@Fred Cannon Yes. I agree its a higher risk, but so far I think the amount of issues I had is minimal and worth the risk. Doesn't mean that can't change in the future, you can't get that interest without risk involved.
I understand your view, if I was in a position similar to you, I might have done the same, but I'm not, so I'm ok with working harder to earn that money, and I worry less about the current cashflow.
@Gil Ganz
I am employing this same exact strategy as you are.
1) Acquire property for all cash - Ideally, this will allow you to acquire a property for at least 5% to 10% below fair market value.
2) Sell the property with the option for seller financing.
I normally ask for a large down payment 25% to 33% with the balance amortized over 30 years but with a balloon in 5 to 10 years
I think the only difference between my strategy and yours is that I am willing to make updates to the property(nothing major).
In general I'm not ruling out small rehabs, but very small, like <10k. Maybe after I do a couple of such small rehab I will feel more comfortable doing a little bigger ones, but I think the model can work without such rehabs.
Interesting, what's the FMV of the properties you buy? 25-30% sounds a lot to the average joe.
Are balloon payments allowed under Dodd Frank? It's my understand they are not. Also, I think people view these balloons as meaning these people will have to refi, so what does that do to the note value once you want to sell it later down the road?
@Gil Ganz
I read all the pros and con. Reality is based on your perspective. I use this method exclusive. I buy and rehad at least 3 homes a quarter. We sell some of those and take the profits to buy and rehab. We pay our company back the outlay of cash. We take 100% of the profit and buy/rehab homes that are sold where we hold the paper. I never have to pay insurance, fix a toilet, take a late night call or pay a property manager. My company hasn't ran out of cash. In fact, we have increased our cash holding 3 fold. Have a 30 door portfolio. We have had a few homes "come back" but they were easy repairs and have always had a positive impact to our bottom line.
Sounds awesome, I also think holding the paper has a lot of advantages. I'm less fond of the rehab aspect, but that's me, and because I'm not looking to do these kind of things in my own backyard. Doesn't mean its not possible to do it remotely but I like to avoid big rehab projects.
Doesn't Dodd Frank prohibit owner selling and holding more than 1 note per year without a mortgage broker and means testing?
From what I know its 3 per year, and that's only for owner occupied, if you are selling to an investor no problem.
@Gil Ganz hey Gil, I would call this wholesaling to investors using creative financing! Ideally, a wholesale involves the one who finds the deal and their network of flippers who see value in the property with a more extensive renovation. Have you been wholesaling properties?
I'm not sure this can be called wholesaling since I'm not looking to just make the connection, get a fee, and off to the next deal. No, I'm not in the wholesaling business, as mentioned I'm looking to "be the bank".
@Jay Hinrichs Interesting, a note buyer myself, I know that method of lowballing and going up :)
I didn't encounter this kind of requested prices (20-30%) on performing loans, I wish I could buy at those prices, maybe in bulk deals of 500k and north, its prices like that. For sure the lower you go in the property value, the higher the requested interesting rate will be. Judging from your profile, sounds like you have more experience then me, so I can't argue, I can only tell what I have seen from my experience.
Yup we all have our experiences.. Keep in mind there are a lot of note buyers that ONLY troll public records for private seller carry backs and that is where the big yields come from.. they dont come from tapes and competition with other investors or small funds all looking to buy the same assets. those tend to get priced closer to market conditions at the time.. And very location specific.. along with full doc owner occ etc.. when you step into owner carry back notes its a different world for sure.. I mean most HML these days go out at 12 to 15% apr.. so why would anyone buy a long term note at 10% .. everything being equal.
Good point, for note buyers who can get to these individuals who created the loans, they won't look at my loans for 12 or even 15%, absolutely right, but getting to these note holders is not that easy (hence the reward when you do find them), and not everyone can do it. If it was that easy no one would give money to people at 6-7% to begin with, just buy owner finance notes for 50% of the balance :)
@Jay Hinrichs Interesting, a note buyer myself, I know that method of lowballing and going up :)
I didn't encounter this kind of requested prices (20-30%) on performing loans, I wish I could buy at those prices, maybe in bulk deals of 500k and north, its prices like that. For sure the lower you go in the property value, the higher the requested interesting rate will be. Judging from your profile, sounds like you have more experience then me, so I can't argue, I can only tell what I have seen from my experience.
