Finding the Deal
I came across this deal from a bandit sign I had put up in Havelock, NC. The owner called while I was on my lunchtime working out. Out of breath, we had a quick discussion. He described the property and how close it was to the base, Marine Corps Air Station Cherry Point. I told him that I could come and take a look after work.
When I arrived, we immediately hit it off. He was a Master Gunnery Sergeant in the Marine Corps, now retired. He was looking to sell the property and head to Texas to be closer to his family. We looked through the house, and although there were not many needed repairs or much demolition, there were major updates that were needed, to include a new coat of paint and flooring. The walls were nicotine-stained and the owner had made his 3-bedroom home into a 2-bedroom. A new AC unit and a new metal roof had me thinking about a reduced capital expenditure expense per month, while the well-maintained detached garage and the large, fenced-in backyard was appealing from a family rental perspective.
Negotiating
After touring the property, I told him I would be back the next day with a couple offers. Before I left, the owner had made it clear that he was set on his price, 100k.
The next day, I gave him the offers. The numbers made sense at 100k if he seller-financed the whole purchase price at 0% interest over 22 years. The cash offer was well below market value. I asked him if he would be interested in the seller-financed option, explaining that if he could work with my terms, he could get his price. I tried to remain cool and composed as he nonchalantly said, "Yeah, sure". We filled out and signed the purchase agreement, shook hands, and, as I was about to leave, he asked, "So, who's going to pay off the home equity line of credit (HELOC)?" Damn it! He had mentioned that he owned the property free and clear but hadn't mentioned a HELOC.
I went back to the drawing board and thought about different options. He was more than willing to finance the whole 100k, but the home equity line of credit posed an issue that I was not very familiar with. The balance on the HELOC was only $37,000, so initially I thought that it would make sense just to pay it off. Running the numbers though, the return on equity and overall ROI would take a major cut if I were to pay off the HELOC as a down payment. I would need to find a partner to come up with the money to pay off the balance and to perform the renovations that needed to be done before it could be rented. I bounced this around to a lot of the investors that I knew who were looking for deals. It didn't seem like many were interested and I don't blame them. It was looking like a thin deal in need of a lot of money.
I had heard about purchasing real estate subject to the existing financing, from a couple investors I look up to. However, I viewed the strategy more as a mythical creature rather than a practical concept. My hand was forced; this was the most attractive option, due to the terms of the HELOC and the potential to have a 0% down deal. This was the perfect opportunity to learn how to perform a ‘subject to' deal. After talking to a couple investors who had employed this strategy, I met with the seller and asked if he would at all be interested in me making payments towards his home equity line of credit and purchasing the property subject to that line of credit. He had a couple of questions pertaining to if the loan came due and how the payment process would work, but after I answered all of his questions to his satisfaction, he was ready to sign off on the ‘subject to' contract. We drew up another agreement that included 37k as the subject to/HELOC balance and 63k as the remaining owner financed amount, equaling $100,000.
More comfortable with the terms, I pitched my brother the deal at an Airbnb on his birthday weekend. He was confused as to why anyone would finance a property for 0% interest, but was more than willing to participate. We ended up agreeing on a 50/50 split of ownership and closing, holding, and rehab costs. Happy Birthday brother, your present is equity and cashflow! Potentially...
Closing
I started going through all the necessary steps needed to make the ‘subject to' work. First off, I reached out to all the investors that I knew who had done a ‘subject to' and asked how this would work with a home equity line of credit vs a traditional mortgage. I didn't realize that you could do this with essentially any financed lien on a property, not just a 30yr fixed-rate mortgage. However, with a HELOC, the major concern was the seller's ability to pull money from the account, increasing the balance. Access to the HELOC would need to be frozen immediately. The bank helped me with this, preparing all the forms that the seller needed to sign to officially freeze the line of credit.
Next, I needed a limited power of attorney (POA) to have administrative oversight of the HELOC and to be able to speak with the bank freely about it. The first attempts at submitting the POA were met with resistance, but each time it was kicked back I added or removed information until the bank was comfortable with the document.
My attorney was a huge help. This was not his first ‘subject to' transaction, so he did not shy away from getting it done. He reviewed my POA each time I submitted it to the bank. He also made sure the promissory note was fair to both sides, allowing the seller to foreclose if I was delinquent in either the payment of his HELOC or the payment to the promissory note.
