Chapter 2: Finding Your First Property
Let’s say you’ve decided to start with single-family homes rather than apartment buildings or commercial/industrial property. How do you find someone willing to work with you? Here is a list of possibilities:
- Classified ads
- FSBO signs (For Sale By Owner)
- Driving through good areas finding run-down or vacant properties
- Looking for For-Sale signs
- Word of mouth
- Advertise that you buy houses
- Signs announcing that you buy houses
- Magnetic signs on your car that indicate you buy houses
- Business cards stating you buy houses
- Billboards that you buy houses (recall the “We Buy Ugly Houses”?)
- Out-of-town owners of local properties
- Send postcards/letters to selected neighborhoods that you buy houses
In our case, we were driving through a neighborhood in which we would like to purchase a single-family residence (number 4 above). We notice a corner house where the grass has not been mowed and there are a few pieces of furniture in the driveway. Generally, the place looks a little ‘seedy’ but it is not a junker. We have no idea whether or not it’s for sale but we can see through the windows that it is unoccupied. We note the street address and then proceed to the Tax Assessor’s Office (or County Recorder’s Office).
At the Assessor’s Office, we find that the owner’s name is Ida Mae Fuller. We then draft a personal, hand-written letter to Ms Fuller, as follows:
Dear Ms Fuller:
My name is Don. My wife’s name is Jean. We’d like to buy your house at 123 Main Street in Anytown, USA. Please call us at (123) 555-5555.
Why such a simple letter? I’ve tried formal letters and they do get results, but I’ve found that a hand written, simple letter does not frighten the recipient, as might a formal, typed letter. Furthermore, our approach is non-threatening. We’re just stating a fact: We’d like to purchase your house. We send the letter to the 123 Main Street address with a notation at the lower left hand corner of the envelope: “Please Forward.”
Two weeks later, we receive a phone call from Sally Dallas. Sally tells us she is the daughter of Ida Mae Fuller to whom we sent a letter regarding the sale of her home. Are we still interested? We tell her yes. Sally tells us that Ida Mae is age 90 and has come to live with them in another city. Ida Mae is tired of maintaining the house and is enjoying her newly found freedom in her new location 235 miles away. What would we offer?
Here is where you need to take control of the conversation. You have a general idea of the market value, but you do not want to be the first person to name a price. You tell Sally that you are not a Realtor® and that you do not want to list the house for sale. Instead, you are a real estate investor and would like to purchase the house outright. You continue with the question: “If we were to pay you all cash and could close quickly, what is the least amount you could accept?” Sally tells us her mom wants $80,000 and that she had done some fix-up in the kitchen just before she moved out. We respond: “Is $80,000 the best you can do?” Sally says she’ll have to ask her mom but her mom is not home at the moment. “Could we call back?” We agree to call back at 5 PM that afternoon.
After we hang-up, we analyze what we’ve accomplished thus far. We spotted a property that no one else even knows is for sale. We’ve determined that indeed, the property is for sale. We also note that the asking price of $80,000 is the retail price for that neighborhood. We determine that the outside of the house will require general clean-up plus some attractive landscaping plants including bright flowers. The plant materials we have in mind will cost $500 and the clean-up labor and planting of the landscape will run another $500. We had looked inside the house through the various windows and did not see any glaring problems. Perhaps another $1000 for cleaning and selective painting would make the interior very presentable.
Our objective is to purchase the house at a price that will allow us to fix the cosmetics and still sell it on the low side of the retail market for a quick sale. First impressions are extremely important so we want to spend the funds to make the house look pretty, both from the curb (curb appeal) and from within, paying particular attention to the kitchen and bathrooms. If you’re a man reading this, do yourself a favor and let your wife choose the landscaping and interior decorations. Women are the decision makers when it comes to buying a house. Let a woman create the environment that another woman will appreciate.
Reviewing the numbers, if we set our target sale price at $80,000 and we spend $2000 in fix-up costs, we still have to discount the purchase price significantly from there in order to make a reasonable profit. We do not yet know what the minimum price will be so all we can do at this point is evaluate some of our options. Some of the options we can consider include:
- We could offer $60,000 on a cash-out sale. That’s a 25% reduction from the original asking price. After fix-up, our gross profit would be $18,000 if we could resell at $80,000 to the new buyer. We would request a 60-day escrow (independent third-party processor such as an attorney) in order to give ourselves enough time to find the new buyer before the escrow was scheduled to close. Then, our new buyer would obtain new financing thus cashing out our seller and giving us our $18,000 profit. The escrow costs would be paid by our seller, Ida Mae, and by our buyer so none of the closing costs would come out of our gross profit. Escrow would simply pay us our profit out of the new financing obtained by our new buyer.
