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Negotiating as the more reluctant party is a powerful strategy for getting what you want.

As real estate investors, it is easy to be chasing the other party.  They are reluctant and this puts us to a disadvantage.

I talk to a lot of people who want to sell their houses.  Some of them are motivated to sell and some are curious about what they can get.  I only have so much time and money available, so I need to focus my efforts on those that are truly motivated.

I realize now that putting myself in the reluctant position is way to filter out the simply curious.  If I take a moment in our conversation to explain a bit about my business model and then ask the seller how their house will fit in that model, then the sellers filter themselves.  The motivated will work with me to make it work.  The curious will not play.

In my case, I buy houses to rehab/flip or rent.  I explain to the seller that I can’t buy at retail prices – I need to fix the house and then sell it and still make money.  I also tell them that if I have to give them cash up front, then my costs are higher and I will not be able to pay them as much.  I can pay more if I get to make payments over time – either seller financing or delayed payment.  Then I ask them how they can adjust to make this work for both of us.

They need to convince me.  The simply curious do not care about any of this.  They just want their price or they want me to just make an offer.  The motivated understand that solving their problem is going to require them to work with me to come up with a solution.

Have you had a similar experience?

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Case studies of 2 sellers who are motivated to sell their houses. Can we help them out?

The second case that I talk about is a seller who bought a house to rehab it 2 years ago. She has not done any of the work and now needs to sell since she is going to move to another town. The problem is that there is not much margin in the deal.

In the past, I did not have enough lead generation working for my business. When you have few leads, it is easy to get fixated on deals that are difficult and not very profitable. The key is to focus on lead generation so that you see more situations and can find the better deals.

Anybody else have this problem?

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Yesterday, I saw an interesting question.  A seller, who we will call Sally, was talking to an investor, who we will call Ike, about selling her house.  Sally is very motivated to sell now, but she has no equity.  The house is in good shape and was built a couple of years ago.

Although Ike would like to buy it, his financial picture makes it difficult to borrow from the bank (there could be lots of reasons!).  Ike contends that he will be able to borrow the funds needed within 2 years.  He wants to buy the property, but is not sure how he can.

There are a couple of solutions that Ike can try.

Subject-To

Ike can purchase the property now, subject to the underlying mortgage.  This means that the ownership passes to Ike now, but Sally’s mortgage stays on the property in a superior position.  If that mortgage defaults, then its foreclosure can take the property away from Ike.  This is often described as ‘taking over Sally’s payments’. 

The advantage for Ike is that he does not have to qualify for a loan – he just starts making the payments.  Additionally, this mortgage will not show up on Ike’s credit report (it is Sally’s mortgage and stays on her credit report).  The advantage for Sally is that she can move on with her life – her house is sold now.

The disadvantages are some risk for each party.  They should both be concerned with insurance and with default.  Let’s talk about default first.

Sally’s mortgage is likely to have a ‘due on sale’ clause.  This means that the lender has the right to ask for a payoff of the balance when the property changes ownership.  Lenders started adding this clause back in the 1970’s when interest rates went sky high – the banks wanted to force the new buyer to originate a new loan at the higher rates.  However, in the current market, interest rates have been fairly stable and the banks have more foreclosed properties than they should.  As long as payments are being made, and there are no other issues that draw too much of the bank’s attention, most banks are not exercising their right to a payoff.  Sally and Ike both need to recognize this risk, even if small, since it will destroy this transaction.

The mortgage is likely to have an insurance requirement to protect against the loss of the collateral (the house).  Prior to the sale, the insurance shows Sally and the lender as payees in the event of a loss.  Changing the insurance to show Ike as a payee will alert the bank of a change of ownership.  However, if a loss occurs, then Ike will not get any money if he is not on the insurance.  A possible solution is for Sally’s insurance to stay in place and Ike buy additional insurance for his investment.

Wrap-Around Mortgage

This is a type of subject-to transaction.  In this case, Sally takes back a mortgage from Ike for the purchase of the house.  This new mortgage wraps around Sally’s existing mortgage.  In general, the new mortgage balance, interest rate and term are set to be at least equal to the existing mortgage – this way the payment of the new mortgage covers the payment on the existing mortgage.  Ike pays his mortgage payment to Sally and she makes her own payment to the existing lender(s).  Or Ike sends a check to Sally and to Sally’s lender.  Or they may decide to use an escrow service – this gives Ike assurance that the underlying mortgage is being paid.

Insurance is usually kept separate – Sally keeps hers and Ike buys insurance for his part of the investment as it grows.

This method has an extra advantage to Sally – if she tries to borrow money for another house, the new mortgage shows as an asset that balances out the mortgage that continues to show on her credit report.  The lender may discount Ike’s payment some, but the bank will still consider that it is reducing the outgoing drain on her finances.

