Is this strategy Legit?

Is this strategy Legit?

Investor · San Antonio, TX · Member since 2016 · 30 posts · 11 votes

Hey guys, I want to apologize if a similar strategy has ever been discussed, I've been a floater on the forums for a long time now and haven't seen anything like this, so I decided to actually post for the first time.  Even if this question has been asked before, I think my story is unique enough to be entertaining at least.

About three years ago I was approached by an investor who had done 4-5 deals, all long term holds, I'll call him Mike to protect his identity.  He and I became quasi-friends over time and I actually looked to him as a mentor. He introduced me to real estate investing by telling about his rentals and how he got into it.  He never offered to take any money from me or point me to any specific properties, he only recommended books for me to read and answered general questions for me.  I decided to make the leap into real estate largely thanks to his teachings and bought several properties on my own.   Again, my deals were not linked to him in anyway (you'll see why I'm putting emphasis on this later).

Two years went by and out of the blue he invited me to go to Vegas with him.  It actually lined up with a bachelor party the few days before so I agreed.  Looking back and telling the story now, it sounds like an episode of "American Greed."  He paid for everything, the flight, the food, the hotel and even gave me an apple watch when I showed up.  Then he told me the reason I was there was not just to drink and gamble with him but actually to meet his partner.  I had heard of his unnamed partner several times before, but all I knew was that he was a deca-millionaire and Mike's mentor who owned a lot of real estate.  I showed up to this arranged meeting wearing a suit, and I'm glad I did because they were wearing custom $2K suits in this low lit bar.  At first it was an intense interview of me, and then we ate dinner and I was told to go back up to the hotel room or go back to the gambling floor while they talked.  Later I got a text to return and when I came back things were more relaxed, they said they had discussed it and that I was "in."    So that's when they started telling me their plan, and why I'm here asking if this is legit, because it sounds crazy.

Their plan was to tag team a property, each with our own LLC's. The first guy's LLC would find a great deal, high rent possibility, low price, good area etc. He would buy the property at low cost (preferably at auction) with 20% cash down.

For illustration purposes say its a $100K property, guy #1 finds and buys the property putting down $20K and borrowing the other $80K from a bank. 

Guy #1 would renovate/repair if necessary and put a renter in there with as high rent as possible then put it on the market. Guy #2's LLC would come in and put in an offer at as high valuation as possible, whatever his bank's appraiser would allow. (funny how appraiser's price matches the offer isn't it?)

Illustration: Guy #2 offers $200K.  Guy #2's bank approves with 20% cash down.  Guy #2 pays $40K his bank pays $160K.  The rent is covering the mortgage. 

So now Guy #1 is getting paid $200K, pays off his $80K mortgage and now has $120K cash free and clear. Guy #1 pays Guy #2's LLC $40K after closing and so now Guy #1 has $80K profit, and Guy #2 has a solid cash flowing property for 0 money down.

Guy #3 has spent the whole time saving up his own $20K down payment to buy another property and repeat the process, except that now Guy #1 has the funds to come in and buy Guy #3's property 20% cash down.

Rinse and repeat until all 3 guys have cash flowing properties and a solid $40K in their bank accounts. Then restart the cycle again and again until each guy has 5 cash flowing properties worth $1million and $200K cash, 100% OPM (because the banks shoulder it). At that point stage 2 would commence where we form a trust combining the 3 LLC's (now 15 properties total, book value $3 Million). The trust can do other things such as leverage their portfolio or even REIT and IPO.

My obvious question was how do you transfer large sums of cash between the LLC's? Their plan was to let the process take place over several years and via several methods. The 10K cash/year "gift" rule, employing the other LLC's services for repairs and renovation, and other means of which lowering the tax burden as much as possible, but still being legal.

I thought about it a lot, and risks were that I end up buying a dump at the higher valuation and they cut fence and run without giving me "back" my down payment. But they assured me that, 1) why would they "run" from a machine that is working and generating cash over and over again, and 2) every property would be considered and approved by the group before being put in rotation, so we would each agree that it is worth the higher valuation before giving the go ahead to move forward and so the worst case scenario is that I would be left with the deed to a cash flowing property.

