Cashing Out: Selling the Property

Real estate investors who flip houses typically don’t like to hold onto properties for very long. They buy properties, renovate them, and put them right back on the market, or they sell to another investor who renovates and sells the property or keeps it as a rental. Either way, the house flipper rids herself of the property, cashes out her profit, and has more capital to invest in the next property.

The following sections explain two ways you can cash out by selling the property: putting the property back on the market or selling to another investor.

Buy-fix-sell: Listing the property for sale

Taking the buy-fix-sell approach consists of purchasing a property, renovating it, and holding it just long enough to make at least a 20 percent profit above the costs to buy, fix, hold, and sell the property. For more about marketing and selling the property for top dollar, see Chapter 21.

If you’re going to list the property for sale, I strongly encourage you to list it with one of the top real estate agents in your area, preferably a member of the National Association of Realtors.

SELL IT YOURSELF?

Homeowners often try to sell their homes on their own to avoid paying an agent commission, but it rarely saves them enough to justify the hassle. What usually happens is that when a buyer shows up to place an offer on the house, the buyer knows that the seller is saving about 6 percent by listing the home himself. So, the buyer automatically deducts 6 percent from his offer. If the seller accepts that offer, he essentially gives the buyer as much money as he would have paid an agent, and the seller had to do all the work without the additional benefits of having professional assistance and advice. According to the National Association of Realtors, the typical FSBO home sells for $174,900, compared to $215,000 for agent-assisted home sales!

Most people choose to sell sans agent because they’ve had a bad experience with a real estate agent or felt that the agent didn’t do enough to justify his 6 percent commission. This is a very valid point, but it simply means that the seller didn’t pick the right agent.

When selling a house, don’t just look at the cost of hiring an agent. Look at the cost of not hiring an agent and consider the benefits that an agent brings to the table … particularly the closing table.

Buy-sell: Selling to another investor

If you enjoy the hunt but nothing else about flipping houses appeals to you, you can still make money in the house flipping business. The buy-sell strategy has two approaches:

Find the property, actually purchase it, and then turn around and sell it to an investor. The drawback to this approach is that you have to pay at least a portion of the closing costs both when you buy and sell the property. In addition, if the investor you plan to sell the property to backs out, you’re stuck with it — you have to find another investor or fix and sell the property yourself. In either case, you have holding costs to consider.
Flip contracts. To flip a contract, you find a property with profit potential, negotiate the sale price and terms with the seller, and have the seller sign an agreement (a contract) to sell the property to you or to your assigns — anyone you want the property sold to. You then find a willing buyer and exchange the contract for a finder’s fee. People who flip contracts are often referred to as “bird dogs” because they find property for the hunters (the investors who ultimately purchase the property).

When you sign the contract, write “and/or assigns” after your name. For example, if your name is Joan Johnson, you’d sign “Joan Johnson and/or assigns.” This gives anyone you decide you want the property sold to the right to buy it.

Exploring Cash-Flow Possibilities

Buying a property, fixing it up (or not), and then placing it back on the market is the most common way to profit from your real estate investment, but it’s not the only way. You can instantly profit from your property by refinancing your loan to pull the equity out of it, or you can sell or lease the property back to the previous owners, or even sell the senior mortgage you bought at a foreclosure auction to another lienholder.

In the following sections, I reveal several strategies to pull the equity out of your property, along with other novel ways to profit from your real estate investment.

Refinancing to cash out the equity

Homeowners commonly refinance their homes to cash out equity. To refinance, you take out a new mortgage for more than you currently owe on the property and pay off the old mortgage. Assuming you purchased the property significantly below market value and your credit is in pretty good shape, you may be able to turn right around after the purchase and refinance to cash out that equity.

I say “may” because some lenders won’t refinance a mortgage until after you’ve owned a home for six months and a day, a year and a day, or even two years and a day. This is because a house is worth only what you actually paid for it or what it appraises for, whichever is lower. A home equity loan to cover repairs and renovations, however, is often easier to obtain.

