PLP 093-Subject 2 Investing And Lending In The 2nd Position
On today’s show, Keith Baker is joined by Ray Sasser and Landon Rothstein to discuss a niche topic that always seem to have a perceived risk - Subject 2 investing. What does it mean to purchase a property subject 2? Ray is known throughout the investor community as an expert rehabber as well as an expert transaction engineer. Landon is a full-time real estate investor and has teamed up with some amazing partners. Together they host one of the fastest growing real estate meetups in Houston. Don’t miss this episode as they explain Subject 2 investing and lending in the 2nd position.
Subject 2 Investing And Lending In The 2nd Position
Ray Sasser & Landon Rothstein Explain Sub2 Investing
I’m going to bring on two guests that have been on the show before. They’re both full-time real estate investors in the Greater Houston area. They are my friends, Ray Sasser and Landon Rothstein. I always tell people to avoid second liens until they are very seasoned and confident in what they’re doing in private lending. However, this topic on subject-to, buying a property subject-to and possibly lending on what money the investor needs to get the seller out of the house. I’ve wanted to talk about this on the show, but I haven’t figured out the best way to do that because I want to learn about it from all angles, not just from the lending perspective but something to incorporate into my investing portfolio. Make no mistake, I’m neither endorsing nor recommending you incorporate junior liens into lending any sub-to deals. It’s a possibility. You can make money and you can lose a lot of money. It's just like any other thing, you’ve got to know what you’re doing and navigate through tricky waters. I want to shed some light on this topic from two people who utilize this strategy in their real estate every day and they’re not out on the circuit trying to sell a book.
This is Ray. I'm honored that you put me on the upper billing of the marquee.
You're very welcome. Thanks for coming back on because we are going to discuss a niche topic that I have stayed away lending on these types of deals because of perceived risk. I understand that you are one of the masters of creating a subject-to deal with and then getting private lenders to fund the down payment to the seller. Let's go ahead and back it all up and explain in case nobody knows what it is. What does it mean to purchase a property subject-to?
In a nutshell, subject-to is you're taking over the note, the existing financing that's already in place from the seller. A lot of people get involved with subject-to but they don't seem to know the difference between a real subject-to and an assumption. What we're doing is not an assumption. We are leaving the financing in the original seller's name and then we're making the payments for that person. To get there, we have to do some catching up over arrears. I might have to make a payment to a wholesaler. The wholesaler is bringing me the deal and sometimes the seller will want some money. There will be some money that'll take to get into that position. Once you're there, you usually have a nice low-interest rate. I'm getting interest rates. I've had one as low as 2.8%. They're generally around 3% to 4.5%, maybe 5%, which is a whole lot lower than I pay my private lenders. You know this for a fact, Keith, because you're one of them. The subject-to is pretty powerful once you get into them.
I charge a lot more than 3% to 5%, don’t I?
The main thing I was saying here with the difference between the assumption and taking over the position of the original seller is we're not putting anything in our name, which is critical. You don't want these things in your name. You don't want to have to go through all the hurdles the banks are going to make you go through and get approved for a loan. With the subject-to, that loan is staying in the original seller's name.
Landon, I was even told that because you're not personally liable for that, you don't even have to show it as a debt on your income and debt statements. In reality, it looks at income, but you don't have the debt obligation. It makes your P&L look a lot better.
That's true because you're not tied to it. Your Social Security is never coming up in that situation. It doesn't get recorded on your credit. It's obviously recorded on the previous seller's credit. That's why you've got to be consistent with making the payments. Another question that I get a lot with the sellers, they'll ask me, “How do I know you're going to make the payment?” Part of what I was saying before is, “If I gave you $10,000 in arrears and gave you another $3,000 and walk away, I don't want to lose that money. I've got to make my monthly payments. Otherwise, the bank is going to foreclose on me.”
[bctt tweet="Let time work for you and let the money be your soldier." username=""]
If the seller is motivated, this is not near as bigger an issue as people conjure it up to be in their head as potential buyers. The one thing that Landon's said, the arrears, if you're not active out there, you may not understand, but the arrears that almost all these subject-tos that are going to have passed to the payments that are owed. I'm seeing anywhere from $0 to $35,000 or $40,000. If the number gets too big, then it might not make sense to do the sub-to, but you’ve got the arrears and then you’ve got to solve their problem. Their problem might take $5,000 or $10,000 or $20,000 or $30,000. In sub-to, you could literally be in it anywhere. We've been anywhere from $0 to about $50,000 and under the right numbers, they can now make sense.