Help me out here, what do you guys think?

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Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes
9y
Samuel Riehn Legality aside, there are a couple of easy flaws. You (the buyer) can't choose your appraiser. In many cases the loan agent is required to choose the appraiser blind (just based on their bid or through a rotation). If you borrower is colluding with a lender who is colluding with an appraiser, that's...well...collusion. Believe me, if that's going on there's a kickback cost in there someone. The practical issue (not legal) is at the end of it you do not have 5 properties worth $1M. You have fraudulently appraised properties worth a lot less. And if you think that will fly in an IPO with a Big 4 auditor looking at the books, asset value, etc. you're out of your mind. This entire strategy seems contingent on buying a property for $100K that's worth $200K after minimal renovations. If it's that easy to the math yourself: STEP 1: Buy property 1 for $20K cash, minimal renovations, sell for $200K, pocket $100K (I know, I know, taxes and realtor fees hurt you) so let's say $80K. STEP 2: Use the $80K to buy 3 more 20% down properties using the $20K balance for renovations. Sell for $600K and pocket $520K, let's call it $420K after taxes. STEP 3: Even if I'm off by $100K I've just turned $20K into $320K with zero crazy strategies. If it works and the appraisals are legitimate why on earth go through all of the issues of setting up LLCs and do the money transfers. I could be missing a bunch of steps but it sounds a fun mix of collusion and fraud on it's outset.
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  • Real Estate Investor · Memphis, TN · Member since 2016 · 940 posts · 695 votes
    9y

    @Samuel Riehn -

    First of all if your gut says sketch, then it probably is.  Personally, it all sounds fishy to me.  Why would he not tell you in advance what they were thinking before paying you to come to Vegas - much less giving you gifts.

    Also if these guys are so good, then they should have other investors who they don't have to "interview" to go in with them.

    If it sounds too good to be true, then it probably is.  I'd be leery of any "easy money" schemes.

    My two cents.

    Let us know what happens (before we see it on TV... :)

  • Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes
    9y
    Samuel Riehn Legality aside, there are a couple of easy flaws. You (the buyer) can't choose your appraiser. In many cases the loan agent is required to choose the appraiser blind (just based on their bid or through a rotation). If you borrower is colluding with a lender who is colluding with an appraiser, that's...well...collusion. Believe me, if that's going on there's a kickback cost in there someone. The practical issue (not legal) is at the end of it you do not have 5 properties worth $1M. You have fraudulently appraised properties worth a lot less. And if you think that will fly in an IPO with a Big 4 auditor looking at the books, asset value, etc. you're out of your mind. This entire strategy seems contingent on buying a property for $100K that's worth $200K after minimal renovations. If it's that easy to the math yourself: STEP 1: Buy property 1 for $20K cash, minimal renovations, sell for $200K, pocket $100K (I know, I know, taxes and realtor fees hurt you) so let's say $80K. STEP 2: Use the $80K to buy 3 more 20% down properties using the $20K balance for renovations. Sell for $600K and pocket $520K, let's call it $420K after taxes. STEP 3: Even if I'm off by $100K I've just turned $20K into $320K with zero crazy strategies. If it works and the appraisals are legitimate why on earth go through all of the issues of setting up LLCs and do the money transfers. I could be missing a bunch of steps but it sounds a fun mix of collusion and fraud on it's outset.
  • Investor · San Antonio, TX · Member since 2016 · 30 posts · 11 votes
    9y

    Andrew, I had the same questions of the group, so let me tell you their answers. A) the properties would be worth the higher valuation, though the offer would include a rosy push. Similar to the BRRRR method, the properties would be renovated and based on higher rent incomes worth more, but instead of a cash out refinance, its a sale. The offeror would submit an offer that is say 10% higher than market, chalking it up to competition or hot market. The appraiser would not be "in on it" at all, but of course we would be hoping for the appraiser to do the usual pencil whipping they always do that give a property somehow the exact value of the bid. (we all know that's weird how that works). But of course if the appraiser said no, its actually worth 5K less, then the sale would still occur, just whatever % less the appraiser limits us to.

    My thoughts exactly on the, why couldn't I do this on my own? Their answer is, this would be way faster.  Using the above method, the team could acquire properties at accelerated rates using each other.