Lease Option

Ike can rent the property with an option to purchase it at a later date.  In this case, the deed stays in Sally’s name until the option is exercised.  Ike and Sally can set the rent at the market value or any value they choose.  Some of the rent can be counted towards the purchase price (usually as part of the down payment). 

In the previous methods, if a default happens, Sally would need to foreclose to get back the deed to the property.  In this method, she can just evict Ike.  Evictions are often quicker and cheaper than foreclosures.  If the option is recorded, then some additional action will be required to clear the cloud from the title.

In all three methods, Ike benefits from any appreciation of the property.  However, in this method, some of that appreciation can be shifted to Sally by setting a higher purchase price on the option.  Basically, let’s say that the current purchase price is $200K, and the option price is set at $220K in 2 years.  Now, Sally will get the first 20K of appreciation in those 2 years and Ike will receive the rest of the appreciation as equity.

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In this video, I explain what a ‘closing’ is, the major players involved and some different types of closings.  This video came about because I had to do some explaining about how a double closing should work – I thought that it would be useful to share the concepts to a wider audience.

This video contains some new information about seller financing.  It includes some background on how often seller financing is being used and new information about how HUD is trying to limit it.

As I mentioned in the video, I want to provide some more information about the SAFE act and how HUD interprets this regarding seller financing.  You can read HUD’s complete interpretation here.

HUD is taking comment on their interpretation of the SAFE act through February 16, 2010.  Please tell them that they need to exclude all seller financing from the regulation!  Click here to submit a comment

What Should You Say in Your Comment
Say what you feel, but say it politely!   The message should include that you would like the definitions in the proposed rules to be changed so that private individuals can originate and service loans on properties they personally own.  Some ideas from others:

• bank loans are not available on some types of properties
• the tight lending climate has made bank financing “out of reach” for many
• seller financing is an “age old” tradition based on private property rights
• these rules would prohibit even partial seller financing – i.e. a “seller second”
• according to HUD’s “Residential Finance Survey” in 2001, roughly 40% of all non-farm residential properties in the US are owned free and clear
• an estimated 6 million Americans own a property other than their own primary residence
• an estimated 4.5% of Americans own three or more properties, many purchased solely as investment properties
• 40% of non-owner occupied residences are mobile homes which are more difficult to sell with bank financing
• approximately 5% of homes in US are for sale or for lease… seller financing may be key to liquidating this inventory

Here is some background:

 

 The Housing and Economic Recovery Act of 2008 (Pub. L. 110–289, approved July 30, 2008) (HERA) constitutes a major new housing law that is designed to assist with the recovery and the revitalization of America’s residential housing market—from modernization of the Federal Housing Administration, to foreclosure prevention, to enhancing consumer protections. The SAFE Act is a key component of HERA designed to improve accountability on the part of loan originators, combat fraud, and enhance consumer protections.

HUD has stated that they read the SAFE act as having a broad requirement for licensing ‘loan originators’.  They perceive that a large number of folks will need to be licensed – basically, if they deal with a loan ‘application’, they need to be licensed.  In their PDF file, on page 5, they do include the following exclusion:

The SAFE Act encourages States to establish minimum standards for the licensing and registration of State licensed mortgage loan originators and encourages the Conference of State Bank Supervisors (CSBS) and the American Association of Residential Mortgage Regulators (AARMR) to establish and maintain the NMLSR for the residential mortgage industry for the purpose of achieving the following objectives:…

To me, this means that you will need to have a loan originator’s license if you offer seller financing on anything other than an owner occupied residence.  You will need a license for vacation homes, vacant land, inherited property (unless you move in), rentals (from single families to fourplexes), etc.

The commercial context implied by the taking of an ‘‘application’’ is also absent where an individual seller provides financing to a buyer pursuant to the sale of the seller’s own residence. The frequency with which a particular seller provides financing is so limited that HUD’s view is that Congress did not intend to require such sellers to obtain loan originator licenses. Accordingly, this rule would provide in § 3400.103(e)(5) that such individuals are not subject to State licensing requirements.

Please add a comment now!

Thanks to the folks at MetroREIT who brought this to my attention.

In this video, I describe what a Land Trust is, the roles involved, and talk about why it is useful when owning real estate.  Land Trusts do not provide asset protection but are useful for camouflage

This video describes the sandwich lease option.  I also discuss details about how to structure the lease option to avoid some costly mistakes.

I discuss the 3 stages of foreclosure and talk about investing in each of those stages.  Also discuss the relationship between short sales and foreclosure.  I give some valuable advice on dealing with the pitfalls of foreclosure investing.