Using Other People’s Money to Seller Finance

Mike: Welcome to the FlipNerd.com podcast. This is your host Mike Hambright and on this show, I will introduce you to VIPs in the real estate investing industry as well as other interesting entrepreneurs whose stories and experiences can help you take your business to the next level. We have three new shows each week which are available in the iTunes store or by visiting FlipNerd.com. So without further ado, let’s get started.
Hey, it’s Mike Hambright with FlipNerd.com. Welcome back for another exciting VIP interview where I interview successful real estate investing experts and entrepreneurs in our industry to help you learn and grow. Today I’m joined by Ian Flannigan with Golden Falls Properties. Now Ian uses a number of vehicles to use other people’s money to finance his deals and has become an expert at solutions that include seller financing. We’re going to talk a lot about that today. So today he’s going to share with us his unique approach to using seller financing where, effectively, somebody else finances the deal. It could be the original seller; it could be a bank, or another lender. They finance the deal and then he generally wraps that note and sells it on to an end user and makes a spread on it.
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Hey, Ian, welcome to the show.

Ian: Hey, how are you, Mike?

Mike: Good, good, so what some folks don’t is that you are just a few miles from my office. You’re about, maybe, ten minutes away. Actually, I didn’t even know it until we got started. We were in the same market and I think we run in some of the same circles but haven’t met. Well maybe we have met before but haven’t, certainly, talked for a while so good to see you.

Ian: Yeah, absolutely, well thank you, man. Thanks for having me on.

Mike: Yeah, yeah. So what’s interesting for me in doing all of these shows is I get to talk people that using different approaches and techniques to kind of operate their businesses. And I’ve had some people on that run seller financing models but they’re different and they’re usually using private financing or some different techniques than what you’re using. So I think it’ll be interesting to, I think it’s a potentially powerful way, or obviously it is a powerful way to make deals happen that maybe you wouldn’t otherwise be able to do.

Ian: Yeah, absolutely.

Mike: Yeah, yeah, so tell us a little bit. Why don’t you introduce yourself and tell us about how you got into real estate investing?

Ian: Okay, well, thanks again for having me on. I’m Ian Flannigan. I’m from Dallas, Texas. I got into real estate investing kind of like most real estate investors. They knew that there was a better way to make a living and the dream of passive income and so forth. And I hate to sound cliche but that little purple book, “Rich Dad, Poor Dad” really had an impact on me because I’ve been the employee and I was the self-employed hair-dresser guy and I just knew that I didn’t want to stand behind a chair for the rest of my life. I made great money cutting hair and after doing it for a decade plus, I just realized that I didn’t want to stand behind a chair for the rest of my life and I wanted the trajectory of my life to change.
So after buying my first house back in 2006, I caught the bug and I really never looked back. And here we are, all these years later, and I’m a full-time real estate entrepreneur. I have multiple companies. I kind of have my hands in all different types of things; consulting, retail sales, investing, private capital. All these other things that come with the territory, I now do on a full-time basis. And, man, it’s great. It’s finally paid off, all the hard work that I’ve put in and all the failure that I experienced in the beginning pushed me to where I’m at today.

Mike: Yeah, that’s great, that’s great. Yeah, it’s interesting how a lot of folks that find their way into real estate investing end up adopting a kind of different model about how they monetize the business, how they operate the business. Like in my business, for example, I’ve kept it kind of pure, in the sense that I rehab, wholesale, and keep houses as rentals. I don’t really do anything exotic. I’m kind of throwing self-financing into the bucket of exotic, which, it’s not that exotic anymore for sure. And a lot of people that have done it for a long time know that it’s been a great opportunity all along. There are just not a lot of people that have adopted that model or found a way to do that as a primary channel for their business. So I’m looking forward to hearing some of your ideas of how you operate your business.

Ian: Yeah, absolutely.

