Circumventing the Earnest money Deposit?

Question

Has anyone found a creative way to either avoid having to put down the EMD or a source who might supply such when dealing with a bank?  :idea:

I have a potentially AWESOME deal and need a creative way to get around this obstacle:

There is an REO for 30% below appraised (1k emd needed), no one in my area wants to deal with it (needs work) but has great cash flow potential. My LLC would purchase it from the bank via transactional funding and I will purchase it from my LLC via owner financing for 100% current value. There is a note buyer who will purchase the promissory note from the B-C deal for a discount, which will supply the funds to my flash funder all occuring on the same day. Leaving me at the table with a nice spread after closing costs. HOWEVER, the EMD is causing a major speed bump in the path to victory, as I am not prepared to supply it. Someone once said that obstacles are only excuses and I want to prove them right here.

Can anyone throw ideas out as to where this deposit might come from? All ideas and thoughts are welcomed!

Jon Holdman · Answer

Let's start with this piece:

$1160 would be very nice for cash flow.  You won't even come close to that.  Go to the Rental Property forum and read the sticky threads about expenses.  This statement is based on the number one big lie told to new RE investors:  "cash flow = rent - PITI".  IT DOES NOT!!!  You say your a new investor.  Please, please don't believe this lie.  Its just not true.  Read those posts and you'll understand the reality of rentals much better.

In your first post you say the property will be purchased by you from your LLC using owner financing for 100% of its current value.  Assuming you pay the closing costs for that loan, about $5000, I'd estimate, out of the cash you have, you are correct that the P&I would be only about $640.  With total rent of $2000, ALL expenses, vacancies, and capital items of about $1000, you're left with $1000 in NOI.  That gives you real cash flow of $360 a month.  For a duplex, that's excellent.  Not the unrealistic $1160 you're thinking, but a great deal nevertheless.

The listing agents comission is paid by the seller, not the buyer.  If you're buying this from a bank, the bank is paying that comiission out of the $30K sales price.  This should not appear on your side of the transaction.  Even if you pay the full 6% out of your money, that's $1800.  If you do this, be sure its not on the sellers' transaction, too.  Not saying this might not be what's being done, but this would be a very unusual way to handle the commission.

If there is a commission on the sale between the LLC and you, then I call BS.  There should absolutely be no commission on that sale.  If someone's slipping a commission in on that second transaction, then they are blatantly ripping you off.  Please tell me that's not happening.

If I understand correctly, your getting about $42,000 from the transaction funder.  $3,100 for the transaction funding is about 7.5% of this amount.  Thats a very high percentage.  But, perhaps there's some big fee plus a percentage that makes this high for the small amount.

I'm not sure what the note buyer finder's fee is 1% of, so I'll assume its 1% of the $95K face value or $950.

I'd estimate closing costs, even for two transactions, to be only $3000 at the most.

I'm only coming up with $8,850 in fees, not $12,000

Transaction funder: $3,100
Note Finder: $950
Commission: $1,800 (6% of $30K purchase price)
Closing costs: $3,000
Total $8,850.

Where's the other $4K?

So, overall you get a $95K loan.  The note buyer pays $80,750 for that note.  You pay off the $30K purchase plus the $12K in other stuff and you have about $38,750.

You spend $12K on renovations, $5000 to refinance, and you're left with about $21,750.  There will be interest payments to your private lender.  It would be safer to assume it may take a year to get the refi completed, though I would hope you could make it happen faster than that.

Speaking of the refi, you will need to be sure you qualify for that.  You'll need enough income to cover the new note and all your existing obligations.  You may or may not be allowed to include the rental income.  Fannie Mae guidelines require it be on two tax returns before it can be counted.   Other lenders can be more flexible.  The lending environment is ugly.  I'm in the middle of a refi right now, and it changes day by day.

The HVCC guidelines are yet another new wrinkle and I'm hearing of some dreadful appraisals.  Please be extremely conservative with your values.  If you want to refi the $95K, you'll need every penny of that $125K valuation.  Really, more like $127K.  You'll have no control of the comps the appraiser uses, so be sure the worst comps support that value, not the better ones.

I'll ask for the third time if you've independently verified the value and the rents.  At best, sellers always slant their story by using the best comps they can find.  That's not what the appraiser will use for the refi.

So, yes, this seems like quite a good deal, assuming the value and the rents are correct.  I remain concerned that there is a lot of money seemingly disappearing off the table.  You say these fees are reasonable.  I don't see it.  But perhaps the end result makes it acceptable.

