? for John Boy or other Sub2 practitioners... - Posted by JP

Real Estate Investing
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Posted by gerald(tx) on September 07, 2003 at 13:07:47:

The reason I put the optional year in the contract is mostly for reassurance to my buyer. He’s thinking, “gosh what if I can’t clean up my credit in two years, will I lose everything”?

My reply is that "if there are no bankruptcy or forelosure on your record, there is usually no problem – IF you will pay all your bills on time, especially your house payment to ME! (notice how I’m setting him up for no late payments to me)

“However, if for some reason something should cause you to slip, I’ll extend it another year for a $1k fee. (notice here that the penalty is another incentive to always pay on time.)”

Also your question is about L/O. – I SELL! The buyer knows HE BOUGHT the home. My feeling and experience is that L/O amounts to glorified landlording.

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? for John Boy or other Sub2 practitioners… - Posted by JP

Posted by JP on September 06, 2003 at 22:23:24:

John Boy gave an example in one of his posts describing the Sub2/LO strategy where you take a property that is worth 150k sub2 the existing loan balance of 145k. Then sell it on a L/O at 165k in 1 year. Add in the cashflow, etc. etc. you ended up making around 25k in that example. Sounds great, but how realistic is it that the t/b will be able to get enough of a mortgage to buy the house for 165k a year later? A house worth 150k today is not going to be worth 165k in a year (well not in 95% of the country anyway) so the appraisal won’t hit 165k and the t/b is SOL unless they come up with more money out of pocket to cover the difference. Was this an over-exaggerated example or a case where you as the investor really don’t care if the t/b is able to excercise his option or not, after all you can just repeat the process with someone else.

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Re: ? for John Boy or other Sub2 practitioners… - Posted by JohnBoy

Posted by JohnBoy on September 07, 2003 at 16:14:21:

No, this was not an over-exaggerated example. Interest rates have been at low levels for the past few years, causing home values to increase. Your idea of 95% of the country where homes would not increase by that much is over-exaggerated. Maybe in your area and in some other areas, homes may not increase that much, but it most areas they do increase.

In my area the average home value has increased by 8% per year. In others, they have increased far more than that, especially in CA.

A home worth $150k a year ago, where values have increased by 8% would make the home worth $162k today.

If you got at least $5k in option money from the t/b’er, then the amount they would need to exercise the option would be $160k. If you gave rent credits it would be less. If you extend another year, even less.

If for some reason the house does not appraise for enough in a year, then you have several options…

Agree to renew the L/O for another year.
Lower the option price to get cashed out.
Have the t/b’er pay the difference.
Carry back a second mortgage for the difference.

How realistic is it that the t/b’er will exercise the option and/or be able to buy the property?

Depends!

Depends on whether or not they still want to exercise the option. Depends if they cleaned up their credit in order to qualify for a loan. Depends on if you are willing to extend them more time if needed. (if they have performed on their end as promissed then this is never a problem on my part).

If they don’t exercise the option, then you get another t/b’er and start the process over again. More option money. More monthly cash flow. More profit over the long run. If they do exercise the option, great! You get paid off and cashed out. Go replace it with another property.

It’s not about cheating people and making it so they can never buy the property. Although some investors do it that way, that is not the right thing to do. We want them to buy the property. If it takes longer for them to buy it, or if we have to start over again with a new t/b’er, then so be it. We just make more money from it.

It has been estimated that 65% of t/b’ers never exercise the option. This is not because the property won’t appraise and is over priced. It is mostly because of the t/b’ers own doing. They decided they no longer want the property. They didn’t perform on their end of the deal by cleaning up their credit, or they breached their contract, failed to pay on time, failed to take care of the property, got transferred to another area, etc, etc, etc.

We make it fair for them to be able to exercise the option. We extend them time if needed as long as they have performed on their end of the agreement, paid the rent on time, and taken good care of the property. If not, we don’t extend and replace them with another t/b’er.

Whether they exercise the option or whether then can exercise or not is all on them. They have been given a fair opportunity. Whether or not they perform or decide different is up to them.

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Why do you guys even do these deals? - Posted by Margie Samms

Posted by Margie Samms on September 07, 2003 at 24:31:03:

No offense, but why do you guys do these types of deals? Who in the world wants to wait 2 years to make your profit when you could just focus on buying properties for 20% (or more) below FMV, flipping them, and making your profits immediately? It seems the only reason you would do these types of deals is because it might be easier to find them as opposed to finding properties you can buy for 25,30,40% below FMV. Is that why? Just curious … what am I missing?