Mike: Yeah, so what’s interesting, if you think about it at a high level, rehabbers and wholesalers, they effectively have to buy low and sell high; or rental properties, find a way to buy it low enough to make a spread on it. The interesting play with seller financing is, and not that you don’t want to buy the houses as deep as you can, but if you’re participating in the financing, if it’s more a financing play, you don’t necessarily have to buy the houses quite as deep as the other exit strategies, right?

Ian: Absolutely, right, and every offer you make it needs to have a seller financing component to it because not all your leads are going to fall into that 40 to 60% of market value. So if you’re getting those clean properties that sellers are really motivated, it doesn’t matter if they have a mortgage on it or not, if they say, “yes,” that they would consider selling with a down payment and a balance monthly, you’re golden.

Mike: Yeah, and talk a little bit about, at a high level, you’re ultimately selling to people that probably have some credit issues or can’t buy houses the traditional route, which is a huge percentage of the population, right?

Ian: It’s a massive percent of the population. After the crash the credit got really, really tight and getting conventional financing is really tough. Even FHA now is starting to loosen up, I’ve heard a couple mortgage broker friends of mine say that they can get people qualified with a 580 credit score but they’ve got to have their paperwork buttoned up. They call it the two-two-two, two years of tax returns, two years of bank statements, two years of employment. And they can’t have all these things. But, typically, our profile of buyer, they can have beat up credit, that’s okay. They just have to have solid job history and prove that they have an income. That’s a massive part of our population. So we’re able to really sell these properties very, very quickly. And we’re at the point now where we have more buyers than we have properties.

Mike: Yeah, that’s somewhat bittersweet, right?

Ian: Yeah, absolutely, because it just depends on where you are in the market cycle. Like you were talking earlier, the 40 cents on the dollar deals just aren’t flying across the tables anymore. So it’s harder and harder to get. And the seller financing play or seller carry back or the subject two applies to those properties that are, maybe underwater or 95% LTD or something like that. So it just gives you an additional strategy to be able to take those kinds of properties down whenever you do have a really motivated seller.

Mike: Yeah, so maybe you could give an example of a deal that you financed. I know you said you have a bank that lends money that allows you to wrap on those, maybe you could give an example of the structure of a deal. Like how you borrow the money, and what interest rate they charge you, what interest rate you charge the end buyer and kind of how you monetize that and make a spread on it.

Ian: Okay, well, just an easy example, and we have a mixed bag of where we get our financing from. But just to make this an easy example, we have a private, well they’re a home, savings, and loans, it’s a relationship that we have and they’re basically loaning us capital for acquisitions on 20 year financing at about 8%. And then we’ll turn around and, for example, let’s say we buy a property for $40,000. They’ll fund the $40,000 and we have a note payment to them, let’s just say $400. It’s 8% interest on a 20 year amortization and then we’ll turn around and sell the property for $60,000. And we’ll mark the interest up, we arbitrage the interest, so we’ll do it like 10.5%, sometimes 11%. Usury laws in Texas right now are 11.99%. Previously they were 17.99% so yes, we can legally charge that much.
So we create a spread between the purchase price, the interest rate, and then the monthly payment. So if I’m going to sell a property for $60,000 on a 20 year amortization at 11% interest, that principle interest payment is going to be much higher than what my principle interest payment is going out to the lender that funded the deal. That’s essentially called a wrap mortgage. The bank is in the first position, they have the first lien deed to trust. And then we create a second lien, and it’s a deed to trust as well, with the end user, and we create the spread that way.

Mike: Yeah, and then your end user, ultimately they own the home. I mean, they have a mortgage on it, but they are the home owner so you’re not renting it per se. Talk about some of the pros, I know what they are, but talk about some of the pros and cons of them being an owner versus them being the tenant and you’re renting to them.

