Can Foreclosure Investing Be Criminal?

I recently attended a “free” seminar on how to “get rich quick” in foreclosures. The speaker had a different angle than the usual “steal it from the homeowner” method.

The speaker suggested that you approach the homeowner with the following plan:

1. Tell the homeowner you will make up his back payments and give him some cash.
2. Take title to the property.
3. Lease it back to the former owner with an option to buy it back for one year.

The speaker suggested that after one year, the house would be yours if the former owner didn’t exercise his option. Sounds great doesn’t it? You could beat out all your competition who are trying to “steal” the same house.

Well, here’s the catch. The poor homeowner in foreclosure will be your best friend when you make up his back payments. However, when the year is up and he can’t get his house back, the trouble will begin.

In a number of cases, these homeowners will go to court and claim that the “sale/leaseback” was really just a disguised loan. He or his attorney will ask the court to “re-characterize” the transaction as a loan and place title to the property back in his name. If the court agrees, the loan is illegal, since it is usurious.

Here’s how it works: Let’s say that you find a house in foreclosure worth $100k. The balance of the loan $50k, and the homeowner is behind $5k. You agree to make up the back payments of $5k and take title. You then lease it back to the homeowner with an option to buy it back for $100k, its fair market value. What’s the problem?

The problem is that if the court re-characterizes the transaction from a sale/leaseback to a loan, you have loaned the homeowner $5k at 1000% interest! Think about it… you give him $5k, and he has to pay $50k ($100k option price minus the $50k loan balance) to get his equity back. 1000% interest is usury, and the court will set aside the loan. You will lose the house AND your $5k.

If you’re not familiar with the word “usury,” it means charging more interest than permitted by law. The consequences of a usurious loan are usually civil; the court will declare the loan void and the borrower won’t have to pay it back. If you get caught making usurious loans on a regular basis, you’ll be hearing the words “loan-sharking” and “racketeering.” These are CRIMINAL acts that will get you in jail. Many foreclosure real estate investors have been indicted on racketeering charges for doing exactly what I described above.

Many states have recently passed foreclosure legislation that restricts the type of transactions you can do with a homeowner in foreclosure, as well as require certain disclosure in contracts. Review your state law with a qualified attorney before buying a foreclosure property.

Illegal Flipping and Lender Seasoning

There has been a lot of negative press and misinformation lately about double–closings. Many people have been indicted recently under what the press has labeled “Property Flipping Scams.” Misinformed lenders, real estate agents and title companies will tell you that double–closings are now illegal. In fact, they are nothing of the sort.

A double closing is simply two back–to–back closings wherein the proceeds from the second closing is used to fund the first closing. Both closings are done in escrow so that the “middleman” can buy and resell a property for profit without using any of his own cash. The middleman profits because he buys the property below market and resells it for market price. This process has been done tens of thousands of times over the last 100 years – legally, ethically and PROFITABLY!

The so–called “illegal property–flipping schemes” work as follows: unscrupulous investors buy cheap, run–down properties in mostly low–income neighborhoods. They do shoddy renovations to the properties and sell them to unsophisticated buyers at inflated prices. In most cases, the investor, appraiser and mortgage broker conspire by submitting fraudulent loan documents and a bogus appraisal. The end result is a buyer that paid too much for a house and cannot afford the loan. Since many of these loans are insured by the Federal Housing Authority (FHA), the government authorities have investigated this practice and arrested many of the parties involved.

Despite the negative press, neither flipping nor double–closings are illegal.

The activities described above simply amount to loan fraud, nothing more. Newspapers have inappropriately reported the activity as illegal “property flipping,” rather than simply “loan fraud.” So, whenever you hear a real estate agent or mortgage broker say, “flipping is illegal”, you know they are misinformed.

The misunderstanding of the flipping business has not been without consequence. Many title and escrow companies simply will not do a double–closing. Fortunately, there’s many that still do double closings, but they are also keeping a close eye on potential fraud (as they should).