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some play if differently… - Posted by gerald(tx)

Posted by gerald(tx) on September 06, 2003 at 23:37:12:

Me, I don’t like to play it that tight. There are so many bargains in today’s market (if you really look for them), I feel it best to only buy properties that I can buy right.

In my scenario, I would look for a $150k, no repair needed sub2 I could buy for around $130 - $135k. Then sell it on a wrap for say, $157k on a 2yr baloon with option for an additional year.

This way two years gives them enough time to clean up their credit, you don’t have much worry about the property not appraising enough at refinance time, nor the T/B looking for a better deal with his newly found good credit.

If you buy a property with good equity already in it, it’s hard to screw things up and not make a profit. The least risk vs reward is my philosophy.

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Re: ? for John Boy or other Sub2 practitioners… - Posted by Marco Antonio

Posted by Marco Antonio on September 08, 2003 at 01:51:21:

Just for the sake of an example, say I did 20 such deals in the next month on 2 year options. If your 65% estimate is close (which I’d believe) then 2 years from now I’d have sold 6 properties and be left with 14 of the original 20. I guess at that point if a person wanted to cash out as opposed to finding more t/b’ers, the properties will have appreciated enough in those 2 years to more than pay for your selling costs and you could just sell them the “traditional” way and pocket the locked up equity that you picked up when you took them sub2 less than FMV. So I guess either way you make about the same whether they were to excercise their option after 2 years or not eh? And of course you could just hold on to them and find more t/b’ers too.

I guess one of my concerns is that many of the properties I take sub2 will require me to pay off their loans within 2-3 years. I’m just getting started, and I try not to even bring it up, but so far it seems like I will need to agree to pay off the seller’s existing mortgage within X period of time to give them enough confidence to do the deal with me. So say I agree to 3 years, and then I sell on a 2 year L/O. With the 2 out of 3 that don’t excercise after 2 years, that gives me plenty of time to sell those properties in order to pay off the original seller’s mortgage and pocket my profit. I guess I just wouldn’t be comfortable if I did a bunch of deals and then a few years down the line I have a ton of balloon payments coming due that I need to pay, and a bunch of t/b’ers who aren’t excercising their options. You know?

Do you and most others agree to pay off your seller’s mortgage within 3, etc. years or do you only do the deal if they agree to an indefinite timeframe i.e. you may just keep making their payments for the next 25 years with no definite timeframe that they can count on?

It seems like these deals are going to be the “easiest” by far … we’re just getting started and already made about 5 offers in the past week. I just want to make sure I cover all my bases before I get too far along.

We’re experimenting with Bill Barnett’s “multiple offer” strategy … do you generally just pitch them on the subject 2 or do you also make multiple offers including a “lowball” all cash offer when appropriate? Or do you and most others only target those with little equity? It seems that those in the “middle” … with say 20% equity … are the toughest ones of all. Not enough to lowball and flip, and probably too much for them to just walk away from all that equity unless they are extremely motivated. Personally I wouldn’t want to be giving homeowners 5k, 10k, etc. at a time for their equity when I won’t see payday for 2 years. How do you guys handle that?

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Re: Why do you guys even do these deals? - Posted by Brent_IL

Posted by Brent_IL on September 07, 2003 at 12:14:20:

You?re not missing anything. Your right; for those of us who don’t do major rehabs, it is much easier to find several high LTV subject-to deals than it is to find one property available at 70% of FMV. The exit is similar for all of them. Our fixed costs are spread over a larger number of transactions, so a few properties don’t have to pay for everything.

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Re: Why do you guys even do these deals? - Posted by mattc

Posted by mattc on September 07, 2003 at 08:07:55:

Margie,
Do you have a hard time finding the properties
in the 25-40% below FMV range? How do you find them
mainly - if you don’t mind? Are they mainly in nice, but lower-middle neighborhoolds, or in nicer neighborhoods also?

Are you mainly flipping the ones you do find, for 5-10K
assingment fees to other investors, or retail buyers - or do you buy and hold ala Sheets - or lease option them to tenant buyers?

Just curious - thanks in advance.

mattc

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Do you really find takers on this? - Posted by JP

Posted by JP on September 07, 2003 at 22:55:36:

A 2 year balloon seems a little risky for most people isn’t it? Do you get many takers on this type of offer you make? What happens when they can’t refinance in 2 or 3 years … you just foreclose on them and take it back??

