Subject-To’s: They Pay You
There is another way, however. Consider the above scenario, when the monthly mortgage payment is $2,200, and market rent is $1,800. For the sake of example, let’s say you want a $300 monthly cash flow for every property you own. So that’s impossible, right? Wrong. If you do your research in advance of the deal, you can negotiate with the seller to include a monthly payment of $700 directly to you, the buyer. This is good for the seller, who now only has to pay $700/month instead of $2,200. It’s great for you, because you use the rent and part of the “they pay you” money to pay the mortgage, and the remaining $300/month goes directly into your pocket.
This structure comes with obvious risks. There is no guarantee that the seller will continue to make his monthly payments to you, which can result in negative cash flow for your property. However, if you are a savvy investor, you will include in the subject-to agreement a clause which states you will allow the property to go to foreclosure if the seller’s payments are not made to you in a consistent and timely manner. Since the financial work is still in the original owner’s name and credit, foreclosure would be a devastating blow to the seller. He would either be highly motivated to pay you, or financially ruined. Even in the worst case, you lose nothing by ceasing payments of the mortgage.
Subject-To’s are always a good way to curb the risk of investing in a piece of property, but “they pay you” subject-to’s are a special way to profit even from homes which at first glance appear as financial red flags. If the contract is negotiated skillfully and responsibly, then you can receive a monthly check, while ensuring that even in the worst case scenario, you will not lose money on your initial investment.
Tell us what you think.
http://investmentpropertymadeeasy.com/
Comments (8)
It won't sell in the real market
Don Konipol, almost 14 years ago
Bryan: I was not privileged to read the discussion or participate in the discussion on the definition of cash flow on BP. I was not a member yet unfortunately. I do not disagree at all that there will be more expenses than just PITI. Your point is well taken. Maybe a better definition to have used and explained would have been NOI from the commercial side which would take into effect the other expenses. Thanks for the discussion.
Jay Redding, about 14 years ago
Hi Jay....thanks for the response. On BP many have called Rents - PITI the "anti rule." We have had some spirited debates about how to underwrite deals and what the real "cash flow" is for investment property. We all have different opinions about this, but one thing that is almost universally agreed on is that rents - PITI = cash flow is DANGEROUS for people to use. My comments in this post were to point that out. The option premium is unlikely to cover the scope of costs associated with turnover in my experience. I guess if you charge high option premiums this is more likely to be the case, but then you enter the realm of "equitable interest" or courts ruling that you are taking advantage of people. A 5-10% option premium is unlikely to cover roofs, make-ready, vacancy, property management (even if it is your time), etc. during a turnover. I like wrap sales and lease/options to control more property early in one's career. Later on I think that people should learn to raise money and migrate to projects with better yields like MFDs and such.
Bryan Hancock, about 14 years ago
Bryan: Point well taken. Obviously not every tenant will exercise their option. A way to hedge against the turn over expenses is your non-refundable option fee. Depending upon what you require as the option fee, this money can be set aside to cover make-readys etc. If an investor is only requiring a small amount (which I don't recommend), then this would not cover it. Due diligence is also required of the investor to know what deffered maintenance will be required in the furture. As a general rule, newer homes more often than not will not require as much deffered maintenance. I totally agree that every investor , regardless of what holding strategy they are using, should always have a cash reserve on hand for suprises. They do happen. Your option fee is one way to fund that cash reserve as long as your are requiring a significant amount. I personally require that the lease option tenant has some serious skin in the game. Thanks for your comment Bryan and your points are well taken.
Jay Redding, about 14 years ago
Even with a lease/option or wrap sale the functions like a NNN lease in theory the buyer doesn't always exercise the option or refinance per the contract. If you structure a whole portfolio of these properties you will still need to have slush money to cover rehabs as tenants don't exercise options or refinances. You will likely have to replace some roofs and such during make-readys too. Rents - PITI still won't equal "cash flow" in this scenario either, although I agree it will be closer using exit strategies where the tenant/buyer functions partially like an owner.
Bryan Hancock, about 14 years ago
Joshua and Bryan: Thanks for your comments. I agree with you if the exit strategy is only a straight rental. However, if your exit strategy is a lease option or contract sale to be exercized within a specificed time frame to the end user and all upkeep as written in the contract or lease is to be the responsiblity of the new buyer, this does start to look better. I did not make that clear in the post. Thanks,
Jay Redding, about 14 years ago
I'm going to have to agree with Bryan here. Anyone who has spent time here on the site has likely seen discussions about cash flow and the 50% rule, and regardless of the details, the bottom line is that there are far more expenses with a rental property than just PITI. The $300 that you claim goes into the investor's pocket actually goes to all the other expenses that come with a rental. Maybe there is something left, maybe not.
Joshua Dorkin, about 14 years ago
I think that Rents - PITI does not equal "cash flow."
Bryan Hancock, about 14 years ago