Real estate investors often only look at a real estate investment only from their own investment perspective. However, sometimes it can be beneficial for you as the real estate investor to put yourself in someone else’s shoes in order to see things from their perspective. Doing this can help you to think out of the box and if you can figure out how to resolve their problems then you can use creative real estate strategies to make a very healthy profit when you sell your properties.
I will give you an example of a very common situation in today’s real estate market. Many people that are currently renting would like to own a home. They are aware that prices are ridiculously cheap and they would like to take advantage of the cheap prices by buying a house at a good price.
Some renters have good credit and should be able to qualify for an FHA loan if they have a FICO score of over 620, are currently employed and can document their income. Many of these potential first time homebuyers do not have much savings and are not able make a large down payment. More importantly they are unaware that they can be approved for a mortgage loan and are not familiar with programs like the FHA mortgage which allows them to put down as little as 3.5% for their down payment. As an investor, the strategy for dealing with these renters is to screen them and see if they would be good candidates to become first time homebuyers. The best way to do this is to have a good relationship with a mortgage broker that is knowledgeable about the FHA program and who has experience working with first time homebuyers.
As an investor you can purchase a cheap bank owned property or short sale using borrowed money from a private lender or hard money lender at a deeply discounted price. After you purchase the property you can fix up the property and make the necessary repairs to have the property ready to be listed on the market. You can then advertise this property for sale to a first time homebuyer at full market value. Experienced investors can purchase, fix and sell one of these houses 6 months later for a very nice profit.
The type of homes that are the best candidates for doing this in today’s market are entry level starter homes which are priced affordably. These homes are located in decent neighborhoods that are affordable – exactly the type of neighborhoods where first time home buyers go shopping for a home. Since the US Median Income was $50,000 last year most young couples shopping for their first home can only afford a monthly payment of around $1,200. In some states like New York, California and Hawaii prices will be higher. The key to finding the right neighborhoods is to find affordable neighborhoods with working class people where there are many homeowners and not many renters. As an example, in South Florida our investors can purchase properties for $50,000, spend $15,000 repairing the property and can then resell the property to an FHA buyer with a mortgage for around $100,000. Executed correctly the profit should be between $20,000 and $25,000 in this price ranged market.
The challenges with this strategy are the following:
Most novice investors trying this strategy are at the mercy of the appraiser and are dependent on listing the property on the MLS with a real estate agent. If they do sell via this strategy they will have to pay the real estate agent a commission and will in most cases also have to pay some or all of the closing costs since FHA buyers often do not have enough money for both the down payment and the closing costs. The seller should expect to lose 10% to 12% of the sales price just to commissions and closing costs. Ultimately whether or not the investor manages to pull off a quick sale will depend on:
The two most critical components are the appraisal and pre-approved buyers. If the appraisal comes in low (say $80,000 instead of $100,000) then after deducting realtor’s commissions and closing costs the investor may be looking at a very small profit or in some cases even a loss. Remember that while the investor is repairing and marketing the property they are still paying interest payments, property taxes and insurance which also need to be deducted from the net profit. The HVCC law makes getting an appraisal at the price necessary even more difficult since the appraiser may not be familiar with the local market and there may not be many retail comps. For this reason it is imperative that investors use very conservative estimates for what they thing the house is worth before entering into any transaction to purchase a house.
As an investor when you are contemplating a purchase ask yourself what the lowest amount that the house could appraise for would be and then plug in your numbers to see if the investment makes sense. Being conservative in your buying decision will mean waiting for the right opportunity to buy at the right price. You will need to be patient since this will take some time.
It is a good idea for you to network with as many mortgage brokers as possible. Investors need pre-approved buyers. Some mortgage brokers have pre-approved buyers looking for a house to buy. These mortgage brokers are great to work with since they will help you find a buyer for your home in exchange for doing the mortgage. Ask these mortgage brokers to screen their pre-approved buyers to ask what they are looking for and then go and find them a house.
As an investor, if you find a house that is a good fit for them then you should be ready to draw up a purchase contract for them to sign and you should meet them to show them the house. If they like the house you should have them sign the purchase contract and get a deposit from them.
One interesting thing that I have noticed with first time home buyers and mortgage brokers is that in many cases mortgage brokers with pre-approved buyers have no houses to offer their buyers. Ironically investors often have no first time buyers. That is why networking with mortgage brokers is very important. Every real estate investor should look to network with and find a good FHA mortgage broker that can help them find pre-approved buyers.
You can also use creative strategies to sell your house without using a real estate agent and a mortgage broker. If you do not have pre-approved buyers and you are worried that the house will not appraise for a high enough value then you should consider seller financing and rent to own lease options. The advantage of seller financing and lease options is that when you sell the house you do not need a mortgage to be approved nor do you need an appraisal. You also do not need a pre- approved buyer. What you do need is someone that has more cash than your typical FHA buyer.
Some people that are interested in buying may have recently lost their home to foreclosure or a short sale. Many of these people are looking for a house but don’t like the idea of renting since they were previously homeowners. They cannot get approved for a mortgage because their credit has been recently ruined because of the foreclosure or short sale and this is where the opportunity for you as an investor is created.