Some lenders have placed “seasoning” requirements on the seller’s ownership. If the seller has not owned the property for at least six months, the lender will assume that the deal is fishy and refuse to fund the buyer’s loan. This may be a problem if you bought a property cheap and are reselling it quickly for a profit (the good, old American way!). This should not be confused with LAW – it is simply an underwriting guideline for some lenders. Of course, guidelines are just that – by going up the chain of command, you can generally get approval from loan underwriting by showing the property is being resold for a higher price because either it was purchased in a distress situation (e.g., foreclosure) or that substantial repairs were made. Keep good records of your repairs to show to the lender.

If the buyer is getting an FHA insured loan, there is no way around the “seasoning” issue. FHA regulations prohibit the funding of a purchase where the seller has not owned the property for at least 90 days, NO EXCEPTIONS. This generally should not be a problem in a fix–and–flip situation, since it will likely take you 90 days by the time you acquire, rehab and sell. But, if you are planning on buying the property and reselling it in a double–closing, the end–buyer CANNOT go with an FHA loan.

BRONCHICK’S RULE:
ALWAYS REMAIN IN CONTROL OF YOUR DEALS!

A smart investor should stay on top of the process and anticipate these issues. If you are buying a property and reselling it quickly, particularly in a double closing situation, you must anticipate this problem and deal with it. Let the buyer, his real estate agent and his lender know that there may be a seasoning issue. If you stay in control of the loan process and steer your buyers to a mortgage company that doesn’t have a hang–up with double–closings, then seasoning won’t become an issue. Generally speaking, only FHA and subprime lenders have the “seasoning hang up” – FNMA underwriting guidelines do not prohibit funding a purchase money loan where the seller has not owned the property for a minimum period of time.

If you do get into a last–minute jam in a double–closing situation, there is a solution, which is called a “reverse assignment.” You simply assign your contract with the end–buyer back to the owner and step out of the deal. Your “consideration” for doing so, is the profit you would have otherwise made. This consideration can be documented in writing and secured by a lien on the owner’s property to be paid to you at closing.

Real estate investing is like weight loss

It amazes me how many people get started in real estate investing, only to fail when the going gets tough. As soon as someone discovers they can’t get rich in a week or two, they are on to the next “hidden guru” secret. It’s the same as weight loss - everyone talks about it, many try it, but few succeed. There are thousands of “get rich quick” and “get slim quick” gimmicks. No wonder both the real estate investing information and weight loss products industries make BILLIONS!

Weight loss isn’t easy... ask anyone who has tried it. However, the concept of weight loss is very basic - burn more calories than you ingest and your body will react accordingly. Unless you have a medical disorder, this formula works for just about anyone. Simple as it may be, the formula is HARD, meaning it takes a lot of DISCIPLINE AND HARD WORK. So, the weight loss industry has offered us thousands of ways to make it easier. Many of these solutions do work, but they only work if you put forth effort.

Now, let’s start with the premise you don’t need any of these “solutions” to make real estate OR weight loss work for you. You can eat less calories, go walking or jogging every day and you will lose weight. But, having knowledge of the caloric content of different foods is relevant. Also, for many people, knowing the carbohydrate content is relevant. Having the advice of a physician, dietician and personal trainer will help you prevent injuries and maximum your effort.

Same principle applies to real estate - you can go out and make hundreds of offers to motivated sellers and find a good deal. However, having information about how to solve the seller’s needs and construct an offer will help. Having an attorney, real estate agent or “guru” to assist you with constructing the offer and the paperwork will make it easier. Having advice from other people who have already done hundreds of deals will also make it easier for you to learn from other people’s success (and failures). However, whether it’s weight loss or real estate, the bottom line is not just knowing, but DOING. You can’t blame the diet if you don’t stick to it. Many people have successfully lost weight using the ZONE, WEIGHT WATCHERS, ATKINS and other similar plans. Many people have succeeded with the famous “guru” plans, but many have failed, likely because they didn’t give the required effort, NOT because the plan isn’t effective.

