The New Path to Real Estate Wealth: Earning Without Owning

fm.qxd 3/30/04 9:28 AM Page iii THE NEW PATH TO REAL ESTATE WEALTH EARNING WITHOUT OWNING Chantal Howell Carey and Bil...

Author: Chantal Howell Carey | Bill Carey

123 downloads 1661 Views 1MB Size Report

This content was uploaded by our users and we assume good faith they have the permission to share this book. If you own the copyright to this book and it is wrongfully on our website, we offer a simple DMCA procedure to remove your content from our site. Start by pressing the button below!

Report copyright / DMCA form

DOWNLOAD PDF

fm.qxd 3/30/04 9:28 AM Page iii

THE NEW PATH TO REAL ESTATE WEALTH EARNING WITHOUT OWNING

Chantal Howell Carey and Bill Carey

John Wiley & Sons, Inc.

fm.qxd 3/30/04 9:28 AM Page vi

fm.qxd 3/30/04 9:28 AM Page i

THE NEW PATH TO REAL ESTATE WEALTH

fm.qxd 3/30/04 9:28 AM Page ii

fm.qxd 3/30/04 9:28 AM Page iii

THE NEW PATH TO REAL ESTATE WEALTH EARNING WITHOUT OWNING

Chantal Howell Carey and Bill Carey

John Wiley & Sons, Inc.

fm.qxd 3/30/04 9:28 AM Page iv

This book is printed on acid-free paper. Copyright © 2004 by Chantal Howell Carey and Bill Carey. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008. Limit of Liability/Disclaimer of Warranty:While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and speciﬁcally disclaim any implied warranties of merchantability or ﬁtness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of proﬁt or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. Every concept, method, form, and entitlement contained herein are the property of this work’s copyright holder. Disclaimer: Every stated “we” was not necessarily the writers’ but could be the writers’ clients or students. “We” is used to protect the privacy of those concerned. For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com. Library of Congress Cataloging-in-Publication Data: Howell Carey, Chantal. The new path to real estate wealth : earning without owning / Chantal Howell Carey, Bill Carey. p. cm. Includes index. ISBN 0–471–46791–X (paper) 1. Real estate investment—United States. 2. Option (Contract)—United States. 3. Real estate business—United States. I. Carey, Bill, 1951– II. Title. HD255.H66 2004 332.63⬘24⬘0973—dc22 Printed in the United States of America. 10 9 8 7 6 5 4 3 2 1

2003070173

fm.qxd 3/30/04 9:28 AM Page v

To all our families, friends, and foes, without all of whom . . . who knows! From each we have learned many lessons through all the “school of life time” sessions. We thank each and every one of you for whatever part you were meant to do!

fm.qxd 3/30/04 9:28 AM Page vi

fm.qxd 3/30/04 9:28 AM Page vii

C

O N T E N T S

Preface

xi

Introduction

xiii

SECTION ONE: REAL ESTATE BASICS 1. Deciding on Your Goals

1

3

Decide on your goals before you invest in real estate. 2. Finding a Good Deal

11

Finding a good deal is the key to your success in real estate. 3. Working with Real Estate Agents

23

Every real estate agent acts in a professional manner with real estate sellers. 4. Evaluating and Inspecting Property

29

Evaluating and inspecting property is a simultaneous process. 5. Writing and Presenting Your Offer

36

There are no oral agreements in real estate. 6. Closing Your Deal

46

Properly closing your deal will make you a lot of money. SECTION TWO: FLIPPING REAL ESTATE 7. What Is Flipping?

55

57

Flipping is buying a property and then selling it quickly. vii

fm.qxd 3/30/04 9:28 AM Page viii

CONTENTS

viii

8. Why Use Flipping?

65

Flipping is the fastest way to make money in real estate. 9. How to Flip

74

Flipping is a two-step process. First tie up a property, then ﬁnd a buyer. 10. When to Flip

81

Flipping at the right time is crucial. 11. Finding Flips

89

Every real estate transaction has a potential for ﬂipping. SECTION THREE: ASSIGNING REAL ESTATE CONTRACTS 99 12. What Is Assigning?

101

Assigning transfers your position in a real estate contract to another for a fee. 13. Why Use an Assignment?

109

Assigning a real estate contract makes you money without buying the property. 14. How to Assign a Contract

118

Assigning a contract begins when you write the initial offer. 15. When to Assign a Contract

126

Assign a contract before the closing. 16. Finding Assignments

135

Every contract can be assigned.

fm.qxd 3/30/04 9:28 AM Page ix

Contents

ix

SECTION FOUR: REAL ESTATE OPTIONS 17. What Is an Option?

143

145

An option gives you the right to buy a property without having to buy it. 18. Why Use an Option?

154

Walt Disney assembled the property for Disney World using options. 19. How to Option

164

Optioning begins with the option contract. 20. When to Option

175

By using an option, you can control property without buying it. 21. Finding Options

184

There are many options when it comes to ﬁnding options.

SECTION FIVE: DISCOUNTED PAPER AND GOVERNMENT TAX LIENS 193 22. What Is Discounted Paper?

195

Discounted paper is a mortgage bought for less than the face amount of the note. 23. Why Buy Discounted Paper?

203

Buying discounted paper makes you money and gives you security. 24. How to Buy Discounted Paper

211

Buying discounted paper is easy.

fm.qxd 3/30/04 9:28 AM Page x

CONTENTS

x

25. When to Buy Discounted Paper

219

Buy discounted paper when it becomes seasoned. 26. Finding Discounted Paper

226

Every mortgage can be turned into discounted paper. Conclusion

235

Appendix A: Deeds Chart

237

Appendix B: Loans Chart

239

Glossary Index

241

261

fm.qxd 3/30/04 9:28 AM Page xi

P

R E FA C E

You’ve lost money in the stock market. Bank certiﬁcates of deposit interest rates are pathetic. Which direction are the yields on Treasury Notes going this week? The real estate market is hot, hot, hot! You want to invest in real estate, but . . . You don’t know how or where to ﬁnd a good deal. You have heard about making money with ﬁxer-uppers, but . . . You’re not good with ﬁxing things that break around your house, so how are you going to repair the plumbing in a ﬁxer upper? The New Path to Real Estate Wealth: Earning Without Owning is your answer. Our step-by-step system is designed to take you from the basics of real estate investing to the sophisticated information that only the insiders know. Whether you are a new or experienced real estate investor, we will show you how to make big money in real estate. This book reveals the ultimate real estate investment secret. Control the paperwork of real estate—the contracts, mortgages, and deeds— and you control who makes money in real estate. Buy and sell real estate paper and you never have to buy or own property itself. You don’t have to have good credit. You don’t have to qualify for a mortgage. You don’t have to be a landlord and deal with problem tenants. No repairing the plumbing. No paying property taxes. No being sued by someone who gets hurt on your property. We show you how to ﬁnd good deals and then ﬂip either the property or the contract and make money.You will learn how to write a great offer, get it accepted, and then assign the offer to another buyer for thousands of dollars. We teach you how to control property the way Walt Disney did using real estate options without revealing your interest in the property to your competitors. We show you how to buy mortgages and trust deeds at a discount and receive a 25 to 35 percent return on your investment. You will learn how to buy government tax liens and have 100 percent guaranteed security of your investment.

xi

fm.qxd 3/30/04 9:28 AM Page xii

xii

PREFACE

The New Path to Real Estate Wealth: Earning Without Owning is the ﬁrst book to combine the information on ﬂipping real estate, assigning contracts, using real estate options, and buying discounted paper and government tax liens all in one place. Although there are good books on several of these subjects, they are too narrowly focused and leave the reader with only one way to make money in real estate. We offer the only book that gives the reader the four best ways to make money in real estate investing. All four can make you big money without buying or owning property!

fm.qxd 3/30/04 9:28 AM Page xiii

I

N T R O D U C T I O N

Over the years, we have traveled from coast to coast teaching real estate, ﬁnancial, motivational, and interpersonal skills seminars to our students. We are always striving to be on the leading edge. Regarding real estate, we have taught everything from buying and selling it creatively as an individual or investor to core classes for licensing and passing broker’s exams. Just about anything you can think of related to real estate, we have taught to someone somewhere! With a new millennium comes new ideas. We have distilled the knowledge and experience we have gained from buying and selling real estate for ourselves and our clients and helping our students over the past three decades. The New Path to Real Estate Wealth: Earning Without Owning is the ﬁfth real estate book we have written. Our ﬁrst book, the best-selling How to Sell Your Home Without a Broker is in its third edition. This book was picked as one of the top 10 real estate books for 2001 by Robert J. Bruss in the Los Angeles Times. Our fourth book, Going Going Gone! Auctioning Your Home for Top Dollar was also written to beneﬁt the homeowner in the selling of a home. Like How to Sell Your Home Without a Broker, our auctioning book was designed to show you how to successfully sell your home yourself without paying a commission. The New Path to Real Estate Wealth: Earning Without Owning is the ﬁrst book in our new series designed speciﬁcally for real estate investors. This Win Going In series will take you from being a novice real estate investor to being an expert. Our premise for the Win Going In series is that no matter what kind of real estate investment you are going to make, you have to win going in. It is no longer enough to make money on the back end of a deal or make a proﬁt when you get out of a deal. The deal has to have a proﬁt built in on the front end or else you shouldn’t do it at all. The New Path to Real Estate Wealth: Earning Without Owning is a breakthrough book for new real estate investors. We know that the

xiii

fm.qxd 3/30/04 9:28 AM Page xiv

xiv

INTRODUCTION

prospect of buying and owning real estate investment property can be quite daunting if you are just getting started. This book takes you from the real estate basics through the four best ways to make money in real estate. From ﬂipping property to assigning contracts to controlling property using options to buying discount paper, The New Path to Real Estate Wealth: Earning Without Owning teaches you everything you need to know to become a successful real estate investor. In all four areas we train you how to make money without buying or owning property! For experienced real estate investors, we welcome the opportunity to broaden your real estate investment horizons. How would you like to make money investing in real estate and never have to deal with a tenant again? How about never having to make a mortgage payment or pay property taxes? What about no more repairs and maintenance to deal with? The New Path to Real Estate Wealth: Earning Without Owning is written for active real estate investors. This is a hands-on book that teaches you how to go out into the real estate market and make deals happen. What is unique about this book is that we show you how to have a Quick Cash investment strategy that you can successfully implement with little or no investment capital. If you are a passive real estate investor, this book is not for you. We will not teach you about limited partnerships or joint ventures. This book will not show you how to get involved with real estate investment trusts (REITS). Passive real estate investments are for another book and another time. Although these are all potential money makers for the passive real estate investor who doesn’t want to buy or own real estate, we don’t recommend you go this route at this time. There have been too many negative investment results for the passive investor over the past ﬁve years. Our philosophy is that you need to be in control of your investments. Counting on a stock broker, investment advisor, accountant, general partner, or real estate fund leaves you completely out of control. When you are an active real estate investor, you are the one calling the shots. You are the one responsible for your successes and failures. Our purpose for the Win Going In series is to teach you all our real estate knowledge and expertise. We want to be the Brain Trust for your successful real estate investment career. You will know you are being a successful investor when you make money on your ﬁrst deal. We would

fm.qxd 3/30/04 9:28 AM Page xv

Introduction

xv

love to hear about your successes. Also, we want to hear what is working for you and what is not working for you. Please e-mail us at thetrustee@ hotmail.com or contact us through our publisher, John Wiley & Sons. Good luck and good deals! Chantal & Bill Carey

fm.qxd 3/30/04 9:28 AM Page xvi

fm.qxd 3/30/04 9:28 AM Page xvii

THE NEW PATH TO REAL ESTATE WEALTH

fm.qxd 3/30/04 9:28 AM Page xviii

P01.qxd 3/30/04 9:28 AM Page 1

S E C T I O N

ONE

REAL ESTATE BASICS

P01.qxd 3/30/04 9:28 AM Page 2

C01.qxd 3/30/04 9:23 AM Page 3

C H A P T E R

1

Deciding on Your Goals

Decide on your goals before you invest in real estate. Knowing your goals helps you determine many of the aspects of your real estate investing. Your goals might include: • Deciding how much time you want to spend investing in real estate. • Deciding how much money you want to make. • Determining how long your time horizon is to achieve your goal(s). • Having speciﬁc goals, such as quitting your job or buying a new car. • Earning a monthly income by carrying mortgage paper. • Receiving as much cash as possible in a short period of time. • Clearing your schedule so you can focus on real estate. • Maximizing your proﬁts while minimizing your risks.

Deciding on Your Goals Take a blank piece of paper and start writing the goals you have for investing in real estate. Write whatever comes to your mind. After you have written ﬁve to ten goals, prioritize them by placing a number to the left of each goal. Then take another blank piece of paper and rewrite your goals in order of their importance to you. 3

C01.qxd 3/30/04 9:23 AM Page 4

REAL ESTATE BASICS

4

This prioritized goals sheet is your road map for real estate investing. The goal(s) become your destination point(s). However, having a road map does you no good unless you know where you are starting out. We need to examine the variables of the real estate market and the variables of your life as a real estate investor to determine your starting point.

Understanding the Real Estate Market In trying to understand the real estate market, it is important to understand how most people think about it. By knowing what everyone thinks about the real estate market, you can design a strategy to take advantage of the little-known secrets that the truly successful real estate investors use to make big money. When you begin investing in the real estate market can affect how successful you are going to be. You need to consider the time of year, interest rates, the economic climate, and tax regulations, as well as your own ﬁnancial condition. You’ll also have to keep in mind credit rating, cash available to invest, and time available to invest (after all, time is money!).

Time of Year In residential real estate, some months of the year are considered better than others for the sale of homes. The question is, better for whom? The residential real estate market is controlled by real estate agents and is biased in favor of sellers. Knowing about this bias can be useful to you as a real estate investor. You are a buyer ﬁrst. Therefore you have to be extra-sharp going in because the deck is stacked against you. Most sellers are represented by real estate agents. Even if you work with an agent as a buyer, in most states your real estate agent is legally working for the seller. In Chapter 3 we show you how to use agents to your advantage when buying real estate. The more buyers looking to buy real estate, the better it is for sellers. February through July/August are the best months to sell real estate. You can see from the chart that the best months to sell are the worst months to buy! The best times to buy are the worst times to sell (see

C01.qxd 3/30/04 9:23 AM Page 5

Deciding on Your Goals

5

September through January in the chart)! However, we are going to show you in this book how to make any time of the year work for you.

Interest Rates Interest rates obtainable by buyers may greatly inﬂuence the number of potential buyers available. When interest rates are low, the number of buyers generally increases. The number of potential buyers increases greatly if this period of low interest rates immediately follows a period of relatively high interest rates. When interest rates are high, the number of buyers generally decreases. The number of potential buyers decreases greatly if this period of high interest rates immediately follows a period of relatively low interest rates. What does this mean to you, a potential real estate investor? When interest rates are low, there are lots of buyers for your properties if you have properties to sell. However, if you are trying to buy properties, then there may be lots of competition from the many buyers brought into the market by the allure of low interest rates. This may mean you have to work harder to ﬁnd a good deal. We are going to show you how to win no matter what the market rates are doing.

Economic Climate A healthy national economy,and especially a healthy regional economy,can be important in determining the best time to invest in real estate. When the regional economy is good, the number of potential buyers who feel conﬁdent enough about the future to invest in a home usually increases,and the price of homes increases,too. Because the number of potential buyers generally decreases in areas experiencing an economic slump, it may be better to retain your property during these times if possible. A rule of thumb in the real estate industry, like in other industries, is to buy low and sell high. This is easy to say but hard to do. When everyone is saying how terrible the real estate market is, that is when you want to buy! When everyone is saying how hot the real estate market is, that is when you want to sell. Most people buy at the top of the market and then try to sell at the bottom of the market! We will show you how to buy low and sell high in any market.

C01.qxd 3/30/04 9:23 AM Page 6

REAL ESTATE BASICS

6

Tax Regulations Tax regulations relating to real estate are particularly important because they may affect your timing in real estate investing. When you are buying real estate, there are some nice tax deductions available associated with real estate loans (points, loan origination fees) and closing costs (escrow fees, title insurance). When you are holding real estate, there are some nice tax deductions available associated with real estate interest, property taxes, and depreciation. When you are selling real estate, there may be a major tax consequence associated with capital gains, recapture of depreciation, or both. Please remember that although this book contains the latest version of the current tax regulations related to real estate, Congress passes tax regulations that are retroactive. This means that Congress can pass a tax law in September or October and make it retroactively apply to January 1. Just like being advised to check with your doctor before beginning an exercise program, we advise you to check with your tax adviser before you begin investing in real estate. Let’s look brieﬂy at some of the current tax regulations. Sale of a Principal Residence Current tax regulations say if you are single and selling your principal residence (your home), you can exclude from capital gains tax up to $250,000 of capital gains. If you are married and selling your principal residence, you can exclude from capital gains tax up to $500,000 of capital gains. Whether you are single or married, you can do this over and over with each new home. The only requirement is that you must have owned and lived in the property two of the last ﬁve years. What this means is you could buy a home, live in it for two years, and then sell the home, make $250,000 or $500,000 in proﬁts (depending on whether you were single or married), and not pay any capital gains tax! Theoretically, you could do this every two years. Some people make buying, living in, and selling their principal residence their real estate investment strategy. Sale of Investment Property When you sell investment real estate you have to pay tax on any proﬁt you make in the tax year that the sale occurs. If you sell investment real estate less than one year after you purchase it, any proﬁt you make will be taxed at ordinary income rates.

C01.qxd 3/30/04 9:23 AM Page 7

Deciding on Your Goals

7

This can be very expensive. If you sell investment real estate more than one year after you purchase it, then any proﬁt you make will be taxed at the more favorable capital gains rates. Another option with investment real estate is to do an Internal Revenue Code section 1031 tax-deferred exchange. This is a special Internal Revenue Code section that allows you to exchange or trade like-kind property for another like-kind property and defer the tax consequence until a later time. As long as you are exchanging property you are holding for the production of income (rental property) or property you are holding for investment (raw land) for like-kind property and you follow the correct procedures, you will be able to defer the tax on any proﬁt you have in the transaction. By the way, you can exchange rental property for raw land and raw land for rental property under 1031 and still qualify for the favorable tax treatment. You are not stuck with exchanging raw land for raw land or rental property for rental property, which obviously would qualify as like-kind property. Finally, recapture of depreciation can occur when you are selling property you are holding for the production of income (rental property). Without getting too complicated, sufﬁce it to say that recapturing depreciation is bad. You do not want to recapture depreciation. Currently you will be taxed at a 25 percent rate on any depreciation you recapture in the sale of rental real estate.

Understanding Your Financial Condition It is important to understand your ﬁnancial condition as you enter the real estate investment arena. How much credit can you obtain from real estate lenders? How much cash do you have or can you free up to put into real estate investing? Can you ﬁnd cash partners to fund the good deals you ﬁnd? We’ll start by looking at your credit rating.

Your Credit Rating It pays to have a good credit rating. People who have fallen on hard times, have late payments, or have credit problems like charge-offs and

C01.qxd 3/30/04 9:23 AM Page 8

8

REAL ESTATE BASICS

bankruptcies pay a high price. They are charged higher interest rates, pay more in loan origination fees (points), and have to make larger down payments than the people who have a good credit rating. You may think you have a good credit rating and ﬁnd out at an inopportune time, like when trying to get loan approval for one of your real estate investments, that one or more of the three major credit reporting agencies has inaccurate or false information in your credit report. This may delay or completely derail your obtaining the ﬁnancing you need to close your transaction. We recommend that you acquire a copy of your credit report from all three credit reporting agencies every six months. The statistics aren’t good when it comes to the accuracy of credit reports. It is estimated that 7 out of 10 credit reports contain at least one inaccuracy! You know you have great credit, but if the credit report contains any inaccuracies, then as far as the ﬁnancial institutions are concerned, you have bad credit once they receive your tainted credit report. You can clean up your credit report yourself fairly simply. When you ﬁnd an inaccuracy on your credit report, call the company that has placed the inaccurate information on your report and ask them to remove it. They will usually do so. Call the credit reporting agency to obtain the phone number of the company that has placed the inaccurate information on your report if it is not contained in the report. The credit reporting agency must give you the phone number. Request that the company send you a copy of the letter they send to the credit reporting agency correcting the mistake(s), and request that they send the same letter to all three credit reporting agencies. That way you are covered in case the inaccurate information is in the pipeline, headed to the other credit reporting agencies that appear to be clear of the bad information. If you have good credit and your credit reports reﬂect that accurately, then you are ready to proceed with your real estate investing adventure. If you have good credit and your credit reports don’t reﬂect that accurately, then we recommend you proceed to clean up your credit reports and move forward with your real estate investing. If you have bad credit, we recommend that you clean it up as best you can and move forward with your real estate investing. Don’t wait to begin real estate investing until you have good credit. The time to begin real estate investing is now. We will show you how to be a successful real estate investor whether you have bad credit or good credit!

C01.qxd 3/30/04 9:23 AM Page 9

Deciding on Your Goals

9

Cash Available to Invest Have you heard the expression “cash is king”? Having cash available to invest in real estate is usually better than having no cash available to invest in real estate.You must decide how much cash you want to start out with to begin investing. Do you have $1,000 to invest? Do you have $100,000 to invest? Most of you will have an amount to invest in real estate somewhere between $1,000 and $100,000. Where are you on the cash available to invest scale? Don’t worry if at this point in time you do not have much cash available to invest in real estate. Cash Available to Invest $1,000

$50,000

$100,000

The point is that there is no “right” amount of cash to begin investing in real estate. We want you to invest in real estate now. Having more cash available to invest is a plus. However, having $1,000 for an earnest money deposit to tie up a great deal may make you more money than having $100,000 for an all-cash offer! We will show you how to invest in real estate whether you have lots of cash, not so much cash, or even no cash. No-cash techniques to buy real estate have been around for over 20 years; for example, see Robert Allen’s Nothing Down (1980). When we worked with Allen in the early 1990s, we developed techniques that allowed investors to buy real estate with nothing down in a high interest rate market. In the ﬁrst decade of the new millennium, we are going to show you how to buy real estate with nothing down in a low interest rate market. We are going to show you how to control the paperwork of real estate, and hence the real estate transaction, whether you have cash or not!

Time Available to Invest In the twenty-ﬁrst century,“time is king.”You must decide how much time you will commit to your real estate investing. Are you going to become a full-time real estate investor,working 40-plus hours a week? Are you going to be a part-time real estate investor, working 10 to 15 hours a week?

C01.qxd 3/30/04 9:23 AM Page 10

REAL ESTATE BASICS

10

Are you going to be a dabbler investor, waiting for a good deal to drop in your lap? To be a successful real estate investor, you must make a time commitment to your real estate investing. We recommend that you ﬁrst make a commitment to being a successful real estate investor. Then, after making this initial commitment, make a daily time commitment to your investing. It would work something like this. Repeat out loud in front of your spouse, family member, friend, or signiﬁcant other the following declaration: “I am a successful real estate investor.” There, that wasn’t so hard, was it? Obviously, just saying you are a successful real estate investor won’t make you one. You have to do something. We are going to help you do something. You are already doing something by reading this book. Now make a daily time commitment to your real estate investing based on your prioritized goals sheet. For example, if one of your top two or three goals was to make one real estate investment a month, you can develop a timeline to make this happen. Start with the completed deal at the end of the month and work your way backward to the beginning of the month. 30-Day Timeline Find

Negotiate

Close

Market

Deal

Contract

Escrow

Deal

Find

Negotiate

Buyer Contract

Close Escrow

You have to ﬁnd a good deal, negotiate contracts, close escrow, market your deal, ﬁnd a buyer, negotiate a contract, and close escrow. We recommend you do something every day in real estate. Some days you will spend 15 minutes looking at real estate ads. Other days you will spend three hours negotiating real estate contracts. Of course, in this book we are going to show you how to shorten this timeline. More about that later. The key is doing at least something every day to get your real estate investing started. We promise you that if you will make a 30-day commitment to do something real estate investing–related every day, you will have done your ﬁrst deal or be right on the verge of doing it. Now that you have decided on your goals and have a better understanding of the real estate market and your ﬁnancial position it is time to take the next step. In Chapter 2 we will show you exactly how to ﬁnd a good deal and what to do about it.

C02.qxd 3/30/04 9:23 AM Page 11

C H A P T E R

2

Finding a Good Deal

Finding a good deal is the key to your success in real estate. Every deal has the potential to be a good deal. As we said in Chapter 1, you want to buy low and sell high. Though this is easily said, it is sometimes hard to do. It is hard to accomplish for different reasons than most people might think. The reasons are not because of the nature of the real estate market. It is hard for most people to buy low and sell high and easy for people to buy high and sell low because of psychological reasons. Before you can ﬁnd a good deal, you have to understand the psychology of the real estate market. Once you understand this, you can move forward without fear that you will make a mistake. The biggest mistake you can make is failing to start real estate investing. After you have overcome the psychological barrier to becoming a successful real estate investor, ﬁnding a good deal becomes a matter of knowing value. We will show you how to know and recognize value in your target area. Then it becomes a simple matter of ﬁnding real estate in which to invest. We will show you the six ways to ﬁnd a good deal.

The Psychology of the Real Estate Market Every market has a psychology that shapes it. For example, in the stock market two emotions—fear and greed—shape the market. People get into the stock market based on fear and greed. They get a hot stock tip from a friend or someone at work or from someone who knows someone. 11

C02.qxd 3/30/04 9:23 AM Page 12

12

REAL ESTATE BASICS

This is when fear and greed take over. They are afraid of missing out by not acting on the tip, and they get greedy by investing before they conduct a due diligence investigation. In other words, they fail to determine value. By the time they get the tip, it is too late. The smart investors are already selling to the people who are buying because of the tip. The smart investors buy low and sell high. Most people are buying high and then wind up selling low when the stock or the market itself moves lower. The real estate market has four times the assets of the stock market! Yet, truth be told, there is no real estate market. There are only people to talk to. We say it this way: Contacts Create Contracts. Contact with people creates opportunity for you as a real estate investor. The psychology of the real estate market is shaped by four emotions—fear, greed, pride and shyness. Every homeowner suffers the pride of ownership emotion. As a real estate investor, you will not suffer from pride of ownership. If you do, it could be an expensive emotion to entertain. Homeowners tend to overvalue their property because they have lived in it, perhaps raised a family in it, and made improvements. When it comes time to sell the property, homeowners tend to inﬂate the value of their home because of the pride they feel about it. A real estate investor takes pride of ownership into account when negotiating with a homeowner, but pride of ownership does not ﬁgure into an objective valuation of property for the investor. Also, an investor is not caught up in the fear and greed of the real estate market. An investor does due diligence before investing. The investor then will be buying low or will not be buying at all! The psychological barrier a real estate investor has to overcome is being shy. As a real estate investor, you must overcome being shy. You may not be shy when it comes to ﬁnding property, making appointments with sellers, and looking at property. Most beginning and even some veteran real estate investors become shy when it comes to making the offer. Don’t be shy. Be bold! You must make your offer based on your analysis of value. You are an investor buying at a wholesale price. As an investor, you cannot pay a retail price. Make your low offer and let the seller decide whether they will accept. In Chapter 5, we will give you a script to use when presenting offers that will have your deals be accepted by the sellers. How does an investor know that they are buying low? An investor knows he or she is buying low because he or she knows value. Your mission as a real estate investor is to become an expert in valuing real estate in your target area.

C02.qxd 3/30/04 9:23 AM Page 13

Finding a Good Deal

13

You will know the retail value, the wholesale value, the appraised value, the loan value, the replacement value, and the property tax value of every property in which you are investing.

Knowing Value Are you ready to become an expert in valuing real estate? We are going to take you step by step through the knowledge we have gained in our combined 50-plus years as investors valuing real estate. We will deﬁne the six values that all real estate investors need to know about the property they are investing in. We will show you three ways to value real estate that are used by appraisers. We will explain the four elements of real estate value that are unique to the real estate market. Then we will reveal four great forces that inﬂuence real estate value. Finally, we will teach you seven ways how to know value in your target area.

The Six Values Every Real Estate Investor Needs to Know There are six values all real estate investors need to know about property in which they are investing. These six values are the retail value, the wholesale value, the replacement value, the property tax value, the loan value, and the appraised value. The retail value is the value an end user, such as a homeowner, places on a piece of real estate. The retail value tends to be the highest value of all the values placed on real estate. The wholesale value is the value a real estate investor, like you, places on a piece of real estate. The wholesale value tends to be the lowest value of all the values placed on real estate. The replacement value is the value insurance companies place on the improvements on a piece of real estate. The replacement value is determined by the cost approach. The property tax value is the value the local property tax assessor in your area places on a piece of real estate. The property tax value could be higher or lower than the retail value. The loan value is the value a real estate lender, such as a bank or mortgage company, places on a piece of real estate. The loan value tends to vary as a percentage of the appraised value. The appraised value is the value a real estate appraiser places on a piece of property. The appraised value is typically at or near the retail value.

C02.qxd 3/30/04 9:23 AM Page 14

14

REAL ESTATE BASICS

Three Ways to Value Real Estate There are three ways to value real estate. The three ways are the cost approach, the income approach, and the market comparison approach. When a real estate appraiser makes an appraisal, he or she will use one, two, or possibly all three of these valuation approaches. The cost approach consists of three parts. First, value the land. Second, value the improvements on the land, such as buildings, and add the value of the improvements to the value of the land. Third, determine the accrued depreciation of the improvements and subtract the accrued depreciation from the combined value of the land and improvements. Let’s look at an example. If the land is valued at $100,000, the improvements are valued at $250,000, and the accrued depreciation is $25,000, what is the value of the property according to the cost approach? Land value Improvements Total Accrued depreciation Property value

$100,000 $250,000 $350,000 –$25,000 $325,000

We added the value of the improvements, $250,000, to the value of the land, $100,000, and got $350,000. We then subtracted the accrued depreciation, $25,000, and came up with a property value of $325,000. The income approach uses the income a property produces to determine its value. We say it this way: The value of an income property is in direct relationship to the income the property produces. Let’s look at an example. The gross rent multiplier method says the value of an income-producing property is determined by the gross annual rent the property receives multiplied by the gross rent multiplier. You can ﬁnd out the gross rent multiplier for your area by calling a commercial real estate company and asking them what it is for your city. If the gross annual rent is $120,000 and the gross rent multiplier for the area is 8, then we multiply $120,000 by 8 and come up with a value of $960,000. Gross rent Gross rent multiplier Value

$120,000 ⫻8 $960,000

C02.qxd 3/30/04 9:23 AM Page 15

Finding a Good Deal

15

Another way to determine value using the income approach is with the formula Value = Income/Capitalization Rate. In this case the income is the net operating income (NOI), which is the gross income minus the operating expenses. The capitalization rate is determined by the market in the area the property is located. For example, in Dallas, Texas, real estate investors might require an 8 percent capitalization rate, and in Phoenix, Arizona, real estate investors might require a 9 percent capitalization rate.You can ﬁnd out the capitalization rate for your area by calling a commercial real estate company and asking them what it is in your city. If the NOI is $80,000 and the capitalization rate is 8 percent (as in Dallas), then the value of the property is $1,000,000. ($80,000/0.08 = $1,000,000) However, if the property was located in Phoenix with the same $80,000 NOI, then the value of the property is only $888,888. ($80,000/0.09 = $888,888) Dallas, Texas $80,000 0.08 $1,000,000

NOI Capitalization rate Property value

Phoenix, Arizona $80,000 0.09 $888,888

The market comparison approach uses the value of similar properties to determine the value of a particular property. How many of you have heard the expression “comps”? Comps is short for “comparable properties.”You compare properties that are similar to the property you are interested in to determine its value. We say it this way: “No Comps, No Contract.” Let’s look at an example. If you are trying to determine the value of a three-bedroom/two-bathroom, 1,600 square feet, attached two-car garage home, you’ll compare it to whatever similar properties you can ﬁnd that have sold within the last 180 days (about 6 months) in the same neighborhood. Property 1 is a home with three bedrooms, two bathrooms,1,625 square feet,and attached two-car garage that sold for $195,000 45 days ago. Property 2 is a home with three bedrooms, two bathrooms, 1,575 square feet, and attached two-car garage that sold for $190,000 60 days ago. Property 3 is a home with three bedrooms, two bathrooms, 1,700 square feet, and attached two-car garage that sold for $205,000 30 days ago. The price per square foot for each of these properties is about $120. ($195,000/1,625 square feet is $120.00, $190,000/1,575 square

C02.qxd 3/30/04 9:23 AM Page 16

REAL ESTATE BASICS

16

feet is $120.63, $205,000/1,700 square feet is $120.59.) If we multiply 1,600 square feet by $120 we get a value of $192,000 for the value of the property we are investigating. Property 1 $195,000 1,625 $120.00

Property 2 $190,000 1,575 $120.63

Property 3 $205,000 1,700 $120.59

Subject property 1,600 square feet ⫻ $120.00 $192,000 This, of course, is a summary chart of the market comparison example information. To help you determine the most accurate values of properties you are analyzing you may want to use a form to organize the information you gather. On the next page we provide a sample comparative market analysis form like we use.

Four Elements of Value There are four elements of value in real estate. They are demand, utility, scarcity, and transferability. These elements constitute the value of a piece of real estate. We use the acronym DUST as a memory aid to keep them in mind. Other people prefer STUD, but we won’t get into that. Demand is the ﬁrst element of value. Demand is the number of people that want the property. The more people that want the property, the more valuable it becomes. Utility is the second element of value. Utility is the use that a property can be put to or made of. The more uses a property can be put to or made of, the more valuable the property. Scarcity is the third element of value. Scarcity has to do with the supply of real estate available. This supply could be what is on the market or the total possible number of properties in an area. The more scarce the supply of real estate available, the more valuable the property. Transferability is the fourth element of value. Transferability is the key element of value in real estate. You can have the best property in the world, worth millions of dollars, and if you cannot transfer the title to

C02.qxd 3/30/04 9:23 AM Page 17

Finding a Good Deal

17

C02.qxd 3/30/04 9:23 AM Page 18

18

REAL ESTATE BASICS

your property to a buyer, then you have no sale. Likewise, if you are a real estate buyer and have written a great wholesale offer that has been accepted by the seller, your deal is worthless unless you can get the seller to transfer clear property title to you.

Four Great Forces Inﬂuencing Value There are four great forces that inﬂuence the value of real estate. They are physical forces, economic forces, political forces, and social forces. These forces are present in every real estate market in the country. How they inﬂuence your target area is up to you to determine. We use the acronym PEPS as a memory aid to keep them in mind. Physical forces are the ﬁrst of the great forces that inﬂuence the value of real estate. The availability of schools, shopping, churches, transportation, and parks are some of these physical forces. If these physical amenities are present in your target area, this inﬂuences the value of the area in an upward manner. If these physical amenities are not present or are minimally present in your target area, this inﬂuences the value of the area in a downward manner. Economic forces are the second of the great forces that inﬂuence the value of real estate. The number and types of jobs available, the wages being paid, where in the economic cycle the economy is nationally, and the interest rates for real estate loans are examples of such economic forces. The economic cycle is a repeating expansion, prosperity, recession, depression cycle. Real estate value is greatly inﬂuenced by the economic cycle. Typically, real estate is said to do well in the expansion and prosperity phases of the economic cycle and poorly in the recession and depression phases of the economic cycle. Political forces are the third of the great forces that inﬂuence the value of real estate. The types of zoning, pro-growth or no-growth policies, and environmental regulations are good examples. It is important for you to know the political forces that inﬂuence the value of real estate in your area, for both the present and future investment climates. Social forces are the fourth of the great forces that inﬂuence the value of real estate. The quality of the schools and the number in the area, blighted or well-kept neighborhoods, racial or ethnic strife, and social amenities are examples.

C02.qxd 3/30/04 9:23 AM Page 19

Finding a Good Deal

19

Seven Ways to Know Value in Your Target Area There are seven ways to recognize value in your target area. They are sold comparables, pending comparables, listed comparables, expired comparables, appreciation rates, new or planned development information, and vacancy rates. Sold comparables are the ﬁrst way to know value in your target area. Sold comparables, as the name implies, are comparable properties that have been sold and have actually closed escrow. Sold comparables set the ﬂoor of retail value for real estate. This means that if a sold comparable property had a sell price of $125,000, a similar property should sell for no lower than $125,000 in a normal real estate market. Sold comparables are useful for properties that have sold in the last six months. Anything sold beyond six months is not considered a good comparable. Pending comparables are the second way to recognize value in your target area. A pending comparable is a property that has sold but has not closed escrow. Pending comparables indicate the direction of real estate value. When the pending comparable closes escrow, it will become a sold comparable. If the sold comparables are indicating a value of $125,000 and the pending comparables are indicating a value of $127,000, then you have an indication that the direction of real estate values is going up. Listed comparables are the third way to know value in your target area. Listed comparables are properties currently on the market and similar to property in which you are considering investing. Listed comparables set the ceiling of retail value for real estate. They set the ceiling because they have neither sold nor closed escrow. They are merely an indicator of what sellers would like to get for their properties. Expired comparables are the fourth way to recognize value in your target area. Expired comparables are properties that never sold, let alone closed escrow. Expired listings indicate the value beyond the present market in terms of what retail real estate buyers are willing to pay for property. Retail buyers will buy the lower-priced comparable properties ﬁrst, all else being equal. Appreciation rates are the ﬁfth way to know value in your target area. Appreciation rates indicate the annual percentage increases in market value. Appreciation rates give you a sense of how hot or cold the real estate market is. Double-digit appreciation rates indicate a hot real estate market. Single-digit rates indicate a good market, and zero or negative rates indicate a cold real estate market.

C02.qxd 3/30/04 9:23 AM Page 20

20

REAL ESTATE BASICS

New or planned developments are the sixth way to recognize value in your target area. By studying the path of new development and buying property in the path of that development, you can ensure that you are buying property that will appreciate in value. Vacancy rates are the seventh way to know value in your target area. High vacancy rates indicate an area that may have problem properties. Low vacancy rates indicate an area that may have proﬁtable properties.

Six Ways of Finding a Good Deal There are six ways of ﬁnding a good deal. They include checking classiﬁed ads either in newspapers or on the Internet, placing a newspaper or Internet ad, enlisting the help of personal contacts, doing your own scouting, visiting open houses, and working with a real estate agent. Checking classiﬁed ads, either in newspapers or on the Internet, is the ﬁrst way of ﬁnding a good deal. The Friday and Sunday metropolitan editions are the best source for ﬁnding the most comprehensive real estate ads. You are looking for existing property for sale, not new homes. Look in the residential real estate section and not land, industrial, or commercial real estate. Also, start in your target area ﬁrst and expand outward from there. Most of the major metropolitan newspapers have their classiﬁed real estate ads available online. If you are a paperless person, this may be your best source of ﬁnding property without leaving the comfort of your computer. The National Association of Realtors (www.nar.com) and local real estate multiple listing services allow the public to visit their Web sites and peruse available listings. Discount brokers, like BuyOwner.com, post properties they are assisting sellers with. There are also several for sale by owner sites, such as propertySites.com, that can offer access to local properties for sale by owner. Placing a newspaper or Internet ad yourself is the second way of ﬁnding a good deal. Place your ad in the Real Estate Wanted section of the classiﬁed ads. It can be something simple and short.

RE Investor buying property in your area this week only! Cash! Call 800 555-1212.

C02.qxd 3/30/04 9:23 AM Page 21

Finding a Good Deal

21

You can place an Internet ad in your metropolitan newspaper. You can also place Internet ads on local and national Internet sites. Enlisting the help of personal contacts is the third way of ﬁnding a good deal. Tell your family and friends that you want to invest in real estate. Let people know at work, church, and social groups that you are looking for real estate investments. Tell them that if they bring you a good deal that works out, you’ll pay them a referral fee. Also, you may ﬁnd a money partner or investor partner once you start talking to people. As we said earlier, Don’t be shy. Be bold! Doing your own scouting is the fourth way of ﬁnding a good deal. Driving through and around your target area a different way each day can lead you to a good deal. Use side streets rather than thoroughfares. Take an extra 15 minutes driving home from work to look at properties. Shop at a different grocery store to go through unfamiliar neighborhoods. Look at bulletin boards in stores and laundromats for real estate for sale ads. Put up a ﬂyer in the lunch room at work. Talk to people you do business with, like the dry cleaner, shoe repair person, cable company, and plumber, and let them know you are a real estate investor looking for property. Visiting open houses is the ﬁfth way of ﬁnding a good deal. Make it a point to drive around your target area on Saturday or Sunday and stop in on open houses in homes listed by a real estate company and those for sale by owner. Pick up the ﬂyer about the property from the outside signage, or ask for one when you tour the property. Ask questions of the real estate agent or seller holding the open house. Inform them that you are a real estate investor. Tell them you are prepared to make them an offer today if the property ﬁts your parameters. If you are visiting a property hosted by a real estate agent, the agent will ask you questions in an attempt to get you to agree to work with the agent. Agree to nothing until you read the next chapter! Working with a real estate agent is the sixth way of ﬁnding a good deal. When you call on classiﬁed ads placed by real estate companies, you can begin to search for an agent you can feel comfortable working with. Although just about every real estate agent works for the seller, the only way the real estate agent makes any money is when there is a buyer who buys their seller’s property. You can get the real estate agent on your side by helping them make money. When you close your ﬁrst deal, they will then know you are a serious buyer.You will be the best kind of buyer because you are an investor. Rather than making only one real estate purchase every ﬁve to seven years, like most retail buyers make for a home purchase, you are

C02.qxd 3/30/04 9:23 AM Page 22

22

REAL ESTATE BASICS

going to buy multiple real estate purchases in the course of a single year. That means the agent is going to make multiple commissions. When this agent knows your investment parameters, they will actively seek properties for you. The agent can now legitimately go to a property owner and say that he or she has a buyer for their property. In Chapter 3 we will show you the best way to work with real estate agents. Agents can be a great source of real estate investment property. However, Caveat Emptor, let the buyer beware, is a good place to start when you approach an agent. Just as it may take you a while to ﬁnd a good real estate deal, it may take you a while to ﬁnd a good agent.

C03.qxd 3/30/04 9:22 AM Page 23

C H A P T E R

3

Working with Real Estate Agents

Every real estate agent acts in a professional manner with real estate sellers. Ninety-nine out of one hundred real estate agents act in an unprofessional manner with real estate buyers. Why do we say this? Because we were brokers in California and Texas for many years and have had ﬁrsthand experience of how the real estate brokerage business works.

Listing Agreement No real estate agent will work with a seller without a written agreement called a Listing Agreement. The agent will not waste his or her time doing a market evaluation, measuring square footage, checking on ownership and property taxes, putting a sign in the front yard, putting a lock box with a key to the house on the front door, making ﬂyers, advertising the property, and holding open houses without a written agreement. The written agreement is called an Exclusive Right To Sell Agreement. It is commonly called a listing agreement. The agreement is an exclusive authorization by the seller for the real estate broker to list their property for sale with the local Multiple Listing Service (MLS). In return for selling the property, the seller agrees to pay the real estate broker a fee, known as a real estate commission.

23

C03.qxd 3/30/04 9:22 AM Page 24

REAL ESTATE BASICS

24

MLS The MLS is put together by the local board of Realtors to list and share property information with the different real estate companies that participate in the board. The companies agree to cooperate with each other in selling their listings. Each real estate broker agrees to share the listing commission with another broker if the other broker brings a buyer who buys the property. Real estate agents are taught to be very professional when dealing with sellers. Why? Because of the tremendous amount of money being paid by sellers in commissions.

