Pace:
I can’t negotiate my down payment with a bank. The bank has loan programs. They say it’s either 20% down or it’s 35% down or it’s 10% down or it’s three and a half percent down. There’s no negotiating that down payment with a loan. But if I go directly to a seller and I work out subject to or seller finance, I have the ability to negotiate a lower down payment, therefore, giving me a larger cash on cash return. Free real estate as far as I’m concerned.
What’s going on everyone? It’s Pace Morby, today’s host of the BiggerPockets Podcast, you might be wondering where is David? Where is Beardie Brandon? I sent them off to play jujitsu with each other. Is that what you say? You say play jujitsu. I’m not sure, but anyway, in all seriousness, it’s our job here at the BiggerPockets Podcast to show you how to get started building wealth through real estate today. We do that by bringing on top performers, expert investors and just plain regular people trying to make it happen as well.
We do that by laying out the tactics and mindset that will make you financially free. If you make the simple choice to take consistent action, like like, subscribe, et cetera if you’re getting value here. Today we have Ken, Diana, Eric, and Ralph and myself jumping into those four people’s questions. All about creative finance, LLC structures, all the fun things that I wish I knew when I was just starting in real estate. But before we get started, Pace, is there anything else you want to add? No Pace. Let’s get right into it. Ken Doyle, welcome to the show. How can I help you today, brother?

Ken Doyle:
How are you Pace?

Pace:
I’m loving life.

Ken Doyle:
Fantastic. Yeah. My question for you is, with all industries, they go through cycles and real estate market has cycles as well, even though COVID has thrown this off a bit, typically around 18 years with the phases as you go through. So thinking about that from the investor side and specifically on your creative financing, when you look at the phases as we’re going through these cycles, does it dictate any of the types of creative financing you may come to the table with, whether it’s sub to seller financing, novation, whatever the option might be? Or is it strictly driven by the problem you’re trying to solve for the homeowner?

Pace:
That’s a great question. So what you’re asking is, do you make a determination of what strategy you use based on the seller’s needs or does the market typically determine that? So what options you’re talking about is you’re talking about subject to, right? Taking over some of these existing mortgage, transferring the deed to your name. You’re talking about seller finance, where the seller creates an agreement with you, where they become the bank and you hold the deed and make payments to that seller over time or a novation agreement, which is primarily used for a fix and flip a creative finance fix and flip. The answer is really interesting. So if you look at seller finance versus subject to, they are really, really similar to each other, right? We’re going to the seller and we’re saying, “Hey, I would like to work out terms with you on your house rather than me paying it all the way off.”
In a market where people don’t have a lot of equity in their homes, subject to becomes one of these massive, massive power moves. So usually in a distressed market, subject to is super, super strong. So the market does dictate that because people have low equity. If people have low equity, the likelihood of them just saying, “Hey, look, take over my house. I’ll give you the deed.” That is really, really high. Now in a market like this right now, here we are, October of 2021, market is super high. And what does that mean? It means that a lot of sellers have a tremendous amount of equity. And when that’s the case, sellers ultimately are way more willing to sell on seller finance. So we’re seeing a switch. So two years ago, I’d say 70% of our acquisitions in the creative finance world were subject to. Now, that has swapped to be more like 60% are seller finance. It’s almost flip flopped the opposite way.
And the reason being is because now I’m negotiating against the seller’s equity in a seller finance situation. So absolutely the market dictates how we approach that because of their equity going up and down. Now in a novation agreement, novation agreement is flatlined all the way through, right? A novation agreement, we use it for the same reasons all the way through. And the answer to your question is the market usually dictates whether I’m using subject to more often, or if I’m using seller finance more often, hopefully that answers your question.

Ken Doyle:
Absolutely, that was fantastic.

Pace:
Do you have any follow up question?

Ken Doyle:
I do have a follow up. So thinking about the four phases in real estate and if you’re looking at textbook, I don’t know if we’re in textbook. I mean, do we fall, do you think in kind of the recession phase right now? I mean, how do you view that and what should we be looking at going into 2022?

Pace:
The main thing that I look at and I was in the market in 2006, 2007 as a contractor. So I had a different viewpoint. The people who were hiring me to build homes and do construction work, they had so many jobs. I was booked out for like two years. What I realized is a lot of the jobs that I was doing as a contractor were houses that nobody was actually moving into. What these builders were doing is they were pre-selling lots and there was all these people playing all these games. So it was a fake fictitious fugazi situation going on right now we have a true supply and demand issue. A true supply and demand issue. I think even if interest rates tick up a little bit, the market is still going to continue to be hot because what do we have a deficiency of nearly four plus million homes and the homes that we’re renovating and the homes that we’re selling, there’s a family moving into every one of these people. So we have a lack of supply. And at the end of the day, supply and demand really dictate what the market is doing.
A black swan event like COVID, didn’t slow us down. It only heated us up. I’ve never seen anything like it. I think we made about $6 million last year, just in the appreciation of our rental properties, $6 million, if you can believe that. So we don’t look at that as something we can bank on or something that we’re super excited about because we just look at, hey, the market is going to cycle. At some point, it is going to slow down or have a pullback. But we feel me, my colleagues, my partners, and the people that we do research with, we feel like we’re not going to have any slowdown for at least 36 months. Yeah. In fact, we actively have about 25 fix and flips going on at any of time, five or six of those are acquired with creative finance, the other 20 are acquired through some sort of private lending of some sort. We decided we’re going to go from 25 active projects to 30 active projects just because we’re so confident in what’s going on in the retail market.