- We could offer an even higher price; say $70,000, with the proviso that the Ida Mae carries back the financing. Our argument here would be that Ida Mae would then receive higher interest than she could obtain from a bank CD at current interest rates. She would have a monthly cash flow that would undoubtedly last her for the rest of her life. We would find a buyer at the $80,000 figure that would also pay us a larger down payment than we would be paying to Ida Mae. If we structure this correctly, we not only get our buyer to cover our down payment, our buyer also covers our $2000 in fix-up costs plus perhaps another $1000 or two that we immediately put into our pocket. We can simply transfer the seller-provided financing to our buyer, or we can create a wraparound mortgage in which we earn a slightly higher interest and monthly payment than we will be paying to Ida Mae. If we can obtain 5% financing, we can charge 6% financing to our buyer. If we can get Ida Mae to agree to a $3500 down payment, we can charge a $6000 down payment from our buyer. Using 5% interest and a 30-year amortization schedule, our monthly payment would be $356.99 on the $66,500 mortgage ($70,000 purchase price minus $3500 down payment). Our buyer would pay us $443.67 per month on a $74,000 mortgage at 6% interest for 30 years. Monthly, we would make $86.68 ($443.67 minus $356.99) in addition to the $2500 lump sum up front ($6000 minus $3500). We recovered our $2000 fix-up cost and have an additional $500 in cash.
Summary of Our Offer to Ida Mae:
$70,000 Purchase Price to be paid to Ida Mae
- 2,000 Fix-up costs out of our pocket
$72,000 Our total cost
$70,000 Purchase Price
- 3,500 Our Down payment to Ida Mae
$66,500 Mortgage owed to Ida Mae at 5% interest, 30 yr amortization
$356.99 Our monthly payment to Ida Mae for Principal + Interest
Summary of Our Buyer’s Payments to Us
$80,000 Purchase Price paid to us by our buyer
- 6,000 Down payment from our buyer
$74,000 Mortgage (wraparound) owed to us by our buyer
$443.67 Monthly payment from our buyer to us (6%, 30 years)
Summary Between What Our Buyer Pays Us vs. What We Pay Ida Mae
$6000 Our buyer’s down payment to us
- 3500 The amount we pay to Ida Mae as our down payment
$2500 Gross Cash to us
- 2000 The amount we paid to fix-up the outside and inside
$ 500 Net Cash to us
$443.67 Payment we receive from our buyer, Principal + Interest
- 356.99 Payment we make to Ida Mae, Principal + Interest
$ 86.68 Net monthly we make on the difference
- We could offer Ida Mae her full price under a lease-option program. Here we would offer to lease the property from her for a year with the right to renew that lease four additional times. Then we would find a tenant/buyer who would lease from us at a higher rent than we are paying Ida Mae. Additionally, our tenant would give us an option payment larger than the payment we would make to Ida Mae. As a result, we profit from the difference in the option payment up front; from the difference in what we pay as rent versus what we collect as rent; and finally from a higher sales price than what we’d agreed to pay Ida Mae. We might offer Ida Mae $1000 for the option but charge our lease/option buyer $5000 for the option, thus making $4000 up front. We’d handle the lease payment in the same manner as we structured the wraparound mortgage in number 2 above. We’d pay $500 per month in rent but charge $700 in rent to our tenant. We’d start out at a target sales price of $90,000 at the end of one (1) year to our tenant. If the tenant elected to renew the lease/option for another year, a new option payment and a higher monthly rent and purchase price would be established. If our tenant walked away from the deal at the end of the first year, they would forfeit their option payment and we would simply find another tenant/buyer. Recall that we reserved the right to renew our lease arrangement with Ida Mae for an additional four (4) times after the first 1-year period, so we really have a five (5) year lease/option working for us.
Summary of Lease/Option Program
$90,000 Sale Price to new tenant/buyer
- 80,000 Our Purchase Price from Ida Mae
$10,000 Our Profit on the difference
$5000 The non-refundable Option Payment from our Buyer
- 1000 The non-refundable Option Payment to Ida Mae
$4000 Our Profit on the difference
$700 The rent we charge to our tenant/buyer
- 500 The rent we pay to Ida Mae
$200 Our monthly profit on the difference
Of course all of this is speculation since we don’t know as yet what our potential seller will agree-to in price and terms. The advantage of pre-determining our options is that we always have a solution to our seller’s problem. Regardless of what Ida Mae tells us she wants, we have a prepared response to solve her requirements and still make a reasonable profit for our efforts.