    As far as the REIT goes, it would also include the property our LLC's already own plus the flipped properties using this method so the valuation and asset to debt values would be healthy, not fraudulent.

    I just question how this is much different than the BRRRR method? At the heart of it, we are buying properties at distressed values, renovating, raising rents and instead of cash out refinancing, we are selling to each other and then repeating.

    The BRRRR method is simply accelerated because we are using 100% OPM (and the sales are backed knowing we will get our down payments returned on the next deal), and keeping the assets in house.

    Elizabeth, I agree whole heartedly.  If they had approached me with this in a starbucks, I would probably be questioning it much less.  The hype did get me revved up for it, which is what made me pull back and say whoa, whats wrong with this picture? it sounds crazy, too good be true, but is it?

  • Investor · San Antonio, TX · Member since 2016 · 30 posts · 11 votes
    9y

    Just so the group knows, I'm passing on this strategy, but I wanted to throw it out there so others can benefit. It has all the elements of a legitimate real estate deal that I've seen on bigger pockets before. Its a partnership to leverage each other's money and credit, its a BRRRR strategy with some differences, but the presentation of it was fishy.

    I'm just disappointed that this almost got me, I was sold.  Watching "American greed" makes me wonder how the victims could be so gullible, but here I am almost falling for the same tricks.  I appreciate this forum being a place where anyone can lay out a scenario and give peers a chance to pull you back into reality before its too late.  (My wife hitting me over the head helped too)

    Cant help but wonder what would have happened though. And if it is legit, its a very interesting take on partnership REI.

  • Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes
    9y
    Samuel Riehn Sounds like you made the right decision. And, believe me, having 3 people doesn't make it go "much faster" of one of the people is a "deca-millionaire". If these guys have the deals then capital constraint is the least of their worries. Not to mention that the deca-millionaire has other deca-millionaire friends that they could partner with instead of flying out someone to Las Vegas. Imagine how fast this simple plan would work with 3 deca-millonaires! I'm going out on a limb and guessing that they didn't need a 3rd person, they needed a patsy. Or I just lack "vision" 🤷🏻‍♂️
  • Investor · PA · Member since 2013 · 1k+ posts · 602 votes
    9y

    I guess it might work out pretty good for guy #1.  Not so sure about the other guys though. 

  • Investor · San Antonio, TX · Member since 2016 · 30 posts · 11 votes
    9y
    Originally posted by @Jassem A.:

    I guess it might work out pretty good for guy #1.  Not so sure about the other guys though. 

    I see it as a Yieldco/Devco model. Where your development company (Guy #1) needs to drop down assets into holding companies or "Yield companies (Yieldco's)." To get his cash out and build/acquire the next asset while the subsidiary yieldcos reap the long term benefit. This model combined with the the first three letters of BRRRR seems genius to me. I hate the idea of cash out refinancing personally, I'd much rather get the liability off my books and get my cash out through a sale. Then let the other guys hold for rent income. I think this was their plan, they just factor paying the buyer's down payment for them would be worth it to keep it moving.

  • Investor · San Antonio, TX · Member since 2016 · 30 posts · 11 votes
    9y
    Originally posted by @Andrew Johnson:

    Samuel Riehn Sounds like you made the right decision. And, believe me, having 3 people doesn't make it go "much faster" of one of the people is a "deca-millionaire". If these guys have the deals then capital constraint is the least of their worries. Not to mention that the deca-millionaire has other deca-millionaire friends that they could partner with instead of flying out someone to Las Vegas. Imagine how fast this simple plan would work with 3 deca-millonaires! I'm going out on a limb and guessing that they didn't need a 3rd person, they needed a patsy. Or I just lack "vision" 🤷🏻♂️

    Thanks for replying, Andrew. I appreciate your perspective and think you're right. However, you say that 3 deca millionairs could get it done faster, and I tend to agree. This group obviously didn't need me, so that also made it fishy. But the same strategy used between me and 2 other peers (BRRRR'ers) would seem to work. See my post above about Yieldco/Devco model. This strategy, to me, is the same thing: where the yieldco gets outside financing to buy the asset and hold for long term yield/dividends (or in this case rents).