Commissions Let us offer you a new perspective on real estate commissions. As the value of your property increases, so does the amount of money you pay in commissions. The commission is ﬁgured on a percentage of the sales price of your property, not on a percentage of your equity. The problem is the commission comes out of your equity and can be big dollars and a huge percentage of that equity. We are going to give you an example from the introduction of our book Going Going Gone! Auctioning Your Home for Top Dollar. Let’s say your property sells for $200,000 and your remaining mortgage balance is $150,000. You have a gross equity of $50,000. Sales price Mortgage Gross equity

$200,000 ⫺$150,000 $50,000

Disregarding other expenses associated with the sale and just ﬁguring the commission, how much of your $50,000 do you think you will receive at the closing? If you are paying a 6 or 7 percent commission, this will substantially reduce your proceeds. Remember, the commission is calculated as a percentage of the sales price and is paid out of your equity. Sales price Commission (%) Commission ($)

$200,000 ⫻7% $14,000

C03.qxd 3/30/04 9:22 AM Page 25

Working with Real Estate Agents

Equity Commission In your pocket

25

$50,000 ⫺$14,000 $36,000

The last calculation we will show you is the worst! That 7 percent commission becomes an unbelievable percentage of your equity. Are you sitting down? The commission dollars are 28 percent of your equity! Just imagine if your equity was $35,000. If you paid the same $14,000 commission, that would be 40 percent of your equity.

Real Estate Buyers Ninety-nine out of a hundred real estate agents will work with a real estate buyer without a written agreement! When you call a real estate ofﬁce about an ad you have seen in your newspaper, you are calling the company that is representing the seller through the listing agreement. At best, as a buyer, when you work with a real estate agent and are looking at property that has been advertised by the company for which the real estate agent works, the agent is representing you and the seller. The expression caveat emptor—buyer beware—is especially applicable when you are buying real estate. We are going to show you how it looks from the standpoint of the real estate agent when they are in the ofﬁce at the “up desk” answering the phones. Any potential new client calls that come in on the ads that the company is running in the local newspaper are worked by the person at the up desk. We take the time to explain this so you can understand what is going on in the minds of every real estate agent you talk to. As an investor, your success will depend on gaining access to the properties on the market in your target area. Fortunately or unfortunately, real estate agents are the gatekeepers of your access to the real estate market. You have to understand their job, you have to understand their motivation, and you have to enroll them as part of your investment team for you to be a successful real estate investor.

C03.qxd 3/30/04 9:22 AM Page 26

26

REAL ESTATE BASICS

The Scenario for the Real Estate Agent Back to the up desk at the local real estate ofﬁce. Pretend for a moment that you are the agent answering the phones on a Sunday afternoon. Let’s just say it is autumn, so it’s football season. The phone rings, and you answer it. You hope it is a client call. Great, it’s a client call! They are calling about one of your ads in the Sunday paper. It is a property listed by one of the other agents in your ofﬁce. Your job is to talk the caller into making an appointment that afternoon. You want them to come to your ofﬁce. You will meet with them brieﬂy, put them in your vehicle, and then show them the property they called on. Of course, once you have them in your car, you will show them other similar properties that the ofﬁce has on the market. You will also want to take them by your listing on Spring Avenue. That property is nothing like the one in the ad, but what the heck? You’ll get brownie points from your seller for showing the property. After all, your seller needs to see you doing some work to earn that fat commission they have agreed to pay you. A young couple arrives in your ofﬁce at the appointed time. They tell you they only have 45 minutes to look.You see they are big Cowboys fans and it is half-time. They want to be back for the fourth quarter. You introduce yourself, ask a few questions, put them in your vehicle, and away you go. You show them the property they called on, your property on Spring Avenue, and one other property listed with another broker on the way back to your ofﬁce. Time goes by, and a week later you call the young couple to follow up. They tell you they are very excited because they made an offer on the last property you showed them and it has been accepted. As you hang up the phone, you notice the sick feeling in the pit of your stomach. You vow to yourself that this is the last time you work with buyers. Buyers are ﬂakes. Buyers are liars. You are going to stick with sellers. This scenario is played out every week in real estate ofﬁces around the country. We are presenting it here so you know how agents have been conditioned to treat buyers, even buyers like yourself who are wholesale buyers, that is, real estate investors. As we have already said in Chapter 1, the real estate market is biased in favor of sellers. It is biased in favor of sellers because of real estate agents. We recommend you have a professional relationship with a real estate agent as a buyer.

C03.qxd 3/30/04 9:22 AM Page 27

Working with Real Estate Agents

27

Using Real Estate Agents Most Advantageously The following are options for dealing with real estate agents you will encounter in the buying and selling facets of real estate investing. We present the buying options ﬁrst and the selling options last. The options are in order from what are considered the least expensive and restrictive options to those considered the most expensive and restrictive. Bear in mind that commissions and fees are 100 percent negotiable.

Your Options as a Buyer We have already said that when you call about an ad with a real estate company you are at best in a dual agent situation. Inform the agent that you are a real estate investor and ﬁrmly decline any involvement with their company. Allow agents to represent the seller only if the seller pays the real estate commission. Make it clear that you will not sign a buyer listing contract or pay a commission. Approach an agent to consult with you for an hourly fee. That way, if you need some help in an area of the transaction, you have already lined up your consultant. Work with the agent in the capacity of them being a dual agent. The agent works for you and the seller. The agent’s job is to facilitate a meeting of the minds between you and the seller—but the foremost responsibility is to get the best price for the seller. Negotiate with a real estate agent to represent you exclusively in the transaction. The agent works for you, and you agree to pay them a commission in this case. It is important to have all agreements in writing in the real estate world. There may be an agreement form available from the person you choose to represent you. If not, then you may ﬁnd a generic or example buyer’s agent agreement that you can adapt to your needs. We have several adapted versions we use depending on our situation. Do what is best for yours!

C03.qxd 3/30/04 9:22 AM Page 28

REAL ESTATE BASICS

28

Your Options as a Seller You are a for sale by owner, a FSBO for short. Thank the agent for their interest, but ﬁrmly decline any involvement with their company. See our best-selling book How to Sell Your Home without a Broker (3rd ed., Wiley) for a complete system for the FSBO seller. Allow an agent to represent the buyer only if the buyer pays the commission. Make it clear that you will not sign a seller listing contract or pay a commission. Approach an agent to consult with you for an hourly fee. That way, if you need some help in an area of the transaction, you have already lined up your consultant. Work with the agent in the capacity of them being a dual agent. The real estate agent works for you and the buyer. The agent’s job is to facilitate a meeting of the minds between you and the buyer. Negotiate with an agent to represent you exclusively in the transaction. The agent works for you, and you agree to pay them a commission. Every real estate company has their own version of an exclusive right to sell listing. Just be sure you understand what you are agreeing to before you sign any agreement with a real estate company. You may ﬁnd they want to tie up your property for at least six months. You may also ﬁnd they want to charge you a 6 or 7 percent commission. Just remember: all commissions are negotiable. In Chapter 4, we will show you how to evaluate the property you ﬁnd either through an agent or otherwise. You will be able to evaluate a property as if you were an appraiser. We also show you how to inspect a property as if you were a property inspector.

C04.qxd 3/30/04 9:22 AM Page 29

C H A P T E R

4

Evaluating and Inspecting Property In this chapter we will train you to evaluate and inspect property. You are evaluating a property to see if it ﬁts within your investing goals.You are inspecting a property to see what work needs to be done to make it marketable.We will show you our methods of saving time and money by evaluating and inspecting property at the same time.

Evaluating Property In Chapter 1, we had you prioritize your goals for real estate investing. These prioritized goals became your destination point(s) for your investing.Your ﬁrst step in evaluating property is to see if it can match up with your prioritized goals. Our system emphasizes Quick Cash. Get in and get out quickly. Even if you are the type of real estate investor who prefers long-term wealth building, our system of evaluating property will also work for you. Unlike other real estate investing systems, our system does not rely on ﬁnding the right property. Our system is based on ﬁnding the right seller! Finding the right seller is part and parcel of evaluating property. Refer back to your prioritized goals. This is the ﬁrst step in evaluating a property. If the property does not match one or more of your goals for investing in real estate, then ﬁnd another. Let’s say one of your goals is spending no more than 15 hours a week investing in real estate. 29

C04.qxd 3/30/04 9:22 AM Page 30

REAL ESTATE BASICS

30

You ﬁnd a property, and as you are looking at it for the ﬁrst time you realize that it is a complete ﬁxer-upper. New paint, carpeting, ﬂooring, and roof. Repair the plumbing, wiring, and termite damage. Replace the dishwasher, garbage disposal, and stove top. You are good at ﬁxing things, but you realize this property is a fulltime project, requiring 40 hours a week for ﬁve or six weeks. This blows your 15-hour-a-week goal out of the water.Your evaluation of this property is to pass on it.

The Right Property Most real estate investment systems teach you to ﬁnd the right property. Although there is nothing wrong with the right property, we ﬁnd we get better results when we place the emphasis on the right seller. Don’t take us the wrong way here. Ultimately you are buying and selling property. Sometimes it is a matter of matching the right property with the right buyer. This can be the proverbial match made in heaven. We do believe in buying the worst house in the best neighborhood. You will then beneﬁt from the Principle of Progression.You will make a big mistake if you buy the best house in the neighborhood.You will then suffer the negative impact of the Principle of Regression. The economic Principle of Progression as it relates to real estate investing says that if you buy a property below the median price for the area, there will be a positive impact on the future value of that property just because of the area itself. Another way to say this is that when you buy a property below the median price, there are more properties priced at a higher level than at a lower level relative to the property you are buying. First, let’s ﬁgure out what the median price means. The median price is the price point at which half the property in the area is more expensive and half the property is less expensive. The median price is different than the average price. The average price is higher than the median price and is skewed that way because of the expensive property in an area. As we have already said, the median price is the price point right in the middle of all the property values. We know from Chapter 2 that the market comparison approach to value places the most emphasis on sold comparable properties. The median price takes all properties, not just comparable properties, into account. Let’s look at ﬁve properties in the

C04.qxd 3/30/04 9:22 AM Page 31

Evaluating and Inspecting Property

31

same neighborhood that have sold and closed escrow in the last six months. Property 1 is a three-bedroom, two-bathroom, 1,200-square-feet starter home that sold for $105,000. Property 2 is a four-bedroom, twobathroom, 1,500-square-feet older home that sold for $120,000. Property 3 is a four-bedroom, two-bathroom, 2,000-square-feet newer home that sold for $155,000. Property 4 is a three-bedroom, two-bathroom, 1,800square-feet upgraded home that sold for $180,000. Property 5 is a ﬁvebedroom, four-bathroom, 3,500-square-feet executive home that sold for $290,000. What is the median price for these properties? The answer may surprise you. The median price is $155,000, which is the price that property 3 sold for. Remember, the median price is the price point at which half of the properties (4 and 5) sell for a higher price and half (1 and 2) sell for a lower price. What is the average price for these properties? Again, the answer may surprise you. The average price for these properties is $170,000! You can see that the average price is $15,000 higher than the median price ($170,000 versus $155,000). Property 4 and especially property 5, with their higher sales prices of $180,000 and $290,000, respectively, skew the average price higher. As a real estate investor, you are much more interested in the median price. Average Price versus Median Price Average Price Property 1 Property 2 Property 3 Property 4 Property 5 Average Price =

$105,000 $120,000 $155,000 $180,000 $290,000 $170,000

Median Price Property 1 Property 2 Property 3 Property 4 Property 5 Median Price =

$105,000 $120,000 $155,000 $180,000 $290,000 $155,000

The economic Principle of Regression as it relates to real estate investing says that if you buy a property above the median price for the area, there will be a negative impact on the future value of that property because of the area itself. Another way to state it is that when you buy a property priced above the median, there are more properties priced at a lower level than are priced at a higher level relative to the property you are buying.

C04.qxd 3/30/04 9:22 AM Page 32

REAL ESTATE BASICS

32

Using our property examples, if you had purchased property 4 for $180,000, the value of that property for investment purposes would be negatively impacted by the Principle of Regression. Properties 1, 2, and 3 would all be pulling down the value of your property. Only property 5 would be pulling up the value of your property.

The Right Seller Your job as a real estate investor is to ﬁnd the right seller. The right seller is a motivated seller. By motivated we mean that the seller has an urgency to sell the property. The seller has to sell the property because of a new job, loss of a job, retirement, kids going to a new school, no kids left at home, another child on the way, divorce, death in the family, moving up to a bigger property, moving down to a smaller property, foreclosure, and so on. The list is endless. We have already stated that sellers sell for their own reasons and not your reasons.Although you might not accept your purchase offer, let the seller make up his or her own mind about it.You don’t need to feel embarrassed about your offer. There is nothing embarrassing about your offer. Sellers like receiving offers. That is the seller’s goal when putting their property up for sale.They are hoping and praying that someone, you, gives them an offer. In Chapter 5, we will show you how to write and present offers that will be accepted by sellers.

Inspecting Property Inspecting property requires what we call Potential Vision. Some would say this is a version of seeing the world through rose-colored glasses, but what we want you to develop is the ability to see potential where other real estate investors see no potential. Potential Vision is an acquired skill. Practice, practice, practice! Start by looking at where you live.Yes, we know that you have all these projects in various stages of development and completion. These projects range from dreams to something practical. Dreams include putting in a swimming pool or adding an extra bathroom. Practical things in-

C04.qxd 3/30/04 9:22 AM Page 33

Evaluating and Inspecting Property

33

clude painting the kitchen cabinets or cutting back the jungle (your front yard). We want you to start looking at real estate the way investors do.We can tell you story after story of the number of properties we have looked at that, according to the owner, were not ready to be shown. The owners were worried that their place was messy, not presentable, or just plain embarrassing.We told them we didn’t care, and we really didn’t.We have found that there is more potential in a property that is a mess than in a property that shows well! Potential is the difference between the as-is condition of a property and the ﬁxed-up condition of the same property. The greater the difference between the conditions, the greater the potential a property has— potential to make money, that is. Being able to do the ﬁxing up at a wholesale cost, cheaper than the competition, allows real estate investors to make a proﬁt in real estate. The end user, retail buyer, home purchaser wants to buy a property that shows well.You are not the end user, retail buyer, home purchaser. You are a nonuser, wholesale buyer, real estate investor. In fact, you may be the middle person to the middle person.You may ﬁnd a ﬁxer-upper property, see the potential, and ﬁnd another investor to whom to sell the property. The investor you sell the property to will ﬁx it up and sell it to an end user. You make a proﬁt by ﬁnding a good deal and selling it to another investor.You do not have to be the investor who actually ﬁxes the property. So what do you look for when you are inspecting a property? We look at three things. We look at the curb appeal, or outside of the property; the exterior of the property, which is different than the outside of the property; and the interior of the property. To simplify this process we take a clipboard and an inspection sheet.

Walk-Through Inspection We use a walk-through inspection worksheet the ﬁrst or second time we look at a property. This gives us a written record of what we have seen. Try looking at three, four, ﬁve, or more properties in an afternoon and try to remember what the second one looked like! They all start to blend together in your mind.You’ll ﬁnd you can’t do without a written record. You need to have something in writing. At the end of the day, we can

C04.qxd 3/30/04 9:22 AM Page 34

34

REAL ESTATE BASICS

compare four or ﬁve inspection sheets to help us determine which property or properties we are interested in making an offer on.You may prefer to carry a small digital camcorder to record your comments. Most people do walk-through inspections within a few days of the closing. We use an inspection checklist at the beginning of the transaction and at the end of the transaction. When you do a walk-through inspection at the end of the transaction, it veriﬁes that all systems (such as the heating and air conditioning) are functioning properly, all the appliances are in good working order, any and all repairs the seller has agreed to make have been made, any items the seller has agreed to replace (such as the roof or ﬂoor coverings) have been replaced, any personal items of the seller have been removed from the property, and the property has been left in the condition you have agreed on or has been swept, vacuumed, and dusted. A walk-through inspection can be done by you and the seller. However, we have done a walk-through inspection without the seller on many occasions. The purpose of the inspection is to provide proof that the property is being left in the condition the seller and you agreed on according to the terms and conditions of the purchase contract. Although this step is not legally necessary, the walk-through inspection is evidence that the seller has complied with what they said they would do. We recommend using our walk-through inspection worksheet located in our book, How to Sell Your Home Without a Broker, Third Edition ( John Wiley & Sons, 2000; fourth edition to be published in August, 2004). The worksheet has three parts. The ﬁrst part is for the outside or curb appeal.The second part is for the exterior of the property.This is different from curb appeal in that it covers areas that are not readily visible from the street such as the siding walls, foundation, or rear of the property. The third part of the worksheet is for the interior of the property. Because we give the seller a copy of the worksheet, when we come back to present our offer the seller has an idea of the scope of the ﬁx-up that needs to be undertaken. The seller has three pages detailing what is wrong with the property. By using the worksheet, we have already begun negotiations with the seller even though we have yet to write and present an offer! In Chapter 5 we show you how we write and present contracts. Our contracts are written based on our analysis of our walk-through inspections.We back-track from the retail value as determined by our market comparison approach to value (see Chapter 2). Depending on how

C04.qxd 3/30/04 9:22 AM Page 35

Evaluating and Inspecting Property

35

much ﬁxing up is necessary, we can then establish a wholesale price to offer the seller. Example Let’s say the market comparison approach (the comps) indicates the retail value of a property is $155,000. Looking at our walkthrough inspection worksheet, we determine there is $25,000 worth of ﬁxing up necessary to get the property looking good to an end user. What amount would we offer the seller? No, not $130,000 ($155,000 ⫺ $25,000). One rule of thumb you could use is to offer 65 to 70 percent of the retail value. We will offer 65 to 70 percent of the $155,000 retail value.We offer the seller between $100,750 and $108,500 for their property. Keep in mind the property is a ﬁxer-upper. It will be worth $155,000 retail when the repairs are completed. Retail value $155,000 Fixing up ⫺$25,000 Do not offer $130,000 Retail value

$155,000 ⫻65% $100,750

Well then, on to Chapter 5.

Retail value

$155,000 ⫻70% $108,500

C05.qxd 3/30/04 9:19 AM Page 36

C H A P T E R

5

Writing and Presenting Your Offer There are no oral agreements in real estate. Everything must be in writing. Once you have written a contract you have to present it to the seller. By presenting your offer correctly, your deal will be accepted. In this chapter we show you how to write an offer that will get you a great deal and at the same time protect you from winding up in a lousy deal. We will show you how to present your offer to the seller in such a way that the seller will see the advantage for him- or herself in accepting your offer.

Writing Your Offer As we have said, there are no oral agreements in real estate. Technically, you can agree to buy someone’s property and they can agree to sell it to you without a written agreement. But if a dispute arises between you and the seller and you wind up in front of a judge, the case will be thrown out as soon as the judge discovers there is no written agreement. Every state has a statute of frauds that says that for a contract to be valid it must be in writing. If there is no writing, there is no validity. If there is no validity, there is no contract. Besides the requirement that for a contract to be valid it must be in writing, the contract must meet four other requirements. We call this the CoCa CoLa test. We are not promoting or advertising a soft drink but are 36

C05.qxd 3/30/04 9:19 AM Page 37

Writing and Presenting Your Offer

37

using CoCa CoLa as a memory aid. Once you understand the four requirements for a valid contract you will always use the CoCa CoLa test to make sure all the requirements are present.

CoCa CoLa Consent: There must be mutual consent between the parties to the real estate contract. The parties have to agree about the wording and conditions written in the contract. Capacity: The parties to the real estate contract must have the capacity to enter into the contract. This means the parties have to be of sound mind (competent) and of legal age (18 years in most states). There are some exceptions to the 18-years requirement, such as being married, or being married and then divorced, being in the military, or being an emancipated minor. Consideration: This is anything of value that inﬂuences a person to enter into a real estate contract. This could be money, a deed, a service, an item of personal property, an act (including the payment of money), or a promise (including the promise to pay on a loan). If the consideration is an act or a service, that act or service must be performed after the parties enter into the contract. Typically, consideration accompanies the contract in the form of a promissory note or check. Without consideration, the contract is not valid. Lawful: For the real estate contract to be valid, the promises made between the parties and the consideration given must be legal.

Types of Real Estate Contracts There are many types of real estate contracts. We are going to show you the four main contracts that we use for our own real estate investing. We are going to present them from the simplest to the most complex. The purpose of any contract is to communicate. We believe that the simpler the contract, the better the communication between the parties to the contract. When we ﬁrst got into the real estate business, we used a four-page purchase contract in California. We heard from the grizzled real estate veterans that when they ﬁrst got in the business, they used a one-page purchase contract!

C05.qxd 3/30/04 9:19 AM Page 38

REAL ESTATE BASICS

38

We hearken back to yesteryear with a one-page letter of intent. We follow this with an option contract. We then show you a purchase contract. Finally, we present an assignment, which may be the most important contract of all.

Letter of Intent A letter of intent is our homage to the original one-page purchase contract. Really, you can write anything you want to convey your intent to the seller that you are interested in purchasing their property. Typically, a letter of intent is not accompanied by consideration in the form of money. The letter of intent is a precursor to an option contract or a purchase contract, both of which will be accompanied by some form of valuable consideration. If we apply the CoCa CoLa validity test to a letter of intent, we ﬁnd that it fails two tests. It fails the consent test because you are saying that you intend to buy the property but have no consent from the seller. It fails the consideration test because, as we have said, a letter of intent is not accompanied by money. It is just a letter. So although a letter of intent is not technically a valid contract, it meets our requirement that a contract communicate between the parties. We are going to give you several examples of letters of intent. We start with the short and sweet. You can convey your intent in very few words. We will then give an example of one with more words but still only two paragraphs in length. Finally, we will give you an example of a letter of intent that is three paragraphs in length and conveys lots of information. Your location and how much time you have will dictate the length of your letter of intent. Letter of Intent 1 Letter of intent 1 can be written on the hood of your car. You may be on your way to another appointment and see a for-saleby-owner property that you decide to stop and take a look at. You are interested in making an offer on the property at a later time. Yet, you want to let the seller know you are interested and serious about making an offer. In addition, you want to put something in writing to protect yourself in the event another investor, or a retail buyer, or even an agent hoping to get a listing contract comes along before you have time to write and present an offer. This is what you (we) write:

C05.qxd 3/30/04 9:19 AM Page 39

Writing and Presenting Your Offer

39

To the Owners of 711 Lucky Street, Oceanside, California: We intend to make a cash offer on your property within the next 24 hours. In the event you receive another offer before we have had an opportunity to present our offer, we request you give us the ﬁrst right of refusal, and allow us to present our offer before you accept any other offer. Sincerely, Your name Phone number Today’s date Letter of Intent 2 Letter of intent 2 can also be written on the hood of your car. You would use this second example if you have more time and want the seller to realize that you are serious about making an offer. You may want to use this option if you encounter competition when you are looking at the property. You may stop by at an open house and see other buyers expressing interest in the property. Your goal is to have the seller focus on you and lose focus on other potential buyers. It doesn’t hurt to intimidate the competition by handing the seller a written document. The other buyers will think you are making a written offer and may well bow out of the proceedings.

To the Owners of 711 Lucky Street, Oceanside, California: We intend to make a cash offer on your property within the next 24 hours. In the event you receive another offer before we have had an opportunity to present our offer, we request you give us the ﬁrst right of refusal, and allow us to present our offer before you accept any other offer. Our offer will contain no contingencies regarding selling another property. We will close in 30 days or sooner. We will require a pre(continued)

C05.qxd 3/30/04 9:19 AM Page 40

REAL ESTATE BASICS

40

(Continued) liminary title report and clear title provided by you at the closing. We are real estate investors who have money partners and are already buying property in this area. Sincerely, Your name Phone number Today’s date

Letter of Intent 3 Letter of intent 3 is designed to be written away from the property and is to be presented within 72 hours after you have visited the property. As you can see, it is longer and adds a very important ﬁnal paragraph. This paragraph is designed to inform the seller and to build in protections for you as the buyer. Although the second paragraph states that your offer is not contingent on your selling another property, the third paragraph informs the seller that your offer will be contingent on several important points. If these points cannot be resolved to your liking, you will not have to complete the deal.

To the Owners of 711 Lucky Street, Oceanside, California: We intend to make a cash offer on your property within the next 24 hours. In the event you receive another offer before we have had an opportunity to present our offer, we request you give us the ﬁrst right of refusal, and allow us to present our offer before you accept any other offer. Our offer will contain no contingencies regarding selling another property. We will close in 30 days or sooner. We will require a preliminary title report and clear title provided by you at the closing. We are real estate investors who have money partners and are already buying property in this area. (continued)

C05.qxd 3/30/04 9:19 AM Page 41

Writing and Presenting Your Offer

41

(Continued) Our offer will be contingent on a structural pest control inspection, a property inspection, and approval by our money partners. You will be responsible for removing all liens and encumbrances except current year prorated property taxes. Sincerely, Your name Phone number Today’s date

Option Contract An option contract goes beyond a letter of intent. More than conveying your intent to buy a property, an option contract says you are buying property within a certain time frame. Also, you will commit funds in the form of an option fee or option money—basically a deposit—to keep the option open. In Section Four we will take several chapters to talk about real estate options. Our purpose here is to introduce you to the idea of using an option contract as part of your real estate investing Brain Trust. Although an option contract contains all the elements of CoCa CoLa to make it valid, it has a very unique feature among all the different real estate contracts: It becomes a unilateral agreement. An option contract becomes a unilateral agreement once the optionor (seller) and optionee (buyer) sign it. All contracts are bilateral to begin with. Consent in the form of mutual agreement on both the seller’s part and the buyer’s part is necessary for validity. However, once the option has been agreed to, only the buyer can exercise the option. The seller can’t back out of the deal if the buyer exercises the option. The optionee (buyer) can back out of the deal and not be sued for speciﬁc performance. The optionor (seller) gets to keep the option fee the optionee put up, but that’s all.

C05.qxd 3/30/04 9:19 AM Page 42

REAL ESTATE BASICS

42

Purchase Contract A purchase contract is the basic agreement between you and the seller for purchasing the property. Many variations of purchase contracts exist. You can check with local Realtors or title insurance companies to obtain a copy of the type of purchase contracts used in your area. To obtain a standard contract format, see our book How To Sell Your Home Without a Broker. Remember, regardless of the type of purchase contract you use, the purpose of the contract is to communicate. The more straightforwardly the purchase contract states your intentions to the seller, the easier it will be for the seller to understand what you are trying to do with your offer. If the seller understands what you are trying to do with your offer, then it is more likely he or she will be predisposed to accept your offer. In other words, the simpler your purchase contract is, the better. Purchase contracts have been designed to have a standard writing—boilerplate—to be used for all types of transactions. The blank lines and spaces in the contract are to be used by you to customize your particular deal. We recommend you always stipulate that your offer is contingent on the approval of your money partners (see letter of intent 3, third paragraph). As we go through different real estate investment strategies, we will show you what to add to your purchase contract to put that strategy into effect.

Assignment A real estate assignment allows you to take any contract and make money by assigning your interest in the contract to someone else for a fee. In Section Three, we will spend several chapters giving you all the ins and outs of assignments. The important idea to remember is you will write every real estate contract with the clause “and/or assigns” as part of your name in the buyer’s section of the contract. This will give you the right and ability to assign a contract of whatever kind to another buyer for a fee.

Presenting Your Offer We are going to give you a crash course in real estate offer presentation. The purpose of presenting your offer is to have the seller accept it. By

C05.qxd 3/30/04 9:19 AM Page 43

Writing and Presenting Your Offer

43

building rapport with the seller, you dramatically increase the likelihood that the seller will eventually accept your offer. This is referred to as a win/win tactic. We have said that the purpose of the contract is to communicate. You communicate best when there is rapport between you and the seller. The reason you want to build rapport is to get the seller to like you. If the seller likes you, it will be harder to turn down your offer. There are three responses a seller can have to your offer. The seller can accept your offer. The seller can counter your offer. The seller can reject your offer. If the seller accepts, you have a contract. If the seller counters, you have something to work with. If the seller rejects and says no, you may be at a dead end. You don’t want the seller to say no. You begin building rapport the moment you start an interaction with a person. We have found that smiling at, being respectful toward, and being complimentary to a seller builds rapport. You also have to be energetic and upbeat when you interact with a seller to instill the belief that you can get a real estate transaction done. We go into every interaction with a seller with a win/win attitude. We want the seller to win, and we want to win. You will ﬁnd as a real estate investor that getting a good deal is easy. You just have to ask. When we make an offer, we want to get a good deal. We ﬁnd that when we get a good deal, we are solving a problem for the seller. That makes it win/win for us and the seller.

Where to Present Your Offer Presenting your offer over the phone is not as effective as presenting it in person. Presenting an offer by fax or by e-mail is less effective still. Present your offer in person. Always present your offer at the seller’s kitchen table. Arrange to sit at the head of the table with your back to an outside wall. You want the seller’s attention focused on you, not what is going on in the rest of the house. By presenting your offer at the kitchen table you convey that this is a business situation. If you present the offer in the living room, it conveys more of a social interaction. Ask that TV and radios be turned off. Do not accept an offer of food. Accepting an offer of a beverage (nonalcoholic) is ﬁne. Keep the chitchat to no more than ﬁve minutes. At the appropriate time (see accompanying script), you will give the seller a copy of your

C05.qxd 3/30/04 9:19 AM Page 44

REAL ESTATE BASICS

44

offer so they can follow along with your presentation. You are going to make a presentation!

When to Present Your Offer Present your offer within 72 hours of seeing a property for the ﬁrst time. There are two reasons for this. The ﬁrst has to do with you; the second has to do with the seller. We want you to present offers within 72 hours of seeing the property for the ﬁrst time so you will actually go through with presenting offers. It gets very easy to ﬁnd properties, look at the properties, get scared, and not write and present offers, then ﬁnd more properties, look at properties, and get scared all over again. Get the point? You will not make any money as a real estate investor unless you write and present offers. Remember, Don’t Be Shy. Be Bold! We want you to present offers within 72 hours of seeing the property for the ﬁrst time so you will convey a sense of urgency and interest to the seller. Sellers want to know if you are a serious buyer. Serious buyers take action in a timely manner. That is why it says on most contracts that time is of the essence.

How to Present Your Offer We offer you a script to use when you are presenting offers. The script is the same no matter what kind of contract you are presenting. Practice in the mirror at home or with your real estate investment partner before you try it for real with a seller. After ﬁve minutes of chatting at the seller’s kitchen table, this is what you say and do. Script Pull two copies of your offer out of your briefcase or folder. Place them face-down facing you on the table in front of you. Look at the seller and say: “Mr. and Mrs. Seller [if you are on a ﬁrst-name basis use the seller’s ﬁrst name(s)], We are so excited to be able to present our offer to purchase your property today [tonight].” Pause for their response. “Thank you for allowing us to come into your home.” Pause and smile. “As you know, we are real estate investors.” Pause. “Our offer is designed to solve your real estate problems.” Pause. “We want to

C05.qxd 3/30/04 9:19 AM Page 45

Writing and Presenting Your Offer

45

do business with you.” Pause and nod your head up and down. “Would you like to go over the offer?” Pause and wait for the ﬁrst “yes.” Turn over the two copies of your offer, which should be facing you and upside down or sideways to them. Do not give them their copy yet! “Before we go over the offer, we just want to make sure you still want to sell your property. Do you still want to sell your property?” Pause and wait for second “yes” “If we can solve your real estate problems, can we do business?” Pause and wait for the third “yes.” Now give them their copy of the offer. You cannot help the seller solve their real estate problems without making money for yourself. You are an investor, not a philanthropist. Don’t buy the seller’s problems. The purpose of the script is to have the seller be receptive to your offer. If the seller does not accept your offer, talk over the sticking points and ask for a counteroffer. Know what you and your money partners are prepared to do before you accept a counteroffer from the seller. We have found that we can create a win/win situation for us and the seller by using the script. Use the script! In the next chapter we will show you what to do after you have reached a meeting of the minds with the seller. Just because the seller has accepted your offer or you have accepted the seller’s counteroffer does not mean you have made any money. Closing your deal is where the money is made. We believe that properly closing your deal will make you big money. Are you ready to make big money in real estate? Read on!

C06.qxd 3/30/04 9:19 AM Page 46

C H A P T E R

6

Closing Your Deal

Properly closing your deal will make you a lot of money. The best deal is worthless unless you can get it closed. Typically, the checks you receive as a real estate investor come from the closing entity. Find a good escrow company or real estate attorney who understands what you are trying to do. Also, a good title insurance company is an important component of your closing team. Closing is the successful completion of a real estate transaction in which funds are disbursed and title is transferred from the seller to the buyer. Although closing could be accomplished by you and the seller simply getting together and exchanging money and documents, most property transactions today use an escrow type of closing.

Quick Cash System In our Quick Cash system, you may wind up receiving money directly from another real estate investor without going to a closing. You could be assigning a purchase contract or an option contract to another investor, who will then go to a closing with the seller. As we describe the techniques presented in this book to make money without buying or owning property, you will get a feel for when you will go to a closing and when you will not. 46

C06.qxd 3/30/04 9:19 AM Page 47

Closing Your Deal

47

Escrow Understanding how the escrow transaction closes can make you comfortable with a process many buyers and sellers ﬁnd very confusing. Escrow is a type of closing in which you and the seller deposit money and/or documents with a neutral third party—the escrow holder. You and the seller give the escrow holder instructions to hold and disburse documents and funds after certain conditions are met. An escrow is complete when all conditions listed in the escrow instructions are met and all acts performed. When an escrow is complete, the escrow holder disburses the funds and documents to close the escrow. In its simplest format, an escrow would have the buyer put the money in the escrow account at the opening of the escrow. The seller would take the money out of escrow at the closing of the escrow. The seller would put the deed to the property in escrow at the opening of the escrow. The buyer would take the deed to the property out of the escrow at the closing of the escrow. Buyer

Seller

In

In

Money

Escrow

Deed

Deed

Escrow

Money

Out

Out

Many things are occurring during the escrow period: termite inspections, physical inspections, partner inspections, geological inspections, title searches, procuring hazard insurance, obtaining ﬁnancing, preparing loan documents, calculating closing costs, preparing deeds, and so on. The day the escrow closes is considered the buyer’s day. What this means is that all the prorations of property taxes, hazard insurance, mortgage interest, and property rents are ﬁgured on this day. Let’s say the escrow closes on the 14th day of the month. The seller is responsible for paying the property taxes, hazard insurance, and mortgage interest through the 13th day of the month. If the property is receiving rental income, the seller is entitled to receive a prorated share of

C06.qxd 3/30/04 9:19 AM Page 48

48

REAL ESTATE BASICS

the monthly rent through the 13th day of the month. This is because rents are paid in advance, usually on the ﬁrst day of the month. The buyer is responsible for paying the property taxes, hazard insurance, and mortgage interest starting on the 14th day of the month. If the property is receiving rental income, the buyer is entitled to receive a prorated share of the monthly rent from the 14th day of the month until the end of the month. Let’s put some numbers to this so you can get a feel for prorations. Prorations are ﬁgured on a 30-day month. If the monthly rent was $900, the prorated rent for a day would be $30. When closing on the 14th day of the month, the seller would be entitled to 13 days of rent at $30 a day. This would be $390 of the $900 dollars the seller collected from the renter on the ﬁrst day of the month (13 days ⫻ $30 daily rent = $390). The buyer would be entitled to 17 days of rent at $30 a day or $510 of the $900 monthly rent. Remember, rents are paid in advance. Anytime a rent is paid, the rent is paying for the month ahead. Though it goes without saying, we will say it anyway: Never allow a tenant to stay in a property without getting the rent in advance. Seller’s Rent Proration

Buyer’s Rent Proration

$30 daily ⫻ 13 days $390

$30 daily ⫻ 17 days $510

Once the escrow closes, a closing statement is prepared by the escrow holder. The closing statement is set up as a debit and credit accounting. The purchase price appears as a credit to the seller and a debit to the buyer. Let’s say the purchase price was $120,000. Any rental security deposits will be credited to the buyer and debited to the seller. This is because the security deposit does not belong to the seller. All security deposits belong to the tenant. The seller has to pass the tenant’s security deposits on to the buyer. Otherwise, after the sale, when the tenant moves out and wants the security deposit back, the seller will be long gone. The tenant will then look to the buyer as the owner of the property for the security deposit. Let’s say the security deposit was $1,000. Let’s see how the purchase price, security deposit and $900 rent would appear on the seller’s and buyer’s closing statements. Now because the seller had collected the total rent of $900, the seller’s closing statement would show a debit of $510. Because the buyer is entitled to

C06.qxd 3/30/04 9:19 AM Page 49

Closing Your Deal

49

receive the monthly rent from the 14th of the month onward, the buyer’s closing statement would reﬂect a $510 credit. Seller’s Closing Statement Debits $1,000 $510

Purchase price Security deposit Rent proration

Credits $120,000

Buyer’s Closing Statement Debits $120,000

Credits Purchase price Security deposit Rent proration

$1,000 $510

Choosing an Escrow Holder Consider choosing an escrow holder who is willing to take the time to explain what is happening and what you need to do. Choose a company that is located within a convenient distance from where you live, so you can deliver and sign documents or money easily. Depending on your area, the party that acts as the escrow holder can include independent escrow companies, escrow departments of lending institutions, title insurance companies, real estate brokers, and real estate attorneys.

Opening an Escrow After choosing an escrow holder,open the escrow by following these steps: 1. 2.

3. 4.

Contact the escrow holder by telephone or in person. Give the escrow holder all of the relevant information regarding the sale. They may ask you for a copy of the real estate contract. Deposit earnest money, if any, with the escrow holder, preferably in person or, if necessary, by certiﬁed mail. Wait for the escrow company to produce escrow instructions, which may take up to three days.

C06.qxd 3/30/04 9:19 AM Page 50

REAL ESTATE BASICS

50

Escrow Instructions Escrow instructions are the written agreement between you and the seller that translates the contract into a form used by the escrow holder to conduct and close the escrow. The escrow holder may use the contract as a guide to produce the escrow instructions. The escrow holder attempts to prepare the instructions so that the intent and conditions are identical to those in the contract. The escrow holder then asks you and the seller to read and sign the escrow instructions. When you receive the escrow instructions, be sure to read them carefully. Be certain that the intent and the conditions of the escrow instructions are identical to those in the contract. Ask the escrow holder questions about items you do not understand or ones that do not appear to match those in the contract. Sign the escrow instructions only when you are satisﬁed that all items reﬂect exactly the terms of the real estate contract. Once you and the seller have signed the escrow instructions and delivered them to the escrow holder, the instructions take legal precedence over the contract. You and the seller can make changes (amendments) to the escrow instructions only when you both agree (mutual consent) to them. To amend any escrow instruction, ﬁrst discuss the change with the seller. Then obtain the seller’s agreement to the change. Request the escrow holder to prepare documents reﬂecting the change. Once you and the seller sign the documents reﬂecting the change and return the signed documents to the escrow holder, the escrow is amended. Both you and the seller have responsibilities for completing items in the escrow process. The steps you will be asked to take and the order in which you are asked to take them vary depending on the details of your contract, the requirements of your state, the usual procedures in your area, and the process your escrow holder uses. Ask your escrow holder to inform you and the seller what each of you should do and when.

Real Estate Attorney Choose an attorney who specializes in real estate and can guide your transaction through the entire process. Use a local attorney to help you

C06.qxd 3/30/04 9:19 AM Page 51

Closing Your Deal

51

because laws and local customs affecting real estate sales vary. Depending on where you live, you might consider using a real estate attorney in the following ways. Have your real estate attorney write or review any contracts before you sign them. A real estate attorney can hold and distribute funds for you. An attorney can handle any complications that might prevent your closing. The attorney can manage your closing and remedy any defects in the property title. The attorney can work with a title insurance company and arrange for title insurance. You will also want to ﬁnd a real estate attorney who understands your investment goals and the Quick Cash strategy. Our attorney knows about ﬂipping properties, assigning contracts, real estate options, buying discounted paper, and tax liens. We can call our attorney for advice and recommendations at any time. You want a real estate attorney who does real estate law full-time. You don’t need a courtroom real estate attorney who just handles lawsuits.

Title Insurance Company Title insurance companies issue policies of title insurance. These policies ensure that the title is free of liens, which are a charge on real property to pay a debt like a mortgage. The nature and extent of the liens that a title insurance policy protects against depend on the type of policy issued. In some states, a title insurance policy must be issued before the sale of a property can be closed. In many areas title insurance companies act as escrow holders. Check with a real estate agent or title insurance company in your area to see if title insurance companies do closings. Many times the title insurance companies handle real estate closings to be able to provide the title insurance policies. In other words, they handle real estate closings to sell title insurance. Title insurance companies often provide other services, many for little or no charge. They usually answer questions, give explanations, and provide information about property comparables that have sold recently in your area. These companies also deliver important documents involved in the real estate closing process to city, county, and real estate lenders’ ofﬁces.

C06.qxd 3/30/04 9:19 AM Page 52

REAL ESTATE BASICS

52

Title Insurance If you buy property, get title insurance. Never buy property without title insurance. What is title insurance? Title insurance is a policy of insurance issued to you by the title company on completion of the ﬁnal title search, which protects your title to property against claims made in the future based on circumstances in the past. A title search is an examination of information recorded on a property at the county recorder’s ofﬁce in the county where the property is located. The examination veriﬁes that the property has no outstanding liens or claims against it to adversely affect a buyer or lender when the title to the property is transferred to a new buyer or pledged as collateral for a real estate loan. When you are buying property, it is always a good idea to get a preliminary title report from a title insurance company. The preliminary report is usually produced by the title company during the escrow or closing. The purpose of the preliminary report is to make everyone— buyer, seller, lender, escrow holder, title company—aware of the condition of the title involved in the transaction. In Chapter 2, we said there were four elements of value in real estate: demand, utility, scarcity, and transferability. If you can’t provide clear title as a seller to a buyer or real estate lender, your property suffers a huge devaluation. Transferability has to do with clear title. No clear title, no transferability.

Owner’s Policy An owner’s policy of title insurance protects the owner of the real estate. Before title insurance came into vogue in the late nineteenth century, real estate ownership was fraught with perils. A lawyer would be hired to examine the property records and issue an opinion as to the condition of the title. This was called an abstract of title. If a problem from the past arose and another party had a legitimate claim to the property, the current owner was out of luck and lost the property. The displaced, distraught owner would come back to the lawyer who had written the abstract of title to seek redress, but all to no avail. He could sue the lawyer, but if the lawyer had no assets, the owner was left with nothing. This situation happened to Abraham Lincoln’s father three times!

C06.qxd 3/30/04 9:19 AM Page 53

Closing Your Deal

53

An owner’s policy of title insurance protects the owner of record from claims against the title brought by other parties. If a claim arises and you have title insurance, and any monetary damages are to be paid, the title insurance company will pay them. Bottom line: If you buy real estate, get title insurance. By the way, the seller or buyer can pay for the owner’s policy. In some areas of the country, who pays for the owner’s policy is a matter of custom. In southern California the seller pays for it. In northern California, the buyer does. The point is who pays for the owner’s policy is negotiable between the buyer and seller.

Lender’s Policy A lender’s policy of title insurance protects the real estate lender. Let’s face it: Most people buy real estate with little or no money down. The most money a buyer has to put up in a conventional real estate loan situation is 20 percent, and the amount of down payment becomes less from there. That means real estate lenders have 80 percent, 90 percent, 95 percent, or, in the case of a Veterans Administration (VA) loan, 100 percent exposure to a property that they loan money on. A lender’s policy of title insurance protects the lender beyond matters of public record. There may be unrecorded liens or claims against the title. A lender wants to be protected against everything because they have so much money loaned on the property. Typically, the lender makes the buyer who is using the loan proceeds to complete the purchase of the property pay for the lender’s title policy.

