New Twist on Short Sales for RE Investors

Food for Thought....

I attended an REI Club meeting this evening (busy day today) for the first time to get a sense of the turnout, local investor interests, networking, etc. Something I should be doing more of. Anyway, one of the guest speakers was a very experienced and successful real estate investor who was talking about foreclosures and how she makes a huge profit by helping people in default save their house with a short sale. SAVE their house? How could this be?

We walked through an example and it turns out she figured out a very interesting and positive spin on how to work with homeowners in default and lenders with non-performing loans. It's a bit complicated, but here's an example:

Adam Homeowner has a $300K first loan and a $200k second loan and is falling behind on his payments. His house is currently worth $500k meaning he has zero equity. Enter Bob Investor. Bob negotiates a short sale with the bank on the owner's behalf and is able to knock the first down to $250K and the second down to $20K (total of $270K). He then gets a hard-money loan at 65% LTV, meaning he gets a loan for 65% of the current market value ($500K) = $325K. He uses $270K of these funds to purchase the house from the bank (effectively stopping the foreclosure process) and holds the extra $55K in reserve funds (aka cash back at closing). Joe then puts the property in a land trust.

Here's where the story gets interesting. Joe then signs a contract with Adam Homeowner (original homeowner) giving Adam the option to purchase the house back from Joe in 6 months for $450K (10% below market value). Adam has to go find a place to live for 6 months, but then has the opportunity to get his house back with some built-in equity.

In the meantime, Joe finds a tenant-buyer to sign a 6-month lease option contract with the following terms: $20K down, $2000/mo. rent (20% below market rent as incentive) and the "second position" option to purchase the house in 6-months for $450K (the same price as Adam). Read again.....the "second position" option to purchase the house behind Adam. Why would a tenant-buyer agree to being in the second position? Because he gets to live in a house for 20% below market rent and the real possibility that Adam may not be able to come up with the money in 6 months.

After 6 months, Joe Investor sells the house for $450K to either Adam or the tenant buyer. Here's what the numbers look like:

• Joe Investor is able to purchase a $500k house for $270K from the bank thereby creating $230k in equity
• He borrows $325K in hard money ($270K to purchase house, $15K in points, $22K in carrying costs for 6 months = total of $307K) with leaves him an $18k cushion for unknowns.
• He receives $12K in rent ($2K x 6 months) from the tenant-buyer
• After 6 months, whether he sells to Adam Homeowner or the tenant-buyer he nets: $450K purchase price - $325 loan = $125K. Then add $18K unused loan + $12k rent = $155K
• If neither Adam or the tenant-buyer exercise their option to purchase the house, Joe nets the same amount less realtor commissions to sell the house. Of course, he could also sell it for a higher price.
  

Not bad, eh? I wonder how lenders look at this situation. The homeowner gets to walk away from their debt yet is able to move back in with new financing within 6 months. However, the bank does get rid of a non-performing loan. Hmmm...The RE investor who uses this method was very knowledgable of California law and insists this is a legal, healthy and effective way to help owners save their homes. She runs a program called www.millionaireacademy.com (cheesy website) and is heralded by many real estate investors in my area.

I personally am a big fan of the goodwill that's created in this situation, if it's legally sound. I'm curious of everyone's thoughts. Please post them on this blog. Thanks.

Jordan