    I think the deca-millionaire wanted to be the devco, using his LLC and deeper pockets to build/acquire assets, to later drop to me and Mike.

    Essentially the devco, (Guy #1 in my illustration) is fine with selling at a discount to keep the asset in house. Because in other words, he knows if he puts the house up for sale, he'd be lucky if buyers or investors offer him 90% of asking price.  Instead, Guy #2 comes in offering 110% asking and he pays Guy #2 the difference.  In the end he gets the same 90% asking price, but he's given 20% to his partners.  But that's no problem with him because its bank money anyway.

  • Investor · PA · Member since 2013 · 1k+ posts · 602 votes
    9y

    @Samuel Riehn

    I have not heard of a situation where the seller is permitted to reimburse the buyer any part of the down payment. I suppose it could be done with some maneuvering and might make it easier to offload rental properties to other investors. I'd speak with a real estate attorney first.

  • Gulfport, MS · Member since 2017 · 2 posts · 0 votes
    9y

    This seems pretty similar to a real estate scam, the name of which escapes me.  Basically, a group of investors flip properties to each other (usually land within a particular new development) and make it look like they are arms length transactions between unrelated parties, each time at say a 5-10% premium or even 30% premium over the previous "purchase" price, depending on how aggressive they want to get.  Eventually, they try to sell to an unrelated third party, and they use the history of non-arms length transactions to justify a sales prices that might be two to four times higher than the original investors paid a year or two before.  An alternative approach is to not bother selling to the third party, but simply sell to a related party using bank financing, and then skip town while leaving the bank with worthless collateral.  This has obviously become a less popular way to do the scam as there's no way to do it that way without the negative effects following you around.  

    This doesn't sound exactly like that scam. It sounds like the goal is just to use non-arms length transactions to squeeze a little bit more LTV out of the properties. But I'm still not sure that wouldn't be found to be illegal if you did a non-arms length transaction just to increase the leverage available to you and your partners.

  • Investor · San Antonio, TX · Member since 2016 · 30 posts · 11 votes
    9y
    Originally posted by @Jassem A.:

    @Samuel Riehn

    I have not heard of a situation where the seller is permitted to reimburse the buyer any part of the down payment. I suppose it could be done  with some maneuvering and might make it easier to offload rental properties to other investors more easily. I'd speak with a real estate attorney first.

    Absolutely, attorney's are the answer. But I've seen it done on Wall Street, the parent LLC just needs to hold a stake in the sub or yieldco LLC, then the money can flow back and forth pretty easily under "MSA's" and other tools. The subsidiary LLC would just need to maintain the corporate veil as a separate entity, in this case, backed by myself or Mike. We would be the ones looked into for credit checks.

  • Investor · San Antonio, TX · Member since 2016 · 30 posts · 11 votes
    9y
    Originally posted by @Johnson Jacks:

    This seems pretty similar to a real estate scam, the name of which escapes me.  Basically, a group of investors flip properties to each other (usually land within a particular new development) and make it look like they are arms length transactions between unrelated parties, each time at say a 5-10% premium or even 30% premium over the previous "purchase" price, depending on how aggressive they want to get.  Eventually, they try to sell to an unrelated third party, and they use the history of non-arms length transactions to justify a sales prices that might be two to four times higher than the original investors paid a year or two before.  An alternative approach is to not bother selling to the third party, but simply sell to a related party using bank financing, and then skip town while leaving the bank with worthless collateral.  This has obviously become a less popular way to do the scam as there's no way to do it that way without the negative effects following you around.  

    This doesn't sound exactly like that scam. It sounds like the goal is just to use non-arms length transactions to squeeze a little bit more LTV out of the properties. But I'm still not sure that wouldn't be found to be illegal if you did a non-arms length transaction just to increase the leverage available to you and your partners.

    That is a new one to me, but yeah that does sound similar.  I agree, the law favors the banks in these types of situations which is why I'd rather not bother with it.  I think you're right, this strategy I don't think is intended to be a scam but instead a way to add value to the team by buying at best-case valuations, and splitting profits.  The smaller guys keep the rentals for longterm income, the bigger guy gets more to keep building.  I may have painted these guys to be scummier than they are. Like I said I've known Mike for years and don't think he's a scammer, cant speak for the other one, but for the limited times we've talked since I don't think he is capable of that.

