Residential to Commercial

One of the most common ways to increase value while shifting classes or use is to have a property re-zoned from residential to commercial usage. A property that is located on a busy street would be a prime example. The busy street lowers the value for a residential property because of the noise and associated traffic. It is even more true of a corner lot. So, this busy location is a detriment.

However, for a commercial property, the traffic is an asset. If it is a corner lot with heavy traffic on multiple sides, that is even more of a bonus. A savvy investor might see the commercial potential of a property, possibly even years before having it re-zoned. In fact, it is preferable to buy the property well before it can be converted to commercial zoning and rent it out for residential purposes. The reason that one may choose to do it this way is that the property can be purchased for the best price, and then carried with the costs offset by a renter while the investor seeks to have the property re-zoned. Depending on local rules and nearby zoning, as well as future plans the city may have, it might take a year or more to get the property properly re-zoned. Meanwhile, because the property is located on a busy thoroughfare, advertising for renters is as easy as putting a sign on the property.

Keep in mind that frontage may be just as important for commercial property as acreage. That is another reason that corner lots are such a premium. They have as much as twice the frontage/acre as a lot on just one street. Obviously, lot dimensions will play into this, but in almost all cases the corner lot is the premium.

Low Density to High Density Residential

Another popular way to increase land value is to change it from a lower density residential to a higher density residential usage. Finding a single property or an assemblage of properties to re-zone to higher density can increase the attractiveness of the property to a developer.

Of course, as with most real estate, location is everything. A townhouse or condo development might not be in demand in a less densely populated area, but might support very high valuations in a sought after area. It might also be a great way to capitalize on a smaller parcel adjacent to a popular subdivision. For those familiar with the St. Marlo subdivision at the extreme southern end of Forsyth County out side of Atlanta, The Weston, which is next door is a great example.

Apartment to Condo Conversions

This is an often overlooked strategy that is similar to flipping, but on a huge scale. It is out of the realm of most investors, but purchasing an apartment complex and converting them to condo can be extremely profitable. This is especially true of a slightly older community. As the community ages, the demand for it may decrease. As demand drops, the rent may not keep up with fresher complexes. At the same time, the mechanical systems will be getting ready for an overhaul. If one can purchase the entire operation at a reasonable price, one might be able to flip it to individual ownership.

There are a few different strategies that can be employed depending on the needs of the investor as well as the needs of the community and subject property.

Starting at the lowest end of the economic scale, if the property is converted to condo, there might be reluctance from current residents. One way to overcome this is to build a pricing model that allows the majority to remain in place, increase the value of the community and more quickly sell the remaining units. Finding a financing solution that allows the tenant to be converted to a buyer means that one doesn’t need to market as many units. Offer to pay closing costs, finding sources of down payment assistance or 100% loans would also help to ease the transition. If there is a way to allow the current residents to buy in below the prices that the property will be marketed at, this is even better. This gives the current residents instant equity, and they will be more likely to be better neighbors since they now have a stake in the community. Occasionally, converting to low income housing may also carry tax benefits for the investors. Having single unit or multi-unit investors in line should there be residents that don’t wish to purchase is also an option, but not as attractive since there will be a lot of residents without a financial stake in the community.

The same strategies can be used with higher priced properties as well. But, financing is often easier to set up. Many of the residents may already to considering purchasing their next residence, and allowing them to buy in below market will be very attractive. Set up several programs that allow different pricing based on renovations to existing units. Offer a low price for un-renovated units (only to residents in those units), a mechanical only upgrade, and a full upgrade including fixtures, etc. For a full upgrade, one might offer a nearby similar unit to allow a faster transition.

This can also be done with vacated apartment complexes, but there will generally be much higher renovation costs. However, the profit margin may be significantly higher. While driving through New Orleans earlier this year, I couldn’t help but think that there were huge opportunities in renovating apartments.

Commercial to Condo

Loft conversions are hugely popular. Most of the conversions that are currently being done are very high end. However, this can be done at various price points. The primary difference will be in the level and quantity of finish for the units. Finding a building worth saving, that is convertible to residential space is the first challenge. It needs to be unique and have plenty of character.