Ken Doyle:
That’s great to hear.

Pace:
Yeah, it is crazy. And I would say from our wholesale business, where a lot of our contracts are selling in our wholesale business, those are going to hedge funds. There’s so much cash in the market right now because the hedge funds are saying, “We believe that the market’s going to continue to soar and soar and soar.” And they are partly to blame for the manipulation of the market a little bit, but really they see what we see or rather I should say, we see what they see because you know they’re ahead of the curve on us. They do way more research. They have way more money, way more resources, but they’re pouring their money into real estate right now because they know even if they buy over retail. And I’ll tell you a really interesting thing that just happened to us. They’re paying over retail on houses right now and they’re happy to do so.
We just sold a house to Opendoor. Okay? We sold a house to Opendoor and the retail value of the property was $350,000. They paid $399,000 site unseen. They waved appraisal, they waved their inspection, bought as is 399. They never even saw the house. Okay? Why are they doing that? Couple of things.

Ken Doyle:
They’re moving the market.

Pace:
They’re moving the market because here’s what happened. We researched that neighborhood and found they owned 21 homes in that neighborhood. So them paying $49,000 over retail, what they did is they amplified the value of all those other homes. So yes, they might have paid $49,000 over retail on that one house, but they probably made a million and a half dollars in appreciation by forcing the appraisals for history to happen in that market. We see the people doing that. We see a lot of that happening and there is manipulation in the market, but here’s the funny thing. Retail buyers, because interest rates are so low and demand is so high. And supply is so low. Retail buyers are also coming in and waving appraisal, waving walkthroughs, waving all of these things, even inspection. The last 25, 30 houses that we’ve sold on the retail market have all waived anything that you would normally expect a buyer to want. Appraisal, a waving an inspection. They’re not waving the inspection. They still do the inspection, obviously, because their lender wants it. But what they’re doing is they’re saying, “As is, we’re not going to ask for any repairs.”
Now what I remember back in 2006 and 2007, is I remember the speed of the market. I remember people saying, “It’s not going to slow down, it’s going to keep going.” And so of course we have trepidation, of course we have hesitation, but we have a very different world than we had back then. I’m sure you can agree. Lending practices are different with Dodd–Frank and all the other things that are going on. People have a lot of cash. People are putting down payments down. These are qualified buyers. There’s no subprime scam going on right now. And so the buyers moving into these homes are qualified good buyers. I feel like we have a really strong chance of having growth over 36 months before we have any sort of pullback.

Ken Doyle:
Fantastic. I love to hear that.

Pace:
Buy real estate.

Ken Doyle:
Buy real estate.

Pace:
Ken Doyle, everybody. Thank you Ken. I appreciate you brother.

Ken Doyle:
Thank you for your time, I appreciate it.

Pace:
Diana Moreno, welcome to the show. How can I help you today?

Diana Moreno:
Hey, what’s up Pace? Yeah. I had a question actually about how to come for buyers who want a certain return in their investment.

Pace:
Okay. So you have buyers that you are wanting to bring deals to. You want to bring investments to these buyers, right? So let’s say it’s somebody like me. Okay? I can tell you everything that comes down to for us is the yield. Okay? So yield is a fancy word for basically cash on cash return. So let’s talk about that for a second. Most investors are looking for a cash on cash return of at least 12%. Let’s say that I go buy a house and I go get a mortgage to buy that house. That mortgage requires me to put three and a half percent down and I buy the house for $200,000.
Well, I already know I’m going to put seven grand down. Three and a half percent at 200 grand is seven grand down. I’m going to pay for some closing costs, I’m going to pay some other miscellaneous expenses. Let’s just put it up to $15,000 all in I’m 15 grand in, getting a loan on this property and now I turn around and I rent it out. Okay? If I make, and I’m going to have you do some math. So pull out your calculator. Are you on your phone or are you on your laptop?

Diana Moreno:
Yeah, I got my phone on me, so I can do some math.

Pace:
Okay, great. So let’s do some math. If I invested $15,000 in that property, don’t type in 15 grand yet. I’m just going to lead the audience down this road. And this property makes me $300 a month in net income. I get to put that in my pocket, after all my expenses. That means at the end of the year, I have $3,600 from that property’s cashflow. Are you following me on that?

Diana Moreno:
Yeah.

Pace:
Okay. Now what we want to do is we now want to say if I invested 15 grand and I have $3,600 at the end of the year in cashflow, what is my return? What is my yield? So let’s do this math 3,600 divided by 15,000.

Diana Moreno:
.24.

Pace:
So that’s a 24% return on your money.

Diana Moreno:
Wow. Okay.

Pace:
Okay?

Diana Moreno:
I see what you mean.