Ian: Absolutely. Well every time we go back and forth with whether or not we should hold a property as a rental versus selling it with owner financing. All the numbers tilt towards owner financing. The reason is that taxes and the insurance is on top of their principle interest payment and I’m not absorbing that in the spread. So if my payment to my end user is, let’s say the principle interest is $600, then their total monthly payment will be $600 for the principle interest payment and then, let’s just say, a $100 for taxes, a $100 for insurance. Then our third-party servicing company, we pay for the setup of it but the borrower actually pays that amount. So their payment will be somewhere around $835 a month. So if I’m paying out my bank at $400 and the payment coming in from my borrower is coming in at $600 then I have a net $200 a month cash flow on the deal.

Mike: Right, and to clarify what you just said, you have a servicing company that’s kind of servicing the loan. Going after them, sending invoices potentially, and they’re escrowing the taxes and insurance to protect, you, as the second lien holder and the first lien holder. And they’ll notify you in the event that their insurance lapses or they have unpaid taxes or something like that.

Ian: Absolutely, yeah, that’s exactly what they are there for. And they’re licensed through the state so they’re regulated. Just like any mortgage, anybody that has a mortgage, there’s a servicer that you mail your payment to. Whenever they close the deal, the borrowers pay the first year of insurance up front. Then they escrow for three months of taxes and insurance and then the servicing company will make that payment to the insurance company for renewal and also to the county for the taxes. And then they send you all the information saying it’s paid and all that.
So that’s exactly what they do and in the event that the borrower doesn’t make a payment or they’re behind, the servicing company has a protocol and a way that they handle getting that payment and/or starting the process to initiate a foreclosure. But that typically doesn’t happen because these folks are just ecstatic that they are able to buy a property and able to move in and own their own home.

Mike: Yeah, I think if there’s any kind of negative connotations that people have on, “Well you’re charging 10-11% to somebody.” Well their alternative is that they have to rent. We’re so spoiled to think that government subsidized financing is the way that everybody should live. But if these people want to own a home, it’s more risky. It’s just like anything, if you have a higher risk level, then it’s going to cost you more to play.

Ian: Absolutely, and I’ve heard some other folks say that the interests rates will get back up there. You remember back in the 80’s they were 18% and that was typical. So with the biggest crash in human history, much less American history, they had to rock bottom those interest rates, which were artificial to begin with. They should have never gotten as low as they have been, 8-10% should be where they are but, we may see that, it may take a couple years. But we don’t know that, it just depends. They’re going to keep it low as long as they can.

Mike: Yeah, and one thing that’s an interesting fact and I’m sure you can kind of validate this is, whatever interest rate you’re charging and they’re ultimately paying for the seller financed deal, is probably at least equivalent or maybe even better than what it would rent for if they paid rent.

Ian: Absolutely, yeah, because remember, I’m not absorbing the taxes and the insurance. Plus the management of the property, all the differed maintenance. There are some pros and cons and I do hold rental properties. We do have a small portion of rentals and duplexes in our portfolio and we leverage that for write-offs, expenses, depreciation. So I definitely leverage the rental model but the bulk of our portfolio for cash flow is all in notes. Because when you’re the lender, you don’t get the phone call in the middle of the night that the toilet stopped up or the hot water heater went out.

Mike: Right, and one other thing that I know, and correct me if I’m wrong, that to consider in this model is that when you’re pricing your property, it’s probably more important to price it using what they would pay as rent versus what the ARV is. A lot of people would say that the after repaired value is based on recent sales and if you’re not using traditional lending then that doesn’t really matter. What somebody is looking to buy that house for is what would it cost me to rent a house versus to own a house. They’re not saying what would it cost me to own a house two blocks over, three or four months ago.

Ian: Yeah, absolutely, keeping the payment equal to or less than the rent in the area is very important. You don’t want to price the property out of an area. But whenever we sell the notes, we have to sell the properties for pretty much what they were appraised for because in the packet that we use to market to our note buyers, they want to see an appraisal. They want to see an underwriting package so they know that we didn’t inflate the property and take advantage of a home owner and then pay too much for a note when they shouldn’t pay that certain amount. We keep it legit; we’re a pretty transparent with everybody in the transaction. That’s just the way we do business.