If one is shooting for the lower end of the market, all that needs to be done is to provide the stubs for plumbing, and require the buyer build out kitchens and baths on their own. Set some sort of minimum standards, and be sure all work is permitted and done to local code.

Moving up, one may choose to put in baths and a kitchen, either fully finished or in some other state agreed by the buyer. One could also go as far as to have several private rooms, and fully outfit the space with high end finishes and fixtures. Additional amenities could be included ranging from pool and parking to high-speed, wireless internet access.

In all of the condo conversions, whether from apartments or commercial space, it is very important to set up some sort of Owner’s Association. This will help keep cohesion in the community as it is populated. This also provides a mechanism to care for common property and maintain amenities. Another issue that the OA will need to deal with is the level of renters for the community. The lower the percentage of renters v. owner-occupants, the lower the maintenance needs generally are. However, if there are no renters allowed, it might adversely affect resale values. There are a lot of different strategies for dealing with that particular situation.

Written by Lane Bailey

Lane can be contacted through LaneBailey.com

In Real Estate Investing 101, Part II, we covered buying and holding property for long term appreciation and wealth building. This is by no means a get rich quick scheme, but is one of the most proven ways to build wealth over time.

Finding an appropriate property

Just like with flipping, property is a required ingredient. In fact, the same sources will work for buy and hold strategies as for flipping. The primary difference is that buy and hold strategies are generally a little less stringent on cost control, as well as condition. One can be in the property for a little more money because there isn’t a short term margin to mind. REOs (bank owned property), pre-foreclosure, short sales, older homes needing updating and strong but ugly properties are still the best options.

Rental homes are more price sensitive for marketing. While a flip may be done at any price level, rentals are a bit more picky. While it certainly requires knowing the market, generally in the Atlanta area, the best options are in the $125k to $250k area. There are opportunities below that, as well as above, but the meat of the Single Family Residential (SFR) market will be around this range.

Under $125k- Pro- Just as with a flip, these properties are easier to carry when they aren’t producing. Con- Even with a generous appreciation, the actual cash value will not go up as much as with more expensive properties.

$125k to $250k- Pro- This is the most active area of the market. There are more renters available, so it may be easier to keep the property occupied. Con- This is the most active area of the market. There are more properties to compete against for the renters.

$350k to $500k- Pro- These are executive rentals, and usually the renters will be more mindful of the property. There are property owners that concentrate on this market because it is quite profitable and low hassle. Con- There are higher costs to carry the property when it isn’t rented, and it may require more expenditure between renters to update the property. The renters will be pickier about amenities, fixtures and finishes.

Over $1m- Pro- The rental rate to cost is usually higher because of the rarity for SFRs. Most of these properties will be commercial, which usually have longer leases and often don’t require the landlord to make the improvements of maintain the property. Con- For the SFR market, this is a rare rental. There certainly are some out there doing well, but they will be shorter term (usually) and require more and more expensive marketing to fill. For commercial properties here in Atlanta, one needs to be very careful because there is a LOT of available commercial space.

Putting together the numbers

As with the flipping article, I have an Excel spreadsheet to examine the deal more closely. It isn’t fancy, but it does help keep all of the important points front and center so that the details don’t get in the way of the big picture.

When filling out the spreadsheet, the light gray areas are for users to input information. The light green areas have calculated values. Remember, the more accurate the input information, the more accurate your profit analysis will be.

As with flipping, it is very important to know what the upfront costs will be, both for acquisition, but also for any required renovation. However, unlike flipping, if the investor wants to reduce costs, and has the needed skills, doing more work themselves, instead of hiring contractors can be more manageable. Most investors aren’t going to have a bunch of projects running at once. If one DOES plan to have a lot of project going at one time, or if one is not appropriately skilled, hiring contractors is a better plan.

On the linked worksheet, we can see that the fictional investor purchased a property for $200k. It needed a further $25k in renovations. After renovation, the unit has an expected rental of $2250/mo. and requires about $1800/mo. to carry. I factored vacant periods in, as well as needed maintenance through the use of set-asides and reserve funds. These are included in the monthly carrying costs. I specifically expect a 90% occupancy rate. That may be a bit high, but I also tried to balance that by under shooting the expected annual increase in value.

