Real Estate 21st Century Style

January 16, 2004


Currently my business is centered on finding people in pre-foreclosure. I "buy" their house to prevent the foreclosure, then either sell it to a new buyer or lease it back to the current owner for 1-3 years until their financial status is better. When I say I "buy" their house, in reality I get control of the property through a land trust, then find my new buyer without actually transferring title to myself. When I get the new buyer, the old buyer sells it to me, then 30 seconds later I sell it to the buyer I found in what is called a "dual close." That way I have no out-of-pocket costs. Of course the new buyer buys the property for 20-30k more than I "paid" for it. At this point, I have several such deals in the pipeline, but nothing has come out the other end yet (I haven't been doing this very long). However, I know several people who do this full-time, and they are raking it in!

Right now in the greater Portland area, there are about 100 foreclosures a week. I believe we have the highest rate in the country. Every month, 50,000 people in this area are late making their mortgage payment. For the clients I have met, the most common cause is job loss. These people typically get a house where they need two incomes to afford them, and when one of them loses their job, they are screwed. I see people who have borrowed 125% of the value of their home, and others who have their home financed at over 10% (presumably because they routinely overextend themselves so their credit is shot). In my first deal, I have a house in Oregon City where the owners managed to borrow 230k on a house maybe worth 160k. This was possible because the bank just did a drive-by appraisal. The bank that holds the second mortgage of 50k will probably lose most of it. I see this all the time.

Since I was laid off from my job in March, I have been collecting unemployment insurance as I get my business going. I receive $1070 a month in rental income from my two rental units (I own a tri-plex). With this as my financial situation, I am pre-qualified for a 100%, non-owner-occupied loan at 7.8% interest rate. True I have excellent credit, but the fact that I can get this type of loan with no real income is a bit scary.

Nonetheless, given that the high-tech industry has collapsed, and I will not be able to get a web programming job in the foreseeable future (and probably never again), I think this is the best business for me to be in. Basically, I'm going to take the money and run. I ultimately want to invest the cash in small apartment buildings where I can realize a steady income. I want to ultimately buy several of these in many different parts of the country, with the idea that when things get bad they don't always get uniformly bad (for instance, Portland is really suffering right now, but there are parts of the country that are doing better). To buy commercial property you need 20% down, which I hope will shelter me from significant downturns in the housing market. I also want to own a home outright (so I don't have to worry about payments), and of course clear my debt. I don't know if your predictions will come true, but I have been through enough already to know that I need to plan for disaster, just in case.

"Short the bank" refers to a technique real estate investors use to get a better price for a property. In a foreclosure auction, liens (i.e. mortgages) are paid in the order in which they are applied. So, for instance, the money paid for a house at auction is given to the holder of the first lien. Whatever is left over is paid to the second lien holder; whatever is left over from that is paid to the third lien holder, etc. (if property taxes are owed, they are always paid first). Because a property never sells at auction for its full value, and the lien holders know this, they are usually willing to deal. You approach the bank and offer them less money for their lien than the amount of the mortgage. The offer you give them depends on what position they hold.

Real world example: Lets say you have a house worth about $150,000 that is mortgaged at 100% (I see this all the time). Suppose they have a 100k first mortgage and a 50k second. I am virtually guaranteed to be able to "short" the second by a substantial amount. That second lien holder will usually take about 5k for that 50k mortgage. Therefore, I have just created 45k in equity. And, because the first and second lien holders are almost never the same bank, I can sometimes even short the first, say take them down to 80k-90k (they are in a stronger position, so you can't discount as much). If the property is in bad shape, all the better, because they know they will not get much for it at auction. So, when I approach the bank, I show them pictures of all the bad things about the house. Banks make their money by making loans, not by holding on to distressed houses.

This technique was actually invented by Fannie Mae, and is a common practice in the home loan industry. However, in most cases only a new buyer can short the bank. The homeowner cannot. There are exceptions to some of this. For instance, VA loans usually cannot be shorted more than 5% of value. And, some lenders won't deal at all (but most will).

When I approach a client, I need their full cooperation to do this, because the banks want financial info from the client to ensure the client does not have the means to pay their mortgage. Usually this is not a problem, because the client is against a wall and has no alternatives. I tell them that I will buy their house for the cost of all liens held against the property, but that I have to specify a dollar amount on the purchase and sale contract that I show the bank. So, I write down a very low number for the purchase price. If I am not embarrassed by the offer, it is too high. For the above house, I would offer something like $72,500. Of course the bank won't take that, but it starts the negotiating process.

Notice that when you are dealing in real estate you are dealing with expensive things (houses), so even a measly 5% can translate into thousands of dollars. I am expecting my deals to average about $15,000 apiece (though I suspect this is a very conservative estimate; probably by half). How many deals do I have to do in a year, at 15k apiece, to make a good living? Keep in mind that I have been doing this for six weeks, and I currently have four people under contract and potentially four more ready to sign. I know I am going to make money at this, but as yet nothing has come out the other end of the pipeline.

If I find a deal that I do not want to do for whatever reason, I can "wholesale" the property. Basically, I can go to my real estate club and sell my contract for 1-3k to another investor. Or, in "lease-backs" (where I buy the house and lease it back to the current occupants), I can refer that property to CCN for a flat $1800 referral fee. How many of those do I have to do to make a good living? Also, keep in mind that after I get a signed contract I immediately begin marketing the property. Since I am getting it at a significant discount, I can afford to price it cheap to sell it fast. In most cases, I never have to actually buy the house. The out-of-pocket on these deals is the $10 I give the homeowner when I sign the contract (money has to change hands for the contract to be legal) plus the marketing cost. Currently, I spend about $500/month on direct mail, plus miscellaneous office expenses.

When I sell a house, I can also be creative. I can do a lease-to-own, where the buyer gives me 3% down as a security deposit, and pays rent with the understanding that they will buy the house from me at a set price in 1-3 years. Because that 3% down is a deposit, it is not taxable income (until it is actually applied to the purchase). Also, because the tenant is intending to buy the property, and they put a substantial amount down as a deposit, they are virtually guaranteed to be good tenants.

Posted by manystrom at January 16, 2004 11:00 PM

Excellent illustration of how distortions in a debt oriented system, deemed so vital for national economic recovery, have allowed even more distortions. If one reads most of W. Buffett's annual reports, he keys into the concept most notably termed "malinvestment". Aside from its breathtaking lack of liquidity, accurate valuation, or even efficiency of pricing & transaction quality....this is what residential RE has become on the US 'body economic'...a colossal malinvestment. Sorry folks, it's just another consumer durable, and when we decide to make this jobs program masquerading as an "investment", more transparent, quick, & efficient....look out below. T I M B E R!

Posted by: Billy Dale Moffitt at January 20, 2004 06:33 AM

Am interested in buying or taking over a property before foreclosure. How do I get the information of a lingering foreclosure.

Posted by: R. Henscheid at January 26, 2004 12:34 AM

i can no longer afford my home i need an invester to buy it can you help it's a one br condo located in carnasie good condition garage and car port going for $180,000. if you interest or any other invester i look forward on an e.mail

Posted by: san at January 28, 2004 11:14 AM

title is true. after 9+ years in tech, I am in realestate financing via multiple aspects (refi, debt consolidation, purchase, investment, etc.), and making beaucoup bucks....

Posted by: at February 2, 2004 10:48 AM

There are some signs of rising interest rates and the end of the housing price boom in 2005.

Posted by: Centre for Urban and Community Studies at February 7, 2004 04:13 AM
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