BiggerPockets


How To Create Big Profits For You & the Seller Using Forced Equity

Posted on Monday, February 04, 2013

It’s no secret…the better condition and more modern the home, the easier it is to sell & the more money the Seller is likely to get for the home right?
 
But what if that home is badly in need of repairs or looks like something out of That 70’s Show, complete with shag carpeting, embossed wallpaper & pea green appliances?  Not that there is anything wrong with 70’s décor but let’s face it…that doesn’t appeal to most of today’s Buyers and renovations can cost several thousands of dollars, leaving many homeowners without options.  Or is there?
 
For some of these homeowners, the cost to remodel the house is the difference between them walking away or selling it for a profit.  Let’s look at an example:
 
Scenario 1
 
Let’s say the homeowner owes $100K on the mortgage.  In “as-is” condition, the house could be worth between $105K to $110K.   That is if they could find a Buyer who’s interested in an outdated house that’s badly in need of repairs.  Even then, they would likely have to come out of pocket to cover some portion of the closing costs and Realtor commissions.
 
Scenario 2
 
That same homeowner still owes $100k on the mortgage, only this time we’ll look at the After Repair Value (ARV).  ARV is an estimate of what the house could sell for if it were fixed up and modernized with new appliances, flooring, kitchen, baths, paint, landscaping, etc.  In this case, the ARV is $200K.  Quite a difference right?  Let’s assume that it would cost $50k to completely renovate this home.  Since there isn’t much equity in the house to begin with, a bank probably isn’t going to loan on this project.  So what now?
 
This is where creativity kicks in.  What if the homeowner could find someone who’s willing to fund, renovate & sell the property for them in exchange for a share of the after sale profit?  Sounds crazy?  It’s really not.  Investors, Realtors & others are doing deals like this every day.  It’s called “forcing equity” and, if the numbers work, it can be a win-win for the homeowner & the Investors.   In Scenario 2, the house sells for $200K, less the balance owed of $100k and rehab costs of $50k, leaving a difference of $50k to cover closing costs, commissions & profit.   And based on numbers we’ve seen, the profits can be much bigger than this depending on the property, required renovations, location & market conditions, etc.
 
So, whether you’re a homeowner who’s sitting on a potential pot of gold or an Investor who’s capitalized & armed with a Team to make it happen, it’s about creativity, commitment & team work! 


Comments (2)

  1. Tiny_1399666016-avatar-ireallylikethis

    What strategies do you believe are most viable to find properties that would make good forced equity deals? This strategy seems like a good one to have in your toolbag, but I'm unsure if it can be a primary strategy. Would you agree?


  2. Tiny_1399650409-avatar-bpadgett02

    Hi John, You're correct in that this wouldn't be a primary strategy for many, however, there are companies out there that do nothing but this (i.e. http://www.renovationrealty.net/). We use this strategy when we come across a home owner who's sitting on a break even equity position or just below break even with a house in as-is condition. Depending on the neighborhood, equity position & market conditions, we may be able to come in with $50K to $75k in renovation funds and create another $100K to $150K in additional value. I've seen it even higher than that. We also educate our Realtors on this strategy. If they get a listing that falls into this category and they think they can drive up the value via forced equity, they will call us and have us look at it. It's a win-win for everyone. The home owner sells their house AND makes a profit, the Agent gets a bigger commission and we as Investors make a profit. The last thing a Realtor wants to do is lose a deal because the home owner has to come out of pocket to pay the commission or put $ into the house that they don't have. Let me know if you ever do a deal like this. We would love to hear about it! Brian


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