@Gil Ganz there are three more effective strategies for someone in your position who wants to "be the bank":
1. Lease option. Lease option is also a purchase program, but the tenant can choose to not exercise the option and walk away. You said you do not want someone to walk away, but in a lease option you don't care. In fact it is often more profitable if people do walk away. You get a down payment, plus a couple years worth of payments and you get a property back that has increased in value. You find the next lease option and do it again.
2. Hard money lender. You don't acquire the property, the term is shorter and the interest rate is higher. These arrangements are front end loaded with prepaids. If you want to be a lender, this will get you higher return. It is very easy to find deals to invest in and it doesn't involve having to acquire properties.
3. Invest in under performing notes. You get the note at a discount. You may need to foreclose, but often you can turn the situation around.
The problem I see with your BFF (Buy Flip Finance) strategy is that it depends on someone keeping a loan for 30 years to make your money. There are several things that can go wrong:
1. You are lending to people who can't get loans from banks. Banks are experts at risk management, which means only higher risk people are borrowing from you. High risk means higher opportunity for default. It could be a costly process to get the property back, which means you better have profit on the front end, either through purchase equity, down payment or points.
2. If someone is qualified, but got rejected from the bank due to a minor issue, odds are good that issue will correct over time. The first opportunity they get, they will refinance out of your high interest loan. You get two years worth of payments and they pay off the loan. Now you have your cash and you need to find a new property. Not the end of the world, but how much money did you really make in those couple years?
3. Even if situation 1 or 2 doesn't apply, the reality is that people don't live in houses for 30 years. Even more true for less expensive starter homes. In this situation, they will be out in 5 years give or take. Similar to my other two points, how do you make sure that profit is made in those first few years.
How can your strategy work better? Make sure you load profits up front. I am talking making money on the acquisition, non refundable deposit, points at closing, etc. You need that to cover risk and you need to ensure you get some type of return on the investment. If people default, it will take some money to fix up the house after you get it back.
Now on to the better strategy...
@Joe Villeneuve made a valid point. Using leverage will compound your return. You can generally leverage at a ratio of 4 or 5 to equivalent cash purchases - more if you are really good. In other words with 25% down, you can by 4 properties and with 20% down you could buy 5 properties versus an all cash purchase.
Lets compare leverage to all cash and making money from financing:
Option 1: Buy one property for cash and finance it to a buyer. Over 30 years you get X% annual return on that cash. At the end of 30 years, you have your original cash plus the annual X% return. The problem is due to inflation, your effective return decreased over time. Unlike a savings account, which is compounding (interest on interest), a loan is fixed on only principal. You can reinvest your interest and principal as you get paid, but strictly off the loan the return is very limited. To illustrate this, if you invested $100,000 in a savings account at 2%, after 30 years you would have over $180,000. If you loaned someone $100,000 at 4% over 30 years, they would repay $177,000.
Option 2: You buy four properties with leverage and rent them out. Over 30 years you get monthly cash flow and your tenant pays your mortgage. At the end of 30 years you own the properties at their appreciated value. You also received annual return via cash flow and thanks to appreciation in rents, the cash flow increases annually inflation adjusted. In addition to cash flow, you can access equity on all four properties at any time over the 30 years, through cash our refinance or an equity line of credit.
We can play with the numbers and run scenarios, but in every reasonable scenario, option 2 will return significantly more money. That is the power of leverage.
Great discussion thread and thanks for letting us all try to poke holes in your plans.
Thanks for the detailed answer Joe, I really appreciate it, people trying to poke holes in what I say is a win-win the way I see it.
Now, regarding what you wrote :
Lease option - I'm less familiar with them, I will check it out.
Hard money lending - You are right, it is a viable option, a good friend of mine is doing just that. Not ruling it out.
Non performing notes - I'm doing that as well, wish I could get my hands on more. Reasonably priced inventory has dried up a bit in last 12-18 months, at least from what I'm seeing, and it's not that I'm looking for 2015 prices or something similar.
