L/O Extensions for MattB & Alex G and others - Posted by Doug W

Real Estate Investing Real Estate Law
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Posted by Eric C on June 24, 2001 at 14:52:47:

Hi Tony -

I really think that Gerber hit the nail on the head when he speaks about ?entrepreneurs? often coming from the ranks of ?technicians?.

While this isn?t exactly a new insight for anyone who has ever done any small business consulting, it is very often overlooked.

Many folks believe that the only things necessary for business success is the ?technical? or ?proprietary? skills (or knowledge) they already possess. Nothing could be farther from the truth.

Though it’s very beneficial (and sometimes crucial) to have (or to gain)an in-depth knowledge of your business, there are other skills that are equally important. One of those skills is the ability to detach from your day-to-day fight for survival long enough to make strategic decisions for the long-term health of the venture.

A lot of people never get that far. Instead, they reach a stage I call ?mental vapor lock?. This occurs when they can no longer see past tomorrow. Often this becomes a ?point of no return?. Literally.

RE can offer some advantages. But don?t make the mistake of believing that ?employees? or the lack of them is either a problem or a benefit. Things are rarely that simple.

Having employees is a little bit like having wealth. They can, like money itself, reflect and amplify your business model. They can extend your reach and help you reach levels of success that would be impossible without them.

But, that same process of amplification can also be very unforgiving to flaws that might earlier have gone undetected or were too insignificant to cause harm. Like any weakness, they can accelerate the destruction of your venture.

As with so many other things, the choice is up to you.

Good luck in your venture.

Take care,

Eric C

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L/O Extensions for MattB & Alex G and others - Posted by Doug W

Posted by Doug W on June 19, 2001 at 06:46:09:

AS I have been reading these posts and some of the courses I have noticed numerous different recommendations on how to acquire property for L/O’s. Alex G does not recommend sandwich L/O. He prefers to acquire property on contract for deed, etc… Matt B does more of the classic sandwich L/O with one year leases and built in extensions possible. Others recommend a 3 -5 year Lease on the buy side.

Obviously, there is more than one way to skin this cat…which is good. (My apologies to the authors for paraphrasing their recommendations)

My question/concern is this: If a large percentage of your T/B’s don’t exercise and/or qualify for a mortgage at the expiration of their lease term then you need to either extend their lease or find another T/B. Percentages stated on this board run around 40 - 50% for successfull exercise from T/B’s. Wouldn’t it be better to have a 3 year L/O on the buy side instead of a one year contract with extensions?
I am of course thinking of a sandwich L/O in this case.
What is the avantage of a one year contract with built in extensions?

Thanks

Doug

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Re: L/O Extensions …different opinions - Posted by Alex Gurevich, TX

Posted by Alex Gurevich, TX on June 20, 2001 at 20:59:15:

Doug,

I think Tim pretty much summed it up for you.

  1. If you want to reduce your liability for loan payments and be able to drop the house if you can’t keep it rented to cover your costs, you are better off with L/Os. You reduce your liability by shortening the initial term of your L/O (agreement on buying end). Yet you reserve yourself the right for multiple extensions to allow you to ride it for a long time if you wanted to.

  2. If that liability isn’t a concern, you’ll get more control with “subject to” and you typically get unlimited amount of time to do what you want with the house.

In my experience, when faced with L/O offers like that, most sellers will make a note that you are putting some protective (for you) and dangerous (for them) clauses in your contracts.

In their mind it will indicate you are not sure about your ability to handle the property and may turn it back to them. For most of those sellers it’s the last thing in the world they want to deal with, the house returned back to them. Therefore, you’ll be preceived as not strong enough financially for the sellers to trust you with handling the payments.

You can guess what kind of effect it will have on your closing ratio.

Keep in mind, you are not dealing with sophisticated businessmen whose only game is to negotiate best terms of transactions all day along and they’ll just trade consessions with you back and forth like the book says.

These are unsuspecting concerned consumers who know very little about what you are trying to do. Any hesitation or undecisiveness on your part or even funny one-sided clauses in your paperwork is quickly recognized and the corresponding opinion of you is formed.

I am sure I’ll have some L/O lovers who’ll disagree with my assessment.

As you noticed the opinions on the subject of liability polarized quite a bit. I believe the reason lies in the difference in the “investment phases” people are going through in their lives.

In my opinion, for the vast majority of investors who have not built any significant wealth, in millions of dollars of liquid assets (not contractual paper spreads
on hghly levereged properties), there’s no point of being afraid of liability.