    What I cant help but keep coming back to is the slight difference between this and a cash out refinance. When cashing out in a BRRR, we always try to get that valuation as high as possible to take as much money back out as possible (at least that's what I've gathered in my 6 months reading and listening to bigger pockets). Yet the selling at highest possibility valuation to someone willing (though arms length is questionable) to pay higher is somehow very bad/illegal. Doing it wrong the latter leaves the buyer with a lower value house, while doing it wrong with the BRRR can leave ME with the lower value asset. Makes you think...

  • Investor · PA · Member since 2013 · 1k+ posts · 602 votes
    9y

    @Samuel Riehn

    Sounds like it could work if you would want to buy at 80-90% of appraisal.  I typically look to buy at closer 50% but I can understand how this might not be possible for all buyers because of competition and having to show up at the courthouse steps with cash and take on more risk in order to obtain that kind of deal.

  • Investor · San Antonio, TX · Member since 2016 · 30 posts · 11 votes
    9y
    Originally posted by @Jassem A.:

    @Samuel Riehn

    Sounds like it could work if you would want to buy at 80-90% of appraisal.  I typically look to buy at closer 50% but I can understand how this might not be possible for all buyers because of competition and having to show up at the courthouse steps with cash and take on more risk in order to obtain that kind of deal.

    Right. 

    Though as a military guy I know there are wanna be investors or regular guys buying retail value homes with the VA loan for 105% LTV after they roll in that VA funding fee. I'm not necessarily afraid of buying 90% of appraisal if the rents are still cash flowing. These are A-B neighborhoods they'd be looking to buy in.

  • Investor · PA · Member since 2013 · 1k+ posts · 602 votes
    9y

    @Samuel Riehn

    If the numbers make sense then I might consider buying one just to see how it goes. Based on 30 yr 4% you would be looking at 764/mo P&I on 160k. What do you think the 200k home would rent for? You would want DSCR to be at least 1.25 but preferably closer to 2-3.

  • Investor · San Antonio, TX · Member since 2016 · 30 posts · 11 votes
    9y

    @Jassem A. 

    I haven't actually been presented a property from the group yet. I was just using the made up numbers given during our meeting. But using those values I would want at least 16-1800/month gross rent.  Based on the areas that they operate out of (Baltimore, Alaska, and parts of Florida) I think that would be possible.

  • Investor · PA · Member since 2013 · 1k+ posts · 602 votes
    9y

    @Samuel Riehn

    Sounds like it could be worth looking into. I would prefer to buy properties locally myself but this could be a good strategy to expand into other markets without that much money out of pocket. 

  • JD MartinBusiness Member
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    Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes
    9y

    Wow. There are so many holes in this thing I'm glad it's not a canoe, and I'm glad I'm not in it?

    What are the chances you buy a house for $100k, spend zero dollars on rehab on it, and have it be worth $200k?

    What are the chances of an appraiser magically making it out to $200k without any real money having been spent on rehab? I've done cash-out on lots of houses I owned, cash, and few of them doubled in less than a year and that was *after* spending good money on a rehab.

    What are the chances that you find a renter willing to pay some much in rent that when Guy #2 buys it for an inflated price, it's still a cash-flow monster?

    What happens when any of the following happen:

    Appraisal on House #1 doesn't cut it and Guy #2 declines to purchase;

    Renter on House #1 was a scam, or left early, and renter #2 doesn't pay enough for Guy #2 to cover his costs?

    Guy #1 decides he doesn't want to pay for Guy #3's house and just keeps his cash in his pocket?

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  • Real Estate Investor · Dallas, TX · Member since 2009 · 183 posts · 153 votes
    9y

    This is 100% a scam.  

    No legit deals ever start out this way. Dude flies you to Vegas and buys you a watch?  WTF Scam.

    No person worth Millions has any legit reasons why he needs your help. Scam.

    And I would wager you get to be guy #3.  The other two get bought out and you are left holding the bag with a house not worth anywhere close to what you just paid.  