Now regarding the points on BFF (I like the name :D), you raise valid issues. Banks are great at risk management, what they do lack is my eyes is the flexibility. I agree the type of people who will not be able to get conventional financing is someone with a higher default risk, this is why the minimal downpayment I would want to have in most cases is 10%. Any lower and it means the risk of them defaulting is really high and I would want a really big discount to make up for it (like getting the house super cheap compared to FMV). As for them refinancing after 2-3 years, I'm fine with it. Take the example I gave earlier, 90k loan for 2 year, I am in for 75. They pay two year and then payoff, I got in the meantime 24*1189 that's 28.5k, and their balance is 78k, so all in all I turned 75k to 106k in two years, I wish everybody many deals like that.
I don't need the borrower to keep paying the loan for 30 years, I can sell that at any time if its performing (I can't sell it as well if it's non performing, but for very big discount). If they stop paying after 3y, in that period I got (going back to my earlier example) roughly 40k, it's going to same time to go through the legal process and it can cost few grand, that's correct.
Regarding leverage, I understand the concept, but assume that for me, taking a traditional mortgage to finance property purchase is not an option. So while it might be a great, and proven way of making money, it's less suitable for me.
Keep in mind a 30 year mortgage with a 10% rate owner created will have a pretty deep discount if sold on the open market... I would run your PV models at 15 to 20% returns for the note buyer and see how much cash that generates.. now you could do what a lot of folks do and just sell part of the income stream to pull a little cash out.. ? but the sale of the entire note.. I think would create a discount so large that its a non starter as an exit.
You'r right, a 30y term is going to require a future sale to have a much bigger discount, so it has it's drawbacks, and it can kill the deal to begin wit. Advantage to doing 30y is payment is more borrower friendly, and the fact payments are so much more interest than principal in the early years. In any case, when creating the loan, future sale exit strategy definitely needs to be calculated.
Why 15-20%? There are lot of parameters in play, property class, how good is the payment history etc', but from what I see in the market, an investor would probably buy such a performing loan closer to 10-12% (I can see it reaching a bit higher but not 20%). Keep in mind I'm not talking about properties worth <50, I can see how the lower the property value, the extra % a buyer would want.
OK run it at 12 to 15% most of the capable buyers are not looking for 10% yeilds is my experience way to much risk and such for such a small return.
Ok so say similar example house cost 40, sold it for 50k with 5k downpayment and 4k loan for 30y, that's 394 a month.
If borrower paid for 3 years, that's 14k paid, balance left 44,168, to sell it to someone looking for 12% it going to be 37.9k, meaning you put it 35 you got 51.9, for 15% its going to be 31k meaning you put 35 and got 45, so in theory even 15% can work. Factor in servicing costs, and other costs (could be another few k for whoever helped created the deal), so if you sell the loan for 12% you should be ok (relative term), and the closer it is to 15% the closer it is it to just making your money back with some change, meaning if the market would really want 15% on such a loan , for 30y term to work, something in the numbers would need to change (either lower house price to begin with, bigger downpayment).
In reality I think if the borrower has paid perfectly for 3y it should be more closer to 12% than to 15, and in reality there are going probably going to be hiccups in the payment history, so calculating the exact numbers is harder than what I described.
@Gil Ganz there are three more effective strategies for someone in your position who wants to "be the bank":
1. Lease option. Lease option is also a purchase program, but the tenant can choose to not exercise the option and walk away. You said you do not want someone to walk away, but in a lease option you don't care. In fact it is often more profitable if people do walk away. You get a down payment, plus a couple years worth of payments and you get a property back that has increased in value. You find the next lease option and do it again.
2. Hard money lender. You don't acquire the property, the term is shorter and the interest rate is higher. These arrangements are front end loaded with prepaids. If you want to be a lender, this will get you higher return. It is very easy to find deals to invest in and it doesn't involve having to acquire properties.
3. Invest in under performing notes. You get the note at a discount. You may need to foreclose, but often you can turn the situation around.
The problem I see with your BFF (Buy Flip Finance) strategy is that it depends on someone keeping a loan for 30 years to make your money. There are several things that can go wrong:
1. You are lending to people who can't get loans from banks. Banks are experts at risk management, which means only higher risk people are borrowing from you. High risk means higher opportunity for default. It could be a costly process to get the property back, which means you better have profit on the front end, either through purchase equity, down payment or points.