As we delve into the numbers, what we find is that the cash flow accounts for a total of over $550k over the thirty year period. Further, the property increases in value by over $300k. This means that if the property is held the full thirty year term, the mortgage would be paid, and the investor would have collected almost $1.1m over the thirty year term, after selling the property. Even after discounting the original total investment, there is still a profit of $800k.

But, the real magic is in the leveraging. In this example, the investor fronted less than $80,000 and ended up with over $1,000,000. If one actually spends a little more for a property that doesn’t need as much renovation at the beginning, one may have a better total return.

Putting together a good team

Any good investor needs partners. These are the people one needs to have available:

Real Estate Agent- A good agent will know what is on the market. The agent should be able to help minimize the initial costs, while making sure that the property is suitable for renting, and will be readily marketable for that purpose.

Rental Agent- Knowing what a given property can rent for is valuable information. Also having someone ready to market the property as soon as practical is valuable to cut down non-productive time.

Inspector- Spending a few hundred dollars for a good inspection is money well spent. Missing a failing HVAC system or a roof issue could cost thousands. Knowing that a particular siding or electrical system has shown itself to be unreliable can also be very valuable. If one can find an inspector that will give good cost estimates of repairs and upgrades that need to be performed, one may be able to cut down on the number of contractors that need to be consulted prior to buying a property. The inspector can also provide invaluable insight into the long-term viability of the expensive systems in the property.

Mortgage Loan Broker- Unless one is going to owner/occupy the properties for a number of years at the beginning of ownership, one needs to work with a mortgage broker that understands investment loans. Structuring the loan appropriately for the investor can decrease the monthly costs, and increase the cash flow of the property.

Rental Marketing Strategies

The whole point of this exercise is to get the property rented and keep it that way. There are a few things to keep in mind to maximize the long term return, and minimize risk.

Hire a good rental agent. They are part of the team. A good agent will help get the right exposure for the property, as well as make recommendations that will make the house more marketable. These are specialists. Depending on the individual agency they are with, there may be a one-time fee or they may be a monthly percentage.

Stage the property. A vacant house makes it harder for renters to mentally move in, just like buyers. A few rooms that are well staged will really increase the value in the minds of renters, so it is generally well worth the cost. This is especially true for higher end homes, but may be the thing that tips the balance for ANY property. With rentals, this may be a real standout, as few rental properties are staged.

Set rent appropriately. To get, or more likely keep, a good renter, be flexible. A good renter can cost less money between rentals. If it is a longer term renter, there will be fewer vacant periods.

Be flexible on lease/purchase possibilities. I have heard that about 1 in 8 lease purchase sales actually close. If offering a lease purchase is what it takes to get a good renter, or to keep a good renter, remain open to the possibility. It may be well worth the risk that the property may sell. Also, if the buyer/renter would like some of the rent credited to down payment, most lenders require that only the amount above market rent be applicable to down payment. Usually this money is forfeited as earnest money if the sale doesn’t close.

Research. Plan. Prepare. Remember the old adage that it takes money to make money. This holds true in buying real estate to hold as well. Targeting the money is less important than in flipping, but spending it appropriately is still important. Also, understand your own market and your own limitations.

Written by Lane Bailey

Lane can be contacted through LaneBailey.com

Finding an appropriate property

Obviously the first ingredient in a profitable flip is the property. Despite what one may see on TV, it takes a little while to find good candidates. The various types of properties that may make good flip candidates are foreclosures or REO (bank owned properties), fixer-uppers, older homes that need updating, and ugly properties that are otherwise in good shape. Cost is obviously important, but condition is also very important.

Remember, not only will there be an expense for the repair, but there is also a cost to carry the property while the repairs are being done. For example, if Property A needs $20k in rehab, can be completed in 8 weeks, and will cost $2k/mo. to carry, it may be more attractive at $176k than Property B, which needs $50k in rehab, will require 16 weeks at $1500/mo. and is priced at $150k. This assumes that they would both be able to fetch the same price at the end of their renovation.