You don’t have to cash out all the equity in a property. You can cash out a portion of it to cover the cost of repairs and renovations and cash out the rest of the equity when you sell the property.

When refinancing to cash out the equity in a home, be as careful shopping for mortgages as you were when you borrowed the money to purchase the property. Avoid high-cost loans and any loans that have prepayment penalties, especially if you’re planning to place the house back on the market soon. See Chapter 5 for guidance on shopping for low-cost loans.

Reselling a foreclosure property to the previous owners … or their family

After you officially own a foreclosure property, it’s yours to sell, and the previous homeowners have to move out … if they didn’t move out already. Sometimes after foreclosure, however, the homeowners break the news to other family members who are in a position to bail them out by loaning or gifting them money or buying the house and letting them live in it. In such cases, you may be able to sell the property back to the original owners or their family.

In the following sections, I reveal some do’s and don’ts that apply to these situations, along with some of the positive aspects of selling a foreclosure back to the previous owners.

Reselling to the previous owners

The previous owners are likely to do whatever it takes to remain in their home. If their financial situation has improved since the foreclosure or friends and family members have offered them a good chunk of cash, they may now be in a position to buy back the property. The opportunity, however, is not always available or attractive for you as an investor. Keep the following caveats in mind:

If the property has any liens against it that were wiped off the books by the foreclosure, those liens reattach themselves to the property if the previous homeowners buy it back. This can often drive the homeowners back into foreclosure, which isn’t something you or they really want.

If selling the home back to the previous homeowners is not an option because of the possibility of having other liens reattach to the property, you may be able to sell to a family member who agrees to let the homeowners remain living in the house.
You can’t strip the homeowners of all the equity they have built up in the property. Say, for example, you purchase a property worth $300,000 for $175,000. If you sell it back to the previous homeowners for $300,000, you’ve taken all the equity out of the house. You have two options here — sell the house to someone else for $300,000 or sell it back to the previous owners at a discount of, say, $250,000. Whatever you do, you don’t want to be an equity stripper. See the nearby sidebar “Equity stripping — don’t do it!” for details.

Why would you agree to accept less than full market value for the house? Whenever I can earn a quick, tidy profit on a house and do the right thing for the homeowners, I jump at the chance. Usually, I develop a close relationship with the homeowners during the foreclosure process, and I don’t want to destroy their trust by taking them to the cleaners. In addition, I don’t want to ruin my reputation in the community — I’m in it for the long term. If I treat the homeowners fairly, they’re likely to recommend me to others they know who find themselves in similar situations. If you can earn a fair profit while helping your fellow human beings, I strongly encourage you to do so. Otherwise, simply have them move out and sell to someone who can afford to pay the full price.

Another reason you may want to consider selling the property back to the previous owners comes down to simple economics. Say you’re facing the likelihood of holding the property for six months. At an estimated $100 per day in holding costs, you’re looking at a total bill of $18,000. On top of that, figure closing costs of 7 percent on $200,000 (a total of $14,000), and your bill is now up to $32,000. Now figure in your time and effort plus the costs of repairs and renovations. Sure, the homeowners get a break, but you also save yourself some money.

If you took out a traditional loan to purchase the property, your mortgage probably has a due-on-sale clause, which means you can’t sell the property back to the previous homeowners without the lender’s approval.

EQUITY STRIPPING — DON’T DO IT!

Homeowners who are facing foreclosure are often unaware of their options and of just how much equity they have built up in their property. They may have been making their monthly mortgage payments for 10 or 15 years while housing values in their neighborhood have been rising at a rate of 5 percent to 10 percent annually. They’re completely unaware that the house they bought for $100,000 ten years ago is now worth $150,000, and they’ve paid off about $14,000 of the principal, so they now have $64,000 worth of equity. All they see are the monthly bills coming in that they can’t pay.