Buyer’s Policy A buyer’s policy of title insurance protects the buyer of real estate. The buyer’s policy is similar to the lender’s policy in that it protects the buyer for matters beyond what is in the public record. Although the buyer becomes the owner and is protected by the owner’s policy, a buyer may feel they want extended coverage for their real estate investment. This is why title insurance companies offer a buyer’s policy. The title insurance companies make more money, but they also provide valu-

C06.qxd 3/30/04 9:19 AM Page 54

54

REAL ESTATE BASICS

able coverage. We recommend getting a buyer’s policy if you are going to buy land. If you are buying property that has improvements already on it, in a city limits, a buyer’s policy is probably not necessary. Congratulations! You have completed Section One. Now we move into the really good stuff. The rest of this book is brain food for real estate investors. If you are a beginning investor, fasten your seat belt. If you are a practicing investor, welcome aboard! If you are a seasoned investor, our purpose is to give you some fresh ideas to broaden your investing horizons. Welcome to our Brain Trust. Good luck!

P02.qxd 3/30/04 9:27 AM Page 55

S E C T I O N

TWO

FLIPPING REAL ESTATE

P02.qxd 3/30/04 9:27 AM Page 56

C07.qxd 3/30/04 9:19 AM Page 57

C H A P T E R

7

What Is Flipping?

Flipping is buying a property and then selling it quickly. It is part of the Quick Cash strategy used by many real estate investors. Rather than holding on to a property for income and appreciation, ﬂipping allows an investor to get in and out quickly, hopefully with a proﬁt.

Flipping First Attitude We are going to use examples in this section to give you a sense of the many possibilities that ﬂipping offers to make Quick Cash. Flipping is also the basis of our overall strategy for this book. By studying the examples, you should start to expand the way you look at buying and selling real estate. When you have a ﬂipping ﬁrst attitude, you will discover new ways to make money in real estate investing unforeseen by the average real estate investor. There are two main tactics in the ﬂipping strategy. The ﬁrst of these is what we call ﬁnd and ﬂip. You ﬁnd a property, knowing that you are going to ﬂip it as soon after you close escrow on it as you can. The second tactic is what we call Find, Fix, and Flip. You ﬁnd a property, ﬁx it up as quickly as possible, and then ﬂip it.

57

C07.qxd 3/30/04 9:19 AM Page 58

FLIPPING REAL ESTATE

58

Find and Flip Example 1 We found a seller who wanted to get out of his rental properties. We made an offer on a studio efﬁciency condo, 600 square feet, in Del Mar, California. This property was tenant occupied and rented for $700 a month. The property was located one freeway exit away from the location of the annual Del Mar Summer Fair and Del Mar Thoroughbred Race Track, where the “turf meets the surf.” The tenant was planning on staying. The seller sold us the condo for $63,000, which was the loan amount to the bank. The value of the condo was $72,000.The seller basically signed over the deed and walked away from the property! Why would a seller do this? As real estate investors, we must allow sellers to make up their own minds. Although we might never accept our offer if we were the seller, we cannot presume to know the seller’s motivation or ultimate goal. We offered the seller $63,000 for the condo. We made no down payment. We took over the existing $63,000 bank loan. The seller gave us a quitclaim deed to transfer title in the property to us. Our offer Purchase price $63,000 Down payment $0 Loan amount $63,000 How did we make money in this deal? We found another investor who wanted rental income property. The investor gave us $4,000 cash, and we gave him the title to the property in the form of a quitclaim deed. We “owned” the property for one week! By ﬂipping the property, we had an immediate proﬁt and no landlording headaches. Our Flip Purchase price $67,000 Down payment ⫺$4,000 Loan amount $63,000 Our Proﬁt Received Paid Made

$4,000 $0 $4,000

C07.qxd 3/30/04 9:19 AM Page 59

What Is Flipping?

59

Example 2 We found a piece of vacant land that was worth $1 million. We discovered that the seller was motivated to sell. The seller wanted his price but was ﬂexible on terms. We have found a fundamental truth in the real estate investing marketplace: If the seller wants their price, you get your terms. We have found the corollary to be true, too: If the seller wants their terms, you get your price. We offered the seller $1 million for the property. Did we have $1 million? No! How much down payment did we have? None. How much of a loan from a bank did we want to get? Zero. Who was going to be the lender? The seller! How much was the seller willing to “loan” us? The full amount, $1 million. For how long was the seller willing to loan us the $1 million? Five years. What was the monthly loan payment we wanted to make? Zero. What was the interest rate the seller would accept? Six percent. How was the interest to be paid? Annually. Let us summarize. We offered the seller $1 million for the piece of land. We made no down payment and had no monthly payments. We would owe the seller $60,000 annually (6 percent of the $1 million “loan”). Our Offer Purchase price $1,000,000 Down payment 0 Loan amount $1,000,000 Did we want to pay the seller $60,000 in 12 months? No, of course not. Do we have any money in this deal? No. How did we make money on this deal? We ﬂipped the property. What does that mean? We turned around and sold the property to a new buyer within 30 days after closing. How much did we ﬂip the property for? $1.1 million, $1.2 million, $1.3 million? None of those because we said the property was worth $1 million. We ﬂipped the property for $1 million! How much down payment did we ask for? One hundred thousand dollars, two hundred thousand dollars, three hundred thousand dollars? We accepted zero down payment because we wanted to sell the property quickly. Did we ask the new buyer to get a loan from a bank? No. How much did we “loan” the buyer? The full $1 million. For how long did we loan the buyer $1 million? Five years. Did we get monthly payments on our $1 million “loan”? No. What was the interest rate we negotiated? Eight percent. How was the interest to be paid? Annually.

C07.qxd 3/30/04 9:19 AM Page 60

FLIPPING REAL ESTATE

60

Let us summarize. We accepted $1 million from the new buyer as the purchase price. We got no down payment or monthly payments from the buyer. The buyer would owe us $80,000 annually (8 percent of the $1 million “loan”). Our Flip Purchase price $1,000,000 Down payment 0 Loan amount $1,000,000 Do you see how we made money? When we received our $80,000 payment, we paid our $60,000 payment, leaving us a $20,000 proﬁt! Our Proﬁt Received $80,000 Paid ⫺$60,000 Proﬁt $20,000

Find, Fix, and Flip Example 3 We found a property that was a three-bedroom, two-bath, 1,900-square-feet, single-family residence in a good neighborhood. The owners were in the process of getting a divorce. They had moved out of the property in anticipation of foreclosure. The property was a mess. The roof needed repair. The carpets had to be replaced. The ﬂoor coverings were beyond repair. Painting was needed inside and out. The landscaping was early jungle. The pool was a breeding ground for mosquitoes. As we looked at this property for the ﬁrst time, our Potential Vision became 20/20! This property had all the attributes of big potential. It was the right property. More important, the seller was the right seller. They were very motivated to sell. We got their written permission to talk to their lender. We were able to put off the foreclosure for 60 days. We wrote our offer for 65 percent of what we had determined was the retail value of the property. (Remember, the retail value is the value a property has to the end user, like a homeowner.) We felt the retail value was $135,000. Our offer was for $84,500, all cash at closing.

C07.qxd 3/30/04 9:19 AM Page 61

What Is Flipping?

61

Our Offer Retail value Percentage Our offer

$135,000 ⫻ 65% $84,500

The offer was also contingent on our money partners’ approval. If our money partners didn’t approve of the deal, we had no deal. The seller accepted our offer with no counteroffer. To satisfy the consideration aspect of CoCa CoLa, we wrote a $500 promissory note to the seller. A promissory note is like a check. Most people don’t seem to understand this, but a promissory note is a written contract you sign promising to pay a deﬁnite amount of money by a certain future date. Instead of the promissory note being drawn on a commercial bank, like your check is drawn, it is drawn on you! It is enforceable for payment just like a check. Here is the promissory note we used in this transaction. Promissory Note Example

We brought in our clean-up crew and in ﬁve days had stripped out the carpeting and ﬂoor coverings, cut back the jungle landscaping, drained and cleaned the pool, and painted the entire interior of the house Navaho White (this makes the house look bigger). We did nothing about the roof. Our total cost was $2,200. We left the big stuff for the next real estate investor.

C07.qxd 3/30/04 9:19 AM Page 62

62

FLIPPING REAL ESTATE

We called through our list of investors who liked to do major ﬁxups. The third one on our list that we showed the property to wanted to buy it. We had the purchase price of $84,500, plus our ﬁx-up cost of $2,200 in the property for a total of $86,700. Our Fix-up Purchase price $84,500 Fix up ⫹$2,200 Total $86,700 We sold the property for $92,500 just 10 days after we had made our offer to the seller. We got our ﬁx-up cost back ($2,200) plus $5,800. Not bad for 10 days’ work. Our Flip Purchase price $92,500 Received $92,500 Paid $86,700 Made $5,800 Example 4 Sometimes a real estate deal gets you more involved than you want to be. Our last example in this chapter is instructive in two ways. First, it is another example of a ﬁnd, ﬁx, and ﬂip. Second, it reveals one of our mistakes. Hopefully you can learn from our mistake without having to make it for yourself. We found a property that was a four-bedroom, three-bath, 2,700square-feet, single-family home in a good neighborhood. Elderly people had lived in the home. They had not been able to maintain the property as they got older. Their children had to move them into a nursing home as their health deteriorated. The children were selling the home to generate cash to pay for the parents’ new living arrangement. We wrote our offer for 65 percent of the retail value. We felt the retail value was $200,000. Our offer was for $130,000, all cash at closing. Our Offer Retail value Percentage Our offer

$200,000 ⫻ 65% $130,000

C07.qxd 3/30/04 9:19 AM Page 63

What Is Flipping?

63

We felt we were getting a great deal. We thought we would spend $20,000 on ﬁxing it up and then sell the property for $190,000 to $195,000. We would get our $20,000 ﬁx-up money back, plus make at least $40,000. This investing thing was a piece of cake! Unfortunately for us, this is not the way this deal turned out. Our Projected Proﬁt Receive Pay Fix up Make

$190,000 $130,000 $20,000 $40,000

Our $20,000 ﬁx-up budget blew up in our faces. Once we started tearing the house up, we found mold and dry rot. This was not good. We wound up spending closer to $30,000. Still, we felt we would be all right. We would just make less proﬁt. At this point in our real estate investing, we were doing the major ﬁx-up. This was the biggest one we had ever done. We would buy the property, do all the ﬁxing, then sell it to a retail buyer homeowner. We felt this was the way to go because we would make the most money. With this property, we had gotten into a major remodeling. We realized too late that we were no longer investors on this property but were in the remodeling business. Instead of doing the job for a homeowner who was going to pay us, we were the homeowner! We had also violated the Principle of Regression on this property. Instead of having a property at or below the median price for the neighborhood, we had a property that was now at the top end of prices for the neighborhood. We had one of the best properties in the neighborhood. Ninety-eight percent of the properties in the neighborhood were not as nice and were priced lower than the property we were trying to sell. We ﬁrst tried to sell the property for $200,000. We had no offers in 30 days. We lowered the price to $190,000. We had no offers in two weeks. We lowered the price to $180,000. Still no offers in two more weeks. We were starting to get nervous. It had taken us 60 days to ﬁx up the property. We were now another 60 days into the mission. We were making payments on the $130,000 mortgage the seller had carried back at 12 percent interest only for six months, payable $1,300 monthly. We had $30,000 out of our

C07.qxd 3/30/04 9:19 AM Page 64

64

FLIPPING REAL ESTATE

pocket in ﬁx-up costs plus $5,200 for four months of payments. Plus we were only two months away from the balloon payment of $130,000! This was not good. We ﬁnally sold the property, right at the six-month deadline, for $165,000. We lost money on the deal but felt fortunate that we got most of the money we had put into the property back. Our Loss Received Paid Fix up Payments Loss

$165,000 $130,000 $30,000 $7,800 $2,800

Right then we realized we never wanted to be in that position again. We knew real estate investing worked. We knew ﬂipping worked. We decided that owning and ﬁxing property didn’t work. In Chapter 8, we will show you all the advantages to ﬂipping real estate. Flipping is where real estate investors make money. Flipping is where you will make money.

C08.qxd 3/30/04 9:18 AM Page 65

C H A P T E R

8

Why Use Flipping?

Flipping is the fastest way to make money in real estate. Our investment strategy is Quick Cash. Other investors employ the strategy of long-term wealth building, wherein they buy and hold property for income and appreciation. Flipping also addresses the problem traditionally associated with real estate investing—the lack of liquidity. Once you invest money in real estate, it can be difﬁcult to liquate or sell your assets quickly. Because real estate is the biggest-ticket item there is, there are the fewest buyers in the marketplace compared to any other commodity.

Quick Cash Strategy Each strategy has its advantages and disadvantages. We like Quick Cash (and thus ﬂipping) because we don’t like landlording (we’ve tried it), we love the art of the deal (ﬂipping allows you to make lots of deals), and we like making money right away. In this chapter we will show you the advantages and disadvantages of ﬂipping as a real estate investment strategy. We will also show you the advantages and disadvantages of long-term wealth building as an investment strategy. In most cases, an advantage of the ﬂipping strategy may be a disadvantage of the long-term wealth-building strategy. Of course, an advantage of the long-term wealth-building strategy may be a disadvantage of 65

C08.qxd 3/30/04 9:18 AM Page 66

66

FLIPPING REAL ESTATE

the ﬂipping strategy. Our goal is to have you embrace the ﬂipping strategy, but you may ﬁnd you like long-term wealth building as a real estate investing strategy. No problem. But that is another book!

Top 10 Advantages of Flipping We are going to give you the top 10 advantages of using ﬂipping as a real estate investment strategy. These 10 plusses include: quick cash, no landlording, no monthly mortgage payments, no property taxes, no hazard insurance, no maintenance costs, no homeowner association dues, no lawsuits from people hurting themselves on the property, no extensive record keeping, and no income tax problems. 1. Quick Cash Cash is king! Long live the king! The problem with real estate investing for most people is that it takes too long to make any money. Yes, we know that if you bought a two-bedroom, one-bathroom home in Coronado, California, in 1968 for $20,000, you would be sitting on a property worth $800,000 today. But who has the time or the patience to wait that long? We don’t; do you? Flipping is the answer. When you are a real estate investor whose strategy is Quick Cash, patience does not have to be one of your virtues. In fact, impatience becomes one of your strengths! You become impatient with the deal you are working on and want to get it closed so you can get on to the next deal. The more deals you get involved with, the more money you will make. 2. No Landlording Do we really have to tell you about our landlording horror stories? Do you really think you can be a successful landlord? Being a landlord is a heartless, thankless job. No matter what you do, you’re wrong. Being a lord of the land or a lady of the land has a noble heritage. In olden times there was a symbiotic relationship between the lords and ladies and their tenants. The tenants lived on the property, raised their families, and farmed the land. In return the tenants paid rent to the lords in the form of most of the crops they grew. There was no money. Or at least, most people did not have money, because there were no jobs. Everyone’s “job” was working the land. Unfortunately, this symbiotic relationship from the Middle Ages has been shattered by the realities of today’s world. Landlords are targets for

C08.qxd 3/30/04 9:18 AM Page 67

Why Use Flipping?

67

other people’s problems. As a target, you would become the recipient of a lot of crap. 3. No Monthly Mortgage Payments Month in and month out, 12 months a year for 30 years. Three hundred sixty payments. Let’s look at an example. A $200,000 loan for 30 years at 8 percent interest is payable at $1,467.53 monthly, including principal and interest. Multiply the monthly payment by 360 payments and you will pay a total of $528,310.49. Monthly Payments Monthly payment $1,467.53 30 years ⫻ 360 Total of payments $528,310.49 The really nauseating number is when you realize that you originally borrowed only $200,000! You wind up paying $328,310.49 in interest! That is 164 percent of the amount you borrowed. Amount of Interest Total of payments $528,310.49 Amount borrowed $200,000.00 Amount of interest $328,310.49

4. No Property Taxes Depending on your state, you may pay property taxes once a year or perhaps twice a year. In states like Texas, where there is no state income tax, property taxes can be quite substantial on even modest properties. On a property valued by the county property tax assessor at $137,000, the annual property tax bill can amount to $4,000! If you calculate that on a monthly basis, you are paying $333 a month for every month you own the property. Monthly Property Taxes Annual property taxes $4,000 Monthly property taxes $333.33 5. No Hazard Insurance Flipping requires no ﬁre insurance, no liability insurance, and no earthquake insurance. No insurance, period. The

C08.qxd 3/30/04 9:18 AM Page 68

68

FLIPPING REAL ESTATE

last time we checked, all kinds of insurance are expensive. Real estate lenders calculate a monthly insurance payment when qualifying you for a real estate loan, even when you prepay the insurance payment in escrow for the coming year. In addition, the monthly ﬁre insurance payment is the ﬁnal I in the PITI payment associated with a real estate loan: Principle, Interest, Taxes, and Insurance. You know, the PITI payment, as in, isn’t it a pity? 6. No Maintenance Costs New roof: $6,000. New dishwasher: $400. Gardener: $100 monthly. Pool maintenance: $75 monthly. Are you getting the picture? Real estate ownership entails signiﬁcant maintenance costs. There is no way around this other than not owning property. That’s why we prefer making money without owning property. You may have heard the phrase “deferred maintenance.”That is bad. Deferred maintenance is the polite way of saying a property is a ﬁxerupper because the property owner spent no money on regular maintenance through the years. Now it is going to cost way more to get the property in shape than the amount the property owner would have spent over the years in regular maintenance. Again, an obvious solution: don’t own property, ﬂip it. 7. No Homeowner Association Dues If you are or have ever been part of a homeowner association, then you know the frustration of dealing with the sometimes mini-tyrants. Not to mention $100, $200, or $300 (or higher) monthly dues. Special assessments from an association can also be levied for painting, landscaping, or rooﬁng in the thousands of dollars. If you don’t pay your monthly dues or special assessments, then your friendly homeowner association can foreclose on you and/or sue you. Homeowner associations are no longer just attached to condominiums. We are seeing more and more maintenance associations attached to Planned Unit Developments (PUDs) and single-family residences (SFRs). 8. No Lawsuits Do you know any good attorney jokes? Seriously, if you own real property (especially if you rent it out), there is a real probability that you will be sued. If not by one of your tenants or guests, then certainly by a cutthroat attorney who looks up your real estate holdings in the public record to determine if they will take a case based on the assets that you own that they can go after.

C08.qxd 3/30/04 9:18 AM Page 69

Why Use Flipping?

69

We are not kidding about this. When you own property, you are a target for frivolous lawsuits. Some of you reading this already know exactly what we are talking about. You have been sued for no apparent reason. But we know that some of you have paid legal settlements just to make the frivolous lawsuit go away. Our solution? Don’t own real property. Control real property. How do you do this? Good question. The answer is what this book is about. 9. No Extensive Record Keeping Can you say certiﬁed public accountant (CPA)? When you own rental real estate, you must keep extensive records. You will have a full-time job as a CPA or you will be paying a CPA. You will have rent receipts, security deposit receipts, check books (notice we used the plural here). You will have checking accounts and bank statements to reconcile. Don’t forget the legal requirement in some areas of having a trust account for tenant security deposits. You will keep maintenance accounts. You may have employees with all the paperwork and tax nightmares that entails: worker’s compensation insurance, unemployment insurance, health insurance, OSHA safe working condition requirements, Social Security taxes, withholding federal income taxes. This list goes on and on. 10. No Income Tax Problems Currently, when you recapture depreciation you pay 25 percent in taxes. How easy is it to recapture depreciation? Very easy: Just own rental real estate and take depreciation, then pay the hefty tax bill!

Disadvantages of Flipping Our ﬁrst inclination was to leave this section blank, but we will list a few disadvantages of ﬂipping. These four downsides include no participation in future appreciation, no income tax write-offs, no monthly income, and no pride of ownership. 1. No Future Appreciation When you employ the Quick Cash strategy, you are not looking to invest in real estate for future appreciation. However, you may ﬂip a property to another real estate investor who is interested in future appreciation. If you have done your homework and

C08.qxd 3/30/04 9:18 AM Page 70

70

FLIPPING REAL ESTATE

bought the property wisely, then it may be very attractive to the longterm wealth-building real estate investor. 2. No Tax Write-Offs When you use ﬂipping as a real estate strategy, you will miss most of the tax write-offs associated with ownership (primarily the interest in the mortgage loan). We do not feel this is a true disadvantage. Sure, everybody likes a good tax deduction. But you have to have a proﬁt to use the deduction against. We like making money. Flipping real estate practically guarantees you will make money. We will take our chances on having a tax consequence with a guaranteed proﬁt by ﬂipping property. When you hold real estate, you may make money (you may make a lot of money), but you also may not make money. The longer you hold real estate, the more likely it is that something bad will happen. 3. No Monthly Income Again, this is not a disadvantage for us. We actually make more monthly income than most real estate investors who own rental property. We receive monthly income from other investors, rather than from tenants. We ﬁnd that other investors have way more money than tenants! The real estate investors always pay on time. 4. No Pride of Ownership Pride of ownership can be an expensive virtue. How much does it really cost to own real estate? The answer is, it all depends on many factors. However, we have owned real estate, and we know that it is simply an expensive proposition.

Long-Term Wealth Building We said we would teach you about long-term wealth building as a real estate investment strategy. Again, we are not adverse to this approach. You may ﬁnd that you are more suited to this strategy than you are to ﬂipping.

Advantages of Long-Term Wealth Building The advantages of long-term wealth building are fourfold. As we have already said, the advantages of this strategy mirror the disadvantages of

C08.qxd 3/30/04 9:18 AM Page 71

Why Use Flipping?

71

ﬂipping: future appreciation, income tax write-offs, monthly income, and pride of ownership. 1. Future Appreciation When you employ the long-term wealth building strategy, you are looking to invest in real estate for future appreciation. Future appreciation is the name of the game for you. Depending on the appreciation rate in your area, the value of your property may double every 10 years. The value of our friend’s property in California doubled over ﬁve times in 35 years! The property doubled in value every seven years. The friend bought the property in 1968 in Coronado, California. The property was a two-bedroom, one-bathroom, 700-square-foot beach bungalow not actually on the beach. John bought the property for $20,000. Today the property is worth $800,000. 2. Income Tax Write-Offs When you use long-term wealth building as an investment strategy, you will gain tax beneﬁts associated with real estate ownership. Many investors count on the tax beneﬁts as an important component of their investing. These tax beneﬁts include long-term capital gains treatment of real estate proﬁts on property held for more than one year. Also, the ability for a real estate investor to do an IRC 1031 tax-deferred exchange, which defers the recognition of proﬁt (and hence taxation) to a later date. Any maintenance and repairs made to property are deductible. Don’t forget everyone’s favorite—depreciation. 3. Monthly Income Many real estate investors are quite successful at being landlords. We know some who generate $5,000 a month in positive cash ﬂow. Some generate $10,000, $15,000, or even $20,000 a month! That is a lot of money. If you can consistently generate positive monthly cash ﬂow, you will deﬁnitely build long-term wealth. 4. Pride of Ownership Pride of ownership is an advantage of the long-term wealth building strategy. When a real estate investor takes pride in the investment properties, they take better care of them. They do the maintenance to keep the property in top condition. This attracts a better quality of tenant. Rents are paid on a consistent basis. Monthly income goes up. Future appreciation is enhanced.

C08.qxd 3/30/04 9:18 AM Page 72

72

FLIPPING REAL ESTATE

Disadvantages of Long-Term Wealth Building The disadvantages of long-term wealth building are many. They include waiting for your money, landlording, monthly mortgage payments, utility bills, property taxes, hazard insurance, maintenance costs, homeowner association dues, exposure to lawsuits, extensive record keeping, and complicated income tax problems. 1. Waiting for Your Money The problem with the strategy of longterm wealth building is that is long-term! For most people it takes too long to make any money. 2. Landlording Here is the short list of landlording horror. Rent not paid on time or at all. Unlawful detainer actions. Eviction notices. Hiring an attorney. Dealing with an attorney. Paying an attorney. Being in court. Losing in court. Winning in court (only the attorneys really win). Collecting on your winning court judgment. Being collected on for the tenant’s winning judgment. Huge messes to clean up. Concrete in the toilet. Concrete in the drains. Concrete in the oven. All true. 3. Monthly Mortgage Payments Month in and month out, 12 months a year for 30 years. Remember our earlier example: A $200,000 loan for 30 years at 8 percent interest is payable at $1,467.53 monthly, including principal and interest. You will pay a total of $528,310.49 over the life of the loan. Whether you have a tenant or not, and if the tenant doesn’t pay the rent, you still have to pay the mortgage. 4. Utility Bills Oh, you think you have no utility bills because the tenant pays for all the utilities? Think again. Who is going to pay for the water? Who is going to pay for trash collection and recycling? What about the electricity for the security systems and outside lighting? Who is paying for the electricity for the pool ﬁlter and pool light? What about the utilities for the washers and dryers? The owner is paying for all of these expenses. 5. Property Taxes Depending on your state, you may pay property taxes once a year or perhaps twice a year. Property taxes can be quite substantial on even modest properties in some areas. The owner of the property is responsible for paying these taxes. 6. Hazard Insurance Fire insurance, liability insurance, earthquake insurance, oh my. The last time we checked, any kind of insurance is expensive, assuming you can even get it.

C08.qxd 3/30/04 9:18 AM Page 73

Why Use Flipping?

73

7. Maintenance Costs Real estate ownership entails signiﬁcant maintenance costs, as we mentioned earlier. There is no way around this other than not owning property. Remember, deferred maintenance is the most expensive maintenance. 8. Homeowner Association Dues If you are or have ever been part of a homeowner association, remember that we mentioned the frustration that can arise from dealing with them. Not to mention the monthly dues or special assessments for painting, landscaping, or rooﬁng. Remember, also, if you don’t pay your monthly dues or special assessments, then the association can foreclose on you and/or sue you. 9. Lawsuits If you own real property, there is a real probability that you might be sued, if not by one of your tenants or guests, then certainly by a cutthroat attorney who looks up your holdings in the public record to determine if they will take a case based on the assets you own. We personally know this to be true. 10. Extensive Record Keeping Are you a CPA? Be ready to hire one. When you own rental real estate, you must keep extensive records: rent receipts, deposit receipts, check books, and trust accounts, to name a few. 11. Income Tax Problems Can you say audit? Can you say recapture of deprecation? Currently, when you recapture depreciation you pay 25 percent in taxes. How easy is it to recapture depreciation? Very easy. Just own rental real estate and take depreciation! Now that you know the advantages of ﬂipping real estate rather than buying and holding it, we are going to show you how to ﬂip your real estate deals. If you think the advantages of long-term wealth building as an investment strategy outweigh the advantages of Quick Cash and ﬂipping, then continue reading because we will convince you otherwise. In Chapter 9 we will show you how easy it is to ﬂip properties. Flipping is a mindset. Remember to think about ﬂipping a property even before you see a property. Flipping is a two-step process. The ﬁrst step is to tie up a property. The second step is to ﬁnd a new buyer. In the next chapter be prepared to discover our real estate investment axiom.

C09.qxd 3/30/04 9:18 AM Page 74

C H A P T E R

9

How to Flip

Flipping is a two-step process. The ﬁrst step is to tie up a property. This is otherwise known as making an offer. The second step is to ﬁnd a buyer, known as making money on your deal. The ﬁrst part of this chapter will be about how to tie up a property. We will introduce you to our real estate investment axiom: Buy the property ﬁrst, then get the ﬁnancing. Once you understand this technique, you will be able to tie up any piece of property anywhere in the country. This real estate investment axiom is so revolutionary that if it is all you get out of reading this book, we ﬁrmly believe you will be a successful real estate investor. The second part of this chapter will be about types of buyers. When you are a real estate investor, you only make money when you sell real estate. You don’t make any money when you buy a property. Although this book is about making big money in real estate without buying or owning property, we have to show you how most investors work before we can show you how we do real estate investing.

Tying Up a Property Buy the Property First, Then Get the Financing In the 1990s, when we traveled the country teaching real estate investors Robert Allen’s Nothing Down seminars, we blew them away 74

C09.qxd 3/30/04 9:18 AM Page 75

How to Flip

75

with “buy the property ﬁrst, then get the ﬁnancing.”In city after city, people in the seminar told us we could not buy real estate that way. We told them to try it our way and report back to us what happened. Lo and behold, from Seattle to Orlando, from Los Angeles to Baltimore, from Chicago to Dallas our students found that they could indeed buy the property ﬁrst, then get the ﬁnancing! Mindset Most (if not all) residential retail buyers of real estate (home buyers) have this mindset: how much money do I have to put down (down payment), and how much of a monthly payment can I afford (what we call the PITI payment: Principal, Interest,Taxes, and Insurance). With this mindset, they go to a lender to get prequaliﬁed or preapproved. What the real estate lender says determines how much of a house the home buyer thinks he or she can afford. Of course,being prequaliﬁed means nothing once you actually apply for a loan. Only the lenders and agents don’t tell you this important detail.You can be prequaliﬁed for a $200,000 real estate loan and actually wind up receiving only a $175,000 loan at closing. You are a real estate investor, not a home buyer.You are a wholesale buyer of real estate. You are going to do things differently. Everyone (except us) will tell you get your ﬁnancing ﬁrst, then buy the property. We ﬁnd this unnecessary, time wasting, expensive, and disheartening. Example 1 We found a four-bedroom, two-bathroom, single-family home in Bedford, Texas. The seller was asking $159,000. The seller had an assumable VA loan with a remaining balance of $129,000. The agent told us the seller was ﬂexible. This was music to our ears. When the agent asked us what we were prequaliﬁed for, this was our response (and will be yours). We told the agent that we were real estate investors. If the property met our parameters, we had the ﬁnancial resources, along with our money partners, to buy the property. We offered the seller no money down and agreed to take over the payments on the loan. The seller accepted our offer. We did not have to qualify for a new loan. We did not have to qualify to take over the seller’s VA loan. We did not have to come up with a down payment. We made an offer that worked for us. We let the seller decide whether to accept the offer. Why the seller accepted was his own business. Asking price Purchase price Difference

$159,000 $129,000 $30,000

C09.qxd 3/30/04 9:18 AM Page 76

76

FLIPPING REAL ESTATE

We now had a property available to ﬂip. Only by making an offer can you start the process of ﬂipping a property. No offering, no ﬂipping. We ﬂipped the property for $136,000 within 30 days to a retail buyer who was going to live in the property. The buyer was very happy to get a good deal. We were happy because we made $7,000. Sales price Purchase price Proﬁt

$136,000 $129,000 $7,000

Example 2 We found a three-bedroom, two-bathroom, single-family home with a pool that was owned free and clear, meaning there was no ﬁnancing against the property. The sellers had either paid cash for the property when they bought it or lived in the property so long that they had paid off any ﬁnancing used to purchase it. We offered the sellers no money down and asked them to carry back the ﬁnancing on the property. In other words, we asked the sellers to be the bank. Why would a seller do this? Doesn’t every seller want to be cashed out at the close of escrow on every real estate transaction? The answer is not always. We ﬁnd out what the seller is going to do with their equity before we make our offer. Equity Equity is the difference between the sales price of a property and the amount of ﬁnancing a seller owes on the property. In this example, the equity is the same as the sales price because the seller owes nothing on the property. Sales price Loan amount Equity

$210,000 $0 $210,000

The sellers didn’t need their equity in cash. They were interested in an income stream. The seller was planning on putting their equity into certiﬁcates of deposit (CDs) at the bank. When we showed the sellers that they could quintuple the amount of interest they would receive from the bank by carrying back the ﬁnancing on our purchase, they were very excited. We noted before that your job is to create win/win situations. This was just such a scenario. This is what the seller would have received at the bank if they had deposited their equity into CDs.

C09.qxd 3/30/04 9:18 AM Page 77

How to Flip

77

CD $210,000 CD interest rate ⫻ 1% Annual amount of interest $2,100 Monthly income stream $175 This is what the sellers received by carrying the ﬁnancing on our transaction. Mortgage amount $210,000 Mortgage interest rate ⫻ 5% Annual amount of interest $10,500 Monthly income stream $875 We ﬂipped the property to a retail buyer who had had some credit problems in his past. This buyer could not qualify for conventional ﬁnancing. He had a good job and could afford the payments on the seller carry-back mortgage. We sold the property for $221,000 and made $11,000. The original seller was happy with the income stream. Our buyer was happy because he was able to get into a nice home. We were happy because we had ﬂipped another property, made money as investors, and were part of a triple-winning situation. Sales price Purchase price Proﬁt

$221,000 $210,000 $11,000

Types of Buyers There are only two types of buyers in the real estate market. There are retail buyers, and there are wholesale buyers. This is very good news for you as a real estate investor. Most real estate investors are wholesale buyers by deﬁnition. It is pretty hard to be a real estate investor and pay retail prices for property. You won’t make any money. In fact, you will lose money on a consistent basis. Then, instead of having real estate investments, you will have liabilities.

C09.qxd 3/30/04 9:18 AM Page 78

FLIPPING REAL ESTATE

78

Three Choices As a real estate investor, you have three choices of whom you are going to ﬂip your real estate properties to. You can ﬂip your properties to retail buyers (homeowners). You can also ﬂip your properties to other investors (wholesale buyers). Or, and this is the way we prefer to do our investing, you can ﬂip your properties to both retail and wholesale buyers.

Retail Buyers We have found that most real estate investors ﬂip their properties to retail buyers. You may have seen the billboard ads that read,“We Buy Ugly Houses.” These are real estate investors who pay wholesale for property. They go in and ﬁx up the property. Then they sell the property as a For Sale By Owner (FSBO) to a retail buyer end user. There is a lot of money to be made doing this type of real estate investing. How else could you pay for all the billboard advertising? The problem with retail buyers is they can be too ﬁnicky. They want everything to be perfect. Because most of the property you are dealing with as an investor is existing property (used property), it will never be brandnew. Retail buyers can nickel-and-dime you to death on small items. Example 3 Early on in our real estate investing career, we tied up a three-bedroom, three-bathroom single-family home with a pool. We spent $8,000 ﬁxing up the property. We found retail buyers who said they were in love with the house. To make the deal work, we agreed to repaint the inside of the house, which we had just painted Navajo white, the colors the buyers wanted. We also agreed to run a natural gas line to the utility room so the buyers could use their gas dryer. Finally, we had a tree removed from the pool area because the buyers were concerned that the roots were going to crack the bottom of the pool. Can you guess what happened? The buyers came down with a disease that all retail buyers get during the course of a real estate transaction. Some buyers get a mild case of the disease. Some buyers get a severe case of the disease. Unfortunately for us, these particular buyers came down with a terminal case of the disease. Buyer’s Remorse What is this dreaded disease? Buyer’s Remorse! Every buyer experiences the onset of this disease once their offer is ac-

C09.qxd 3/30/04 9:18 AM Page 79

How to Flip

79

cepted by the seller. There is no known antidote or medication. The disease has to run its course. The symptoms of Buyer’s Remorse usually strike at night when a buyer is about to go to sleep. Sometimes the symptoms strike after the buyer has fallen asleep, and they awaken as if from a nightmare. The buyers start having doubts about the purchase. Are they doing the right thing? Should they look at more properties? Did they offer too much? Can they really afford the monthly payments? Is the house big enough? Is the house too big? They start to sweat. They get out of bed and get a drink of water. They go back to bed, but they can’t fall asleep. The questions beginning swirling again in their heads. What if they don’t qualify for a loan? What if they do qualify for a loan? Who is going to take care of the pool? What if the pool does leak? In our case, three weeks after we had accepted the buyers’ offer, and three days after we had ﬁnished repainting, installing the gas line, and removing the tree, the buyers backed out. Their case of remorse became terminal for them and for us. Our deal was dead. Bottom line: Provide allowances for the work to be done after closing if you must to make the deal work, but don’t spend your time or money on it before closing. Example 4 The other problem with retail buyers is they usually do not pay cash for their real estate purchases. They have to qualify for a loan from a real estate lender. This means you will have to wait longer to get your money. Forty-ﬁve days is a fairly standard closing period from the time an offer is accepted to get a loan processed and funded. In the case of a government-insured loan or a government-guaranteed loan such as FHA (Federal Housing Administration) or VA (Veterans Administration) loans, it may take anywhere from 45 to 75 days to fund the loan and close the escrow! Again, early on in our investing career adventure, we tied up a 3-bedroom, 1.5-bathroom condo. We bought it for $77,000 with nothing down and took over the seller’s existing loan. We ﬂipped the condo to a retail buyer who made an FHA offer to us for $87,000. This looked like a sure money maker for us. Sales price Purchase price Proﬁt

$87,000 $77,000 $10,000

The escrow was to close in 45 days or sooner. When it ﬁnally closed after 79 days, we had quite a surprise. Not only did we have al-

C09.qxd 3/30/04 9:18 AM Page 80

FLIPPING REAL ESTATE

80

most three months of interest due on the old loan being paid off, but we had almost three months of property taxes to pay and almost three months of homeowner association dues to pay as well. Coup de Grâce The coup de grâce was the four discount points we had to pay for the buyer on the $84,000 FHA government-insured loan. Each discount point was 1 percent of the loan amount, or $840! Needless to say, we were not happy with what happened to our $10,000 proﬁt. Potential proﬁt Interest Property taxes Homeowner dues FHA discount points Actual proﬁt

$10,000 $1,540 $750 $353 $3,360 $3,997

Wholesale Buyers We actually prefer ﬂipping our investment properties to wholesale buyers. Wholesale buyers do not get Buyer’s Remorse. We know some of you are saying,“Wait a minute. How can you make any money selling real estate to a wholesale buyer? Don’t wholesale buyers want to pay a wholesale price?” We do ﬂip our investments at a wholesale price to wholesale buyers! We are not greedy about it. We prefer to do many smaller deals and make a proﬁt rather than one or two big deals that are very timeconsuming and entail more risk. (See Example 4.)

Retail and Wholesale Buyers We have come to appreciate that being successful real estate investors is strictly a numbers game. Although we prefer to ﬂip our properties to other investors (wholesale buyers) for all the reasons we just talked about, we are still smart people. Our marketplace is retail and wholesale buyers. The more buyers you have in your potential pool, the more likely you will be able to ﬂip your properties successfully. In Chapter 10, we will go over the best times to ﬂip your real estate investment properties. Flipping real estate is like anything else in life: practice makes perfect. So practice, practice, practice.

C10.qxd 3/30/04 9:18 AM Page 81

C H A P T E R

10

When to Flip

Flipping at the right time is crucial. Actually, we’re just kidding. It has been our experience as real estate investors that there is no right time to ﬂip property. What we want to teach you in this chapter is how to determine when to ﬂip. The answer is easy. Flip the property before you make an offer on it. Flip the property after you have made an offer on it. Flip the property before you close escrow. Flip the property after you close escrow. In other words, ﬂip property any time. Any time you can make money, that is.

Flipping before You Write the Offer Can you ﬂip property before you write the offer? Sure, why not? In the last chapter we talked about retail or wholesale buyers for property you want to ﬂip. There is no rule or law that says you have to write an offer before you ﬂip a property.

Caveat The one caveat we will give you about ﬂipping property before having a written offer accepted by the seller is this: You must have something in writing with the potential buyer before you give them any information about the property or the seller. 81

C10.qxd 3/30/04 9:18 AM Page 82

82

FLIPPING REAL ESTATE

Can you ﬂip a property too soon? Is this bad? Should you have waited for the second or third investor to come along? Our experience tells us that if you have a deal, take it. The old adage “a bird in the hand is worth two in the bush” must have been coined by a real estate investor. Nondisclosure and Noncircumvention Agreement It is important to protect yourself in any real estate transaction. That is why we stressed CoCa CoLa as part of any real estate contract. We also said that for a contract to be valid, it must be in writing. How do you protect yourself as an investor in a real estate transaction where an offer has not been written to (let alone accepted by) the seller? What would prevent a potential buyer of your ﬂipped property from going directly to the seller after you tell the buyer and cutting you out entirely? This is where a nondisclosure and noncircumvention agreement comes into play. It becomes the agreement before the real estate contract. On page 83, you’ll ﬁnd an example of a simple nondisclosure and noncircumvention agreement, which we use to give us protection with potential buyers of a property that we have not tied up yet with a contract. Why would we bother to show a potential buyer a property when we have not gotten an accepted offer? Why don’t we just wait until the offer is accepted? We then would not have to have such an agreement. Network of Real Estate Investors We have a network of real estate investors who specialize in ﬁxer-upper property. We have them look at property that we ﬁnd to get an amount that they think it will take to ﬁx it up. They also give us a price they are willing to pay. We then have a range of prices and buyers who we can ﬂip the property to. This helps us know how to negotiate with the seller. Example We found a property that was a bomb, as in the property needed to be blown up. The property had been vacant for a year. We knew we needed to strip everything back to the studs. We thought we might have to use napalm to kill the rats, mice, roaches, ﬂeas, molds, and bacteria that called this place home. When we were about to get back in our vehicle after looking at the inside of this property for the ﬁrst time, we looked down at our clothing. We were covered in ﬂeas! We were fresh meat that had just walked in the door. We spent the next 30 minutes doing the ﬂea dance.

C10.qxd 3/30/04 9:18 AM Page 83

When to Flip

83

C10.qxd 3/30/04 9:18 AM Page 84

84

FLIPPING REAL ESTATE

We brushed each other off one at a time. Then we would have to move 20 feet away so the ﬂeas we had just brushed off did not jump back on. We laughed later in the day when we realized how funny we must have looked to anyone watching and not knowing we had ﬂeas! Although our Potential Vision was going crazy, we were still hesitant to make an offer without some help. Because our expertise is not in construction or remodeling, we wanted to show the property to investors who did have this knowledge. We were looking for second and third opinions. We approached three investors who we knew were in the ﬁx-up business. We had each of them sign the nondisclosure and noncircumvention agreement. Then we showed the investors the property at different times. (By the way, on these subsequent visits we all wore coveralls over our clothing.) One investor said the property could be ﬁxed for $25,000. The second said the property could be ﬁxed for $35,000. The third said he wouldn’t touch the property with a 10-foot pole! With the information from these investors, we wrote an offer on the property for the land value. Without our investors’ help, we would have overpaid for the property. We told the seller that the building was basically worthless. We would have to completely gut the building and start over. The owner was asking $62,000. We offered the owner $39,000 cash. We bought the property for $39,000. Our Offer Asking price Our offer Purchase price

$62,000 $39,000 $39,000

Now we needed to ﬂip the property. Which one of the three investors do you think we ﬂipped the property to? The ﬁrst investor, who gave us a $25,000 estimate? The second real estate investor, who gave us a $35,000 estimate? Or, did we ﬂip the property to the third investor, who was the one who wouldn’t touch the property with a 10-foot pole? Our Flip We ﬂipped the property to the investor who wouldn’t touch the property with a 10-foot pole! We told him about the $25,000 and $35,000 estimates from the other investors, and he decided he might just be able to make some money on the deal. We ﬂipped it to him for $52,000.

C10.qxd 3/30/04 9:18 AM Page 85

When to Flip

85

Our Flip Sales price Purchase price Proﬁt

$52,000 $39,000 $13,000

Flipping after You Write the Offer We have found that we ﬂip the majority of our properties after we write the offer and have it accepted by the seller. This gives more control of the entire situation. Once we have our offer accepted, the seller knows we are serious. The seller also feels more comfortable giving us access to their property the multiple times we may need to take potential buyers through it.

Modus Operandi We want you to understand our modus operandi here. Though real estate investors have been ﬂipping real estate for a long time, we are following in that great tradition with several important improvements. Most real estate investors ﬂip property after they take title to it. In other words, after they have closed escrow. We have given several examples of ﬂipping property after we have taken title (closed escrow), but we are taking you into new territory now. This new territory includes what we just covered with ﬂipping property before you write an offer. It also includes ﬂipping property after writing an offer and ﬂipping property before you close escrow.

