How to Lose 71k Doing Sub2 Deals


By: gerald(tx)

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Gerald(tx) shares the story of a fellow investor of his in TX. I thought it would be good for some of the more inexperienced investors who might be listening to some of the "no equity, no problem" GURUs to read it so I asked him if I could post the story here.

Read it and learn from it. Don't let this happen to you.

Sub2 is a great way to buy property but you can't polish a turd.


"I recently got a call from a woman quite distressed, seeking my advice. She had lost $71k in a little over a year from her Sub2 investments. Her savings were gone, her credit cards maxxed out, now she faced possible lawsuits. She made a lot of mistakes as a newbie. I thought I would relate her story here, perhaps it will help some newbie avoid the same. As you read, you can spot her mistakes.

First, she got a realtor friend to find the properties for a bird dog fee of $1k each. He quickly found five homes, just what her course had told her -- one or two year olds, it didn't matter if they had no equity -- appreciation would make her rich.. All of them had mortgage balances of around $135k. So she got into the homes simply by making up a couple of back payments on each, plus a little paint and spruce up.

One of the things she didn't realize was that these homes were originally $125k, but when sales got slow the builder did a "one dollar total move-in" marketing by rolling the down payment and closing costs into the loan. So she was really into these $125k houses at about $140k.

Next thing was to offer them for sale, no qualifying, owner financed. Her guru had said to add 10% per year for appreciation, and get a minimum of 10% down. Plus, create a new note jacking the interest rate up 2 points for a good cash flow. So she did just as her guru said, advertising them at $170k, with $17k down, and high payments.

Three months passed, along with her making 15 more house payments, not a single sale. Then reality set in, the guru's "magic formula" didn't fit all areas. Here, most owner financed homes got around $5 or 6k down. And payments had to be reduced to the current market. She filled three of the houses and by the fifth month was taking anybody who could fog a glass, who had anything down, vacancies were killing her. Even though she kept $170k on the contract, she didn't understand that T/Bs who agree to pay $45k above market will never follow through and refinance when the contract is due.

The next thing she didn't realize was initial taxes are based on vacant lot assessment, and to her surprise she was notified that all of the houses would have escrow shortages and the payments would be going up about $400 per house, per month.

In a further calamity, several "one dollar move-in" neighbors defaulted and went into foreclosure. Since appraisals are based largely on recent sales, foreclosure auction prices watered down the appraisals to around $118k. Yes, properties can depreciate as well as appreciate.

To top it all off, a couple of her T/Bs got behind in their payments, moved out and trashed the places. So she dug further into her funds for refurbishment.

When she called me, one of her five houses was performing, two were vacant, and two were ready for eviction.

She had talked to one of her former sellers and asked if he could take the house back. The seller refused, got irate and threatened to sue if she allowed the property to go into foreclosure. He had sold it to her for debt relief so he could preseve his credit. If she ruined his credit, he would sue to take her personal residence.

I wish I could say I helped her, but I'm afraid I didn't. She was wanting to know if she could assign the homes to another unsuspecting newbie. There are legal problems here also. Or giving the deeds back in lieu of foreclosure, even though her name wasn't on the note. She was asking if bankruptcy was the best to protect her homestead or if she could create some kind of trust to save her assets.. I sympathized with her but she has some serious legal issues with which I didn't want to be playing lawyer.

It's sad to see situations like this. Here is a nice lady who just wanted to make a little money in real estate, now she's in debt, lost her savings and could lose her home.Many gurus fill their students full of hype to peddle their courses, but it's not all the guru's fault. Newbies get stars in their eyes and become completely oblivious to the risk involved. The risk is real. I've been investing for over 20 years and I still lose on a property occasionally. Any other old timer will tell you the same thing. I have had many profitable Sub2s and made good money at it, but I admonish every newbie to tread lightly with caution -- particularly as we enter into the coming period of rising interest rates."

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