In our experience there are many people out there that are renting or are in the process of losing their homes that would like to own a home instead of renting one. If you put yourself in their shoes you will see that they are looking for a house that they can stay in for a long time and they are looking for payments that they can afford. They would also like to ultimately own the home. If they only have 5% to 10% of the purchase price as a down payment consider a lease option (rent to own). If they have 10% to 20% of the payment then you can consider offering them seller financing.
If you do offer seller financing then I suggest that you get the largest deposit you can get from the buyer. If the buyer defaults on his payments and stops paying you then it could take you a considerable period of time to get your house back since you would have to sue them and start foreclosure proceedings against them. This is why you need the protection of a large deposit. You need a cash cushion of at least 1 years rent to make it worthwhile. If you have a private lender then your lender will have to be agreeable to you selling the house with seller financing.
My experience has been that the larger the deposit that the buyer puts down, the less likelihood that they will walk away from their house. I also find that buyers that put down larger deposits will take better care of the house. We offer our buyers seller financing with 20% down and an annual interest of 9.75% on the mortgage balance. I structure the mortgage payments as interest only five year balloon mortgages. It will usually take a period of up to 4 years for someone to repair their credit to the point where they can refinance their loan with us and pay off the loan with a conventional mortgage which is why we use the 5 year term.
Here Is An Example Of How This Works:
Your purchase price $50,000
Repairs to fix the house $15,000
Total Cost Including Repairs $65,000
Sales Price to New Buyer $100,000
Buyers Down Payment $20,000
Buyers Monthly Interest Payment (9.75%) $650
Buyers Monthly Taxes and Insurance $300
Buyers Total Monthly Payment $950
*Equivalent Market Rents Are $1,250 So Buyer Owns a Home For Less Than Renting*
Structuring the deal like this has numerous benefits:
The key is to have potential buyers that are looking for seller financing opportunities before you purchase the house. I find that one of the best ways to do this is to advertise my existing rental properties as rent to own homes with seller financing available. Doing this attracts other potential buyers that I can store in my database. I currently have many potential buyers looking for a rent to own home or seller financing home. When I am thinking of purchasing a house I can have these potential buyers go by the house before I purchase the house and if they like the house then they can give me a deposit to secure the house. Many of the rent to own buyers can become seller financing opportunities down the road when they want to exercise their lease option if they cannot get approved for a conventional mortgage.
If you use borrowed money from a private lender to purchase houses then you will need the approval of the lender to do a “wraparound mortgage” more commonly known as a “wrap”. You need to make sure that your existing mortgage does not have a due on sale clause and if you have a private lender then you should first check with them to see if they are willing to let you do a wraparound mortgage. The way the wraparound mortgage works is like this:
Let’s say that you borrow $65,000 from a private lender for the purchase and rehab of the property. You agree to pay 10% interest to the lender which is $541.66 per month (interest only). Then you find a potential buyer for the property for $100,000. The buyer gives you a $20,000 down payment which you get to keep and you give them a mortgage for the $80,000 balance. Assume that you charge your new buyer 9.75% interest then your buyer’s monthly payment would be $650. Every time your buyer pays you $650, you would in turn pay your private lender the $541.66. Keep in mind that you are still responsible for making the payment to your lender even if your buyer misses their payments. If your buyer defaults and stops making payments then you will still be able to get your property back by suing the buyer via the foreclosure process. However you will need to continue to make all of the payments to your lender while you are waiting to get your property back which could take some time.
In the above strategy, there is no appraisal required so the deciding factor to most buyers is not the purchase price but the monthly payment. You could just as sell the house for $110,000 or even $120,000. Selling the house for $20,000 more makes the payment go up by only $162.50. The buyer’s payment would now be $812.50 instead of $650.00. Compare those payments to current market rents of $1,250 for the same house and you can see that for the buyer it is a good deal. If that same house would cost $1,200 per month and your buyer can buy it with a monthly payment that is less than that then it would make sense for them to buy instead of renting.
This is an example of putting yourself in your buyer’s shoes. Because no appraisal is required you could sell the house for any amount that you and the buyer agree to as long as they can afford the payment and as long as the payment is reasonable compared to what that same house would rent for. Remember that the determining factor for the buyer is their monthly payment not the purchase price. However, please keep in mind that your sales price should still be reasonable relative to comparable sales in the neighborhood. I suggest you print out 3 of the highest recently sold homes and save them for your records to justify your sales price.
If you are going to do a wraparound mortgage or seller financing it is critical that you utilize an attorney and do not try to do this by yourself. Using an attorney also has the added benefit of being able to establish an escrow account for the buyer where you can give the buyer a payment that includes their property taxes and property insurance. This enables the buyer to send the payments directly to the attorney who in turn will send your portion to you and keep the remainder in escrow for taxes and insurance. Having the buyer know that you have an attorney representing you will be an added benefit.
One final thing to note is that there are currently new regulations about seller financing that might require sellers to be licensed as a mortgage broker in order to offer seller financing. There are some exemptions that apply if you are the owner of the house but the laws are constantly changing so please consult with your attorney about current Federal and State Laws before considering any creative strategies like seller financing or lease options.