Flipping without Owning You may be thinking of a question here. You may have grasped the fact that ﬂipping real estate is easy, if you are ﬂipping property you own. If you own the property you have the title to the property in the form of a grant deed or a warranty deed depending on what ownership deed is used in your state. (We have included in Appendix A the ownership deeds that are used in all 50 states and Puerto Rico.)

C10.qxd 3/30/04 9:18 AM Page 86

FLIPPING REAL ESTATE

86

After you make a deal with the new buyer and ﬂip the property, you give them ownership of it by giving them a new grant deed or warranty deed. You could even use a quitclaim deed, as we described with some of our deals.You own the property, so it is easy for you to sell or ﬂip your ownership interest in the property to a new buyer. Your question may be: How do you ﬂip real estate you don’t own? That is a very good question! It turns out that we are not in the real estate investment business at all. That would imply that we invest in real estate, that we own real estate. Real Estate Wholesale Deal Business We are in the real estate wholesale deal business! We negotiate a great deal with an owner of a property. In other words, we tie the property up. We then ﬁnd a new buyer. This could be a retail or a wholesale buyer. We then ﬂip the deal to the new buyer. We don’t ﬂip the property. The property just happens to come along with the deal. If the new buyer is a wholesale buyer, they are going to ﬂip the property again to a retail buyer. We are interested in owning real estate for just as long as it takes to ﬂip a deal. The real estate just happens to be the lawful subject of the deal. Assigning When you read Section Three on assigning, you will get the full picture of what we are talking about here. What you want to take away from this discussion is that there is a way to ﬂip real estate without actually owning it! In fact what you are assigning are Real Estate Contracts. Once you can grasp this concept you are going to be like a real estate kid in a real estate candy store. Does anyone smell money?

Flipping before You Close Escrow We ﬂip 95 to 98 percent of our deals before we close escrow. What is the difference between ﬂipping after you write the offer and ﬂipping before you close escrow? The difference is when you ﬁnd a new buyer for your deal.

Finding a New Buyer If you ﬁnd a new buyer after your write the offer and before you open escrow, the new buyer will open escrow with the seller. If you ﬁnd a

C10.qxd 3/30/04 9:18 AM Page 87

When to Flip

87

buyer after you open escrow and before you close it, the escrow between you and the seller will have to be amended to reﬂect the new buyer as the other party to the seller in the escrow. You will not be a party to the escrow any longer. This difference will become more apparent as we go through other sections of this book. For now, sufﬁce it to say that if you can ﬂip a deal after writing your offer and before opening an escrow, you will save valuable time and make money more quickly. If you have to wait to ﬂip a deal until after you open escrow, you may also incur some additional expenses. You may be responsible for paying for the preliminary title report. You may also be responsible for paying for part or all of the buyer’s side of the escrow fees.

Flipping after You Close Escrow Most real estate investors ﬂip properties after they close escrow. Most are more comfortable closing escrow on a property and owning it ﬁrst before they ﬂip it.You have to ﬁnd your comfort zone with this aspect of real estate investing. What we ultimately want to expose you to is ways to make money in real estate without buying or owning property. Because this chapter is about when to ﬂip property, we include this traditional time of Flipping property. This is when most people are used to ﬂipping property—after they close escrow. Please do not take us the wrong way. Plenty of real estate investors have made lots of money ﬂipping real estate after the close of escrow. We are not saying that owning real estate is a bad thing. We just prefer making money in real estate investing without buying or owning property!

Timeline for Flipping This is a good place to make another timeline so you can easily visualize when the different periods to ﬂip your deals occur. What we are saying is new here is anything to do with ﬂipping your deal, up to and including ﬂipping your deal before you close escrow.

C10.qxd 3/30/04 9:18 AM Page 88

FLIPPING REAL ESTATE

88

Until the close of escrow, you are ﬂipping the deal and not the property. You don’t own the property and hence can’t ﬂip it until after escrow closes. After escrow closes, you do own the property, and you are ﬂipping the property and not the deal. Flipping the property is the same old stuff. Timeline for Flipping Deals Write offer

Open escrow

Close escrow

Flip

Flip

Flip

Flip

before

after

after

after

writing

writing

opening

closing

offer;

offer;

escrow;

escrow;

new

new

new

old

Summary You can ﬂip your deal before writing an offer with the help of the nondisclosure and noncircumvention Agreement. You and the new buyer sign this agreement. You show the new buyer the property. You ﬂip the buyer the deal after they help you determine a price to offer the seller. You can ﬂip your deal to a new buyer after writing your offer to the seller. You can do the ﬂip either before or after you open an escrow. In either case you will make money on the ﬂip. Finally, you can ﬂip the property after escrow closes. In Chapter 11, we will give you the low-down on the best kinds of property to ﬂip. Also, we will show you where to ﬁnd properties that you can ﬂip. Really, ﬂipping real estate is in the mind of the Quick Cash investor. What kind of a real estate investor are you?

C11.qxd 3/30/04 9:26 AM Page 89

C H A P T E R

11

Finding Flips

Every real estate transaction has a potential for ﬂipping. Flipping is in the mind of the imaginative real estate investor. We go into every deal thinking we are going to ﬂip it to another investor or even a retail buyer. We want you to develop this same ﬂipping ﬁrst attitude. In this chapter we will work on the language of real estate. Remember, you can ﬁnd properties to ﬂip using the six ways we talked about in Chapter 2. For us, ﬁnding a good deal is ﬁnding a deal or a property we can ﬂip. As you recall, these ways of ﬁnding a good deal included checking classiﬁed ads, placing your own newspaper or Internet ad, enlisting the help of personal contacts, doing your own scouting, visiting open houses, and working with a real estate agent. We want you to come away from this chapter with ﬂipping as a way of life for your investing.

The Language of Real Estate When you have a ﬂipping ﬁrst attitude, you look at the language of real estate differently than most other real estate investors. We have said that it is not so much just ﬁnding the right property, although that is important. We also have said that you have to ﬁnd the right seller. We are going to give you the 13 key words or phrases that we look for or use when we go through classiﬁed ads, place our own Internet or classiﬁed ads, work with our personal contacts, do our own scouting, 89

C11.qxd 3/30/04 9:26 AM Page 90

FLIPPING REAL ESTATE

90

visit open houses, and work with an agent. When you see one or more of these words or phrases, you’ll know that you have found the right seller.

1. Must Sell Any time you encounter the phrase must sell, you have come on the right seller. The right seller is ﬂexible. They know that for them to win, which is for them to sell their property, you, the investor have to win, which means you’ll get a good deal. That’s why it is called win/win. It is perfectly acceptable to ask the must-sell seller why they must sell. We have heard reasons that made sense to us if we were in the situation to reasons that did not make any sense at all. We have had sellers tell us they must sell because they were being transferred to a new job, they were getting a divorce, they were being foreclosed on, there was a family illness, there was a death in the family, they had lost their job. All of these made sense to us as must-sell situations. But we have also had sellers tell us they must sell because their pet had died and they would have too many bad memories if they stayed in the house. We have had sellers tell us they had a premonition that a tornado was going to level the house, so they had to sell before they were all killed. (These particular sellers didn’t seem to mind that after we bought their property we would be killed.) Sellers have told us the house was now haunted (we kid you not), so they must sell. One seller has told us that because their neighbor was moving, they were in a must-sell situation so they could move, too. What was really weird about this last one is that the seller wasn’t moving so he could move to the same area as the neighbor. He actually hated the neighbor that was moving. He was moving because he felt sure that an even worse neighbor was going to move into the neighborhood! The point here is that a seller’s must-sell reason is his or her own. As a real estate investor, yours is not to reason why. Yours is to write offers and Don’t Be Shy. Be Bold!

2. Under Market The phrase under market can let you know that you have come on the right property and seller. Remember, as a real estate investor you are a

C11.qxd 3/30/04 9:26 AM Page 91

Finding Flips

91

wholesale buyer. You cannot afford the luxury of being a retail buyer. A property that is advertised as being under market puts you ahead of the game from the get-go. Of course, you have to investigate to be able to determine if the seller really knows what they are talking about. Under market to the owner of a home may still be overpriced to you as an investor. You have to know value in your target area. (See Chapter 2 to get a complete training on knowing value.) We have seen too many properties where a homeowner has overimproved the property for the neighborhood. The best description of this phenomenon was given to us by a seller in describing a property. The seller told us,“I have a $200,000 property in a $150,000 neighborhood.” Talk about nailing a deﬁnition of the Principle of Regression. The seller was asking $167,000. On the surface this looked like a great deal. The property was $33,000 “under market.” It may have taken $200,000 to replace the property in the event of a ﬁre (the cost approach to value). But the neighborhood said the property was worth $150,000. We passed on the deal. Sometimes your best deal is the deal you don’t make. Cost approach value $200,000 Sales price $167,000 “Under market” $33,000 Sales price Market value Over market

$167,000 $150,000 $17,000

3. Below Appraisal Below appraisal is a phrase we like to hear. This occurs when a real estate agent tells us the property they are marketing for the seller is priced below appraisal value. We know we have the perfect combination. We have the right property (below appraisal) and we have the right seller. How do we know that we have the right seller? Because only a ﬂexible seller will put their property on the market at below the appraised value. Again, however, you have to be careful here. Below what appraised value? Are we talking below the appraised value for insurance purposes? Are we talking below the appraised value for property tax purposes? Are we talking below the appraised value for a home equity

C11.qxd 3/30/04 9:26 AM Page 92

FLIPPING REAL ESTATE

92

loan? Or are we talking about below the appraised value for a recent market comparison (market comparables)? The last value is the only one that counts when you are a real estate investor.

Example We were looking at a 5-bedroom, 4.5-bathroom, 5,000-squarefeet property with a pool and guest house with kitchen in a very nice neighborhood in Euless, Texas. The insurance value was $500,000. The property tax value was $225,000. The home equity loan value was $325,000. The market comparison value was $285,000. The property was on the market for $305,000. Values Insurance value Property tax value Home equity value Market comparison value On the market price

$500,000 $225,000 $325,000 $285,000 $305,000

We offered $250,000, and the seller accepted our offer. We ﬂipped the property to a dentist on a lease option for $275,000. In Section Four, we will expand on how we make money on these kinds of deals. Our purpose here is to train you on what below appraisal means.

4. Transferred Transferred tells us we have the right seller! In today’s economy, when someone is transferred, they are often happy to have a job to be transferred to! Transferred sellers are very motivated to sell property quickly. They want to sell their old property so the family can be all living together in the new property. We have often encountered the situation in which one partner has been transferred out of town and is living in a hotel, apartment, or even the new home while the spouse and kids are left behind in the old property. The spouse has the burden of selling the property with the partner’s long-distance help. This is not a pretty sight for the sellers, and we have done some of our most proﬁtable deals in this situation.

C11.qxd 3/30/04 9:26 AM Page 93

Finding Flips

93

5. Divorced When you see or hear the word divorce, there is often a real estate deal close by. There are 2 to 3 million new marriages each year, and statistics suggest that up to half of new marriages end in divorce. What happens to the family home when there is a divorce? Statistics tell us that most real estate in a divorce winds up being sold so that the assets can be divided between the ex-spouses. We have found the best offers in a divorce-involved property are all cash offers. Each side is willing to take a hit on the purchase price because each wants as much of their equity in cash as possible. Sometimes we have been able to put a deal together several months after the divorce when the property becomes too much for the remaining party to handle.

6. Foreclosure Foreclosure is one of the nastiest words to encounter if you are the party being foreclosed on. Foreclosure is, however, one of the most exciting words to encounter when you are a real estate investor. Foreclosure Ad Usually, you see something like this in a real estate classiﬁed ad:

Seller in foreclosure. Bring all offers. 3Br/2Ba $169,500. Good area. 817 555-2663

Call on the ad. Identify yourself as a real estate investor. Find out when the foreclosure sale is scheduled to occur. In Texas, foreclosure sales take place the ﬁrst Tuesday of every month on the steps of each county courthouse. Get the permission of the seller to talk to their lender to see if you can buy more time to work out a deal before the foreclosure.

C11.qxd 3/30/04 9:26 AM Page 94

FLIPPING REAL ESTATE

94

We recommend you buy property in the preforeclosure stage. In this stage the sellers are behind on their mortgage payments and on the verge of receiving formal foreclosure notiﬁcation from their lender. In this situation, the sellers are under a lot of pressure and are looking for any offer that comes to the table. Once the formal foreclosure notice is sent out, the clock starts ticking to the foreclosure sale. This is the kind of deal in which your ability to ﬂip a property quickly becomes very important. If you can ﬂip this deal before escrow closes, you and the sellers will be happy. If you have to wait to close escrow before you can Flip this type of deal, you may run out of time if the lender is uncooperative and insists on foreclosing.

7. Illness Unfortunately, illness is a fact of life. Sometimes your job as a real estate investor can really help people out of a tough situation. A real estate classiﬁed ad we saw read something like this:

Illness forces sale. Great family home in good area. Priced to sell. $275K. Call Jon. 972 555-7877.

We called Jon and found out that his wife had multiple sclerosis. They had a two-story home, and Jon’s wife can no longer climb the stairs. They are selling because they need a one-story home and they need money for medical bills. Your heart may well go out to these people, but you are a real estate investor and still have to make money on this deal. Luckily, this became a win/win situation. The property was worth $300,000. We offered Jon and his wife $258,000. They accepted the offer because it was all cash in 30 days. We ﬂipped the property for $265,000 within 10 days to a real estate investor who was going to buy the property, add to it, and sell it for $425,000 to $450,000.

C11.qxd 3/30/04 9:26 AM Page 95

Finding Flips

Sales price Purchase price Proﬁt

95

$265,000 $258,000 $7,000

8. Death “Death forces sale.” This was the heading of a classiﬁed ad we read one morning in our local newspaper. Pretty tough situation. But the widow needed to sell after her husband was killed in a trafﬁc accident. It has been said that someone else’s misfortune can become a stranger’s good fortune. This was the case in this situation for us. We made an offer on the property that was an equity sharing offer. We agreed to a price for today and agreed to split any future appreciation 50-50 with the owner. That way, she did not have to move out of her home. We would split the monthly PITI payment 50-50 for our equitysharing interest. That way she could afford to stay in the property. We ﬂipped our equity-sharing interest to a real estate investor for $4,500.

9. Owner Will Carry When you see or hear owner will carry, you have found a built-in real estate lender to ﬁnance the deal. The owner is going to act as the lender. They are going to carry a mortgage or trust deed for part or all of the purchase price of the property. What is so exciting when you encounter this situation is that you know the seller is ﬂexible. We have ﬂipped many properties to other investors who wanted rental units. They did not want to have to qualify for a loan from a traditional lender. Once we had negotiated a contract where the seller agreed to act as the lender for the transaction, there was a simple matter of ﬁnding an investor who wanted to take advantage of a typically lower interest rate than was available from a bank. With a lower interest rate, the investor had a lower mortgage payment. With a lower mortgage payment, the investor was more likely to be able to have the rent create a positive cash ﬂow. The difference on a $200,000 loan amortized for 30 years at 8 percent from a bank and a $200,000 loan amortized for 30 years at 6 percent that the seller would carry back is almost $270 a month.

C11.qxd 3/30/04 9:26 AM Page 96

FLIPPING REAL ESTATE

96

Bank loan at 8% Seller ﬁnancing at 6% Monthly savings

$1467.53 $1199.10 $268.43

This property was a duplex rented for $800 a month per unit for a total monthly rent of $1,600. Although the monthly rent would cover both the bank loan at 8 percent and the seller carry-back loan at 6 percent, after operating expenses there was no positive cash ﬂow with the bank loan, but there was a positive cash ﬂow with the seller carryback loan. Cash Flow Bank loan $1600 $1458 $225 ⫺$83

Rent Loan Expenses Cash ﬂow

Seller loan $1600 $1199 $225 $176

10. Nothing Down No down payment. Zero. Nada. Nothing down means a seller wants the property to be the most competitive one on the market. If you are a buyer, which property would you prefer? The property that required a 20 percent down payment out of your pocket or the one that required nothing out of your pocket?

11. 100 Percent Financing A variation of nothing down is 100 percent ﬁnancing. When we see this we know we have very astute sellers who know they will receive a higher return on their equity if they carry the ﬁnancing on the sale of their property than if they take cash and put the cash in the bank. (See Chapter 9, for an example of the startling difference.) We might instead have a worried seller who has to sell the property and is willing to ﬁnance the sale rather than lose all the equity. Either way, 100 percent ﬁnancing is something you need to check out. This is one of those phrases that we never pass up when we encounter it. One thing to look out for when you see 100 percent ﬁnancing is a property that will go with VA ﬁnancing. This means the seller will coop-

C11.qxd 3/30/04 9:26 AM Page 97

Finding Flips

97

erate with a VA buyer, and the property may qualify for a VA-guaranteed loan from a real estate lender. A veteran has to qualify for the loan. Although there is no down payment, this is not seller ﬁnancing.

12. Motivated Seller A motivated seller is the right seller. As a real estate investor, you are looking for motivated sellers. A motivated seller is also ﬂexible. A ﬂexible seller is a seller you can make a wholesale deal with. Motivated sellers come in all shapes and sizes. A motivated seller may be motivated to take a lower price for the property. A motivated seller may carry back ﬁnancing to make the deal work. A motivated seller may just give you the deed to their property and walk away. It would be fair for us to say that all the sellers with whom we have done business are motivated. When we encounter a seller who is not motivated, we usually have a very hard time doing business with them. However, there are more motivated sellers out there than you might think. Remember—Don’t Be Shy. Be Bold!

13. Lost Job The color pink is an anachronism from the twentieth century when people actually got a pink slip to let them know that they were either ﬁred or laid off. In the twenty-ﬁrst century economy, companies want fewer workers doing more work. As a real estate investor, when you see lost job or laid off in a real estate ad or when one of your personal contacts gives you an alert about someone losing a job, more than likely there is a real estate deal to be had. It is a fact of life that many people live paycheck to paycheck. When they lose the paycheck, the family home may not be far behind.

What’s Next Congratulations on completing Section Two! You now know the what, why, how, when, and ﬁnding of ﬂipping. Section Three is next. This is the pivotal section in this book, and it covers assigning.

C11.qxd 3/30/04 9:26 AM Page 98

98

FLIPPING REAL ESTATE

Our number one way we ﬂip real estate is through assigning real estate contracts. This is how we are able to ﬂip real estate without buying or owning property and without closing escrow. We really are not ﬂipping real estate at all. To ﬂip real estate, technically, you need to own the real estate. We are ﬂipping real estate contracts. We “own” the contracts. Once you know how to assign contracts, your real estate investing career is going to take off!

P03.qxd 3/30/04 9:27 AM Page 99

S E C T I O N

THREE

ASSIGNING REAL ESTATE CONTRACTS

P03.qxd 3/30/04 9:27 AM Page 100

C12.qxd 3/30/04 9:26 AM Page 101

C H A P T E R

12

What Is Assigning?

Assigning a real estate contract transfers your position in the contract to another person for a fee. Said technically, assigning a real estate contract allows you, the assignor, to assign the contract to a new person, the assignee. In this chapter we will give you more insight into the language of real estate, speciﬁcally the language that relates to assigning real estate contracts. We will explain what an assignment fee is, and we will tell you the appropriate dollar range for assignment fees. We will also show you the types of contracts that can be assigned and the types of contracts that cannot be assigned. We will spend some time talking about the purchase contract and deposit receipt. This is because this contract will be the primary contract that most readers will be assigning as real estate investors.

Real Estate Words Ending in -OR and -EE Part of being a successful real estate investor is becoming familiar with the language of real estate. Real estate words ending in -or are givers of money or paperwork. Real estate words ending in -ee are receivers of money or paperwork. Typically, if the paperwork is going one way, the money is going the other way, and vice versa. Let’s look at several examples. 101

C12.qxd 3/30/04 9:26 AM Page 102

ASSIGNING REAL ESTATE CONTRACTS

102

Grantor/Grantee A grantor, the seller, gives a grant deed to the grantee, the buyer. The grant deed transfers the seller’s ownership interest in the property to the buyer. (See Chapter 2 for a discussion of transferability as an element of value.) The grantor gives paperwork, the grant deed, to the grantee, who receives the paperwork in return for money or other valuable consideration. The paperwork goes one way, and the money goes the other way, as we noted.

Lessor/Lessee A lessor, the landlord, gives a lease to the lessee, the renter. The lease transfers the landlord’s right of possession in the property to the renter. The lessor gives paperwork, the lease, to the lessee, who receives the paperwork in return for rent payments.

Mortgagor/Mortgagee A mortgagor, the borrower, gives a mortgage to the mortgagee, the lender. The mortgage gives a lien against the property title to the lender for the amount of the loan. If the borrower does not repay the loan, the lender can foreclose and take the title and property away from the borrower and sell it to repay the loan. The mortgagor gives paperwork, the mortgage, to the mortgagee, who receives the paperwork in return for loaning money.

Assignor/Assignee An assignor, you, gives an assignment to the assignee. An assignment gives your right to purchase a property under the terms of a purchase contract to a new buyer. The new buyer literally steps into your shoes and can buy the property under the same terms and conditions you negotiated with the seller. The assignor gives paperwork, the assignment, to the assignee, who receives the paperwork in return for money or other valuable consideration.

C12.qxd 3/30/04 9:26 AM Page 103

What Is Assigning?

103

Assignment Fees The money you receive for assigning a contract is called an assignment fee. The fee is negotiable between you, the assignor, and the person you assign the contract to, the assignee. The other party to the contract that you have had accepted—seller, lessor, assignor, optionor, or whomever— has no say in your negotiations with your assignee.

Dollar Range for Assignment Fees What kind of dollar amount should the fee be that you receive for assigning a contract? We have assigned a contract for as little as $1,000. We have also assigned a contract for as much as $100,000. Typically, the fees we have received for assigning contracts range between $5,000 and $15,000. Dollar Range for Assignment Fees $1,000 X

$5,000 XX

$15,000

XXXXXXXXXXXXXXXXXXXX

$100,000 X

X

X

XXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXXXXX

Types of Real Estate Contracts You Can Assign Virtually every type of real estate contract can be assigned. You can assign purchase contracts, options, leases, lease options, mortgage contracts, trust deeds, the list goes on! You can even assign an assignment contract! We ourselves have assigned purchase contracts, option contracts, lease option contracts, and assignment contracts. If it is a real estate contract, you can ﬁgure a way to assign it. Once you have negotiated a good deal and, as we said in Chapter 5, put it in writing, then you are in a position to look for someone to whom

C12.qxd 3/30/04 9:26 AM Page 104

ASSIGNING REAL ESTATE CONTRACTS

104

to assign your good deal. Assigning a contract is the easiest and quickest way to ﬂip real estate.

Purchase Contracts The complete name for this contract is actually purchase contract for real estate and deposit receipt. This is the contract that contains the terms and conditions to which you and the seller agree when the seller accepts your offer to purchase the property. Although the elements of CoCa CoLa have to be present in every area of the country for the purchase contract to be valid, there may be some local variations that are particular to your state or area. For example, purchase contracts in Texas use the wording Y’all, meaning the singular and plural at the same time. For example,“y’all’s deposit amount.” No not really, we’re kidding. You can get a blank purchase contract from our book How to Sell Your Home Without a Broker. You can access the Texas Real Estate Commission’s contract at www.trec.state.tx.us. The truth of the matter is that you can use a napkin at a restaurant to write a real estate offer on. As long as the purchase contract is in writing, it is valid. We don’t recommend using napkins to write your offers, however—the ink runs on the napkin when it gets wet. (We’ve tried it.) If you are working with a real estate agent and they want to use their contract, then use their contract. As we have said, the purpose of the contract is to communicate. It is not worth the aggravation spending the time to educate a real estate agent on why you should use your contract. Just make sure everything you want in the contract is communicated by whatever purchase contract you use. Otherwise, you are going to have a problem sooner or later. You’ll want to include everything you can possibly think of in your purchase contract. Every blank space is either ﬁlled in, or the letters NA (not applicable) are written in. You are negotiating not just for yourself but also for the buyer you are going to assign the contract to. Believe us when we tell you the new buyer wants a really good deal! Deposit Receipt We now will discuss the deposit receipt portion that appears in the purchase contract. Consideration must be included with every purchase contract to satisfy the requirements of CoCa CoLa. Let’s take a look (see page 105) at the portion of the purchase

C12.qxd 3/30/04 9:26 AM Page 105

What Is Assigning?

105

contract that deals with the deposit receipt. The deposit is also known as earnest money. You can see that the deposit that serves as the consideration for the offer can be for any amount and in virtually any form. We don’t recommend using cash. Cash can too easily disappear. We also don’t recommend using a cashier’s check. A cashier’s check is the same as cash. Although a cashier’s check will likely not disappear, you still have to come up with cash to get one.

Many people in the real estate investment business use a personal check or business check as the form of consideration accompanying their purchase contracts. Although this may be ﬁne for a retail buyer who makes a real estate offer once every ﬁve or six years when they are buying another family home, it will not work for you as a real estate investor. With the number of contracts you will be writing and presenting, you can’t afford to have that many personal or business checks ﬂoating around. Promissory Note We recommend you use a promissory note as your deposit instrument for all your contracts. Please refer to Chapter 7 to see a completed promissory note. Our purpose is to have you be familiar with how you handle completing the beginning of the purchase contract for the deposit receipt area. In the “or” section you write “promissory note.”

C12.qxd 3/30/04 9:26 AM Page 106

ASSIGNING REAL ESTATE CONTRACTS

106

We recommend the use of promissory notes for two reasons. First, by using a promissory note you protect your cash. Second, you don’t have 10, 15, or 20 personal checks out there accompanying all those offers you are writing and presenting. You only have to turn the promissory note into cash if your offer is accepted and you are going to open an escrow. If you assign your purchase contract before you open escrow, then the promissory note never gets cashed!

Option Contracts More than conveying your intent to buy a property, a real estate option contract says you are buying property within a certain time frame. Also, you will commit funds in the form of an option fee or option money, basically a deposit, to keep the option open. In Section Four, we will spend several chapters talking about real estate options. Our purpose here is to introduce you to the idea of using an option contract as part of your real estate investing Brain Trust. Although an option contract contains all the elements of CoCa CoLa to make it valid, it has a very unique feature among all the different contracts. An option contract becomes a unilateral agreement once the optionor (seller) signs it. All contracts are bilateral to begin with. Consent in the form of mutual agreement on both the seller’s and buyer’s parts is necessary for validity. However,once the option has been agreed to,only the buyer can exercise it. The seller can’t back out of the deal if the buyer exercises the option. The optionee (buyer) can back out of the deal and not be sued for speciﬁc performance. The optionor (seller) gets to keep the option fee the optionee put up, but that’s all. We use an option contract that is already set up to be assigned by the wording in the contract itself. In the event you are using an option contract that is not set up to be assigned, all you have to do is add the words “and/or assigns” to the buyer or assignee name portion of the contract. We have underlined the word assigns in our sample contract.

C12.qxd 3/30/04 9:26 AM Page 107

What Is Assigning?

107

Mortgage Contracts, Trust Deeds, Leases, Assignments Every type of real estate contract can be assigned. Mortgage contracts, trust deeds, leases, and even an assignment contract can be assigned. Even car dealers and motorcycle dealers use assignments in their rebate programs. The following paragraph is taken from a Harley-Davidson mailer sent to us as we were writing this book.

The eligible retail purchase customer must assign [our emphasis] the cash allowance to one of the Tarrant County Harley-Davidson Dealerships. The retail purchase must show the cash allowance as having been applied to the motorcycle’s purchase price. Our point is that assigning contracts is everywhere in the business world. Once you are aware that assigning of contracts is going on, you will start to see assignments all over the place. We want you to feel comfortable with the idea of assigning real estate contracts. Whether you are the assignor or the assignee, you will make money using assignments.

C12.qxd 3/30/04 9:26 AM Page 108

108

ASSIGNING REAL ESTATE CONTRACTS

Cannot Be Assigned The only time a contract cannot be assigned is when the contract itself stipulates that it cannot be assigned. The following wording from a residential lease contract is an example of a contract that cannot be assigned.

Our take on this clause preventing an assignment of the lease agreement is that everything is negotiable. If you needed to assign this lease, you could always go back to the lessor and negotiate with them on assigning this lease to another lessee. In Chapter 13 we will show you the advantages of using an assignment contract. Assigning a purchase contract makes you money without buying property. Assigning is the fastest way to ﬂip a property. Assigning a contract is the quickest way to make money in real estate investing. Assigning avoids all the pitfalls of real estate ownership.

C13.qxd 3/30/04 9:26 AM Page 109

C H A P T E R

13

Why Use an Assignment?

In this chapter we will show you the advantages of using a real estate assignment contract in your investing. Once you have negotiated a contract with a seller, a lessor, an assignor, or an optionor, you are in a position to assign the contract. It makes no difference if you are assigning a purchase contract, a lease or lease option contract, an assignment contract, or an option contract. You are going to make money. This chapter answers the question of why you want to assign contracts. There are four main reasons for doing so. Assigning a purchase contract makes you money without buying the property. Assigning is the fastest way to ﬂip a property. Assigning a contract is the quickest way to make money in real estate investing, and it avoids all the pitfalls of real estate ownership.

Advantages to Using an Assignment Assigning Makes You Money without Buying Property Assigning a purchase contract makes you money without buying property. In a traditional real estate investment, you (the investor) make money by ﬁnding a property, writing and having your offer accepted by the seller, opening and successfully closing an escrow, ﬁxing up the 109

C13.qxd 3/30/04 9:26 AM Page 110

ASSIGNING REAL ESTATE CONTRACTS

110

property (if necessary), and then selling the property to a retail buyer. If we made a timeline, it would look like the following: Buying Timeline for Buying Real Estate to Make Money

Find property

Write

Offer

offer accepted

Open

Close

Fix

Sell

escrow

escrow

up

property

Make money We are being rather generous with the timeline. It is actually harder than that. The reality of making money when you buy real estate the traditional way begins with that timeline. You really don’t make any money until you do the following: advertise and show the property, receive and accept an offer, and open and close escrow. Then, and only then, do you make money. Selling Timeline for Buying Real Estate to Make Money Ads & Show

Receive

Accept

Open

Close

property

offer

offer

escrow

escrow Make money

Assigning Is the Fastest Way to Flip Property Assigning a real estate contract is the fastest way to ﬂip property. Let’s face it. Paperwork is the name of the game in real estate investing. The less paperwork involved in a real estate transaction, the better. The less paperwork involved, the less time it takes to complete the transaction. The less time involved on your part and the part of the real

C13.qxd 3/30/04 9:26 AM Page 111

Why Use an Assignment?

111

estate investor or retail buyer you are assigning the contract to, the faster the turn-around time for you. In Chapter 7, Example 1, we talked about a Del Mar, California, condo we ﬂipped. To refresh your memory, these are some of the particulars of that transaction. We are using it here to show you the amount of paperwork we had to do on a very simple and very quickly done ﬂip that was not done as an assignment. Del Mar, California Condo Flip Example 1 The seller sold us the condo for $63,000, which was the loan amount to the bank. The value of the condo was $72,000.The seller basically signed over the deed and walked away from the property! Purchase price Down payment Loan amount

$63,000 $0 $63,000

How did we make money in this deal? We found another investor who wanted rental income property. The real estate investor gave us $4,000 cash, and we gave him the title to the property in the form of a quitclaim deed. We “owned” the property for one week! By ﬂipping the property we had an immediate proﬁt and no landlording headaches. Paperwork for Flip without Escrow This is the paperwork involved in the transaction, even one as simple as the condo example. We wrote a purchase contract and a promissory note, which we presented to the owner of the condo. The owner gave us back our promissory note and a quitclaim deed to transfer title. There was no escrow and, therefore, no escrow paperwork involved in us buying the property.

We received a purchase contract and a personal check for $500 as a deposit from the investor to whom we ﬂipped the property. We gave the real estate investor a quitclaim deed.

C13.qxd 3/30/04 9:26 AM Page 112

112

ASSIGNING REAL ESTATE CONTRACTS

The investor gave us a cashier’s check for $4,000 and we gave the investor back the personal check. Again, we didn’t have an escrow, even with all the additional paperwork involved between us and the investor.

Paperwork for Assignment What if we were able to have just assigned our purchase contract instead of doing a traditional ﬂip, where we actually owned the condo for a week? Would we have speeded up the ﬂip by having done an assignment? How much paperwork would be involved if we had assigned our purchase contract with the owner of the condo to the real estate investor? We would have written a purchase contract and a promissory note, which we would have presented to the owner of the condo. The owner would have given us back our promissory note. So far, everything is the same. Here is where the assignment transaction changes the paperwork. The owner of the condo would not give us a quitclaim deed. They would give one to transfer title to the investor to whom we assigned the purchase contract. We now have one less quitclaim deed using the assignment of contract. The next paperwork that changes with the assignment is there would be no second purchase contract. We would not receive a purchase contract from the investor. The investor would take over our position in the ﬁrst purchase contract. The investor would also not write a personal check to accompany their offer to us. We would have received just a cashier’s check for $4,000 from the investor. The investor would have received the quitclaim deed from the owner.

C13.qxd 3/30/04 9:26 AM Page 113

Why Use an Assignment?

113

The difference in the amount of paperwork for the Del Mar ﬂip and the Del Mar assignment is substantial. The ﬂip paperwork ran to seven items. The assignment paperwork would have been only four items. Our point is that assigning a contract is the fastest way to ﬂip property. Assigning a contract is ﬂipping property! Flipping is good. When you use assigning as a ﬂipping tactic, you’ll streamline the paperwork and reduce the time involved in the transaction. You’ll also make the same amount of money on the deal! Paperwork for Flip with Escrow In Chapter 7 we gave an example of a piece of vacant land we found that was worth $1 million that we ﬂipped. To refresh your memory we will re-present some of the particulars of that transaction. We do so to show you the amount of paperwork we had to do on a ﬂip that involved an escrow and the additional paperwork that entails. This ﬂip also was not done as an assignment. Vacant Land Flip Example 2 We found a piece of vacant land that was worth $1 million. We offered the seller $1 million for the piece of land. We made no down payment and had no monthly payments. We would owe the seller $60,000 annually (6 percent of the $1 million “loan”). Purchase price Down payment Loan amount

$1,000,000 0 $1,000,000

We ﬂipped the property for $1 million! We accepted zero down payment! We loaned the buyer $1 million for ﬁve years at 8 percent with no monthly payments and interest paid annually ($80,000).

C13.qxd 3/30/04 9:26 AM Page 114

114

ASSIGNING REAL ESTATE CONTRACTS

Purchase price Down payment Loan amount

$1,000,000 0 $1,000,000

Do you see how we made money? When we received our $80,000 payment, we paid our $60,000 payment, leaving us $20,000 proﬁt! Received Paid Proﬁt

$80,000 $60,000 $20,000

Here is the paperwork involved in the transaction. We wrote a purchase contract and a promissory note, which we presented to the owner of the vacant land. We had escrow instructions to execute. The owner gave us a grant deed to transfer title. We gave the owner a promissory note for $1 million secured by a trust deed.

We received a purchase contract and a personal check from the real estate investor. We then had another set of escrow instructions to execute. We gave the investor a contract for deed to transfer title. The investor gave us a promissory note for $1 million secured by a trust deed.

C13.qxd 3/30/04 9:26 AM Page 115

Why Use an Assignment?

115

Paperwork for Assignment What if we were able to have just assigned our purchase contract instead of doing a ﬂip where we actually owned the vacant land? What would the paperwork have looked like then? We would have written a purchase contract and a promissory note, which we would have presented to the owner of the vacant land. The owner would have given us back our promissory note. There would have been an escrow between the owner of the vacant land and the real estate investor. The owner would have given a grant deed to transfer title to the buyer to whom we assigned the contract. The investor would give the owner a promissory note for $1 million secured by a trust deed. Instant Money The best part of this deal is we would have received a cashier’s check for $20,000 from the real estate investor as an assignment fee immediately. We would not have had to wait a year, like in the actual deal, to get our money. The difference in the amount of paperwork for the vacant land ﬂip and the assignment is substantial. The ﬂip paperwork ran to 12 items. The Assignment paperwork would have been only seven. Our point is assigning a contract is the fastest way to ﬂip property. Actually, assigning a contract is ﬂipping a contract! As you look at the paperwork reduction going from the ﬂip to the assignment in Example 2, note that the paperwork reduction has a lot to do with eliminating duplication.

C13.qxd 3/30/04 9:26 AM Page 116

ASSIGNING REAL ESTATE CONTRACTS

116

Assigning Is the Quickest Way to Make Money Assigning a real estate contract is the quickest way to make money in real estate investing. If we had been able to assign our purchase contract from the vacant land example, we would have had our $20,000 a year sooner. As we have said, Quick Cash is our investment strategy. We needed to ﬁnd a technique to facilitate making money quickly. Assigning contracts was our answer. The timeline for assigning contracts is substantially different than the timeline for a traditional real estate investment. Even with ﬂipping property, you can’t make money as quickly as when you assign contracts.

Assigning Timeline Assigning Contracts to Make Money Find property

Write

Offer

Open

offer accepted escrow

Close

Fix

Sell

escrow

up

property

Make

Make

Make

Make

money

money

money

money

C13.qxd 3/30/04 9:26 AM Page 117

Why Use an Assignment?

117

As you can see, you can make money quicker and at more junctures along the way than with a traditional real estate investment strategy of buy the property, own the property, and sell the property.

Assigning Avoids the Pitfalls of Real Estate Ownership Assigning a contract avoids the pitfalls of real estate ownership. We feel that assigning is the best tactic in the ﬂipping strategy. As with any ﬂipping tactic, assigning has multiple advantages to the traditional real estate investment strategy. These advantages include no landlording, no monthly mortgage payments, no property taxes, no hazard insurance, no maintenance costs, no homeowner association dues, no lawsuits, no extensive record keeping, and no income tax problems. For a detailed description of each of these advantages, refer to Chapter 8. In Chapter 14 we will show you exactly what to do to be able assign any contract successfully. Once you assign your ﬁrst contract and make money, you will look to assign everything else.

C14.qxd 3/30/04 9:25 AM Page 118

C H A P T E R

14

How to Assign a Contract

Assigning a real estate contract begins when you write the initial offer. In the initial offer you make to the property owner, whether it is a purchase contract, an option contract, a lease option contract, or an exchange agreement, you use the terminology and/or assigns in the contract.

And/Or Assigns You have a new name from this moment forth. Think of it as if you are being given a royal title, Much better than sir or madam. Better than your royal highness. More powerful even than your majesty. From now on, as a real estate investor writing contracts, you will be known as: Your Name and/or assigns. Using ourselves as examples, our new names are Bill Carey and/or assigns, Chantal Carey and/or assigns, and Bill and Chantal Carey and/or assigns. Assigning a contract makes you money without buying or owning the property. Let’s look at an example. Using the information we talked about in Section One, you have found a property that you want to make an offer on. We said in Chapter 5 that there are no oral agreements in real estate. Every contract must be in writing. Using the purchase contract, you begin to write, that is, ﬁll in the blanks of, the contract.

118

C14.qxd 3/30/04 9:25 AM Page 119

How to Assign a Contract

119

You ﬁll in City, and State, and Date. Then you ﬁll in the name of the buyer. Example 1

Now comes the exciting part! Before going any further into the contract, we are going to guarantee that you can make money with this property without buying it or owning it. Unlike 99 out of 100 real estate investors who will go on to the “sum of $_______” section, we are going to stay on the “Received from” section. We are going to add three words to this line that are the three most powerful words you can have in a contract. Example 2

By adding “and/or assigns”to the buyer’s name, we have created the opportunity for Bill to make money in three ways instead of only in one way. As in our ﬁrst example, without and/or assigns, in our second example, Bill can buy the property, close on the property, and ﬂip it for a proﬁt. (See Chapter 10)

C14.qxd 3/30/04 9:25 AM Page 120

ASSIGNING REAL ESTATE CONTRACTS

120

By adding and/or assigns Bill creates a second way to make money. Bill can bring in a money partner to fund the transaction, Bill Carey and assigns, say, Chantal Carey. Bill and Chantal are now buying the property. By adding and/or assigns, Bill also opens up a third way to make money. Bill can assign the contract, Bill Carey or assigns, for a fat fee, to, say, Chantal Carey. Now Chantal is buying the property. Bill is not buying the property but assigns his interest in the purchase contract to Chantal and makes money without buying or owning the property.

Assignment Contract We have shown you how to assign a real estate contract using the and/or assigns name addition. What about an actual assignment contract? We ﬁnd that having an assignment contract available makes assigning any contract a more viable option. You still want and/or assigns in the buyer’s name section in whatever contract you are writing. By using the assignment contract in conjunction with and/or assigns, you build in an added layer of written protection for yourself, the owner of the property, and the new buyer. Assigning a contract is completely above board and legal. An assignment of contract is not a stealth real estate tactic designed to bamboozle a real estate owner. Remember our adage that the purpose of the contract is to communicate. When an owner asks you what and/or assigns means, this is what you should say: And/Or Assigns Script “__________ (Seller’s Name), the AND/OR ASSIGNS clause gives both you and us the added ﬂexibility of bringing in additional buyers or money partners to successfully close our transaction. Would that be al right with you?”

C14.qxd 3/30/04 9:25 AM Page 121

How to Assign a Contract

121

In our experience, the owner’s answer has always been yes. Sometimes we have had to work with the owner for a while and educate him or her on the beneﬁts that this phrase had for them. What do you do if the owner’s answer is no? You want to make sure the owner understands what you are trying to do by having the ability to assign your contract. Flexibility is the name of the game in making a real estate deal work. If the owner will not agree to give you the ﬂexibility you need by having and/or assigns in your contract, let the owner know that you will not proceed to present the rest of the contract. You must stick to your guns on this point. And/or assigns is that important to your real estate investing success. It is much harder to come back to the negotiating table after you have already reached an agreement with the owner. Have and/or assigns be part of your agreement from the beginning.

Assignment of Contract There is a full page view of an Assignment of Contract on page 124. We are going to spend the rest of this chapter breaking it down. We will show you how to ﬁll it out so that you are completely comfortable with using it right away. We will now present our version of an assignment of contract in sections. The beginning section of the assignment is all about disclosing information.You ﬁll in the date the assignment is being ﬁlled out. This may be the same date as when the assignment is executed or signed, but it does not have to be. Because an assignment of contract is a real estate contract, your purpose here is to communicate: names, addresses, phone, fax, and cell lines, plus email addresses. All the players need to know who is involved in the transaction. The assignment of contract acts as your line-up card. You, of course, are the original buyer.

C14.qxd 3/30/04 9:25 AM Page 122

122

ASSIGNING REAL ESTATE CONTRACTS

The next section stipulates the contract date of the original contract and the property address, which is the subject of the contract.

Now comes the meat of the assignment. This is where you as the original buyer exercise your unqualiﬁed right (no restrictions) to assign the contract you have negotiated with the owner to a new buyer. You as

C14.qxd 3/30/04 9:25 AM Page 123

How to Assign a Contract

123

the assignor assign all your rights, obligations, and responsibilities in the contract to the assignee. The assignee agrees to fulﬁll all of the terms and conditions of the contract as if they were you. We give special emphasis to the new buyer fulﬁlling the closing requirements of the contract because we want the deal to actually close for the property owner.

Now comes our favorite part of the assignment of contract. This is what we call the “show us the money” section. This is the where you make the agreed-on “how much” without buying or owning property.

You, as the original buyer, execute (sign) and date the assignment of contract ﬁrst. Then, the new buyer does so. This is where the new buyer gives you the agreed-on consideration.