Both real estate investing business and weight loss are simple, but neither is easy. It takes a lot of work. Having a proven “system” or plan helps, but only if you stick to it. If the diet plan says, “exercise 3x times per week”, you can’t be sloppy about it and expect results. It’s like the people reading a book on the treadmill at the gym - if you can read a book, you’re not working HARD ENOUGH. Likewise, people call newspaper ads and say “hey, you wouldn’t want to sell me your house cheap, would you?” This is not DOING it is TRYING. You have to give 100% to a particular plan or formula before you say, “this stuff doesn’t work.”

Many people who are interested in weight loss join a gym or hire a personal trainer. From personal experience, I can say that both are great for weight loss. But, the weeks I didn’t show up, it was a BIG WASTE OF MONEY! The same thing goes for a real estate training system or mentor program - if you don’t put forth any effort, it won’t work! And, of course, you’ll likely get bitter about all the money you spent and blame the guru. After all, it can’t be YOUR fault!

That brings us to another topic - the “scam” side of the real estate and weight loss business. Sure, the “magic pills” that melt off fat are probably a scam. These snake oil salesman are offering the lazy and desperate people a solution - no work and results. Hah! If you bought into this scam you deserve to be parted from your money. Likewise, any real estate guru who promises riches with no work is also a scam. My favorite promise is “no selling involved” - that’s the biggest lie ever told. No business can be successful without a certain amount of selling of their product or service to customers - period! So, while there is a dark side to the weight loss and real estate investing information businesses, I assert that most people fail at both because of their own lack of action, not the fault of the “systems.” If you aren’t willing to work, another weight loss program or real estate seminar won’t get you any more results than you are currently getting - save your money and take MORE CONSISTENT ACTION with what you are currently doing.

However, if you are willing to work hard and take a lot of consistent action, a guru or program will likely give you more results. If you bought a book, course or program and already have results, another program, course or book will likely give you tools to get MORE RESULTS. I often hear about successes people have with my real estate programs, but a lot of them are not FIRST TIME successes. They are most often people who have already been successful, and, using my tools, became MORE successful. If someone asks me whether my program will make them successful, I ask, “what other programs have you bought?” If they have already spend thousands on other programs and have done NOTHING, I discourage them from buying mine. These people are looking for the elusive “holy grail” that all the other programs left out. More than likely, the missing element is lack of action on their part.

If you aren’t willing to take action on a massive scale, you won’t get more results by buying more products. If you have the discipline to work hard and take consistent action, then products and services will help you get there faster. Whether you are looking to get rich or lose weight, the bottom line is YOU!

The ethical real estate investor

Many people have a very 19th century view of real estate investors. They think that we are modern-day “robber barons” who prey upon distressed or ignorant people, take advantage of them, and laugh all the way to the bank. The truly sad thing is that some real estate investors think this of themselves, and think that in order to get ahead, they must behave unethically. The truth is that, in the long run, it pays to be a scrupulous investor. Do you really expect referrals if you “take advantage” of people? Of course not. Envision yourself as a problem solver and your business will be much more successful - and you’ll be able to sleep at night.

Help People With Their Problems

PT Barnum said, “There’s a sucker born every minute.” But in today’s world, “suckers” are a little harder to find. The Internet makes knowledge much more widely available, and people are generally more savvy then they’re given credit for. In fact, ignorance is much more likely to err on the side of overpricing a home than underpricing it, and besides, do you really want to make your living by taking advantage of people? Doing so will likely come back to haunt you. Instead, you should focus on finding people with problems. It’s your job to help them.

There are thousands of properties across the United States that people desperately want - need - to unload, and they’re willing to do so at a discount and with favorable terms. Perhaps the owners have been involved in a divorce, received a job transfer, or they’re under a tremendous amount of financial distress. Don’t think of yourself as "taking advantage" of the situation. Think of yourself as extending a helping hand. The sellers will be able to detect the difference in your attitude and will respond differently to you. And after all, they need to sell. It’s hurting them each day that their home is on the market. If you come along and are able to negotiate mutually agreeable terms, then it is a win-win situation.

