You have probably been to a seminar or listened to a real estate speaker tout the benefits of buying property subject to existing financing. If unfamiliar with this term the concept works as follows. Real estate investor finds a distressed owner who is typically behind on a mortgage and/or property taxes. The owner is willing to transfer the property to an investor in exchange for a nominal sum and the investor’s agreement to pay off any mortgage or tax arrears. Going forward, the owner will remain liable on the mortgage but the investor will make the mortgage, tax, and all other payments associated with the property. Sounds like a winning strategy – buy a house at a discount and use another person’s credit for the financing (remember the seller remains liable on the mortgage). Or is it?
This week I spoke to a client who purchased an apartment building, subject to existing financing, in 2012. Suffice to say, some deals are just wrong from the start and only get worse. This one began with a horrible joint venture LLC agreement (see my prior blog post discussing this joint venture LLC) followed by a property that struggled to turn a profit and minimal understanding of protecting oneself in a subject to transaction. Thus, we arrive at today with the property is buried in real estate tax liens, mortgage payments, and mechanics liens. How could this happen? Simple, a lack of experience and control.
Mistake #1 – Not obtaining a title report to uncover any discrepancies with the property.
An investor should have been willing to spend some extra money to determine if the title is clear. Before acquiring property, a title report is your best insurance to protect what you are buying against adverse claims. A title report would have discovered the unpaid taxes and alerted the investor.
Mistake #2 – Paying the seller the monthly mortgage payment.
The investor paid the mortgage payment each month to the seller who in turn paid it to the lender. Paying a mortgage in this manner will work as planned until the seller decides she needs the money more than the lender. When buying property subject to existing financing, always make the mortgage payment directly to the lender.
Mistake #3 – Allowing others to hire contractors without oversight.
The investor allowed an onsite property manager to hire contractors to rehab certain aspects of the property. The investor did not participate in reviewing the bids or defining the scope of work. Ultimately thousands of dollars in unnecessary work was completed, and funds were not available to pay for the work.
Points of Advice When Using this Strategy
This deal was put together with duct tape, rubber bands, and chewing gum from the outset. If you are considering entering into a “subject to transaction” I suggest you proceed as follows:
- Obtain a credit check on the seller – granted their credit is not going to be great if a few mortgage payments have been missed but, if you find several collection companies bringing claims you may be in for rough times. If the seller files for bankruptcy after you purchase the property, a bankruptcy trustee might strip you of ownership.
- Obtain a title report
- Have the seller seek advice from an attorney – the last place you want to find yourself is in court with a seller arguing you took advantage of him and stole his equity. This happens all to often with these transactions, and it is remedied if the seller has an opportunity to seek an attorney’s advice.
- Use a land trust to avoid alerting the seller’s lender – have the seller deed the property into a land trust wherein you are listed as the trustee. After the property is recorded into the trust, the seller will assign you the land trust interest.