It's not an assumption. You're going to be paying the note for the seller, keeping it in their name. It is not just a great accounting tip from you, Ray, but that's great because it doesn't much hit your credit, it does not reflect it. It doesn't limit up or eat up one of your many mortgages that Fannie Mae will allow. I could see the benefits of that. When you say $50,000 in arrears, I picture a Ray Sasser house, which means that's about 100 Landon houses.
One of the things that the subject-to has done for me, I'm getting into a whole lot of nicer houses. I'm getting houses that are over $300,000 or $400,000. I'm getting into them at a low bar. I don't need to jump through all the hoops to get approved for a loan. It may have come up with anywhere from zero to $50,000 to get in. I'm not having these little rinky-dink Landon houses. With the subject-to, it's opening up a whole new, bigger, better world for me.
The house that I did the drive-by on out here near me, I was impressed. I had a little tear in my eye for you. I am like, “He's growing up. That's a nice house.”
The house he checked out for me in Katy, that's what I'm talking about. That's right in that ballpark that was around a $400,000 house.
The arrears, I would assume and correct me if I'm wrong, it's not just payments and late fees to the mortgage, the bank. There’s maybe not a property tax, but the HOA is for sure. What are the hidden fees?
A lot of times, there are not really hidden fees because most of the sub-tos come when you do foreclosures or it's pre-foreclosures. A lot of times, we're dealing with a seller and the bank. The bank has what they call suspense accounts. They're accounting for the taxes and the escrows, it does get complicated. Every one of these, you've got to look at how the fees are broken down because you're going to have a foreclosure. You're going to have a payoff amount and a reinstatement amount. The payoff amount might be $90,000 and the reinstatement might be $20,000. The question is, “If I pay the $20,000, does that mean the balance of $70,000?” The answer is no. You have to get the reinstatement amount. You have to get the payoff amount. You have to put the two forms side by side and see which ones you get credit for and which ones you don't. It's very possible that the reinstatement might be $20,000 and the payoff is $90,000, then when you reinstate it, the payoff real balance is $75,000.
You have to figure out how they're doing their math because each mortgage company does it differently. You have to make a decision to reinstate. It's not uncommon on a sub-to, for example, the same scenario, $20,000 reinstatement, a $90,000 pay off. Once you reinstate it, the payoff is $75,000. You’ve got to say, “I'm in this for $95,000.” If the seller wants to stay 5%, which is not unusual, then you're in it for $100,000. If it's got after-repair value, ARV, $170,000 or $180,000, you do those deals all day long. If you're a wholesaler, you set it up like that so that when you turn around and sell it to, hopefully, me or Landon or anybody else, then you set that sub-to up, we're much more excited about doing that deal. We'll look at that deal a lot sooner than we might look at some other deal where it's all cash.
Landon has asked on several occasions if I'd be willing to give a private loan on a sub-to deal in order to cover the arrears or get the loan reinstated, get the borrower happy, and take a second position behind the existing note. I've also learned from Landon, I'm very conservative and I tell them no politely. I let them down gently. Landon, I understand you've found somebody, a private lender who is taking the second position liens and providing the arrears and let's call it the ketchup money.
[caption id="attachment_2706" align="aligncenter" width="600"] Subject 2 Investing: Most of the Sub 2 come when you do foreclosures or pre-foreclosures, you’re dealing with a seller and the bank.[/caption]
Let's talk about the technical aspect. The reason why people would say no is because that underlying lien is a first lien. It is putting that lender in the second lien position. As long as there’s a second lender, there are a couple of ways you can offset that is you want to verify the values there. In our scenario, if it's $90,000 or you're in it for $105,000 and the worth is $180,000 and you're bringing that $15,000 or $20,000 as a second lender, you've got an underlying of $75,000. You've got about $20,000 on top of that as a second lender. You've got about $60,000 equity in it. Your top loan-to-value for both loans is probably around 60%. As long as your LTV is low, as long as you can control that first, in other words, let's say Landon gets hit by a bus, do you have the right to come in and make those underlying payments? I think you're relatively safe. Everything else, as a lender, you've got to do your due diligence. Have somebody else put eyes on the property, make sure it's a house. It has four walls, a roof and it's not sitting over a sinkhole. You’ve got to make sure that there's real equity there and do real comps. I think that second liens are never as good as first. As far as second liens go, it's probably a pretty safe bet for the right people.
Let me tell you how to negotiate with Landon. He said, “I don't like that. What if you die?” Someone gives you some collateral on something else. I do a blanket mortgage for these collaterals.
