Monday, November 23, 2009

Contract Sales- Make a Good Deal

You have a house. You want to sell it on contract to a good buyer- fast and full priced. How do you make a good deal and protect yourself.

Let's Make a Deal!
How do you structure your deal to make the most of your willingness to sell on contract? Let's cover the selling price first:
  • Since you are willing to carry the contract, you should ask for full price. What's full price? First, find 2-3 Pay an appraiser. It will cost you $200-400 and make sure that it's an appraiser that is recommended to you. There are too many appraisers who are afraid to give an accurate appraisal.
  • You don't not need to pay any closing costs. Don't let anyone tell you that you need to pay 3%- that's only for a government loan. You are not the government. You are not constrained by government rules on seller assistance. Get the full price.
The interest rate will have a significant impact on the month payment from your buyer. Too high and you put them at risk of defaulting on the loan. Too low and you are missing out on a significant amount of profit. Of course the payment will need to cover taxes, insurance and any underlying mortgage.

Next- you need an amortization term. Possibilities? Interest-only, 30-year, 25-year, 20-year, 15-year. (Actually, any number of years would be fine.) Again, this will impact the monthly payment. The longer the term, the lower the payment. It will also impact your taxable income. Shorter terms have more principal paid each month. The principal paid back to you is not taxable.

The term of the loan depends on how long you want the capital to be out. Some people will need 1-2 year balloon payments because they need the cash back fast. Others want a long-term cash income stream that would last for their lifetime. The buyer may have refinancing constraints, such as a bankruptcy or short sale. Common balloon periods are 3-10 years, unless the seller is looking for long-term income.

Protect Yourself
First, get to know your buyer. Sit with them. Understand their story. Then, verify it. Get a background check. Not just a credit score- their credit may be really bad but they could be a great buyer! (See my last blog to read why.) See if they have a criminal background or any other issues other than their credit scores.

Next, make sure that they have a down payment. At least 5%, but 10-20% is even better. You are selling them an expensive asset so they should have "skin in the game." Contract home buyers qualify for the $8,000 first-time home buyer tax credit offered by the federal government. They should also qualify for any state or local tax incentives.

Use an experienced title company to close the transaction. They will protect you through ensuring the transaction is recorded correctly. You will also need a seller's title insurance policy. Your buyer's title insurance is only good until you sell the house.

Set up the monthly payments to go through an escrow company and ensure that taxes and insurance are collected each month. They will also pay any underlying mortgages to protect the buyer.

Need More Information?
This is just a minimal outline of how to do a contract sale. There are tax and legal ramifications of selling a house on contract. You should contract professionals. Expect to pay fees- title company, legal, or even a real estate agent's commission, to close this transaction. Another source of advice would be professional real estate investors.

Don't know any real estate investors? Go to a local real estate investor's club meeting. There are people at the meetings who can help you.

Contract sales are a GREAT way for both parties to get what they want. The more open and honest people are, the more likely a good deal can be struck.

Tell me about your last contract sell, or e-mail with any quesitons!

Tuesday, November 17, 2009

Contract Home Buyers- Where Are They?

A couple of weeks ago I wrote about contract sales- the future of real estate. I wrote that the number of contract sales are going up as the number of qualified buyers who can't get traditional bank financing increase, even as more and more home owners are willing to sell on contract.

Questions: Where do you find qualified borrowers who can't get traditional bank financing? Isn't that an oxymoron? By definition, isn't the person who is not qualified to go to a bank or credit union to get a loan an un-qualified borrower? Or is there something special about how a bank works that eliminates a lot of people who would be good people to sell a home to on contract?

Why are the banks automatically disqualifying people?
Two reasons:

#1. There are internal guidelines written by loan policy committees. Underwriters need to follow these guidelines. To get an exception they need approval from higher up in the bank. Who wants to stick their neck out to get an exception to the rules?

#2. There are FHA guidelines. The federal government now buys 90%+ of all loans. The federal agencies will only buy the loans that follow their own guidelines.

Let's take a look at some of the conditions that automatically disqualify some borrowers at a bank that may not disqualify them from buying a house from you on contract.

Those Pesky Bank & FHA Rules
Let's start out with an obvious disqualification- Bankruptcy. This is an easy one. It takes about 3 years for someone who has declared bankruptcy to get a mortgage. Remember, not 2 years and 364 days- 3 years.

