Risk of Subject To / Lease Option deals - Posted by Fred Bauer

Posted by roger martin on September 11, 2003 at 24:38:02:

i said historiclly yes in someplaces that happened in spots not all over,atre you saying he should let what ifs stop him from investing

Risk of Subject To / Lease Option deals - Posted by Fred Bauer

Posted by Fred Bauer on September 09, 2003 at 20:02:32:

I’ve been reading a lot about subject to and lease option deals lately here on this board, and I’ve been thinking about these types of deals myself. To all of those focusing on or doing a lot of sub2/LO deals, I pose the following serious question that’s been bugging me …

What happens if the housing market takes a turn and property values were to decline 5-10% over the next few years, the economy stays sluggish etc.?

It’s quite possible.

You’d have a bunch of t/b’s who could no longer excercise their options, and if you’re lucky you’ll be able to L/O the properties again to someone else at a lower price.

Best case scenario you’ll end up breaking even or making a relatively small amount of money in return for all of your hard work. Worst case scenario you’ll have to rent out a bunch of properties at breakeven or even negative cashflow for who knows how long until things turn around again.

The relative ease of finding sub2/LO deals is very appealing, as finding profitable deals is generally the hardest part of the game, but I am always hesitant to pursue anything where my success is so highly dependent on external forces that I have no control over (the economy).

I would love to get input on this, from both sides …

Re: Risk of Subject To / Lease Option deals - Posted by Ronald * Starr(in No CA)

Posted by Ronald * Starr(in No CA) on September 10, 2003 at 24:36:04:

Fred Bauer------------------

Well, it looks to me as though the only problem you have is that you are realistic.

Everything you have said so far in this thread sounds exactly right to me.

I have a discussion down below in answer to a question about “live in or rent” about investing either in quick turn, which you have mentioned, or very long term hold and rent, which I call “owning forever” or until you die, whichever comes first.

I think you are 100% correct in all that you say. The lease-option approach has grown greatly over the past 5-8 or 10 years, although the approach has been around a long time–just not much used. It has grown greatly in a time of strong appreciation in most of the country. So those who advocate the technique and the many practitioners typically have not been through a down market using it.

I have warned several times over the past 18 months about the technique being vulnerable to hard times.

My advice: if you don’t want to take the risk of the lease-options do not do so. Just do the quick turn investments and leave it at that. You will have less risk. You will have a strategy that makes sense and works, even in down markets.

Good InvestingRon Starr*

Re: Risk of Subject To / Lease Option deals - Posted by Jim FL

Posted by Jim FL on September 10, 2003 at 24:26:38:

Good topic, and one that I personally try to address often when teaching or discussing REI with others.
You seem to make an assumption here,(I know why, more on this later), that when you buy a property sub2, you are not buying it for significantly under market value.
Now, some courses, no, most courses about sub2 that I’ve seen popping about over recent years do tell you to target 2-5 year old houses, with little equity.
These are easy to sign up, and they are plenty.
I don’t subscribe to that method…anymore.

When I first began to use the sub2 technique, I did as I was taught, and bought a lot of houses for high LTV’s.
I’d sell most of them with a L/O for above market value.
Thank goodness, most of them have since sold.
I still have a few, and since I’ve had them a while, they are not as scary.

I understand your concern, more than you know.
I know the feeling one gets when there are SEVERAL vacancies, with houses that are encumbred to the top, or very near.
This hurts.
Since feeling that pain personally, I changed my investing attitude and slowed down a lot.
I admit, I was once at a point where I did 8-12 transactions per month.
Boy was that fun, for a while.
Notice I did not call them “deals”.
Then, sure, they were deals to me.
Now, I’ve been at this longer, fallen, stumbled, almost lost everything, and persisted through, adjusting along the way until I had a new system in place.
I no longer do a high volume of deals as before.
I still do more than most based on what I see others in my market doing.
The good news is that the deals I do sign now, all have plenty of meat on the bone.

My new, and very simple philosphy is this;
I will only buy a property, no matter what method I use to aquire it, where I KNOW I can sell it fast, even at a discount, for immediate profit.
Simply put, I buy right, well under value.

