Brand new. Optioned my first house. Now what?

Real Estate Investing Real Estate Gurus
1

I’m brand new. Have no background in real estate. I have been watching an acquaintance of mine (in another state) ranting for months about making great cash flow in real estate investing. My life has taken a hard financial turn, so I decided to take his “training.”

I get the gist of what he does…option houses and resell them using a lease option or “subject to” contract for a higher amount. He pockets their down payment (as equity from the spread), puts them in the house and creates monthly cash flow of at least $300/month on the payments until he closes them out. He does this all day long, himself. I have a background in sales and marketing, so I felt confident I could do it to and like working with people and helping them solve their problems.

He does not advertise the price of the home (which is usually high), but focused on the terms and buyers who can’t qualify for a mortgage.

His training lacked all the nitty gritty details–which I assumed would be flowing in as I got rolling or as he saw that I was serious and not just another training junkie who “studies” in lieu of “doing”. So I jumped in with both feet.

It’s been a couple weeks and now I have optioned my first house and have buyers calling me, but don’t have the knowledge to proceed. He is not available to answer my millions of questions and I am always left feeling like a nuisance for having detailed questions.

The owner of the house is upside down, so I optioned it for the balance on the mortgage–figuring even if I didn’t finish the deal, it was a REAL house to advertise to begin building my buyers list and get me rolling. The good news is she would be happy to be out from under the payments and her circumstances do not require her to close out that mortgage anytime soon.

I would be very grateful to hear what my options are for putting a deal together assuming I can find a buyer who is willing to pay a higher price for the opportunity of home ownership as an alternative to renting.

Thank you. I have really gotten myself into a jam, but feel I can enjoy this business once I know the details of what the heck I am doing! There is no risk in taking out an option but I will not proceed further into legal transactions without more knowledge and safety. Please help!

2

Ok, first off, let me congratulate you for taking your first step. Most don’t even get that far. 2nd…I think you need ALOT more education on this. Yes, I’m sure your friend made it sound easy and simple,(and it is once you know what you are doing) but what he is doing with the subject to is almost certain to lead you into some serious headaches down the road that you will not be prepared for. There is a better way to do these transactions where you dont have to have all the headaches. If you want, private message me your email and I will send you some resources on what you need that will help walk you through these types of transactions.

3

FreedomProperties,

What name should I use to address you?

I am not sure you are in a real jam. If you optioned the property you could just let the option expire with little harm done to you. Not good for building a track record.

What state are you in? The process can be subtly different based on the legal process used in your state. Mostly in terms of how the title is transferred.

What are you learning from the buyers who are calling? Is the property something they want? Are the numbers more or less lining up? I am not suggesting you have the numbers right. I just figure you must have said something in the ads so what do the callers think?

4

Thank you!!

John and Peilthetraveler…THANK YOU FOR RESPONDING TO MY POST.

My name is Catherine and I am located in Florida.

John, in response to your questions:

The theory behind the training I got was the engine behind the machine is the buyers list. So I began advertising before I got a house secured with a couple “coming soon” ads–focusing on terms–to begin to put my buyers list together.

I am about to begin advertising my specific house now–so I have not gotten a specific response on this house in particular. I got the option at the end of the week and then started to feel a lot of discomfort and decided to hold off on advertising it for the weekend while I tried to better educate myself.

I scoured this site (and others) all weekend and now my head is just swimming with extraneous pieces of information about lease options, “sandwich” lease options and “subject to” purchases and feel no more clarity than when I started–just more unsure and more confused.

I am fully aware that I need more education and more help–and am eager to jump in, but don’t even know where to start or how discern what will get me rolling and what will only leave more holes that need filling and more question marks–or worse–risk.

I don’t need to learn it all, and I don’t need to make giant killings on the deals, but need to find a nice type of deal structure to ease myself into this endeavor (with very little cash to work with)–that I can understand and be comfortable with.

My hope is to find a way to tip toe my way through this first deal as I need an influx of cash to take more education/coaching/or whatever it is…I need.

I will post again when I start getting a response to this house.

Thank you again!!

5

Freedom PPropertes,

Suggest you google “SAFE ACT” and read that to insure that you are doing things correctly.

It may or may not apply to you…check it out.

6

Catherine,

Personally, I think books are pretty useful for linking a strategy together. Online is better at detail while the book can provide the long version.

Two suggestions.

Look for Wendy Patton’s Lease Option book. Second, see what books you can find from William Bronchick. Bronchick is the co-host of the legal forum on this site.

I like how you want to apply yourself. You can learn as you go as long as you avoid complex deals initially. You also want to check the legal requirements for lease options in your specific state. Bill H’s suggestion is on target in that area.

7

John and Bill: Thank you for jumping in.

I google SAFE ACT and it seems to apply to loan originators. Does that apply if I am working with “subject to” existing mortgages?

John,
I visited Wendy’s site and her books look very much in the target of what I am trying to learn. Thank you for the recommendation. Without any frame of reference, maneuvering through the sea of information to find the right information for me is as hard as anything I am doing. I hope they have them at the bookstore because I don’t feel like waiting for mail. I am on the edge of my seat to move forward.

