The next wave of motivated salespeople is coming! Well that’s what I keep hearing anyway. We’ve been talking about this and other COVID-related tips on our YouTube channel. If you haven’t checked, please do so. One short video a week helping real estate investors like you make more money. While you’re there, do me a favor and watch our videos on YouTube and click subscribe. The more subscribers we have, the more people will see our videos and the more people we can help.
I am regularly asked what the next opportunities will be for real estate investors. Especially during these difficult times. Last month I opened up and discussed my opinion on what to watch out for. I mentioned that I don’t think transactions subject to lease options are the easiest fruit. At least not in the short term. Not sure what a lease option or subject is? Check out this post.
Other super smart real estate investors disagree with me. Their argument is that when there are distressed salespeople, there is more motivation and the salespeople will be more open to your creative offers. Although I don’t disagree, I think most of these sellers will have other options. Subject and lease options are most often used when there is an extremely motivated seller, the one who must sell, but does not have the capacity. It could be imminent foreclosure, but most of the time it’s when they don’t have the equity to price the property correctly and pay all closing fees and commissions. If they are unable to make payments, interest and late fees continue to rise, pushing them further and further away from a successful closing. Both the subject-to option and the lease option are fairly safe for the buyer, but are risky transactions for the seller. With these transactions, the seller remains in the underlying loan. They are still responsible, but depend on someone else to make the payments. These transactions are perfect for solving the seller’s problem when they have no other choice.
There are two reasons why 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 salespeople who don’t have the capital to sell in the more traditional way. In most markets, the rate of appreciation has skyrocketed in recent years. Anyone who has owned a home for a while will likely have equity only with appreciation. Add that to the fact that the 2008 credit crisis virtually eliminated low, no-down loans. Unless the buyer used VA or FHA, there is a high probability that they will have 10% or more as a down payment. They have capital from the day they bought the house. The interesting thing about VA loans is that they have a low default rate. VA borrowers often have no problems because the debt-to-income ratio to qualify for these loans is low, which means that the borrower has more than enough income to support the debt. You also don’t see a ton of VA loans unless you’re in a military town. So this leaves us with FHA loans that represent less than 15% of the total loans that exist. FHA loans can be risky due to flexible guidelines and a 3.5% down payment requirement.
We have talked in the past about the risk of leniency agreements and how these could be causing a small increase in supply. When those start to expire, we could see a wave of loan defaults. While that’s true, according to Black Knight, only 9% of forbearance loans are less than 10% in equity. Even the most troublesome loans, the ones that could cause a collapse, have equity and should be able to be sold with a real estate agent if necessary. The only interesting argument is the recent refinancing frenzy. With rates at record lows, people have been leveraging their capital. Although this is the case, the LTV guidelines for a cash refinance remain low, so even those borrowers retained their home equity.
The other reason I don’t think we’ll see a wave of lease or lease option opportunities is interest rates. These strategies work very well in a high rate environment. If the real estate investor can afford another loan at a low rate, he or she can pay more for the property. In a low rate environment like the one we live in now, investors can rate new loans that are similar to or better than a seller’s loans. There are few incentives to pay more for a property. The Fed has already committed to keeping rates low until 2021.
With all of that said, I don’t want to discourage you from keeping an eye out for these buying strategies. As many of you know, I have done over a hundred of these and this is how I got started as a real estate investor. I really love these strategies. Both work well in any market and there will always be sellers for whom this type of offer is perfect. I just wanted to share why I think investors hoping this is the next big deal might have a long wait.