Subject-To Deals Risky?

[Dylan Speer]

Hi everyone,

I recently got contacted by an investor who is interested in doing a "subject to" deal on a condo I own. The proposal sounds promising, and I wanted to reach out to see if anyone here has experience with this type of arrangement.

The investor has offered to give me $10,000 upfront, which seems to indicate that he has some skin in the game. Additionally, he mentioned that a lawyer would be involved in the transaction, which provides some reassurance. However, I'm still cautious and want to ensure I'm not missing any critical details.

Has anyone here done a subject-to deal before? How did it go, and what should I watch out for? Also, with the investor putting down $10k upfront, does this typically mean they're more likely to keep up with the mortgage payments?

I'd appreciate any insights, advice, or experiences you can share. Thanks in advance for your help!

Best,

Dylan 

[Tom Gimer]

@Scott Trench Had a deal close last month with a combination of your scenarios/players. The seller was desperate and the buyer was a well capitalized pro. This is actually the more common situation, in my experience.

After signing but before the deed was recorded, the seller got scared that the buyer was a fraud, was not going to pay the mortgage and was simply going to rip the rents (as @Jay Hinrichs likes to say) and torpedoed his own deal by alerting the lender of the transfer! Seriously. And this was after the buyer had paid the mortgage current.

Proper sub-to contracts provide for significant liquidated damages in the event the seller behaves like this. Unfortunately this one did not.

Just got finished unwinding that deal.

[James Hamling]

@Dylan Speer what is a subject-to? 

All this hype around it, all these people hammering at it, yet the vast majority are all but clueless on transactions. 

Subject-to essentially means "if this, I will that", and that's it, just that simple. 

It's used, and long been used, in normalized settings for example in selling a property "subject-to" sellers securing a new primary residence themself. For some people, this is really important, they don't want to buy a new home with the sale of current being a question mark, they want certainty, many hold a fear of "what-if" on non-sale of home or a price too low. 

And than there is other iterations, for example on various land deals bought subject-to a zoning or other variance being awarded. 

See, this is how subject-to is meant to be used. 

Now, there is other forms of selling a home where buyer does not need to get financing via 3rd party (bank), namely a Contract For Deed Financing. Or lease with purchase options, these are arguably the 2 forms most vastly used over more years than I can recount, generations. 

What your considering here is some franken-sale "monster" of twisting these 2 into a manner neither was ever meant to be utilized as. 

It only ever makes sense in context of someone looking to take advantage of the other, seriously. 

Because let's look at buyer side. How does over-paying make sense? For a lower interest rate? Ok, that's an argument of buying the rate down, sooooo why not do that with a lender, they let you buy down pts. Ok, so next is no $ to do that. Ok, now we are back to taking advantage, because buyer is NOT capitalized properly, and banks won't lend to them because of RISK of non-performance.      So now, buyer is over-paying and under capitalized, what a recipe for good outcomes right (oh so much sarcasm). It's setting self up for failure, because everything ahs to go right for a duration of time INCLUDING equity growth to infill that hole one dug day 1 via over paying. 

For seller, you have the stupidity highlighted from buyer side, there is VERY high risk involved for buyer NON-performance.     But now, you also gave up control, you gave up all upside, for what, a pile of risk?     

If a buyer wants to buy using sellers financing, DO THAT, and there is transactions for that, again C4D. Or LWO. 

Sub-to sounds good, and that's about it. Selling a dream that a person with just $5k/$10k can get properties and become a landlord/investor with trash credit and no income.....     It's a narrative that sells.... No different than any of the other late night infomercials for generations selling how anyone can make millions doing little to nothing with little to nothing..... 

It's all BS. It's a get-rich-quick scheme. 

Sub-to assures someone is getting F'd in every transaction. That's the reality of todays market. 

Maybe MAYBE in an '08' market it could have made sense for some, it could have been a win-win. But notice, you need very specific series of ingredients to have it make sense. 

Today, in todays market, even in foreclosure setting, a person has ready options. Cash buyers galore. Term buyers galore (C4D). 

Every instance of sub2 buyers I have seen have been that, chasing rainbows, and with no financial strength to perform going forward. Because those with financial strength, don't buy Sub2 because don't want to over-pay and don't want the mess of it all and being tied to a seller who has issue not to mention the potential legal impacts of DOS and what nots.