That was my next point is if you can collateralize that second appropriately, then you eliminate and mitigate a lot of risks if you cross collateralize to protect that second. I like that idea.This is a true private lender. This is someone you had a relationship with before. You didn't pick them out of the phone book. You told him, “I'm doing real estate investing, it is a big deal what I'm doing.”
I knew him before my real estate investing days.
This is not a private lender thing. It's understanding the process. If you don't understand it, then it's worth learning because there are banks out there that do nothing but loan car dealers money to buy cars with. To me, how can a bank prosper and grow and go from one branch to the seven branches and work with that market segment with all the shenanigans that are going on? It's knowing who you're dealing with, knowing that you're properly collateralized and making sure that the properties are what you think they are. If you checked the boxes that need to be checked, that it's very doable.
This is why I wanted to have you both on the show to not only explain it to me but also to the audience because to me, the second lien is a bad word. I call it the Dave Ramsey effect. He says, don't use credit because he screwed up his credit. I tell people don't do second liens.
Dave Ramsey also said that we're having a depression in the real estate market because the number of houses reduced. It wasn't because we were having a depression. It was because the inventory dropped. People were buying houses as fast as they can be produced. I don't know about Dave Ramsey. I like a lot of what he says, but the devil's in the details. You have to figure out what the details are. Second liens get a bad name because, for example, there are people out there that go and get hard money loans. There are $30,000 or $40,000 short. They can't get to the first draw, so they bring in somebody else. To me, that's a high-risk loan. That's a product that's not performing. You're relying on the first borrower, the person borrowing on the first lien. You're requiring for that guy to produce a product that's not existing. If the house is not performing, he's going to turn it into something, but you've got to make up, $40,000 or $50,000 he's short because he can't afford the down payment. He can't afford the first draw.
Those people are doing those second liens. That scares the hell out of me. There are too many things that can't work. In this case, you've got a property that's probably already mature, that's in a reasonable subdivision. A lot of times, these houses are built from 2005 to 2009 when the interest rates were low. They don't need any major improvement. I would be more concerned with a major rehabber borrowing money because he doesn't have enough money holding capital to get through the first stages of the deal. Second liens can be very dangerous. That's called gap funding and I've never understood why anybody would be a lender in gap funding. I don’t know if you have people that come on and talk about that.
No, in that scenario. I get approached a lot. I've got this hard money lender who will do the loan. I just need to come up with this cash and it's no, because I'm not investing in a property so much at that point. I'm investing in a process, that guy's work product, whether he or she is able to perform much riskier, than a properly collateralized second lien.
[bctt tweet="Everything in real estate can be complicated. You need to educate yourself." username=""]
I've been in the leadership role in the REIA for quite a few years. We hear a lot of the horror stories that people don't talk about. We had our REIA here in San Antonio. We had people that had about fifteen rehabs going and they were getting gap funding for every one of them. Their days on market extended and they started holding the houses a little bit longer and all their loans started collapsing. We didn't even know it was going on. A couple of our members came to us and literally said, “This is what we're dealing with. What can we do?” We gave them the best advice and gave them names of the attorneys that specialize in that. Almost all those people lost their gap funding because they were being second lien holders on projects that people were working on.
They weren't even qualified to get them done. If you're going to be a gap funder, you better be like a JV partner. You better have a way to buy that person out. It’s better to be with somebody that's got a real track record. Not somebody who's been doing it for 2 or 3 years, but somebody doing it for a long time and has done a lot of transactions. I got in front of the room in San Antonio and said, “If you're a gap funder and you're not a professional lender, you're probably going to lose money.” We'd stop.
I’ve got to keep you away from one of my lenders. I have a bridge loan set up with one of my lenders. He gave me a $600,000 line of credit that I'm using as a temporary place and hold it until I get long-term financing in place. I've got a company that will let me do long-term wraps. I'm using my private lender’s money to get the deals because time is of the essence. You’ve got to have your cash ready to go and he has as good as cash. I literally get it sometimes the same day or usually the latest the next day. I've got the money instantly. We process them off with this company that's letting me do the long-term loans.
What interest rate are you getting?
For the long-term money, its 8.5%.
That's pretty good.
It is because they're the only people in the whole world that seemed to let me do a wrap.
