Assignment, Simultaneous Closings, or Other Ideas?

Question

Hello, Investor Pros!

My husband and I have a potential opportunity in front of us. Our friend, let's call him "Bob", in the San Francisco Bay Area has a property built in 1960 that has never been updated. My husband and Bob have been friends for years, we've never seen his home, and there have been some red flags that make us believe Bob could be a hoarder. A realtor suggested a list price of $1.7M. I had the idea to make an agreement with Bob to purchase the home from him for $1.8M with the contingency to help him go through his things and put them in storage within a month or other agreed upon set timeframe. Then we would use our $100k cash and take 2 or 3 months to renovate the property then list it. From the comps it seems we could sell the updated property for $2.2M (conservatively). I would want to write in the contract that Bob would be paid his $1.8M out of escrow from our buyer paying $2.2M. We would receive the difference between $1.8M and $2.2M for doing the renovation and helping Bob move, potentially making $300k. What do you think the best way to structure the deal is? Is this a crazy idea? Are there other stipulations you would include in a deal like this?

Thank you so much in advance for your help!! :D

Allie Dickson · Answer

Thank you @Justin Abdilla! Do you still think it's risky even with properties in the Bay Area getting multiple over-asking price offers within a few days of listing? In my mind it's very similar but less risky than an investor who flips property because we don't have to put up the $1.8M in the beginning. Maybe I'm missing something here?

Justin Abdilla · Answer

I have absolutely no idea how the Bay Area market functions, so I'm not at all qualified to answer whether that's predictable.

I think it's equally risky to an investor putting up $100,000 on a property that the investor expects will generate $150,000 in profit.  If I were to translate this to Chicago, it would be like putting $50k down on a wholesale for a property that's selling at $200k and needs $100k of work to sell for $450k.  You just better be damn sure that the property gets to $450k for all the work you're going to put into it once all the expenses are calculated, or you're going to have done a lot of work for free.  I'm not really worried about the $100k you've got in the game to get the assignment, but I'd be worried about the money you're putting in to rehab it as not generating 1:1 ROI.

Maybe the Bay Area is such a hot market that it's less risky than I think, but I tend to be risk averse as an attorney.

Allie Dickson · Answer

@Justin Abdilla Thank you. Makes total sense. Your idea to receive the guaranteed $300k profit would make us sleep better at night.

Justin Abdilla · Answer

Holy moly, you're taking all the risk!  You have 5% in the game, maybe even less.  That means 95% of the property is a margin sale.  The way to contemplate these margins is that you're paying $100,000 to take on 17x that in liability.  Once you sell the property, you have to pay off that 17x liability and your $100k that you have into the property.  If the property doesn't sell for over $1.8m, you are below your breakeven, and honestly it's probably a bit more than that because of all the money you'll have to put into a restoration job.

To increase your profits, you can do one of two things, you can either increase the sales price or lower your liabilities.  It will be hard to increase the sales price above the $2.2m you're asking, so I think you probably need to look for a way to lower the liability.  Is there a way that you can convince Bob to take a bit more of the risk here?

I would think of some type of contract where Bob pays you and your husband a rehab fee to be put onto real estate escrow.  I would want mine first in this type of deal, and maybe just agree that my rehab fee is $300k for a list of improvements.  Maybe bill your services as rehab/reno rather than wholesaling, but I don't know if there are state-specific laws for licensing and consumer protection that will apply in that instance that would stop you from doing it.  I just think having the profit secured for you, and making the cash flow a more predictable number will help you all mutually benefit from this transaction over you and your husband putting $100k into the game for an eventual $2m in liabilities and hoping to hit the break even.

All those numbers are purely hypothetical of course, but I would probably talk one of my clients out of jumping on this opportunity as you phrased it.  You're only looking at ~10% of profit margins once everything is all done, and you're in the property at 5% of its value.  That's narrow, but it can still be profitable if you work some guarantees into it.

I hope you, your husband and Bob all make a mint on this one, though!

Randall Weatherall · Answer

I would confirm the hoarder status and how bad it is, then double, triple-check your $100k number.  It seems like a fairly thin spread given the risk on your behalf and the ability to sell for $2.2MM (don't forget commission is coming out, so that's $132,000 if 6%).  I think Bob needs a reality check on his situation and should agree to a lower amount depending on how bad it is since I'm sure it's unlistable as-is, only marketable to investors that will tear him apart on price.

Just be sure that you don' do all the work for a small return while Bob sits on his full amount of $1.8MM.  The way I see it, $1,800,000 + 100,000 + 132,000 = $2,032,000 and that's really not a lot of wiggle room as it is now, but it could still be a great chance!  Just be sure to do your due diligence and get comps from multiple agents in the area before proceeding.  Lastly, to cover you in the closing, you'll need an attorney to draft a contract between you and Bob and then all of you with the Agent that's chosen to list it as you'll need to be paid through the Brokerage (most likely) that's receiving the commission, but check with your local and state laws for all of this; I'm in TN.

Allie Dickson · Answer

Thanks, Randall!! That is so helpful and you're right. Being that he's a friend I was trying to be more accommodating, but he would otherwise be dealing with a bunch of investor sharks that wouldn't be as helpful. I really appreciate your input.

Assignment, Simultaneous Closings, or Other Ideas?

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