Be a Full-Time Problem Solver

The surest path to real estate investment success is to focus solely on helping troubled people solve their problems. Many distressed sellers are embarrassed about their situation, or don’t want to tip their hand for fear that you’ll take advantage of them. So simply ask the following questions of anyone you find through a classified real estate ad. Why are you selling? When do you need to sell by? What are your plans after you sell? What is the minimum amount of cash you need in your pocket as a result of this deal? What do you plan to do with the proceeds from the sale of your home? If we were to close within a week and I paid cash for the full purchase price, what’s the best deal you could give me?

Do not act like an interrogator. Strike up a conversational tone. Truly desperate sellers will be anxious to talk to you. Keep the conversation moving and get all of the information you need. Casually ask the same question in different forms more than once to make sure their story remains consistent. As previously stated, many distressed sellers are embarrassed of their situation. Do your best to make them feel at ease.

You Can’t Solve EVERYONE’S Problems

There’s two requirements for every deal I do with a motivated seller:

1. I make money
2. I solve the seller’s problem

If I can’t do BOTH, I won’t do the deal. This is a good rule to live by, since doing one without the other is not good for your business. If you help the seller and don’t make money, you are working for charity (which is fine, but keep it separate from your BUSINESS). If you make money and don’t help the seller, you are a slimeball!

Don’t waste time on the phone with people who don’t need your help. Unmotivated sellers take time away from your real vocation - lending a hand to those who need it. Stick to your principles and you will not only be conducting yourself like a Good Samaritan, you will be building a real estate investment empire in the process.

A House is its own best comp

An appraisal is a certification by a licensed professional that a house is worth a certain amount based on comparable sales. It is, however, an opinion of value based on one person’s analysis and experience. The actual “market value” is the amount a buyer is willing to pay and for which a seller is willing to sell under normal circumstances.

Investors often misunderstand the phrase market value. Here’s a good way to understand this: Imagine that a home has been on the market for several months. Typically, homes in this particular market sell within a few weeks. But if the seller doesn’t receive a single offer, you have to assume the property is overpriced. Several factors may contribute to the problem, including the condition, location, and layout out of the house. However, all these get factored into the asking price. In short, if the house is priced right for its location, condition and features, it will sell within the same time frame of other houses in the neighborhood.

Many times the real estate broker takes a listing at a higher price than “market” with full knowledge that the home is listed too high. Sometimes brokers do this to win the listing over competing brokers by telling sellers what they want to hear. Like the barber who says, “It’s a great haircut,” they’ll say, “I’ll get you a higher price.” Most often, having a price that is higher than market is the seller’s fault (rather than the broker’s) because the seller has unrealistic expectations about the property’s value.

However, you can’t always blame sellers. They get their information from other brokers, the sale prices of other homes in the neighborhood, information and misinformation from neighbors, and the most recent appraisal. Therefore, your job as an investor is to sift through the information and determine the real value of the property.

In the real estate business, the subject property is often its own best “comp.” This means that the final sales price agreed upon by the buyer and seller is generally the property’s true market value. It doesn’t matter what the real estate broker, appraiser, neighbor, or mortgage broker have said. The actual selling price will determine the property’s value.

A common trap for novice investors is the so-called “bargain” property. For example, a house is appraised at $200,000 and available for only $150,000. Certainly, there are cases in which a property is available for a real discount of 25 percent, particularly if the property is in disrepair or the seller is extremely motivated as in the case of a divorce or foreclosure.

Absent motivating circumstances, however, if the property in question sells for $150,000, the comp has been established for this house. The value of the property is what it sold for, regardless of what the appraisal shows. Many houses are listed on the MLS as “priced below appraisal” and, in fact, sit for months without selling. If a property was listed on the MLS at $150,000 for six months when the average number of days on market in that price range is 96 days, does the $200,000 appraisal mean anything? Obviously not!