If you don’t have much, what do you have to lose, even if the values did drop 50% and you lost your yet unrealized paper profits?

What’s the use of being overly cautious when you haven’t got anything of value anyway. People who are in the wealth building phase of their investments do quite often go out on a limb, so to speak, and take that extra risk. By taking this calculated risk you have a chance of doing 30 deals next year with an average paper profit of $30,000-$40,000. That puts you on a path to possibly cashing $1,000,000 in 2-3 years. You can get wiped out if things go wrong, but do you have a $5,000,000 cash nest egg to lose? You probably don’t, and here’s your chance to make $1M.

Which would you choose?

If you did have $5M in cash to protect, you might be quite a bit more cautious in your approach because even 10% on your money is a very comfortable living on passibe income, and you would have a tendency to only (or mostly) play the sure thing with very little downside risks.

Again, to sum it up, in the early stages of wealth building, why not be aggressive and take more risk. When you have built wealth, time to get more conservative with your projects or at least diversify and spread the risk.

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Re: L/O Extensions for MattB & - Posted by Terry (Houston)

Posted by Terry (Houston) on June 19, 2001 at 07:59:51:

The reason for the one year extensions, as I understand it, is becuse what happens if you get into the middle of the deal and find out you can’t move the house?

You miscaculated the rents, unexpected vacancies, can’t move it for whatever reason. Or the underlying loan goes up too high, Not enough taxes being escrowed whatever.

At the end of a year you say goodbye! Have a lease for longer? You’re stuck.

May be why I like subject to deals better.

Terry

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My take… - Posted by TRandle

Posted by TRandle on June 19, 2001 at 07:55:28:

Doug,
What if your market has a large decline over the next 12 months? The property you optioned isn’t worth what you agreed to pay for it and you can’t get the rent to cover the payment you agreed to make. Sorry, you’re locked in for two additional years.

That’s why it’s recommended by many to not have the longer initial period. With the renewal provision, you maintain control of the situation. How about a one year term with 25 renewals, with the purchase price to be the loan balance?

I rarely use L/O for the purchase side anymore, but do use that tool for the “sell” side. My agreement with the TBer’s is verbal as far as extensions and no one has pushed hard yet to have it in writing.

If they will pay up to $200 for my inspector so that I can make sure the place is in the same condition as when they moved in, AND they’ve paid on time, then we can discuss renewal. The terms as far as price and monthly will probably change, but it costs me too much to move them out, clean the place and get someone else. If the current TBers are taking care of the place and paying on time, I do want them to be able to buy.

I’ll renew as many times as necessary, or so I think at this point. I’ve only been doing this a couple of years so we do have some folks in year two, but I’ll probably renew again if they wish.

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Re: My take…? - Posted by Eric C

Posted by Eric C on June 19, 2001 at 11:45:35:

Hi Tim -

Are you using any other form of risk/liability limitation other than the one year lease terms that can be (not required to be) renewed?

Could you use a termination or kill fee? Agreed upon liquidated damages such as 3 months rent (or equivalent) to allow yourself an exit?

Or are you doing your buying “subject to” so that little or none of this is necessary?

Sorry to be so obtuse, but it’s been a long time since I’ve dealt with single family L/O’s. And I’ve never purchased a property “subject to” (technically). Probably won’t either.

But since I’m getting married soon, I realize that there will be some subtle (and some not so subtle) pressure to have me stay “close to home” more.

While I have no real reason to change what I’m doing (long term), I might want to look again at SFR markets particularly since they may be slowing significantly. That’s OK. When things get tight, that’s when I make the most money (profit).

I like what Merle is doing in Missouri, but I do wonder about his down side risk a little. I’ve been in markets where a 50% decline is real and painful. To buy at 80% would definitely seem to leave me “out on the skinny branches”, so to speak.

No disrespect intended Merle. You obviously know your market and are comfortable with your system ( I hate that word).

Anyway, finding money (or investors) is always the easy part. Paying them back – no matter what – can be far more difficult.

It looks like I’ll be in Austin the weekend after the 4th of July. Is there a possibility we can get together?

See you,

Eric C

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Re: My take…? - Posted by TRandle

Posted by TRandle on June 19, 2001 at 13:31:08:

Eric,
No, I don’t buy using L/O anymore, only Sub2 or cash right now. I haven’t ruled it out as a possibility, but I just don’t offer it as an alternative to the seller.

The only real “seminar” I’ve attended was on one of my first L/O and it wasn’t that expensive, but it certainly caused some adjustments in the way I do things.