C14.qxd 3/30/04 9:25 AM Page 124

124

ASSIGNING REAL ESTATE CONTRACTS

C14.qxd 3/30/04 9:25 AM Page 125

How to Assign a Contract

125

It is possible to use a closing agent as a neutral third party in the event that either you or the new buyer would be more comfortable doing so. The closing agent would hold the cashier’s check from the new buyer until you both executed the assignment of contract. You would then receive the cashier’s check, and the new buyer would receive the executed assignment of contract. You would have your money, and the new buyer would be able to close on the deal with the owner. In Chapter 15 we will show you the best times to do your assignments. You can assign a contract before, during, and after the closing. When do you think is the best time to assign a contract? We have our own favorite time. Can you guess when it is?

C15.qxd 3/30/04 9:25 AM Page 126

C H A P T E R

15

When to Assign a Contract

You can assign a real estate contract before, during, and after the closing. Assigning a contract before the closing is the way we like to do our own transactions. You tie up the property with an accepted contract and immediately search for a buyer to whom to assign the contract. Assigning a contract during the closing is our second favorite way we like to do our transactions. You tie up the property and assign the contract before the closing takes place. The assignee takes your place in the closing and then winds up closing the escrow. Assigning a contract after the closing is the ﬁnal way we like to do our transactions. Again, you tie up the property with an assignment clause in the contract. If you don’t ﬁnd a buyer before closing and wind up closing the property yourself, you can still quickly transfer your interest in the property to another buyer after closing. Essentially, you are going to ﬂip the property using what we call an assignment deed. Look at the timeline for assigning contracts. This will give you a way to visualize the different times you can use an assignment. Anytime you can assign a contract and make money is a good time to do the assignment.

Assignment before Closing We don’t ever want to close an escrow. At least not in the traditional way most real estate investors do. We want to “close”our deals a different way. 126

C15.qxd 3/30/04 9:25 AM Page 127

When to Assign a Contract

127

Timeline for Assigning Contracts Write

Open

Close

offer

escrow

escrow

Assign

Assign

Assign

before

during

after

closing

closing

closing

In the normal course of events, a real estate transaction goes like this. A real estate investor ﬁnds a potential property. The investor writes an offer on the property and presents the offer to the seller. There is a negotiation back and forth between the seller and the investor. There is an agreement as to price and terms. Then the seller and the investor open an escrow, or, depending on local real estate practice, go to a closing. Once the escrow is complete, the escrow closes. The seller receives money or other valuable consideration from the investor, and the investor receives the title to the property.

Close by Assigning As we showed you in the previous chapter, we close our deals by assigning our seller-accepted real estate contract. By using the assignment of contract, we use a one-page escrow instruction between us and the new buyer. The new buyer then steps in and completes the escrow or closing process in the traditional way. Example 1 We presented an offer to a seller on a 4-bedroom, 2.5bathroom, single-family home in a good neighborhood. The sellers were asking $165,000 for the property. We offered all cash $142,000 with escrow to close in 30 days or sooner. The sellers made us a counteroffer of $146,000. We made the sellers a counteroffer to theirs of $143,000. The sellers accepted our $143,000 counteroffer.

C15.qxd 3/30/04 9:25 AM Page 128

128

ASSIGNING REAL ESTATE CONTRACTS

Seller’s asking price Our ﬁrst offer Seller’s counteroffer Our counteroffer Final purchase price

$165,000 $142,000 $146,000 $143,000 $143,000

Do not be alarmed if your head is starting to spin. Sometimes these real estate offers can go back and forth many times over several days. Our next step was to bring in a new buyer to whom to assign our accepted purchase contract. We found a retail buyer who wanted to live in the property. We used our one-page assignment of contract. They agreed to pay us a $7,000 assignment consideration. The catch was that the new buyer did not have $7,000 to pay us and have enough money left for a down payment. How many of you see another catch in this transaction? Congratulations if you realized that we had an all-cash offer accepted by the seller. We now had a new buyer who was making a down payment and getting ﬁnancing from a lender. Although this becomes all cash to the seller at closing, it is still different than the terms and conditions of the original offer. We went back to the seller and told them we were assigning the purchase contract to a new buyer. However, we needed to make some changes in the purchase contract to reﬂect the change in the property ﬁnancing. We used our one-page form for contract changes and additions (see page 131) to make the change.

C15.qxd 3/30/04 9:25 AM Page 129

When to Assign a Contract

129

Assignment during Closing An assignment during closing is a very common occurrence in our real estate investing. We have said our favorite time period to do an assignment is before closing, but doing an assignment during closing runs a close second. The difference between assigning before closing and during closing is whether you have formally opened escrow or not. An assignment before closing means you have written an offer and had it accepted but have not opened escrow before you assign the contract. An assignment during closing means you have done all of the above and opened an escrow. We reprise our assigning timeline from Chapter 13. We have already handled assigning a contract after writing an offer and before the offer is accepted. In that situation you use the nondisclosure and noncircumvention agreement to bring potential assignees into the picture. This protects you from someone trying to go around you and deal directly with the property owner. The only way the potential assignees found the property or the deal was because of you. In this chapter we focus on making money after you have an offer accepted. Assigning Timeline Assigning Real Estate Contracts to Make Money Find

Write

Offer

Open

Close

Fix

Sell

property

offer

accepted

escrow

escrow

up

property

Make

Make

Make

Make

money

money

money

money

Example 2 Using the information from Example 1, we now turn to a situation in which we thought we were doing an assignment before closing that became an assignment during closing. We opened escrow with the seller. When we found the new buyer, we brought him into the escrow. We were no longer a principal in the transaction (original buyer) but were now recognized as a partner with the seller.

C15.qxd 3/30/04 9:25 AM Page 130

130

ASSIGNING REAL ESTATE CONTRACTS

We structured the transaction with the new buyer this way. The new buyer agreed to pay $150,000 for the property. They were going to make a $15,000 down payment and get a $135,000 loan from a real estate lender. The proceeds of the $135,000 loan and the buyer’s $15,000 down payment would be deposited in escrow. Out of the $150,000 deposited in escrow, the seller would receive their $143,000 price at the closing. We would receive our $7,000 partnership fee from the remaining balance at the closing. New buyer purchase price Down payment New loan

$150,000 $15,000 $135,000

New buyer purchase price Seller received amount Our received amount

$150,000 $143,000 $7,000

C15.qxd 3/30/04 9:25 AM Page 131

When to Assign a Contract

131

C15.qxd 3/30/04 9:25 AM Page 132

132

ASSIGNING REAL ESTATE CONTRACTS

Assignment after Closing At ﬁrst blush it might seem out of place for us to talk about assigning a real estate contract after the closing. However, as we have taught you to do with every contract you write, you used the clause and/or assigns when you wrote the purchase contract. What do you do if you decide to close the transaction yourself because it is such a good deal or you have not found a new buyer before the closing date comes? Well, at that point, you are now a property owner. The fastest way to assign your interest in a property after you have closed escrow is to quitclaim the property to a new buyer. Whatever interest or title you have in the property is transferred to the new buyer. We could give you a quitclaim deed to the White House at 1600 Pennsylvania Avenue and we would transfer to you whatever interest or title we have in the White House. However, because we have no interest or title in the White House, our quitclaim deed would transfer nothing to you. Our point is that a quitclaim deed is unlike a grant deed or a warranty deed. A quitclaim deed has no warranties whatsoever. On page 133, we give you a sample quitclaim deed to add to your tool box of assignment contracts. Again, our purpose is for you to think outside the box that most real estate investors think inside of. No one but us will tell you that you can assign a piece of real estate after you have closed escrow. We call a quitclaim deed an assignment deed. We use this deed when we want to quickly get out of a property that we wind up owning. Example 3 Can you think of an example that we have already used in a different chapter that illustrates our use of a quitclaim deed to assign our interest in a property? Congratulations, if you said Example 1 from Chapter 7, the Del Mar Condo. We go back to that example to bring you full circle in our discussion of assigning real estate contracts. Assigning a contract, as we have said, is ﬂipping. Instead of ﬂipping the property, you ﬂip the paperwork that controls the property. We received a quitclaim deed from the seller. We gave one to the real estate investor. We suggest that you become an expert in the paperwork of real estate. Become an expert in the paperwork of contracts and you can make money investing in real estate anywhere in the country.

C15.qxd 3/30/04 9:25 AM Page 133

When to Assign a Contract

133

C15.qxd 3/30/04 9:25 AM Page 134

134

ASSIGNING REAL ESTATE CONTRACTS

In Chapter 16, we will show you what kinds of contracts can be assigned besides purchase contracts. You can assign exchange contracts, land contracts, and mortgage contracts. You can assign trust deeds, tax liens, assignment contracts, and option contracts. There is no limit to the kinds of real estate contracts you can assign. Once you assimilate the assigning tactic into your investing strategy, you will begin to ﬁnd all kinds of contracts to assign. Real estate contracts to assign will begin to ﬁnd you. We look to assign every contract we write. The more contracts we can assign, the better we like it. This is where we make our money. As we told you at the outset, our real estate investment strategy is Quick Cash. You can assign a contract before, during, or after closing. No matter where you are in any real estate transaction, assigning the deal is the fastest way to make Quick Cash!

C16.qxd 3/30/04 9:25 AM Page 135

16

C H A P T E R

Finding Assignments

Every real estate contract can be assigned. There is only one exception to this statement. As we have mentioned, the one exception is a contract that has been negotiated and it is agreed that the contract cannot be assigned! A lease is an example of a contract that may contain a clause that places a prohibition on assigning the contract.

Finding Contracts That Can Be Assigned Where do you ﬁnd contracts that can be assigned? The majority are purchase contracts, but we will show you what are some of the other kinds that can be assigned. You can assign exchange contracts, land contracts, mortgage contracts, trust deeds, tax liens, assignment contracts, and option contracts. If it is a contract that deals with real estate, that contract can be assigned, subject, of course, to the caveat we just stated. Even then, you may still be able to assign the contract. We will show you how. 135

C16.qxd 3/30/04 9:25 AM Page 136

ASSIGNING REAL ESTATE CONTRACTS

136

Exchange Contracts An exchange contract is used in an Internal Revenue Code (IRC) Section 1031 tax-deferred exchange. Real estate investors use this to defer the recognition of proﬁt in a real estate transaction. According to the tax code, a real estate gain (proﬁt) is taxable when the gain is recognized. If the gain is not recognized, then it is not taxable. What does this mean? In a typical real estate investment transaction when the seller sells a property, any gain made on the sale is recognized in the year of the sale and becomes taxable as a capital gain, ordinary income, or, in some cases, both. Let’s say you bought a duplex in 1995 for $200,000. You sell the duplex in 2005 for $300,000. Excluding things like capital improvements, depreciation taken over 10 years, acquisition costs, and selling costs, you would have a taxable recognized gain of $100,000. (That is assuming you have no offsetting capital losses.) Any tax on this $100,000 recognized gain would be payable as part of your 2005 federal income tax ﬁling. Tax Consequences of Selling the Duplex 2005 sales price 1995 purchase price Recognized taxable gain

$300,000 $200,000 $100,000

If you consider the same scenario and do a 1031 Exchange, you can have some (if not all) of the $100,000 gain go unrecognized. Instead of just selling the duplex, what if you exchanged the duplex for a fourplex? You exchange the $300,000 duplex into a $500,000 fourplex. All of your $100,000 gain from the duplex will be exchanged into the fourplex. Because you did an exchange of like kind property (investment property for investment property) your $100,000 gain will not be recognized, and any tax will be deferred! Tax Consequences of Exchanging the Duplex Fourplex exchange price Duplex exchange price Recognized taxable gain

$500,000 $300,000 $0

C16.qxd 3/30/04 9:25 AM Page 137

Finding Assignments

137

Without getting too technical, there are usually at least three parties in an IRC 1031 tax-deferred exchange. There are the two parties involved in the exchange, plus a third-party buyer. Although it is possible for two property owners to exchange properties, it is not likely. You may want their property, but they might not want your property. As the owner of the duplex, you are “selling” and want to do a 1031 Tax-Deferred Exchange. The owner of the fourplex is selling and just wants out of the fourplex. You have to ﬁnd a buyer to make this exchange work. You want to “buy” the fourplex as part of exchanging the duplex. The owner of the fourplex wants to sell the fourplex to you. The fourplex owner is not interested in buying your duplex. You must ﬁnd a buyer for your duplex to make the exchange happen. Essentially the buyer of your duplex will agree to help you in the exchange. He or she will switch places with you and “buy” the fourplex. Then you will exchange the duplex for the fourplex. Your buyer will wind up with the duplex he or she wanted. You will wind up with the fourplex you wanted. The owner of the fourplex will have sold it, which is what he or she wanted. Everyone gets what they wanted. This becomes a triple-win situation. Exchanging the Duplex Buyer of duplex

Owner of duplex

Owner of fourplex

becomes

becomes

becomes

“owner” of fourplex

buyer of fourplex

seller of fourplex

becomes

becomes

becomes

owner of duplex

owner of fourplex

a taxpayer

How does assigning an exchange contract work here? We were the “buyer of the duplex” who agreed to participate with the owner of the duplex in helping them structure this exchange, except we were not interested in buying or owning the duplex. We were interested in making money by ﬂipping our purchase contract to another buyer. The whole point of Section Three is that the fastest and most profitable way to ﬂip real estate is to assign the contract. In this case, we as-

C16.qxd 3/30/04 9:25 AM Page 138

ASSIGNING REAL ESTATE CONTRACTS

138

signed an exchange contract so the new buyer we assigned the contract to had to agree to participate with the owner of the duplex in completing the exchange.

Land Contracts A land contract is a type of purchase contract wherein the seller retains the title to the property until the buyer fulﬁlls the terms of the contract. Another name for a land contract is a contract for deed or a contract for sale. A land contract is used when a buyer may have a small down payment or none at all. It can also be used when the seller is carrying the ﬁnancing on the property. Essentially, a seller will not give the buyer the deed because the seller wants to make sure the buyer will fulﬁll the monetary terms of the land contract. When the buyer fulﬁlls the terms, the seller transfers the deed to the property. A land contract can be assigned just like a purchase contract. The original buyer, you, assigns interest in the land contract to a new buyer for an assignment fee. The new buyer steps into your shoes and fulﬁlls the terms and conditions of the land contract. The new buyer will not get the deed to the property from the seller until he or she fulﬁlls the ﬁnancial and the monetary terms of the contract.

Mortgages Real estate mortgages are assigned from lenders to investors every day. Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) act as the nation’s clearinghouses for packaging pools of mortgages that are sold as real estate investments on the Secondary Mortgage Market. If you are a seller of real estate and help the buyer by carrying back a mortgage as part of the purchase price, you can assign your mortgage. By doing so, you receive a lump-sum cash payment from the mortgage assignee. The mortgage assignee then receives the monthly payments from the borrower. We will have an in-depth look at the buying and selling of mortgage paper in Section Five.

C16.qxd 3/30/04 9:25 AM Page 139

Finding Assignments

139

Trust Deeds Trust deeds are another form of mortgages. Some states use trust deeds as their primary real estate ﬁnancing device. Other states favor mortgages instead. Some states use both. See Appendix B, which will give you the preferred real estate ﬁnancing device for your state. As with mortgages, trust deeds can be assigned. Discounted paper is made up of both mortgages and trust deeds. As a real estate investor, you can make a lot of money buying and selling discounted paper. You are not buying real estate; you are buying the ﬁnancing associated with real estate.

Tax Liens Tax liens are liens placed against the title to real property by a taxing authority. The taxing authority could be a city, county, port authority, school district, special assessment district, state, or federal government. Whoever is willing to pay the taxes due essentially gets either the title to the property or the tax lien itself. You do not have to be the owner of the property to pay the taxes assessed against it. Taxing authorities are only interested in getting money. The taxing authority does not care who the taxpayer is, as long as the tax gets paid. In Section Five we will show you the wonderful investment opportunities available by investing in another form of real estate paper—tax liens. Again, in keeping with the theme of this book, when you invest in tax liens, you make money in real estate without buying or owning property. Once you purchase (pay off) a tax lien on someone else’s property, you are the owner of the lien. You can hold the lien for income or potential property ownership, or you can assign your interest in it for cash.

Assignment Contract We have been in the position of being the assignee in an assignment contract. Though this is not a bad position, we prefer to be the assignor. After all, the assignor (original buyer) makes money as soon as they assign the contract to the assignee (new buyer).

C16.qxd 3/30/04 9:25 AM Page 140

140

ASSIGNING REAL ESTATE CONTRACTS

As the assignee, you are actually positioned to have to buy the property. We don’t want to buy the property. Our solution was to assign our assignment contract. We went from being the assignee in the ﬁrst assignment contract to the assignor in the second.

Assigning the Assignment Contract Assignment contract 1 Assignor/Assignee (Us)

Assignment contract 2 Assignor (Us)/Assignee

Why did we accept being an assignee in contract 1? Because we saw a way to make money! How did we avoid having to pay the assignment fee in contract 1 before we received the fee from contract 2? We made the fee due to the assignor of contract 1 coincide with the timing of the fee we received as the assignor of contract 2.

Assigning the Assignment Example What is the story here? Another real estate investor negotiated a purchase contract on an apartment complex. When they couldn’t get ﬁnancing for the property, the investor assigned the purchase contract to us. We put together and accepted an assignment contract with the caveat that we would not pay them an assignment fee unless we were able to assign our assignment contract to a third investor with the ability to get ﬁnancing or pay cash for the apartment complex. The only numbers that are relevant here are the assignment fee numbers for contracts 1 and 2. If we could make the fee for contract 2 bigger than the fee for contract 1, we would be happy. Who cares about the value or purchase price of the apartment complex? Of course, the real estate investor, assignee 2 from contract 2, did. Because they were getting a wholesale price and were going to pay cash for the apartment complex, we had a money maker on our hands. The deal was in the millions of dollars. We had agreed to pay a $100,000 assignment fee under the terms of contract 1. We received a $200,000 fee under the terms of contract 2. Assignment contract 2 Assignment contract 1 Net difference to us

$200,000 $100,000 $100,000

C16.qxd 3/30/04 9:25 AM Page 141

Finding Assignments

141

Option Contracts We have already talked about assigning option contracts. To do so, we use our standard and/or assigns clause in the buyer’s name section. If the option contract is set up with the wording optionor/optionee, you use and/or assigns in the optionee section along with your name.

Assigning an Unassignable Real Estate Contract It has been our experience that there is no such thing as an unassignable contract. The toughest contracts to assign are the ones from lenders after they have foreclosed on a loan and are reselling the property. Real estate owned (REO) properties are the source of our most proﬁtable inventory. Lenders are in the business of loaning money for real estate; they are not in the business of buying or owning property. In fact they make big money in real estate without buying or owning property! When they have to “buy”property in a foreclosure, they are most interested in selling it as quickly as possible. However, lenders are just as hoodwinked as the rest of us when it comes to listening to attorneys. They put the dumbest things in their contracts. Remember, our position on any contract is that the purpose of the contract is to communicate. Real estate attorneys, just like all other attorneys, make money by keeping people from communicating. The following is actual verbiage taken from a lender’s contract that their attorneys put in. We were actually trying to make a deal with this lender on a property they had taken back in a foreclosure.

C16.qxd 3/30/04 9:25 AM Page 142

ASSIGNING REAL ESTATE CONTRACTS

142

Needless to say, this paragraph was unacceptable to us. How did we get around this affront to our investing sensibilities? Did we get the lender’s prior written consent before we wrote an offer? No, we did not. Chantal wrote the offer as a trustee of a trust. As such, we were speaking the language the lender could understand. She did not know when she wrote the offer which trust was actually going to buy the property. The lender accepted her offer as Chantal Carey, Trustee and/or assigns. She assigned the lender’s unassignable contract to a real estate trust within seven days after her offer was accepted.

Brain Trust We must say here that dealing with REO lenders and their attorneys is very difﬁcult. You must legitimately be a trustee before you can write and present contracts as one. We do not recommend this technique if you are just starting out as a real estate investor. For those of you who are more advanced or trustees and want to consult with us for more information, contact us through our e-mail address, [email protected]. You must fully identify yourself or we will not open the email nor respond. We are now ready to embark on Section Four. Some of you will become rich as real estate investors dealing exclusively with options. We will show you why Walt Disney, Donald Trump, and savvy real estate developers and investors worldwide prefer the option as their contract of choice.

P04.qxd 3/30/04 9:27 AM Page 143

S E C T I O N

FOUR

REAL ESTATE OPTIONS

P04.qxd 3/30/04 9:27 AM Page 144

C17.qxd 3/30/04 9:24 AM Page 145

17

C H A P T E R

What Is an Option?

A real estate option contract gives you the right to buy a property without the obligation of having to buy it. In a normal purchase contract, when the buyer and seller have a meeting of the minds and sign it, the buyer must perform and go through with the agreed-on purchase. If the buyer does not perform based on the terms of the contract, the seller can sue the buyer for speciﬁc performance. An option contract allows the buyer and seller to have a meeting of the minds, sign the option contract, and offer the buyer a time certain to exercise the option. If the buyer does not exercise the option, the option expires, and the buyer owes no further obligation to the seller. Put another way, an option contract gives potential buyers the right to purchase a property before the speciﬁed future date in the contract for the amount and under the conditions written in the contract. Typically the buyer has to put up an option fee so that the seller will give the buyer the option to begin with. The fee may or may not go toward the purchase price. If the buyer does not exercise the option and go through with purchasing the property, then the seller gets to keep the fee.

Optionor/Optionee Here we are again with our old friends -or and -ee. Remember -or ending words in real estate give something. Words ending in -ee receive some145

C17.qxd 3/30/04 9:24 AM Page 146

REAL ESTATE OPTIONS

146

thing. Typically, an -or entity gives real estate paperwork to the -ee entity for valuable consideration (money). An -or/-ee example would be a grantor (the seller) gives a grant deed (paperwork) to the grantee (the buyer). In return the grantor receives money from the grantee for the deed. Another example would be a mortgagor (the borrower) gives a mortgage contract (paperwork) to the mortgagee (the real estate lender). In return the mortgagor receives a loan (money) from the mortgagee for the contract. In an option contract, the parties to the contract are the optionor and the optionee. Can you ﬁgure out who is the seller and who is the buyer? If you follow the logic from the previous paragraph, you know the optionor is giving real estate paperwork (the option contract) to the optionee. It also means that the optionee is giving money to the optionor. If you said the optionor is the seller, congratulations. That makes the optionee the buyer.

Option Fee The option fee is the consideration given by the optionee (buyer) to the optionor (seller). This is what satisﬁes the CoCa CoLa requirement and makes an option contract valid. In return for the fee, the optionor gives the option to the optionee to purchase their property. The option fee is usually a percentage of the agreed-on purchase price for the property. This percentage can range from as low as 0.5 percent on a higher-priced property to as much as 10 percent on a lowerpriced property. For a $100 million purchase price, the option fee may be $500,000. On a $300,000 purchase price, the fee may be $30,000. Option Fee Percentages $100,000,000 ⫻ 0.05% $500,000

Purchase price Option percent Option fee

$300,000 ⫻ 10% $30,000

The option fee can be applied to the purchase price in the event the optionee exercises the option to purchase. Sometimes the fee does not apply to the purchase price. This may happen when a second or even third option time period is negotiated.

C17.qxd 3/30/04 9:24 AM Page 147

What Is an Option?

147

Option Fee Applied to Purchase Price We made an offer on a ﬁve-bedroom, four-bathroom, 5,000-square-foot single-family home in a great neighborhood. Our offer was in the form of an option contract. We wanted a six-month option period because we were concerned about which way the real estate market was headed. Were we still in the prosperity phase of the real estate cycle, or were we headed into a recession? If the real estate market was headed in a downward direction, we were not going to buy the property. If the market was headed in an upward direction, we would. We negotiated the fee to apply toward the purchase price if we exercised the option. If we did not exercise the option, the seller would keep the fee. In this case the option fee was $2,500. Although this was a very small percentage of the purchase price ($300,000), the seller still accepted our contract. Purchase price Option fee Remaining balance

$300,000 ⫺$2,500 $297,500

Option Fee Not Applied to Purchase Price It happens more frequently than you might expect that the negotiated option fee does not apply to the purchase price. Why would the optionee accept a deal wherein the option fee they put up does not apply to the purchase price? Home builders often acquire ﬁnished lots for construction through option contracts with a real estate developer. The builder agrees to buy the lots over a speciﬁc period of time (the option period) and the developer takes a nonrefundable option fee as a percentage of the purchase price (sound familiar?). The option contract limits the home builder’s exposure to loss to the amount of the option fee. In many cases the home builder will want to extend the option past the original time period. Let’s say the ﬁrst option period was six months. An extension could be needed by the homebuilder being unprepared to start building, or the homebuilder not having ﬁnancing together, or the homebuilder wanting to get into a new ﬁscal year and delaying the purchase.

C17.qxd 3/30/04 9:24 AM Page 148

REAL ESTATE OPTIONS

148

To extend the option period for another six months, the developer may require another option fee from the builder. Sometimes the second option period may be extended to a third or even a fourth. Although the developer may have been willing to apply the ﬁrst option fee toward the purchase price of the lots, the developer may not be willing to apply any of the other fees to the purchase price once an extension or extensions are agreed to. If the builder was able to exercise the option in the ﬁrst option period, the $200,000 fee would have applied to the purchase price. The builder would have to come up with additional funds of $2.2 million. 1st option Purchase price $2,400,000 option fee applied $200,000 additional funds $2,200,000

2nd option Purchase price $2,400,000 option fee $200,000 additional funds $2,400,000

3rd option Purchase price $2,400,000 option fee $200,000 additional funds $2,400,000

If the builder was able to exercise the option in the second period, the ﬁrst $200,000 fee would have already gone to the developer and not applied to the purchase price. The second fee would go to the developer and not apply to the purchase price. The ﬁnal purchase price to the homebuilder would be $2.8 million. If the builder was able to exercise the option in the third period, the ﬁrst, second, and third option fees would have gone to the developer. The builder would still pay the $2.4 million purchase price. The ﬁnal purchase price to the builder would be $3 million. 2nd Option $2,400,000 $400,000 $2,800,000

Purchase price Option fees Final price

3rd Option $2,400,000 $600,000 $3,000,000

If for whatever reason the builder cannot go through with the purchase of the lots, the builder still beneﬁts from using an option contract. Even in the third option period scenario, the builder limits losses to $600,000 (the three $200,000 fees), which is only 25 percent of the $2.4 million purchase price. $600,000 option fees 25%

versus versus

$2,400,000 purchase price 100%

C17.qxd 3/30/04 9:24 AM Page 149

What Is an Option?

149

If the builder does complete the purchase at the end of the third six-month option period, the builder may still beneﬁt greatly by using an option contract. In the 18 months of the combined periods, the value of the lots may have gone up 30 to 40 percent and be worth more money than the builder winds up paying to the developer. Remember, the developer cannot raise the price of the lots to the builder unless there is an agreement to do so in the option contract. $2,400,000 ⫻ 30% $720,000 $3,120,000

Original value Value % increase Value increase New value

$2,400,000 ⫻ 40% $960,000 $3,360,000

There might well be an option in a purchase contract to terminate the contract unilaterally on the buyer’s part. The buyer will lose the option fee but will get back their earnest money deposit! The seller cannot sue the buyer for speciﬁc performance if this termination option is part of the original negotiated purchase contract. Also note that if the buyer does go through with the transaction, the termination option fee will or will not be credited to the sales price at closing. This crediting or noncrediting of the termination option fee is a matter of negotiation between seller and buyer.

Uses of Options in Real Estate The two main uses of options in real estate investing are purchase options and lease options. The two examples we have already presented are purchase options. A lease option can be a very good way to landlord your way to a proﬁtable sale of your investment real estate. By selling your investment property using a lease option, you practically guarantee having a good tenant during the leasing period. (More about that later.)

Purchase Option Our use of options as real estate investors deals mainly with purchase options when we are “buying” property. Of course, because we are interested in making big money in real estate without buying or owning

C17.qxd 3/30/04 9:24 AM Page 150

150

REAL ESTATE OPTIONS

property, we use a purchase option to tie up property, not to buy it. We make money by ﬂipping the purchase option contract. Nothing changes for us just because we are using a purchase option rather than a purchase contract. We still want Quick Cash. We are going to give you another purchase option example from our own experience. There is a distinction between a real estate developer and a home builder. A developer buys raw land and prepares it for development. The developer will divide the raw acreage into building lots, bring in water and utilities, and sometimes put in the streets. A home builder can start from scratch, like a developer. However, many builders prefer just to build homes. As we talked about earlier in this chapter, builders like to use purchase options to tie up residential lots owned by developers. We found a real estate developer who had 60 lots, water and utilities to the property, and the streets laid out and graded but not paved. We made an offer using a purchase option. We offered the developer $360,000, with a six-month option period and a $15,000 option fee that would apply toward the purchase price. Purchase price Option fee Remaining balance

$360,000 ⫺$15,000 $345,000

We had 30 days to come up with the $15,000 option fee. Within three weeks we found a home builder who was interested in building on 40 of the 60 lots. We sold them 20 lots for $160,000. We gave them a sixmonth purchase option for an additional 20 lots for $220,000. We received a $20,000 option fee. Sold ﬁrst 20 lots Option fee 20 lots Cash received

$160,000 ⫹$20,000 $180,000

We went back to the developer and exercised our option. We took $15,000 of the $20,000 option fee we received from the builder and gave it to the developer. We also gave the developer the $160,000 cash we had received from the sale of the ﬁrst 20 lots. This left us with $5,000 cash in our pocket. Option fee received Option fee paid Cash in our pocket

$20,000 ⫺$15,000 $5,000

C17.qxd 3/30/04 9:24 AM Page 151

What Is an Option?

151

We obtained a release from the developer on the ﬁrst 20 lots after we paid the option fee and the $160,000 we had received from the builder. The builder was now able to begin building on the ﬁrst 20 lots. We still owed the developer $185,000. Purchase price Option fee Remaining balance Cash paid Still owed

$360,000 ⫺$15,000 $345,000 ⫺$160,000 $185,000

Within six months the builder had completed construction on the ﬁrst 20 lots. The builder exercised the Option on the second 20 lots. We received another $200,000 cash. Sold second 20 lots Option fee paid Additional cash

$220,000 ⫺$20,000 $200,000

We went back to the developer and paid off the remaining $185,000. We released the second 20 lots to the builder. We had an additional $15,000 cash, making a total of $20,000 cash in our pockets. Can you believe this: we owned the last 20 lots free and clear! Additional cash Still owed Additional cash

$200,000 ⫺$185,000 $15,000

Lease Option If you agree to lease your property with an option to buy, use a lease option or a combination of a lease, an option, and a purchase contract. This enables you to obtain income from a property that otherwise might cost you money. If the buyers do not exercise the option, you get to keep the option fee. Keep in mind that a buyer can purchase your property at any time within the lease period. This may cause you a tax problem if the buyer does so in an unfavorable tax year. Also, you do not receive money for the sale until the property is sold, which is usually near the end of the lease period.

C17.qxd 3/30/04 9:24 AM Page 152

152

REAL ESTATE OPTIONS

Unless you have negotiated otherwise, you cannot legally increase the purchase price during the term of the option period. You could negotiate that the price of the property when the buyer exercises their option be a value determined by some mutually acceptable method. After the buyer lives in the property, he or she may discover certain inconveniences that they didn’t expect and may try to avoid purchasing the property. If you decide to use a lease option, consider requesting approval for it from the real estate lender who holds the mortgage on the property. The loan may contain a provision that calls for an acceleration of the loan payoff in the event of a lease option. Include a provision in the lease option that if the buyer does not purchase the property they forfeit the lease deposit as well as the option fee. Add a clause that the buyer makes monthly lease payments that equal or exceed your PITI payment. You might decide to include a provision that you credit the buyer with a portion of the monthly lease payment toward the purchase price. We revisit the property we talked about earlier in this chapter where we said the option fee applied to the purchase price. We made an offer on a ﬁve-bedroom, four-bathroom, 5,000-square-foot single-family home in a great neighborhood. Our offer was in the form of an option contract with a six-month option period. We negotiated the option fee to apply toward the purchase price if we exercised the option. If we did not, the seller would keep the option fee, which was $2,500. The seller accepted our contract. What do you think we did with this property? We found retail buyers and “sold” them the property using a lease option. The lease option period was for six months. The option fee was $2,500. We agreed on a purchase price of $300,000. Let’s summarize so far. “Bought” Property $300,000 $2,500 6 months

Purchase price Option fee Option period

“Sold” Property $300,000 $2,500 6 months

So how did we make any money on this deal? Everything is the same between the “bought” numbers and the “sold” numbers. We negotiated a $2,500 monthly lease payment from our buyers. Over the six months we would receive $15,000. None of the lease payment would apply to the purchase price. We were guaranteed good tenants because they were buying the property and were practically homeowners.

C17.qxd 3/30/04 9:24 AM Page 153

What Is an Option?

153

We went back to the seller and negotiated a six-month lease for a $1,000 monthly payment. All of our lease payments would be credited toward reducing the purchase price! Are you starting to get the picture here? We made money on this deal two ways. We received a net $9,000 in lease payments. We received $6,000 at closing because of the reduced purchase price we paid to the seller based on our lease payments being credited. So we made $15,000 total on the deal. Is this a fun way to make money or what? Lease payments received Lease payments paid Net lease payments Purchase price received Purchase price paid Net price difference Net lease payments Net price difference Total made on deal

$15,000 ⫺$6,000 $9,000 $300,000 ⫺$294,000 $6,000 $9,000 ⫹$6,000 $15,000

In Chapter 18 we will give you the 10 reasons for using a real estate option. All we’ll say here is that if it was good enough for Walt Disney, it is good enough for us. What did Disney need to use options for? Some of you may already know. Please, read on.

C18.qxd 3/30/04 9:24 AM Page 154

C H A P T E R

18

Why Use an Option?

When you use a real estate option contract, you can tie up a property without revealing who is buying it. It gives you the right to buy the property without revealing your identity. This is because you wait to exercise your option until you have put together all the pieces to your overall real estate plan. An option gives you the luxury of tying up a property and not having to close on it. Once you close on a property, your name is revealed in the public record as the buyer of the property. Walt Disney assembled the property for Walt Disney World in Florida using option contracts. He did not want to tip his hand to the many different property owners from whom he needed to purchase property. If remaining property owners knew he was buying property, they could hold out for a higher price. Disney would have had to pay big bucks once word got out that he wanted to put all the properties together for Walt Disney World.

Ten Reasons to Use an Option Contract There are 10 key reasons to use an option contract as a real estate investor. These reasons are to maintain privacy, protect your cash, provide limited risk/high return, control property, buy time, assemble partners, watch the direction of the market,handle contingencies,procure ﬁnancing,and do income tax planning.

154

C18.qxd 3/30/04 9:24 AM Page 155

Why Use an Option?

155

1. Maintain Privacy If it was good enough for Walt Disney, it’s good enough for us. As we have said, when you close escrow on a piece of property, the grant deed or warranty deed is recorded at the county recorder’s ofﬁce. This deed becomes part of the public record. This means anyone in the world can get on the Internet and ﬁnd out who owns that property. Why? Because the deed names the grantor, the seller, and the grantee, the buyer— that’s you.

When your name is recorded on the deed at the county recorder’s ofﬁce, it is like having your identity on a billboard advertising you are in the neighborhood buying property. Although this may not necessarily be a bad thing if you are trying to ﬁnd property of a general nature in an area, it can be a disadvantage for two reasons if you have your real estate investor eye on a particular property or properties. It is a bad thing because, like in Walt Disney’s case, with assembling multiple pieces of property you tip your hand to owners of property you still need to tie up. This can make your remaining property purchases very expensive. It can be a disadvantage because you tip off other real estate investors who could be your competitors that you are buying property in a particular area. Do you think that Donald Trump targets an area to make a real estate investment in and then makes a public announcement or tips his hand to let his competition into the bidding? Of course not. Use an option contract to maintain your privacy.

C18.qxd 3/30/04 9:24 AM Page 156

REAL ESTATE OPTIONS

156

2. Protect Your Cash Just like with the stock market, where you can protect your cash by using a stock option, using a real estate option protects the amount of cash you have in any single investment. Rather than buying property with 100 percent of your cash, by using an option you control 100 percent of the property with only a small percentage of your cash. We have already given several examples in the last chapter of how using an option fee limits your cash exposure in a real estate investment. Even in the situation where we described three six-month option periods with three $200,000 option fees, the investor still protected his or her cash with the use of an option contract. Protect Your Cash $600,000 option fees 25%

versus versus

$2,400,000 purchase price 100%

If, for whatever reason, the investor decided to not go through with this transaction, his or her cash position would be protected on a threeto-one basis. For every $1 the investor put up in option fees, $3 remained in cash reserves. This is with a 25 percent option fee, which is about 15 percent too high because of the three fees. If it was only one fee of $200,000 we would be looking at an 8.33 percent option fee.

3. Limited Risk/High Return Using an option contract limits your risk as an investor and gives you a high return. Real estate investing is the last bastion of leverage. Even in a traditional home purchase, a lender requires a maximum of 20 percent down payment. With a 20 percent down payment, any real estate lender in the country will give you the best interest rate and loan you money for 30 years. If you make a 20 percent down payment of $40,000 on a $200,000 purchase price, you will be borrowing $160,000 from a lender. If the property increases in value by 5 percent annually, you will be getting a 25 percent annual return on your $40,000 down payment (investment). Leverage Down payment 20% Loan amount 80% Purchase price 100%

$40,000 $160,000 $200,000

C18.qxd 3/30/04 9:24 AM Page 157

Why Use an Option?

157

Appreciation Purchase price Annual appreciation Value increase

$200,000 5% $10,000

Return on Investment Value increase Amount invested Investment return

$10,000 $40,000 25%

If you think the investment return is good using the leverage available in a standard real estate transaction, how good do you think the investment return is using an option? We said in Chapter 17 that option fee percentages range from 0.5 percent to 10 percent depending on the size of the transaction. Option Fee Percentages $100,000,000 0.5% $500,000

Purchase price Option percent Option fee

300,000 10% $30,000

What would our $200,000 transaction look like from a return on investment perspective if we put up a 10 percent option fee of $20,000 for a 12-month option period? The return on the cash investment looks a lot better than what you are getting on your CDs, doesn’t it? Leverage Option fee 10% Purchase price

$20,000 $200,000

Appreciation Purchase price Annual appreciation Value increase

$200,000 5% $10,000

Return on Investment Value increase $10,000 Amount invested $20,000 Investment return 50%

C18.qxd 3/30/04 9:24 AM Page 158

REAL ESTATE OPTIONS

158

4. Control Property The name of the game in real estate investing is control. Donald Trump controls way more real estate than he owns. When you have control of something, you are many times in a better position than when you own something. Our Quick Cash real estate investment strategy is based on controlling property, not owning it. We take this one step further by controlling property with the paperwork of buying real estate. By using an option contract you can control lots of property without owning any of it. We will brieﬂy mention the advantages of controlling property without owning it. You may remember them from Chapter 8. These advantages include quick cash, no landlording, no monthly mortgage payments, no property taxes, no hazard insurance, no maintenance costs, no homeowner association dues, no lawsuits, no extensive record keeping, and no income tax problems. The advantages of controlling property with an option contract are the same as the advantages of ﬂipping property. Except it is better with the option contract because you can ﬂip the contract rather than ﬂipping the property. In other words, with the option you control the property without owning it. Let’s add some numbers to this controlling property with options scenario. How much property could you control using $2.4 million as option fees? Let’s say the option fee percentage is 10 percent. Some of you can do the math in your head. This amount, $2.4 million, is 10 percent of what number? That’s right—$2.4 million is 10 percent of $24 million. No wonder Donald Trump likes to use real estate options.

5. Buy Time By using an option contract you can buy time. You may need time to bring in a money partner. You may need time to put together your ﬁnancing. You may need time to ﬁnd a new buyer. Now is a good time to talk about money partners. There is a ton of money out there looking for a good real estate investment. Our experience as investors has been ﬁnding the right property and/or the right seller is much harder than ﬁnding a money partner. If you are the kind of person who has a lot of money to invest in real estate, congratulations! We wish you luck ﬁnding a good deal. Unless you ﬁnd someone like us in your area, you will wind up paying too much

C18.qxd 3/30/04 9:24 AM Page 159

Why Use an Option?

159

for your properties. Of course, you could always contact us! We do business anywhere! We will probably say this at least 10 times through the course of this book. Buy the property ﬁrst, then get the ﬁnancing. Most people think of a money partner as someone who puts up the down payment or can pay cash for the property. Sometimes ﬁnding a money partner is ﬁnding someone who will put up their credit or ability to get a real estate loan. In the time we were writing this book, we found an ad for a property that was advertised $1 million under market. We wrote an offer on the property in the form of a real estate option contract. This was a property we thought about keeping for ourselves. We used the option period to ﬁnd a money partner who would qualify for and obtain a loan to be used to purchase the property. We were planning on assigning the option if we didn’t keep the property. Our point for now is that the use of the option gave us the ability to buy time and get a money partner.

6. Assemble Partners We use an option contract when we need to assemble partners to go in on the real estate transaction. Sometimes these partners are money partners. Sometimes they are developers. Sometimes they are home builders. Sometimes they are your real estate team for the area. You may need to ﬁnd a real estate attorney. You may need an escrow company or a closing agent. What about a title insurance company or even a termite company? You may need to ﬁnd a real estate agent. Whatever the partnership needs are that you must fulﬁll to put together a successful transaction, by using a real estate option, you will give yourself the necessary time to form the partnership(s).

7. Watch the Direction of the Market You can use an option to tie up a property and watch the direction of the market. Everyone has 20/20 hindsight with regard to the turning points of the real estate market. The trick is to have 20/20 foresight with regard to these turning points. When things are going well, that is easy to recognize. When things are going not so well, that is easy to recognize. We have already told you in Chapter 2 that the economic cycle is one of expansion, prosperity, recession, and depression. Then it repeats

C18.qxd 3/30/04 9:24 AM Page 160

160

REAL ESTATE OPTIONS

itself. Real estate value is greatly inﬂuenced by the economic cycle. Typically, real estate is said to do well in the expansion and prosperity phases and poorly in the recession and depression phases. Remember our example from the previous chapter. We said we made an offer on a ﬁve-bedroom, four-bathroom, 5,000-square-foot singlefamily home in a great neighborhood. Our offer was in the form of a real estate option contract. We wanted a six-month option period because we were concerned about which way the market was headed. Were we still in the prosperity phase of the real estate cycle, or were we headed into the recession phase? If the market was headed in a downward direction, we were not going to buy the property. If the market was headed in an upward direction, we would buy the property. We told you how we made money on this deal. But what if the market had turned? What if the retail buyer we found for this deal got cold feet? What if we couldn’t sell the property? Our 20/20 foresight was in setting up this deal as an option contract. That way, if the market had turned, our risk would have been limited to our option fee of $2,500 if we had not found a buyer. Let’s say we had found the retail buyer, done the lease option with them, and at the end of the six-month option period, the real estate market had turned downward. The retail buyer then chose not to exercise the purchase option. How would we have made out? We would not have exercised our purchase option with the seller. The seller would get to keep our $2,500 option fee. We would get to keep the buyer’s $2,500 option fee. Option fee paid to seller Option fee received from buyer Money lost on deal

$2,500 $2,500 $0

The seller would get to keep the six monthly lease payments of $1,000 each. We would get to keep the six monthly lease payments of $2,500 each. Lease payments from buyer Lease payments to seller Money made on deal

$15,000 $6,000 $9,000

C18.qxd 3/30/04 9:24 AM Page 161

Why Use an Option?