Mike: Talk a little bit about the importance of disclosure, just making sure everybody understands what’s going on. When a traditional buyer is signing documents from a mortgage company they’re the size of a phone book, nobody’s reading it but it’s chock-full of disclosures to protect them and protect, in theory, both sides. But you, in many ways, I’m sure had to replicate that where everything is disclosed it’s all out there encouraged people to read it and really understand what they’re getting into. Just talk about the importance of disclosure in the seller financing model.

Ian: Well, definitely. If we borrowed money and they’re in first position, we have what’s called an underlying lien disclosure which basically describes to that buyer that there is a mortgage on this property that your seller is responsible for making. And they have to sign and acknowledge that information that they understand that there is a lien on the property underneath their lien that’s in second position. Kind of the same thing if you’re purchasing a subject-to.
I just closed on a subject-to deal last week and the document set was about 45 pages long just disclosing to the seller that they understand that the loan is going to stay in their name. They understand that there’s a due on sale clause, that the note could be called due, so on and so forth. There’s a lot of buzz about Dodd-Frank, and I think most people just have a misconception about what it is. But we use it to our advantage and make sure that we comply and that all parties are understanding and disclosed to both sides exactly what we’re doing and we don’t have any problems.

Mike: Right, just for those that are listening that heard you talk about a sub to, maybe just explain that real quick as to what that is.

Ian: Yeah, subject-to is a purchasing strategy where you can acquire a piece of property and leverage the mortgage that is already on the property. So, a lot of leads that we target are bankruptcies, divorces, pre-foreclosures, anybody that has a financial type of distress situation that just needs to get out of the house. Like I said before, you’re 40 to 60% cash offer isn’t going to work for a seller like that. So when you buy a property subject-to you basically take ownership but the mortgage stays in their name.
Yes, you have to make those payments, and then when you turn around and sell it on a wrap, you disclose to both parties. I’m completely upfront with my sellers, they understand that I’m an investor, they understand the risks involved and they understand that I intend to resell the property. They stay sign off on that on the disclosures and the same thing with the buyers. They understand that there is a mortgage on a property that is not in my company name and we just completely disclosed to that end buyer exactly the details on both sides of the transaction. They’re ecstatic that they can get into a property and not have to have 20% down or go through the whole underwriting process with traditional lenders.

Mike: Yeah, I know sub-to’s have kind of a bad wrap sometimes, no pun intended there on the wrap part, because that original seller’s credit could get hurt. But I think for those that use it wisely, they do exactly what you said. They’re disclosing it very clearly to the seller, here’s what’s going on, and probably using a professional servicing company that knows immediately if there’s a payment issue, what’s going on versus somebody that just sells it and they’re totally out of the deal. And somebody doesn’t finds out until six months later that they’re about to get foreclosed on for something they didn’t know payments were missed at all.

Ian: Yeah, absolutely and you know a benefit to the seller is that if an investor like myself comes along and I buy the property subject-to and they’ve been behind on payments, well I’m going to cure those payments. And over time their credit will get better because it’s not a foreclosure, it’s not a short sale, they can have some dings on their payment history. But an investor coming in and buying a property subject-to has a lot more benefit to that seller than they realize. And it’s important to be able to understand the process and educate those sellers that, “Look this is a benefit to you because we’re going to take over the property and we’re going to make those payments on time each and every month.”
And back to what you’re saying about disclosing to parties, in the third party servicer, whenever we board the mortgage, we have to give them all the information. We actually have to send them all closing docs, they go through a HUD statement, they go to the notes in the deeds of trust, they go through absolutely everything.
They comb all those files because they want to make sure that every detail is accounted for, all the taxes that were paid, the pass-throughs on the taxes and insurance premiums, the late payments on the note. Every attorney writes a note a little bit differently; sometimes it’s 5% of the principal interest payment, so on and so forth. There are a lot of little details that they go in and figure out.

