Subject To Deal. What am I missing here?

Question

Hi All,Longtime lurker first time poster. I’m considering accepting the terms of a Subject To deal and want to know if I’m missing anything. I’ve done several deals in the past but have never done a subject to. I'd like to get everyone's thoughts on the deal but also on subject to generally and make sure I'm not missing anything. This deal was the result of heavy negotiating with the seller and the wholesalers.

Here are the basic contours of the deal. $33k entry fee for three duplexes. The breakdown is $23k in arears, $10k in assignment fees to the wholesalers who brought me the deal. I also agreed to cover closing costs meaning I'll be $40k all in. It is 6 units in total, 5 of which are rented all well below market. The rate I'm assuming is bad (9.25%). My goal would be to buy, rehab, get up to market rents, refinance at a better rate.

Three duplexes in Virginia:

Property 1 (2 units - 2 bed 1 bath each)

- Appraised Value: $245k

- Mortgage Payoff - $183k

- PITI: $1709.57

- Interest Rate: 9.25%

- Total Current Rent: $600 (one unit is vacant)

- Market Rent Based on HUD: $2986

Property 2: (2 units - 2 bed 1 bath each)

- Appraised Value: $270k

- Mortgage Payoff - $202k

- PITI: $1845.29

- Interest Rate: 9.25%

- Total Current Rent: $1450

- Market Rent Based on HUD: $2986

Property 3: (2 units - First is 3 bed 1 bath, second is2 bed 1 bath)

- Appraised Value: $263k

- Mortgage Payoff - $190k

- PITI: $1809.04

- Interest Rate: 9.25%

- Total Current Rent: $1500

- Market Rent Based on HUD: $3572

Other Factors:

Total Current PITI is $5363.90

Total Rent is $3550

Tenants are all month to month with 1 unit vacant

Equity After Deal: $197k (may be more as appraisals were done 1 year ago)

Rehab costs to get market rent: $20k per unit or $120k

Let me know your thoughts!

Bill B. · Answer

Sounds like he’s not collecting all the rent he says he is otherwise they would still be making the payments. You know there has to be deferred maintenance. I might cherry pick the best property or try a lower price. Make sure you get estoppels for all rents/security deposits.

Joe Baier · Answer

He's owned the properties since 2006. Did a cash out refinance last year and started missing payments 3 months ago. LTV is 75% so basically no pay down but he's been using the rental funds to cover other bills.

Patti Robertson · Answer

On another note, I know this is not a popular opinion, but I wrote a BP blog about why I feel sub-to should be illegal.  Here is a link if you want to check it out.  https://www.biggerpockets.com/member-blogs/9232/65349-why-i-...

Bill B. · Answer

Assuming seller had to put 20-25% down it seems like almost zero loan pay down. It seems like they bought them a year or two ago, they’ve been horrible and the seller is just trying to bail? If so, why would the rate be so high? Be super careful if you aren’t able to make these mortgage payments out of pocket if no rent comes in or a large capex expense “suddenly” comes up.

Ps. The only way I can figure the seller hasn’t just purchased these properties is the entire market they are in is collapsing and prices are falling, another possibility.

Patti Robertson · Answer

IMO you would be way better off with a commercial loan than buying these sub-to with his inferior mortgage. The MTM leases don't bother me.  Once you figure out what tenants are work keeping you can put them in long term leases.  In every single case I have even seen, my lease is far superior to the one the seller was using.  I prefer tenants to come with no leases for this reason.

Be careful looking at the published HUD rents.  They are quoting rent PLUS utilities.  You can only get that rent if you include all utilities, which you would never ever want to do.  Typically the actual max rent is $200-300 less than what is published there.

I looked this portfolio up in our court records and this seller has only taken two tenants to court - ever.  It's pretty much impossible that there would only be two situations where a tenant didn't pay in a low end unit - and all of these are located in very low end neighborhoods.  It is likely he has tenants with big delinquencies.  I suggest asking for a rent roll that includes current tenant balance just to see how healthy the rent roll is.  That said, I never don't buy because of a tenant.  In Virginia a bad tenant is pretty easy to replace.  You just want to make sure you will have the ability to replace the bad ones one at a time, preferable, to keep cashflow coming in and spread out your expenses.

Steve K. · Answer

I wouldn't touch this unless you're 100% confident in your pro-forma rents. Can you really double the current rents like you're projecting? How is the micro-location compared to your rental comps that are commanding double the rent?

I would also double your rehab costs and make sure the numbers still work, as that is how rehabs like this tend to go.

Aside from that, taking over a 9.25% rate negates the main advantage of using Subto IMO. I'd look for a different method to purchase. This seems like a good case of KISS (keep it simple stupid). Conventional financing, buying with cash then refinancing after rehab, partnering if needed, heck even using hard money might be preferable here rather than taking on the additional risk of using subto, without much benefit because of that high rate...

Sean Hudgins · Answer

@Joe Baier, I am not a SUB2 expert, but I am local to the Norfolk market, and I would be a little concerned about your projected rents. You are looking at more than doubling the rents that are currently being collected. Now, I know you are looking to rehab, which will help get the higher rents, but I'm not sure I completely agree that you will be able to get those numbers just based on what they are renting for now. I would caution that though HUD may have a market rent price for the City of Norfolk, there is a very drastic difference based on the actual location in the city. Section 8 may be an option as their vouchers are less concerned with specific locations in the city.

Another point I want to bring up is your equity position. Yes, you have equity going in, but you also have $120k in renovation costs; what is your expected ARV and equity position after you spend the $120k, and does that $120k take into account the holding costs to do those renovations?

As others have said, if you're going the SUB2 route, I think you should have some really clear conversations with the seller. I would personally have a backup plan in place if the notes are called or anything goes south with the Mortgage companies.

Feel free to reach out if you want to talk. I would definitely get really solid on your expected rent numbers before you pull the trigger.

Subject To Deal. What am I missing here?

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