As for interest rate, I buy from builders for as low as 5.125 30yr lock. I have done C4D for as low as 4%. I don't need sub2 to get great rates. And if I can do it, so can others. 

Sub2 is a pitch, to sell how-to, full-stop.

Will I give away a property on a  promise someone will make mortgage payments for me, HELL-NO! That's what tenants are for! 

[Ben Zimmerman]

Quote from @James Hamling:

How does over-paying make sense? For a lower interest rate? Ok, that's an argument of buying the rate down, sooooo why not do that with a lender, they let you buy down pts. 

It's apparent that you have never been party to a sub2 deal, or given any real thought to the benefits to a buyer.  Sure you can buy down rates at a bank, but that costs thousands of dollars in lender points and fees, and you aren't going to move the rate very far.  You might turn a 7% mortgage into a 6.5, but your not turning it into a 2-3% mortgage.  

Lets take a standard 400k house and assume you and I both start with 80k in cash.  You could get a new loan, pay 20% down (80k), and 7% interest on the remaining 320k balance, and that would cost you $2,129 per month (principle and interest).  

Or, I can "overpay" and pay 410k to obtain the house sub2 with a 2.5 interest rate, and finance the entire 410k balance, and still only pay $1,620 per month.  So even though I owe 90k more than you do, I'm still saving 500 per month in payments.  Not only that, but you blew 80k in down payment money, where as I still have my 80k sitting in the bank as potential reserves.  So I have a significantly lower monthly payment, and higher cash reserves.  I am simply much more stable financially than you are.  Not to mention you are going to be paying your loan for 30 years, where as my loan will likely be paid off in 20-25 years since the original home owner has already paid into that loan for a handful of years.

I'm obviously not advocating that you should overpay for anything, I'm simply stating that you could overpay, and still be financially solid.  The only way that the total balance matters is if you are somehow forced to sell the property shortly after buying it, and are thus underwater.  But with my lower payments I catch up and offset that extra 10k in purchase price in only 20 months, and my 80k cash reserves in the bank means there is no realistic scenario where I am financially forced to sell immediately after buying it.  That's enough cash to float the mortgage for 4 years without ever collecting a dime in rent.

Yes, there is a growing trend that sub2 is a way to get into real estate with no money.  But that is a guru teaching bad information problem, not a problem of a sub2 deal in general.

[James Hamling]

Quote from @Ben Zimmerman:

Quote from @James Hamling:

How does over-paying make sense? For a lower interest rate? Ok, that's an argument of buying the rate down, sooooo why not do that with a lender, they let you buy down pts. 

It's apparent that you have never been party to a sub2 deal, or given any real thought to the benefits to a buyer.  Sure you can buy down rates at a bank, but that costs thousands of dollars in lender points and fees, and you aren't going to move the rate very far.  You might turn a 7% mortgage into a 6.5, but your not turning it into a 2-3% mortgage.  

Lets take a standard 400k house and assume you and I both start with 80k in cash.  You could get a new loan, pay 20% down (80k), and 7% interest on the remaining 320k balance, and that would cost you $2,129 per month (principle and interest).  

Or, I can "overpay" and pay 410k to obtain the house sub2 with a 2.5 interest rate, and finance the entire 410k balance, and still only pay $1,620 per month.  So even though I owe 90k more than you do, I'm still saving 500 per month in payments.  Not only that, but you blew 80k in down payment money, where as I still have my 80k sitting in the bank as potential reserves.  So I have a significantly lower monthly payment, and higher cash reserves.  I am simply much more stable financially than you are.  Not to mention you are going to be paying your loan for 30 years, where as my loan will likely be paid off in 20-25 years since the original home owner has already paid into that loan for a handful of years.

I'm obviously not advocating that you should overpay for anything, I'm simply stating that you could overpay, and still be financially solid.  The only way that the total balance matters is if you are somehow forced to sell the property shortly after buying it, and are thus underwater.  But with my lower payments I catch up and offset that extra 10k in purchase price in only 20 months, and my 80k cash reserves in the bank means there is no realistic scenario where I am financially forced to sell immediately after buying it.  That's enough cash to float the mortgage for 4 years without ever collecting a dime in rent.

Yes, there is a growing trend that sub2 is a way to get into real estate with no money.  But that is a guru teaching bad information problem, not a problem of a sub2 deal in general.