Are you doing a sub-to or a wrap? Before you get into that, Landon may have told you that we're doing a webinar and we’re going to talk more about this and then we're doing a whole day class on sub-to on how to negotiate for the sub-tos, how to do and talk about what the extra strategies will be, which will include either renting or doing a wrap. Even for flippers, it’s good because for a flipper, instead of bringing in $100,000 to the table, you might be bringing $20,000. The point that people miss is that if you're the wholesaler and you have options sending this up and say, “I'm going to sell this to my potential buyers. I'm going to negotiate an all-cash transaction.” If you were to say, “Try for the sub-to first as a wholesaler, then structure that.” When you go to sell it to the marketplace, somebody like me or Landon or people that are really active, if you say, “You only have to bring $20,000 to the table because $70,000 or $80,000 can be done a subject-to,” even as a flipper, that's a good thing. I might not have to bring in a hard money lender. If I don't have to bring in a hard money or private lender for that first because I'm taking it over as a sub-to, that deal gets to be a lot more attractive. I might be able to do it out of my IRA and my bank account and I don't have to pay those extra costs. If you don't mind, can you tell them what the wrap is and what that means and how you're doing it?
The wrap means that there's already an underlying lien in place. When I sell, I sell to my end buyer on owner finance. These are perfectly fine. You’ve got to disclose that you have an underlying lien. You can’t not tell the end buyer that there's an underlying lien there. My lender is okay with it. My borrower is okay with it. As long as all your documents are signed, you're fine. Some of the other things I would've added there with the classes that we're going to have is a checklist for the subject-to process. We have a separate checklist for documents that I need from my end buyer and then we'll have a sample contract. That'll help the people get these subject-to deals done.
[caption id="attachment_2707" align="aligncenter" width="600"] Subject 2 Investing: We're having a depression in the real estate market because the number of houses reduced.[/caption]
The key on the wrap, when you're wrapping that loan, you're wrapping it in what interest rate?
What is your underlying cost?
It depends. I get loans as low as 5.5%. With this one company, I'm doing a lot of work with 8.49%. I've got a little bit of a spread even. 8.49% is the highest that I ever have underneath.
If you're doing a sub-to, then what is it?
The sub-to, I might get those at 2.8% or 3%, 3.5% all the way up to maybe 4.5%, 5%.
Explain that. I know you probably have a lot of the same people, but for me, the arbitrage is the whole story. That's the whole reason to be excited.
You lock up a house, take it over sub-to. I'm talking from the investor, not as the lender at this point. I'm very in favor of it. There are two things I wanted to say. One, it was a smooth segue into promoting the class and getting the plug. I like that. Two, aren't you having a private lender speak at that class?
We'd love to have you because talking about private lending, we get confused. We think this is about real estate. It's not, it's about understanding the money. From a private lender's perspective, that's what it's all about. What you're about to say on the arbitrage, this is what it's about. I think I spent the first 15 or 20 years real estate investing working on the wrong stuff, such as fixing up houses, collecting rent and chasing tenants. The more we start focusing on the money aspect of it and how to make the money work for us when we're awake and asleep and Landon would be on one of his many cruises, the more we realize how important understanding the money is. To me, the whole point of the sub-to class and the wraps, the primary focus of that is going to be, “What does that mean money-wise?” That's the main thing we've got to understand. Once we understand why that's important, then we can drill down into, “How do you convince somebody to do the stuff too? How do you tell that buyer that there's an underlying mortgage and what happens if you don't pay that underlying mortgage?” How do you have those conversations and how do you protect that buyer? How do you create this process where it's safe for all the people that participate? What do you do if something goes wrong?
You bring up a good point about the financing instead of slaving away rehabbing houses and collecting rent. I'm doing a deal in Humble where the end buyer is going to pay me $431,000 and interest over the course of the loan where I owe right around $200,000. I'm going to make over $200,000 just on the financing aspect of this, not counting my spread on the property. That's where the real magic comes in.
How many hours will it take you to make that $200,000?
Not much. Probably, literally under 30 hours. That’s dealing with the power of attorney and getting all the docs sign and going through closing. Over the years, I have my note servicing company collect the money from the buyer, so not too much there either, but I've probably got about 30 hours in.
You've got to collect it over a period of time. If you get a 100 of these, you're not going to be the person collecting them. Two or three years, the person collecting the goal was to figure out how to reach that point.
I don't do on any of these anymore. I let the note servicing do it.
That’s all about automation. I’m getting to your point. Most people start off by creating a job for themselves, whether they're a landlord or flipper. Normally, people come in later on and become private lenders or to deal with the money because they understand the process, they can analyze the deal quickly. If you follow Robert Kiyosaki's Quadrant, that’s the investor’s highest one at the top as far as being passive. What I love about private lending is being passive. I’m looking forward to this class because I want to put together a learning module on being a private lender on a sub-to deal, where you can mitigate, where there’s risk and where you can get yourself into some serious trouble, and going back to the LTV and whatnot. At the end of the day, as a private lender, I'd be vetting on you and Landon more than the property and knowing what you both can do.