If the local market suffered a serious decline, I could get hurt, depending on the degree. I have bought and will probably continue to buy houses Sub2 that would be better candidates for a L/O, at least from a risk perspective. My best guess at this point is that I could sustain a 20% drop, but any more than that would cause the need for some serious creativity.

Within the next 6 months I will be putting some investor funds to work with my Money Partner Program and may need to be a bit more cautious where I place those funds.

I’m still interested in finding a way to work together on some project, even if it’s small.

Unfortunately, we’re leaving for Virginia on the 7th for a couple of weeks so I’ll have to catch you next time. Take care.

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Re: 50% decline? - Posted by Stacy (AZ)

Posted by Stacy (AZ) on June 19, 2001 at 12:06:48:

Eric, what were the circumstances for the 50% decline? Was it in California during the recession (after out-of-control home price inflation)? Was it in a small town dependant on a local industry that went bust?

This kind of decline has never happened in Phoenix (knock on wood) in the decades I’ve been here. I’m not implying bad times can’t cause all sorts of problems, but a 50% decline must have a story behind it. Tell me what to look for.

Stacy

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Oh well,… - Posted by Eric C

Posted by Eric C on June 19, 2001 at 14:23:00:

Well,

I guess that we’ll have to put off that meeting for another day.

Anyway, I’m hopeful of luring JHyre up from Houston for that weekend and picking his brain a little. And if I can get Alcorn to show up too…

Well, let me just say that the beer will flow and ideas will flow.

See you,

Eric C

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Re: 50% decline? - Posted by Eric C

Posted by Eric C on June 19, 2001 at 13:06:50:

Hi Stacy -

First of all, I’m not sure that I consider a 50 percent decline all that unusual.

And as for small towns, would you consider Houston, Dallas, Austin, and San Antonio to be small?

Or how about Detroit in the '70s? Orlando in the pre-Disney '70s?

Boston in the late eighties? How about New York City (after 1987) for a few years there?

Let’s not forget the drop in CA that was quick and painful. It was doubly painful since they didn’t really believe it could ever happen. They never do.

Even Phoenix has had a few ups and downs. In 1987, I was told that the market there was so hot that it was impossible to buy houses (or other things) below the market. It wasn’t.

And by the early '90s, the same people were pleading with me to buy them out; that Phoenix was done. Again, it wasn’t.

You want to know what to look for? How about easy credit? for homebuyers? for builders? for investors?

Or front page articles about the increase in housing permits. And you might want to check on those market times too. Is the number of days to sell a house (even through MLS) increasing? decreasing?

In other words, I firmly believe that there is an economic crisis (of sorts) just waiting somewhere down the road each of us. No matter where we live. No matter what we do.

Because that has been my experience and because I belive it to be true, I plan ahead.

Manage your good times with the idea that rough times lie ahead. Simple.

What happens in boom times and in busts is a reflection of the degree of irrationality in the marketplace. The market is always irrational (my opinion)but the question is to what degree.

During boom times, the papers are full of wonderful stories and the people believe them. When bad times come, the papers are also full of stories. But this time the stories aren’t so wonderful anymore and the people believe those too.

The truth lies somewhere in between.

What would it take for your market to suffer a decline? Which market are you in? Commercial? Large multifamily residential? Mortgages? Single family residences? Mobile homes?

Each of these has different dynamics and it’s not all that uncommon for one or more of these to be suffering while other sectors surge ahead unaware of the laggards.

Do you remember CD rates in the late '80s and early '90s?

Have you ever thought about the fact that when interest rates declined that it wasn’t wonderful for everyone? How many folks saw 13 percent CDs (their life savings)fall to 2.5?; which is far more than 50 percent decline.

Or when banks (at this same point in time) refused to grant loans to almost anyone, for any reason? I mean why should they? They had fed paper, 100% guaranteed and 100% liquid, and they could make a spread of 3 points. Why take a chance on loaning money to a mere individual?

Think there were a few business owners, contractors and others left out in the cold? You bet. 50%? Hah, you could buy some businesses for the cost of their equipment alone.

And what about the time when the Commercial Credit organization went bankrupt? Funds for commercial mortgages dropped almost to zero and many projects lost over 20% in value (in a one month period) simply because no one could purchase them (nor could they get refinanced).

We don’t need to discuss the Conseco issue further, do we?

