In real estate investing, stuff happens all the time. In fact, many of these no money, no credit gurus admit that Subject To or Sub2 types of deals end in default 70% of the time!
Subject-To Example Case Study
An investor recently purchased a property “subject-to” from a gentleman in Austin, Texas, for $126,000. The property value was $135,000 and had a mortgage of about $1,250 per month, which included principal, interest, taxes, and insurance.
The house was less than two years old and was in immaculate condition. Why did the owner sell to the investor? He had listed with a Realtor for six months and was trying to sell top of the market so he wouldn’t have to come out of pocket for closing costs. Unfortunately, though the house was beautiful, no one wanted to pay higher than market value for it.
The man had a job and was being transferred immediately to the other side of the country in a couple of days. He was in a panic to sell the house by any means possible. He did not feel comfortable being a landlord from afar. He also felt (accurately) that to sell his house quickly, he’d have to drop the price.
After closing costs and fees, he’d probably be upside down and, again, didn’t have the money to come out of pocket for this house. This method of selling his house “subject to the existing financing remaining in place” achieved his goals of ridding himself of the property quickly without coming out of pocket. Sure, there was a high risk of failure in this transaction, but if it worked, he’d accomplished his goals.
Where does all the risk come in? Remember that the mortgage is still in the name of this original seller. The seller has given the deed to the investor, who now owns the house, in exchange for a promise by the investor to pay the mortgage. The investor and seller in this case created a trust, with the property address as the name of the trust.
If the investor fails to make payments, the original seller’s credit is still on the hook, and the seller must foreclose on the investor in order to take the title back. Thus, while the seller has sold the physical property to the investor and the investor promises to pay on the new note, the seller is still ultimately accountable and responsible for the original loan if the investor fails to perform.
Again, this type of transaction is not the type of real estate transaction a person in a normal situation would agree to, as the seller has very little control over payments but is still ultimately responsible for payments and the consequences of not making them. We’ll discuss these consequences later in this chapter.
Back to the subject-to example. ..
Now the investor is on the hook for the $1,250-a-month mortgage payment. Therefore, the investor is going to sell the deed with owner financing in place by creating a new note between himself and a new end buyer. The ideal buyer for this investor is someone who has cash to put down on the house but is unable to qualify for traditional, conventional bank financing for whatever reason (self-employed, bad credit, not at job long enough, etc.).
Once the investor finds such a buyer, the two parties make an agreement. In this scenario, they agreed on a price of $145,000 with an 8.5% interest rate. The buyer put down $10,000 plus closing costs and had a note for $135,000 at an 8.5% interest rate, which worked out to about $1,475 per month, including principal, interest, taxes, and insurance.
The investor received a down payment of $10,000 and will continue to profit from a monthly cash flow of about $225 as long as the buyer keeps up with the payments. It seems like a win-win, doesn’t it? The original seller has someone else paying his payments for him, has no responsibilities for the property itself (he’s not a landlord), and has not impacted his credit score.
The new buyer was able to purchase a house that she otherwise couldn’t qualify for with traditional, conventional bank financing. And the investor made money up front, has monthly cash flow, and doesn’t have negative equity in the house. Aren’t win-win transactions the ultimate goal of real estate? If so, why do I call this strategy a scheme?
I'll share next week how this example easily fell apart for this investor and seller.
Getting into agreements where you know that there is a high propensity for failure just because of the opportunity to grab fast, easy cash upfront is an example of short-term greedy, and short-term greedy strategies rarely end in win-win scenarios.