A word to the wise: When you’re doing comparable sales, look at the sales history of the property itself. Knowing if it was previously listed, re-listed, or sold helps a great deal in determining a property’s true value. Don’t buy a house you think is worth $200,000 just because it is appraised for $200,000 – do your due diligence.

7 Ways to Flip a Property

Flipping” is the buzzword of the year in real estate - flipping books, flipping articles in the newspaper, and even flipping shows on TV! What is flipping, how does it work and how you can profit?

Flipping simply means buying a property and reselling it quickly, as opposed to holding on to a property long term as a rental. Flipping comes in several varieties, most of which are legal and profitable, some of which are not.

Flip Strategy #1: Buy, Fix and Flip

Let’s start with the most common form - the good, old “fix ‘n flip”. This process involves buying a property that needs work, fixing it up, then selling on the “retail” market, that is, to a person who will live in the property. This method is tried and true, and works very well. You can easily make $15 - $50k on one deal, depending on your market and how good you are at finding bargains.

The danger in fix and flips is either paying too much or underestimating repairs. Be very conservative in your fix-up costs and length of time it may take to resell. Also, make sure you include in your analysis the cost of paying a real estate agent to sell the property.

Flip Strategy #2: Buy, Refi & Lease/Option

Rather than sell the fixed up property for all cash, sell for terms. Once you have completed the rehab, refinance the property at its new appraised value. If you did the math correctly, you should have little or no money in the deal. Sell the property on a lease with option to buy. The rent payment from your tenant/buyer should cover your mortgage payment (if not, consider an interest-only or adjustable rate loan that is fixed for 3 years). When your tenant exercises his option to purchase, you reap a larger profit, since you don’t have to pay a broker’s fee. If the tenant exercises his option after 12 months, you benefit from a lower capital gains tax rate.

Flip Strategy #3: Buy & Flip “As Is”

Don’t like to do fix-up work? Consider selling the property “as is” as a light fixer upper. If the local real estate market is hot, you should be able to sell the property in poor condition just a little below market. This is especially the case with houses in “transitioning” neighborhoods. Make sure, of course, that you acquire the property sufficiently cheap enough that you can sell it below market quickly and still profit.

Flip Strategy #4: Wholesale

Strategy #1, the fix and flip, is very popular, which means there are a lot of investors looking for rehabs. You can buy the property cheap and sell it for just a few thousand dollars more to another investor without doing any work. You won’t make nearly as much as the rehabber, but you will realize your profit quickly.

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Flip Strategy #5: Pre-Construction

In very hot real estate markets, prices are appreciating as much as 2% per month. If you time things right, you can put a contract on a pre-construction house or condominium, then flip it to someone else when the development is complete. If it takes 12 months for the development to be complete, and the condo price is $500,000, you could make $100,000 or more in one year! Of course, the opposite is also true - you could end up losing money if the local economy tanks and you end up with a worthless condo that you can’t sell for more than you paid. Use this approach very carefully...

Flip Strategy #6: Scouting

The Scout is an information gatherer, so not technically a property flipper. He is the “bird dog” who finds potential deals and sells the information to other investors. Many people get started as a Scout for other investors because it does not take any cash or prior knowledge to look for distressed properties. The Scout finds a property for sale, gathers the necessary information, and then provides this information to investors for a fee. The fee will vary depending on the price of the property and the profit potential. The Scout can expect to make five hundred to one thousand dollars each time he provides information that leads to a purchase by another investor.