How much would the market have to drop to cause you significant pain? That depends on your method of investing, your ability as a dealmaker and investor, and your reserves. (among other things)

Large declines may never happen to you. I certainly hope that they do not. But you don’t have to leave yourself unprepared either.

My choice is to structure deals that make sense. Economic sense. Now and under most of the likely and unlikely scenarios for the future.

I deal with investors as well as institutions. When they want out of a deal, they get out. Regardless of the circumstances or my plans.

When someone wants out, your best bet is to write them a check for their entire investment. You may write it with some pain in your heart, but there better be a big smile on your face. Period. Because that’s business.

And because that’s the way it is.

Yours,

Eric C

PS - I can be more specific if you wish. My thoughts were to simply convey to you that while I don’t envision another 50 percent decline (anytime soon)in any of my markets, if it were to happen today, I would actually profit rather than suffer.

You can do the same.

PPS - you can also suffer “personal economic crises”. Don’t we see that every day? Foreclosures, bankruptcys, catastrophic illness. Sometimes it isn’t the market itself that experiences the decline, it’s the person. Make sure that you don’t put yourself in a position to force one of these economic squeezes on yourself.

Remember that behind (almost)every foreclosure is a person who believed that it couldn’t happen to them.

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Thank you Sir. How about another? - Posted by Eric C

Posted by Eric C on June 20, 2001 at 14:12:00:

Hey Tim -

Sorry you can’t make it on the 7th.

But it looks like I’m going to be in Austin for the entire week preceding the 7th.

Maybe we can still get together?

Yours,

Eric C

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Re: Oh well,… - Posted by David Alexander

Posted by David Alexander on June 19, 2001 at 21:35:59:

Lets expand on this a bit…

If you were to go back into SFR’s knowing what you know now… what would be your plan… at least as you see it. Would it be as simple as raise alot of cash, by cash at a discount and sell on terms, and hold, L/O and hold long term, or maybe trade paper as we always have discussed.

You get that group together and this becomes a TEXAS PARTY… let me know, I’d just like to be the fly on the wall… Austin is a cheap and quick ride away from the Big D.

Congrats… on the coming nuptials.

David Alexander

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Re: Oh well,… - Posted by Alex Gurevich, TX

Posted by Alex Gurevich, TX on June 19, 2001 at 15:52:08:

Eric,

I’ll likely be in town, so if you have time for lunch in your Austin’s schedule please let me know. I’d love a chat.

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Re: 50% decline? - Posted by Michael (tejas)

Posted by Michael (tejas) on June 19, 2001 at 21:23:36:

Hi Eric,

I always enjoy reading your posts concerning the big picture.

I have no doubt you purchased properties at 50 cents on the dollar in Texas in the eighties, but is this really indicative of the whole market taking a 50 percent nose dive? Or is this just certain investors within a market taking this much of a hit?

I don’t think the median house price in the Texas cities you mentioned dropped by half at any time in the downturn in the eighties. Set me straight if you think I’m wrong.

Michael

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Re: 50% decline? - Posted by Stacy (AZ)

Posted by Stacy (AZ) on June 19, 2001 at 13:43:14:

Thanks Eric. Good post.

Just to be clear, I agree that real estate goes in cycles. It was the 50% that got me. That’s huge. But, you answered my question. I wanted to know what the conditions were that caused this, and you gave some examples.

It hasn’t ever been that bad in Phoenix…at least post WWII. It doesn’t mean it won’t happen (knock on wood again). I imagine that kind of a decline cleaned out the vast majority of investors in those markets you were speaking of. Of course it’s prudent to plan ahead for market downturns, and watch the indicators you mentioned. Thanks for detailing them.

On a side note, you said, “My choice is to structure deals that make sense. Economic sense. Now and under most of the likely and unlikely scenarios for the future.” I certainly agree that this is the best thing to do. But I’d never (or rarely) be able to buy a property if I planned on a 50% downturn as a possible scenario. Not that it couldn’t happen here in my market, but I have to chose to take the risk that a downturn won’t be that drastic. If I had been doing this successfully for several years, I’d hopefully be in a position to be this selective. This doesn’t mean I feel I have to go out and buy properties at retail prices and leave no margin for error. But I just can’t plan for a 50% downturn in my buying strategies at this point.

Thanks again for the informative post.

Stacy

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Sure, I’m in… - Posted by TRandle

Posted by TRandle on June 20, 2001 at 20:21:50:

EC,
We don’t leave until the morning of the 7th so I’m up for whatever. Austin’s good, or if “THE GATHERING” is taking place in Dallas or Houston, I’ll find a way to be there and make it up to my lovely wife another time. Just let me know. Thanks.