Homes may be in almost any price range. Condos may be purchased for as little as $40k, but sometimes there are opportunities with homes prices at $1M or more. In fact, the pricier homes have some advantages in some markets. Let’s cover a few price levels:

Under $100k – Pro- Cheap, easier to carry if it doesn’t sell as fast, possibly a larger market to sell into after completion. Con- Lots of competition bidding up the prices, requires tight control of expenses to be profitable, lots of market competition.

$200k to $400k – Pro- Fewer competitors bidding up prices, often a little larger pool of properties to pick from, usually higher margins. Con- Requires more capital, appropriate level of fixtures and finishes more important.

Over $700k – Pro- Often more generous margins, little competition, fewer buyers that will do work themselves, more fun to make (home theaters, high-end kitchens, etc.). Con- Bring your checkbook, higher level of capital needed, wrong finishes and fixtures will kill chances of a sale, tastes may be fickle.

Over course, you may have noticed that I left generous gaps. These are guidelines, and in different markets, the actual prices will need to be adjusted.

Putting together the numbers

I have a Excel spreadsheet that I will use to examine the transaction. It is available here. While it isn’t fancy, it does cover the information that we need in order to calculate the cost of the flip, and figure out what needs to happen in order to make a profit. There is nothing worse than getting into the flip, and finding out that you forgot something important, and you aren’t going to make money. Unlike a TV show, it is not very often that you can just raise your price in order to get your money back out of the deal.

When filling out the spreadsheet, the light gray areas are for users to input information. The light green areas have calculated values. Remember, the more accurate the input information, the more accurate your profit analysis will be.

The toughest and most important part is getting the right cost estimates for the renovations. The natural inclination is for these to be under-estimated. Many first time flippers plan on doing all or most of the work themselves. This isn’t a great long-term strategy, but there are advantages. The primary advantage is that the flipper increases the profit margin. However, the big danger is that flippers often under-value their own labor. Using painting as an example, painting the interior of a large home may require 20 gallons of paint. A professional painter may bid this job at $4000. The cost of paint would be approximately $600. A job like this might take 60 person/hours. Entering $600 for the cost of repainting the house does not place any value on the time involved in labor. So, even if the person flipping the property is planning on doing the work, they need to break out the labor for these tasks. More than one person flipping a property has spent hundreds of hours only to find that they $/hr were terribly low.

Putting together a team

A good flipper needs a good team. This is even more important if one plans to have more than one or two properties active at any given time. But, these are the people one needs to have available:

Real Estate Agent- A good agent will know what is on the market, and should be able to quickly determine what a good ARV (After Repair Value) for a given property will be. This agent will also know how to price the property to maximize return. That doesn’t always mean maximum price, those closing costs can add up, and if one’s capital is tied up, one can’t move to the next project.

Inspector- Spending a few hundred dollars for a good inspection is money well spent. Missing a failing HVAC system or a roof issue could cost thousands. Knowing that a particular siding or electrical has shown itself to be unreliable can also be very valuable. If one can find an inspector that will give good cost estimates of repairs and upgrades that need to be performed, one may be able to cut down on the number of contractors that need to be consulted prior to buying a property.

Contractors- These contacts can make or break a flip. If the work is good, fast, and appropriately priced it is well worth paying to have it done. Saving a few hundred dollars and spending a few thousand in carrying costs while you wait for a contractor that is behind schedule is not a good trade. Saving a few thousand, and then having to spend money to fix what wasn’t done well is also not a good trade… especially when you have to carry the property that much longer to get everything done.

Project Coordinator- If more than a couple of projects are running, having a person to help keep everything on track is vital. Even the best contractors will have people that need someone to make sure they are there on time, and doing the right work. Even the best flipper needs a second opinion, and someone to run errands or get the right materials.

Mortgage or Commercial Loan Broker- Carrying costs are another make or break expense. Having the capital to complete the project is a requirement. Being able to continually finance projects is also required. Most mortgage lenders (not brokers) don’t want to loan money to flippers without front loading. They make money by either carrying the loan, or charging up front fees. Since the goal is to NOT carry the property, they need to front load the fees. A good loan source can DRAMATICALLY lower your costs.

