I am going to be starting my REI and am looking into using sub2 (nice homes) or LO. I would appreciate any thoughts regarding which you think would be most advantageous for a beginner.
Thank you in advance for your feedback. Happy Holidays!
Both can be effective strategies for succeeding, and both have their detractors and supporters.
In my experience, lease options are an easier starting strategy for the new investor. Low to no risk, easy to understand, and much easier to get a homeowner to agree to do the deal. . .which is everything. That said, eventually any investor needs more than one strategy to succeed. As you grow you will find yourself using multiple tools. In my opinion, start with lease options and go from there.
I think it’s good to have several options at your command. Rather than ask, “Which one to start with?” why not ask, “Which option should I use in a given situation?”
Marketing for Lease/Option and Sub2 prospects can overlap. That’s why listening to sellers and analyzing their motivation level is so important. It allows us to tailor the right solution for them.
For example, there are many sellers who wouldn’t give us the deeds to their houses, and let us take over their loans, but will gladly give up total control of their houses using a Lease/Option.
On the other hand, we’ve got sellers who are not interested whatsoever in becoming/remaining landlords via a L/O, because of negative cash flow, maintenance liabilities, perceived management incompetence, or perhaps limiting their ability to get a new mortgage elsewhere. (Of course we address these objections if we really want to do a L/O, and not a Sub2 deal).
However, these same prospects will give up their deeds, and let us take over their payments, because we’ve offered them a solution that relieves them of management, a debt burden, negative cash flow, and gives them the ability to get a loan on a new house.
Meantime, it takes the same time, money and effort to find both types of sellers that will give us their deeds vs. those that will give us lease/options. The issue is that flipping a lease/option deal doesn’t push off the same amount of cash as a Sub2 deal on the same price point of a house.
We get about 2-5% up front on a lease/option transaction, but we get 5-10% up front on a Sub2 deal.
On a $150,000 house (which is rare to find where I’m at, because the market is SO hot), we’re apt to pocket (before taxes) at least $4,500 on a lease/option flip.
However, on the same house, we can pocket at least $7,500 with one Sub2 financing flip. Same price, but bigger profits for the same time and effort. That’s $3,000 more per Sub2 deal than a L/O flip.
That may not seem like much of a difference until we consider that doing three deals in a given month would mean the difference between making $13,500, or making $22,500. That’s a $9,000 spread between the two strategies over four weeks.
Meantime, apart from the money, we listen in order to determine which strategy will work with a given prospect, and then use ‘that’ strategy.
That all said, sometimes neither Sub2, or a Lease/Option, will work, but an all cash discount ‘does’ work.
So we maintain at least three investing strategies; Sub2, L/O, and all Cash.
There’s more ways to make money than these, and different levels of leverage available, but for starters, it’s good to be armed with these two creative financing options.
Later we can use our built-up nest eggs to buy houses for cash at wholesale prices.
Great question.
Thank you very much for your insight!
Why is it that you can collect a higher amount up front for a Sub2 vs. a LO transaction?
Because in a Sub2 flip, the end/user is a buyer/owner, not an Optionee/Lessee.
In a L/O, the tenant/buyer is not an owner. He just has the right to buy the house and subsequently become the owner when he exercises his option.
BTW, in a typical L/O agreement, the tenant/buyer also cannot deduct depreciation and mortgage interest.
So, selling on a contract using Sub2 financing (as a bridge financing tool), the buyer is given the right to write off interest and depreciation deductions. So, this makes the Sub2 flip much more valuable to the end/user/buyer/owner, and thus commands a higher ‘entry fee.’
Hope that makes sense.
Thank you again for the clarification!
I have one more question I’m not understanding; how can the Sub2 end/user/buyer/owner write off interest and depreciation when the mortgage is not in his name?
When we take title, we have all the rights of ownership. When we sell on a contract, we assign all those rights to our new end/user buyer.
When we sell, we wrap the original loan together, with our equity, and create one new loan that our buyer pays.
We charge interest on that loan. We set a sale price.
The buyer is allowed to deduct that interest on his income tax statement. The buyer also depreciates the improvements on the house, based on the sales price.
There is no difference in ownership rights for our end/user buyers. They own the houses and pay interest on the loans we make to them.
Don’t confuse ‘buying’ Sub2 yourself, with selling on a contract to someone else. These are two separate transactions.
Once you’ve sold/flipped the property on a contract (Contract For Deed, etc), you no longer deduct mortgage interest, or claim tax benefits, on the property.
Those privileges are transferred to the end/user buyer, just as if the buyer had secured his own 3rd party financing, and had title to the property.
BTW, we could transfer title to the end/user buyer, but we don’t …until the buyer pays off the financing we’ve created for him.
Either way, it doesn’t change the way the end/user buyer claims income tax deductions.
Does that help?
Yes, thank you for the explanation!
My knowledge base is not at that level yet as I am just starting to learning about simply flipping contracts.
Thank you again for your time and patience explaining this topic! :beer