But the cool thing about the servicer is, if there is underlying mortgage, they will make that payment directly to that lender. So that’s what’s cool is they take payment from the seller, they pay the underlying lien directly and then we get an ACH for the cash flow on the difference. And then we can log in, they have a website, we can log in and see the status of all the loans at any given time. So great, great service.

Mike: I just want to encourage anybody that’s using sub-to’s to do it the right way because there is a chance for people to get hurt and there’s a right and a wrong way to do it. So make sure you know what you’re doing and you’re disclosing everything you’re doing as well.

Ian: Yeah, well Mike, here’s an amazing golden nugget I’ll toss your way. So if anybody is worried about doing a subject-to deal, they’re worried about the lender calling the note due. Okay, well we can put the property in a land trust and give the seller a small portion of beneficial interest. So whenever you get new insurance on the property and the lender sees that the title is being changed into a trust, well the 1982 Garn-St Germain Act says that lenders cannot call notes due for estate planning purposes.
So if you take title into a land trust and give the sellers a small portion of the beneficial interest, they still own part of that trust and they are still beneficial interest holders of the trust. So a lender cannot call a note due. Now that would be a great strategy to do a just a buy-and-hold, if you’re going to hold it as a rental property, just transfer the deed one time and not turn around and sell a wrap. Or depending on what state you’re on to do a lease purchase. It’s a great strategy and you don’t even have to worry about the lenders calling a note due.

Mike: Yeah, and from what I’ve heard, I know people that have done the strategy pretty broadly, lots and lots of deals and never had a note called due, as long as it’s current. And banks are getting paid, that’s all they really care about.

Ian: I’ve had a lender tell me this, literally, from the horse’s mouth, as long as the payments are made on time, the property retains its insurance policy, and the taxes are current. He’s like I’m not going to take a performing note and take it through a foreclosure. He’s like, forget it because that’s less money that they have to lend out whenever that debt goes from performing to bad now they can’t loan money out. So lenders aren’t going to go take a property through foreclosure when the property is performing or the note is performing for them.

Mike: So, with just a couple more minutes here, Ian, tell us just a little bit about, kind of summarize, if folks wanted to learn how to do this, I know you teach some people how to do this too, but not necessarily to try to be a plug, but of course we want people to be able to learn more about you if they can. But if they want to go down this path to this strategy, learning more about how to wrap notes, how to seller finance and stuff, where would you tell them to go do some research and try to learn more about it?

Ian: Well there’s a lot of information out there but, my opinion, is learn from the people that are doing it because there’s a lot of theory and tons of information on any basic topic. I consult people on doing that so one of the sites that you can do a free webinar to learn more about how we do these deals is on FreedomInvestingAcademy.com/Gift and there there’s a blueprint that you can see visually how we put the deal together. And then there is a free webinar that does into a little bit more detail about how I structured the deals and how I set the insurance policies up, how I negotiate it, how I write my contracts and stuff like that. So that’s a great resource for you.

Mike: Okay, yeah, I’ll add a link down below the video. And talk, just say one more time about how in principle, the closer you get to that end user, typically the more money you can make. And if you provide the financing, the more opportunity you have to make money or the more likely you can make deals work that maybe wouldn’t work otherwise. Just share with us one more time why you’re in this space versus some other exit strategies that are more common maybe.

