Buying bank-owned REO properties using the money of private investors

Buying bank-owned REO properties using the money of private investors

Buying bank-owned REO properties using the money of private investors

Many real estate buyers are aware that there are fantastic bargains in the real estate market. The sheer number of bank foreclosures led to a tidal wave of bank-owned REO properties that flooded the market with low-priced properties. Astute investors are taking advantage of this situation to scoop up houses at bargain basement prices.

If you are considering investing in bank owned properties then you will need to be a cash buyer. This means you are required to show ‘proof of funds’ which is usually a bank statement showing you have the cash available to buy the house.

If you don’t have the money available, then you will have to borrow the money from someone who does. If you have a relative or friend with access to money, they may be willing to lend you money to buy a property in exchange for you giving them a first mortgage on the property. They will effectively become the bank and you will have to make a monthly payment to them.

There are professionals in the real estate business who make these types of loans to people who are not related. These are called hard lenders. The only difference between a hard money lender and a private investor is the interest rate. Borrowing from Aunt Sally can cost you 8% interest per year. A typical hard money mortgage in today’s market would be 15% plus 3 points upfront.

 

Why would anyone borrow money at such a high interest rate? Let’s look at an example. Let’s say you could buy a bank-owned REO property for $40,000 when the house has a true market value to a cash-strapped buyer of $80,000. Paying 15% interest on a $40,000 loan equates to a monthly payment of only $500.

 

Let’s say you waited 90 days for foreclosure and then sold the property to a first-time FHA homebuyer for $79,900. Let’s say you paid a 6% commission to the broker and another 6% to pay the buyers’ closing costs. You would still make $70,000 from this transaction. After paying back the $40,000 you borrowed, you will still be left with a profit of $30,000. Even if you held the house for six months before finding a buyer, you would have only spent $500 per month in interest for 6 months. Your total interest expense would be only $3,000. This will leave you with a net profit of $27,000.

Or to put it another way, by not using any money down (borrowing all the money), you could potentially make $27,000. How easy would it be to sell a house like this to a first-time home buyer? The answer is that it would be extremely easy. Buyers put down just $3,000 (3 ½%) to buy a house with a monthly mortgage payment that is about the same as their monthly rent. You pay all their closing costs. And the government will give them an $8,000 tax credit if they buy before the end of 2009. It’s a win for everyone. The bank can quickly sell their property to a cash buyer. A cash buyer can flip the property and make a quick profit, and the FHA end buyer gets to own a home for the same monthly payment as rent.

The trick to the above deal is to find an $80,000 property that you can buy for $40,000. This is the part that requires training, knowledge and experience. Finding deals like this is an art form and the people who find these deals are known as ‘bird dogs’ or ‘property scouts’.

Many bird dogs sell their trades to cash investors for a small profit. This is known as wholesaling. For example, a wholesaler might enter into a contract to buy the above house for $40,000 and then sell it for $45,000 to another cash investor. Thus, the wholesaler does not have to borrow money from a hard money lender. The wholesaler simply finds a deal, signs a contract to buy it, and then flips the contract to an investor with money for a profit. This is known as the ‘contract award’ and the profit paid to the wholesaler is known as the ‘transfer fee’.

Banks don’t want wholesalers to flip the bank’s property contracts. For this reason, banks do not allow assignable contracts. This means that a wholesaler cannot transfer a bank-owned property to another cash investor. The reality is that there are still ways in which a property can be misappropriated. One way is to purchase the property in a land trust and then transfer the beneficial interest to the land trust. Another way is to purchase the property in the LLC and then transfer the membership interest to the LLC. The problem with these methods, however, is that the end buyer may not want to have a land trust or LLC.

 

For this reason, the best way to sell a bank owned property to another cash investor is to have what is known as a double close. This means that the wholesaler essentially buys the house from the bank and then simultaneously on the same day sells it to another cash investor. The downside is that the wholesaler will pay double closing costs.

 

If the wholesaler has a signed contract and is selling the wholesale deal to an end buyer, then if the wholesaler doesn’t have cash on hand, they may need what is known as ‘transaction finance’. Transaction financing is ideal for bank-owned properties and short sales that a wholesaler flips to an end buyer. Since banks do not allow transferable contracts, the wholesaler will need to schedule a double close with the end buyer. Double closings, also known as simultaneous closings, allow a wholesaler to schedule two consecutive closings for the same property on the same day. The wholesaler will need to have a source of funds to pay for the first transaction. This is where transactional financing (also known as same-day funds) comes in handy.

 

Our company offers transactional financing to all of our private tutoring students. However, our students must schedule both closings with our title company in order for us to offer transactional financing. We will only offer transactional financing if both closings are with our title company (Independence Title & Escrow).

 

If you want to flip a bank owned property, then you will have two contracts and two closings. The first contract is between the bank (seller) and you (buyer). The second contract is between you (seller) and your end buyer (buyer). The ultimate buyer is the person who will ultimately be the long-term owner of the property.

 

Example:

 

Bank

B – You

C – End buyer

 

Let’s say you have a contract with the bank to buy a property owned by the bank for $40,000 (first contract). This is known as an AB transaction.

You offer this property to your cash buyers and find a buyer at a price of $45,000. You sign a contract with that buyer, with you as the seller and he as the buyer (second contract). This is known as transaction BC.

The difference between the two contracts (after deducting closing costs) is your profit you’ll walk away with at closing. Since there are two contracts, there are two closures. This means you will pay double closing costs.

The transaction finance fee we charge is 2% + $495 with a minimum fee of $1,250. For example, if you were to claim $40,000, your fee would be $800+$495=$1,295. We will only provide transactional financing if you use our title company (Independence Title) for both closings.

 

To learn more about transactional financing, please visithttp://lexlevinrad.com/transaction_funding.html

 

Copyright © 2009, Lex Levinrad

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