Is this a good strategy?

Question

Hi all , I'd post and find some insight on what i'm doing in my venture into REI.

First off , I've been a real estate agent for a year now, which really helps me locate good deals, and also gives me a % discount on whatever I buy. Right now my strategy is to buy home at around a 60-70% LTV and land-contract. My hope is to be able to cashout refi the homes for near the land contract price, but still within margin of the new mortgage so i have a little cashflow comming into the property. My goal is to then use the cashout money to invest in other properties,  this way I can secure other lower equity properties , or riskier investments. In general, is this a good strategy? I'm putting together a deal that's looking like this .

$46,000 Purchase price (Needs $5k max in repairs) with Comparable properties running in the range of $80,000-90,000. Land Contracts in our area are becomming more popular with the rate of foreclosures and bad credit want-to-be home owners. The LC range for this home is in the $725-750 area. I believe i could cash it out enough to put 5% down on several other properties (Got my eyes on 2 which are running at about 33% of real worth).

Any insights?

Michael Rossi · Answer

shockergd,

The blunt truth is that your plan is fatally flawed.  Refinancing the property near the land contract price is a recipe for disaster.  Why?  Because land contract and lease option buyers are really renters.  They are doing land contracts/lease options because they have no money and no credit.  The majority of the time, when you "sell" a property with a land contract or lease option, you will get the house back. Moreover, if you're planning on having the "buyer" do the maintenance, be prepared to get the house back with a LOT of deferred and poorly done maintenance.  Remember, these "buyers" have little money and bad credit, that's the reason they are doing land contracts/lease options.

Your general plan would work IF you buy at a huge discount and treat the operating expenses exactly like a rental.  In addition, you should become intimately familiar with your state laws.  I never do land contracts because that requires doing a foreclosure to get the property back.  In Ohio, in most cases, you can use an eviction to get lease-option "buyers" out when they stop paying  -  MUCH FASTER.

TallGray1,

This isn't even close to being right.  Expenses are certainly not only taxes and insurance.  Even if you're doing land contracts or lease options, you still have all the normal expenses (although they may be delayed).  These include management, maintenance, advertising, evictions or even worse - foreclosures, legal fees, damage done by tenants, lawsuits, office supplies, etc, etc, etc.  I could go on and on.  Failing to account for these expenses is a SURE WAY to fail in this business.

Mike

Michael Rossi · Answer

TallGray1,

Why so defensive?  I was simply pointing out the truth about your cash flow equation, which is that it is wrong.

As I said in my post, I do it right by including all of the expenses in my cash flow analysis.  The number one reason that newbies fail is due to the lack of cash flow.  In fact, that's the number one reason that new businesses of all types fail.  Failing to take all of the expenses into account is one of the most common errors and directly leads to failure.

Again, that was my point.  The Cash Flow produced in this example is not $85 per month, it is a loss.  Taxes and insurance are not the only expenses.  There is no rhetoric here, I was just stating the facts.

I assume that if someone is asking a question, they want the truth.  It does make a difference what the expenses are.  In fact, it can make ALL the difference.

Good Luck,

Mike

Brandon Schlichter · Answer

Well , unfortunately i've ran into a problem...

The appraiser only appraised the value of the home for what i'm paying on it (which means he felt the condition was below par, used ONLY reo comps that reflected the value he felt matched it).

Becuase of that , its thrown me out of getting a HELOC due to appraisal seasoning , so i've gotta repair the property out of pocket.

Thankfully to get the value i feel (I'm going for $10k on top of the 43k that i'll have into it) and remburse myself for the $3k i'll be spending on it. There's a big tarp on the roof and the appraiser most likely felt the whole roof needed replacing which isn't correct, the flashing is leaking and only needs some caulk and a very small area (100sqft or so) needs new shingles.

Frank White · Answer

there still are a few banks that do 100% financing... why don't you just buy at the appraised value and forward the difference between what seller wants and appraised value (don't forget about closing cost) to a third party on the hud?  simple and to the point...

... you mortgage payment on 80K (if that's what's its worth) is 80K*.10/12= 660 dont know what your property tax is put i guestimate your total mortgage payment would be about $680

find a renter for $660
your cash flow negative is $20.  set $480 (20*24)aside in an account let it draw intrest

take the apx 30K and reinvest... i hope i understood your question right and this provides a little clarity...

Brandon Schlichter · Answer

I think that I will do a lease-purchase or lease-option now that everyone's sugguested against land contracts. I wish now that I would of gone with a lender with lower closing costs, as adding a refinance on top of this will take away a bit more since i've paid closing costs twice.

Someone sugguested using hard money lenders for things like this , which i believe i will do with the next deals (I've got 4-5 lined up after this one).

