Increasing Your Owner Financed Cash Outs

Increasing Your Owner Financed Cash Outs

Increasing Your Owner Financed Cash Outs
By: Gerald Paul - gerald(tx)

Increasing Your Owner Financed Cashoutsby:Gerald Paul
It is no secret among knowledgable investors that Owner Financing can be one of the most profitable techniques in all of real estate investing. There is always a large pool of people who would like to be homeowners but can't presently qualify for a loan because of credit blemishes, self-employment, length of time on the job, etc.
The advantages of selling to these buyers and providing financing are (1 you can sell quickly, (2 you can get full price for your property, and (3 you can do it without commissions while incurring very low closing costs. On the flip side, the disadvantage is you generally have to wait from one to three years to realize the bulk of your profits, which come on the back end of the transaction when your buyer's credit is improved so they may get their own financing and cash you out.
So it's a great strategy, IF, I repeat, IF you are cashed out and actually see that large backend check.
However, my observation is that of investors using this exit strategy, typically only about 20% are being cashed out. When I first started offering owner financing, my odds weren't much better, but over the years I have honed the technique to where I am now achieving a rate of almost 80%! So effective has this been, I have adopted it as my primary investment strategy. This article should help you pick up a few pointers which will increase your percentage of cashouts and put more money in your pocket.
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The first and all so important cashout determinent is the property itself, and considering the profile of the potential buyer for that property.
In my opinion, the most common mistake a beginner will make is to acquire a property that should be a rental house and try to make it a homeowner domicile. The older, lower to blue collar neighborhoods are usually mostly rentals; those that are owner occupied are often long owned by widows or heirs. When they pass on, these houses too, will become rentals. There are few qualified homeowners looking to move into this neighborhood; no realtors holding Open Houses.
Yet, beginners typically start off with this type house using their magic 70% ARV Minus formula, then finish their rehab only to find the few buyers for the neighborhood are landlords who don't usually pay retail. Since the house won't retail, the newbie may turn to an alternate exit strategy: owner financing with a lease option, a contract for deed, or perhaps a wraparound mortgage.
But this seldom works. The problem of it inherently being a rental is still there. The property winds up being filled by a succession of tenant/buyers who will probably never be able to qualify for a loan of their own. Instead of a cashout and seeing that big backend check, the beginner often ends up being a reluctant, disgruntled landlord, not by design.
The successful practicioners of Owner Financing techniques are those who select the property from the start with the owner financing exit strategy as part of the overall investment plan. It's not an afterthought or a last-resort alternative -- it is the original, planned objective.
So which properties make the best candidates for Owner Financing? And what is the probability of having your buyer qualify to cash you out?
The magic question the investor should first ask himself is "If I were a homebuyer making a respectable income for this neighborhood and able to qualify for a loan right now, is this a house I would choose to be my homestead, to cherish and prize as the place for me and my familiy to spend our lives?"
I often get a knee-jerk response, "well, not this house for me, but there is someone for whom this would be their dream home." And this is just the point: the persons for whom this house would meet their standards are exactly the people who will probably never qualify for a home loan in their lives.
Owner Financing works better for some types of properties than others. There is a hierarchy of properties that, as you go up the ladder, the odds of your buyer ultimately qualifying for a loan and cashing you out distinctly increases.
Let's start at the bottom. War Zones. The probability is near zero! Does this one need explaining?
How about low-income properties? Gosh, there's so many hard working folks who dream of home ownership and you would love to help them out. But realistically, it's certainly less than 10%.
On to your blue-collar properties -- the ones landlords love as bread-and-butter rentals. The percentage ups a little, but with frequent intermittent employment, self-employment, and chronic credit blemishes, even with increased incomes, the odds only go up to about 20%.
If we move up to the newer starter homes or quality rehabs in nicer neighborhoods, it's probably in the 35% range. And finally, what I consider the optimum and my personal favorite at around 50% is the newer home, less than 10 yrs old, just slightly above starter size, in a nice subdivision. Here in the DFW outskirts this 1800 sf will retail for around $140k while yeilding a slight cash flow. (eat your hearts out, California.)
Above this range, you usually will have a negative cash flow, the buyer market size is smaller, and the buyers seem pickier and more problematic. I have not had as good results in the higher end.
Now these percentages are my observations in my market, based largely on the type and value of the home, with just average screening, qualfying and with no special hand-holding techniques. Bear in mind however, there are additional things you can do to up the odds even better.