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Re: Oh well,… - Posted by JHyre in TexOhio

Posted by JHyre in TexOhio on June 21, 2001 at 07:58:14:

The REAL question is…can we get Dave to drink enough that he starts throwing some flying roundhouse kicks again? THAT was a sight to behold!

John Hyre

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Well, stay tuned… - Posted by Eric C

Posted by Eric C on June 20, 2001 at 14:15:01:

… for the party!

Hi David -

Austin is indeed but a short hop from the Big D. C’mon down.

Beer drinking and festivities, I mean tax planning and seminars are scheduled to begin at 7pm or so on the 7th (I think.)

See you,

Eric C

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Austin deadline - Posted by Eric C

Posted by Eric C on June 20, 2001 at 14:16:40:

Hi Alex -

I’ll be in Austin the entire week prior to the weekend of the 7th (which is when our little conference is scheduled).

See you?

Yours,

Eric C

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Re: 50% decline? - Posted by Eric C

Posted by Eric C on June 20, 2001 at 12:46:19:

Hi Michael -

Yep. You are wrong. There were 50% declines and more in some areas.

The term “see throughs” was coined by Texans living in Houston who were forced to look at all the empty office buildings in the skyline.

As far as houses go, prices fell so much (in certain price points and areas) that even recent homeowners (those who purchased within the last year or so) would simply call the bank and say that the keys were in the door. In fact, I got some of these calls myself and I have to tell you it was very depressing.

They could then simply move down the street into another new home and save thousands.

People quickly noticed that with the tremendous amounts of property on the market that if they did have reasonable credit they could often trade up to a much (can you say double?) larger house in a much nicer area (for example the Woodlands) for exactly the same price (monthly payment) they were currently making.

Take a look at the growth in the northern section of Houston-Conroe. Seriously.

Each city had tremendous problems and each was plagued by the overall drop in oil prices that at the time were the lifeblood of the State’s economy.

As late as 1993, I could purchase (and did) houses in the Round Rock area for 19-21K. These houses had been built in the 1987-1990 period and had retailed for $65K.

You could purchase almost anyone of the new (since 1987) hotels in Austin for the balance on your credit card.

I bought performing paper from First City for pennies on the dollar. And a house in the Hills of Lakeway that was completed but never lived in for $225K. It was on the golf course and had 5500 sq ft. In fact, it was such a deal that I purchased the house next door for $205K that was in the same condition.

Lots in Dripping Springs were sold by FDIC for 2K and later sold by a private individual (hmm, wonder who that was) for $17K less than 12 months later.

Dallas – same story.

I sorted through more credit/collateral files than you can ever imagine at the Addison FDIC offices. Bought in bulk (at about .12 - .23 per dollar)and many, many more things as well. Post office contracts, leases, bank charters. You name it – it was there.

In my opinion, the Resolution Trust Corp oversaw the largest transfer of wealth in our nation’s history and it happened in a very short period of time.

50% decline? Oh yeah. That and a lot more in some cases.

Now, you need to understand that I’m not being negative at all. I’m just being practical. People don’t change.

There used to be an old saying that the RE biz was made up of ten year cycles and people with five year memories.

That’s still true.

Psychology and math are my greatest weapons in the RE game. Always have been and always will be.

My point was that downturns happen. Both to entire markets and to individuals. Neither event should come as a surprise to a seasoned investor.

Spend a little time on a beach sometime and watch the surf closely. You can learn a lot about investing that way. And like any experienced surfer, you learn to ride the wave – not fight it.

I can be more specific if you wish.

And I wasn’t trying to be arrogant or rude. I find email to be a very ineffective medium at times – at least for me. It’s hard to cram what I want to say into this little window and I hope that you’ll forgive me.

Mistakes about business and economies are made by the very brightest people on the planet. Nobel prize winners have taken their equations to the absolute limits and almost delrailed the capital system of the entire world in the process. (Long Term Capital).

Their math may have been correct, although I have my doubts. But their interpretation of those equations was clearly wrong.

I am no smarter than the next guy. But I do understand that nothing lasts forever. And that I have to be prepared for change. In my life. In my business. In the world.

That’s OK. I can deal with that. I’m flexible. Heck, you can just call me ‘Gumby’.

Take care,

Eric C

PS - not only did I buy property (as did a lot of other people) for 50 cents on the dollar in the eighties, but I often buy that way today. It works for me.