Business (RE) Proposition (Practical Considerations)

In My Humble Opinion
21

In fact, I think most banks wouldn’t be happy even if they knew it was a gift, and might make the parents co-sign the mortgage. The idea is that the banks see the downpayment not just as a way for the borrower to have some real stake in the property right away, but also as proof that the borrower is capable of living within their means, with enough discipline to save over a decent length of time (and therefore should have the financial discipline to keep up on their mortgage and home maintenance, etc.). Contrariwise, if the borrower needs a gift in order to get a downpayment, that’s an indication that the borrower doesn’t have the financial discipline to save, and might be a bad risk.

So in your case, I don’t think the bank would be happy making a loan if they knew the situation. Look at it this way: if the bank is happy with you borrowing the downpayment from someone else, why wouldn’t the bank be even happier with you borrowing the downpayment from the bank (so the bank makes more of the profit)? Seems unlikely to get a mortgage without misleading (i.e. defrauding) the bank.

But I don’t know anything about commercial RE lending, so maybe it’s possible. In any event, I wouldn’t even consider this until I had a good lawyer look over all contracts and agreements. There are a lot of possibilities, and you needs someone to consider them all.

22

That’s a really good point and I absolutely agree with you. What I meant was that it happens and that if you asked a seasoned mortgage officer at a bank, “hey, do young first time home buyers ever misrepresent family loans as gifts?”, none of them are going to honestly say it never happens. I certainly didn’t mean to imply that they are ok with it or that the bank as an entity or even any underwriter is ok with it.

23

Because if you default the bank will not have to concern themselves with those arrangements, and can seize the property just as easily as if you had no side arrangements.

Because then the LTV would be too high.

If you buy a property for $240K and the bank puts up $180K, then they can be reasonably confident that they’ll be able to recover their $180K if they had to foreclose. But if the bank put up the entire $240K, then they would have to recover $240K in foreclosure from a house currently valued at $240K, which is unlikely to happen.

But this is apparently academic. I am not an expert in bank policies, and if a bunch of knowledgable people are saying they care, then I accept that they do.

[As a practical matter, if I go for this deal, this is something I would leave for the other investors to straighten out with the bank people.]

24

So the bank - which is an entity that has a bazillion dollars sitting around - doesn’t think these guys are credit-worthy enough to pay a mortgage…but you do? Because you’re essentially giving them a loan. You and your good name are on the hook for the entire value of the loan.

What if someone came in here and started a thread about how their brother’s friend needed a car and can’t get a loan, but you can. Should you put the loan in your name? What would the advice be here?

25

One question to ask (and maybe there’s a decent answer) is why did this opportunity fall to you and not someone else?

After all, you’re not the only person who can take out a loan to buy a house. In fact, there’s a ton of people and a ton of businesses, including real estate companies that can do exactly that. The rule of business is if a deal’s too good to be true then it probably is. Doubly so with real estate. Triply so with “savvy” real estate investors.

Another way to look at it is you are essentially borrowing the downpayment from them and giving them a full long-term 80% equity stake instead of the short-term fixed return a bank would ask for. From a financial perspective, they seem to be getting a fantastic deal instead of a simple finder’s fee. Seriously, just go in with your brother and do the deal yourselves.

In short, are you lucky or just the sucker willing to risk the most to gain the least? (hoping it’s the former):slight_smile:

26

I’ve addressed all this earlier.

On a related note, I also recently lent money in a hard money loan. 12% a year with 70% LTV on a short sale (probably a bit over 50% of market value), recorded mortgage, title ins. etc. I don’t think I’m smarter than the bank here either. Again, I’m able to look at this closer (as are other HML lenders).

By that logic no one should ever do anything.

This is a mistake, and one that I’ve pointed out repeatedly in this thread.

If I put up (or borrow for) the downpayment, then I am much more at risk. If the property declines by 10%, that’s money out of my pocket. The way the proposed deal is structured, I don’t lose a penny until the value declines by over 25%.

I am not “borrowing the downpayment from them” because I am under no obligation to pay them back if the property declines in value.

This may or may not be a good deal but it’s far far less risky than a straight up RE purchase (absent other considerations like legal/tax issues). Anyone who doesn’t appreciate this is simply failing to understand the issues.