Thank you again.

8

Also, it was an article by Bronchik that brought me to this site and gave the site credibility in my eyes. I am considering one his home study products but would need to get through this first deal before I could afford it. It didn’t dawn on me to see if he had any books which would be a good way to start now.

9

Catherine,

Bronchick does have a book that will help. Flipping Properties
Make Instant Cash Profits in Real Estate is the title. You can get a paper copy from a bookstore or Amazon (assuming they have it still) or an ebook version from the LegalWiz site.

Start with the books rather than the courses given your budget.

10

Hi John,

Such good advice–thank you! I bought Wendy Patton’s book on kindle last night and have been reading it since 4am this morning. It has been extremely helpful. My biggest caveat (so far, and I haven’t finished the book yet) is that she is always using examples where she (or her students) secure a home at a FMV or slightly below. Her book was written in 2005. Of course, I see the value in this, but am wondering if these same strategies can be applied (or a variation thereof) when real estate is not appreciating so quickly and/or the house cannot be acquired at such a favorable price.

The house I optioned is badly upside down–possibly to the tune of 100k. Even if I don’t make money on the backend–which I am ok with since I am just getting started), I feel I could possibly make money on the front and in monthly cashflow but don’t have any idea how to close out a tenant/buyer (refinance down the road) if the house cannot be refinanced because the appraisal would be way too low–at least for the foreseeable future.

The seller has no urgent need to cash out. Is it feasible to take a longer view and put something together? Tell me your thoughts.

11

Time and debt reduction are the magic

Catherine,

When a property is upside down there is only two levers that can be pulled. You can mix them together.

A. You pay down the debt. [Debt reduction]

Assume the property never goes up in value. If the loan is paid off over time and each month a bit of the debt is repaid, eventually the debt will drift lower than the value of the property. At the end of the loan the debt will be fully paid off so the property will have a positive value.

A. You can wait and hope that the values will rise over time. [Supply vs. demand’; inflation]

This is less of a blind hope and more of a bet on inflation. What really happens is the value of the currency drops so it takes more dollars to buy the same house.

There could also be a rise in the demand. Maybe the area become even more popular to live in so people bid up the price even if there was no inflation to factor in.

In both cases, an interest only loan (no debt reduction) would end up being smaller than the value given enough of a rise.

So, where does that leave us with a L/O?

Four main themes.

  1. The tenant buyer pays a large sum as option consideration and some or all of that is used to reduce the loan balance. [Debt reduction]

  2. The payments are set up so that the tenant buyer is paying extra every month and the extra is being applied to the outstanding balance of the loan. Given enough payments over enough years, the debt will become less than the value of the property. [Debt reduction]

A related idea is the present owner chooses to throw a fixed amount at the loan every month. Maybe they pay $200 a month so each month the loan balance drops more than was expected. Assuming the monthly payments remain the same, the loan balance is reduced at an accelerated pace. Some will call this snowballing where you overpay to reduce outstanding debt. [Debt reduction]

  1. There might be ways for the tenant buyer to improve the property so that it is worth more over the years. Cosmetic changes that help attract a higher value is one possibility. Structural changes that add a room or something similar is another way. [Sweat equity]

  2. Time. The monthly payments keep things ticking over and inflation happens. Or the market recovers so demand to buy is increased. [Supply vs. demand’; inflation]

12

John,
Given the goal of debt reduction, how do I work some profit for myself into the scenarios you described?

Also, thanking for taking the extended effort to lay that out so nicely for me.

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[QUOTE=freedomproperties;886995]John,
Given the goal of debt reduction, how do I work some profit for myself into the scenarios you described?[/QUOTE]

This is where you have to run the numbers and check everyone’s motivation. Potentially there is no money possible in the deal. Some deals are not deals. As Terry V is famous for asking, where is the deal? Just because someone is motivated, there might not be a way to solve the problem.

Assuming there is nothing wrong with the property so no room for sweat equity…

How much can you get at the front end? How much can the payments be used to reduce the debt? How likely is a bit of mild appreciation.

If the buyer has bad credit because of a 1-off problem in the past, they might want to be a tenant buyer and they could have a large down payment. Many folks have piles of cash but can not qualify for a loan.

If the property is in a good school district, getting a child into the school now and buying later might make a world of sense to a motivated parent. That is why the buyer will stretch or do what might seem odd compared to the normal way of buying.

You have to look at the monthly payment from the tenant buyer. What makes sense? It is best if you know how to use a calculator or computer so you can figure out an amortization schedule.

Is the loan on a fixed interest rate? It is a lot easier to do this if the payments are fixed for the life of the loan.

How much over the monthly payment could someone pay if they really wanted to own the home over time? Figure that a person should not be paying more than 1/3 of their gross income for housing. How big of an income would they need to make the numbers stack up so the loan is paid down over time?

We might be out of your depth here in terms of running the numbers. The high level point is the deal has to make sense given the present facts. No use betting on future appreciation if you can get the numbers to stack up without it. If you come up a little short, then a bigger down payment, help from the seller, or some mild appreciation could tip the scale.