You're entire "what-if" scenario is based on a predatory deal.... 

In that scenario, where cash-flow is $500mnth, why wouldn't seller simply rent it out themself?   

So you're entire premise is built upon seller being dumb....

Not to mention handing it over for near market value, with an amazing rate in place, and property condition being turn-key, and seller not having any hidden issues say an IRS tax lien or what not, and, and, and..... 

You question my experience base, lol, that's funny. I question yours. Exactly where have you found this unicorn farm of quality properties with idiot owners/sellers? 

And you conveniently ignore everything I said on Terms sales.... Where i can do a C4D, get a stellar rate, and I have 0 concerns on DOS or any of that. If seller goes and does some craziness, I have legal recourse.

I defer back to what I laid out. Sub2 is "the" scam of the day, maybe as much as 1% of those attempting it have legitimacy, I am probably being gracious at 1%....

The general standing of Sub2 is a giant Hopeium toking fest.

[Don Konipol]

@Scott Trench, you’ve more than adequately explained the two opposite scenarios for subject to.  Well done.

As we all have experienced, most of life happens between the two extremes. 
So, it’s often a judgement call.  IMO subject to transaction work better with commercial property than residential; and better with residential investment property than residential owner occupied. 
My fear with residential owner occupied is that seller’s don’t really understand the risks even if they are disclosed to them. They don’t understand the consequences, or are so desperate they make bad decisions.  If the buyer is substantial and honest it may turn out all right anyway.  If the buyer has no capital and is a recent “graduate” of a guru mentorship program and needs to borrow the earnest money, then disaster is predetermined. 

[Corby Goade]

I don't like em. 

If you aren't in financial distress, what is the benefit to you, as the seller? To save yourself from foreclosure, it might be an option, but otherwise the buyer gets all of the benefits with very little risk. There's a reason this is the preferred method for new buyers with little to no capital. 

[Jay Hinrichs]

Quote from @Tom Gimer:

@Scott Trench Had a deal close last month with a combination of your scenarios/players. The seller was desperate and the buyer was a well capitalized pro. This is actually the more common situation, in my experience.

After signing but before the deed was recorded, the seller got scared that the buyer was a fraud, was not going to pay the mortgage and was simply going to rip the rents (as @Jay Hinrichs likes to say) and torpedoed his own deal by alerting the lender of the transfer! Seriously. And this was after the buyer had paid the mortgage current.

Proper sub-to contracts provide for significant liquidated damages in the event the seller behaves like this. Unfortunately this one did not.

Just got finished unwinding that deal.

I had a sub to seller do that to me.. we closed and she walked right into the credit union and told them she sold the house and was not going to make anymore payments.. I got a demand letter within a few days.  and well that turned into a cash buy LOL.  

[Don Konipol]

Quote from @Corby Goade:

I don't like em. 

If you aren't in financial distress, what is the benefit to you, as the seller? To save yourself from foreclosure, it might be an option, but otherwise the buyer gets all of the benefits with very little risk. There's a reason this is the preferred method for new buyers with little to no capital. 

I have sold subject to a number of times, and I want suffering any financial distress.  Here were some of the benefits to me as a seller of selling sub to

1. By offering sub to financing, you increase the universe of potential buyers to include those unable or unwilling to obtain a new loan.  This results in the ability to obtain a greater price than a cash transaction would.

2. If the loan on the property is a significantly below the current interest rate, and the buyer also saves origination fees and costs, this enables the seller to demand a higher price while the buyer still obtains his ROI objectives

3. If the seller does a “wrap” mortgage and the wrap is for more than the interest rate on the underlying mortgage, the seller retains the differential as monthly net and may be able to create a note with a high double digit yield.

4. Many properties, especially commercial properties, take 60 days or more to go through financing underwriting.  A sub  to transaction can be completed in 3-10 days.  If selling quickly is important to the seller, this is a doable alternative.

5. Some properties are in a position either through disrepair or tenant vacancies that they simply can not be financed at anything close to a reasonable interest rate.  A sub to sale may be the only way to sell such property.  Even if a cash buyer can be found the cash value may be so low that the seller would have to bring a high amount of cash to closing to make up the shortfall amount needed to payoff the mortgage loan. 