I always tell people, don't loan to strangers on the second lien. I loaned to a friend on the second lien and I got robbed on that one, but I did not properly collateralize my lien and that's on me. I am looking forward to it because above all else, I am a huge proponent of creative financing. Looking at a set of rules and finding ways to stay within those rules, but to create profit, to create value and have my money work for me. This is a very interesting concept. This is one of the reasons why I wanted to have you both on the show so I could make me eat a little crow about the second position and to understand a little more how it's protected. Where can they go to find out more about this class and your webinar?
As I'm sitting in this little picnic table and there's a little a canopy or with a tower, a little umbrella over the top. I'm sitting there dealing with a major rehab issue. I look up and there are Landon and my wife walking around smashing grapes with their toes. We're in Napa Valley and they're making wine. On that trip through Napa Valley, as I was on the phone dealing with rehab issues, Landon looked into somebody in the car. I remember him saying while I’m talking on the phone dealing with what stupid contractors do. He said, “That's why I don't do rehabs.” I thought, “That makes a lot of sense. We're on vacation, I'm working my tail off trying to get somebody to finish the job.” When you set this sub-to up, instead of wrap up or even private lending, the goal is to let time work for you and let the money be your soldiers instead of you being the soldier.
[caption id="attachment_2708" align="aligncenter" width="600"] Subject 2 Investing: The primary focus should be what real estate investing means money-wise. Once you understand why that's important, then you can drill down into convincing somebody to do stuff, too.[/caption]
Ray spent over fifteen years rehabbing. It takes him a whole lot longer to figure out to get to where I am. I did it maybe in the third of the time that he did.
To be fair, Ray did this without the same technologies that we have. Isn't it true that when you went to the land grab in Manhattan, didn’t you have to survey your own lots?
I got to work with the founding fathers.
I tease out of love. Landon and I referred to Ray as the encyclopedia of Houston Area Real Estate investing. Thanks again for coming on. Welcome back. This is your second time and the first time you are together. We'll see if we can do some more.
I'm giving my phone number as well too. If anybody wants to call about the class in case the name is too long for them, they can call me at (281) 852-7777.
We're looking forward to it. Thanks again for coming on and for sharing your knowledge about subject-to and helping me wrap my head around it so we can find ways to increase safety and mitigate the risk.
They can come to the webinar too.
If they get on with the computer, we'll have some graphics to show a picture of how it works. Everything in real estate can be complicated and you need to know and you need to educate yourself. If you can borrow millions and millions of dollars without having to qualify for it, that's a good thing.
Thanks again. We'll see you soon.
Thank you, Keith. Thanks for having us.
Thank you, Keith.
I hope you found some value and you learned something. I’m looking forward to going to their class and learning. I will report back on what I find out from these guys. Please help me get the word out and increase awareness for this show by sharing or forwarding this episode to somebody you think might benefit from it or maybe it’s somebody you're trying to cultivate into a private lender. It’s a great source for them. You suggested but it's not your idea, so it’s impartial value to them because it's a third party. Please leave an honest rating and review over at iTunes, Google Podcast or whatever platform you use to listen to this show. You can connect with me at Twitter, Facebook, Instagram, LinkedIn, BiggerPockets. All of the social media stuff, the normal place, the usual suspects. Please remember to look for and utilize the Private Lender hashtags, which are #NeverTrustAlwaysVerify and #MyMoneyMyTerms. I hope your New Year is off to a great start. As always, I wish you safe and prosperous private lending. I’ll catch you on the next episode.
Ray has been buying Single Family houses for more than 30 years around the Houston area. During that time he has bought and sold over 1,000 houses.
He also owns a property management company and typically has 3-4 rehabs going on at any time. Ray is known throughout the investor community as an expert rehabber as well as an expert transaction engineer. Ray is the kind of investor Private Lenders should seek out.
About Landon Rothstein
Landon Rothstein began real estate investing by using conventional bank loans. But he quickly found after the fourth loan the banks would no longer loan to him. That’s when Landon began utilizing loans from private lenders to amass a portfolio of well over 80 rentals and owner financed notes. He now enjoys the lifestyle of a full-time real estate investor, and has teamed up with some amazing partners.
Landon has teamed up with Houston area REI heavy hitter Ray Sasser. Together they host one of the fastest-growing real estate Meetups in Houston.
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