2. If someone is qualified, but got rejected from the bank due to a minor issue, odds are good that issue will correct over time. The first opportunity they get, they will refinance out of your high interest loan. You get two years worth of payments and they pay off the loan. Now you have your cash and you need to find a new property. Not the end of the world, but how much money did you really make in those couple years?
3. Even if situation 1 or 2 doesn't apply, the reality is that people don't live in houses for 30 years. Even more true for less expensive starter homes. In this situation, they will be out in 5 years give or take. Similar to my other two points, how do you make sure that profit is made in those first few years.
How can your strategy work better? Make sure you load profits up front. I am talking making money on the acquisition, non refundable deposit, points at closing, etc. You need that to cover risk and you need to ensure you get some type of return on the investment. If people default, it will take some money to fix up the house after you get it back.
Now on to the better strategy...
@Joe Villeneuve made a valid point. Using leverage will compound your return. You can generally leverage at a ratio of 4 or 5 to equivalent cash purchases - more if you are really good. In other words with 25% down, you can by 4 properties and with 20% down you could buy 5 properties versus an all cash purchase.
Lets compare leverage to all cash and making money from financing:
Option 1: Buy one property for cash and finance it to a buyer. Over 30 years you get X% annual return on that cash. At the end of 30 years, you have your original cash plus the annual X% return. The problem is due to inflation, your effective return decreased over time. Unlike a savings account, which is compounding (interest on interest), a loan is fixed on only principal. You can reinvest your interest and principal as you get paid, but strictly off the loan the return is very limited. To illustrate this, if you invested $100,000 in a savings account at 2%, after 30 years you would have over $180,000. If you loaned someone $100,000 at 4% over 30 years, they would repay $177,000.
Option 2: You buy four properties with leverage and rent them out. Over 30 years you get monthly cash flow and your tenant pays your mortgage. At the end of 30 years you own the properties at their appreciated value. You also received annual return via cash flow and thanks to appreciation in rents, the cash flow increases annually inflation adjusted. In addition to cash flow, you can access equity on all four properties at any time over the 30 years, through cash our refinance or an equity line of credit.
We can play with the numbers and run scenarios, but in every reasonable scenario, option 2 will return significantly more money. That is the power of leverage.
Great discussion thread and thanks for letting us all try to poke holes in your plans.
Thanks for the detailed answer Joe, I really appreciate it, people trying to poke holes in what I say is a win-win the way I see it.
Now, regarding what you wrote :
Lease option - I'm less familiar with them, I will check it out.
Hard money lending - You are right, it is a viable option, a good friend of mine is doing just that. Not ruling it out.
Non performing notes - I'm doing that as well, wish I could get my hands on more. Reasonably priced inventory has dried up a bit in last 12-18 months, at least from what I'm seeing, and it's not that I'm looking for 2015 prices or something similar.
Now regarding the points on BFF (I like the name :D), you raise valid issues. Banks are great at risk management, what they do lack is my eyes is the flexibility. I agree the type of people who will not be able to get conventional financing is someone with a higher default risk, this is why the minimal downpayment I would want to have in most cases is 10%. Any lower and it means the risk of them defaulting is really high and I would want a really big discount to make up for it (like getting the house super cheap compared to FMV). As for them refinancing after 2-3 years, I'm fine with it. Take the example I gave earlier, 90k loan for 2 year, I am in for 75. They pay two year and then payoff, I got in the meantime 24*1189 that's 28.5k, and their balance is 78k, so all in all I turned 75k to 106k in two years, I wish everybody many deals like that.
I don't need the borrower to keep paying the loan for 30 years, I can sell that at any time if its performing (I can't sell it as well if it's non performing, but for very big discount). If they stop paying after 3y, in that period I got (going back to my earlier example) roughly 40k, it's going to same time to go through the legal process and it can cost few grand, that's correct.
Regarding leverage, I understand the concept, but assume that for me, taking a traditional mortgage to finance property purchase is not an option. So while it might be a great, and proven way of making money, it's less suitable for me.