The seller was on a tight timeline to move, as he already bought a property in Texas that he wanted to occupy right away. He was slated to depart for Texas right after our initial closing date. However, the POA required a couple of revisions, which made me hesitant to close before we had a bank-accepted document. I extended closing, making my life a tad bit difficult. The seller was very old fashioned and had a flip phone and preferred snail mail over email. I had to coordinate with a notary in Texas to get the final POA signed, and later, all the closing documents.
We were able to work through everything, even with the seller halfway across the United States. Closing ended with our LLC being deeded the property, having the bank forward me all pertinent loan information, and scheduling two monthly check withdraws from the LLC's operating account: one to the seller, one to the bank.
Rehab/Renting
My initial plan was to install a full bathroom and to add a wall to create a 3-bed/2-bath. I would net the highest return from rental cash flow and value-added via equity. After reviewing the quotes for making a ½ bathroom into a full (installing a shower stall), it made more sense to just add the bedroom. Most of the square footage in the house was a commercial tile that you would find in an office space. Although it is not the most aesthetic look, all it needed was a deep clean to look new again. This ended up saving me about $3,500 - $4,000 on flooring. We ended up agreeing to a mostly cosmetic scope of work, primarily for paint, flooring, and finishes. A two-week job quickly turned into a month-long project. My GC had issues with his subs and had to fire and hire on the spot, extending the timeline. Overall, compared to other rehabs, this one was fairly seamless. There is always something, however, I could have done better. Whether being clearer and more precise in what I was asking for in the scope of work or coordinating with my GC better when planning the final cleaning, property management assessment, and pictures, there was room to improve. The sequencing necessary to coordinate the finish-work, cleaning, and pictures was disjointed on several occasions, due to poor communication on my part. Next time, it will be more effective to use one of my contractor’s subs to clean rather than scheduling one myself.
Once the property was rent-ready, we ran a rental CMA and listed the property for $1095 per month. Originally my rental estimate was $1025. Although this was clearly a 3-bedroom, 1.5-bathroom house, the largest bedroom did not have a closet. My property manager did not feel comfortable listing it as such and put it up as a 2bed/1.5bath. Hindsight being 20/20, I should have added a closet as we were converting the house back to a 3 bed. Regardless, after 2 days of being listed, we received an outstanding tenant prospect who wanted to move in immediately for the full list price. We probably could have listed it for $1,125 - $1,145 and eventually secured a tenant, but it made sense to get it locked up and have the property start performing.
Aside: Someone once told me that real estate is a liability, your lease is the asset!
The lease was intentionally locked in for 18 months, in order to have its expiration coincide with the start of the 2022 Permanent Change of Station (PCS) season. In an area that supports two military bases, I have found this to be crucial. The timing will provide a better window of opportunity to quickly turn the property over to another tenant or raise the rent if the market warrants the increase at that time. Below is how the numbers worked out:
The Numbers
Monthly Expenses/Debt - $718
Property Taxes - $111
Insurance - $81
Property Management (9%) - $91
Maintenance/Repairs - $55
Capital Expenditures - $55
Vacancy - $77
Seller Finance Payment / 0% interest over 22yrs - $235
Payment towards HELOC / 3.125% Variable Interest Only, over 30 years - $140
Rent - $1,095
Monthly Cashflow - $377
Purchase Price - $100,000
Rehab - $15,000
ARV - $130,000
Cash ROI - 30.23%
Total ROI - 49.02%
Future Plans
We will hold this property indefinitely. The financing is just too good not to hold for the long term. Each payment to the seller goes straight to principal (equity!). The only financing consideration that will have to be reassessed each quarter is the variable-rate HELOC. It would behoove us to increase the payments when/if the interest rate goes up. Once we have cash flowed the property for a couple of years, I wouldn't mind aggressively paying down that debt. Overall, this deal will be an excellent contributor towards an up and coming portfolio between my brother and I. Due to how well this turned out, I will be searching and marketing for ‘subject to' deals more intentionally. I can't think of a better way, besides seller financing, to invest with so little outlay in the deal.
Thank you for reading,
Padric “Paddy” Lynch
Start to Finish