161

8. Handle Contingencies We use an option contract when we know there are going to be contingencies that need to be handled as part of the purchase contract. What kind of contingencies are we talking about? Contingencies come in all shapes and sizes. Financing contingencies, money partner contingencies, zoning changes, termite inspections, geological inspections, earthquake insurance, ﬁre insurance, roof inspections . . . The list goes on and on. A contingency in a contract is a condition that has to be met, satisﬁed, or accomplished, otherwise the whole deal can be blown out of the water. One of the most important details to handle in a real estate transaction is to remove the contingencies. We will give you a good example of how you can beneﬁt by using an option contract when it comes to contingencies. If you are a real estate developer, a builder, or a real estate investor, you’ll know that the zoning of a property has an impact on its value. In fact when we talked about the four great forces that affect value, we said that political forces, which include zoning, was one of them. The value of any property is impacted by its zoning. You may think that you can get the zoning changed on a property and thereby increase its value. By using an option contract you can control the property while you are in the process of going through a zoning change. If you don’t get the zoning change,you may choose not to exercise your purchase option.

9. Procure Financing By using an option contract you can take your time procuring the best available ﬁnancing for your real estate deal. We have seen interest rates for loans go from historical highs in the early 1980s to historical lows in the early 2000s. By doing a 6-month, 12-month, 18-month, or even longer option period, you should be able to ﬁnd an attractive interest rate to ﬁnance the transaction. If not, then you do not have to exercise your option. The other ﬁnancing advantage with using an option is that it may give you time to clean up or correct your credit and have the three credit bureaus reﬂect your improved credit in their records. This may

C18.qxd 3/30/04 9:24 AM Page 162

REAL ESTATE OPTIONS

162

allow you to get a loan from a lender and also get a better loan because now you have better credit and a better credit score to go with it. We have already mentioned the advantage of having time to ﬁnd a money partner or partners and/or having your ship come in. Remember our advice. Buy the property ﬁrst, then get the ﬁnancing. By using an option you have “bought” the property ﬁrst. Now you have the time to get the ﬁnancing.

10. Income Tax Planning We have not talked much about income tax planning for real estate investors. As we have said, our investment strategy is Quick Cash. We make money in real estate investing ﬁrst and then think about the tax consequences later. We are not keen on paying income taxes. Nor are we adverse to income tax planning. We would rather have the problem of making too much money as investors and then worrying about the income tax consequences than having a wonderful income tax planning strategy in place and worrying about not making any money. When you use an option contract you can get certain income tax advantages as an investor. We have talked about an IRC 1031 taxdeferred exchange. As a real estate investor, you may want to use an option contract if you are involved in this type of exchange. When doing a 1031 exchange, the process sometimes becomes a chicken-and-egg debate. Which comes ﬁrst? Do you “sell” the property you have and then look for a property to “buy?” Or do you ﬁnd a property to “buy” and then “sell” the property you have? We recommend you “buy” the property you want to exchange into using an option contract. When you ﬁnd a buyer for the property you are exchanging out of, then you exercise your option and “buy” the property you want to complete the exchange. Reverse Option Alternatively, you can “sell” the property you have to a buyer using a reverse option. A reverse option allows you to sell your property to the buyer, but you don’t have to. If you ﬁnd a property you want to exchange into, then you will “sell” your property and your buyer must buy it from you under the terms of the reverse option. Without getting too technical here, in a reverse option the buyer gives you an option to sell your property. But you don’t have to. If you

C18.qxd 3/30/04 9:24 AM Page 163

Why Use an Option?

163

do not sell to the buyer during the reverse option period, the buyer cannot sue you for speciﬁc performance. We will talk more about reverse options in Chapter 21. The income tax advantage of using the reverse option is that you don’t get caught selling a property and triggering an income tax consequence you don’t want to have. If you can’t ﬁnd one of your exchange legs, you don’t exercise your option.You wind up keeping your property rather than selling it. Another advantage from an income tax standpoint is you can sell your property this year, but not close it until next year, when you sell using an option. That way, any tax consequences from the sale won’t be recognized for two years. Before you go on to Chapter 19, we suggest you look through this chapter again. We think we may have ﬁnally impacted some of you veteran real estate investors. Remember, we are your real estate Brain Trust. Start to think and dream like we do, and start making some big money. In the next chapter we will give you the nitty gritty of how to option.

C19.qxd 3/30/04 9:24 AM Page 164

C H A P T E R

19

How to Option

Optioning begins with the option contract. You can take a standard purchase contract and turn it into an option contract. Or you can use an option contract from the beginning. A real estate option contract is similar to a grant deed or a warranty deed in that only the seller needs to sign the document to make it valid. Just like in a grant deed or in a warranty deed, the seller will be granting something in an option contract. In a grant deed or in a warranty deed, the seller is granting title or ownership in the property to the buyer. In an option contract the seller grants the right for the buyer to buy the property during the option period for a price agreed on in the contract. The reason the seller signs a grant deed or a warranty deed and gives the title to the property to a buyer is because the buyer pays the seller lots of money. The reason a seller signs an option contract and gives the buyer the right to buy the property is because the buyer pays the seller an option fee. We recommend using an option contract from the beginning. That way both you and the seller know you are interested in putting together an option at the outset of negotiations. We are going to show you the option contract we have created and use in our own real estate transactions. In the rest of this chapter we will show you how to turn a purchase contract into an option contract and how to turn an option contract into a purchase contract. We will also show you how to use the option section in a lease purchase contract using examples from two such contracts. Finally, we will talk about how you can assign an option contract. 164

C19.qxd 3/30/04 9:24 AM Page 165

How to Option

165

Option Contract We feel very strongly about the value of using options in your real estate investing strategy, whatever that strategy may be. The use of options has made many real estate investors extremely wealthy. Although you know by now that our real estate investment strategy is Quick Cash, for those of you who like long-term wealth building, using real estate options is a great tactic, too. Just ask Walt Disney’s relatives or Donald Trump. We are going to unpack the option contract over the next several pages so you get a feel for the how-to of using the contract itself. Read the contract, study the contract, and learn the contract.

This is a good place to handle the city and state sections of any real estate contract you write. You write in the city and state where you are writing the contract, not where the property is located. Next, you write in the date that you are writing the contract. By the way, you as the optionee/buyer are writing this contract. There is a presumptive close in the way this contract is structured. It shows you have a sincere interest to purchase from the seller the property they are offering for sale, so they should obviously agree to the option. In the Received from section, you ﬁll in your name and and/or assigns just like you do with any real estate contract. Nothing changes as far as and/or assigns goes just because you are doing an option contract.

C19.qxd 3/30/04 9:24 AM Page 166

166

REAL ESTATE OPTIONS

Notice it then says after you write in your name and/or assigns, “The Buyer.” We want the owner of the property to think you are a buyer for their property. We do not want to confuse the owner by having you write in your name and/or assigns and then have the contract say,“The Optionee.”You are already having to explain and/or assigns. What the heck are you going to say about “the Optionee?” Check out this nonsense:

The Sum of/Shown By This is where you write the amount of the option fee as a dollar amount. This is similar to the earnest money deposit section in a purchase contract, including the “shown by,” which tells what form the option fee is coming in. Is the option fee in cash (we don’t recommend using cash for any consideration accompanying a contract), cashier’s check, personal check, or something else? The “or” is where we recommend you write in promissory note. Payable To If you are using a promissory note, you could put the owner’s name here. That would have a very good psychological impact. We all like to see our name on some type of ﬁnancial instrument when it has “payable to” on it. We do, however, recommend putting an escrow company, closing company, or your real estate attorney’s trust account if you are using cash, a cashier’s check, or a personal check. To Be Held Uncashed Until this Option Is Accepted as Deposit Toward The owner does not get the option fee until at the very least they have agreed to give you an option on their property. Just because the owner grants you an option on their property doesn’t automatically mean the owner gets to cash the option fee. Also, the fee must be accepted as a deposit toward the price of the property in this example. The Price of ____________(____) Dollars Here is where you make an offer for the owner’s property for the price of so many dollars written out like a check—ﬁrst the written number,

C19.qxd 3/30/04 9:24 AM Page 167

How to Option

167

then the amount in numerals. Again, this is a psychological plus because the owner is focused on dollars you are prepared to pay should he or she give you this option.

Seller Hereby Gives and Grants to Buyer and/or Assigns This is the place in the option contract where the owner becomes the seller, giving and granting to you, the buyer, and your assigns all the goodies. For a Period of____ Months from the Date Hereof This is where you get the 3, 6 , 9, 12 months, or more to control this property without having to buy it. Hereinafter Known as the First Option Period This important wording sets up the possibility of other option periods beyond this ﬁrst one. The Exclusive Right and Privilege of Purchasing This wording gives you exclusivity as the only buyer of the property during the option period. Even if the seller got a better offer from another buyer, he or she could not sell the property to anyone but you. Brain Trust Is it possible for the seller to make you an offer to give up your exclusive option? The answer is yes! Your question to the seller should be: “How much is this worth to you, seller, if I give up my option?” The Following Described Real Property Located at ______________ This is where you put the address of the property that is the subject of the Option Contract.

C19.qxd 3/30/04 9:24 AM Page 168

168

REAL ESTATE OPTIONS

2. Exercise of Option This is the section of the option contract that gives you and/or assigns the power to exercise your option. It also builds in a second and a third option period. All you need to do to exercise or extend your option is give or mail a written notice to the seller of your intention to exercise or extend the option.You must do this on or before the expiration date of the option or any extensions thereof.

C19.qxd 3/30/04 9:24 AM Page 169

How to Option

169

3. Extension of Option This section gives you the opportunity to negotiate additional option periods. Of course, you have to put up additional fees to get these extensions. We recommend that you ﬁll this out at the beginning of the negotiations. The second or third option fees are not due until the beginning of those option periods.

4. Expiration of Option This section extinguishes the option if it is not exercised. The option takes itself out of existence once the expiration date for the option passes. The expiration date is therefore fairly self-explanatory.

5. Evidence of Title This section gets you title information and has the seller agreeing to provide you with a title insurance policy in the event you exercise your option.

C19.qxd 3/30/04 9:24 AM Page 170

REAL ESTATE OPTIONS

170

6. Real Estate Purchase Contract This is the section that strengthens the option contract. Rather than trying to put a whole purchase contract inside the option contract, we bring in the purchase contract only if it is necessary. The purchase contract becomes necessary when you exercise your option.

In Witness The in witness section provides a place for the seller to sign the option contract. And it provides a place for two witnesses to sign that they indeed saw the seller sign the contract. We do not provide a notary area on our option contract. You defeat one purpose of using the option (privacy) if you have the seller’s signature notarized (a requirement for recording) and then record the option contract at the county recorder’s ofﬁce. Now everyone knows you have an option on the seller’s property. If you feel you must record something because you think the seller may try to pull a fast one and sell the property to another buyer during your option period, then you can record a memorandum of option.

Memorandum of Option A memorandum of option can be recorded to protect your optionee interest in the property. Your name as the optionee does not have to appear on the memorandum of option. If the optionor/seller does try to sell the property to another buyer during your option period, a title company doing a title search for the other buyer will uncover the recorded memorandum of option. This will prevent the seller from transferring clear title, and the deal with the other buyer will fall apart.

C19.qxd 3/30/04 9:24 AM Page 171

How to Option

171

Purchase Contract Our recommendation for how to turn a purchase contract into an option contract is really quite simple. Use both contracts. We speciﬁcally include in section 6 of the option contract that the seller and buyer will use a purchase contract in the event the buyer exercises the option.

We have handled going from an option contract and combining it with a purchase contract. Now we need to handle going from the purchase contract and turning it into an option contract. Our recommendation is to use the supplements section of our purchase contract for real estate and deposit receipt. In the attached documents area,write in “real estate option contract”and put an X in the space beside it.

If you are using a different purchase contract than the one we use, no problem. Find the additional ﬁnancing section, or any place where you have blank lines in the contract. Use the wording from our example to combine the option contract with the purchase contract.

C19.qxd 3/30/04 9:24 AM Page 172

REAL ESTATE OPTIONS

172

Lease Option Contract A lease option contract can be known by several other names. It may be called a lease with purchase option. It may be called a residential lease with option to purchase. No matter what it is called, its purpose is to combine a lease with an option to purchase. In a standard lease, the lessor, the property owner, gives a lease to the lessee, the tenant. In return the lessee pays the lessor rent. In a standard option the optionor, the property owner, gives an option to the optionee, a potential buyer. In return, the optionee pays the optionor an option fee. In a lease option the lessor/optionor, the property owner, gives a lease and an option to the lessee/optionee, the tenant. In return the lessee/optionee pays the lessor/optionor rent. There is no option fee in addition to the rent. The lease may require a deposit to be applied to a security deposit, a key deposit, a cleaning deposit, last month’s rent, and/or whatever else the landlord wants. This is not an option fee. We are going to show you the option clauses in a couple of different lease option contracts. Example 1

C19.qxd 3/30/04 9:24 AM Page 173

How to Option

173

Example 2

We have given you examples of having the lease payments, the rent, apply toward the purchase price in the event the purchase option is exercised by the lessee/optionee. Remember, everything is negotiable. Keep this in mind if you are negotiating any type of lease option contract.

Assigning an Option Contract We use an option contract that is already set up to be assigned by the wording in the contract itself. In the event you are using an option contract that is not set up to be assigned, all you have to do is add the words and/or assigns to the buyer or assignee name portion of the contract. We have underlined the word assigns in our sample option contract.

C19.qxd 3/30/04 9:24 AM Page 174

174

REAL ESTATE OPTIONS

In Chapter 20, we will show you the critical times to use an option contract. These situations dictate why and when you should use an option contract.

C20.qxd 3/30/04 9:23 AM Page 175

C H A P T E R

20

When to Option

As we have said, using a real estate option contract you can control property without buying it. You should think about using an option contract for the reasons we talked about in Chapter 18. To review, those reasons are to maintain privacy, protect your cash, have limited risk/high return, control property, buy time, assemble partners, watch the direction of the market, handle contingencies, procure ﬁnancing, and do income tax planning. Our focus in this chapter is to give you examples of when to use an option contract in your investment. Timing is everything. As a real estate investor, you need to be at the right place at the right time.You also have to use the right investing tools at the right time. Using an option contract at the right time may be crucial to your success, You will get a better sense of when to use an option contract the more real estate deals you are involved with. We liken the use of an option to getting a new vehicle. Once you start driving a new car, you start seeing them everywhere. Once you have the idea of optioning in your mind, you will start seeing optioning opportunities in almost every real estate deal.

175

C20.qxd 3/30/04 9:23 AM Page 176

REAL ESTATE OPTIONS

176

When to Option Maintaining Privacy As we said in Chapter 18, when you close escrow on a piece of property, the grant deed or warranty deed is recorded at the county recorder’s ofﬁce. This Deed becomes part of the Public Record. This means anyone in the world can get on the Internet and ﬁnd out who owns that property. This can be a bad thing because you tip your hand to property owners of property you still need to tie up, making your remaining property purchases very expensive. It can also tip off other real estate investors who could then become your competitors. Lawsuits, Creditors, Divorce, IRS Liens Aside from tipping off surrounding property owners and potential competition, there are four more important situations when it may be in your best interest to use an option contract to protect your privacy. These include being involved in a lawsuit, going through a divorce, being hounded by creditors, and having the IRS on your case. You can’t stop being a real estate investor because of adverse ﬁnancial circumstances that come your way over the course of a lifetime. If you live long enough, the odds are good you will experience one or more of these situations. We personally have experienced all four of these situations at one time or another. When you own real estate, you are a target. Attorneys ﬁle lawsuits against people they think have assets worth going after. Attorneys take on clients for a percentage of the money the attorney can win in court. How many of you have heard the expression “you can’t get blood out of a turnip”? When an attorney is searching the public records to ﬁnd your real estate assets, you want them to think you are a turnip. If your ex-spouse is trying to get money out of you, the ﬁrst place his or her attorney looks is real estate holdings. What real estate holdings? When creditors come after you, what do they come after? They may not be able to get your home, but they can certainly come after your other real estate investments. Don’t even get us started on the IRS or your state taxing authority. If you don’t pay the taxing authority what they think you owe them, they will put tax liens on your real estate assets. When you go to sell these assets, the tax lien will show up against your title to the property. The new buyer will not be able to get clear title from you until you pay the tax lien. Remember, transferability is one of the elements of

C20.qxd 3/30/04 9:23 AM Page 177

When to Option

177

value in real estate. At the very least, if you cannot transfer clear title, your real estate holdings will be diminished in value. So if you are involved in one of these situations, we recommend using options. You can be a real estate investor who controls property without owning it. We are ﬁrm believers in the right to privacy in business affairs. Make using options part of your privacy protection.

Protecting Your Cash Using an option protects the amount of cash you have in any one real estate investment, as covered earlier. You can control the property with only a small percentage of your cash. Example 1 We found a home builder who wanted to sell 10 lots they had decided not to build on. The builder wanted $10,000 for each lot. We had $10,000 to invest. Using traditional real estate investment thinking, how many of the lots could we buy with $10,000? The ﬁrst answer is we could obviously buy one of the lots. We could pay $10,000 cash for it. We would have owned the lot free and clear. We would have no mortgage payments but would still be responsible for property taxes. Answer one All cash Lot price $10,000 Cash invested $10,000 # of lots purchased 1 Some of you are thinking,“Wait a minute. That is not very smart. You should be able to do more with that $10,000.”The second answer is we could buy all of the lots. We could leverage the $10,000 and pay $1,000 down and have the seller carry the remaining $9,000 on each of the lots. We would “own” all 10 lots and have a monthly mortgage payment of $700 to $900 without considering property taxes. We would be using leverage. Answer two Lot price Cash invested # of lots purchased Monthly mortgage payments

Leverage $100,000 $10,000 10 $900

C20.qxd 3/30/04 9:23 AM Page 178

REAL ESTATE OPTIONS

178

The third answer, and the solution we used, was this. We wrote 10 option contracts, one for each lot. We gave an option fee of $1,000 for each contract. We had an option period of 12 months for each option. We had no monthly mortgage payments and no property taxes to pay. Over the course of the 12 months we saved $10,800 in monthly mortgage payments and $4,200 in property taxes. We protected our cash to the tune of $15,000 by knowing when to use option contracts. Answer three Options Lot price $100,000 Cash invested $10,000 # of lots optioned 10 Monthly mortgage payments $0 Cash protected $15,000

Limited Risk/High Return When you use an option contract, you limit your risk as an investor and give yourself a high rate of return. If we use the example above, it is obvious that we limited our risk. We used 10 option contracts instead of buying only one lot for cash, so we spread our cash, thereby limiting our risk. Also, by using 10 contracts instead of leveraging all 10 lots with monthly mortgage payments and property taxes, we again limited our risk by reducing possible cash outﬂows. If the lots went down in value, we would not have exercised our options and would have been out $10,000 in option fees. If we had purchased the lots, we would have been out $10,000 in down payments and $15,000 more in monthly mortgage payments and property taxes. Option Risk $10,000 $0 $10,000

Cash invested Additional cash Total cash at risk

Leverage Risk $10,000 $15,000 $25,000

Okay, so we have limited risk when using options. What about getting a high return? If we use the numbers from the example we wind up getting a very high rate of return. If the lots appreciated 5 percent annually, each lot would go up in value by $500. This would be a 5 percent return on our $10,000 invest-

C20.qxd 3/30/04 9:23 AM Page 179

When to Option

179

ment if we paid all cash and bought one lot. This is better than the return on a $10,000 CD, but not good enough for a real estate investor. If we compare the rate of return by purchasing the lots using leverage and controlling the lots using options, we notice a very stark difference. It is true that leveraging gives four times the rate of return of paying all cash. But optioning gives us two and a half times the rate of return as leveraging does! Case closed. Option Return $5,000 $10,000 50%

Annual return Cash invested Rate of return

Leverage Return $5,000 $25,000 20%

Controlling Property The name of the game in real estate investing is control. When you have control of something you are many times in a better position than when you own something. When you use an option contract, you can control property without owning it. Example 2 We found a property on the fourth fairway of a golf course in La Costa, California. It was a new home, and the builder had not been able to sell the property. We were looking for a California residence but were unsure if we would like living there. This was one of those times when the use of an option contract was perfect. Because we wanted to live in the property ourselves, we used a lease option agreement. We agreed on a $500,000 purchase price, an 18month option period, a $20,000 option fee, and a $2,500 monthly lease payment. The $45,000 18-month total lease payment would apply to the purchase price if we decided to exercise our purchase option. Purchase price Option fee Lease payments Remaining balance

$500,000 $20,000 $45,000 $435,000

At the back of the property bordering on the fairway to one side were 10 fairly good-sized California queen palm trees. They did nothing

C20.qxd 3/30/04 9:23 AM Page 180

REAL ESTATE OPTIONS

180

for the property and actually were going to have to be removed for us to put in the pool and a tennis court. We did some research and found out that we could sell each of the palm trees for $3,500. We had several landscape/nursery companies come out and give us bids on how much they would pay us to harvest the palm trees. Eighteen months later and simultaneously to our exercising our purchase option and opening an escrow we had the trees harvested and the $35,000 put into the escrow as part of our down payment. The property had appreciated and was now worth $600,000. Our purchase price was locked in at $500,000 because of the option contract. Because our option fee and the lease payments applied to the purchase price, along with the sale of the palm trees we now had a $100,000 down payment. Down Payment Option fee $20,000 Lease payments $45,000 Palm tree sale $35,000 Total down payment $100,000 We got a loan for $400,000 from a real estate lender with no qualifying because we had a 20 percent down payment. We also had a $200,000 equity position in the property. Property value Loan amount Equity position

$600,000 $400,000 $200,000

To top it all off, we only had put a $20,000 option fee into the property. We would have had to pay at least $3,500 a month just to lease the property. We owed it all to our knowing when to use a real estate option!

Buying Time When you use an option contract you can buy time to bring in money partners, put together ﬁnancing, ﬁnd a new buyer, or. . . . Example 3 We found vacant land in the path of new development that was zoned commercial and right off a major freeway ramp in the

C20.qxd 3/30/04 9:23 AM Page 181

When to Option

181

Dallas/Fort Worth metroplex. We thought about buying the property for ourselves but had an intuition about getting an option on the property instead. We tied up the property with a purchase option, knowing that we would need to ﬁnd a special buyer for the property. We had a 24-month option period. We were concerned that we had a $50,000 option fee to pay within 90 days. Much to our pleasant surprise, within 45 days after negotiating our purchase option and 45 days before we were going to have to come up with the fee, we found a new buyer. We assigned our purchase option contract to the new buyer for $45,000. They were very happy with the fact that we had negotiated a 24-month option period. That was the amount of time the buyer needed to go through all the planning and zoning bureaucracy with the local zoning board. Score another one for when to use an option contract.

Assembling Partners We use an option contract when we need to assemble partners (money partners, developers, home builders, or a real estate team) to go in on the real estate transaction. Whatever the partnership needs are that you must fulﬁll to put together a successful transaction, by using a real estate option, you will give yourself the necessary time to form the partnership(s). We used an option on the example we just discussed. One of the long-term beneﬁts we reaped by using the option was ﬁnding a good real estate attorney. In the process of trying to ﬁnd a new buyer, we came across ours. No matter where in the country we are investing in real estate, we run everything by our attorney. In fact, our attorney is one of the biggest proponents of using an option when you need to assemble any kind of partners to put your transaction together.

Watching the Direction of the Market You can use an option contract when you want to tie up a property and watch the direction of the market. Chapter 18 discusses an example of when we tied up a particular property with an option so we could watch the market. If the real estate market was headed in a downward

C20.qxd 3/30/04 9:23 AM Page 182

REAL ESTATE OPTIONS

182

direction, we were not going to buy the property. If the market was headed in an upward direction, we would. We told you how we made money on this deal. But what if the market had turned, the buyer backed out, or we couldn’t sell the property? Our foresight was in setting up this deal as an option contract. That way if the market had turned, our risk would have been limited to our option fee of $2,500 if we had not found a buyer.

Handling Contingencies We use an option contract when we know there are going to be contingencies that need to be handled as part of the purchase contract. We have tied up property using an option with dead people. Seriously, every state has a statutory probate time period. In some states, it is as short as six to nine months. In other states, the probate period can be 12 to 24 months, if the will is contested. You may be able to have the executor of the estate grant you an option on the deceased’s real property. You may not be able to close the transaction until the probate process is completed, however.

Procuring Financing Use an option contract when you need time to procure the best available ﬁnancing for your deal. By doing a 6-, 12-, or 18-month or even longer option period, you should be able to ﬁnd an attractive interest rate to ﬁnance your transaction. If not, then you do not have to exercise your option. One of the added beneﬁts we received from using the 18-month option period in Example 2 was the interest rates on 30-year ﬁnancing for jumbo residential real estate loans dropped two percentage points over the course of the option period. You can also use the option period to clean up your credit, if necessary.

Income Tax Planning When you use an option contract you can get certain income tax advantages as a real estate investor. We have talked about an IRC 1031 tax-

C20.qxd 3/30/04 9:23 AM Page 183

When to Option

183

deferred exchange. You may want to use an option contract if you are involved in this type of exchange. Another advantage from an income tax standpoint when using an option is you can sell your property this year but not close it until next year or even the year after, depending on the length of the option period. That way, any income tax consequence from the sale won’t be recognized for one, two, or even three years. In Chapter 21, we complete our discussion of real estate options. We will teach you two things: the types of real estate to option and the types of purchase contracts to convert to option contracts. How many of you are ready to be optionees? How many of you are ready to be optionors?

C21.qxd 3/30/04 9:29 AM Page 184

C H A P T E R

21

Finding Options

Finding real estate options can be as simple as converting a purchase contract into a real estate option contract. You can do this by attaching an option contract to the purchase contract, as we showed you in Chapter 19. You can use the supplements of our purchase contract and indicate that an option contract is attached to the purchase contract. The two contracts combined create an option contract with all the terms and conditions of an actual sale spelled out in the event the optionee exercises the purchase option.

184

C21.qxd 3/30/04 9:29 AM Page 185

Finding Options

185

You can also convert a purchase contract into an option contract by using the following three sentences in the section for other terms and conditions.

If the purchase contract you are using does not have room somewhere to write these sentences, you can take a blank piece of paper, write a section called “Other Terms and Conditions” and just attach this addendum to the contract.

Finding Options, Using Options There are several types of real estate contracts to convert to an option contract. We have shown you how to convert a purchase contract into an option contract and vice versa. We are talking about a different slant in this chapter, which is about ﬁnding options. Your mindset may dictate options ﬁnding you. What we want to give you is a different perspective on taking existing purchase contracts and turning them into option contracts. Of course, you would want to turn them into an option contract because of all the beneﬁts we have talked about previously. But beyond the beneﬁts of using the option contract, there may be additional beneﬁt to not going through with the purchase contract itself.

C21.qxd 3/30/04 9:29 AM Page 186

186

REAL ESTATE OPTIONS

Timing Use an option contract when there is any problem putting a deal together because of the timing. We usually think of a timing problem going into a deal. For example, you might want to use option contracts if you are trying to assemble a larger property for development made up of several smaller pieces of property. What about a timing problem that you want to solve at the back end of a deal? You may be in a situation where you own a piece of property and have to sell it to convert your equity into cash. You really would like to hold on to the property because you think it is going to go up in value. Again, we recommend using an option contract. Example 1 We call this example “Have Your Cake and Eat It, Too.” We are going to introduce you to the buy-back option. The buy-back option can be used in any situation where you must take the risk of sacriﬁcing part of your equity and future appreciation in exchange for getting your hands on some immediate cash. Here is the scenario. You have a property worth $100,000. There is a $60,000 ﬁrst mortgage on the property. You need $30,000 cash. However, you do not want to get a second mortgage because you do not want to make the additional monthly payments. You also don’t want to give up your potential future appreciation. You feel the appreciation for this property is going to be substantial in the next two years.Your problem is how to have your cake and eat it, too (or, how to keep your property but still get your cash). Here is a solution. Advertise your property as a motivated seller. You offer to discount the price in return for a buyer who gives you cash for your equity. You ﬁnd a buyer for the property. You and the buyer agree on a purchase price of $90,000. The buyer pays you $30,000 cash and assumes your $60,000 existing loan. You accept the deal with one contingency. You retain an option to purchase the property in two years for a purchase price of $105,000! You are now able to acquire the needed $30,000. You are free of any loan payments on a second mortgage for this two-year period. You also have an option to purchase the property back over the next two years if indeed the property appreciates as much as you think it will. Sales price 1st mortgage Cash down

$90,000 $60,000 $30,000

C21.qxd 3/30/04 9:29 AM Page 187

Finding Options

187

How does the buyer make out in this deal? The buyer will make a 50 percent proﬁt on the investment if you exercise your option. The buyer will make considerably more if the property appreciates and you don’t exercise your option. Buyer’s Return Sales price $105,000 Purchase price $90,000 Buyer’s proﬁt $15,000 $15,000/$30,000 = 50% Example 2: Sale of a Promissory Note with Buy-Back Option Our next example of using a buy-back option is with a promissory note. In the next section we will have a complete discussion of promissory notes. For now we will tell you that promissory notes can be sold, hypothecated (pledged as collateral), or used to purchase property. Promissory notes can also be controlled through options. Here is the situation. You own a promissory note in the amount of $25,000. The note is payable at $250 monthly. The interest on the note is 10 percent. The note must be paid off in four years. You need $10,000 now to put into another real estate investment. However, you don’t want to sell the promissory note and suffer any loss of principal. You check what the discounted paper market is for your type of promissory note. The current yield required by buyers for your type of promissory note is 25 percent. That means that any buyer of your note will want at least 25 percent return on any cash they use to buy it. Advertise your property as a motivated seller. You offer to discount your promissory note substantially in return for a buyer who gives you $10,000 cash. You ﬁnd a buyer for your promissory note. The buyer will pay you $10,000 cash for your promissory note. You accept the deal with one contingency. You retain an option to purchase the promissory note in two years for $8,720. The buyer of your note will make a 25 percent yield on the $10,000 investment if you exercise your buy-back option. The buyer of your note will make in excess of a 40 percent yield if you do not exercise your option. Promissory note Purchase price Buy-back price

$25,000 $10,000 $8,720

C21.qxd 3/30/04 9:29 AM Page 188

188

REAL ESTATE OPTIONS

Example 3: Lease with Option to Purchase This is an example of how to use an option in the case of a lease with option to purchase. This procedure can really help with the timing of a deal. We will also show you the creativity of using promissory notes to ﬁnance your deals. This promissory note ﬁnancing will serve as a good introduction to the next section, which is on discounted paper. Here is the scenario. We had a client who was a small, rapidly growing corporation. They needed a warehouse plus room to expand. Their cash ﬂow was good, but the cash they had available to allocate to the purchase of property was just $30,000. We found them a warehouse owned by the Ballerinis. We negotiated a purchase price of $300,000 for the warehouse. The Ballerinis wanted monthly payments. There was an adjoining lot available for sale owned by the Davises. We were attempting to have the Davises give us a purchase option for the lot. The Davises wanted $100,000 for the lot and would not agree to a purchase option. They also wanted monthly income. We structured the deal like this. We had our client buy the building only from the Ballerinis. They put $30,000 down, and the Ballerinis held a ﬁrst mortgage for the balance of $270,000. Our offer for the building was contingent on the Ballerinis buying the adjoining lot from the Davises. We suggested to the Ballerinis that the Davises’ lot could be purchased with a promissory note secured by a mortgage created against the land under their building. The Ballerinis created a $75,000 promissory note secured by a mortgage created against the land under the building. The Ballerinis then assigned this $75,000 promissory note to the Davises as part of the $100,000 purchase price for the lot. The Davises carried a $25,000 promissory note secured by a mortgage for the balance of the $100,000 lot price. Building Purchase Purchase price Down payment 1st mortgage

$300,000 ⫺$30,000 $270,000

Lot Purchase Purchase price Assigned mortgage 1st mortgage

$100,000 $75,000 $25,000

C21.qxd 3/30/04 9:29 AM Page 189

Finding Options

189

Our clients would lease the land under the building as well as the adjoining lot from the Ballerinis under the terms of a lease with option to purchase. There would be one lease with option to purchase for the land under the building and a second for the lot. Our clients would pay $800 a month on the lease for the land under the building and $600 a month for the lot. Because the Ballerinis now owned the lot as well as the land under the building, they would receive both lease payments. Stay with us, here. We’ll make this clearer. Our clients would also be paying the Ballerinis a monthly payment of $1,700 on the $270,000 ﬁrst mortgage on the building. Income to Ballerinis 1st mortgage Building lease Lot lease Monthly income

$1,700 $800 $600 $3,100

The Ballerinis were responsible for making the monthly payments to the Davises on the $75,000 assigned mortgage and the $25,000 ﬁrst mortgage. After all, the Ballerinis were now the owners of the lot. The payment on the $75,000 assigned mortgage was $850 a month. The payment on the $25,000 ﬁrst mortgage was $250 a month. Payments by Ballerinis Assigned mortgage 1st mortgage Total payments

$850 $250 $1,100

The Davises monthly income would be $1,100. The Ballerinis net monthly income would be $2,000. Ballerinis’ Net Income Income received Payments made Net income

$3,100 ⫺$1,100 $2,000

We coined this little real estate investor’s couplet out of the deal.

C21.qxd 3/30/04 9:29 AM Page 190

REAL ESTATE OPTIONS

190

Mine is not to reason why, Mine is to ﬁnd a seller and try.

Finding Property to Option How do you ﬁnd property to option? That’s easy: Look everywhere you go. We were out of state in a coastal area doing a marketing event. We were coming into town on a Thursday. We hadn’t made hotel reservations. We headed to the water to check into a hotel. Much to our surprise, every hotel we tried to check in to was completely full! As we were driving on the highway right on the water, we noticed there was a vacancy sign on a pink two-story building. We thought it looked like a cross between a 1950s motel and a strip mall. We found out there was only one room available for the next three nights. Most of the 12 units were rented out by the week. We looked at the room and were pleasantly surprised. We went back to the manager and checked in. You know there is a real estate point to this story. In the vacant lot next to the pink hotel was a for sale sign. We asked the hotel manger what was for sale. He said the lot with the sign was for sale, the pink hotel we were staying in was for sale, and the big brick building hidden by the trees that was boarded up behind the building was for sale. We looked at the manager and asked,“You mean the six-story building that looks like it had been built in the 1920s?” “Yes, indeed that is part of what is for sale,” he replied. All of a sudden, we got very excited! We asked him what the story was. Apparently we had stumbled on a historical gem. The real hotel was the six-story architectural masterpiece, which had been closed down for 10 years. The manager worked for the owner and was also the caretaker for the brick building. We had the manager give us the tour of the hotel. Our Potential Vision was focused and at 20/20. This hotel had been built in the 1920s. In its heyday it was a real Southern belle. What would it look like restored? What could it become?

C21.qxd 3/30/04 9:29 AM Page 191

Finding Options

191

We called the owner and arranged a meeting. We met on our drive out of town, heading back home. Can you guess what kind of a contract we used to tie up this property? Yes, we used an option contract. The property is worth $10 million. We have an option for $7 million. The owner will ﬁnance $4.7 million. It’s a ﬁxer-upper with historical signiﬁcance. Anyone interested in being our money partners? Property value Purchase price Owner ﬁnancing Money partner

$10,000,000 $7,000,000 $4,700,000 $2,300,000

Next, as promised, we will take you into the wonderful world of discounted paper. For those of you who love playing with numbers, fasten your seat belt. How many of y’all are interested in making yields of 10, 12, or 15 percent, or more? All of y’all, right? Dollar for dollar, when you invest in discounted paper, you can make more of a return on your money than with any other investment. We are talking about every other investment, not just real estate.

C21.qxd 3/30/04 9:29 AM Page 192

P05.qxd 3/30/04 9:27 AM Page 193

S E C T I O N

FIVE

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

P05.qxd 3/30/04 9:27 AM Page 194

C22.qxd 3/30/04 9:29 AM Page 195

C H A P T E R

22

What Is Discounted Paper?

What Is Discounted Paper? Investing in discounted paper is the purchasing of real estate promissory notes at a discount from the remaining balance on the note. These promissory notes are the mortgage notes signed by borrowers promising to pay back the money they borrowed from lenders. Let’s say the remaining balance on a Promissory Note is $20,000. Do you think it might be a good deal if you could buy it for $15,000? You would still be paid the $20,000 remaining balance over the remaining life of the loan. So, yes, it is a good deal. Promissory Note Remaining balance Purchase price Proﬁt

$20,000 $15,000 $5,000

What you have to ﬁgure out is what kind of return you want on the money invested to buy the discounted paper. Many of you are used to the atrocious bank interest rates of 1 to 4 percent paid on CDs. How would a 10, 12, or 18 percent return on your money work for you? We know you already have at least three questions. The ﬁrst is whether this is legal. Yes, buying discounted paper is completely legal. The second question might be whether your money will be safe. Yes,

195

C22.qxd 3/30/04 9:29 AM Page 196

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

196

your money will be safe, as we’ll explain later. The third question might be how does one get into this hot stuff? Read on!

Real Estate Paperwork The ﬁrst thing you have to ﬁgure out is the paperwork involved in discounted paper. There are three aspects to the paperwork. First, there is the paperwork involved on the title side, such as grant deeds and warranty deeds. These deeds convey title to real estate from the seller to the buyer. Check Appendix A for which kind of deed your state uses. There is also the paperwork involved on the ﬁnancing side, which is the evidence of debt, such as promissory notes and mortgage notes. This paperwork is used by lenders and borrowers to create a written agreement about the terms and conditions for the loan. Finally, there is the paperwork that bridges the ﬁnancing and title sides. These are trust deeds and mortgages, which are regarded as security devices for the promissory notes and mortgage notes, respectively. They become liens against the property title when they are ofﬁcially recorded at the county recorder’s ofﬁce in the county where the property that is the security for the lien is located. Title

Security Devices

Grant deed/Warranty deed Trust deed Grantor/seller Grantee/buyer Trustee/Trustor Beneﬁciary Mortgage Mortgagor/mortgagee

Finance Promissory note

Mortgage note

Essential Elements of a Promissory Note There are four essential elements of every promissory note. These elements are the dollar amount of the note, the interest rate, the payment (if any) due, and the term of the note.

1. Dollar Amount The dollar amount of the promissory note corresponds to the amount of money loaned by the lender. The note acts as the evidence of the

C22.qxd 3/30/04 9:29 AM Page 197

What Is Discounted Paper?

197

amount borrowed. In more technical terms, the promissory note is the evidence of the debt. Remember, everything in real estate has to be in writing to be valid. Could you borrow $200,000 from your bank on just your word to pay it back? Could you just shake hands with the bank president and walk out with the money? We don’t think so! (If you can, please let us know where you bank.)

2. Interest Rate The second essential element of a promissory note is the interest rate. Real estate lenders rent borrowers money to make their real estate purchases. The rental fee that lenders charge borrowers for the use of the money is called interest. The interest rate charged by real estate lenders to borrowers varies based on the amount of risk involved to the lenders. If the lenders feel there is a high risk involved in making the loan, they will require higher interest rates. If lenders feel there is a low risk involved in making the loan, they will accept lower interest rates. The lender determines the risk involved in making the loan based on two factors. The ﬁrst is the property that will be the collateral for the loan. Lenders rely on the appraisal to determine the property value. If the lender feels the property is a good risk based on the real estate appraisal, he or she will loan money at a lower interest rate. If the lender feels the property is a bad risk based on the appraisal, he or she will loan money at a higher interest rate. If the property seems to be a poor risk based on the appraisal, the lender will not loan any money to the borrower, no matter high how the interest rate. The second risk factor a lender considers is the borrower who will be repaying the loan. Lenders rely on the quality and ﬁnancial strength of the borrower to determine the interest rate on the loan. If the borrower is well qualiﬁed and considered a strong borrower, then the interest rate offered on the loan will be lower. If the borrower is less qualiﬁed and is considered a weaker borrower, then the interest rate will be higher. Usury Each state regulates the amount of the interest rate that a lender can charge for making loans. If a lender charges an interest rate higher than what the state allows for that type of loan,the lender could be charged with usury.

C22.qxd 3/30/04 9:29 AM Page 198

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

198

Some lenders are typically exempt from the usury laws. Commercial lenders, like a bank or mortgage company, that is. Private lenders like you or us are subjected to usury laws if we actually loan money out ourselves. Private lenders extending credit are not subject to usury laws. What determines if usury is involved is whether the private lender is making a hard-money or soft-money loan. If you are a seller who carries back ﬁnancing for the buyer on the sale of your home or investment property, you are making a soft-money loan. You are extending the buyer credit, not actually putting up cold, hard cash. You can charge any interest rate on the promissory note you want to and the borrower/buyer agrees to. If you are a real estate investor or acting as a private party and you loan cash money to a property owner who is, say, behind on mortgage payments, then you are making a hard-money loan. The interest rate you can charge on the promissory note is restricted by the usury laws for your state.

3. Payment The third essential element of a promissory note is the payment to be made. Most promissory notes are structured as amortized notes. This means that a monthly payment is required. Some promissory notes are structured as straight notes. This means that no payment, monthly or otherwise, is required. Amortized Notes Amortized notes are promissory notes that include a principal and an interest payment. At the end of the term of an amortized note, the principal balance will be zero. Amortized means literally “to death” the loan (mort, like a mortal wound). Most loans that people get from real estate lenders are amortized for 30 years. Although the monthly payment is constant if the interest rate is ﬁxed, most of the payment is interest; very little is principal. If we looked at a $200,000 loan with an 8 percent interest rate amortized for 30 years, the monthly payment would be $1,467.53. How much of this payment do you think is principal? Three hundred dollars, $400, $500? Try $134.20. The interest is $1,333.33. In the second month it doesn’t get any better. How much of this payment do you think is principal? Try $135.09. The principal payment increased a whopping $0.89! The interest is $1,332.44.

C22.qxd 3/30/04 9:29 AM Page 199

What Is Discounted Paper?

199

Amortized Note Note amount Interest rate Term Monthly payment 1st principal payment 1st interest payment Payoff amount

$200,000 8% 30 years $1,467.53 $134.20 $1,333.33 $0

Straight Notes Straight notes are promissory notes that have no payment until the total amount of the loan is paid off all at once. This is called a balloon payment. A straight note can have periodic payments of interest, but no principal payment until the loan is paid off. If we looked at a $20,000 straight note with a 12 percent interest rate payable only monthly, all due in ﬁve years, the monthly payment would be $200. Because none of the monthly payment on a straight note applies to the principal, the balance to be paid off in ﬁve years would be $20,000. Two hundred dollars a month for 60 months (ﬁve years) is $12,000. That’s a nice chunk of change. Plus, you still receive the $20,000 payoff. A rule of thumb for determining an interest-only monthly payment when the interest rate is 12 percent is to remove two zeros from the loan amount. Straight Note Note amount Interest rate Term Monthly payment Interest payments Payoff amount

$20,000 12% 5 years $200 $12,000 $20,000

4. Term The term of a promissory note is negotiable between the lender and the borrower. As we have said, 30-year terms are fairly standard for amortized notes made by commercial real estate lenders. When a seller carries back ﬁnancing for a buyer, the term of the promissory note may be for as short as one to two years. Three- to ﬁve-year terms are fairly standard.

C22.qxd 3/30/04 9:29 AM Page 200

200

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

Discount versus Yield The terms discount and yield are often used interchangeably. This is incorrect. To properly invest in discounted paper, you must clearly understand differences between these two terms. Discount The term discount means a percentage off the remaining balance on the promissory note. Let’s say the remaining balance of the note is $10,000. If we wanted to buy that note for an 18 percent discount, how much would we pay? To ﬁgure this out, we would ﬁrst multiply $10,000 by 18 percent. The answer is $1,800. We would then subtract the $1,800 from the $10,000. The discounted value of the promissory note is $8,200. Discounted Value Remaining value Discount percent Discount amount Discounted value

$10,000 ⫻ 18% $1,800 $8,200

Yield The term yield considers other important factors that may vary from note to note. These include the interest rate, the pay-back rate, the term, and the balloon payments, if any. Let’s determine the present value of a promissory note to a real estate investor who desires an 18 percent yield on the investment. The present value is the amount of money the investor will pay for the promissory note today. We will show you the difference between discount and yield. We will give two examples. Example 1 The remaining balance of the promissory note is $10,000. The interest rate on the note is 10 percent per annum (yearly). The payments on the note are $100 per month. The payments will continue until the note is paid in full. The total amount received will be $100 a month for 216 months (18 years) or $21,600. Remaining balance Interest rate Monthly payments Term Total amount received

$10,000 10% $100 18 years $21,600

C22.qxd 3/30/04 9:29 AM Page 201

What Is Discounted Paper?