Jon Holdman · Answer

You say the rent is $2000 and you'll be into this with a $125K loan.  With a 7%, 30 year fixed loan, I put the payment at right at $900 (P&I only.)  If this is a single family, with only one tenant to deal with, this would be a good deal.  If its two units, you're only getting $50/month/unit.  If its more than two units, its too much work for too little payback unless there's some other plan.

You're leaving a lot of money scattered into a lot of peoples pockets.  This seems like a way overly complex way of doing this deal.  This note buyer is paying $81K for a note that's going to pay off $95K in six months!  Somewhere $12K disappears between the $30K purchase price and the $42 you owe after closing.  Transactional funds should costs you less than $1K on this amount, and closing should be similar.  The "individual who found this note buyer" is making out like a bandit.

Why not just do hard money?  If its really worth $110K (you HAVE verified that value, right?  A seller's appraisal is NOT reliable.), then even a conservative HML would lend $65K or so.  That gives you plenty of cash for the purchase, renovations, and you're holding costs.  Then, refi at about $70K so you can pay off the HML and roll in refi costs. Now you're got a great deal, even if this is three or four units.

If its more than four units, you're in different territory for the refi, and it will be more complex than you're thinking.

Frankly, I think you're being taken to the cleaners by a group of people who know each other much better than they're letting on.  There's a good deal here, but not after all these guys take their cuts.  As you're structured it, its a good deal for a SFR, but not if its a multi-unit.

Douglas Christian · Answer

Angela if the deal is that GREAT. Borrow the money from someone and pay them a higher interest rate to get it for a short period of time. Get a CASH advance if you know for sure the DEAL is that GREAT. The person or note buyer or whom ever you are passing the deal through offer it to them by allowing them to put the money up for you. I don't know if it is that GREAT of a DEAL if no one in your area will not touch it. Take it to your local REIA and see if someone there will help you out. Family, friends, co-workers, local church, if it is that good you should be able to find the CASH to get it done.

Much success

SUCCESS BREEDS SUCCESS

Much success

SUCCESS BREEDS SUCCESS

Jon Holdman · Answer

The cost of the refi will depend on a lot of factors, but yes, $5K is probably in the right ballpark.  Some of that will be the pre-paid costs like insurance and taxes.

Idea for coming up with the $1K:

Sell some stuff on craigs list or e-bay.
Borrow from friends or family.
Prosper or lending club.
Credit card cash advance.
401k loan.
An advance from your job.
Get a personal loan from a bank or credit union.

None of these are great ideas, but we're only talking a grand here, and if this happens like you expect you can pay it back pretty quickly.  You should plan on at least a month, and potentially longer to get to closing on a REO.  Banks are always slow.  There's a chance the whole thing will go belly up, but you should get back your earnest money if you stick with all your timelines.

Angela Carter · Answer

Jon,

To answer your questions: No, there is not a commission on the second sale. Yes, the rents are correct and actually lower than the areas average rent for units like these and Yes, I have verified* the appraisal amount. Although the appraisal is estimated, I am confident that when a REFI appraisal is done after repairs, it will come in around $125. 
It was appraised for $132,000 by the county's appraiser using a 1004 URAR. 
The estimated closing costs for the entire transaction came out to be $12k because I was doing an over estimate, just in case.

Transaction funder: 2,500 (min. fee) + 595 proc. fee= 3,095
Note Finder: (1% of purchase price)= 1,000
Commission: 1,800 (first sale)
Closing costs: (3% of 30k + 3% of 100k)= 3,900 
Total Costs: $9,795
The other $2k was an over estimate to cover any misc exp.

After six months is when the note would be seasoned according to gudelines. So I would assume I'd be able to REFI at that point. Let me get this right...I have to pay $5,000 in order to complete a rate and term REFI?!?  :cry:

That was unexpected. I can supply the income verification to cover the new laon and existing obligations without the rental income counted. It looks like I would run into major appraisal ISSUES on the back end when trying to refi, do they (the new lender) appoint the appraiser or can I reccommend who I'd like to use? This is not the best of areas so the appraiser would easily value this property for less than $127k.

I think it would be worth the challenge considering the end result.

Back to the original topic at hand: Earnest Money Deposit. 
This is still the speed bump in the road and I need to find a creative way to supply this to the bank in order to even think about getting to the closing table.

Any suggestions?  :idea:

Angela Carter · Answer

Jon,

The property was a single family and turned into a duplex, it is now legally a duplex. Considering I am also the LLC, the majority of the money being spread around is going to me.
The $12k that seems to disappear is for the estimated total costs to close the deal such as the listing agent's fee, the $3.1k for transactional funding, the closing costs for both the A-B and B-C escrow and attorney services, and the 1% fee for the note finder. I am confident this property is worth at least $100k in its current condition.

