Investing in PRE-Foreclosures using real estate options

[Southern_Lenders]

We've all heard the tragic stories over the years of people losing their homes due to many reasons, some of which are simply out of the owners control.

This Summer I will be buying a house in a very nice multi-million dollar, gated community for 180. If this was a flip, I could easly make 30k on the turn. The home is a foreclosure and only needs a few basic repairs ( carpets, windows, paint). As I was looking through this beautiful home, I couldn't help but think of the people who once lived here, and the stress, sadness, anger, and shame they must of felt.

Investing in foreclosures is nothing new, but what about investing in pre-foreclosures, just days before hitting the auction block?

Here is what I would do:
1. Talk to banks about seriously distressed home owners in danger of foreclosure
2. Contact the home owners, and tell them that I'd like to put their home under option. This is so I can lock in the price I want, and make the seller obligated to sell to me, along with other terms.
3. The seller would sell at 35% under its current market value of comparable homes on that street/ neighborhood. The seller might lose money on the deal, but it will save their credit, and their self-worth to some degree. This would also help me with a fast re-sale.
4. I buy the home for cash, and make all the back-payments + taxes, do repairs if needed and throw the house back on the market.
5. Having saved the previous owners credit, they now might live in a smaller home, or found a nice apartment, but they have been saved ,and I make my $ . A business where everyone wins.

Oh, and my Uncle is a litigation attorney and an experienced RE investor himself. A key team member to have. Ok, so now I need a million dollars. LOL.

[DerekS]

Short sales have come into favor a lot in the recent 2 years, which are basically pre-foreclosures.

The problem with trying to buy a house from a homeowner who is underwater for 35% under market is that in most cases, the deal simply can't come together. It's not like the person has 35% equity but can't make the payments, in most cases, they've got less than 10% (or 5%) equity.

Case in point: Overeager homeowner bought House A in 2007 for $450k. Because of the down market, that house is now worth $400k. Traditionally, a bank would have required a 20% downpayment (80/20LTV) to secure the investment. However, as of late, thanks in part to Barney "Lend to Everyone" Frank and Chris "It has a pulse? Fund it!" Dodd, people could get 100% financing. In some cases, they could get 104% of the house's value.

So now, overeager homeowner, who barely had a downpayment, and made interest only payments, now has a loan balance of $420k on a house that would now go for $400k. Selling at market value isn't even an option (because the loan balance exceeds the market value), let alone selling below market so an investor can make money on the back end.

You're right in the sense that you need cash to make deals like this work. Thanks to short sales, many banks are allowing properties to be sold "short" of their loan balances. It is a cumbersome, slow moving process however, and having cash can only get you so far. Because people so overpaid for houses and put so little money down, there is often a wide margin between the profit generating numbers an investor wants to see, and loan balance that the homeowner/lender must fulfill.

PS- In most cases with short-sales and serious mortgage delinquency, people's credit isn't "saved." It's severely dinged at best. There really is no rosy outlook on the real estate situation of the last couple of years. Hopefully as things mend, some of the ugliness will go away. Being that the current administration won't face the realities of the impetus for the housing collapse, that ugliness is likely to hang around for a bit.

[SCJeff]

There is also something you can do called a "deed transfer". You basically find those home owners in the pre-foreclosure stage and you offer them a way out. You take over all payments and then own the house. This way there is hardly any need for tens of thousands of dollars of upfront costs of purchasing the home, but you still own it and can do what you will with it, whether it be flip it (most ideal), rent it out (maybe to the same family from the transfer). Just an idea, I have an aunt and uncle who does this and it has been quite profitable for him.

[armenh]

There is also something you can do called a "deed transfer". You basically find those home owners in the pre-foreclosure stage and you offer them a way out. You take over all payments and then own the house. This way there is hardly any need for tens of thousands of dollars of upfront costs of purchasing the home, but you still own it and can do what you will with it, whether it be flip it (most ideal), rent it out (maybe to the same family from the transfer). Just an idea, I have an aunt and uncle who does this and it has been quite profitable for him.

Remember you can not do this in every state. For example you can do a deed transfer here in California, but it depends on the state.

To the OP:

There are 2 avenues you can take with this, you can do an Equity Transfer, which you seem to be more interested in or a Short Sale. What you do depends on if the home has positive or negative equity. In the case of positive equity it is obviously best to target the homes with the most equity which will leave you with a greater profit. I find it hard for an individual to decide to do an Equity Sale, because of the fact that they will need to split the money with you. There are many variables to this including if the owner is working on a Loan Modification, or if they really think they are not in a severe situation or it is not as urgent as it seems...It is not as easy as you make it seem.