Since we’re just getting started, perhaps you’re wondering how we can be so sure that we can find a buyer or tenant quickly enough to make all this work without our having to put-up any money. In the first example, we’re planning to sell the property outright to a new buyer at a higher price than we paid. Since we will have negotiated a below-market purchase price ourselves, we can be flexible in our sales price to our buyer. If we note resistance or reluctance at our $80,000 price tag, we can lower that price somewhat to make it more attractive to a buyer. After all, we have none of our own money invested. We requested 60 days (or 90 days, or ??) in order to make this work. If at the end of our escrow period we still have not been able to find a buyer, we can negotiate an extension or simply walk away from the deal. We would have made the offer subject to our finding a suitable buyer within that time frame. Chances are, we’ll have a buyer within a couple of weeks if not sooner.
If our negotiations follow the option outlined in number 2 above, we would immediately place a classified ad under Houses For Sale in the local paper with the headline: No Bank Needed. The last time I ran that headline, I got 30 phone calls on the first day the ad appeared in the paper, and the second person to look at the property bought it. Remember, our seller is carrying back the financing so we’re not dealing with a bank. We reserved the right to transfer the financing to a new buyer as well as allowing ourselves to create a new, wraparound mortgage. Either way, we can accept a new buyer that may not have top credit but who does have cash and can make payments. Not very many investors take advantage of these alternate financing arrangements, and they’re missing out on great deals.
With our third option, we again run a classified ad but with the headline: Rent To Own and we place that ad under Houses For Sale; NOT under houses for rent. We’re not looking for tenants. We want people who want to buy but may be having credit problems to the extent that they can’t qualify for a regular bank loan. This option also gives them the opportunity to “try-out” a home to make sure they like it before they actually buy it. If they make their rent payments on time as well as their car payments and credit card payments, by the time a year passes, they will have improved their credit rating to the point where they will qualify for a regular bank loan.
Stop and analyze what we’ve learned thus far. Our example number 1 above is the way most people go about investing in real estate, yet it is the least profitable. I’m not suggesting you avoid this approach, but consider the profit streams. In Option number 1, there is only one profit to be obtained; the difference between what we pay for the property versus what we can sell it for. In Option number 2, we can make a profit from the difference in down payments. We then make a monthly profit from the difference in mortgage payments. Finally, we make a profit from the sale price differential. We haven’t discussed this as yet, but we have a fourth profit potential: discounted paper.
While we were negotiating the terms of the seller financing, we included a clause that gave us the right of first acceptance in case Ida Mae decided to sell the mortgage to a third party to raise cash. Notes (mortgages) are frequently bought and sold. Usually they are sold at a discount to face value. In our case, our seller provided financing of a $66,500 mortgage at 5% interest for 30 years payable at $356.99 per month that includes principal and interest. We owe Ida Mae that money. If Ida Mae decides to sell our debt to another party, we have the right to purchase that mortgage at whatever bona fide price she is able to obtain from a third party. Because this is a first mortgage and because we are a good credit risk and make our payments in a timely manner, she probably won’t have to discount it more than 20% (some higher risk notes are discounted over 50%). If she decides to sell at a 20% discount, we can then step in and buy it from her for $53,200 (80% of $66,500). Our buyer will still be paying us $443.67 per month and still owe us $74,000 on the wraparound mortgage, but we just made an additional $13,300 buying back our debt from Ida Mae at a 20% discount.
In our third option, we generate a profit from the difference between the option payment we give to Ida Mae versus the option payment we receive from our tenant/buyer. If our first tenant/buyer doesn’t exercise his option to ultimately purchase the property, we find another tenant/buyer and start over with another markup between the option payment we receive and the option payment we make. Next, the rent our tenant/buyer pays us is greater than the rent we pay to Ida Mae so we have an ongoing monthly profit for as long as we are involved in this property. Finally, we again profit from the sales price to our tenant/buyer that is higher than the price we agreed to pay to Ida Mae.
In summary, we’ve come up with at least three (3) viable solutions to Ida Mae’s problem of wanting to sell her house, and every one of our solutions are profitable to all the parties involved. So when we call back at 5 PM, we know that we will have something to offer Ida Mae that will solve her problem.
Note: To be continued - stay tuned