Homeowners’ ignorance of the amount of equity they have built up in their home can make them vulnerable to predatory lenders and other crooks who want to cash out that equity for themselves. These equity strippers employ a variety of schemes to bleed this money out of the homeowners, including schemes such as these:

Mortgage brokers attempt to convince the homeowners to refinance their way out of a financial setback by taking out a loan with higher monthly mortgage payments than the homeowners can afford. The mortgage broker rakes in the payments until the homeowner runs out of money, and then the lender forecloses on the property.
Crooked investors convince homeowners who have a substantial amount of equity built up in their property to sell the property to them for significantly less than the property is worth. The “investor” may promise the homeowners that they can continue living in the home indefinitely, and then, as soon as the homeowners sign the papers, the con artist evicts them.
Con artists offer to save the homeowners from foreclosure. All the homeowners have to do is sign a quit-claim deed over to the con artist, and the con artist will take care of everything. What the con artist does take care of is re-conveying the property’s title to his own name, stealing the house right out from under them.
A con artist may offer to buy the home from the homeowners and lease it back to them. The con artist collects the monthly rent and never pays off the underlying mortgage, so the homeowners lose their rent money and lose the house in foreclosure.

If you buy a property directly from a homeowner facing foreclosure or at auction for a bargain-basement price and then sell the property back to the homeowner at full market value, you’re practicing yet another form of equity stripping, which the courts frown upon. Regardless of whether you get caught, it’s still wrong, and if you do get caught, you can look forward to a hefty fine and perhaps some jail time or at least undoing the transaction and returning the homeowners to the position they were in before they met you.

Financing the buyback through insurance-policy proceeds and other means

Homeowners are often unaware of assets and other collateral they may have to secure financing, or they may come into some quick money after the foreclosure is a done deal. In such cases, you may be able to help the homeowners obtain the funds needed to buy back the property simply by making them aware of their options. Following are two options that may be available:

Life insurance policies: If the home ended up in foreclosure because one of the homeowners passed away and the homeowner had a life-insurance policy, cashing out that policy may provide sufficient funds for the surviving homeowner to repurchase the property. In some cases, a serious illness drives a couple into foreclosure, and then the spouse who was seriously ill passes away, leaving behind a life-insurance policy that can cover the purchase price.
Retirement savings: You can borrow against some retirement plans for the purchase of a house. If the homeowners have sufficient retirement savings, they may be able to borrow against it to buy the house back from you.

Leasing the property to the previous owners

Families are often reluctant to move out of their home because they have kids in school. They really need to sell the house and find more affordable accommodations, but they don’t want to force their kids to change schools. In such cases, you may want to consider purchasing the property and then leasing it back to the family until the kids move out or the family has more time to plan.

Don’t jump into a lease agreement with the previous homeowners before you’ve performed some serious number crunching. If the homeowners couldn’t afford the monthly house payments, don’t sign them up for a lease that has them paying monthly rent they can’t afford. You’ll simply end up with deadbeat renters and set the family up for another failure. Before offering them the option to rent, make sure that they’ve resolved the issues that sent them into foreclosure and that they can afford the rent.

If you decide to rent out the property to the previous homeowners, consult your real estate attorney and have her draw up a lease agreement. Keep in mind that not everyone is cut out to be a landlord.

Offering a lease-option agreement

When a buyer really wants to purchase a property but isn’t currently in the financial position to do so (whether they’re the previous owners or not), you may consider offering them a lease-option agreement — a rent-to-own arrangement. Perhaps the buyers need more time to secure financing or fix something on their credit report, or they’re waiting for an insurance check or another influx of cash. With a lease option, the buyers agree to rent the property from you for a fixed period with the option to purchase the property at the end of that period.

