever were looking for a new tenant or to sell their ground. These were handwritten letters and envelopes that received a surprisingly high response rate of 50%. I'll be honest, not all these responses were positive, but two stuck out and created several phone conversations.

The first was the son of the person I wrote. He informed me that his dad had recently died and he had taken over the estate. He was appalled at how the tenants had been taking advantage of his dad on rental rates for years and how poorly they had taken care of the family ground. He badly wanted a new tenant. I had an opportunity to rent this ground, but my offer was not accepted.

The second informed me that someday he would have an interest in selling his ground. The current tenant has a first right of refusal, but it is unlikely to execute as he is nearing retirement without the next generation coming back.

Last week absentee landlord #2 called me asking if I would put an offer out for his farm ground. Hence my dilemma.

Putting an offer together is an interesting exercise that I'm going to share with you here.

The Return

2026 is my 8^th year being involved with the farm. From my experience, each acre of dryland crop ground can return around $375/a net before rent payment, loan payments, and/or taxes. (This would actually be a 2-year average as I cycle between a corn/soybean rotation, with corn ALWAYS generating higher profit.)

The property being offered is 155a of irrigated crop ground. My $375/a X 155a shows I could support around $58,125 worth of payments/taxes if this were dryland at a 190 bu/a corn & 57 bu/a soybeans. For irrigation, I’m going to round this up to $65,000/a with expecting yields of 225 bu/a corn & 65 bu/a soybeans.

$65,000 in net pre-tax profit is what I could expect with a 100% down payment on the purchase.

Finance Part 1

P.S. The tools used below can be found in the Farm Buying Toolbox | Farm640.

I just bought ground and pulled cash out of that 1031 exchange transaction. I’m a huge believer in hording cash, and I would prefer to put as little of cash as possible into the purchase, so I need to find a way to make this work with the $65,000 net while including financing.

Let’s assume the ground appraises for $13,500/a. $13,500/a X 155a = $2,092,500 market value. Most banks/lenders will finance in the range of 65-70% Loan to Value. $2,092,500 X 70% = $1,464,750.

Stand alone financing at market value is going to require a $627,750 down payment and has annual payments of $113,219/yr. Not only can I not afford to make that down payment, but I could also expect to lose $48,219/yr to cash flow. (FSA joint financing is not an option for me, I just maxed out that program.)

Give up?

NO WAY!

What could I make work?

Finance Part 2

The biggest downpayment I would be willing to consider is around $100,000 so I began working with that.

Backing the purchase price all the way down to $9,500/a, with a $100,000 down payment leaves me with a finance amount of $1,372,500 and payments of $106,088/yr. I know there are some hands raised in the back asking, if the bank will only lend you 70%, how can you do that?!

The bank will lend 70% of the appraised value. Just because I am buying ground at $9,500/a privately does not mean that is what the ground will bring on the open market. I am confident this piece would appraise for no less than $13,500/a, so the finance amount from my first scenario stays in place.

My real problem here is the total annual payment. $106,088/yr (without taxes) is a far cry from the $65,000/yr this property can cover. I don’t dare decrease the purchase price below $9,500/a as that is entering the territory of dryland prices. I’m going to shelf this part of the scenario for now, but we will bring it back up in a bit.

Finance Part 3

The landlord is retiring and doesn’t seem to have a huge need for the money. I asked if he would consider an option with seller financing, and he said to send him an offer.

What structure could I make work?

$10,500/a and creative structure.

But how?

Let’s review a 50/50 deal. I acquire 50% of the purchase price financing through a lender (so the seller would get 50% of the sale proceeds immediately), and I would pay the seller the other 50% of the proceeds in the future (say 5 years).

Why would the seller do this?

They get a portion of the money they want now, I can sweeten the pot for them by paying them an annual holding fee (or interest) on the other half of the purchase for a predetermined time (5 years), and they can look forward to getting another big payday in a few years.

Is it better to get all the money up front? Maybe. But not everyone thinks that way or prefers that structure (you don’t know unless you ASK!).

155a X $10,500/a = $1,627,500 purchase price.

$1,627,500/2 = $813,750 due to seller now at closing.

The $813,750 is financed with a traditional lender on a 30-year amortization.

Now we are talking! (remember, taxes still need paid)

But I want to sweeten the pot a little bit for the seller to make it worth their time for holding the 2^nd half of the financing and offset the risk of them handing over the deed now while taking a second lien position behind the bank for the next 5 years.

An extra $100,000 in their pocket might sound nice to them.

$100,000/5 years = $20,000 payment to the seller for holding the other $813,750 of the purchase. (2.46% return on their ‘investment’). Plus, the extra $100,00 increases the ‘purchase price’ to $11,145/a but on terms that I can more reasonably manage.

While payments of $62,899 + $20,000 + $10,000 taxes = $92,899/yr is well above the $65,000 net I would hope to project after all other expenses, it is a more manageable gap to cover than the other options presented.

What does this look like from a payment standpoint?

After 5 years I would have paid $52,880 in principal balance, having a loan amount of $760,870 remaining. At that time, the other half of the buyout (seller financing) would need to be completed.

Remember, the purchase price was $10,500/a while I feel the market today is conservatively worth $13,500/a. There is real potential that in 5 years the ground is worth $15,000/a.

155a X $15,000 = $2,325,000 projected 2031 market value.

$2,325,000 X 70% Loan to Value = $1,627,500 I can borrow against the property.

$760,870 current loan + $813,750 to complete the buyout = $1,574,620 projected I could borrow against the property. Again, no cash down payment needed. The 5-year holding period gives me the room I need to allow for 2 powerful aspects of real estate to take place:

1)      Appreciation

2)      Debt paydown

With no money out of my pocket (if it cash flows, which it doesn’t look like it will! But you know what I mean!), I can get the whole property into my name.

Last I checked, $0 personal money into a deal X any type of return = extremely strong ROI.

Yes, $121,711 in payments is almost double what I can afford today. But do you know what? We don’t know what the future holds. Heck, I don’t even know what I’m having for lunch tomorrow. Maybe the ground can support $121,711 in payments 5 years from now. I’m willing to take the risk today and wait it out to see what the situation looks like in 5 years. Why?

The Advantage

What would this do to my balance sheet? (to see the full changes to your balance sheet as you scenario plan large purchases, check out www.farmbalancesheet.com, that’s what I use)

$0 down payment has no impact on cash.

$9,271 in principal payment decreases my Working Capital by $9,271.

$813,750 traditional financed loan increases long term liabilities by $804,479 ($813,750 - $9,271 = $804,479).

$813,750 seller carry loan increases long term liabilities by $813,750.

A purchase price of $1,627,500 with a market value of $2,092,500 increases long term assets by $465,000.

Result: Working Capital decreases by $9,271. Net worth increases by $465,000.

Is it risky? ABSOLUTELY! This is a lot of debt to absorb. It will be a cash flow crunch for years. That is why you must buy the ground at the right price. My offer must include a net worth gain that is large enough for me to be willing to offset the cash flow crunch.

Am I screwing the seller? Not at all. I’m going to present him with 2 offers and he can choose the 1 he likes or go find another buyer. I already informed him I can't offer what an investment fund would be willing to pay, and he still asked for my offer.

2 offers? I only have 1 logical scenario that works. There will be more on the 2 offers plus details on an exit strategy next week.

2 offers plus an exit strategy are both ‘musts’ when making an offer.

Have a great week!

Grant