[Southern_Lenders]

SCjeff, Ya i've herd about those kinds of deals. Our real estate club has a speaker by the name of "William Tingle" owner of Sub2deals.com - William Tingle teaches investors about Subject to and Lease Option Real Estate Investing . Basically, the owners gives you the house by transfering the title to you, and you pay the owner a few thousand dollars...this is usually because the owner needs to get out of the house due to other problems like job loss, job transfer, divorce, death in the family, and so on.... I bought his course, but have not read all of it..it seems good so far. It shouldnt matter what state this is in though as there is a way to transfer title in one way or the other.

[ernest1918]

There is also something you can do called a "deed transfer". You basically find those home owners in the pre-foreclosure stage and you offer them a way out. You take over all payments and then own the house. This way there is hardly any need for tens of thousands of dollars of upfront costs of purchasing the home, but you still own it and can do what you will with it, whether it be flip it (most ideal), rent it out (maybe to the same family from the transfer). Just an idea, I have an aunt and uncle who does this and it has been quite profitable for him.

wow I did not know this could be done.....maybe i should do this next year

[Southern_Lenders]

By the end of this month we should be closing on the house I mentioned above. We're paying cash for about 90+% of the price and the mortgage will then be put in my name. I want this to be a stepping stone for a growing real estate portfolio but I'm not sure where to begin. This is going to be several years from now of course, but how do I add more properties if I'm not making 100 grand a year? How do people do it where they buy a new house each year for 10yrs? I read about this in some RE book, but it seems very very unlikely for the average person to do unless they have a multi-million dollar net worth. I also hear that being a Landlord is a real pain in the ass, and probably more trouble than its worth, but I'm not sure if flipping houses will EVER be the same as it was, if at all. What do I do? Here are some other RE investing techniques that I herd about...

1) RE wholesaling -- look for houses with the roof caving in, put them under contract, and flip the contract to a buyer/ investor, and make a quick dollar. The cons of this are: A) I dont want to drive around in the bad parts of town, and B) You need to know, and be able to estimate how much repairs will cost, so you can estimate your profit...I dont know the first thing about fixing up houses...

2) Flipping -- Whats there to say?..It's dead, and probably will be for a very long time.

3) Real Estate options -- Ive been reading the book "real estate options by Lucier" These seem attractive but rather complex at the same time, and probably beyond the scope of the new investor

4) Deed-transfers -- I had the pleasure of meeting a man by the name of William Tingle, an authorty on RE investing that he calls "Subject to deals". I bought his book, but I'm scared that if the bank finds out that I had the deed transfered, that I could get hit with a DOS (due on sale) notice, and be totally f---ed!. Also this tends to fall under landlording from what Ive read.

ideas...

[akula]

What do I do?

okey dokey...let me tell you what the best way to make money in real estate is...one where you have highest upside, lowest downside and the least headaches. you can do it in 10 minutes, from your computer without leaving the house.

1. as a property investor, you have a choice. you have to form a view about the future direction of the real estate market.
right now you are thinking that RE prices are going to go up (ie bull market) which is why you are buying that foreclosed property, with the presumed expectation of selling it for a profit in the future (ie you are long on direct property)

2. this is not the best method to make money from a RE in a bull market. the reason is that you are undiversified, and your gearing level is quite low. this is bad for two reasons: if property values in your local area decline, you are gonna suffer a greater loss than if your investment was diversified across a number of geographically diverse investment properties, some of which could have gone up. likewise, your current loan to value ratio is quite low. this means that your investment returns will be lower than what they could be if your level of gearing was higher.

3. the better solution for profiting from RE bull market is by either buying call options or selling put options on the S&P/Case-Shiller Home Price Index. You can do this via the CME, which trades futures based on the index.

Example:
a) You think that property prices are going up and you want to make a profit.
b) You contact a CME housing futures broker and tell him that you want to buy a call option on a futures contract tracking the CUS index for $600.
c) Right now, the index is at 159.38 points. You make that your strike price. You wanna make money quickly, so you make the maturity for 12 months. The options gives you right to buy one CUS futures contract for 159.38 points. This means that for $600 you've exposed your self to an investment worth $39,845 (the price of a 159.38 futures contract). In a normal RE transaction, where you get 90% of the purchase price as a mortgage, for 1 dollar you put in, you get an additional leverage of 9 dollars (i.e. a 90% loan). With a call option on a futures contract, you get $66, plus your downside is limited to your initial $600 investment, unlike direct RE where you will lose $9 for every dollar you invested if the property market goes down.
d) Overall, your investment means that if property prices across 10 of america's largest cities go up during the next year, you'll make a profit. if they don't, you'll just let the option lapse, and lose your $600.
e) A year later, it turns out you were right. Property prices in america went up by 5%, and the index is now at 167.35 points. That means you make a profit of 7.97 points, or $1992.5. Your return on investment is 232% [(1992.5-600)/600]. If the market went down by 5%, your loss would be $600.
f) Compare this to a normal RE transaction; you have $20,000 dollars. You borrow another $180,000 and buy a property for $200,000. A year later, the property has gone up 5% to $210,000. You sell it for an 10k profit, your ROI is 50% [10/20]. Likewise, if the market had declined by 5%, your loss would have been $10k.

