Did we buy an alligator?
Real estate investors are known for being risk takers. As a matter of fact, most of the time the reason an investor gets into trouble is because they estimated too high on what a property would sale for once they fixed it up.
The outcome for this speculation is that the investor gets too thin with their numbers and overpays for the property.
Be careful that you don’t fall into that trap. One of my real estate teachers named Jimmy Napier would call this situation “buying an alligator.” That’s because those types of houses will eat you alive.
Now, it’s easy to see the speculative trap associated with projecting future sales prices on flip properties, but it can happen on rental properties as well. Today I’d like to tell you about a deal we speculated on. On the surface, the deal looked like an alligator. But when we got done, well… you’ll see.
We met with a seller who had a house and a mobile home for sale on a single property. When we asked her Pete Fortunato’s famous question “Why would sell such a nice house as this?”, we learned she needed to move out of state to be closer to family. She was advanced in age and could no longer take care of the property.
As we talked more, we found the house and the mobile home each had separate loans against them. And when we found out what those loan balances were, we realized there was no equity in this property. To further complicate matters, the mobile home loan was almost a year behind on payments.
Because of this fact, we told the seller we couldn’t buy her home for cash. But we told her we were willing to buy it if we could leave her mortgage in place after the sale. We explained that we would be responsible for making the payments thereafter until it was paid in full. She agreed, and we bought the house subject-to.
Afterward we did a minor rehab and got it rented out for a market rent rate. Once we took our monthly rental expense factor out, however, this house barely broke even.
We knew that fact going into the deal. The mortgage had a 3.75% fixed interest rate with 28 years left to pay on it. So, if it barely broke even for 28 years, why in the world would we buy that house?
By itself, this house was pretty close to an alligator. But the mobile home was what made the deal work.
At face value there was $24,000 left on the loan for the mobile home, and it would have taken $5,000 to bring it current. But the note only had 5.5 years left to pay on it, which meant we would get all of our money back in seven years. That’s a return on investment (ROI) of 14.28%.
That’s a way better return than we could get parking our money at the bank right now. But because we had bought two houses, we realized we had just taken on a lot of risk to get that return.
To see if we could sweeten the deal, we approached the lender on the mobile home and asked them if we could buy their note at a discount. You see, the mobile home note was a year behind, which made it a nonperforming asset for the lender. And when banks have nonperforming assets, it affects their ability to make new loans. If they could sell the note to someone, even if they have to write it off as a loss, it would move that asset out of the nonperforming category and opens up the opportunity for the bank to make more loans.
The lender, however, was not interested in selling us the note at a discount. Instead, they just wanted us to buy the house for what was owed on it. We let them know that we weren’t interested in that price, but that we were willing to make them an offer.
We went back and forth, and after the dust settled, we paid $8,000 for the trailer.
That’s a 66% discount from what was owed on the note. That was pretty good discount, right?
Even better than that is the fact that we rented this house the following week for $800 a month. So within a year, we’ll have all of our money back, bringing our ROI to over 100%. And that turn of events transformed this would-be alligator into a cash cow.
Joe and Ashley English buy houses and mobile homes in Northwest Georgia. For more information or to ask a question, go to www.cashflowwithjoe.com or call Joe at 678-986-6813.