Selling strategies

In order to lower carrying costs, as well recapture capital for the next project, selling the property quickly is important. However, giving it away reduces the profit margin. There are a few things that can be done to help accomplish these conflicting goals.

Hire a good agent. They are part of the team. A good agent will help get the right exposure for the property, as well as make recommendations that will make the house more marketable. They will also have access to people that are in their team that will make the sale go more smoothly.

Stage the property. A vacant house makes it harder for buyers to mentally move in. A few rooms that are well staged will really increase the value in the minds of buyers, so it is generally well worth the cost. This is especially true for higher end homes, but may be the thing that tips the balance for ANY property.

Price it appropriately. Many experienced flippers will price a property 3%-5% below market in order to make it sell faster. This reduces “opportunity costs” and also lowers risk. Opportunity costs are the deals that one can’t pursue because their capital is tied up elsewhere. There is no risk after the property is sold.

Research. Plan. Prepare. Remember the old adage that it takes money to make money. This holds true in flipping real estate as well. But, it is vital that the money be appropriately targeted, well managed, and strictly controlled. This doesn’t mean that it shouldn’t be spent, but that it should be spent on the right things, and taking shortcuts may not be the best idea.

Written by Lane Bailey

Lane can be contacted through http://www.LaneBailey.com

Flipping

The first method I’ll cover to invest in Real Estate is a shorter term option called “flipping”. Basically, flipping a property is buying a property at a below market price and then selling it at a market price. The property may be purchased below market value because it needs repair, or because the sellers have a need to sell the property quickly. The advantage of flipping a property is that it creates a shorter term profit compared to holding a property.

The disadvantage of flipping a property is that one needs to sell it to recapture their expenses. A mortgage or Home Equity Line of Credit (HELoC) may also be used to bring cash back out of the property, but may reduce the overall profit from the sale. When flipping a property, one needs to be very aware of not only the purchase price, but also the full cost of acquisition, renovations, selling the property, and cost of carrying the property.

Keep in mind that loan costs for this type of venture are generally more that of a primary residence. Taxes and insurance will also be higher. An investment scenario might look like this:

$165,000- purchase price
$ 1,650- acquisition costs (about 1% of purchase price)
$ 10,000- renovation budget
$ 11,700- carrying costs (budgeted as $1950/mo for 6 months)
$ 18,000- selling costs (6% for real estate commissions, and 2% for other costs)
$225,000- projected sale price after renovation
$ 18,650- projected profit

One thing to keep in mind is that the Return on Investment (RoI) is actually higher than it first appears. Initially, it would appear to be a 10% profit (about $186k invested to return about $18,650). Over a six month span, that isn’t bad. However, the return is actually much higher. Generally, the loan requirements for this type of property will only require 20% down (or less, but at a higher loan cost). So, that means the actual cash investment is closer to $55,000 ($33k down + $10k rehab + $12k carrying costs). This makes the RoI almost 34%. Not bad, but remember this isn’t like owning a stock, there is a lot of work that goes into making this happen. One also needs to be in a position to “carry the property if it doesn’t sell as fast as planned. The bottom line is that if one is realistic in their expectations, a lot of money can be made pretty consistently.

Buy and Hold

Another tool in the bag of the Real Estate Investor is the “buy and hold option. Buying and holding a property is a longer term strategy. In this case, one is using the increase in values over time, generally in conjunction with rental income, to increase their personal wealth. The renter is the key to this being a hugely profitable strategy. An example of this would be:

$200,000- purchase price ($40k cash, $160k mortgage)

$485,000- selling price (after 30 years at a conservative 3%/yr.)

$1,500/mo.- carrying cost (this will go up slightly as taxes and insurance increase)

$1,600/mo.- rent (first year)

* A note about the rent: I would rent to the “right tenant at a discount to keep them longer term. Also, the rent, which will increase around the same as property values over time will go from $1600 in the first year to $3900 in the 30th year. Keep in mind that while the carrying cost will go up, they won’t go up nearly at the same rate as the rent.

