Subject To Investing After COVID – Is This the Next Big Opportunity?
The next wave of motivated sellers is coming!!! Well, that is what I keep hearing anyway. We have been talking about this and other COVID related advice on our YouTube channel. If you have not checked it out, please do. One short video a week helping real estate investors, like you, make more money. While you are there, do me a favor and view our videos on YouTube hit subscribe. The more subscribers we have the more people will see our videos and the more people we can help.
I get asked on a regular basis what the next opportunities will be for real estate investors. Especially during these trying times. Last month I opened up and discussed my opinion on what to keep an eye on. I mentioned that I do not believe that subject to or lease option transactions will be the low hanging fruit. At least not in the short term. Not sure what a subject to or lease option is? Check out this post.
Other super smart real estate investors disagree with me. Their argument is that when there are distressed sellers, there is more motivation and sellers will be more open to your creative offers. Although I don’t disagree, I believe that most of these sellers will have other options. Subject to and lease options are most frequently used when there is an extremely motivated seller, the one that must sell, but they don’t have the ability. It could be a looming foreclosure, but most often it is when they do not have the equity to price the property correctly and pay all the closing fees and commissions. If they are not able to make payments, the interest and late fees continue to accrue, putting them farther and farther from a successful closing. Both a subject to and a lease options are pretty safe for the buyer, but they are risky transactions for a seller. With these transactions, the seller remains on the underlying loan. They are still liable, but they are relying on someone else to make the payments. These transactions are perfect to solve the seller’s problem when they have no other option.
There are two reasons I think it will be a while before we see any real traction with these buying strategies.
As mentioned, these creative buying strategies work well with motivated sellers that do not have the equity to sell the more traditional way. In most markets, the appreciation rate has been through the roof in recent years. Anyone that has owned a house for a while will likely have equity with appreciation alone. Add that to the fact that the 2008 credit crises virtually eliminated low and no money down loans. Unless the buyer used VA or FHA, there is a high chance that they have 10% or more as a down payment. They have equity from the day they purchased the house. The interesting thing about VA loans is that they have a low default rate. VA borrowers do not typically run into trouble because the debt to income ratio to qualify for these loans is low, meaning the borrower has more than enough income to support the debt. You also do not see a ton of VA loans unless you are in a military town. So, this leaves us with FHA loans which represent less than 15% of the total loans out there. FHA loans can be risky because of the loose guidelines and the 3.5% down payment requirement.
We have talked in the past about the risk with forbearance agreements and how those could be causing some pint up supply. When those start to expire, we could see a wave of loan defaults. Although that is true, according to Black Knight, only 9% of the loans in forbearance have less than 10% in equity. Even the most troubled loans, the ones that could spark a crash, have equity and should be able to sell with a Realtor if needed. The one interesting argument is the recent refinance frenzy. With rates at record lows, people have been tapping into their equity. Although this is the case, the LTV guidelines for a cash out refinance is still low, so even those borrowers retained equity in their homes.
The other reason I do not think we will see a wave of subject to or lease option opportunities is interest rates. These strategies work great in a high rate environment. If the real estate investor can take over another loan with a low rate, they can pay more for the property. In a low rate environment, like we are in now, investors can lock in rates with new loans similar to, or better than, taking over a seller’s loan. There is little incentive to pay more for a property. The Fed has already committed to keeping rates low through 2021.
With all this said, I do not want to discourage you for keeping your eye out for these buying strategies. As many of you know, I have done over a hundred of these and is how I got started as a real estate investor. I really do love these strategies. They both work well in any market and there will always be sellers that this type of offer is perfect for. I only wanted to share why I believe that investors that expect this to be the next big opportunity might be in for a long wait.