I've been offered some bizarre sub2 deals. One lady had several rentals to get rid of that she was ready to walk away from. I didn't know why she would walk away, but they were all over-financed by a large margin.
Sometimes, upside down deals can be worth "messing" with, if there's no time limit to refinance the loans, and the existing financing is stable. That is, the loans are not "neg ams" negative amortizations, interest only, or adjustable loans with high interest caps, and the like.
When the principal keeps going up, and the income doesn't...trouble happens. When the payment goes up and the value doesn't...trouble also happens. Anytime, the payment structure is unpredictable or likely to get out of control...trouble happens...for those that, without thinking things out, do these deals against all better judgment.
Well, when I found out what her payments were, I thought, "This was either the worst terms ever, or the best ones ever. She was $200,000 underwater (over-leveraged) with her loans, but her rents covered her payments.
Well, after talking with her I discovered the most amazing thing... And it wasn't what I expected...
She had pulled a quarter million out of these properties two years previous, then the market tanked, and finally she was left with a quarter million in the bank, and upside down by the same amount. Of course, I'm kidding... She didn't have squat in the bank...left. Like many amateur investors who accidentally "hit a jackpot" in real estate timing, she blew the money on...whatever...!
Okay, whats this have to do with "a Sub2 sucker deal"...?
Well, despite the common misconception, not every seller writes with crayons that gets themselves in a crack with real estate and is willing to do a Sub2 deal with us. Some sellers are quite sophisticated. Meantime, it's up to us to figure out which deals are worth a hoot, and which ones just make us "look" like we write with crayons in the aftermath of a deal gone terribly wrong.
That all said, let's take a look at a good deal and then compare with some bad ones...
Good deal... - Seller has one or two loans that total 90% loan-to-value, or less (or 10% equity remaining, or more).
- Seller needs out of the payments/situation "yesterday"
- Seller has "gone through" at least one failed escrow and perhaps two real estate agents.
- Seller has a fully amortized, fixed rate, or reasonably-capped ARM loan, with no balloon payments coming due.
- Seller needs to salvage/maintain/improve his credit.
- Seller needs/wants to qualify to buy a cheaper/different home.
When the stars line up, we've got a good deal. Now, here's the anatomy of a "bad" deal from a "good" prospect. - Seller has one or two loans that total over 100% loan-to-value, or more (or no equity remaining).
- Seller needs out of the payments/situation "yesterday" and can only short sale, default, or modify the financing .... and screw his credit...
- Seller can't list his house conventionally, because he'll have to pay out of pocket for the closing and real estate costs..
- Seller has a fully amortized ARM loan with higher interest payments, high cap on the interest and a balloon payment due (all of which will torpedo this deal).
- Seller needs to salvage/maintain/improve his credit (He's screwed).
- Seller needs/wants to qualify to buy a cheaper/different home ( His option used to be to, "buy and bail," until last year, when banks got wind of this tactic ). That is, the seller maintains his credit, buys another house, cheap, and then lets his old house "go back to the bank" (maybe the same one that made him the new loan...! heheheh.
To recap: Good deals: - Motivated seller who writes with crayons (just kidding) and has burned through a couple agents and failed escrows.
- Low interest rate loans with no balloons or adjustments.
- At least 10% equity.
- Wants to buy another house immediately.
Bad deals: - Motivates seller who writes with crayons (just kidding, again!)
- Teaser rates, high rates, negative amortizations, high interest caps, early payoff dates.
- No equity, or upside down.
- Dreams of buying another house sometime before the "rapture"
It pays to know your numbers. I've been plowing through lots of operating data sheets for apartment buildings lately. When I first started looking at them after so many years of not doing that... I was hilariously rusty.
I used to be able to rattle off percentages and do mind calcs like "Rainman." However, for a while, I looked blankly at data sheets trying to remember why agents continue to pawn off "Pro Formas" on me, and never offer the actual operating numbers.
I've had agents tell me that they don't provide the actual operating numbers without a written offer. In other words, the Seller is testing the water, and doesn't want to get organized unless he's got an actual sucker on the line that would actually fall for that approach.
Normally, I would pass on a situation like this, but let me tell you a story about a Seller who had no numbers, did not know his numbers, and as a result gave me several hundred thousand dollars in equity because of his ignorance.
The Seller had just foreclosed on the building that he had previously seller-financed. He didn't have any numbers, except the taxes and insurance invoices. He also didn't have a clear idea of who was in the building, or who was paying rent. He didn't know the market rents or vacancy factor in the area. Otherwise, I had to make my own assumptions of what the potential was. This was my first apartment purchase.
After all was said and done, I bought this property for less than 25% of it's retail value because the Seller himself didn't know his numbers whatsoever. He offered a sale price I felt was too good to be true, and I recognized the sale price as being so grossly under market that I could literally barely hold the pen to write up the agreement. To make matters worse, I didn't have a pre-printed sale agreement with me, so I had to write a "shorthand" contract on a sheet of yellow lined note paper. All I listed was the price, the down, the closing date, the loan balance, and the interest rate. I closed three months later.
Now because I knew my numbers I was able to confidently and quickly, if not not nervously and feverishly act! :D
The Seller, meantime, did not know what he'd done to himself until he went back home and found his answering machine full of inquiries about his building. I would love to have been a fly on the wall and saw his face after listening to 30 messages asking about his apartments! he he he
I did spend 90 days defending my contract after the Seller realized what happened and wanted to back out for obvious reasons. I wouldn't back out, and we finally closed after threatening to tie the property up six ways from Sunday, or until his great grand children were dead, whichever occurred last.
This story would have never happened had I not analyzed over 100 operating data sheets in depth, and performed forecasts and what-ifs on every one of them to see what I could do under various scenarios. I knew my farm, and my numbers.
Since I knew exactly what I could do with 30 newer units in downtown Kansas City, and the Seller did not know, I achieved a 75% discount.
The moral of this story is, know your numbers, be able to make educated guesses, and then seize the opportunities when they present themselves.
Somebody might say, "But Jay, that was a gross steal. How could you not know that, regardless of whether you had analyzed 100 other data sheets, or not?" Well, the analysis gave me confidence to avoid second-guessing myself, and flinching at the last moment. Months before, without having done hardly any analysis, I had come across other "steals," but hadn't really appreciated what I was looking at...or the scarcity of deals like this. As a result, I blinked...and lost deals to investors that did know my farm better than I knew it.
Meanwhile, the fact remains that the Seller did not know I WAS BUYING A STEAL --- from him.
Someone recommended that we, "Know Thy Numbers". I never recommend this to Sellers! :D
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