While there are a few things to plan for, such as repairs, upgrades and time without renters, if one held the property for 30 years, they would have a property worth almost $500,000 with no mortgage. I would feel confident in saying that the cash flow from the rents (especially as they increase) will cover any expenses in the long term. Compare this to a 6% return on the down payment from a mutual fund, and the $40k down payment would possibly yield $230k.

Shifting classes

Either of these strategies can be used with both commercial and residential properties, as well as undeveloped land. The property may also be shifted from one class to another. Land can be flipped by building a home (residential) or shopping center or warehouse (commercial). A warehouse type of building may be renovated into loft apartments (B&H, and residential) or sold as loft condos (flipped). A home on a busy street may be renovated to offices and be re-zoned commercial and either rented or sold. Obviously there are a lot of variations that can be employed.

But what about for a different budget?

Also, the price and financial commitment can be varied as well. Condos ready to be flipped often come on the market at prices well under $100k, and occasionally as low as $50k. A $15k investment may be able to yield a $25k or $30k return. Also, one can partner with others looking to do the same type of investment and form a partnership. This arrangement adds complexity, but also spreads the risk.

Lastly, remember to talk with your accountant and/or tax preparer about the tax ramifications of these types of investments. One may be able to employ deductions and credits to lower their tax liabilities from their investments. If you have any questions, or would like to get started in real estate investing, please feel free to contact me.

Written by Lane Bailey

Lane Can be contacted through http://www.LaneBailey.com

In Real Estate Investing 101, Part II we covered buying and holding property for long term appreciation and wealth building. We also touched on class shifting to increase value.

Real Estate Investing 202 continued on the Buy and Hold theme and offered deeper insight into making it profitable. In Real Estate Investing 203, we looked at shifting property classes for highest and best use, while increasing property value and return.

This time, we are going to look at investing from a different perspective. The previous articles have been about buying property “wholesale” and selling it “retail”. But, there is another way to buy property that may be more efficient as well as more profitable.

Want to make $50,000,000?

Invest in REO Bulk Portfolios. The problem is that this is out of reach for the VAST majority of real estate investors. It requires a huge commitment of time, energy, and (most importantly) cash. For a $50M profit, one should expect to spend a little more than $100M. But, the result can be a fairly passive profit in the 40%-50% range within 6 months to a year.

Decoding the alphabet soup

REO is industry jargon for Real Estate Owned. This is property that has be foreclosed and repossessed by mortgage lenders. Some lenders retail the property through traditional channels. They hire real estate agents to market the properties along side any other area property. The lenders usually have a few more hoops for buyers to jump through, and often aren’t in the best of condition. These are the foreclosed properties mentioned in the earlier articles.

Bulk REO portfolios are simply large groups of properties that the mortgage lender doesn’t want to take the time to market. By gathering these properties together, they are able to dispose of them more efficiently. Since they often need to sell them quickly because of banking regulations, they price them to move. They can be priced any where from 40% to 70% of BPO or LTV. Of these, pricing relative to BPO is much preferred.

BPO is Broker Price Opinion. It is similar to an appraisal, but much simpler and less expensive. It is also like a CMA or Comparative Market Analysis that your local real estate agent might provide when you are looking at buying or selling a home. Contrary to the name, a BPO may be issued by a real estate agent that isn’t licensed as a broker. When dealing with REO bulk portfolios, some sellers might not actually hire a broker or agent to do the opinion. In cases where the properties are new (builder loan defaults and other similar situations), they may rely on online valuations. This is rare, though. The bottom line is that is the property carries a BPO of $200,000, and is being sold at 50% in the package, it is costing the buyer $100,000. The BPO also takes into account the current condition of the property, including repairs it may have needed at the time the BPO was issued.