Foreclosure- If the buyer is trying to purchase there home back, then the three year rule applies again. We just sold a home back to the original owner of a home that we had purchased 3 years earlier. They tried to apply at about 2 years and nine months and they were told that they had to wait a FULL 3 years.

No Credit- There are people in this world who have always paid with cash who earn a lot of money, but how do you purchase a home without a credit score?

Bad Credit- Have you heard about the 24 year olds working the oil fields and making $40/hr with 20 hours of overtime a week, but can't pay their bills on time? Lot's of cash, really bad credit.

Self-Employed- Even business owners with six-figure incomes and W-2 wages find it harder to get a loan than their employees. This includes doctors, dentists, engineers, accountants, and many other professionals.

Finding Low-Risk, Unqualified Borrowers
So where do you find people to purchase properties on contract? Here are some ideas:

Bankruptcy Attorneys: Many people who just went through bankruptcy now have a lot MORE cash to spend than before. Some of them just lost their homes and need to find a new one. With a clean slate, they could be good purchasers.

Foreclosures & Short Sales: When someone loses a house, they need a new one. The biggest question is: WHY did they lose the house? Was it due to unrealistic financing? Did they pay regularly for 3-5 years and then get killed when the rate adjusted? Good candidates.

People Renting Homes: Often times renters want to own, but the bank is holding them back. Look for single family homes owned by companies or someone who lives out of state.

Human Resources Departments: Employers want a stable workforce. Homeowners are more stable. Companies look for "perks" that cost them nothing. Have a special offer for the employees i.e. $500 RC Willey or Home Depot gift card at closing. Don't forget the military. For example, Hill AirForce base is the biggest employer in Utah.

"Bird-dogs"- Beginning real estate investors often start by finding deals for other people. Get them looking for you.

WAIT- Aren't These People High Risk???!!!
That's why the bank and federal government disqualifies them. Let me ask you something- did the banks do a good job of making good loans? Do you really trust the government to come up with guidelines of who YOU should sell a house to? Besides- there are was to protect yourself when selling on contract that I'll cover in my next blog.

Have you sold a property on contract? Was it a successful sale?

Thursday, November 12, 2009

Commercial Real Estate Crisis 2010

Do you think that the residential real estate crisis is bad? It is. The culprit: financing. First easy money, then no money for buyers.

Along comes commercial real estate, right behind residential. The predictions are that it will be worse. Much worse.

Commercial Real Estate Loan Cycles
Residential real estate loans are generally for 30 years, paid down over the entire time span. Commercial loans can have 20 or 30 year amortization schedules, but they generally have 5-10 year calls. The balance is due in 5-10 years. Generally this means refinancing the property every 5-10 years.

What Happens if You Can't Refinance a Commercial Loan?
It's an interesting thing- a borrower pays year after year on their loan, and then they can't refinance. Do they stop paying? No! Many times payments continue. Does that mean it's a performing loan? Absolutely not. The loan is outside the terms of the agreement and since it hasn't been repaid, it is in default. Yes, in default even though it is being paid each month. From a bank's financial perspective it means the exact same thing as if the loan wasn't being paid.

When a Bank Has a Loan in Default
There are two ways to be in default: 1. Stop paying on the loan each month. 2. Don't pay your balloon payment. Either way the bank bank has to set-up reserves and takes a massive loss.

Welcome 2010- From Bad to Worse
When did the easy financing start? In the early 2000's. So what time is it? Time to refinance all of those easy-money commercial loans! Guess what? Not possible. There is no money for commercial refinancing. The banks have today, and will have many more tomorrow, a massive amount of defaulting commercial loans.

The Opportunity
There will be opportunities to purchase loans that are "performing" from a monthly payment viewpoint but in default because they haven't been repaid. Who will purchase these loans or properties? People with cash. Individuals. Partnerships. REIT's. Hedge Funds. Wan't to get into commercial real estate? Start learning now how to put people together to raise cash and purchase performing assets in default for a fraction of market value as determined by the rents collected and net income on the property.

Agree? Disagree? Interested in putting a commercial real estate investment group together? Let me know. I'd love to talk.