[QUOTE=freedomproperties;886995]Also, thanking for taking the extended effort to lay that out so nicely for me.[/QUOTE]

No problem. REI is a good field in that people tend to want to share. Normally there are enough deals for everyone so no need to hide information. I started a while before you so call this a bit of payback given the help I have received along the way.

14

Sell the Sizzle

Catherine:

Good advice from others. There may or may not be a deal there. But the key is finding (or trying to find) someone willing to pay the monthly cost. And your friend has an excellent approach: “He does not advertise the price of the home (which is usually high), but focused on the terms and buyers who can’t qualify for a mortgage.”

There you go.

Since the property you’ve optioned is upside down, advertising it at a price high enough to cover the mortgage would result in an above-market price. So you don’t do that. You promote it as a property that someone can buy who otherwise wouldn’t be able to buy. Likely someone with poor credit but some cash. And lots of people who’ve gone the short sale route or foreclosure have the cash. Many have lived rent-free for 6 months, 12 months, or longer while the banks went through the short sale or foreclosure process. A lot of them have large chunks of cash. And they have an income.

You might simply sell (assign) your option. Figure out what an equivalent downpayment might be on the property. Then market it as: “Gorgeous 3 bed/2 bath colonial. Just $x,xxx and take over payments. Poor credit OK. No bank approval needed.”

It’d be more difficult to do a sandwich lease-option assuming the monthly payments on the property are at or above current rental prices. If they’re not, though, and there’s a reasonable spread you could do that. Your ad (truncated) would be something like “Gorgeous 3 bed/2 bath colonial. Just $x,xxx up front and $y,yyy a month. Poor credit OK. No bank approval needed.”

Hope that helps.

15

Wordsmith,
Thank you for your post. I am about to begin advertising it to see if I can put a spread between the payment and the rental price. My gut is that I can, but barely. My original trainer set the window of opportunity at $300 cash flow–you stay in. Anything less–you assign. I’ve research local rentals and there is possibly an opportunity for that–but I’ll let the market tell me, after advertising.

The fuzziest part for me is closing them out, at some point. That is where my trainer was always vague. He was not clear on how long he drags the deals out, often saying there is no rush to close them out. I can see the cash flow benefit of that and don’t have a problem with that aspect, but am wondering if I need to have a clear path paved for them, or simply work on their credit and hope for the best. The seller wants to take over their deceased father’s mortgage and move her family into that house (that she loves). If the deal can be clean and comfortable, I don’t see her needed to rush to new financing.

Thank you again for your input, everyone. It is very encouraging to see people jump in to help me.

I found a real estate investing club, locally. Is it a good idea to attend a meeting and begin to participate in my local real estate investing community. I have no idea what (if anything) they do at the meeting which is over lunch at a Chinese restaurant–or if it is simply networking. Any words of wisdom on that front? Again, I know almost nothing about this business and have “fallen” into it by accident, but I’m in with both feet now, so I want like hell to make it work. THANK YOU.

16

I agqain caution you to be careful in what you and your friend are doing.

Are you a loan originator?..under the SAFE act.

If yuu buy for 100 and sell for 150…WHO origintes the extra $50K?

The act was specifically written to prevent selling to people wo canot afford the mortgate.

However, there is only a $25,000 fine for each deal…!

17

Thank you, Bill, for the warning. I will keep that top of mind in this deal (if there IS a deal at all)

Sadly, he was an acquaintance–not a friend–or else HE would be helping me right now. He offers boot camps and other information for sale, but because I met him through another group (having nothing to do with real estate investing), I landed in his program without any frame of reference to what other real estate investors do or other trainers’ products.

He sells “subject to” and takes over the payments of existing mortgages. He does not necessary put deals together with people who badly upside down (I don’t know if he does, actually). The last time I spoke to him about this house, I had not yet learned that she was upside down, but he gave me the bums rush so badly, that I no longer feel comfortable even calling him again.

Hence, here I am…asking a thousand dumb questions that he never answered.

18

SAFE in FL (or anywhere)

For all, quick way to learn how your state law enforcement views a seller/note creator’s rights and restrictions under its SAFE version* pick up the phone and call your State Atty General’s office. You’ll find yourself talking to an Ass’t AG who’ll give you his agency’s take on its law.

*Every state has now adopted Fed SAFE in its own way and I’d guess no 2 states have exactly the same statutes. Some states are pretty lenient, some pretty restrictive.

19

Thank you Everyone…

Thank you everyone for all your input and help!

20

[QUOTE=
The owner of the house is upside down, so I optioned it for the balance on the mortgage–figuring even if I didn’t finish the deal, it was a REAL house to advertise to begin building my buyers list and get me rolling.
[/QUOTE]

I am not at all experienced in option to purchase deals. But I have purchased a couple of homes in Florida. One I sold and one I am holding as a rental. They were both purchased at the Lee County foreclosure auction. Each of these I purchased for cash at well over a 50% discount from the mortgage that had been in place. The retail market value was about 50% or there abouts. Seems to me the mortgage needs to be paid down considerably for this to work out well.