[Also, the return is a lot lower too, of course, which is one reason it may not be worthwhile despite the lower overall risk - the risk/reward ratio might not be worthwhile. But some people seem to think this is a uniquely risky investment, when in reality it’s the opposite - again, absent legal/tax issues.]

27

I apologize, I did not intend to propose logic, but merely sought to ask a very standard question for any one-off “unique” investment opportunity. It is the same question I would directly ask any family member or friend who wanted advice regarding a complex, apparently low-risk deal with high returns.

I’ll restate it without the editorializing.

“Why did this opportunity fall to you and not someone else?”

Even if you don’t want to answer it here on the dope, you should still answer it for yourself. The deal may be legitimately good. Having a good answer to this question should help you decide. Your choice.

28

Again, it’s about as valid a question as you could ask about any deal anyone ever does. “Why did you decide to buy this house? It’s publically listed so obviously everyone else in the world thinks it’s not worthwhile”. “Why did you decide to buy this stock at this price? At the time you bought it, obviously every other investor was unwilling to pay that price.” And so on. It’s a specious question (unless there’s something more to back it up other than the mere fact that you’re the one doing the deal and not someone else). And it’s even more specious here than it is in the examples I gave, since this type of deal is not something as easily marketable as the other examples.

[If you want to know the history here, my brother is, as mentioned, an experienced and savvy RE wheeler dealer, and as is so often the case, he knows a lot of other RE wheeler dealers. And he knows these two other guys in the field whose judgment he respects and who he thinks are generally decent guys, and he knows that they are looking for someone with the ability to get a mortgage willing to take on this type of deal, so he asked me if I’m interested. So now I’m considering it. It’s not like this has been considered and rejected by everyone in the country or something.]

ETA: it’s not an “apparently low-risk deal with high returns”, it’s an apparently low-risk deal with low returns. Still, low returns on no money invested is not a bad deal.

29

I have no advice, but wanted to ask if I’m the only that pictures the two investers as wearing sunglasses at all times?

30

Working within the numbers that you have given.

I am thinking more of the following type of situation…

  1. With an $1800 a month mortgage, it takes you 2 months to find and “install” the first tenant - which is money you are paying out of your pocket, and don’t get back until after they have been repaid their deposits.
  2. The tenant pays rent on time, but has a personal problem after 6 months and stops paying. It takes you 4 months to move them out (which if my take on US real estate law is accurate is actually a short amount of time). You personally are in for another $7,200.
  3. Because the eviction was acrimonius, the tenant trashes the house.
  4. You now have to do $40k worth of renovations before the house can be sold or retenated.
  5. That money will be all on you (most likely)
  6. The house is untenated for another three months while you renovate and look for new renters - all the while you are paying a mortgage of $1,800 a month.
  7. At this stage, you have made mortgage payments out of your pocket amounting to $18,000 - about 80% or more of which will have gone to interest, and not principle.
  8. You now sell the house for exactly what you bought it for. You will have to pay transfer fees, closing costs and the commission to the estate agent - which will amount to how much?
  9. But let’s say you are lucky and come out with a $30k after clearing the mortgage - who gets that money? It’s not you right?
  10. I would be running the numbers very carefully - how long must this business opportunity need to run “trouble free” before you personally start to get money out of it?

We have a house in another location we rent out. This has been ongoing for about 9 years - in that time we have had mostly good tenants. One owed three months rent that took a while to clear, but also we had to buy new stuff for the house - stove, replacing broken items etc. From my experience (which isn’t universal) you don’t make money from rental properties per se - where the money comes from is the capital gains and the equity you are building (i.e they are cash negative until you sell them if you have a mortgage). I don’t see anything in this deal that gives you cash until you are about 6 or 7 years in, yet you will be up for cash if it doesn’t go according to plan, and that cash you don’t get back until the other guys have been paid back their deposits.

What I would suggest instead is that you form a partnership, they offer $$$ as paid up capital, you offer a personal surety on the mortgage. The mortgage is paid by the partnership, if the partnership declares a profit, it is shared from day one. I would suggest three equal parts.

Like this, if the investment goes bad, I think you are better protected.

31

It sounds like you’ve sold yourself on this and are just looking for validation. Good luck!

32

FWIW, the numbers I gave were just to illustrate the terms of the deal, for someone who asked. They are not at all real numbers.

