I have had a real estate investment model in my head for a while and would like to hear other peoples opinion on it, since there may be something I am missing or not seeing. I thought the model up as a way to both help the homeowner and make money, in addition to minimizing the amount of capital one has to invest. Basically, it is a way for a homeowner who has significant equity, but bad finances, to partner up with an investor and flip their own home.
For example, say a homeowner owes $100K on their home. However, the home needs about $20K in repairs/updates in order for it to sell at the market value of $200K. Assuming the homeowner has bad finances/credit and cannot just go pull equity out of their home to fix it up, then I come in and finance the repairs with the condition that I get x% of the profit after the home sells, where x% may be 30-50%.
Of course, I would need to somehow secure my equity/investment through a lien or deed (or some other method?). However, in this example I could potentially make $34K-$20K off of a $20K investment, and the homeowner would walk away with $47K-$34K, (these numbers include a realtor fee of 6%). Whereas in order for the homeowner to make the same amount off the sale, they would have had to sell their home as is, needing significant repairs, for $156K-$142K, which would probably be difficult. And in addition, by me doing it this way I only had to put up $20K, instead of actually buying the home and trying to flip it. Hence, if I where to do this with 5 homes I would only need $100K in capital, instead of lets say $500K in capital if I where to buy and flip 5 homes for a comparable profit.
Now, of course the limiting factor in this model is finding homeowners in a distressed financial condition with significant equity in their homes. However, if they have owned their home for 15-20 years, they probably have significant equity.
I just wanted to share this idea and see what other people thought. It may be genius, or it may be stupid, but any criticism or comments are welcome.
Thanks for your input,
I really like this. I was thinking the other day about this same model. Here are the conclusions I came to:
I think some of the strengths are;
Less cash out of pocket. This is the big one. No down payment. No paying a pile of cash to the hard money guy. No transaction fees.
Less time getting going. You don't have to qualify and do escrow etc.
I think some of the problems are;
Where do they live while you are doing the remodel? It would be nightmare trying to rehab with them living in the house and you'd have a fight (understandably) about everything from the work schedule to the carpet color. Who picks the realtor, what's the sale price etc etc etc.
How do you get them out/get them to sell? What if they decide they like the house just fine now and want to stay? A lien is not sufficient insurance for your money. It's only activated when they transact the property. You could literally NEVER see your money back.
Technically the control of everything is still theirs. What if they have obligations, back child support etc, anything or anyone laying claim to the proceeds of the sale. Ouch!
I think the real opportunity is;
Control. What you want is control of the property. You don't have to "own" the property, you have to control it. If you can control it with a little money down you can do the fix and profit off the flip.
For instance using your scenario, they owe 100k on a home that would sell for 200k with 20k improvements. They are aware of this but their predicament is they have bad credit or otherwise no ability to borrow. The market value of the home (142-156 k) is still above what they owe and they could walk away with some cash in their pocket even if they fixed nothing. But let's say they are super motivated, like someone, died, lost a job or got a transfer. Or they just don't want deal with the hassle of listing and showing and feeling all the pressure to clean and fix and stage etc. So they're motivated in a couple ways and totally realistic about their situation.
If you did a lease option, you could come to them and illustrate the idea of partnering and say "Hey, I'll give you the max amount that you could probably get out of this place and you don't have to bother with anything, I'll handle all the difficult parts. I'm going to agree to buy your house and at 142k today, as is. You do nothing. I'll give you a five grand option fee right now so you can move, find another place to rent etc and get on with life. It's your money, you can spend it, do whatever you need with it. I'll also pay you a lease payment every month which will cover your mortgage. We'll set it up so the money goes straight to the bank. Meanwhile I'll fix the place up and list it with a realtor etc. I'll deal with all the headaches and hassles, if anything breaks I'll fix it, you have no worries." When it sells you'll get your remaining 137k, which means a total net profit of $42,000 in your bank account and I did all the hard work while you focused on taking care of your life. If in a year I haven't been able to sell it you get your new, improved house back, freshly remodeled, payments up-to-date and you keep the 5k. How's that sound?"
They accept, they move out, you put 20k in the rehab and sell it at 200k and now upon sale you've got 25k in it plus realtor fees of 17k in realtor fees and closing costs then the 137k option you're paying the owners, of which they keep 37k which all is done out of escrow. Plus, lets say you paid 3 months of $700 mortgage payments so $2,100. So you put $25,000 in and got $18,900 out in 3 months. Not too bad especially if your not doing the repairs with your own time.
I think numbers wise the only difference from your scenario is paying the mortgage payment, that could be anywhere from $500 to $1,000 or more depending on when they bought, at what price and interest rate etc. But logistics wise it's way more realistic.
Ideally you would negotiate a lower price with them, that's the easiest way to pick up extra money in the deal. They should also probably be paying their share (the majority) of Realtor fees and closing costs (12k in this scenario) Also, you could give them a smaller option fee. Depends on what your and their needs are. I could see doubling your money in this scenario pretty easily if you watch your margins and how you do your contracts.
Off course you're also at risk if the house doesn't sell but then again there's always that risk, you're just buying the potential upside cheaper. And if the whole market tanks you walk away without having to default.
So I started out to talk you and myself out of it but maybe I've talked myself into it now! I would love to hear opinions from more experienced flippers. I have only done one flip and the hard money guy made more than I did. That was the worst part. In this scenario, sure the owner makes a bunch for essentially financing it for you but you're not plunking 25% down up front and the paying big interest only payments each month. You're essentially getting great terms.
Found this thread which talks about other ways to partner with seller and have better security on your interests.
This is interesting. I think to get around some of the repayment issues would be to give them a 6-month (more or less) "grace" period that after work is complete, they have to sell the house or pay on the loan.
It's a good model, and one that we've had in our arsenal for a few years.
However, we've found that very few homeowners are going to want to go through with this--most people who want to sell their house want to sell it RIGHT NOW without waiting for a month or two while repairs happen, and especially don't want to be living in the house while those repairs are happening. They usually just sell their house all-cash instead of worrying about the extra money they could get through repairs.
It's incredibly difficult to find someone who's willing to do it, but if you do, it's a great and lucrative strategy.
Juan is correct. Taking a security interest in a property has you wearing the hat of a lender, trying to take equity can put you into predatory lending areas and usury violations.
Structure these deals buying an interest in the property, say 50% using seller financing, the arrangement allows for your cash injection to go to your side of the equity. In this way you are not a lender but a co-owner in title. You also need to belly up with your responsibilities, fix by a certain date, put it on the market, etc. In that agreement you have the power of sale, if a owner partner backs out, they are liable for costs of court and collections of your equities as your cash contribution along with damages at some stated amount. If you fail, then you need to pay as you need to accept risks as well, it can't all be to your favor. Calculated risks, reasonable, fair and customary for the work performed.
Neither a lease nor an option puts you in a position to do rehabs, don't go that route.
Setting the property into an LLC can make sense too, partner with the owner and the terms are in the operating agreement. Once that property is sold, that partner is removed and your LLC can be ready for the next project.
The key is to stay away from being in a lender's position. Concentrate on being the "contractor" partner and having rights to workmen's liens which can force sales. Judgment needs to be employed, having to go to court to patrician a property or force sale is costly and takes time, but with the proper agreements you'll be in the driver's seat. See your attorney.
The concept is a good one and I've done this many times for distressed properties, each deal can be different too, it's never a cookie cutter strategy to get to a final conclusion.
Again, RE basics will teach you the best way to proceed, what liens are available to you, structuring the transaction, powers of sale, title interests and financing from other sources to complete the project. Good thought overall :)
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