Having been in the real estate lending business and catering mostly to real estate investors for the last decade I have learned just how greedy people can become. Hearing the term "microwave society" back in the eighties did not prepare me to experience it so much in the new millennium. Perhaps it is a result of microwaves, cell phone, video games, on demand video and audio, down-loadable spreadsheets and online education. Perhaps it is just the manifestation of latent guttural beliefs that one is owed the world. All of this reads strangely as the introductory paragraph to an article about investing in single family homes but stay with me.
During the last few years we in the United States have seen many very dramatic swings in the value of real estate, the availability of real estate financing and the cost of financing real estate investments. Looking back into the late nineties you will see that purchasing a real estate investment grade single family residence required at least ten percent down payment, fully documentable income and assets, a strong credit history and proof to the lender that the buyer, the investor, had the ability and desire to repay. Property values were appreciating at a nominal rate and investors were happy. Cue the new millennium.
Beginning around 2002 higher loan to value (LTV) financing became more popular and the private mortgage insurance (PMI) companies started insuring investment mortgages up to ninety-five and even one-hundred percent. Times were good but the borrower still had to demonstrate an ability and willingness to repay the loan. Interest rates were around nine to ten percent on the lender paid PMI variety but all was well because property values were now appreciating at a faster rate.
Flipping properties for big profit was spreading like wildfire and being propelled by massive volumes of disinformation and even information which has landed hundreds, if not thousands, of experienced and inexperienced real estate investors, mortgage bankers, closing attorney, real estate appraisers, and real estate agents in jail or on probation. Property values during this period were highly distorted and it was all financed by greedy investors buying into the frenzy on Wall Street which made available funding to real estate investors who neither deserved nor appreciated the opportunity they were given. Now we can get back to serious investing with conscientious investors who have pride in their industry and pride in their community.
Here we earnestly begin what you really want, perhaps need, to know. Baron von Rothschild, oft quoted, at the end of the Battle of Waterloo said, "The best time to buy is when there is blood on the streets, even when it is your own." Reasonable people today all agree that the streets, indeed, are bloodied with the leftovers from this recent subprime collapse which dragged down with it the economy. Heads should roll but in the mean time you and I must continue to feed, clothe and shelter our families.
Initially let us examine two very important aspects of today's market economy regarding real estate investment for the average citizen. Most importantly there are plenty of properties available at decade low pricing. In almost every area of the nation single family properties may be purchased from banks and lenders at prices often as low as thirty percent of their value as it was two years ago. Finding these properties is very simple because they are advertised almost every where. In fact it is almost impossible not to encounter a bank owned property at this current time. So when you find one you need money. Either the money comes from yourself or someone else. That leads us to the second very important aspect.
Financing investment properties, as I bemoaned in the opening paragraphs, was too easy in the earlier part of the new millennium. In fact many of the properties that ended in foreclosure or other transfer back to the lender were originated as investment type loans during the last few years. Today it is much more difficult for even a creditworthy borrower to acquire properties using bank or other commercially available financing. Even private investors such as hard money lenders have dried up or pulled in their lending reach. But you must have funds to invest without boundaries.
Many gurus still teach the very dangerous method of acquiring real estate by a process of changing the deed to a new party or entity. Hundreds of gurus earn millions of dollars per year teaching this method that I will give you right now in a nutshell for free. Find a seller who will trust you enough to assign the control of the property to you or an organization from which you gain benefit by using a Quit Claim Deed. In most states this requires going to a real estate attorney and signing the QCD and having it recorded.
What the gurus do not want you to know and who steam when people like me tell you is that this is a violation of the Due on Sale (Due on Transfer) clause in most modern mortgage agreements. These gurus, especially the ones who have made literally millions of dollars selling DVD series, mentoring programs, seminars, workshops, and bootcamps, will argue is that the lender cannot enforce the DoS Clause if you place the property into a trust and more specifically the Illinois Type Land Trust. They are wrong and let me demonstrate.
The United States Code, Title 12, Chapter 13, § 1701j-3 it labeled "Preemption of due-on-sale prohibitions" and seals the deal that DoS is enforceable in all cases especially when it is obvious that the reason for the use of a trust is to attempt to avert the mortgage agreement. You may read the text at Cornell University's online repository at http://www4.law.cornell.edu/uscode/12/1701j-3.html
All of the above was written in order to write this: You simply need to know the truth and the truth is if you depend on the subject to (also called nothing down) method of investing in real estate you can possibly lose. The truth is the DoS is rarely enforced and if it is you simply need to be ready to pay off the existing loan in full. This means converting equity in some other holding to cash or obtaining a mortgage backed by the subject property. In short, subject to simply means "subject to the rate and terms of the existing loan(s) against the property."