6. For a variety of reasons, it may be necessary for a property owner to no longer hold legal title to a property or have an entity he controls hold title.  Sub to allows title to be “parked” in the name of a trusted friend or family member without that person having to obtain a loan or have legal liability for that loan.  

7. A buyer may be planning to purchase the subject property for cash when a liquidity event he’s anticipating occurs.  Selling to him sub to allows the seller to get out of a property sooner rather than later (if that’s what’s desired) and have the loan paid off when the buyer has his liquidity event. 

doing any CREATIVE  real estate deal SUCCESSFULLY requires the knowledge, experience and capital to be able to set up the transaction properly, with safeguards in place, and structure the transaction so both parties have positive reinforcement to “make it work”.  It also requires the ability to evaluate the party on the other side of the transaction, making judgements that go far beyond credit score or balance sheets.  If you don’t possess, or don’t YET possess those abilities, then stay away from creative transactions, unless you employ someone who does have those abilities to respresent you. 

[Ben Zimmerman]

Most sub2 sales involve a seller who is distressed, but that doesn't necessarily make it a predatory deal.

Just about everyone in the US knows that owning and renting real estate is a tried and true method to wealth, but 99% of people will never own a rental property for a wide variety of reasons, fear being one of the biggest.  Just because someone could make $500 per month renting doesn't mean they will.  In fact in most cases they won't.  Either due to fear, lack of knowledge, lack of capital reserves, or any other number of possible reasons.

I have purchased roughly 50 homes sub2, and in none of those instances was I the only person making offers to the seller. Some of the sellers had previously listed their home on the MLS, some were facing preforeclosure, some were moving and didn't have enough equity to pay closing costs, some were.....

Literally anyone could have made an offer on these homes, and many people did.  But my offers are accepted because I have a proven track record of successfully executing these deals, keep several million in liquid funds, and I can offer them more money than anyone else.  If you want to offer them a better deal, then by all means go ahead and do so!  Surely if my "predatory" deal is able to make money, there is enough meat on the bones for you to be able to offer them better terms and still make a boatload of money for yourself.

I can offer people more money than anyone else, that isn't predatory, for a lot of people that's salvation.

[Don Konipol]

If a buyer has the financial capability to handle possible temporary negative cash flow and ability to refinance in the unlikely event the note is accelerated, and the seller has the ability to do a background check on the buyer and reach an intelligent decision, then the benefits of a real property transaction without the expense, time and qualifying necessary to obtain new financing and perhaps the benefits of a lower interest rate can successfully accrue to the benefit of both parties to the transaction.

If the buyer is an undercapitalized inexperienced recent “graduate” of a guru program and the seller is willing to sell to anyone, whether breathing or not, then the transaction has a high likely hood of ending in disaster.

When both parties are knowledgeable and understand the risks of the transaction, nobody is “taking advantage” of anyone else.  Those that “don’t see” the benefit to a party likely are unable to comprehend that their own perceptions, history, experience, and motivations are not “universal” in scope.  People have different needs, wants and desires, which any other person might - or might NOT - be able to understand.  People who are money motivated (I’m raising my hand!) tend to believe everyone is motivated by money; people who are lifestyle motivated think everyone is motivated by the least amount of time expended; people who are risk adverse can’t believe other people are willing to “bet” on outcomes even when the odds are clearly in their favor. 

80% of the time (IMO) people who make decisions we disagree with are not making stupid, ill informed decisions or being “tricked”; they just have motivation, needs and desires different that our own.  

[James Hamling]

Quote from @Ben Zimmerman:

Most sub2 sales involve a seller who is distressed, but that doesn't necessarily make it a predatory deal.

Just about everyone in the US knows that owning and renting real estate is a tried and true method to wealth, but 99% of people will never own a rental property for a wide variety of reasons, fear being one of the biggest.  Just because someone could make $500 per month renting doesn't mean they will.  In fact in most cases they won't.  Either due to fear, lack of knowledge, lack of capital reserves, or any other number of possible reasons.

I have purchased roughly 50 homes sub2, and in none of those instances was I the only person making offers to the seller. Some of the sellers had previously listed their home on the MLS, some were facing preforeclosure, some were moving and didn't have enough equity to pay closing costs, some were.....