LTV stands for Loan To Value. In this case, if the property originally sold for $100,000, and the buyer put $5,000 down, the LTV would be 95%. So, in theory, if the property is being sold at 50% LTV, and the buyer is paying $100,000 for it, the bank loan was about $200,000. The problem is that we don’t actually know what the property might be worth. On one extreme, the defaulting owner may have put 20% down. Sticking with our $200,000 house, this means that they put up $40,000, and the bank was on the hook for $160,000. At 50% LTV, the bulk buyer would be paying $80,000 for the property. At the other end of the scale, the buyer might have put nothing down, and they might have overpaid for the property. With the current real estate climate, there is a possibility that the property devalued. Further, when people aren’t able to make their house payment, maintenance and repairs are often deferred. So, we might be talking about a property that was purchased at $200,000 with a 100% loan, but now is only worth $150,000. Buying it at $100,000 (50% off of LTV) still would yield a profit, but not as much as buying at 50% BPO, which would be $75,000. The biggest problem with buying based on LTV is predictability. We don’t have as much of an idea about the retail value of the property in its current condition.

Now for more of the basics

As previously mentioned, these are portfolios, and are purchased in bulk. Calling up the local bank will not get you a 50% deal on property. Bulk REO portfolios are usually offered in packages starting around $50,000,000. Most are sold in packages priced at $100M to $500M per transaction. Some packages are $1B or more. There are a few consolidators that will sell smaller packages, but they are generally marked up as they are broken up. And, because these are broken up from bigger packages, it is more difficult to specify property types. Even the smaller packages generally start around $10M.

With the more traditional packages, priced at or above $100M, the buyer is able to custom order the properties. The buyer can request only properties within a certain geographic area, price range, and type (single family, attached, commercial, etc.). Keep in mind that we are talking about a LOT of property. Even with a valuation of $300,000 each, at 50% ($150,000), there would be over 650 properties in a $100M bulk portfolio. Finding all of the properties to fit the order would normally take a few counties, at least.

When the order is placed, the compiler puts a package together. The package may be from a single institution, or from multiple institutions. In order to place an order, the buyer fills out an order form, provides a Letter of Intent (LoI), and completes a Non-Circumvent, Non-Disclosure Agreement (NCND). They also must get the information ready for their Proof of Funds (PoF) letter that will be required by the selling financial institution.

A Letter of Intent may also include the order information. However, primarily the LoI is just a document that states that the buyer wishes to purchase a bulk REO package. It may also outline what types of properties the buyers wishes to buy, otherwise that info will need to be provided on the order form.

In order to maintain the security of the involved brokers and principals, a Non-Circumvent, Non-Disclosure Agreement is entered into by all of the parties. The NCND keeps the buyer’s broker, the seller’s broker and the principals from disclosing sensitive information to outside parties, as well as keeping them from going around anyone involved in the agreement to complete future sales.

A PoF letter is exactly that proof of funds. These transactions are seldom done with mortgages in any recognizable format. We will go into why this is the case in just a moment, but for now we will just say that the sales are done through a wire transfer. In effect, the sale is a cash sale. The property is sold without encumbrances, and with a clear title.

After the compiler gets the order together, there is a short period, generally about 48 hours, during which the buyer can reject specific properties from the package. At the beginning of the period, the buyer puts up a deposit (like earnest money) that is generally 10% – 15% of the package purchase price. With the completed list of properties in hand, the 48 hour countdown to reject properties begins. They have seven days to complete ALL due diligence. After seven days from the delivery of the order, the deposit goes hard. In other words, it is no longer refundable. The transaction is generally closed about 15 days from the delivery of the order to the buyer.

Since these deals go from beginning to end in 15 days or so, there is simply not enough time for a bank to go through the steps they would need to finance the property purchase based on using the property as security. However, after closing the transaction, it may be possible to get a package loan on 60% – 80% of the cost of the properties. However, this will complicate the disposal transactions and decrease profits. So, at closing the buyers need to have their funding in place, and it needs to not be dependant on the property.

Strategies for selling hundreds of properties

For most buyers, holding the properties isn’t the option that they are looking for. Turning the properties is the goal. Generally, there are a few different strategies that sellers use to dispose of the properties. These depend on both the properties and the type of buyers.

Wholesale sellers sell to other investors at a discount from BPO. This allows them to minimize further expenditure, while maximizing return for less than optimal properties. The properties can often be moved fairly quickly. One drawback is that more expensive properties are more difficult to sell. Most retail investors are competing for the lower end of the market.