No, it’s not me. But the point is that despite your lengthy list of everything going wrong, I don’t lose any money either. The other investors lose quite a lot, under your scenario. Which speaks to the point I’ve been repeatedly making - that as real estate deals go this one is a pretty low risk deal for me, with the risk being primarily taken by the other investors. (For some reason a lot of people have had a hard time grasping this.)

What you’re saying boils down to this: if there are no profits, then my 20% share of the profits is worthless. This applies to any business venture.

33

F-P, I told you, didn’t I? :slight_smile:

But I think the early posts about the bank’s view of all this were spot-on. You don’t want to do anything that could even remotely be characterized as lying to a bank to get a loan–that could land you in all sorts of shit, even jail. Many jurisdictions have a crime that’s essentially just “lying to a bank,” so it’s not like you would have to even go so far as to engage in fraud or something–the lying to the bank part could be fully sufficient to cook your goose.

34

I agree.

Even if I wasn’t averse to this type of thing for ethical reasons it would be insane for me to do anything of that sort in this case.

There are a lot of shenanigans going on in the RE world, but I’m not a RE guy and I don’t do this for a living. This proposed deal is a low risk deal but it’s also a low potential return. To risk getting embroiled in legal troubles over a small-time deal like this would be crazy.

I’ve already made clear at the outset that everything has to be absolutely on the up-and-up or it’s a non-starter.

[Beyond the issue of lying to the bank about the source of funds, what I was nervous about was whether the investors have some connection to the seller. As noted above, I’m pretty sure this is to be a short sale, and there needs to be an arms length relationship between the buyer and seller. I have no idea who owns this property now, but if it’s someone connected to these investors, then I could be construed as having connections to the sellers based on my partnership with these investors. This type of thing is going on all over the place, as I’ve discussed in another thread, but I personally don’t need to get involved in this.]

35

A few questions -

  1. If these guys are such savvy RE guys, why can’t they get a mortgage? Their credit-worthiness should be a big red flag about the kind of people you’ll be working with.

  2. Where did they get the money they’re using to invest? People with poor credit aren’t normally great savers. It’s certainly your business to know where the money is from since you’ll be funding your venture with it. What if they’re getting it from a third party who came upon it illegally?

  3. You seem pretty casual about the short-sale aspect of this. As I understand it, short-sales are actually quite difficult to pull off and banks are very slow to process short-sale applications, and don’t usually approve them. Buyers and sellers can get put on ice for months while waiting for a decision, which often is denied. Just wondering if you’re well-educated on short-sales and how they work and how that affects your outlook on this deal.

36

I’ve discussed this earlier. A lot of RE people can’t get mortgages these days because they don’t have steady incomes and/or because they have a history of short sales or defaults. (That’s also the reason these people are paying 12% for hard money loans.)

Apparently it’s become socially acceptable for people to walk away from underwater properties these days. People tell themselves that the banks knew they were only going to get back the value of the building and whatever. I’m skeptical of this argument, but that’s what goes these days - there was a big thread on this MB about the ethics of this, IIRC (I didn’t read it, so I don’t know what the prevailing SDMB position was).

Personally I think people are a lot more likely to default on a loan from a bank than from another individual to whom they have some sort of connection. But that’s not something I would rely on. What I do rely on is that the likelihood of defaulting on loans originally made at the height of the RE bubble is much higher than the likelihood on loans used for short sale purchases at a much lower point in the cycle.

This is not a legitimate question for someone familiar with these types of people. Having money or access to it is part and parcel of being a RE wheeler dealer. (See above.) It’s not out of the realm of possibility that they’ve earned some money along the way by all sorts of shenanigans - these are also part and parcel of being a RE wheeler dealer, apparently. But that’s not something I need to concern myself with, AFAICT.

I’m pretty well educated on the general nature of short sales these days. (I started another thread in this forum discussing common short sale abuses.) I’m not up on all the nitty gritty details of it. The details are the affair of these investors, and if they can’t pull it off then obviously the deal will never get off the ground. My understanding is that they are beginning to deal with the bank even now, although whether that’s with me or some other investor is up in the air.

[I do have some concern about their possibly making under-the-table payments to the seller, or being themselves connected to the seller, as I’ve discussed earlier in this thread.]

