June 17 2013 El Cajon, CA Project

June 17, 2013 Investor Newsletter

546 Galena Street, El Cajon, CA 92109 Single Family Home Project

We have finally found a deal to do in San Diego! Galena is a 1,862 square foot El Cajon home with 4 bedrooms and 3 baths and a large 11,200 square foot lot. It is in bad shape making it the ugliest home on the block. The homeowner simply wants to move out of the house and deed the property to us. He owes $293K with an ARM loan, currently at 2.75%, interest only payments of around $1,100 per month including tax and insurance impounds. The owner’s wife has another smaller home down the street she inherited that they want to move into. In exchange for giving us the home, he wants a remodeled kitchen placed in their new home paid by EAC which can be done for about $7K. Galena is worth about $420K after S80K of rehab. It needs only about $50K of rehab to get it rent ready. The owner is willing to stay on the loan as long as it takes us to sell the property. Because of his willingness to do this, we can do this project differently than the typical fix and flip. Because the current interest rates are so low and the market is appreciating so strongly, our strategy will be to hold onto this property longer to allow more market appreciation before selling it.

1. Stage One – The Rehab
1. We will rehab the property for only $50K to make it rent ready.
2. The kitchen of the other house will cost $7K.
3. The whole project should take us 6 weeks. The holding costs during this time will be mortgage payments and utilities costing $1,500/ month or $2,250.
4. Legal and miscellaneous costs should be around $2,000.
5. We promised the agent who brought us the deal about $9K.
2. Stage Two – The Rental
1. We will rent the property for $2,200 per month, giving us about $1,000/month in cash flow after maintenance expenses are taken out.
2. This comes out to be over 18% annualized return on the original $70K invested. The mortgage rate is tied to the 6-month LIBOR, which has continued to drop even as rates on mortgages have recently bumped up. Since the rate adjusts only in November and May, it is likely that we will maintain this cash flow throughout the holding period.
3. We will sign a 12 month lease, but throughout the entire 12 month period, we will put it up for sale and look for our ideal cash-rich but credit-poor buyer.
3. Stage Three – The Sale
1. We will attract this kind of buyer by listing the home for sale with owner financing.
2. The current annual appreciation for El Cajon is 7%. If the home is currently worth $420K rehabbed, in 12 months with this rate of appreciation, it should be worth $450K. If we offer owner financing, it could sell for more than that.
3. The strategy will be to sell the home for $450K as is but $480K (or more) if the buyer wanted further rehab making the buyer fund the rehab.
4. If we sold the home for $480K with 30% down ($143K), after all costs are taken out, the original $70K is paid back, and additional $30K for rehab, we have a profit of $9K+ or an annualized return of 14%.
5. The home will be sold with the current ARM loan in place with the balance of the new loan at $335,680. Since original investment has been paid back, all return below has infinite return.
6. The current loan is dependent on the 6-month LIBOR rate, adding 2.25% to calculate the current rate. We will write up the new loan with the same terms as the current loan but adding an additional 2 percentage points, ensuring positive cash flow even if rates rise.
7. The difference between the new mortgage and the underlying mortgage payments will be profit for us and the higher the rate the more the cash flow. For example, if we take 11% which is the highest capped rate for the underlying ARM loan, and amortize it, the monthly payments will be $2,686. If we charge the new homeowner 13% amortized loan, the payments will be $3,637. We do not expect the rates to go up that much in 2 years, but this would be the worst case scenario.
8. This will also incentivize the homeowner to refinance us out as quickly as possible. We will push to have this done within 12 to 24 months. At that time we will receive another payoff of $40K+ as the new loan amount is higher than the original loan amount.
4. Worst case scenarios
1. If we cannot for whatever reason find the right buyer and there is a market downturn, we will simply sell the property as quickly as possible. If we list it at $410K for sale by owner, we should be able to unload this property quickly and break even.
2. If the new buyer cannot refinance us out and defaults on his payment, we can foreclose on him, and resell the property with owner financing or outright sale. The underlying mortgage will be less than $300K, and we should be able to quickly unload the property for $350K even if the market had some correction.

This is a very interesting deal with several ways to profit. The uniqueness of this deal is that we can use the current low interest rate loan to finance the rehab and to wait for further appreciation in the current strongly appreciating market to get top dollars for this home. We will structure it so that there is a preferred return of 12% annualized for our investors, followed by 4% return to EAC, with the remainder paid out to 70% to investors and 30% to EAC. With the above scenario, during 12 months of renting the property, the cash to investor could be $9K. At the time of the sale of the property, the payout to the investor will be the original $70K invested plus $13K. During the 12 months of owner carry, the cash flow to the investor could be as high as $8.5K. The payout at the time of refinance could be as much as $30K. The total payout to the investors for 2 years of investment could be as high as $60K for an original investment of $70K. There have been a lot of assumptions built into this project, but there are 4 profit centers that increase the odds of us making money.