Retail sellers spread their properties around to real estate agents to list. These are often asset management companies and other similar business entities. These may be the properties that one sees listed as “corporate owned” in the MLS. In many markets, this can bring the maximum return, but is really only viable for the best of the properties. And, it may take a long time.

Properties that don’t move through the other methods generally end up in auction. The biggest problem is that by the time get to auction; they have been left sitting for many months or even more than a year. Most properties will have degraded further from sitting disused. Even if they haven’t grown mold or been trashed by squatters, they have cost money to carry. That may be directly if a loan was obtained to pull cash back out of the property, or indirectly through lost opportunity costs.

So, how should we get rid of the properties?

I would recommend a combination of the accepted methods, but with a twist. A good real estate agent will know which properties are likely to sell without much hassle. This agent should also be able to give pricing scenarios that minimize market time, while preserving at much margin as possible. So, feed this agent the cream of the properties, and price them aggressively to sell quickly.

For the properties that aren’t going to sell at retail, mix them between wholesale and auction strategies. Surprisingly, auctions often deliver better prices for the seller, but if there are too many properties sold at once, the market is diluted. The same holds true for the properties that are to be sold wholesale to investors.

Finally, properties that aren’t likely to sell well through the traditional channels might be best disposed of through selling at very deep discounts to contractors or other vendors. These super deals can really help to curry favor and move your other projects to the top of the scheduling heap, as well as provide leverage for pricing discounts.

Innovative strategies for smaller investors

Because of the financial resources required to complete one of these deals, they are generally restricted to only the highest level of individual investors, as well as institutional investors. Actually completing the transaction, from start to finish would normally take a bare minimum of $12M – $13M. In addition to the $10M for the property, there would need to be a reserve for improvements, taxes, commissions and other transaction expenses. Almost all of this needed to be effectively in cash (ok, not in cash, but in available capital. For a $100M bulk REO purchase, one might expect to spend an additional $10M.

By turning around the property disposal and beginning by auctioning off some of the properties that aren’t cherry picked off of the top, additional cash is generated. This should reduce the additional capital requirement. Basically, it would fund the later stages of the transaction, as well as spin off cash to begin to pay back the investor, or investors.

A great strategy for smaller investors would be to form a group (I’m not a lawyer or accountant, so I can’t go into structure such as LLC, Corp, or partnership, etc.). Instead of focusing on ownership of individual properties, the investment could be treated as more of a passive investment. Hire a good real estate professional, or have a major partner responsible to run the day-to-day operations of the properties. Aside from the marketing for the properties to be sold retail or wholesale, and any renovations that are needed for any of the properties, there isn’t much management that needs to be done. There will need to be marketing for the auctioned properties as well, but if those are disposed of early in the transaction, that need will be minimized.

While there may be increased expenses from purchasing in smaller quantities, part of that may be offset by being able to sell at higher prices. When selling 50 to 100 properties, there are many more options than there are when selling 500 to 1000 properties. When looking to dispose of 750 (nominal number) properties, more will have to be auctioned and wholesaled simply to make the remainder logistically possible. Aside from renovation resources (time, money and contractors), marketing and selling properties can be expensive for a real estate agent. Hitting one with 300 properties might be counter productive. However, having too many agents can make logistics more difficult, as well as increase overall marketing costs because of duplicate efforts.

Building a relationship with the Bulk REO Portfolio sellers, by doing regular transactions (perhaps quarterly, or even monthly if properties can be sold quickly enough) will often allow for leverage on brokerage fees. Another advantage of working regularly with the same REO sellers is that they may be able to bundle small orders with larger orders to lower the price in relation to REO. For $10M packages, many compilers are looking to sell at 60% or even a little more. As the order size grows, the price may come down to 50% for $100M deals, and even as low as 45% for $1B packages. If a $10M order gets bundled to a $100M order, the smaller order might get filled at 55%. That extra 5% discount can translate to $500,000.

Research. Plan. Prepare. Remember the old adage that it takes money to make money. This holds true in buying Bulk REO Portfolios as well. This time it means it takes a LOT of money… to make a LOT of money. Also, understand your own market and your own limitations.

Written by Lane Bailey

Lane can be contacted through LaneBailey.com