Let me give you an example.
My last sub2 deal signed, we got in for nothing, the seller covered two payments.
The loan balance was about 58% of value, and the houses needed cosmetic repairs.
I know my market, and because I was in low, my exit strategies are numerous.
I have the option to sell the house “As is” to an owner occupant seeking a handyman special, with light repairs.
I could sell this to another investor, either a rehabber wanting a small job, and decent profit.
An investor who will fix it and keep it as a rental.
I could fix it and lease option it, creating a larger profit over time.
or, the exit I settled on…fix it up and sell it retail, making a nice chunk of cash.
Problem though, I’m not skilled at fixing things, and with a number of projects in the works, my cash is tight.
Holding this house and fixing it, would not be fun.
Not too bad, but I’d rather get in, get out, and make a deposit.
So, knowing a local contractor who has been rehabbing historic homes for years, making a decent slow profit, I made a proposal. (The contractor is one of my best friends by the way.)
We agreed to partner on the deal.
He is doing the repairs and clean up, at his expense.
It will be done at the end of this week, and we still have until November when our payments begin.
We already have someone making an offer, at full retail price, but contingent on the repairs being completed.
We will split the profit 50/50.
All I did was sign it up, change the locks, and turn it over to my buddy.
Marketing was easy, a sign in the yard, some flyers, and word of mouth in the much sought after neighborhood.
Could I have done this deal alone?
Sure, easy.
However, this keeps it hands off for me, and while my buddy is finishing this deal up an we wait for closing, I’m signing other deals.
I’ve already got another house sub2 that he and I will work, much like this one.
We plan to do about 1 or 2 per month.
Should be a nice way to keep him busy and getting paid, as well as me.

So, you are right, should you buy sub2, at or very near market value, then lease option for higher than current market value, yes, you could be asking for trouble.
I know this first hand.

Instead, I now work less deals, for more profit, and less risk.

Believe me, those of us who have been at this for any decent length of time have figured out a little something.
Work smart, not hard.
High volumes of transactions does not always equal big or smart assured profits.

I used to tell myself years ago, “I want to do 100 deals per year”.
Guess what?
I’ve done that more than once, and while it was fun at the time, I’m too old for that pace, and life is too short.
I’d much rather do 2 deals per year and make the same money as 50 transactions.

Make sense?

By the way, I’ve talked to a lot of other somewhat seasoned investors lately, and the majority of them are slowing things down volume wise.
Heck, several of them are selling things off, and turning to low LTV paper.
That is my long term plan.

I hope to someday not own a single piece of real estate, but hold a whole mess of paper.

Anyway, sorry to ramble.
I just felt after reading your post that you too had fallen victim to those espousing low equity sub2 deals, and thinking the sub2 method was flawed because of this.
It ain’t…if you buy right.

Take care,
Jim FL

Re: Risk of Subject To / Lease Option deals - Posted by Stewart

Posted by Stewart on September 09, 2003 at 21:44:42:

This is the risk of doing sub2 and having a bunch of them. However, if you don’t do many at one time and build it up over time your biggest problem is making sure they are filled and you don’t have negative cash flow. Keep in mind that over time the balances are getting paid down so the longer you have a particular house the better off you will be in a downturn.

Re: Risk of Subject To / Lease Option deals - Posted by Nick

Posted by Nick on September 09, 2003 at 21:40:12:

I can think of worse reasons not to do a Sub to deal. I am more concerned about the insurance and the mortgage company thing. But it does not stop me from sub 2 deals. You can what if, yourself right out of this business. You have to look at the negatives but dont focus too hard on them. What if everything went right? I would say if you do your homework, dont just jump into something that does not make sence, and evaluate each deal carefully, chances are better that you will make money than loosing. You have to know your market but cannot predict the future. Pay your money and take your educated chances.

Re: Risk of Subject To / Lease Option deals - Posted by Chad (FL)

Posted by Chad (FL) on September 09, 2003 at 21:11:32:

I am still learning about Lease Options, but from my understading, one of the best ways to protect yourself is to sign a 1 year lease with the right to renew at the end of the year. So that way you can walk away at the end of the year if you need to.

What does everyone else think?