4. As you can see, exchange traded property derivatives are a better way to profit from a property bull market than by taking a mortgage and buying a house. With derivatives, you don't need $20,000 in savings to get into the market (i.e. $20k vs $600), your upside in terms of ROI is much higher (i.e. 50% vs 232%) and your risk is much lower ($10k vs $600). The other thing, of course, is that transaction costs are much lower. To buy a call option you'll pay the broker a very small fee. A couple of bucks. To sell a property, you'll pay the broker thousands of dollars which will erode a large part of your profits.

Anyways, that's some ideas for you based on a simple hypothetical. Imagine how many call options you can buy for $20,000 instead of buying one house worth $200k. At $600 a contract, you can get 33 contracts. At 159.38 points, that's $1,314,885 worth of real estate. At a 7.97 point upswing, you'd get a profit of $45,952.5 instead of $10,000.

Try to read over what I just wrote and get your mind around it. It's a better way to make money from real estate. It's worth learning.

[Southern_Lenders]

You didnt mention the part where I need at least 5,000 in some cases to even open a futures account, not to mention to monthly platform fees, and CME exchange fees. In a year that would easly cost 600 or more. I'd rather just buy DRN options. I dont need a futures account for that, and can do it on my thinkorswim platform which I use for stocks.

[akula]

You didnt mention the part where I need at least 5,000 in some cases to even open a futures account, not to mention to monthly platform fees, and CME exchange fees. In a year that would easly cost 600 or more. I'd rather just buy DRN options. I dont need a futures account for that, and can do it on my thinkorswim platform which I use for stocks.

That's right, great point.
There are a number of issues associated with CME options, including liquidity.
That said, I guess the point is that exposure via derivatives is a noteworthy alternative to longing direct property
Thanks for the heads up about Direxion's product
I wasn't aware of it. It looks interesting.

[DerekS]

I know little of real-estate options and deed-transfers, so I can't really offer any insight on those subjects.

I do have knowledge of the first two methods you've mentioned, so I can comment on them.

For starters, if you want to make money in real estate, be prepared to go wherever you have to go to find the deals- even if it's a rough area. The problem with wholesaling goes far beyond just finding the house and estimating repair costs to arrive at an "ARV" (after repair value.) Wholesalers love to drop terms like ARV, when in reality, a house is only worth what the market will bear. The biggest issue is hustling the properties once you've got them under contract. If you ratify a contract for $15,000 and have a 30-day escrow, you need to find the person to which you're going to assign the contract prior to closing. That means finding someone who will pay your $5k or $10k premium in the allotted time frame, lest you be forced to perform on the contract.

I worked with a group of wholesalers who had the ingenious idea to ratify contracts and assign these contracts to students of their "investment school." The wholesalers charged a flat fee (about $10k) to find the property, handle the paperwork, secure contractors/plans, facilitate financing/titlework, and then get the ball rolling on everything. These were PA guys coming down to Baltimore to capitalize on our vast inventory of vacant/decrepit properties. The idea was amazing- the issue was the scalability of the task, and their insatiable appetite for more houses.

For the average rip and run investor, wholesaling is a tough game.

Flipping certainly isn't dead- in fact it happens every day. The issue is that the easy, "Flip This House" mentality of flipping is dead and buried. It's back to a margins business, where economies of scale, a tight network of contractors, and wads of cash get it done. If you have the contacts and can move fast, flipping is still viable. It's not the kind of thing I'd advise for a first timer- at least not in this market.

I'm of the opinion that the best strategy is to buy properties rough, fix them up right (but as cheaply as possible) and rent them/manage them yourself. This isn't a get rich quick scheme, but one that takes time and money. The benefits include the equity bump that you get during rehab, the amortization of your mortgages by tenant paid rent (and in some cases cash flow), the advantages of tax savings through depreciation, etc. It's an excellent side business if you've got the time and a strong primary source of income. It can also be done full time, though you have to scale up (because volume = more money) and you have to be willing to work in rougher areas where your margins are greater (read cashflow.)

Just my .02 on the subject.