Flip Strategy #7: Illegal Flipping

OK, I am not advocating this approach, because it is illegal. Illegal property-flipping schemes work as follows: unscrupulous investors buy cheap, run-down properties in mostly low-income neighborhoods. They do shoddy renovations to the properties and sell them to unsophisticated buyers at inflated prices. In most cases, the investor, appraiser and mortgage broker conspire by submitting fraudulent loan documents and a bogus appraisal. The end result is a buyer that paid too much for a house and cannot afford the loan. Since many of these loans are federally insured, the government authorities have investigated this practice and arrested many of the parties involved. As a result, the public perceives is flipping to be illegal.

The fact is, “flipping” - as I described in the beginning of this article - is NOT illegal. Loan fraud in the process of flipping is what is illegal, so don’t confuse the two. The other six ways to flip are very legal, very ethical and very profitable!

The Basics of Foreclosure Short Sales

You will likely come across dozens of properties in foreclosure with little or no equity, that is, the seller owes at close to or more than the property is worth. In these situations, lenders are sometimes willing to accept less than the full amount due, commonly referred to a “short pay” or “short sale.”

Negotiating a short sale with the lender is a difficult process, generally because it is a daunting task finding a bank officer who has the authority to accept a discount. You will have to call around to locate the lender’s “Loss Mitigation Department”. More than likely, each lender you deal with will have a separate name for this department, so be patient when calling. Much like getting your phone bill corrected, you can expect the process to involve a lot of waiting on hold and being bounced around an intricate maze of automated voice mail systems. Once you get in touch with the right person, then the negotiating begins.

From the lender’s perspective, a short sale saves many of the costs associated with the foreclosure process - attorney fee’s, the eviction process, delays from borrower bankruptcy, damage to the property, costs associated with resale, etc. In a short sale scenario, the lender gets the property back faster, so it is able to cut its losses. Your job as the investor is to convince the lender that it will fare better by accepting less money now.

The lender will want some information about the property, the borrower and the deal he has made with you. Specifically, the lender wants to know what the property is worth. The lender will generally hire a local real estate broker or appraiser to evaluate the property (called a broker’s price opinion or “BPO”). You can also submit your own appraisal or comparable sales information. In addition you will want to offer as much specific negative information about the property as possible. Also, include some relevant information about the neighborhood and the local economy if things are bad (copies of newspaper articles with “bad news” may help). A contract’s bid for repair estimates should also be submitted, which, of course, should be the highest bid you can obtain!

The lender will also ask for financial information about the borrower. Sort of a backwards loan application, the borrower must prove that he is broke and unable to afford the payments. The borrower must show that he has no other source of income or assets to repay the loan. This process may involve as much, if not more paperwork than an original mortgage application! The borrower should submit a “hardship letter”, which is basically a sob story about how much financial trouble the borrower is in. This may require a little literary creativity, and some help on your part. Don’t lie, just paint a picture that doesn’t look good.

Finally, the lender generally wants to see a written contract between you and the seller. The lender wants to make sure the seller isn’t walking away with any cash from the deal. Generally, the contract must be written so that the buyer pays all costs associated with the transaction, so that the “net cash” to the seller is the exact amount of the short pay to the lender. A preliminary HUD-1 settlement statement is often requested, which can be difficult, since many title and escrow companies simple won’t prepare one in advance of closing. You can prepare your own HUD-1, and simply write “preliminary” on the top.

Don’t be surprised if your first short sale bid is rejected. Lenders aren’t emotionally attached to their properties, so they aren’t as likely to give you steal. Many short sales fall through if the BPO comes in too high, which is often the case. You can’t pull the wool over a lender’s eyes – if the property isn’t is need of serious repair, it is unlikely you can convince the lender the property is worth a whole lot less than the appraised value.

The process of the short sale is not that complicated, but the success or failure of the deal depends upon how you present it to the lender. Many novice investors and realtors give up at short sales quickly because their first deal is rejected. Like any business, short sales takes practice to get good. Generally speaking, loss mitigators are pretty good at spotting an amateur investor. If you know what you are doing, the loss mitigators are more likely to make a deal with you.

Want to become an expert at short sale deals? Register for William Bronchick's upcoming Foreclosure Investing Boot Camp.