201

In this example, there is only one variable to consider. That variable is the present value of the income stream to the investor desiring the 18 percent yield. Nothing will change for the borrower paying on the promissory note. Stay with us here. The investor will receive the same $100 each month if he or she buys this promissory note. What we are ﬁguring out is what amount would the real estate investor buy the promissory note for today (the present value). Remember, the investor wants to receive an 18 percent yield on the investment. Using a ﬁnancial calculator and solving for an 18 percent yield, the investor would pay $6,399 for this promissory note today. Notice this would be a discount of $3,601 from the $10,000 remaining balance amount of the promissory note. Instead of an 18 percent discounted value, this would be a 36 percent discounted value. This illustrates the difference between discounted value and yield. Discounted Value Remaining value Discount percent Discount amount Discounted value

$10,000 ⫻ 36% $3,601 $6,399

Financial Calculator If you are going to invest in the discounted paper arena you will have to acquire and learn how to use a ﬁnancial calculator. It will be well worth both your time and ﬁnancial investment. We recommend Hewlett Packard calculators. Example 2 Let’s use the same promissory note but with a balloon payment in 36 months. Our investor still wants an 18 percent yield. How will the balloon payment affect the yield? This requires the determination of one more variable in our ﬁnancial calculations. We have to ﬁgure out the present value of the balloon payment. The balloon payment amount at the end of three years will be $9,304. The present value of that balloon payment is the amount of dollars it will take at 18 percent for 36 months to equal $9,304. Present Value The present value of the balloon payment is $5,444. The present value of the income stream is $100 per month at 18 percent for 36 months, or $2,766. The present value of the promissory note discounted to yield 18 percent is $8,210.

C22.qxd 3/30/04 9:29 AM Page 202

202

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

The investor wants to receive an 18 percent yield on the investment. The investor would pay $8,210 for this promissory note today. This would be a discount of $1,790 from the $10,000 remaining balance amount. Now the discounted value equals the yield. Discounted Value Remaining value Discount percent Discount amount Discounted value

$10,000 ⫻ 18% $1,790 $8,210

We hope we have not given you the proverbial drink out of a ﬁre hydrant with this ﬁrst chapter on discounted paper. Some of you are probably very excited. This section might be why you bought the book in the ﬁrst place. For those of you who are feeling in over your heads, keep reading. The amount of money you can make investing in discounted paper is phenomenal. In the next chapter, we will teach you the advantages and why you should do so.

C23.qxd 3/30/04 9:29 AM Page 203

C H A P T E R

23

Why Buy Discounted Paper?

The Advantages to Buying Discounted Paper There are 12 advantages to buying discounted paper: safety of investment; high yield; no additional money; no management; never a bad time; invest full- or part-time; monthly income; unlimited proﬁt opportunities; high probability of early payoff; returns both principal and interest; no employees, inventory, or overhead; and beneﬁts of real estate ownership without the drawbacks.

1. Safety of Investment Investing in discounted paper offers more security than investing in real estate. Let’s compare the safety of your investment if you were the owner of a property to that if you were an investor who buys the second mortgage on a property. The retail value of the property is $100,000. There is a ﬁrst mortgage on the property for $50,000 held by a bank. There is a second mortgage on the property for $20,000 held by a private lender. The owner of the property has $30,000 equity. If the value of the property declines to $80,000, the only loss will be to the property owner. There is still enough equity to protect the holder of the ﬁrst and second mortgages.

203

C23.qxd 3/30/04 9:29 AM Page 204

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

204

$100,000 $50,000 $20,000 $30,000

Property value 1st mortgage 2nd mortgage Owner’s equity

$80,000 $50,000 $20,000 $10,000

If you bought the second mortgage of $20,000 for $15,000 (a 25 percent discount) the value of the property would have to decline to $65,000 before your position as the holder of the second mortgage would be affected! Property value 1st mortgage Invested in 2nd mortgage Owner’s equity

$65,000 $50,000 $15,000 $0

2. High Yield A seller sold his home for $200,000. He agreed to accept an offer in which the buyer put $50,000 cash down. The buyer assumed the ﬁrst mortgage of $100,000. The seller extended credit for the balance of $50,000 to the buyer on a second mortgage. The terms of the promissory note for the second mortgage called for payments of $500 per month, interest only for three years at 12 percent per annum, plus a balloon payment of $50,000 at the end of three years. Sales price 1st mortgage 2nd mortgage Down payment

$200,000 $100,000 $50,000 $50,000

You contacted the seller and made an agreement to purchase the second mortgage for $40,000. Considering that no payments on the note have been made, what is your yield? We know the seller’s yield would be 12 percent if he held the second mortgage for the full three years. You would receive 15 percent annual interest if you were receiving $500 monthly just on your $40,000 investment. $500 ⫻ 12 months = $6,000 $6,000/$40,000 = 15%

C23.qxd 3/30/04 9:29 AM Page 205

Why Buy Discounted Paper?

205

However, you are also going to receive a $50,000 balloon payment in three years. This will be a $10,000 premium on top of returning your $40,000 investment. That translates to a 70 percent return over three years on your $40,000 investment, or a 23 percent annual yield. Total of monthly payments Balloon premium Total return Initial investment

$18,000 $10,000 $28,000 $40,000

$28,000/$40,000 = 70% 70%/3 years = 23% annual yield 3. No Additional Money Unlike a traditional real estate investment, once you have bought a promissory note there is no additional money you have to put into your discounted paper investment.You will have no monthly mortgage payments. In fact, you will receive monthly mortgage payments. You do not have to pay property taxes. There are no property management fees to pay. There is no homeowner insurance or hazard insurance to keep on the property. You have no maintenance costs. You never pay homeowner association dues. You will never be involved in lawsuits from people hurting themselves on “your” property. You won’t have to pay someone for extensive record keeping. You will have no recapture of depreciation. Unlike many other investments like stocks, when you buy discounted paper, you will never be asked for nor will you have to provide more money than your original investment. You will not be getting calls from your stock broker that ask you for more money: “This is Harry at the stock brokerage company. I am sorry, sir. You have a margin call. Please send us a check for $10,000.” When you buy discounted paper, you will sleep soundly.

4. No Management Discounted paper is management-free. You do not need a resident manager. You don’t need a property manager. You don’t need a property management company. You don’t need a money manager. You don’t need a fund manager. You won’t have to hire a risk assessment manager. There is no portfolio manager. You won’t have to worry about upper management, lower management, or middle management.

C23.qxd 3/30/04 9:29 AM Page 206

206

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

All you have to manage is to ﬁnd yourself a good discounted paper deal. Then buy it. If you buy discounted paper, you already have a good deal. It’s already discounted!

5. Never a Bad Time We talked in Section One about timing your real estate investing to the best months of the year. We know that some months are better to be a real estate seller. Some months are better to be a buyer. None of this applies in the discounted paper market. Any time is a good time to buy discounted paper. We have bought it when it has been a seller’s real estate market and when it’s a buyer’s real estate market. We’ve bought discounted paper in high interest rate markets and in low interest rate markets. When you can ﬁnd a good deal, it doesn’t matter what the real estate market (or any other market) is doing. Yield is the name of the game in the discounted paper market. When you ﬁnd a discounted paper deal that matches your desired yield, you should buy it.

6. Full- or Part-Time You have the ﬂexibility of being involved as a full-time or part-time player when you buy and sell discounted paper. We recommend that you start as a part-time player. After you have successfully completed your ﬁrst deal, you can decide how much of your investing time should go into discounted paper. Our goal is for you to have an open mind on the discounted paper topic. Some of you will want to get involved as full-time discounted paper investors. Some of you will choose the more standard real estate investing vehicles, like ﬁx-ups or landlording. For those of you who are not going to be full-time discounted paper investors, we still want you to be aware of these opportunities when they come your direction. By creating a promissory note with the equity we have had in a property, we were able to use that note to buy another property. We structured that promissory note agreement so that we had the ﬁrst right of refusal to buy it in the event the seller wanted to liquidate the note for cash. When that occurred, we were able to buy the promissory note for a discount and effectively buy the property for a lower price.

C23.qxd 3/30/04 9:29 AM Page 207

Why Buy Discounted Paper?

207

We found a seller who would take part of their equity in a promissory note. We created a note for $25,000, which we secured with a second mortgage against the property we owned. Property We Owned Property value Existing 1st mortgage Our equity

$178,000 $107,000 $71,000

First Right of Refusal After about 18 months from when we closed escrow, we got a call from the seller. They wanted to know if we would be interested in buying the promissory note. They had called us ﬁrst because of our agreement that we had the ﬁrst right of refusal. The ﬁrst right of refusal means you have the right to buy something ﬁrst. How it works is you have the ﬁrst right to say no to buying something that is for sale. If you want to buy it, you buy it. No one else can buy it until you ﬁrst refuse to do so. The seller needed $18,000 cash to handle a business emergency. We said we would buy the promissory note for $18,000. In effect we wound up getting a $7,000 reduction in the price we were paying for the seller’s property. Our point is that because we were aware of discounted paper possibilities, we were able to proﬁt in a situation in which we weren’t even looking to buy discounted paper! Promissory note Purchase price Discount

$25,000 $18,000 $7,000

7. Monthly Check When you buy discounted paper you get a monthly check. This is called a cash ﬂow. Promissory notes can have one or more cash ﬂows. Most have two cash ﬂows. Let’s say you have a promissory note in the amount of $20,000. The note is payable at $200 a month. The interest on the Promissory Note is 12 percent per annum. The note must be paid off within ﬁve years. Because the payments are interest only, there will be a balloon payment of $20,000 at the end of the ﬁve years. If you hold the note for the full ﬁve years, you receive 59 payments of $200. You will receive one

C23.qxd 3/30/04 9:29 AM Page 208

208

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

payment of $20,200. We really like that 60th monthly payment. How about you? 59 payments of $200 = One payment of $22,200 = Total payments =

$11,800 $22,200 $34,000

8. Unlimited Proﬁt Opportunities There are no limits to the proﬁt opportunities when you invest in discounted paper. There is no cap on how many hours a week you can work. There is no limit on how many discounted paper deals you can do. There is no ceiling on the amount of money you can make. If you are going to buy and sell discounted paper for your own investment account, then there are no federal or state licensing requirements. It is the same as if you are buying and selling real estate for yourself. If you are going to broker the buying and selling of discounted paper for a commission, then you will need a real estate broker’s license from your state. There are commercial companies who broker the buying and selling of discounted paper. They can be a good resource for information and money partnering. A way to make money without doing a discounted paper deal yourself is to be a ﬁnder of these deals. Sometimes these companies will pay you a ﬁnder’s fee if you direct them to a deal that they are able to put together. Brain Trust Consider doing your discounted paper buying and selling inside a tax-free or tax-deferred retirement vehicle. A SEP or Roth IRA would be ideal. That way your proﬁts compound and grow without the loss of a tax bite.

9. High Probability of Early Payoff Most real estate loans are paid off early. There are very few loans that last for the full 30 years. Most loans have a due on sale clause. This means that a property may not be sold or transferred without the loan being paid off. In the event the new buyer wants to assume the seller’s existing loan, the permission of the holder of the promissory note is necessary.

C23.qxd 3/30/04 9:29 AM Page 209

Why Buy Discounted Paper?

209

Depending on the agreement when the promissory note is created, some notes may be assumable. When a seller carries a promissory note from a buyer, the note is usually not automatically assumable. Whether a promissory note is assumable or not is a matter of negotiation between the parties. Prepayment Penalty Many real estate lenders require a prepayment penalty in the event the borrower pays off the loan before the stipulated term. Lenders do this to protect their yield. On a 30-year loan paid off before 5 years, the prepayment penalty typically can be 6 months’ interest on the remaining balance of the loan. If your remaining loan balance was $100,000 and your interest rate was 7 percent, your prepayment penalty would be $3,500! Prepayment Penalty Remaining balance Interest rate Annual interest 6 months’ interest

$100,000 ⫻ 7% $7,000 $7,000/2 = $3,500

On seller-carried promissory notes, we recommend not having a prepayment penalty. It turns out that the yield is increased if a borrower pays off the note more quickly. The borrower will be discouraged to make an early payoff if there is a penalty in the promissory note.

10. Returns Both Interest and Principal You can structure your investing in discounted paper to have your return include periodic payments of both interest and principal. Typical 30-year real estate loans from a bank or mortgage company are such amortized loans. This means that the monthly payment includes both interest and principal. The amount of principal returned with each monthly payment is minuscule in comparison to the amount of interest in the early years of these loans. With discounted paper you can buy loans with a 30-year term. However, you will more likely be buying loans with a much shorter term. Some of these loans will be amortized for a 30-year term. They will have a ﬁve-year due date.

C23.qxd 3/30/04 9:29 AM Page 210

210

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

During the ﬁve years, you are receiving a monthly return of interest and principal. Then, at the end of the ﬁfth year, you receive a balloon payment of the remaining principal. As you know, not much of the principal has been paid 5 years into the 30-year loan term. Let’s say you have bought a promissory note with a face amount of $25,000. The note is amortized for 30 years. The interest rate is 10 percent. The monthly payment is $219.39. The term of the loan is ﬁve years. You will receive $13,164 in monthly payments over the ﬁve years. You will also receive a balloon principal payment of $24,144! Talk about your return of interest and principal! Amount of promissory note Total of monthly payments Balloon principal payment Interest and principal returned

$25,000 $13,164 $24,144 $37,308

11. Requires No Employees, Inventory, or Overhead When you are in the discounted paper business you need no employees. You do not have to keep or maintain any inventory. Your overhead is nonexistent. Do we need to say more?

12. Beneﬁts without the Drawbacks You have all the beneﬁts of real estate ownership when your invest in discounted paper. We think the number one advantage is the security of your investment. The real estate can’t be stolen. The land will still be in the same place tomorrow that it was today. The building isn’t going to disappear in a robbery. Unlike the stock market, the more money you put into the property (to make improvements, for example), the better your return. When you buy discounted paper, the underlying security for it is the real estate to which the discounted paper attaches. Unlike a stock, which isn’t worth the paper it is written on, the paper that the discounted paper is written on creates a lien on the title to real property. In Chapter 24 we will teach you the three criteria to consider when you are buying discounted paper. These include the promissory note being seasoned, the loan-to-value ratio of all the notes secured against the real property, and the yield you will be receiving on your investment.

C24.qxd 3/30/04 9:29 AM Page 211

C H A P T E R

24

How to Buy Discounted Paper

Three Criteria There are three important criteria to consider when you are talking about buying discounted paper. These should especially be used by those of you who are novice discounted paper buyers. These criteria should still be used by those of you who are experienced real estate discounted paper buyers. The ﬁrst criteria to consider is whether the promissory note you are buying is seasoned. The second is the loan-to-value ratio of all the promissory notes secured against the real property. The third is the yield you will be receiving on your investment.

Seasoned A loan is considered seasoned when the borrower has consistently made the payments over a period of time. The textbook deﬁnition of seasoned is consistent payments over a three-year period of time. Many seller-carried promissory notes are short-term. They are typically three to ﬁve years in duration. In practice, most of these loans are considered seasoned after only one year of consistent payments. If you purchase promissory notes with good equity protection, however, the question of whether they are seasoned becomes moot. You don’t have to rely on whether you have a good borrower as the primary 211

C24.qxd 3/30/04 9:29 AM Page 212

212

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

source of your investment protection. The borrower becomes secondary. The property itself becomes the main source of protection for your investment. Borrower Default In fact, when you hold a promissory note on a property with great equity protection, you hope for a default on the borrower’s part because you stand to make even greater proﬁts if you end up having to foreclose on the property. Let’s say you sell a property for $150,000. The buyer assumes your $90,000 ﬁrst mortgage. The buyer makes a $30,000 cash down payment. You carry a $30,000 promissory note secured by a second mortgage on the property. Sales price Assumed 1st mortgage Equity New 2nd mortgage Down payment

$150,000 $90,000 $60,000 $30,000 $30,000

Two years go by. The property is now worth $168,000. The buyer defaults on the ﬁrst and second mortgages. You foreclose on your second mortgage. You get the property back subject to the ﬁrst mortgage. Let’s say it cost you $5,000 to make up the back payments on the ﬁrst mortgage plus the foreclosure expenses. How do you come out? You keep the original $30,000 down payment. You keep the two years’ worth of payments you have received on your second mortgage, which amount to $7,200. You get the beneﬁt of two years of the principal reduction on the $90,000, now $88,000, ﬁrst mortgage. The property is worth more now, $168,000, than when you sold it the ﬁrst time, $150,000. You have practically doubled your original $60,000 equity! This is enough to make you almost want the buyer to default, but that is not very nice. Property value now 1st mortgage now Equity position Cash down payment Payments on 2nd mortgage Foreclosure Total net return

$168,000 $88,000 $80,000 $30,000 $7,200 ⫺$5,000 $112,200

C24.qxd 3/30/04 9:29 AM Page 213

How to Buy Discounted Paper

213

Loan Ratios When you are investing in a promissory note secured by a second mortgage, one guideline is that you should make sure that the ratio between the amount of the ﬁrst promissory note and the second does not exceed 3:1. For example, if the amount of the ﬁrst loan is $90,000, the amount of the second loan should not exceed $30,000. Property value 1st mortgage 2nd mortgage

$150,000 $90,000 $30,000

$90,000/$30,000 = 3 We say this because you don’t want to have the second mortgage be too near in dollar amount to the ﬁrst mortgage. Many times when borrowers are heading into default, they will make payments on the second mortgage and not the ﬁrst. There are two reasons for this. The ﬁrst reason a borrower will do this is that the second mortgage is usually a smaller dollar amount than the ﬁrst one. The monthly payment on the ﬁrst mortgage of $90,000 may be around $700. The monthly payment on the second mortgage may be between $200 to $300. Obviously, the monthly payment on the second mortgage is much smaller than the monthly payment on the ﬁrst mortgage. When borrowers get in ﬁnancial trouble, they will be able to afford the smaller monthly payment on the second mortgage. They may not have the money to make the larger monthly payment on the ﬁrst mortgage. The second reason borrowers make payments on the second mortgage is that they may feel guilty about not paying you. They have a faceto-face relationship with you. They know you. The ﬁrst mortgage holder is usually a big, faceless, institutional real estate lender. The ﬁrst mortgage holder will not be ﬁnancially hurt if the borrower does not pay them.You, on the other hand, could be ﬁnancially devastated if the borrower does not pay you. Ratio below 3:1 What happens when the loan ratio between the ﬁrst and second mortgages drops below 3:1? Let’s say the ﬁrst mortgage is $80,000 and the second mortgage is $40,000. This is the same $120,000 worth of loans as when we had a $90,000 ﬁrst mortgage and a $30,000 second mortgage. The problem is the loan ratio between the $80,000 ﬁrst mortgage and the $40,000 second mortgage. That loan ratio is 2:1.

C24.qxd 3/30/04 9:29 AM Page 214

214

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

1st mortgage 2nd mortgage

$80,000 $40,000

$80,000/$40,000 = 2 The monthly payment on the $80,000 ﬁrst mortgage may be around $600.The monthly payment on the $40,000 second mortgage may be $300 to $400. The gap between the monthly payment for the ﬁrst and the second mortgage is narrowing greatly. $90,000 1st/$30,000 2nd 1st mortgage payment on $90,000 2nd mortgage payment on $30,000 Difference in monthly payment

$700 $300 $400

$80,000 1st/$40,000 2nd 1st mortgage payment on $80,000 2nd mortgage payment on $40,000 Difference in monthly payment

$600 $400 $200

With the 3:1 ratio, the gap between the monthly payments is $400. With the 2:1 ratio, the gap between the monthly payments is $200. If the borrower gets into ﬁnancial trouble and has to decide on which payment to make, what do you think will happen? 1:1 Ratio What happens if the ratio becomes even smaller? Let’s say the ﬁrst mortgage is $60,000 and the second mortgage is also $60,000. This is the same $120,000 worth of loans as before. The problem is the loan ratio between the $60,000 ﬁrst mortgage and the $60,000 second mortgage, which is obviously 1:1. 1st mortgage 2nd mortgage

$60,000 $60,000

$60,000/60,000 = 1 The monthly payment on the $60,000 ﬁrst mortgage may be around $450.The monthly payment on the $60,000 second mortgage may be $500 to $600. If the borrower gets into ﬁnancial trouble and has to decide on which payment to make, what do you think will happen?

C24.qxd 3/30/04 9:29 AM Page 215

How to Buy Discounted Paper

215

$60,000 1st/$60,000 2nd 1st mortgage payment on $60,000 2nd mortgage payment on $60,000 Difference in monthly payment

$450 $600 $150

We say the borrower will pay the smaller monthly payment of $450 on the ﬁrst mortgage. We think the borrower will not pay the higher monthly payment of $600 on the second mortgage. To heck with that face-to-face guilt stuff. Besides, the borrower is probably more afraid of being foreclosed on by the holder of the ﬁrst mortgage then they are of being foreclosed on by you.

Yield Yield is the third criteria to consider when you are buying discounted paper. As we said in Chapter 22, yield is the total return on your investment. It is more than just interest rate. We are going to give you several situations in which how you structure the promissory notes and how you think about the buying and selling of these notes has a big impact on your yield. We are going to start with a very basic transaction and move on from there. Hopefully each situation will generate new ideas for you on how to participate in the discounted paper arena. Basic Situation A seller sells a property for $100,000. The buyer pays $20,000 cash down. The buyer assumes the seller’s existing ﬁrst mortgage of $60,000. The seller extends credit to the buyer in the amount of a $20,000 promissory note. Because there is already a ﬁrst mortgage on the property, the loan from the seller will become a second mortgage secured by the property. Purchase price Down payment Assumed 1st New 2nd

$100,000 $20,000 $60,000 $20,000

In most cases, the seller would prefer cash at the time of the sale. The seller generally needs all cash to move up to a newer, more expen-

C24.qxd 3/30/04 9:29 AM Page 216

216

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

sive property. The investor who purchases the promissory note from the seller will offer the seller an amount less than the balance due on the note. Face amount of promissory note Investor offer Discount

$20,000 $15,000 $5,000

The seller will accept immediate cash in exchange for a discount on the face amount of the promissory note. As a result, the investor will receive the beneﬁt of a cash discount plus the principal and interest due on the note. Discounted paper will provide the investor with a higher yield than other investments. The investment is secured through the safety and low risk of real estate security. If the borrower does not pay back the loan, then the lender can foreclose on the property. A Second Mortgage? Or Second and Third Mortgages? By structuring a promissory note to ﬁt the situation, you can sometimes save yourself or the seller thousands of dollars. A seller can get a better price for the property by selling it to you for terms rather than for cash. What if the seller says she needs $6,000 in cash for moving expenses and miscellaneous costs, including sales expenses. You write an offer that is full price. The seller is to carry a $25,000 promissory note for her entire equity. The note is to be secured by the property. If the seller sold that promissory note, they would have to accept a substantial discount. The most they would receive is $15,000. That would be a loss to the seller of $10,000. Face amount of promissory note Investor offer Discount

$25,000 $15,000 $10,000

You suggest the seller carry back two promissory notes. Have the seller carry back a $10,000 note secured by a second mortgage and a $15,000 note secured by a third mortgage. You have a buyer for the second mortgage who will pay $6,000 cash. (This could be you!) This gives the seller the needed cash. The seller retains the third mortgage and the corresponding beneﬁts. This

C24.qxd 3/30/04 9:29 AM Page 217

How to Buy Discounted Paper

217

saves the seller $6,000 in discounts. You obtain the property on your original terms (or better if you are the buyer of the promissory note). No-Discount Second Mortgage A discount need not always be taken to generate cash on a seller carry-back second mortgage. Although market rates for money will vary, by structuring promissory notes to beneﬁt all parties, you should be able to put any deal together. Here is a basic solution to a common problem. A seller owns a property valued at $100,000. The existing loan is assumable at a 9 percent interest rate. The balance of the promissory note is $60,000. The seller needs all of his equity out of the property for an important business investment. You want to buy the property. You have $20,000 cash. A new loan of $80,000 would bring the payments to $950 per month, with an interest rate of 14 percent. This would make the monthly payments about $100 per month too much for you. You offer the seller the $20,000 cash down payment. You assume the existing $60,000 ﬁrst mortgage. You have the seller carry back a $20,000 promissory note secured by a second mortgage. Purchase price Down payment Assumed 1st mortgage New 2nd mortgage

$100,000 $20,000 $60,000 $20,000

You offer the seller 20 percent interest only, all due in three years as the terms for the promissory note. The seller then sells this promissory note for no discount due to the rate of interest. The seller received $40,000 cash. You acquired the property with no loan points. You have three years to reﬁnance the property and pay off the second mortgage. The total monthly payments are within your budget. Your Payments for First Three Years 1st mortgage $60,000 @ 9% 2nd mortgage $20,000 @ 20%

= $503.52 per month = $333.33 per month $836.85 per month

Some of you are thinking about how high the interest rates are in this situation. Your effective interest rate for the two promissory notes is 11.75 percent!

C24.qxd 3/30/04 9:29 AM Page 218

218

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

Effective Interest Rate $60,000 ⫻ 9% = $20,000 ⫻ 20% = Total interest Total loans

$5,400 $4,000 $9,400 $80,000

$9,400/$80,000 = 11.75% We hope we have stimulated you into a discounted-paper frenzy. In the next chapter we will teach you about more situations when it is not just a matter of when to buy discounted paper. Many times, it is a matter of when to create the paper itself. Once the paper is created, then it can be bought, sold, discounted, used to buy or sell real or personal property, or even to make a tax-deferred exchange work.

C25.qxd 3/30/04 9:28 AM Page 219

C H A P T E R

25

When to Buy Discounted Paper

In this chapter we are going to present many different situations where the use of discounted paper can make a deal happen. It is not just a matter of when to buy. Many times it is a matter of when to create the paper itself. Once the paper is created, it can be bought, sold, discounted, used to buy or sell real or personal property, or even to make a tax-deferred exchange work.

Price or Terms Beauty is in the eye of the beholder. So are real estate beneﬁts. To some people, whether real estate investors or not, the price is the most important beneﬁt to receive in a real estate transaction. If they get their price, then they believe they got a good deal. To other people, the terms are the most important beneﬁt. If they get their terms, then they believe they got a good deal. Few of us would be served if there was just one way to do things. We present a an example of how both parties were satisﬁed through the use of discounted paper. A seller had a lot for sale for $30,000. He told us he was ﬁrm on the price. We presented an offer for $25,000 all cash. The seller responded with a full-price counteroffer of $30,000. We wrote another offer for $10,000 cash down with the seller to carry back a $20,000 219

C25.qxd 3/30/04 9:28 AM Page 220

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

220

promissory note, payable at $200 per month, all due in ﬁve years. This offer was accepted. Purchase price Down payment Promissory note

$30,000 $10,000 $20,000

We didn’t really want to pay more than $25,000 for this lot. So here is what we did. We found another party that would sell an existing promissory note for $15,000 cash. The balance of this note was $20,000, payable at $200 per month, all due in ﬁve years. We took our remaining $15,000 cash from our original $25,000, which was what remained after our $10,000 down payment, and bought the promissory note. Cash to invest Down payment Purchase note

$25,000 $10,000 $15,000

Our $200 monthly payments on the promissory note for the lot were now offset from the $200 monthly payments on the note we had purchased at a discount. The seller received what he wanted, which was a $30,000 full-price offer for the lot. We received what we wanted, which was to pay $25,000 for the lot. We bought the lot for $25,000, really, because the payments on the note we purchased were a perfect offset for the payments on the note for the lot.

Paper for Cash Many times, sellers don’t need cash when selling property. They may be willing to take a promissory note for their equity. How about a situation in which you give the seller a promissory note for more than the equity? This seller then can be a source of funds down the road. We found sellers who were willing to take a promissory note for their equity in their $100,000 rental house. The sellers’ equity amounted to $40,000. They mentioned that they had a CD that would mature in about 90 days. The sellers were looking for a place to reinvest that would provide them a greater yield on $20,000 of their maturing CD. We

C25.qxd 3/30/04 9:28 AM Page 221

When to Buy Discounted Paper

221

had a client with substantial equity in an ofﬁce complex who wanted to buy the rental house. On behalf of our client, we wrote an offer to the seller. The offer had our client create a promissory note against the ofﬁce complex for $60,000. The interest rate on the note was 12 percent. They would use this note to buy the seller’s equity. The seller would assign the ﬁrst $20,000 of their CD proceeds to our client at the maturity date for the CDs. Value of ofﬁce complex Existing mortgage New 2nd Remaining equity

$280,000 $126,000 $60,000 $94,000

Value of rental house Existing mortgage Sellers’ equity Ofﬁce complex new 2nd Assigned CD proceeds

$100,000 $60,000 $40,000 $60,000 $20,000

Our client bought the rental house with no cash down. Within 90 days of closing, our client also received $20,000 cash. The sellers received full market value for the rental house. The sellers also received a very secure investment and improved their yield on invested capital.

Paper for Probate Property As a real estate investor, you may want to acquire probate property. This is property that is part of someone’s estate. Let’s see if we can buy the property for promissory notes. Cash is not always required, as in the following example. We met with three heirs in an estate that was going through probate. By terms of the deceased’s will, each heir was to get one-third of the estate. Heir 1, who was also the executor of the estate, wished to take his share and pay off a second mortgage on his home. The balance of this second mortgage was $11,000 payable at $120 a month. Heirs 2 and 3 wanted to invest their shares in a well-secured investment. The tax appraiser’s value of the house in probate was $46,850. The remaining loan balance owed on the existing ﬁrst mortgage was $12,100.

C25.qxd 3/30/04 9:28 AM Page 222

222

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

This loan was an assumable FHA loan. We felt the house was worth a minimum of $49,000 wholesale. We offered the heirs $49,000 for the property. We assumed the existing FHA ﬁrst mortgage. We created new promissory notes and distributed them to the heirs as follows. A promissory note for $12,300 was given to Heir 1. The interest was 14 percent annually. The payments were interest-only $143.50 monthly. The term of the note was for 5 years. This note was to be secured by a second mortgage on the house in probate. A promissory note of $12,300 was given to each of the remaining heirs and offered the same interest rate, monthly payment, and balloon payment as the note for Heir 1. These notes were secured by other property we already owned free and clear. The offer was accepted, and the transaction was approved by the court. Purchase price Assumed 1st Equity to heirs

$49,000 $12,100 $36,900 To Heirs

Heir 1 new 2nd Heir 2 promissory note Heir 3 promissory note Total to heirs

$12,300 $12,300 $12,300 $36,900

We were able to buy the property with no cash. Heir 1 received income that exceeded his outﬂow on the second loan that he considered paying off. Heirs 2 and 3 received a good return secured by high-equity real estate.

Offset Negative and Obtain a 1031 Moving a promissory note can beneﬁt you in more ways than one. This is how we moved a note to accomplish an IRC 1031 tax-deferred exchange. This also eliminated the negative cash ﬂow on the property. We accepted an offer of $10,000 cash and carried a promissory note in the amount of $23,000 secured by a second mortgage on the sale of a duplex. We agreed to do this if the buyer would accommodate us in completing a 1031 exchange.

C25.qxd 3/30/04 9:28 AM Page 223

When to Buy Discounted Paper

223

We found a triplex to exchange into. The seller’s equity in the triplex was very low in comparison with the equity in our duplex. Duplex

Triplex

$40,000 ⫺$7,000

Market value 1st mortgage 2nd mortgage Equity

$33,000

$79,000 ⫺$40,000 ⫺$30,000 $9,000

Offer on Duplex Sales price Assumed 1st New 2nd Cash down

$40,000 $7,000 $23,000 $10,000

The owner of the triplex was open to most anything. They were in a problem situation. We wrote an offer that included a camper (we knew the seller liked to take ﬁshing trips) plus the cash and promissory note from the duplex. Offer on Triplex Value of camper Cash Total

$6,000 $3,000 $9,000

Our offer on the triplex was contingent on the promissory note holder secured by the second mortgage on the triplex accepting a trade of the note secured by the new second mortgage on the duplex plus $7,000 cash in exchange for reconveying (wiping out) the existing second mortgage on the triplex. At close of escrow, this was our position in the triplex. Position in Triplex Value of triplex Assumed 1st Reconveyed 2nd Equity

$79,000 $40,000 $0 $39,000

The owner of the triplex was out of the problem situation. The holder of the second mortgage on the triplex received $7,000 cash plus

C25.qxd 3/30/04 9:28 AM Page 224

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

224

a smaller ($23,000) well-secured second mortgage on the duplex. (Check the loan ratio between the ﬁrst and second mortgages on the triplex at the beginning of the deal: $40,000 to $30,000, almost 1:1.) We completed an IRC 1031 tax-deferred exchange. We wound up in a good equity position.

Overpay for No Payments If a promissory note being used to acquire property has more equity than the property, the excess equity can be used for future payments on the property for a speciﬁed length of time. We had a buyer who had an $18,000 promissory note secured by a second mortgage, all due in three years. The buyer wanted to use the note to buy a ﬁxer-upper. We had a property that the buyer wanted. Buyer’s 2nd Mortgage Balance Interest rate Term Monthly payments

$18,000 12% 3 years $300

Our Property Property value 1st mortgage Equity

$45,000 $30,000 $15,000

There are three problems: 1. 2. 3.

The buyer needed $5,000 for the ﬁx-up. The buyer had no income to support the monthly payment on the ﬁrst mortgage of $300 during the renovation period. The buyer had $3,000 more due on their promissory note than we had equity.

We accepted the buyer’s $18,000 promissory note for the equity in our property. The excess equity in the note was applied to the ﬁrst 10 months of payments on the ﬁrst mortgage.

C25.qxd 3/30/04 9:28 AM Page 225

When to Buy Discounted Paper

Equity in promissory note Equity in property Equity difference $300 ⫻ 10 months

225

$18,000 $15,000 $3,000 $3,000

We showed the buyer how to create a short-term promissory note secured with a second mortgage against the property for $6,000. We bought the promissory note for $5,000. The note was a straight note with no payments. It was due in 12 months. We received full price for our property. After 10 months we got to keep the $300 monthly payment on the $18,000 promissory note. After one year we received a $6,000 balloon payment on the second mortgage we bought from the buyer for $5,000. After three years we received the balloon payment on the $18,000 promissory note. Our Return $300 ⫻ 26 months = 1-year balloon 3-year balloon Total Cash for ﬁx-up Our return

$7,800 $6,000 $13,200 $27,000 $5,000 $22,000

The buyer was able to purchase the property with no money down. He obtained cash for ﬁx-up expenses. He had no payments during the renovation period. This was a true win/win deal. In the next chapter we are going to show you where to ﬁnd discounted paper. You may be surprised about where we will have you look. As you can see from all the situations we have described, discounted paper opportunities are all over the place. Don’t worry if you are concerned about having only a small amount of money to invest in discounted paper. It is very possible to get a money partner or funding source either to help you buy or sell the good deals you ﬁnd.

C26.qxd 3/30/04 9:28 AM Page 226

C H A P T E R

26

Finding Discounted Paper

In this chapter we will conclude our discussion on discounted paper. We will focus on ﬁnding discounted paper. You may be surprised about where we will have you look. There is a virtually untapped arena of discounted paper associated with tax liens. We will also talk about whom you can sell discounted paper to. It is very possible to get a money partner or funding source either to help you buy or sell the good deals you ﬁnd. Again, as part of our Quick Cash strategy, we recommend that you ﬂip your discounted paper deals by assigning them to a private or commercial buyer.

Discount the Note Prior to Foreclosure You have the opportunity to make a signiﬁcant gain by purchasing a promissory note from a lender before the foreclosure sale. You will buy the lender’s position in the note for a discount. Then you will have two ways to make money. Either the borrower will make up the default and you will make a signiﬁcant yield as the holder of the note. Or you will foreclose on the defaulting borrower and wind up owning the property that is the security for the note. You will look for lenders that are private parties with limited experience in foreclosing on a promissory note. This is usually the case when the promissory note holder is an out-of-the-area private party. These 226

C26.qxd 3/30/04 9:28 AM Page 227

Finding Discounted Paper

227

lenders are often unaware of foreclosure processes. They tend to have more motivation to sell than a local or professional note holder. When you are contacting these lenders, it is very important that you are well prepared to discuss the foreclosure situation. You should be able to make a presentation with as many speciﬁcs as possible. You need to know the details of the foreclosure procedure, the risks to the lender, and the options to minimize risk to the lender. Obtain as much preliminary information as you can prior to the meeting. This should include copies of the notice of default, a property proﬁle, and a report on taxes paid. The notice of default will be posted at your county courthouse. A title company will provide you a property proﬁle and tax information. Take pictures of the property. Various shooting angles may be helpful in demonstrating to the lender that the property may have more risk than desirable to the lender. Include any letters of testimony that you may have received from prior transactions, or character letters of reference. Complete a market analysis, using comparable sales that have closed no longer than three months prior to the appointment. Include questions for the beneﬁciary (discussed shortly) to be answered by the lender at the scheduled meeting time. The foreclosure procedure outline, showing the time for each phase and the borrower’s options, will be a vital part of the presentation. Itemize the cost to repair, hold, and improve the property to saleable standards. Include the cost for holding and marketing the property. Put together a presentation book that includes all of the above and use it as a guide at the meeting with the lender.

Questions for the Lender 1. 2. 3. 4. 5.

Are you aware of the foreclosure proceeding? Do you know what you will have to do to protect your interest? Do you have the resources to maintain the payments on the prior loans? Are you willing to take the time and make the effort to foreclose? Would you accept cash now rather than possibly nothing in the future?

Before you offer to purchase a promissory note, you should be certain that your evaluation of the property indicates that it is a smart invest-

C26.qxd 3/30/04 9:28 AM Page 228

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

228

ment. You should consider the ﬁxed-up market value of the property, minus selling costs, repair costs, holding costs, and a reasonable proﬁt. Some real estate investors have historically used a 30 percent discount as a guideline. The most efﬁcient way to do this is to calculate an actual yield you want to have and make a decision based on your expected rate of return. You should always anticipate that the borrower may ﬁle for bankruptcy protection and stay the foreclosure (stay is the legal term a court uses to halt foreclosure temporarily).You also need to ﬁgure in what will happen in the unlikely event that the borrower pays off the loan. If such is the case, you should count on a minimum rate of return that is acceptable to you. A 20 percent return is a reasonable guide for the risk involved. Once you make an agreement with the lender, you should use the services of an escrow company for effective transfer of the money and all related documents.

Tax Liens This is an area of discounted paper that is attracting a lot of interest around the country. Federal tax liens are IRS liens. State tax liens are from your state income taxing authority. Local tax liens are from the county or city property taxing authority. Whatever the source of the lien, you have an opportunity to make money. These tax liens are placed against the title to the taxpayer’s property. The taxpayer cannot sell the property and give clear title to a buyer unless the lien is paid off. Usually, the taxpayer does not want to sell the property. In the event the taxpayer does not pay the tax, after a period of time the taxing authority will foreclose on the property. The taxing authority sells the property to the highest bidder at a tax lien sale. The winning bidder pays the amount of tax due. Sometimes the taxing authority will accept less than the lien amount. Even for them, something is better than nothing. As the winning bidder, you receive a tax certiﬁcate from the taxing authority. The taxpayer does not automatically lose the property. They have a statutory time period to come up with the money plus interest and redeem the property. However, the taxpayer now has to come up with more money than just the lien amount.

C26.qxd 3/30/04 9:28 AM Page 229

Finding Discounted Paper

229

You have two ways to make money in this situation. The ﬁrst is the interest on the tax certiﬁcate. As the holder of the certiﬁcate, you are entitled to interest on the money you paid to buy it. This interest is paid by the taxpayer. The interest rate is set by the taxing authority. This interest must be paid by the taxpayer in addition to the tax lien itself for the lien to be paid off. In some states and for some tax liens, this interest rate is quite hefty. In Florida, for example, on some tax liens the interest rate can be as high as 18 percent! The second way you can make money as the holder of the tax certiﬁcate is in the event the taxpayer does not redeem the tax certiﬁcate. Then, as its holder, you can convert the tax certiﬁcate into a tax deed for title to the property. Just as the holder of a promissory note who forecloses wipes out any junior liens and takes title to the property subject to any senior liens, you, as the holder of the tax certiﬁcate, can do the same thing.

IRS Tax Liens An IRS tax lien gets recorded against the taxpayer’s property. It can be a junior or senior lien in relationship to other liens against the property. If the tax lien is senior to the foreclosing lender, the buyer at the foreclosure sale takes the property subject to the existing IRS tax lien. You may ﬁnd it difﬁcult to get marketable title to the property while the lien is still in place. The lien can cloud the title to the property. This will make it difﬁcult to resell. Sometimes the new buyer can negotiate with the IRS to pay part of the lien to get it off the property. This is buying the tax lien for less than its face amount. You know, discounted paper! If the tax lien is junior to the foreclosing lender, the IRS must be notiﬁed and has the right to sell the property again within 120 days of the foreclosure sale. The IRS will do this if they feel there is more equity in the property to get money to pay off the tax lien. The IRS must pay back the investor who bought the property at the foreclosure sale for purchase money and expenses. It is smart not to do any improvements or ﬁx up the property until the 120 days has expired. If you do and IRS sells the property, you might want to be the new buyer to protect your investment! Of course, you might then wind up overpaying for the property.

C26.qxd 3/30/04 9:28 AM Page 230

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

230

Finding Someone to Sell Discounted Paper To Selling discounted paper is like selling real estate. You have to ﬁnd a buyer. In our Quick Cash system you ﬂip the contracts and not the property. When selling discounted paper, we ﬂip the contracts associated with it and not the paper itself In the case of either real estate or discounted paper, we ﬂip if we happen to “own” the real estate or discounted paper. But whom do we ﬂip it to? We will give you the buying parameters of a company that buys discounted paper. They will pay you a ﬁnder’s fee if you are the middle person in a deal. They will pay a broker’s commission if you actually broker a deal. We will leave the company nameless. We present these parameters to give you an idea of what a company in your area might require to purchase discounted paper from you. You need to investigate before you do business. This company will purchase mortgage and deed of trust promissory notes, land contracts, and contracts for deed. The property types include single-family homes (one to four units), condos, townhouses, and mobile homes with land. They will purchase paper from anywhere in the country. Each company will have credit quality of the borrower and documentation requirements, like copies of the note, appraisals, credit reports, and hazard insurance. Also, the investment-to-value ratio they will make will range from 65 percent to 75 percent of the property value, depending on the property type. Seasoning and positioning of the note—ﬁrst, second, third—are important considerations for the amount the companies will pay. There is also a minimum and maximum note value amount. Finally, most of these companies will want to use title companies, appraisers, and escrow companies that they select.

Brain Trust We are going to complete the Discounted Paper section with three money-making ideas. We are going to show you how an all-inclusive trust deed (AITD) or wrap-around mortgage works. We want you to see how creating paper can be a marvelous leverage tool. We will also show you how to overencumber property to pull cash out. All three of the

C26.qxd 3/30/04 9:28 AM Page 231

Finding Discounted Paper

231

Brain Trust ideas mentioned here are worth studying. You may be in a position to use one, two, or all three in a deal.

