The next wave of motivated sellers 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. One short video a week that helps real estate investors, like you, make more money. While you’re there do me a favor and check out 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 am regularly asked what the next opportunities for real estate investors will be. Especially during these difficult times. Last month I opened up and discussed my opinion on what to watch for. I mentioned that I don’t think lease option transactions are the low hanging fruit. At least not in the short term. Not sure what a leaseable option is? Look at this post.
Other super smart real estate investors disagree with me. His argument is that when sellers are in distress, there is more motivation and sellers will be more open to your creative offerings. While 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 who must sell but lacks the capacity. It could be an impending foreclosure, but most often it happens when they don’t have the capital to properly list the property and pay all closing fees and commissions. If they can’t make the payments, interest and late fees continue to add up, putting them further and further away from a successful closing. Both subject and lease options 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 they trust someone else to make the payments. These transactions are perfect for solving the seller’s problem when he has no other option.
There are two reasons why I think it will be a while before we see real traction with these long strategies.
As mentioned, these creative buying strategies work well with motivated sellers who don’t have the capital to sell in the more traditional way. In most markets, the appreciation rate has skyrocketed in recent years. Anyone who has owned a home for a while will likely have equity from appreciation alone. Add that to the fact that the 2008 credit crunch all but eliminated low and no down payments. Unless the buyer has used VA or FHA, there is a high chance that they will have 10% or more as a down payment. They have equity from the day they bought the house. The interesting thing about VA loans is that they have a low default rate. VA borrowers generally don’t have a problem 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 don’t see a ton of VA loans unless you’re in a military town. So this leaves us with FHA loans that make up less than 15% of all loans out there. 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 they could be causing limited supply. When they start coming due, we could see a wave of loan defaults. While that is true, according to Black Knight, only 9% of loans in forbearance have less than 10% equity. Even the most problematic 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 tapping into their capital. While this is the case, the LTV guidelines for a cash-out refinance are still low, so even those borrowers retained equity in their homes.
The other reason why I don’t think we’re going to see a wave of clamp or lease options is interest rates. These strategies work very well in a high rate environment. If the real estate investor can get another loan at a lower rate, he can pay more for the property. In a low-rate environment, such as the one we find ourselves in now, investors can lock in rates on new loans that are similar to or better than taking a loan from a seller. There are few incentives to pay more for a property. The Fed has already committed to keeping rates low through 2021.
With all of this being said, I don’t want to discourage you from being on the lookout for these buying strategies. As many of you know, I’ve done over a hundred of these and that’s 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 who are waiting for this to be the next big thing might have a long wait.