Literally anyone could have made an offer on these homes, and many people did.  But my offers are accepted because I have a proven track record of successfully executing these deals, keep several million in liquid funds, and I can offer them more money than anyone else.  If you want to offer them a better deal, then by all means go ahead and do so!  Surely if my "predatory" deal is able to make money, there is enough meat on the bones for you to be able to offer them better terms and still make a boatload of money for yourself.

I can offer people more money than anyone else, that isn't predatory, for a lot of people that's salvation.

Aaaand we are full circle coming back to my original statements. This is all rather circular. 

As your saying here the entire premise to how your getting properties is OVER-paying. Your justifying this in the interest rate your getting. And than in the low down payment. 

On over-paying with low down, that is LEVERAGE. And in this case your bragging to OVER-leveraging a property. 

Now, if sitting on a pile of cash, that is "insulation" or PROTECTION for the various "what-if's" that can and WILL arise for persons in such OVER-leveraged positions. And we all know 99.95% of people chasing sub2-Rainbows DON'T got that pile of cash to mitigate OVER-leveraged position. 

So when a furnace goes out, there f'd. Any significant expense, 90%+ of those buying on Sub2 are F'd. Making the Sub2 seller F'd.

Way WAY too few ever speak of this. Why? Because it negates the sub2 hopeium toking fest. Because it is a slap of reality that one DOES need $$$$ to do it all. 

And for 3rd time, your avoiding CONTRACT FOR DEED...... 

I notice Sub2 people HATE when I bring up C4D, because they got nothing for that argument. I can buy C4D at same low down, get same low rate, but now I have no DOS worries. I have no worries of what seller does. It's all very clear cut, simple, LEGAL and with protections you don't have in Sub2.

And guess what, you can over-pay using any purchase mechanism. It's not hard to buy properties when your saying you'll pay more than anyone/everyone. So nothing special there. 

Now if you wanna talk maximum bang for your buck, how about Lease with Purchase Option? If the place allows sub-let, I can acquire properties for as little as $1,500 down. 

And, to-boot on LWO I could actually press any property maintenance onto seller. So if/when furnace goes out, it's on seller to pay to repair/replace. 

How about that???? 

See, I don't do Sub2 BECAUSE I don't need to, and it's NOT the best transaction method in any transaction I've come across, because I know the other transaction methods and they have always presented more benefits at less risk.

Sub2 carries a LOT of risk, it does and you know that, everyone informed knows this.

I have never known of or heard of a single instance where DOS is called for a C4D or LWO, not a 1. And I have done some jazzy really crazy C4D structures before like sandwich C4D's.

You can brag how your Sub2 are all great grand and groovy but fact is your 1 event away from a forced liquidation event. 1 court ruling on Sub2, 1 event where lenders do look-backs and enforcement, your goose is cooked. Unless your stating that pile of $ your sitting on is enough to clear financing on all 50????? Which we know it isn't, because if it was you'd be doing something else not sitting on $1.3m liquid cash just burning up to inflation in an account somewhere.

No, you'd be in commercial taking down deals where sub2 is a far more normalized and accepted thing. With far bigger pay-days. Especially now, today. 

So what your not saying speaks volumes. Your sitting on what, maybe as much as $100k? A decent pile of $ but you know it only affords 1-2 conventional purchases hence chasing the Sub2-rainbow. But as over-leveraged as you are, it's a house built not on sand but jello.....

Your 1 sizable event from getting whipped out. 

The path to wealth is a road through a grave-yard littered with bodies all saying "it was so good, until....". 

Wealth creating is NOT about how much you make, it's about how much you KEEP.... 

[Don Konipol]

It’s all getting a little PERSONAL.  Why can’t people differ on their preferred strategy, and accept that what works well for one might not for the other?  Does it have to be “my way or the high way”.  
Honestly how can you have been in the real estate investing arena for 10, 15, 20 or more years and not seen every single strategy work - and the same strategy fail?  Different circumstances, different economies, different geographical areas and different players all have tremendous influence on the success or failure of a strategy , or tactic.  

The only thing that’s consistent is that a HUGE percentage of people (99%?) spending $40k on a mentorship program are going to end up never receiving a return on their investment.  

What’s far more important than the specific strategy someone utilizes to gain an advantage as a real property investor is their (1) knowledge of real estate principles, law, and finance (2) experience and (3) capital and credit capacity.