AITD or Wrap-Around Mortgage An AITD or wrap-around mortgage can put a deal together for you. It works to give the seller a great yield. It gives a buyer who cannot qualify for conventional ﬁnancing a good interest rate. Let’s say the seller has a property worth $100,000. She has a $50,000 balance on a promissory note that is secured by a ﬁrst mortgage on the property. The interest rate is 8 percent. The equity position is $50,000. Property value 1st mortgage Equity

$100,000 $50,000 $50,000

The buyer has a $20,000 cash down payment. The seller agrees to carry back an $80,000 AITD at 11 percent. Purchase price: Down payment AITD

$100,000 $20,000 $80,000

The AITD wraps the existing $50,000 ﬁrst mortgage and the seller’s remaining $30,000 equity after the $20,000 down payment. What do you think the seller’s yield on that $30,000 equity inside the AITD is? Let’s ﬁnd out. Remember, the buyer is paying only 11 percent interest. AITD Existing 1st Remaining equity $80,000 ⫻ 11% = $50,000 ⫻ 8% = Net income $4,800/$30,000 = 16% yield

$80,000 $50,000 $30,000 $8,800 $4,000 $4,800

C26.qxd 3/30/04 9:28 AM Page 232

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

232

You can ﬁgure out the AITD yield using this method from above. Or you can use a formula. The AITD yield formula is the AITD interest plus the product of the amount of the AITD override and the amount of the wrapped mortgage(s) divided by the AITD-wrapped equity. AITD Yield Formula AITD % ⫹ AITD override ⫻ (wrapped mortgage/AITD equity) The AITD override is the difference between the AITD interest rate and the interest rate of the wrapped mortgage(s). Let’s plug in our numbers from before. AITD % ⫹ AITD override ⫻ (wrapped mortgage/AITD equity) 11% ⫹ (11% ⫺ 8%) = 3% ⫻ ($50,000/$30,000)

11% ⫹ 5% = 16%

Creating Paper We have talked about creating a promissory note on property in which you have equity. We then said you could take that note and use it as a down payment on another property. Let’s say you have a property that is worth $100,000. There is a ﬁrst mortgage of $80,000 against the property.You have an equity position of $20,000. Property value 1st mortgage Equity

$100,000 $80,000 $20,000

In this situation, your $20,000 equity is called dead equity. From a lending standpoint, you can’t borrow it out of the property because the property already has an 80 percent loan-to-value ratio ($80,000 ﬁrst mortgage). However, you can create a promissory note for $20,000 secured by a second mortgage.You can then take this note and use it to buy another property. Let’s say you ﬁnd a property you can buy for $200,000. The property has a ﬁrst mortgage of $180,000, which is assumable. The seller’s equity in the property is $20,000.

C26.qxd 3/30/04 9:28 AM Page 233

Finding Discounted Paper

Purchase price 1st mortgage Seller’s equity

233

$200,000 $180,000 $20,000

The seller agrees to accept the $20,000 promissory note from your property as the payment for the equity. You now control two properties worth $300,000. Your ﬁrst property is worth $100,000. Your second property is worth $200,000. Your ﬁrst property has an $80,000 ﬁrst mortgage and a $20,000 second mortgage. You have zero equity in this property. Your second property has an $180,000 ﬁrst mortgage. However, you have a $20,000 equity position in this property. The $20,000 equity you have in this second property is also dead equity. What can you do? You can create another promissory note for $20,000 secured by a second mortgage. You can then take this note and use it to buy yet another property. Let’s say you ﬁnd a property you can buy for $200,000. The property has a ﬁrst mortgage of $180,000, which is assumable. The seller’s equity in the property is $20,000. . . . We think you get the point. This is what your situation looks like after this second transaction. You own three properties worth $500,000. Your ﬁrst property has an $80,000 ﬁrst mortgage and a $20,000 second mortgage. You have zero equity in this property. Your second property has an $180,000 ﬁrst mortgage and a $20,000 second mortgage.You have zero equity in this property. Your third property has an $180,000 ﬁrst mortgage. However, you have a $20,000 equity position in this property. If these three properties appreciate only 5 percent, you will have a $25,000 appreciation. This is on your $20,000 equity position. That is a 125 percent return on your equity! $500,000 ⫻ 5% $25,000 $25,000/20,000 = 125%

Overencumber Sometimes it is possible to overencumber property to create cash at closing. You ﬁnd a seller who has a property worth $100,000. The

C26.qxd 3/30/04 9:28 AM Page 234

234

DISCOUNTED PAPER AND GOVERNMENT TAX LIENS

seller has a $20,000 ﬁrst mortgage on the property and equity of $80,000. Property value 1st mortgage Seller’s equity

$100,000 $20,000 $80,000

You write an offer in which you get a new $80,000 ﬁrst mortgage. This pays off the existing $20,000 ﬁrst mortgage and leaves $60,000 cash. Of that, $50,000 goes to the seller and $10,000 goes to you at closing. This gives the seller $50,000 of his or her $80,000 equity. You give the seller a $30,000 promissory note secured by a second mortgage. The seller now has the full $80,000. The property now has an $80,000 ﬁrst mortgage and a $30,000 second mortgage. That is $110,000 worth of mortgages secured against a property value of $100,000! New 1st Old 1st Cash To seller To you New 2nd Total mortgages

$80,000 $20,000 $60,000 $50,000 $10,000 $30,000 $110,000

bm_concl.qxd 3/30/04 9:17 AM Page 235

C O N C L U S I O N

Congratulations on completing The New Path to Real Estate Wealth: Earning Without Owning. We know that you have a lot of material to digest. Our hope is that we have stimulated your interest in making money in real estate. Our recommendation is for you to go back to the section that was the most interesting for you. Please reread it. Then get started. Look at property. Write an offer. Flip a property or a contract. Assign something. Control a property with an option. Buy some discounted paper. Our point is: Do something! Make some money! And so, we bid you adieu! We do a great service for our clients, both sellers and buyers of all types, as well as all our students. We are always coming up with more creative possibilities for investments and problem solving. So we have this to say to you: get creative! Pull a group of people together and contact us for a seminar. Are you a lone ranger right now? You won’t be for long, but meanwhile you can e-mail us for feebased consulting. We are always open to new possibilities, so let us know if you need a partner. Get out there and do something now! Let us know what did or didn’t work for you. You can contact us through our publisher, E-mail us at [email protected], or write us at P.O. Box 274, Bedford TX 76095-0274. Remember to watch for the rest of this Win Going In! series to come out in the near future. God bless y’all! —Bill & Chantal Carey

235

bm_concl.qxd 3/30/04 9:17 AM Page 236

bm_appA.qxd 3/30/04 9:17 AM Page 237

A P P E N D I X

A

Deeds Chart

G = Grant deed is a deed using the word grant in the clause that awards ownership. This written document is used by the grantor (seller) to transfer title to the grantee (buyer). Grant deeds have two implied warranties. One is that the grantor has not previously transferred the title. The other is that the title is free from encumbrances that are not visible to the grantee. This deed also transfers any title acquired by the grantor after delivery of the deed. W = Warranty deed is a deed in which the grantor (usually the seller) guarantees the title to be in the condition indicated in the deed. The grantor agrees to protect the grantee (usually the buyer) against all claimants to the property. * = Special deed. State Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware District of Columbia Florida Georgia

Deeds W W G G G W W G G W W

State Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada

Deeds W W W W W W W W G W G

State Deeds Oklahoma G Oregon W Pennsylvania G Puerto Rico * Rhode Island W South Carolina G & W South Dakota W Tennessee W Texas G Utah W Vermont W (continued) 237

bm_appA.qxd 3/30/04 9:17 AM Page 238

APPENDIX A

238

(Continued) State Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky

Deeds W W G&W W W W W

State New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio

Deeds W G&W W G W G&W W

State Virginia Washington West Virginia Wisconsin Wyoming

Deeds G W G W W

bm_appB.qxd 3/30/04 9:17 AM Page 239

A P P E N D I X

B

Loans Chart

M = Mortgage, a contract by which you promise your property without giving up possession of the property to secure a loan.You also retain title to the property. TD = Trust deed, a contract used as a security device for a loan on your property, by which you transfer bare (naked) legal title with the power of sale to a trustee.This transfer is in effect until you have totally paid off the loan. In the meantime you have possession of the property. *Mortgage preferred; trust deed also valid. **Trust deed preferred; mortgage also valid. ***Use note to secure debt. State Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware District of Columbia Florida Georgia Hawaii

Loans M & TD M & TD M & TD M TD TD M M TD M & TD *** M

State Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire

Loans M M M & TD M M M M & TD** TD M & TD* M & TD M & TD M

State Loans Oklahoma M & TD Oregon M & TD Pennsylvania M Puerto Rico M Rhode Island M South Carolina M & TD South Dakota M Tennessee TD Texas TD Utah M & TD Vermont M Virginia M & TD* (continued) 239

bm_appB.qxd 3/30/04 9:17 AM Page 240

APPENDIX B

240

(Continued) State Idaho Illinois Indiana Iowa Kansas Kentucky

Loans M & TD M & TD M & TD M & TD M M & TD*

State New Jersey New Mexico New York North Carolina North Dakota Ohio

Loans M M & TD M M & TD M & TD M

State Washington West Virginia Wisconsin Wyoming

Loans M & TD TD M M & TD

bm_gloss.qxd 3/30/04 9:16 AM Page 241

G L O S S A R Y

bm_gloss.qxd 3/30/04 9:16 AM Page 242

bm_gloss.qxd 3/30/04 9:16 AM Page 243

Abstract of title A summary of the history of ownership of a property from public records. This history includes all changes of ownership and claims against the property. Acceleration clause A provision in a loan document that makes the balance owed on a loan due and payable immediately after a speciﬁed event occurs. The event may be missing a payment or violating another provision of the loan. Acknowledgment A formal declaration before a public ofﬁcial that one has signed a speciﬁc document. Adjustable rate loan Adjustable rate mortgage, ARM; a loan that allows adjustments in the interest rate at speciﬁed times based on a named index. Adjustable rate mortgage

See Adjustable rate loan.

Adjusted sales price As a seller, the price for which you sell your home minus closing costs and commission, if applicable. Agent A person authorized by another, the principal, to act for him or her in dealing with third parties. AITD

See All-inclusive trust deed.

Alienation clause

See Due-on-sale clause.

243

bm_gloss.qxd 3/30/04 9:16 AM Page 244

GLOSSARY

244

All-inclusive trust deed Wraparound mortgage, AITD; a junior (second, third, and so forth) loan (mortgage or trust deed) at one overall interest rate used to wrap the existing loans into a package. The amount is sufﬁcient to cover the existing loans and provide additional funds for the sellers. Sellers pay on existing loans from buyers’ payments. Sellers remain primarily responsible for the original loans. Amortization Gradual paying off of the principal on a loan by payment of regular installments of principal and interest. Annual percentage rate APR; an interest rate that includes interest, discount points, origination fees, and loan broker’s commission. Appraisal An examination of a property by a qualiﬁed professional to estimate its market value as of a speciﬁc date. APR

See Annual percentage rate.

ARM

See Adjustable rate loan.

Assessment Tax or charge by a governmental body for a speciﬁc public improvement covering the property owner’s portion of costs. Assessments are in addition to normal property taxes. Assign Assignee

Transfer. The person to whom interest is transferred.

Assignment Transfer of any property to another. Delegation of duties and rights to another. Assignor

The person from whom interest is transferred.

Assume Buyers taking over primary responsibility for payment of existing loan. Sellers then become secondarily liable for the loan and any deﬁciency judgment. Assumption fee The fee a lender may charge for work involved in allowing buyers to assume primary liability for payment on an existing loan. Attorney A person licensed to practice law by giving legal advice or assistance, as well as prosecuting and defending cases in courts. Authorization to sell A listing contract allowing a real estate professional to act as an agent in the sale of property. Bankruptcy Relief by a court of an obligation to pay money owed after turning over all property to a court-appointed trustee.

bm_gloss.qxd 3/30/04 9:16 AM Page 245

Glossary

245

Basis The cost of a home when purchased, including down payment, loans, and closing costs. Beneﬁciary type of loan.

The lender of money on a property used in a trust deed

Beneﬁciary statement A statement provided by a lender using a trust deed type of loan that usually lists claims that do not appear on loan documents. Bridge loan A short-term loan to buyers who are simultaneously selling one house and trying to buy another. Broker

See Real estate broker.

Buyer’s agent A real estate broker or sales associate who represents the buyer in a transaction. Buyer’s broker

A real estate broker who represents the buyer.

Buyer’s market A condition in which there are more sellers than buyers; prices generally decrease. Call

Demand payment of a debt.

Capital asset Property, both real and personal, held by a taxpayer and not excluded by tax laws. Capital gain Proﬁt from selling or exchanging a capital asset in excess of the cost. Capital improvements Additions to property that are permanent, increase property value, and have a useful life of more than one year. Capital loss Loss from selling or exchanging property other than a personal residence at less than its cost. Cashier’s check A bank’s own check guaranteed to be good by the bank at which it is drawn. Casualty insurance

See Hazard insurance.

Certiﬁcate of title A report, produced by a party providing abstracts of titles, stating that based on an examination of public records, the title is properly vested in the present owner. CC&Rs Covenants, conditions, and restrictions; a document listing private restrictions on property. Often used when buyers have an interest in common areas.

bm_gloss.qxd 3/30/04 9:16 AM Page 246

GLOSSARY

246

Classiﬁed advertisements type and listed accordingly.

Advertisements that are separated by

Closing Closing escrow, settlement; the ﬁnal phase of a real estate transaction that involves signing loan documents, paying closing costs, and delivering the deed. Closing costs Costs of sale; the additional expenses over and above the purchase price of buying and selling real estate. Closing escrow Closing fee

See Closing.

See Closing.

Closing statement A written, itemized account given to both seller and buyers at closing by the escrow holder and detailing receipts, disbursements, charges, credits, and prorations. Commitment An oral or written agreement to make a loan made by a lender to a potential buyer. Competent person A person who meets certain criteria set by a state for competency. These laws often include being a natural person who is an adult or an emancipated minor, mentally competent, and not a felon deprived of civil rights. Commission Payments to an agent, such as a real estate broker, for services in the selling or buying of a home. Conditions Requirements that must precede the performance or effectiveness of something else. Provisions or qualiﬁcations in a deed that if violated or not performed nullify the deed. Condominium An undivided ownership in common in a portion of a piece of real property plus a separate interest in space in a building. Consideration Anything of value that inﬂuences a person to enter into a contract, including money, a deed, an item of personal property, an act (including the payment of money), a service, or a promise (such as to pay on a loan). Acts or services must be performed after you and the buyers enter into the contract. Contingency

A condition on which a valid contract depends.

Contingency release Wipe-out clause, kick-out provision; provisions providing that you will continue to market your home until you receive another offer to purchase your home that does not contain the contin-

bm_gloss.qxd 3/30/04 9:16 AM Page 247

Glossary

247

gencies you indicated or buyers remove those contingencies you speciﬁed. After you receive a contract without the detailed contingencies, the original buyers have the speciﬁed time you agreed on to remove the contingencies or you may sell your home to the buyers who offered you a contract without the contingencies. Contract for deed

See Land sales contract.

Controller ’s deed

See Tax deed.

Conventional loan ernment agency. Convey

A loan that is not guaranteed or insured by a gov-

Transfer.

Costs of sale

See Closing costs.

Counteroffer A statement by a person to whom an offer is made proposing a new offer to the original offeror. Covenants Agreements or promises contained in and conveyed by a deed that are inseparable from the property. Pledges or the performance or nonperformance of certain acts or the use or nonuse of property. Credit report

A detailed report of a person’s credit history and rating.

Deed A document containing a detailed written description of the property that transfers property ownership. Deed of trust

See Trust deed.

Default Failure of a person to fulﬁll an obligation or perform a duty; failure to make a loan payment when it is due. Deﬁciency judgment A court decision making an individual personally liable for payoff of a remaining amount due because the full amount was not obtained by foreclosure. Delinquent payment

A payment that was not paid when it was due.

Demand fee Demand for payoff charge; a fee for a written request to a lender for lender’s demand for payment of the loan in full and the supporting documents necessary for release of the lien against the property. Deposit Money that buyers submit with a purchase offer as evidence of their intention and ability to buy. Depreciation

Loss in value from any cause.

bm_gloss.qxd 3/30/04 9:16 AM Page 248

GLOSSARY

248

Disclosure

Making known things that were previously unknown.

Discount points Discovery

See Points.

Disclosure of things previously unknown.

Divided agency Agent’s action in representing both parties in a transaction without the knowledge and consent of both. Down payment Money that you and buyers agree on, or that a lender requires, that buyers pay toward the purchase price before escrow can close. Dual agent A broker acting either directly or through an associate licensee as agent for both seller and buyer. Due-on-sale clause Alienation clause; an acceleration clause in a loan giving the lender the right to demand all sums owed due at once and payable if the property owner transfers title. Earnest money

See Deposit.

Emancipated minor A person who is under the age to legally be an adult in the state in which they live but who has some other criteria that allow them to function as adults. The criteria may include being lawfully married or divorced, duty in the armed forces, or emancipated by court order. Eminent domain Governments’ power that allows them to take private property for public use after paying what they feel to be a fair price. Encumbrance A charge, claim, or lien against a property or personal right or interest in a property that affects or limits the title but does not prevent transfer. Equity The part of a property’s current value that is owned and on which no money is owed; the property’s value minus the liens owed against the property. Escrow A process in the transfer of real property in which buyers and sellers deposit documents or money with a neutral third party (the escrow holder). Buyers and sellers give instructions to the escrow holder to hold and deliver documents and money if certain conditions are met. Escrow instructions A written agreement between seller and buyers that extrapolates the purchase contract into a form used as directions on how to conduct and close the escrow.

bm_gloss.qxd 3/30/04 9:16 AM Page 249

Glossary

249

Exclusive agency listing A listing with only one agency that provides that if the real estate professional obtains the buyer, you must pay the broker the commission. If you sell your home yourself, you are not liable for the commission. Exclusive right to sell listing A listing providing that during the time listed only that broker has the right to sell your home and earn the commission, no matter who makes the sale. Extended coverage title insurance This coverage protects against numerous risks that are not a matter of record. FHA Federal Housing Administration; a federal governmental agency that manages FHA-insured loans to protect lenders in case of default by buyers. FHA loan Financing by having a conventional loan made by a lender and insured by the FHA. Fiduciary A person who is in a position of trust who must act in the best interest of clients. Fire insurance

See Hazard insurance.

Fixed-rate loan A loan on which the percentage of interest remains at the same rate over the life of the loan. The payments of principal remain equal during the entire period. Fixture Items permanently attached to or for which special openings were made in a home and its associated structures. Fix-up costs ness items.

The expenses of improvements, repairs, and attractive-

Foreclosure The process by which a property on which a borrower has not paid is sold to satisfy a loan against the property. Fraud Willfully concealing or misrepresenting a material fact to inﬂuence another person to take action. The action results in the person’s loss of property or legal rights. FSBO For sale by owner; a phrase describing a homeowner selling property without using a real estate broker. Gift deed Grant deed ownership.

A deed given for love and affection. A deed using the word grant in the clause that transfers

bm_gloss.qxd 3/30/04 9:16 AM Page 250

GLOSSARY

250

Grantee

Buyer; receiver of a title to a property.

Grantor

Seller; holder of a title to a property.

Guarantee of title on the deed.

A warranty that title is vested in the party shown

Hazard insurance Casualty insurance, ﬁre insurance;insurance protection against stated speciﬁc hazards, such as ﬁre, hail, windstorms, earthquakes, ﬂoods, civil disturbances, explosions, riots, theft, and vandalism. Home equity line of credit Credit given by a lender based on the amount of one’s equity in a property. The line of credit becomes a loan secured by a mortgage or trust deed when the borrower uses some or all of the credit. Home inspection

See Physical inspection

Home inspector A qualiﬁed person who examines and reports on the general condition of a home’s site and structures. Homeowner association dues Monthly fees owners of homes pay to their homeowner association for the items it provides. Homeowner’s insurance A policy protecting a homeowner from liability and casualty hazards listed in the policy. Impounds Reserve fund; funds held by the lender to ensure payment in the future of recurring expenses. These expenses can include insurance premiums and taxes. Improper delivery Delivery of a deed that has not passed out of seller’s control and/or was not delivered to buyers during the seller’s lifetime. Improvement costs

Expenses for permanent additions.

Imputed interest rate The minimum rate the IRS requires for a seller-ﬁnanced loan. If you charge less than the minimum rate, the IRS taxes you on the minimum. Index A measurement of interest rates on which changes in interest charges on adjustable rate loans are based. Inspection records Notices indicating that inspections have been conducted by the proper local authorities at certain speciﬁed points in the building process.

bm_gloss.qxd 3/30/04 9:16 AM Page 251

Glossary

251

Inspection reports Reports by inspectors about the condition of various aspects of your property, including defects and repairs considered necessary. Installment note A loan paid back in at least two payments of principal on different dates. Installment sale A sale that allows the seller to receive payments in more than one tax year. Interest A charge or rate paid in arrears (after incurred) to a lender for borrowing money. Interest-only loan A loan for which only the interest is paid and no principal is repaid until the ﬁnal installment. Jointly and severally liable sonally liable.

Liable along with other parties and per-

Joint tenancy Vesting wherein two or more parties acquire title at the same time. Each party has an equal, undivided interest and equal right to possess the property, including automatic right of survivorship. Judgment Final determination by a court of a matter presented to it. A general monetary obligation on all property of the person who owes the money. This obligation applies in each county where an abstract of the court judgment was recorded. Lack of capacity Inability to enter into a contract because one is not a competent person by his or her state’s criteria. Landlord

The owner or lessor of real property.

Land sales contract Contract for deed, real property sales contract; an agreement in which the seller retains title to property until the buyer performs all contract conditions. Lease A contract that transfers possession and use of designated property for a limited, stated time under speciﬁed conditions. Lease option A contract that stipulates that potential buyers are leasing a property for an agreed-on rental payment. These buyers have the right to purchase the property before the speciﬁed future date for the amount listed in the contract. Part of the lease payment is considered option money toward the purchase price.

bm_gloss.qxd 3/30/04 9:16 AM Page 252

GLOSSARY

252

Lease purchase A contract that states that buyers are leasing the property for the agreed-on amount and conditions. The buyers agree to purchase the property at the agreed-on time for the agreed-on amount. Legal description A formal description giving a property’s location, size, and boundaries in written and/or map form. Lessee use it.

The tenant or person who leases property from the landlord to

Lessor The landlord or owner of property who leases the property to the tenant for the tenant’s use. Liability Responsibility for damages to other people or property; what you owe against an asset. Lien A claim against a property making the property security for debts, such as loans, mechanic’s liens, and taxes. Lien releases Documents releasing one from monetary liability to the party listed after fully paying that party. Liquidated damages The amount of money you may keep if the buyers default or breach the contact. Lis pendens An ofﬁcial recorded notice that legal action is pending against the title to the property. Listing Authorization to sell; a contract allowing a real estate broker to act as an agent to buy, lease, or sell property for another. Loan disclosure statement A lender’s account summary required by the Federal Truth in Lending Act. Loan discount fee

See Points.

Loan fees One-time charges by the lender for initiating a loan, including points, appraisal, and credit report on buyers. Loan origination fee Lender’s charge for arranging and processing a loan, usually based on a percentage of the loan. Loan tie-in fee A fee charged by whoever handles closing for their work and liability in conforming to the lender’s criteria for the buyers’ new loan. Market value The amount buyers are willing to pay and sellers are willing to accept within a reasonable time.

bm_gloss.qxd 3/30/04 9:16 AM Page 253

Glossary

Marshal’s deed

253

See Sheriff’s deed.

Mechanic’s lien A claim ﬁled against property by a contractor, service provider, or supplier for work done or materials provided for which full payment has not been received. MLS

See Multiple Listing Service.

Mortgage A contract to secure a loan by which you promise your property without giving up possession or title. Mortgage default insurance Default insurance; insurance coverage enabling the lender to receive a part of the outstanding balance in the event you default. Mortgagee

Lender of money on property using a mortgage.

Mortgagor

Property owner who borrows money using a mortgage.

Multiple Listing Service MLS; an agency to which real estate brokers belong to pool their listings with other brokers. If a sale is made, the listing and selling brokers share the commission. Negative amortization Process in which payments on a loan do not cover interest payments and the difference between the payment and interest due are added to the loan balance. Net listing A listing providing that the broker retain all money received in excess of the price set by the seller. Nominal interest rate

Interest rate stated in a promissory note.

Notary fee A charge paid to a notary public to witness signatures on some of the legal documents in a transaction. Notice of default Warning sent to a borrower on a loan cautioning the borrower that the payment is delinquent. Offset statement A statement regarding a loan provided by the seller when a beneﬁciary statement is not available. Open listing A nonexclusive right-to-sell agreement one can make with one or more real estate professionals. It provides that if you sell your home yourself, you are not liable to the broker for a commission. If, however, a real estate professional obtains the buyers for the property, you must pay the broker the commission you have negotiated. Option A contract to keep an offer to buy, sell, or lease property open for a period and under the terms agreed on.

bm_gloss.qxd 3/30/04 9:16 AM Page 254

GLOSSARY

254

Optionee

The person who gets the option on a property.

Optionor

The owner of a title who gives an option.

Option to buy

See Purchase option.

Payment records

Checks, receipts, and written ledgers.

Payment statements Monthly stubs showing your payment date, amounts applied to principal and interest, and remaining balance due, as well as annual summary statements. Permission-to-show listing A listing contract that allows a real estate professional to show your property only to the person or persons named in that contract. You pay the commission only if someone on the list purchases your home. Personal property Items that are not permanently attached to your home or other structures on your property. Pest control inspection Structural pest control inspection, termite inspection; inspection for infestation or infection by wood-destroying pests or organisms. Physical inspection Home inspection; examination of the general physical condition of a property’s site and structures. Planned unit development PUD; a subdivision in which the lots are separately owned but other areas are owned in common. Points Discount points, loan discount fee; a one-time charge by the lender to adjust the yield on the loan to current market conditions or to adjust the rate on the loan to market rate. Each point is equal to 1 percent of the loan balance. Power of attorney A document that gives one person the power to sign documents for another person. Power of sale clause A provision in a loan allowing the lender to foreclose and sell borrower’s property publicly without a court procedure. Preliminary title report Report summarizing the title search performed by a title company or lawyer for a property. Prepayment penalty A ﬁne imposed on a borrower by a lender for the early payoff of a loan or any substantial part of a loan.

bm_gloss.qxd 3/30/04 9:16 AM Page 255

Glossary

255

Principal One of the parties in a real estate transaction, either you or the buyers. In a loan, the amount of money borrowed. Principal residence An IRS term denoting the residence wherein you spend the most time during the tax year. Probate court A court that handles wills and the administration of estates of people who have died. Promissory note The written contract you sign promising to pay a deﬁnite amount of money by a deﬁnite future date. Property taxes Taxes assessed on property at a uniform rate so that the amount of the tax depends on the value. Property tax statements Documents that the county assessor’s ofﬁce mails to home owners itemizing the semiannual or annual tax bill on a home and indicating the payment due dates. Prorations Proportional distributions of responsibility for the payment of the expenses of home ownership. This distribution is based on the percentage of an assessment or billing period during which the seller and buyers own the property. Purchase contract The contract containing terms and conditions to which you and the buyers agree when you accept the offer to purchase your home. Purchase option Option to buy; the type of contract in which buyers agree to purchase the property for the amount listed in the contract, if they decide to buy your home and make the purchase within the listed period of time, and agree that you keep the option fee if they do not buy the property. Quitclaim deed A deed using the word quitclaim in the clause granting ownership and thus releasing the grantor from any claim to that property. A quitclaim deed has no warranties. Real estate

See Real property.

Real estate broker A real estate agent who represents another person in dealing with third parties. This person must take required courses, pass a broker’s exam, and be licensed by the state. A broker may employ other qualiﬁed individuals and is responsible for their actions. Real estate professional

A real estate broker or sales associate.

bm_gloss.qxd 3/30/04 9:16 AM Page 256

GLOSSARY

256

Real estate sales agent A person who is licensed by a state and who represents a real estate broker in transactions. Real Estate Settlement Procedures Act

See RESPA.

Real property Real estate; land and whatever is built on, growing on, or attached to the land. Real property sales contract

See Land sales contract.

Reconveyance deed A deed that records full satisfaction of a trust deed–secured debt on your property and transfers bare legal title from the trustee to you. Recording Ofﬁcial entry of liens, reconveyances, and transactions into the permanent records of a county. Release of contract An agreement that all responsibilities and rights occurring as a result of a contract are invalid. Repair costs Expenses for work maintaining a home’s condition, including replacement and restoration. Request for notice of default A recorded notice allowing a county recorder to notify lenders of foreclosure on a property in which the lender has an interest. Rescind To cancel a contract and restore the parties to the state they would have been in had the contract never been made. RESPA Real Estate Settlement Procedures Act; a federal law that requires that buyers be given, in advance of closing, information regarding their loan. Revocation Involuntary cancellation that occurs when the time limit has expired and one or both parties do not perform in accordance with the terms of the contract. Sales associate A real estate professional with either a broker’s or sales license who acts as an agent for a broker. Satisfaction of mortgage your mortgage off in full.

A document indicating that you have paid

Sale leaseback An agreement in which the seller sells the property to buyers who agree to lease the property back to the seller.

bm_gloss.qxd 3/30/04 9:16 AM Page 257

Glossary

257

Seller buy-down loan A loan in which the effective interest rate is bought down (reduced) during the beginning years of the loan by contributions a seller makes. Seller carry-back loan A loan for which the seller acts as a lender to carry back or hold mortgage notes from buyers. These notes may be ﬁrst, second, or even third loans. Seller’s agent

See Listing.

Selling agent

See Buyer’s agent.

Seller’s market A condition in which there are more buyers than sellers; prices generally increase. Settlement Severalty

See Closing. Vesting of title in which you hold title by yourself.

Sheriff’s deed Marshal’s deed; a deed used by courts in foreclosure or in carrying out a judgment. This deed transfers a debtor’s title to a buyer. Single agent transaction.

An agent representing only one party in a real estate

Speciﬁc performance Law that allows one party to sue another to perform as speciﬁed under the terms of their contract. Standard-coverage title insurance The regular investigation for this insurance generally reveals only matters of record and location of the improvements with respect to the lot line. Straight note A promise to pay a loan in which the principal is paid as one lump sum, although the interest may be paid in one lump sum or in installments. Subject-to loan An existing loan for which buyers take over responsibility for the payments, and seller remains primarily liable in the event of a deﬁciency judgment. Take sheet A form used to collect information necessary to prepare the escrow instructions. Tax deed Controller’s deed; a deed used by a state to transfer title to the buyers.

bm_gloss.qxd 3/30/04 9:16 AM Page 258

GLOSSARY

258

Taxes

See Property taxes.

Tax stamps A method of denoting that a transfer tax has been paid in which stamps are afﬁxed to a deed before the deed may be recorded. Termination of agency

Ending of an agency agreement.

Time is of the essence A statement that one party in a contract must perform certain acts within the stated period before the other party can perform. Title

Evidence of one’s right to a property and the extent of that right.

Title insurance The policy issued to you by the title company on completion of the ﬁnal title search protecting against claims in the future based on circumstances in the past. Title insurance companies

Companies issuing title insurance pol-icies.

Title search An examination of information recorded on your property at the county recorder’s ofﬁce. This examination veriﬁes that the property has no outstanding claims or liens against it to adversely affect the buyer or lender and that you can transfer clear legal title to the property. Transfer fee

See Assumption fee.

Transfer tax Documentary transfer tax; a tax that some states allow individual counties or cities to place on the transferring of real property. Trust deed A document, used as a security device for the loan on your property, by which you transfer bare (naked) legal title with the power of sale to a trustee. This transfer is in effect until you have totally paid off the loan. Trustee A person who holds bare legal title to a property without being the actual owner of the property. The trustee has the power of sale for the lender’s beneﬁt. Trustee’s deed A deed used by a trustee in a foreclosure handled outside of court to transfer the debtor’s title to buyers. Trust funds Funds held by a closing agent or escrow holder for the beneﬁt of the buyers or seller. Truth in lending A federal law that requires disclosure of loan terms to a borrower who is using his or her principal residence as security for a loan.

bm_gloss.qxd 3/30/04 9:16 AM Page 259

Glossary

259

Unconditional lien release Waiver of liens; a release, usually signed by a contractor, after a job is complete and you made the ﬁnal payments waiving and releasing all rights and claims against your home. Unenforceable

Not able to be enforced; void.

Unlawful detainer The unjustiﬁable keeping of possession of real property by someone who originally had the right to possession but no longer has that right. Usury

Interest charged in excess of what state law permits.

VA Veterans Administration; the federal government agency that manages VA loans. VA loan GI loan; ﬁnancing made by having a conventional loan made by a lender guaranteed by the VA. Vendee

Purchaser or buyer.

Vendor

Owner or seller.

Vesting

Interest that cannot be revoked.

Veterans Administration Void

To have no effect; not enforceable by law.

Voidable Waive aware.

See VA.

Able to be set aside.

Unilateral voluntary relinquishment of a right of which one is

Walk-through inspection Buyers’ physical examination of a property within a few days before closing, verifying that systems, appliances, and the house itself are in the agreed-on condition. Warranties Printed or written documents guaranteeing the condition of property or its components. Warranty deed A deed in which the grantor explicitly guarantees the title to be as indicated in the deed. The grantor agrees to protect buyers against all claimants to the property. Wrap-around mortgage

See all-inclusive trust deed.

Zoning Governmental laws establishing building codes and governing the speciﬁc uses of land and buildings.

bm_gloss.qxd 3/30/04 9:16 AM Page 260

bm_Index.qxd 3/30/04 9:16 AM Page 261

I N D E X

bm_Index.qxd 3/30/04 9:16 AM Page 262

bm_Index.qxd 3/30/04 9:16 AM Page 263

Ad sample, 20 AITD (all-inclusive trust deed), 230–232 yield formula, 232 Amortized notes, 198–199 Assigning/assignment, 98, 101, 102 advantages, 108, 109–117 (see also Flipping/ﬂips, advantages of) closing by, 127–128 contracts, 120–124 (see also Offers/contracts; Contracts, assigning/ assignable) assignable, 103, 134, 135–142 assigning, 140 form, 124 not assignable, 135 becomes assignable, 141–142 deed, 132 fee, 103 ﬁnding, 135–142 how to, 118–125, 126–133, 135–138, 140–142 language, 101–102, 118 mortgages/trust deeds, 138–139

options, 173 paperwork, 112–113, 115–116 script, 120 tax liens, 139 timeline, 116, 127, 129 when to, 126–132 after closing, 132 before closing, 126–128 during closing, 129–130 Average price, 30–31 Balloon payment, 64, 199 Bilateral agreement, 41 Brain Trust, 163 concepts, 167, 208, 230–234 tools AITD/wrap, 231–232 create paper, 232–233 option, 41, 106 overencumberance, 233–234 Buyers assignee, 102 grantee, 102 investors, 33 mortgagor, 102 optionee, 41, 106, 145–146 263

bm_Index.qxd 3/30/04 9:16 AM Page 264

264

Buyers (continued) retail, 33, 78–80 serious, 44 wholesale, 33, 80 Buyer’s day, 47 Capitalization rate, 15 Carry back ﬁnancing, 76, 95 Cash ﬂow, 207 CDs (certiﬁcates of deposit), 76 Charts average versus median price, 31 escrow, 47 exchange, 137 real estate paperwork, 196 Closing, 46 agent for assignment, 125 by assignment 127–128 statement, 48–49 See also Escrow; Title, insurance/company CoCa CoLa, 36–37 Comparative market analysis comparables, 15, 19 form, 17 way to value, 15–16, 30, 33–35 Consideration, 37, 38, 105 Contracts assigning/ assignable, 38, 42, 98, 101–104, 106–107, 120–124, 134–142, 173 (see also Assigning/assignment) not assignable, 108, 135 becomes assignable, 108, 141–142 purpose of, 42 See also Offers/contracts Counter offer, 45 CPA (certiﬁed public accountant), 69 Curb appeal, 33

INDEX

Dead equity, 232 Discounted paper, 139 advantages of, 203–210, 216–218 (see also Discounted paper, ﬁnding, when to buy or create) criteria for, 211–216 loan-to-value ratio, 213–215 seasoned, 211–212 yield, 215–216 discount versus yield, 200–202 ﬁnding, 226–229 buyers, 230 paperwork, 196 promissory note elements, 196–199 what is, 195–196 when to buy or create, 219–225 (see also Discounted paper, advantages of) Discount points, 80 Dual agent, 27 DUST. See Value, elements Earnest money, 49 deposit receipt, 104–105 See also Consideration; Offer/ contracts, writing, types Equity, 76 Equity sharing, 95 Escrow, 47–50 closed, 85 company/holder, 46 choosing, 49 instructions, 50 opening, 49 paperwork, 196 Exchange 1031 tax-deferred, 7, 71, 162, 222–224

bm_Index.qxd 3/30/04 9:16 AM Page 265

Index

chart, 137 contract, 136–138 Exclusive Right to Sell Agreement, 23 FHA (Federal Housing Administration), 79 Financial condition cash available, 9 credit rating, 7–8 clean-up, 8, 161–162 time available, 9–10 understanding, 7 Finding good deals, 11, 91 six ways, 20–22 agents, 21–22 contacts, 12, 21 Internet and placing ads, 20–21 (see also Real estate language, ads) open houses, 21 newspaper and placing ads, 20 (see also Real estate language, ads) scouting, 21 First right of refusal, 207 Fixer-upper, 30, 33, 61, 63 Flipping/ﬂips advantages of, 65–69 disadvantages of, 65, 69–70 discounted paper, 230 ﬁnding, 89–97 (see also Finding good deals, six ways) option contracts, 150 paperwork, 111–115 with escrow, 113–115 without escrow, 111–112 process, 74–80 tied up property, 74–77 (see also Offers/contracts) tactics, 57–64

265

ﬁnd and ﬂip, 58–60 ﬁnd, ﬁx, and ﬂip, 60–64 timeline, 88 what is, 57 when to, 81–88 after you close escrow, 87 without owning, 85–86 after offer, 85–87 before offer, 81–85 Foreclosure, 60, 93–94 discount paper, 226–228 FSBO (For Sale By Owner), 78 Goals, 3–4, 29 Going Going Gone! Auctioning Your Home for Top Dollar, 24 Grant deed, 102, 164 Gross rent multiplier, 14 How to Sell Your Home Without a Broker, 28, 34, 42, 104 Inspections, 47 (see also Property, inspecting) Landlording, 66–67, 72 lease, 102 option, 172–173, 188–189 lessee, 102 lessor, 102 Long-term wealth building, 29, 65, 70–73 advantages of, 65, 70–71 disadvantages of, 65, 72–73 Median price, 30–31 MLS (Multiple Listing Service), 23–24 Mortgage/trust deed, 102, 138–139

bm_Index.qxd 3/30/04 9:16 AM Page 266

266

NAR (National Association of Realtors), 20 NOI (net operating income), 15 Nondisclosure and noncircumvention agreement, 82 form, 83 Nothing/no money down, 9, 53 Offers/contracts, 36 based on analysis of inspections, 35 based on value, 12–13 (see also Value) presenting, 36, 42–45 how to, 44–45 when to, 44 where to, 43 writing, 36–42 CoCa CoLa, 36–37 contract requirements, 37, 104 purpose, 36, 37, 42, 104 types of, 37–42, 104–106, 136–141, 145, 164 assignment, 38, 42, 104, 106 exchange, 136–138 land contract, 138 letter of intent, 38–41 option contract, 38, 41, 106, 145, 164 (see also Options) purchase contract, 37, 38, 42, 104 changes/additions, 128, 131 Options, 145 assigning, 173 contract, 164–170 fee, 41, 106, 146–149, 156 applied to purchase, 147

INDEX

not applied to purchase, 147–149 ﬁnding, 184–191 property to, 190–191 how to, 164–174 (see also Options, ﬁnding; Options, reasons for/when to) memorandum of, 170 optionor/optionee, 145–146 reasons for/when to, 154–163, 175–183, 186–190 assemble partners, 159, 181 buy time, 158–59, 180–181, 186–190 control property, 158, 179–180 (see also Flipping/ﬂips, advantages of) handle contingencies, 161, 182–183 income tax planning, 162–163 limited risk/high return, 156–157, 178–179 maintain privacy, 155, 176–177 procure ﬁnancing, 161–162 protect cash, 156, 177–178 watch market direction, 159–160, 181–182 reverse, 162–163 uses/using 149 lease, 151–153 option contract, 172–173 purchase, 147–151 contract, 171 PITI (Principle, Interest, Taxes, and Insurance), 68 Potential vision, 32, 60 Preliminary title report, 52 Prepayment penalty, 209 Principal of Progression, 30

bm_Index.qxd 3/30/04 9:16 AM Page 267

Index

267

Principal of Regression, 30–32, 63, 91 Promissory note, 61, 195 elements, 196–199, 207 sale, 187 using, 105–106, 166 Property, 29–35 evaluating, 29 ﬁxer-upper, 33 inspecting, 29, 32, 33–35 walk-through checklist, 33–35 potential, 33 right one, 30–31 See also Value Prorations, 47–49 PUD (Planned Unit Development), 68

interest rates, 5 psychology, 11–13 four emotions, 12 tax regulations, 6–7 deductions, 6 sale of investment property, 6–7 1031 tax-deferred exchange, 7, 71, 136–138, 162 sale of principal residence, 6 timing relating to lease purchases, 151 relating to reverse options, 162–163 time of year, 4–5 understanding, 4 Real estate paperwork, 196

Quick Cash strategy, 57, 65, 69, 134, 226 system, 29, 46, 230 Quitclaim deed, 58, 132 form, 133

Sellers assignor, 102 grantor, 102 mortgagee, 102 motivated, 32, 97 optionor, 41, 106, 145–146 right ones, 29, 32, 90–97 SFRs (single-family residences), 68 Straight notes, 199

Real estate agents, 21–28 commissions, 23–25 ﬁnding, 21–22 listing agreements, 23 MLS, 23, 24 working with, 23–28 as a buyer, 4, 25–28 advantageously, 27–28 as a seller, 4 advantageously, 28 Real estate attorney, 46, 50–51 Real Estate Investment Axiom, 74 Real estate language, 101–102, 118 ads, 89–97 Real estate market, 5–7, 11–13 economic climate, 5

Taxes, 6–7, 71, 136–138, 151, 162–163 Tax liens, 139, 226, 228–229 Timeline assigning, 116, 127, 129 ﬂipping, 88 thirty day, 10 Timing, 5–6, 8–10 Title insurance/company, 42, 46, 51–54 buyer’s policy, 53–54

bm_Index.qxd 3/30/04 9:16 AM Page 268

268

Title (continued) lender’s policy, 53 owner’s policy, 52–53 search, 52 take, 85 Transferability, 52 (see also Value, elements, transferability) Unilateral agreement, 41, 106 Usury, 197–198 VA (Veteran Administration), 53, 79 Value, 12–20, 30–35 appraisal, 13 elements, 16 demand, 16 scarcity, 16 transferability, 16, 18, 52 utility, 16 forces inﬂuencing, 18 economic, 18 physical, 18 political, 18 social, 18

INDEX

knowing, 13 appreciation rates, 19 comparables, 15 expired comps, 19 listed comps, 19 new/planned developments, 20 pending comps, 19 sold comps, 19 vacancy rates, 20 loan, 13 property tax, 13 replacement, 13 retail, 13 ways to, 14 cost approach, 14 income approach, 14–15 market comparison approach, 15–16, 19, 30, 33–35 form, 17 wholesale, 13 Warranty deed, 164