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Option for additional year… - Posted by randyOH

Posted by randyOH on September 07, 2003 at 12:33:40:

Gerald,
You say you give your tenant an option for an additional year. Is this written into your original option contract or is it just verbal? Does the original option price stay the same? Do you require any additional option money?

Thanks in advance,
Randy

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Re: some play if differently… - Posted by Allan Smith

Posted by Allan Smith on September 07, 2003 at 24:26:17:

Sounds good … how much do you get them to put down when you sell it on a wrap like that? And do you get even more money out of them for the 3rd year option as option consideration? I guess one downside with this strategy is that if you are a dealer (seems likely for someone doing more than 1 or 2 of these no?) then you won’t get preferential installment sale treatment i.e. you will owe taxes on the profits before you even receive them. No? Can you elaborate a little more on your strategy? Thanks!

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Re: ? for John Boy or other Sub2 practitioners… - Posted by rm

Posted by rm on September 08, 2003 at 08:20:46:

If you call one of your sellers in 3 years and tell them that you need more time to cash out the property, they’re probably going to give it to you. “Would you rather extend our agreement, or do you want the house back in its current condition?” The last thing they want is to revisit their old headache.

As far as confidence goes- it’s up to you to supply it. When you reach a certain level of self-confidence, this will be a non-issue. For now, I’m betting that it’s more an issue for you than it is for them.

>>I guess one of my concerns is that many of the properties I take sub2 will require me to pay off their loans within 2-3 years. I’m just getting started, and I try not to even bring it up, but so far it seems like I will need to agree to pay off the seller’s existing mortgage within X period of time to give them enough confidence to do the deal with me. So say I agree to 3 years, and then I sell on a 2 year L/O. With the 2 out of 3 that don’t excercise after 2 years, that gives me plenty of time to sell those properties in order to pay off the original seller’s mortgage and pocket my profit.

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Re: ? for John Boy or other Sub2 practitioners… - Posted by JohnBoy

Posted by JohnBoy on September 08, 2003 at 07:12:36:

We never agree to pay off their mortgage within a certain time frame. If it takes 10 years then it will take 10 years. We tell them we do our best to get the loan paid off as soon as possible, but we can not guarantee it will be paid within a certain amount of time. We have no control over whether someone else will follow through and buy the property. Therefore it could take longer. However, we do tell them it is in our best interest to get the loan paid ASAP since that is when WE get paid our profit. But until that happens we do guarantee the payments will get made and that will help with improving their credit rating. That is the best we can offer.

Now if there is a LOT of equity involved that we would stand to make on the deal, then we might agree to paying off the loan in a certain amount of time if that is what it takes to get the deal. If we stand to gain a LOT of equity then we would refinance it ourselves if we had too, just to get all that equity. But if there is little equity, then we never agree to paying off the loan early.

Always remember, if the seller could sell it to pay off the loan then they wouldn’t need you. It’s because they can’t sell it now which is why they need you. So NEVER agree to pay the loan off within a certain amount of time. It could be in a year or it could take until the loan matures. We can’t guarantee when. Only that we will make the payments until we can get the loan paid.

If there is a lot of equity where the seller needs to get some of that equity, then they have to agree to wait until the property is sold before they will get it. Again, that could be in a year, 5 years, 10 years, or whatever. We might agree to give them something now just to cover moving expenses if needed, but that is about it. Any more equity then they have to wait.

I’m the buyer. It’s MY way or the highway! If they don’t like my way, NEXT! There are far to many other properties to buy that I can buy MY way. I don’t need to give in to their way. I’m NOT a motivated buyer. And if they’re not a motivated seller…NEXT! Motivated sellers agree to MY terms, period. If not, they are not motivated enough. Call me if things change and if you need me. Next!

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Re: Do you really find takers on this? - Posted by JohnBoy

Posted by JohnBoy on September 08, 2003 at 07:18:51:

When selling on contract, this is exactly the way it works. If they can’t get refinanced in that time, then they obviously failed to perform on their end by cleaning up their credit. Otherwise they would have no problem getting refinanced. We might agree to a new contract depending on the circumstances. But if they need to go and refuse to leave, we simply EVICT them. In my state, there is no need to foreclose when selling on a contract for deed, unless their contract was for more than 5 years AND they have 20% or more in equity in the property. Otherwise we can just evict them.

Each state has different laws pertaining to contract for deed sales. So it’s important to understand the laws that pertain to your state. Some states do require a foreclosure while some do not.