Ian: Well, I’ll tell you this, Albert Einstein was on the record saying one of the ninth wonders of the world is compound interest. So whenever you start looking at capital and financing, what do the largest banks in the world do? They finance everything and what do they love financing? Well they love financing real estate. So once we really started crunching numbers, the performance of a loan with interest outperformed any type of flip strategy or return on investment for marketing that you could possibly do. There’s no other strategy, other than maybe hard money lending or something like that, but back to its lending.
So getting back to the lending strategy and then getting out of the mindset that the house itself. Once I really got my head around the business, I realized it was about the financing, it wasn’t about the house. The house is the vehicle but everything that drives the vehicle is the financing.
So it’s just so broad I can talk about this for hours because I just love it but it’s really about the financing. So if you really just crunch the numbers, and I like saying this, a $60,000 house will never appreciate 11% a year for 30 years. But a $60,000 note at 11% will perform for 30 years and pay dozens of times over for what that property is worth. So if you really understand the financing behind the deals and you start crunching your numbers, yes, you can make big profits on wholesale deals and flips. But you have to redeploy that capital to try to get that return over and over and over.

Mike: Right, can you give any kind of quick statistics on default rate? Maybe some people that are listening are saying, “Hey you’re effectively selling to a subprime buyer, which isn’t necessarily the case. One other thing I want to say that I don’t want to put the words in your mouth, I don’t know how many Hispanic buyers you sell to, but the reality is, there are a lot of Hispanic buyers out there that just have no credit. And in the reason is that they haven’t abused credit like some other people have. So they maybe don’t even have a credit card to pay cash with a lot of things so they don’t have established credit, if you will.

Ian: Absolutely, well Mike, Hispanics are a big part of our business. And here’s the thing about Hispanic buyers, the federal government will allow them to pay taxes even if they don’t have a green card or they are an illegal alien. So as long as they have their TIN number, or tax identification number, we can legally sell them a house with a Mexico consular card. So there are a massive amount of folks that have cash that have it sitting under their mattress or whatever the case may be.
But you know we require a little bit more that. They have to have a bank account and then we also have a CPA that we can refer them to to help them get their tax returns done. Uncle Sam will allow them to pay taxes and not have citizenship here. So Hispanics are a big part of our business. Yes this is sub-prime lending, out of about 75 loans that we’ve done over the past 24 months, we’ve had less than a 3% default rate. I took back my first house last year and we’re going to take another one this year so 2 out of 75 that we’ve had to deal with.

Mike: Yeah, that’s not bad.

Ian: And then you know there’s a small portion of folks that pay late each time, each month a couple days late, and you’re going to have that in your portfolio. But it’s a great one and like you were talking about earlier, keeping the rent payment equal to or less than the rent, I’m not trying to do this on half a million dollar homes. So we found our niche, our price point, our target, our demographic and we’ve built our business around that. But I’m still expanding. And, like I said, I still do wholesaling, I still do rehabs, I kind of still do everything. But the last three years we’ve been really focused heavily on owner financing just because it’s performed so well for us and our investors.

Mike: Yeah, and even for yourself, it has a lot of the same benefits of rental properties and doesn’t have some of the cons of rental properties have so effectively you’re getting some mailbox money. You got a check to come in every month that you don’t have to think much about unless something pops up. But for the most part you’re creating passive income streams, right?

Ian: Absolutely, and also those notes are very, very valuable because you can pledge those as collateral for more money.
So there are a lot of different strategies that you can do with the note business and I’ve been fortunate to have been around a lot of guys that really understand financing and money and notes. And I’ve been able to rub elbows with hedge funds and look at what they’re doing on a massive, massive scale and it just comes down to that collateral value, that note. We have an investor we’re selling notes to and he’s pledging the notes as collateral through another lender and not even using his fund. It’s kind of crazy. But just the layers and layers and layers.

There are some many different ways and so many different niches of real estate and for people getting started in the business, it’s kind of tough to get focused on what to do, what to do next, how can you make money and really get out there. But seller financing is powerful. If you understand it it’s just an extra layer of your business that you’re not leaving money on the table when those valuable leads come in.

Mike: Yeah, awesome, well hey thanks for sharing your insights with us today, appreciate your time.

Ian: Yeah, you got it, Mike, anytime.

Mike: Yeah, and you’re right in my backyard so I’m sure we’ll cross paths sometime soon.

Ian: Absolutely.

Mike: All right, buddy, take care.

Ian: All right, thank you.
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