Do you remember playing Monopoly and saving up to buy the fourth house so you can build a hotel to double your rent? What if you had the opportunity in real life to buy ten properties at once and start collecting rent on all of them? A plethora of bank-owned properties are coming to market, giving savvy investors the opportunity to make this type of wholesale purchase (also known as wholesale REO). Last year, banks sold millions of properties as REOs in bulk. This trend will continue throughout 2011 as a record number of properties continue to be foreclosed on and the cost of entry remains low.
How low? You can get in the game for as little as $50,000 for a small portfolio of bulk cash flow REO properties or as little as $100,000 for ten or more properties ready to become cash flow wealth building engines. These homes are not in the high-rent Park Places of the world, but in working-class Baltic Avenue-type neighborhoods, giving investors the ability to buy ten homes for the price of one or two.
The first premise of the bulk REO business model capitalizes on the large underserved market of working-class people who earn enough to cover rent, but can’t qualify or save enough to buy a home (see “Why Good People Can’t get loans”). Working class people are willing to buy houses and are willing to do repairs, at the right price. That price is equivalent to rent. It makes sense. Let’s say the median rent in an area is $450. Offer a working person a seller-financed home for $450 or less per month and they’ll take the deal. And they will make the payments because they already have a history of rent payments. These loans are designed for success, not doomed to failure.
The second premise of the bulk REO business model is that it provides a healthy cash flow with interest rates around 9.5% and an average term of 15 years.
Buying REOs in bulk gives investors the opportunity to put these portfolio building strategies into practice. An active investor will purchase more than 10 homes and then resell them to owner-occupants with seller financing (also called land contracts, deed contracts, or installment contracts). The investor’s name remains on the deed for the term of the contract while the owner-occupant makes monthly payments. The owner-occupant also bears full responsibility for property taxes, repairs, and maintenance. At the end of the term (15 to 20 years) the deed is transferred to the owner-occupant. Meanwhile, the investor gets a significant return on the initial investment.
For example:
Wholesale purchase price $12,000 (one house)
Sale price $37,000
Initial payment $1,000
Price financed $36,000 (15 years, 9.5% interest)
Amortized over 15 years $67,500
Less purchase price -12,000
Return on Investment $55,500
Passive investors who want access to the big returns, but don’t want to set up a massive REO business to sell homes to individuals, can buy a piece of the business. They buy the land contracts and underlying properties from active investors who have initiated seller financing and are looking for cash. These contracts are sold at a discount, offering even more advantages to the passive investor. For example, a 15-year 9.5% interest contract with a face value of $36,000, earning $375 per month, can be had for $26,500. Over its term, the contract will earn $67,500; that’s a 40% return on investment.
buyer beware
The bulk REO market is an exciting and fast-paced business, but as with any potentially high-return investment, there are plenty of charlatans. The internet is full of websites that claim to sell bulk REO listings (also known as bulk REO tapes); however, some of these listings are fraudulent and others contain truly unsaleable properties: burned-out structures, vacant lots, and uninhabitable mobile homes. To navigate this challenging market, trusted mentorship from a reputable listing broker is imperative. Do your due diligence. Ask for references. A reputable company will be happy to provide more than five non-relative references! Find out about after-sales support and get it in writing. Ask for the rates. Some companies hide their fees, others offer full disclosure, but all companies charge fees. Finally, take the plunge. The market for severely undervalued homes will dry up. Will you be the person with an income-generating portfolio to see you through your golden years? Or will you be the person who says, “If only…”
Why Good People Can’t Get Loans
1. Banks do not make loans for less than $60,000. The value of most bank-owned homes is $50,000 or less. Without private financing, these houses will remain vacant.
2. Many low-income families struggle to maintain a good credit score. Banks don’t like this. The savvy private investor knows that credit scores do not predict a person’s ability to pay a mortgage. The monthly payment is the predictor: loans are repaid at the correct price.