Increasing Your Owner Financed Cash Outs (part 2)
By: Gerald Paul - gerald(tx)

Increasing Your Owner Financed Cashoutsby: Gerald Paul
There are pointers that will further increase your cashout percentages:
- Recognize that a huge segment of the population will never qualify for a mortgage loan. They are permanent credit risks and are destined to be renters all their lives. It would be nice to "give them a chance", but stick with reality. Don't try to make homeowners out of these people.
- The present credit status of your buyers should be within striking distance of qualifying. FICO scores can usually be improved by at least 50 points over two years with conscientious effort. The buyers I like are those who have undergone a severe damaging event to their credit, such as major hospital bills, divorce, business failure, etc. In other words, their current credit status is a temporary situation, not a chronic one. They are eager to return to their former ranks of credit worthiness. Conversely, if a buyer's credit report shows chargeoffs going back for years, you are looking at a chronic situation which is unlikely to dramatically improve in your relationship.
- Having a relationship with a good mortgage lender who will work with you in exchange for your buyer's business is a valuable asset. I introduce my buyers to my loan officer who tells them face-to-face, if they will do certain necessary things, she will probably be able to get them a loan in less than two years. My loan officer sends them a monthly e-zine and periodic mailings. I also stress the importance of never being late for a payment and keeping a series of at least 12 cancelled payment checks. This continued massaging and communication pays off by instilling confidence in your buyers, and keeps you somewhat in control. It is so much more effective than simply telling your buyers to work at cleaning up their credit on their own and hoping they will comply. Hope is a poor business model.
- Newer construction is usually preferable to older rehabs. Reason is, during the first two years before your buyer refinances, a lot of surprises, known or unknown to the rehabber, can erupt. These are usually magnified in the mind of the buyer. Rehabs are typically in older areas which have no HOA to maintain standards and eyesores can surface. Throw a 'neighbor from hell' into the mix and the buyers often say, "maybe it might be better to just forfeit our down payment (or option fee) and shop somewhere else. After all, with our credit now improved, we can buy anywhere."
- Your advertising should be such that it attracts the most responsible prospects. For example: suppose you were in the market for a new TV or refrigerator. You pass a store sign "Rent To Own". Would you shop there? Probably not, because you know these stores overcharge by preying on the ignorant and desperate. If you advertise your home as "Rent To Own", you have just conveyed that same image to your best buyer prospects who are likely to bypass your property. To get the best prospects, your advertising and presentation should be geared to their intelligence and dignity.
- The ability to pay is the primary overriding consideration. If your prospects don't have sufficent income to comfortably (not just barely) make the payments, there is no point in going any further. And the income must be verifiable and sustainable for the future.
- The amount of down payment is important in that the greater the amount, the more binding the buyer is to the property. I currently insist on at least 4 to 5% down. If a person doesn't have that amount of cash up front, he shouldn't be house hunting -- for my property at least. It's tempting to want to bend on this to fill the house now before another payment is due, but I assure you it is better in the long run to wait until a stronger buyer comes along.
- Never be too eager to sell. Don't get excited just because your buyers say they want the house and have the down payment. I grill the prospects, explaining that they are using MY cash and MY credit, that I am not looking for a temporary resident. If they are not totally committed to owning the home, it would be better that we not enter into any agreement. It often sounds like I am trying to talk them out of it. I take their application and credit info release, but I am totally non-committal. I sell "pretty homes", and I want them to feel obligated if I "allow them" the privledge of buying my home.
- Don't overprice your property. Make your profit by buying bargains and selling at FMV. At the beginning your buyers are concerned with the amount down and monthly payment, but as refinance time approaches, total price looms larger. When they realize they are overpaying, they will take their newfound credit elsewhere.
- Structuring your deal as Owner Financed (using a CFD or wrap) is more effective than a Lease Option. First, you have no landlord responsibilities or liabilities. But more importantly, with Owner Financing, buyers are more committed, boast to friends and family they have "bought a home." In fact, it would be embarassing if they could not refinance and lose the home. Conversely with a L/O, the mindset is still that of a renter (who happens to have an option to buy.) It's so much easier to say, "we decided not to exercise our option." It may be largely psychological, but the degree of committal is enormous. Most of the heavy hitters using Owner Financing as their primary investment strategy never mention the words, "rent" or "lease".
Now, here's the rub. In most states, it is more difficult to foreclose on an owner than evict a renter. In my state, there's not much time difference, but if you live in a state which uses a lengthy judicial foreclosure process that takes months, it may be more logical to L/O. However, good structuring by a competent attorney can often overcome this obstacle. So let me qualify this one -- weighing all factors, if you have a practical choice, Owner Financing is preferred.
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That's about it for the main items. It would be nice if it were an exact science and we could assign a weighted point value for each, but it doesn't work that way. Depending on your market, certain items can be considerably more important than others. The best we can do is state that the more items you cover, the greater your chances of a cashout becoming a reality. And when that happens, those fat, backend checks are awfully sweet to cash.