Lease options are not always viable, but if the homeowners can come up with a down payment and provide some assurance that they will be receiving money or be able to qualify for financing in the specified time, a lease option enables you to establish cash flow while you’re waiting to sell the property. I usually structure lease-option deals as follows:

Down payment: Normally I require 5 percent to 10 percent down. You may want more money down when dealing with buyers who’ve just been through foreclosure. You credit them for the down payment by taking it off the purchase price, but a substantial down payment assures you that they’re serious. If they can’t afford it, they can’t afford it — let them move on.
Rent: I usually specify that rent is due on the first of the month and set the rent at about 1 percent of the purchase price or as close to that amount as is affordable. You don’t want to be too flexible, but you don’t want to break the bank either. I offer a bonus for paying on time and add the monthly payments to the down payment.
Terms and conditions: The agreement should spell out the lease term and conditions. Your lease-option agreement should contain a forfeiture clause stating that non-payment results in the forfeiture of the option and the down payment. The agreement should also contain a statement that the option is exercisable at any time, with no prepayment penalty or anything like that. I tell the renters that if they win the lottery and want to pay it off tomorrow, that’s fine by me. I want them to succeed, and I want to realize my profit — the faster the better.

Make sure the renters understand that they are renting with an option. If they don’t exercise their option during the option period, they may forfeit it. If they don’t pay rent, they may forfeit it. Make the terms clear. Follow up with them throughout the lease-option period, ask how their mortgage hunt is coming along, and refer them to mortgage lenders you may know.

During the paper-signing stage, I get permission to make audio recordings of each conversation. I tell my client that this is a protection for all of us to make sure that we live up to our parts of the agreement. I make sure that we’re thorough, that we allow them to ask questions, and that we encourage them to seek legal counsel.

Assigning your position to a junior lienholder

Say you buy the first mortgage at a foreclosure auction (see Chapter 8 for more about foreclosures). Do you have to take possession of the property to make a buck? Nope. You can sell your position to a junior lienholder and avoid the ugliness of eviction and the hassles of repairing and renovating the property. Here’s how it works, assuming you’re working in an area that has a redemption period:

You buy the first mortgage, either at auction or by negotiating a short sale with the lender, and you pay any back taxes due.

You now have controlling interest in the property.
You wait out the redemption period.

If the property has other liens against it, another investor may buy one of the junior liens. If another investor buys a junior lien on the property, the clock on that redemption period just begins to start ticking, while you’re already partially through the redemption period on your investment.
You approach the holder of the junior lien and say something like, “Look, if you buy my interest, I’ll sign over my position to you.”

Make your offer worth it for the junior lienholder; otherwise, she may be better off redeeming your lien (to gain the controlling interest in the property) and waiting a little longer. If your offer makes sense and the junior lienholder knows what she’s doing, she’ll find the offer attractive because she gains not only your first mortgage but also your position in the redemption period rather than having the clock reset on the redemption period.

LEVERAGING YOUR POSITION

Knowing the lienholder positions, as I discuss in Chapter 8, can often open your eyes to win-win situations with other parties who have a financial interest in the property.

I purchased a first mortgage on a property at auction. The house had a second mortgage on it — a lien held by the local police department and our county prosecutor. The owner had pled guilty to drug dealing and had to pay a fine of about $50,000, which was taken as a lien against the house. We were about a week shy of the expiration of the redemption period, and the county was going to redeem us, meaning we stood to get our money back, and that was about all.

I knew from experience that the county didn’t want to pay me off and then take possession of the property and have to sell it, so I called the prosecutor in charge of drug seizures in Macomb County and explained the situation to her. I told her that if she would agree not to redeem our first mortgage, we would split our profits with the county 50/50. It took me less than an hour to work out an agreement. She came back with a counteroffer. She wanted a guaranteed minimum of $20,000, which was a smart move on her part. I agreed.

We took possession of the property and sold it for a $37,000 profit. The county received the first $20,000, and we received $17,000. We sold the house pretty quickly and got what we wanted out of it, and the county was able to acquire $20,000 without the hassle of dealing with the property. Had we not struck a deal, we would have walked away with nothing.

The take-home message here is that you have to remain constantly vigilant throughout the foreclosure process and be prepared to deal with the other lienholders. Remain flexible and constantly on the lookout for win-win opportunities … otherwise, you may just find yourself the big loser.

Considering Your Options: Cash or Cash Flow?

Setting a Goal: Cash or Cash Flow