Keep in mind a 30 year mortgage with a 10% rate owner created will have a pretty deep discount if sold on the open market... I would run your PV models at 15 to 20% returns for the note buyer and see how much cash that generates.. now you could do what a lot of folks do and just sell part of the income stream to pull a little cash out.. ? but the sale of the entire note.. I think would create a discount so large that its a non starter as an exit.
You'r right, a 30y term is going to require a future sale to have a much bigger discount, so it has it's drawbacks, and it can kill the deal to begin wit. Advantage to doing 30y is payment is more borrower friendly, and the fact payments are so much more interest than principal in the early years. In any case, when creating the loan, future sale exit strategy definitely needs to be calculated.
Why 15-20%? There are lot of parameters in play, property class, how good is the payment history etc', but from what I see in the market, an investor would probably buy such a performing loan closer to 10-12% (I can see it reaching a bit higher but not 20%). Keep in mind I'm not talking about properties worth <50, I can see how the lower the property value, the extra % a buyer would want.
@Gil Ganz I am floored at the volume of ignorance being thrown at you in this thread, I apologize for them.
I am not certain as to a "correct" industry term but I and others actually doing such refer to it as Finance Flipping and it is a grand-slam when properly deployed.
The formula once used, for template reasons, is when we sold on 3yr term sale price was 117% of our current market price. Deposit was taken as a non-fundable option fee in construct, interest rate between 5-8%, amortized on 30yr term. There was an option to extend option for additional 12 months for a 1pt fee.
Now where this model really makes $$$$. On average only about 35% ever close. What happens is John & Jane Doe, John is a plumber with his own 1 man operation subing for everyone and always maximized write off's, Jane does daycare from home as a cash operation. Big Bank xyz said they don't have enough reported income to qualify for a mortgage, spend 2 years paying tax's and come back. BUT they still want the home in the area they want sooooo when they found out they could do this C4D thing they thought it was well worth it as home prices keep rising so, it actually save $$$$ to pay a bit more to get a home today vs how much more it will be in 2 years.
2 1/2 years later John & Jane just wrapped up mortgage application and guess what, 2yrs ago they thought $300k was what they'd spend, max, because they are thrifty, and now they got approved for $450k and the C4D at $280k is looking a bit... well yesterdays thing compared to what Jane has found online for $425k, and she feels it's deserved for all the work they did.
What happens, John & Jane walk away from their C4D and instead buy that nicer, newer, much more $$$$$ home they now are approved for.
You the investor, got a big pop of $$$$ when the Doe's contracted, received solid monthly payments because afterall they didn't want to loose everything they paid for, and now you get the property back, market price has increased, and it's rinse and repeat.
By the numbers you will do this 3 times per property.
Anyone saying there is no money in it is just ignorant, plain and simple. Anyone saying you'll loose money has no business being on BP, that's such a incorrect statement that it does not even merit a response.
@James Hamling
Thank you very much for this example, that's definitely a possible scenario :)
I didn't understand the exact terms in this example, can you clarify? You wrote 3y term, then you wrote 30y.
To be upfront and honest I am & will be a bit light on exact perfect detail and mechanics as 1) it is very detail laden, and 2) not really interested in broadcasting my hard earned "secret recipe" that have developed over the years.
Generally speaking the terms for a C4D or option would be 3-5 year terms. I prefer a 2 or 3 year term with an option to extend vs doing anything longer than 3 years. In my mind setting a terms deal up for more than 3 years is just landlording at that point.
When I design a payment schedule I use a 30 year amortization schedule. I have known of some who use other means but I prefer it this way as its hard to argue against. When doing terms deals a very important aspect is protecting ones self from future litigation as that is the #1 problem investors run into, buyers coming back months or a couple years later and saying "hey, you ripped me off". I find it important to design contract FOR litigation, that way litigation never needs to happen. ****as a tip, the #1 item I see getting novice investors in litigation is charging an illegal interest rate, be sure to know commerce laws in your specific jurisdiction and odds are it's capped at a lot less than you'd think.
Great stuff James appreciate it, of course I don't expect to get a perfect recipe here, but just these bits of information help a lot.