    Scam Scam Scam

  • Investor · San Antonio, TX · Member since 2016 · 30 posts · 11 votes
    9y

    @Jassem A.

    I was actually looking to try it out with my Father. He is on the edge of retirement age and just had a brain aneurysm that will likely force him into retirement. He owns 2 homes, one is under construction that probably needs $60K to finish, he has taken HELOC's out on his primary residence throughout his life to maintain liquidity in his company, so even though he's been in the home I grew up in for 26 years he still owes 130K. I had an appraiser come out and said that it was worth 200K. If I bought his home for full retail, and had him pay me low rent for the rest of his life, I can write off the losses and he will pay for my down payment thru annual $10K tax-free gifts. He would have 70K to finish construction on his second home which he can sell free and clear for easily 180K. That, along with the sale of his business assets, would be his retirement.

    Meanwhile I own a $200K home that I paid no money down on, and I'm taking several hundred dollar loss on rent per month, but I'm taking care of my dad.  Plus, I wont have to pay for property management or anything to maintain the home because he always has and will still do repairs himself.   

  • Investor · PA · Member since 2013 · 1k+ posts · 602 votes
    9y

    It could work out fine in some markets I would guess and my assumption is that guy #1 would spend some money on repairs but probably not a lot. Most bank owned properties around me go for half of what they would probably appraise for after a light rehab. If you buy at the courthouse steps then sometimes you can pay even less. Less likely to find these kinds of deals in hot markets though or in good neighborhoods.

  • Investor · San Antonio, TX · Member since 2016 · 30 posts · 11 votes
    9y
    Originally posted by @JD Martin:

    Wow. There are so many holes in this thing I'm glad it's not a canoe, and I'm glad I'm not in it?

    What are the chances you buy a house for $100k, spend zero dollars on rehab on it, and have it be worth $200k?

    What are the chances of an appraiser magically making it out to $200k without any real money having been spent on rehab? I've done cash-out on lots of houses I owned, cash, and few of them doubled in less than a year and that was *after* spending good money on a rehab.

    What are the chances that you find a renter willing to pay some much in rent that when Guy #2 buys it for an inflated price, it's still a cash-flow monster?

    What happens when any of the following happen:

    Appraisal on House #1 doesn't cut it and Guy #2 declines to purchase;

    Renter on House #1 was a scam, or left early, and renter #2 doesn't pay enough for Guy #2 to cover his costs?

    Guy #1 decides he doesn't want to pay for Guy #3's house and just keeps his cash in his pocket?

      There were two ways they thought of doing this. 1) buying HUD blind auction homes (obviously nowhere near 100K I used that as an easy example) and reno them and get a HUD renter in there paying 10% of the home's purchase price every month. Or 2) Pretty sure they intended to develop properties, buy land at auction or tax lien and build. Doubling their money is probably unreasonable and unlikely, again, I used fictional numbers. But you're right, things look way to rosy, and there are way too many things that could go wrong. I'm out.

    • Investor · San Antonio, TX · Member since 2016 · 30 posts · 11 votes
      9y
      Originally posted by @Michael P.:

      This is 100% a scam.  

      No legit deals ever start out this way. Dude flies you to Vegas and buys you a watch?  WTF Scam.

      No person worth Millions has any legit reasons why he needs your help. Scam.

      And I would wager you get to be guy #3.  The other two get bought out and you are left holding the bag with a house not worth anywhere close to what you just paid.  

      Scam Scam Scam

      I don't even like Apple! haha. Yeah you're very very likely right. Don't know why I didn't see it when I was there.  Took a few nights of sleeping on it before I realized how shady it was.

    • Investor · PA · Member since 2013 · 1k+ posts · 602 votes
      9y

      @Samuel Riehn

      I don't see a problem with helping out family or allowing family to help you but I try not to mix family with business. The loss you are taking each month will likely reduce your DTI and might prevent you from obtaining another mortgage in the future.

    • Jay HinrichsBusiness Member
      Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
      9y

      @Samuel Riehn  glad you figured it out.. sounds like loan fraud to me. and those 2k suits  ( which are middle of the road ) are exchanged for Orange ones

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