This method is once again gaining in popularity due to the fact that lenders are not making loans to financially strong credit worthy buyers who would be good holders of the property. With both Government Sponsored Enterprises (GSE) Fannie Mae and Freddie Mac limiting the number of investment properties financed to four that really limits the operational horizon of today's investors. Worsening matters is the fact that some lenders incorrectly interpret the GSE guidelines to mean four properties total including the primary residence. They are absolutely incorrect in this misreading of the letters.
Acquiring subject to is really very simple. The buyer makes the offer to the current title holder to assume making payments on the existing mortgages and to keep the property in livable and good condition until the existing mortgages are satisfied at which time the QCD is nullified. An initial installment may be made to the property owner but it is not required. Generally an agreement between the buyer and the property owner is made to demonstrate with surety that the mortgages, which remain in the name of and the financial responsibility of the original mortgagor.
Using an irrevocable Illinois Type Land Trust with the new buyer as the beneficiary is more costly and a little more time consuming and according to federal lawmakers does not provide the type of protection the gurus preach. You may, however, for your own satisfaction elect to use this type of Trust to hold the property because it does afford more protection against many things that the straightforward party to party Quit Claim Deed.
Investing today with conventional financing, while more difficult than it was just a few short months ago, is still possible. As written in a previous paragraph the GSE's, Fannie Mae and Freddie Mac, both limit investors to four investment properties regardless of income, assets and credit. If four non-owner occupied and/or second homes are on the buyer's credit there is simply no need to pursue a solution through a lender which sells to either of the GSE's. As you have imagined this is most or all of the conventional lenders.
Alternative lenders who offer additional opportunities are few but they are available. My current employer is one lender which offers two more financed properties to any investor who qualifies regardless of how many homes they have on credit. Certainly there may be others so check around in your local area. My company only operates in the southeast. These lenders are portfolio lenders like regional banks or large corporations who understand the value of mid loan to value mortgage secured by real estate in their area. In most cases they assume they will end up with the property back in their control. Since they already have a sense they may be getting the property back it is simply a bonus when they do not.
Another method is to purchase using funds from a self-directed retirement account. Full cash can be used but there is also a little known but very powerful solution called a "non-recourse loan for IRA investors". This allows the investor to acquire an unlimited number of properties using down payment from the retirement account and it works with single family properties as well as multi-family properties so long as they are cash flow producing. Since these properties belong to the IRA which is managed by a custodian they do not show up on personal credit and do not hamper the GSE four limit in any way.
Finally the investor may purchase homes using a line of credit on their other holdings including their primary residence or other investment properties. While most of these equity lines are tied to prime rate and adjust with the rate it is still possible to achieve financing on investment properties at relatively low interest rates and quite often very low closing costs - sometimes even no closing costs.
Investing in small homes is very rewarding to tens of thousands of investors who do not have the desire to own large investments. In fact owning just one home for long term can be highly rewarding. As an example if one purchases a home today for one-hundred thousand dollars and that home increases in value just five percent per year by the twentieth year that home will be worth two-hundred and sixty-five thousand dollars. This doesn't even take into consideration any net profit from rental income during the same period. So if that sounds too good to be true change the appreciation rate to two percent and in twenty years that same home would be worth one-hundred and forty-eight thousand dollars plus any net profit from rental income. On average, especially in the state of Georgia, annual appreciation for the last fifty years has been at or near five percent including good times and bad times.
Equity harvesting has always been a great way to boost your income while keeping at least twenty percent in equity in your investment real estate holdings. The best part about equity harvesting, which is done by refinancing the property, is that taxes are deferred either until the property is sold or the owner dies. However, as of now the IRS 1031 exchange is still a way to continue to defer taxes so long as the new administration does not make good on their promise to punish successful investors. The subject of tax deferred like-kind exchanges is a book within itself which I do not intend to breach in this already massive article. Let us just leave it at the point that taxes have never been due on money borrowed and keep it there until some major Marxist tragedy strikes America.
I hope you have enjoyed this lengthy read which may have created more questions than answered. As a serious real estate investor you owe it to yourself to study, compare what you study from one guru to another, learn to evaluate opportunities while leaving your emotions in your heart, and take care of your credit, income and assets. There is plenty of opportunity today for incredible success in real estate while the others are standing around like deer in the headlights complaining about how bad things are.
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Ken Cook is a real estate investment trainer in the John Adam's Real Estate Investment Institute at Emory University in Atlanta, Georgia. He is also Director of Operations for Novation Mortgage, a leader in the Black Belt Real Estate Investor's Institute, an author and prolific blogger. He can be heard regularly on BlogTalkRadio and found on Twitter at @thekencook
Ken Cook is Director of Operations and a certified Fraud Detection and Deterrence Officer for Novation Mortgage in Marietta, Georgia. He is also an accomplished author and industry trainer. He may be reached at 678-946-0101 or through http://novationmortgage.com Novation Mortgage uses the DISSCO system from Interthinx on every file submitted for approval.
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