Re: Risk of Subject To / Lease Option deals - Posted by Fred Bauer

Posted by Fred Bauer on September 09, 2003 at 21:51:02:

I’m not quite sure I understand … you seem to contradict yourself when you say “if you don’t do many at one time and build it up over time …”. My first thought is that 1) if you don’t do many at one time you aren’t going to make much money, and 2) building it up over can only happen by doing lots at one time.

If you only have 2-3 deals going at any one time you aren’t going to make much money (unless you are doing some crazy profitable deals). At the same time, you can’t do 20 deals a year without exposing yourself to significant risk - at least that is what it looks like to me.

As far as balances being paid down, let’s be realistic. Unless these are very seasoned mortgages, you aren’t getting much paydown in 1-3 years.

I feel you are missing my point … - Posted by Fred Bauer

Posted by Fred Bauer on September 09, 2003 at 21:47:47:

My point is that with these types of deals your profits are heavily dependent on the market going up - unless you buy into enough equity to reach your desired profit by L/O’ing at today’s FMV (which almost no one does). My point is that you could run into serious trouble if the market were to NOT go up, which would not be the case if you were doing rehabs, short-term flips, etc. What in your mind justify this extra risk?

I’m talking about taking sub2 and selling on a L/O - Posted by Fred Bauer

Posted by Fred Bauer on September 09, 2003 at 21:21:37:

I’m talking about taking sub2 and selling on a L/O…

Re: Risk of Subject To / Lease Option deals - Posted by Stewart

Posted by Stewart on September 10, 2003 at 08:42:13:

Well sure, in the short run, you don’t have much protection. But in the long run you will. If you went out today and got 20 homes (not like anyone can do that), you would have a huge exposed risk, however, 1 home a month or every 2 months over several years would be a much better position. Keep in mind that ideally you are picking your deals, getting them with some equity in them from the start is a must if you want to limit your risk (and ensure better profits). Taking a house sub2 with a balance equal to FMV is not good. Over time, you would have let’s say 20 or 30 homes (that you got 1 at a time over time.) It would have to be a big downturn to really mess you up. Plus, you should be keeping a big cushion for just a thing (as in any investment situation). This is especially important in markets that may have been up and down in the past. In my area, I don’t know if I have ever seen a down market (maybe a flat one.)

Re: I feel you are missing my point … - Posted by roger

Posted by roger on September 09, 2003 at 23:08:55:

you can what if yourself to death ,fact is cost of housing historicaly has gone up 5% per year since the 1880s nation wide so stop with the what ifs and read up on the subjects in the archives , join in or do someother type of r,e, if it stills scares you, sorry for being blunt thats the way life is and thats the answers i like best they are more truethful

great news everyone, appreciation of 5% every year - Posted by b

Posted by b on September 09, 2003 at 23:37:21:

Fred has a good point. Do you really think that because you say that historically housing has gone up 5% a year nationwide, that it means there is no risk in doing L/O? Are you suggesting the increase was constant and steady? If you are you are ignorant. All it would take is a 2-5 year downturn (historically realistic) and alot of the L/O fanatics would be screwed. Fred is right, there should be a lot more focus on the reality of what is going on around everyone amidst all this excitment over what seems like an easy way to make money. When in reality it is an extremly risky (for both parties) way of exiting a deal (because you haven’t really exited until someone exersizes their option), which in a downmarket, no one would. I agree with fred, there are better, less risky ways of playing the game.

Re: I feel you are missing my point … - Posted by Fred Bauer

Posted by Fred Bauer on September 09, 2003 at 23:34:42:

With that type of attidude and short-sightedness only luck will keep you from going backrupt. If you were to do only a tiny bit of research you will see that there have been numerous periods of 3-5+ years, all over the country, in the not so distant past where property values have gone down and even “crashed” 20%, 30% and even 40% or more. I was hoping for some intelligent discussion, but obviously won’t get any from you. Thanks anyway …

Huh… - Posted by Roger Martinez

Posted by Roger Martinez on September 11, 2003 at 09:40:02:

Not the way to “Win Friends and Influence People”, Fred.

I would have to comment that your pride and ego will most likely do YOU in. Gheeze…why so terse? Good luck! Sounds like you’ll need it.