37

I have a hard time “grasping” the “low risk” aspect of this deal because you’re wrong - as the named title holder, you are legally responsible for a whole raft of shit regardless of whether you want to believe so or not. Somebody gets injured and wants to file a suit? They’re filing against you. State says there are taxes unpaid? They have to be paid by you. Unpaying tenant files an illegal-discrimination suit against you? It’s your name on the filing papers, not your partners. Need a new roof? You have to pay, not your partners.

Rand is right - the SDMB is not really the place to go for business advice. However, given my twenty years+ experience as an entrepreneur, business-owner, working grunt, executive, etc, if there’s one thing that’s constant is this: If somebody proposes a deal that is “non-traditional”, it’s usually because:

a. They don’t have their shit together,
b. They’re scamming somebody, somehow

Yeah, I know it’s your brother, who is a savvy RE wheeler-dealer and all, but still… people who invest in real estate generally do so under their names (or, better, under the name of their LLC or C-corp). Anybody who tries to do something under somebody else’s name is trying to hide something from somebody, and that’s a situation I couldn’t allow myself to get into. YMMV.

Again, it seems as if you’ve already sold yourself on this deal. I truly hope things go well for you on this.

38

All these things are part and parcel of the RE business, and the costs for these things (to the extent that they’re not covered by insurance etc.) would come out of the income, like any other RE business. Really, what you’re saying is merely that various forms of costs might exceed income such that the business loses money. OK, it might (though I think it’s unlikely) but my point is - again - that it would have to lose about 25% of it’s value before I lose money. By comparison, if this was a straight up RE deal, with me putting up the down payment, then all the items you listed would come out of my pocket.

If you can’t deal with the RE business altogether, that’s something else. (Personally I think now is a great time to get in, but that’s just my opinion.) But to the extent that you can, then you are going to have to deal with the potential downside, which includes many of the things you list and more. My point was and is that unlike an ordinary investor, I have a 25% cushion before I lose anything.

To be clear, I’m not saying this is no risk. I’m saying it’s a lot less risky than an ordinary RE deal.

Actually, I suspect Rand would refute you on this. Because I have a couple of BIL’s who are tax lawyers too, and my understanding is that much of what tax lawyers do (at least at the top tier firms these guys work for) is come up with innovative ways to structure deals.

What you’re saying might be true in some cases, where there’s no readily apparent reason that the deal can’t be more straightforward. But in challenging situations there will always be clever people coming up with clever ways to get around it. The challenges that these guys are facing are real, and it’s not hard to understand why they’d be open to this type of deal.

This is not nearly true, and in any event you’ve already made this assertion. Whatever.

39

Everyone’s already talked to you about how this “no risk” situation is a whole heaping load of risk for you, which you’re ignoring. So let’s try a different tact. It’s an investment for you, right? You’re hoping to get paid, right? So when will you see money.

Let me throw out some numbers. You can change these to suit your individual purposes but they’re to be used as just references. First, the house is worth $125,000. So 20% down is $25,000 meaning the mortgage will be $100,000. On a 30 year fixed at 6% interest, your monthly payment will be $600.

So let’s say you get it in July and get unbelievably lucky and get a tenant by August. You charge $1,250 in rent per month. That’s $15,000 in rent per year.
Now, insurance on the place needs to be secured. Let’s put that at $1,000 per year. Taxes need to be paid. Let’s put that at $1,250 per year. Some money needs to be allocated towards normal wear and tear and expenses for when shit breaks. That’s $1,000 per year.

So where are we? $15,000 - $1,000 - $1,250 - 1,000 - $7,200 (mortgage costs) = $4,450 in gross profit.

Remember now that the investors get their money first. So you’ll see absolutely NOTHING until they’re paid back their $25,000.

In just this simplistic scenario where we assume gross profits are really net profits, you’re waiting until sometime in 2017 before you see a single dime. And even then, you’ll be getting (assuming it all works out just peachy) 20% of the net or around $900 per year.

Again, all that for assuming all that risk that everyone upthread has been trying to beat into your head is completely and 100% your responsibility if things go shitty on this deal.

40

I’ve not ignored anything in this thread. And i’ve also never said it’s “no risk”. I’ve repeatedly said it’s “low risk”, and significantly lower risk than an ordinary RE deal, for reasons I’ve given.

Explain this to me. Why would you feel the need to change what I’ve said so as to be able to pretend that I’ve ignored things? What’s in it for you? You can just skip this thread if it bothers you …