Eric Medemar · Answer

I cant tell from the question whether you are planning on buying or selling on land contract or both but anyway here are my thoughts.

When our economy in michigan was decent, I knew and still know alot of guys that were buying up homes at around 60%-70%Ltv, and then selling them on land contract with 5% down.  The problem is that most of the people that wanted to buy on land contract, had bad credit.  They got there bad credit by not paying there bills, and based off of that history, why would they pay your bills.  Well needless to say, the guys that sold on land contract lost about 60% of the contracts, and simply ended up with trashed houses, and empty pockets. So based soley on what I have witnessed I would avoid selling alot on land contract.  One guy I know has 75 vacants right now.

The strategy that I have been using is buying with a commercial line of credit, fixing then refinancing like you plan to do.  One example, I bought a home for 33,500 put 3,500 in repairs then the bank financed for 80 ltv with was 56k.  I took the difference and put it towards buying some more as you plan to do.  Instead of selling on land contract, I will put really good tenants in while I am waiting to flip. I have done 8 homes in 2007 using this strategy.

N/A N/A · Answer

Mike
Well put.  Often in the hast of responding, the shell of the concept is described and not it's complete content.  Also, as NooB pointed out, quite often the obvious is not pointed out.  Certainly an investor would not/should not overlook the details.  THEY WILL MOST CERTAINLY LEAD TO DEMISE.  No harm no foul.  I had perceived the original comment as slightly insulting.  It wasn't intended and now clarified.  All in all, the combined message will hopefully provide insight and lessons to individuals seeking knowledge.
Glenn

Tom McGiveron · Answer

for what it's worth -

i think that a lot of people post on forums like this and say all sorts of stuff - people just want to help out by giving feedback.

i think both of you are offering, like most people, your opinion and the "rhetoric" is really what ALOT of people in these forums need - maybe not in this thread per se, but, when someone reads something like what you wrote Tall - they automatically like to point out things that you didn't mention because while these forums are great for people to pick up some info here and there - sometimes posts that don't point out the rhetoric or mantra of sound investing - make people want to point out what's left out in other peoples posts....

does that make any sense? lol

sometimes experienced investors leave out the obvious because to them - it's obvious...and the experienced investor is willing to take risks that maybe the inexperienced "investor" should not take...

i'm still waiting a response about all these "advantages" he has has a real estate agent...

some of what he says...or at least the way he wrote it sounds very "iffy" to me.  i just want clarification...maybe i'm missing something.

be  8)

N/A N/A · Answer

Schockergd,

Some of the term you used, I'm not familiar with, but I think I get the gist of you rational.  If I'm correct in my interpretation, it's a great plan.  I use something similar.  Here's what I've interpreted:

You purchase at 46k, put 5k into make ready (total 51k) and retail value is 80k minimum (determined by market sales comps) you then cashout refi at max lender allowed guidelines (here in TX it's 80% LTV on non-ower occ), pocket some and rent (is that what Land Contract means), either way income of $725.  Is this correct?

The short is:
51,000 purchase repair
64,000 cashout

13,000 gain from refi

operating proforma
640/mo PITI (using rule of 1% loan amount estimation)
725/mo income

85/mo positive cashflow

I do this by buying properties at similar discount, use hard money or other short term finance solutions to acquire and rehab, then use permanent mortgage solution to cashout, hold and cashflow for income.  Great strategy!  Keep in mind the warning of All Cash, don't get over leveraged, if something goes wrong and you get stuck with the property and no tenant - you could end up bankrupt or foreclosed simply because you didn't have reserves to weather the storm.  Lastly, his point about interest rates, borrowers that can't qualify traditionally should be charged higher rates considering the risk.  Simply put, they've demonstrated that they don't fulfill their obligations to other lenders, why would it be any different with you?

Hope that helps.
Glenn

Brandon Schlichter · Answer

Ok, lets see what i can answer........

Noobdog, i am a buyer agent on this one, the property is listed by a out-of-area broker that has no advertising , or MLS support in this area, no one knows about this property, so i am not self dealing , or otherwise (and i've stated on all documents that i am a agent).

Tallgrey , i'm thinking of doing something very similar to what you're doing. The only issues i'm looking at right now are closing costs on the refi , ect. I should of used a hard money lender on this one to begin with, but I didn't think to call them up. I think i'm going to hold out on the cashout for a little while. I only need around $5k out of the deal up front so i can buy my next property with a even higher cashflow ($80k duplex for $40k with a income of $1000 a month).

I'm really trying to weigh all the options on getting a little bit of cash out of this deal to do some rehab on the property + have money for the next flip. The value of this property is in the $80k to $90k region.