The problem with a HML is that the locals require a 10% down payment to secure the loan, as well as proof of good enough income. The old HML's who would supply rehab funds for no money down are obsolete now as they have lost so much $ they have gone out of business.

I would not be in it for a $125k loan as I would be doing a rate and term refi, not a cash out. I would've received a $38k check at the first closing so I wouldn't need to pull more money out, only paying off the note buyer is needed. The payment would be somewhere around $640 (P&I only) for a $95k loan 7% int 30 year fixed. Roughly $840 per month PITI. A positive cash flow of $1160 isn't too bad a deal?

The group of people that I've gathered to close this deal surely are not making out like bandits or taking me to the cleaners. Rather, getting their "cut" just like anyone else would want to. I dont mind paying for their fees because these are reasonable. Once again, I would be leaving the table with a $38.75k check at closing. I'd be happy with that. 
I'd have cash in pocket, a positive cash flow and a mortgage that the tenants would pay for. After five years or so when the market returns, I could sell and make another spread. 
Does this still not sound like a good enough deal to jump hoops through?  :lol:

Angela Carter · Answer

Jon, 
          
          I'll give you scenario with numbers so you can better understand this deal. 
          
          The purchase from the bank to my LLC would be 30k. The purchase from the LLC to myself would be $100k (minus the "down payment"). This is a 65k difference. The estimated appraised value is currently $110k with an  ARV of $125k. (It appraised for $132k in 2007). 
          
          Now, the note buyer stated he would pay 85% of loan amount for the note which is $80.75k. From this amount, I pay off the transactional funder, closing costs and fees to the individual who found this note buyer which is about $42k total. This leaves $38.75k at the closing table. Yes, there is still a loan for $95k however, once I implement the repiars and renovations with about $12k and rent the property out which is a cash flow rent roll of about $2k per month I can refinance after 6 months at the new appraised value of $125k. This pays off the note buyer and gives me a more normal interest rate. 
          I am a new investor, but I think those numbers are in line with a great deal? Don't you?

Curt Davis · Answer

If you are not able to come up with $1,000 in EM then you might want to either beg, borrow or steal, minus the steal.

There is no way around the earnest money deposit from the bank. Sorry.

If your LLC would purchase the home cash which it sounds like, then why not write a em check from your LLC ?

Also, why would you want to owner finance it from yourself?

Jon Holdman · Answer

This doesn't sound like the sort of deal you should jump through hoops to get.  You say it priced at 70% of its value.  Have you personally verified the value?

You say it needs work.  OK, that makes it too expensive.  70% of value might be OK if it needs no work (though why would it have a big discount if its perfect), but you have to subtract off the amount of work.

Your LLC is going to buy this and wholesale it to you.  So, 2% for the transaction funding, maybe 4% total for the two closes, so you're at 76% of value.

Now, I really don't understand your financing.  You say "owner financing".  But your LLC is the owner, and it doesn't sound like its in any position to do owner financing.   I think you're saying your LLC is going to sell you the property with owner financing, then immediately sell the note to a note buyer, gaining back enough cash to pay off the transaction lender.  From what we're hearing in other discussions, a discount of 80 cents on the dollar would be an above average price for this unseasoned note.  Your LLC needs 70% (purchase), 2% (transaction), and 4% (closing costs) to pay off the transaction lender.  With an 80 cents on the dollar discount, the loan amount would need to be 95% of the value.  (95% of the property value times the 80% of face value of the note the note buyer will pay equals 76% of the property value, which is what you owe the transaction lender).  You mention the financing is 100% of current value, so we're in the right ball park.

Now, you don't say what you exit strategy is.  But you do realize you end up with a property you've paid 100% of value to buy.

Why?

That's not an awesome deal in anyone's book.  You've just put a ton of money in a bunch of people's pockets, but its all coming out of yours.  This deal makes no sense.

You say it has great "cash flow potential".  Really?  Have you read in the Rental Property forum about rental expenses?  Lots of sellers claim "cash flow = rent - PITI payment".  They're pulling your leg.  A better equation would be "cash flow = (rent / 2) - P&I payment".

Angela Carter · Answer

Yes, I am in the process of begging or borrowing but have not had any luck yet. My LLC would be purchasing with cash however the funds are given througha transactional funding source which supplies all funds except the emd. The only reason I would owner finance is to sell the note to the note buyer as opposed to a cash buyer. This way the A-B funds are there as well as the B-C funds.

Circumventing the Earnest money Deposit?

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