Pace:
So this is how I look at all my deals. I look at what’s my cash requirement, how much money do I have to put into the deal? And how much money will I make in my pocket at the end of the year? That would be my cash on cash return. My yield, if I put in $15,000, how much money will that yield me in return? That’s where the silly word yield comes from. How much will it yield me? So cash on cash return is the single most important way to comp a house for a buyer. You’re going to look at it from their side of things. And you’re going to say, “How much cash is going to have to be invested in this property? And how much money will they make year over year?” And you divide those numbers and it comes out with a percentage. I know Brandon Turner, who’s the main host of the BiggerPockets Podcast. He says repeatedly over and over and over. He’s happy with anything 12% and above. So a house like that, 24% return, that’s a pretty dang good return.

Diana Moreno:
Yeah. Get doubled on that return there.

Pace:
So it’s a very simple way of looking at things. And so what you want to do is when you’re looking at opportunities for your buyers, the main thing I ask buyers is I will ask the buyers, say, “Hey, buyer?” For me, for example, I get people call me and go, “Hey, Pace, I want to bring you on opportunities. What is your cash on cash requirement? What are you looking for to make on your yearly investment into the property?” For me, I’m a little bit crazy Diana, because I use creative finance. And so I have an unfair advantage against other people that are going out and getting loans. I require, I will not look at a deal unless there’s a 30% cash on cash return. I won’t even look at it.

Diana Moreno:
Yeah.

Pace:
What I would rather do is if somebody brings me a deal that’s less than 30% cash on cash return, I will wholesale that or help them find a buyer for it. But I’m not interested in a 12, a 15, a 20% cash on cash return because utilizing creative finance, we get a lot of free houses. So when I get free house, guess what that means? My cash investment is very, very low. Therefore, my return on my cash investment is very, very high because I didn’t have to put much in to get a lot out. Does that make sense?

Diana Moreno:
Yeah. That makes sense. Yeah, that totally makes sense. And I can see why you would do creative finance there because if you’re getting 85% return on it, it’s nothing, I mean it’s-

Pace:
It’s ridiculous.

Diana Moreno:
Yeah. It’s ridiculous.

Pace:
And if you look at people that are investing in the stock market, do you know what the average return in the stock market is? It’s close to 7%. So if you are somebody investing in the stock market and you get a 7% return on your investment, wouldn’t it be better just to be in real estate and make 12, 15, 24, 85% return?

Diana Moreno:
Oh yeah, no doubt. Yeah. Wow.

Pace:
So what I want you to do is when you go talk to potential buyers, people that you’re going to field deals for, and you’re going to submit deals to, I want you to ask first and foremost, “What type of cash on cash return are you looking for?”

Diana Moreno:
Yeah.

Pace:
And that will tell you how to go look for deals for them. So for example, I have a deal somebody sent to me yesterday, okay? It’s a $2 million apartment complex that the seller is saying, “Hey, I’m willing to sell this entire apartment complex on seller finance. But I want a million dollar down payment.” He wants a 50% down payment on a $2 million purchase. So what you’re then doing is you’re requiring your buyer to put a million dollars in cash down. So I can tell you their cash on cash return is going to be so small. It will not be worth their time.

Diana Moreno:
I see.

Pace:
Okay?

Diana Moreno:
Yeah.

Pace:
And so you’ll know where to negotiate with that seller, where you go, “Look, seller if I put a million dollars into the property, my cash on cash return is going to be very low. The most I can offer you is $150,000 down.” And then that allows your buyer to… You really have to ask your buyer how much cash on cash return do they want in order for you to negotiate with the seller that you’re talking to about seller finance or subject to.

Diana Moreno:
Oh yeah. That makes total sense.

Pace:
Do you have any follow up questions for me?

Diana Moreno:
No, not anymore questions, but yeah. I can see why you would not want to give so much of a high down payment at first, yeah, because of the cash on cash return.

Pace:
Right. And that’s a thing that’s great about creative finance is that I can negotiate my down payment with my seller. Whereas I can’t negotiate my down payment with a bank. The bank has loan programs. They say it’s either 20% down or it’s 35% down or it’s 10% down or it’s three and a half percent down. There’s no negotiating that down payment with a loan. But if I go directly to a seller and I work out subject to, or seller finance, I have the ability to negotiate a lower down payment. Therefore, giving me a larger cash on cash return, free real estate as far as I’m concerned.

Diana Moreno:
Yeah. Free real estate for sure.

Pace:
Diana, you’re amazing. Thank you for the question.

Diana Moreno:
Thank you, Pace.

Pace:
Eric Clinton, how are you doing my brother? Welcome to the show.

Eric Clinton:
What’s up Pace, what’s up?

Pace:
What do you got for me today?

Eric Clinton:
Well, here we go like yourself, my goal is to fix and flip and do some buy and hold. So I put together a team of people with me to go ahead on this venture. And I need to know how important, because I heard this on your 26 hour live. You know that if you didn’t have your LLC, you weren’t in business and you said, “Get off the platform.” And so immediately I took care of that. I mean, I had one that just wasn’t functional for what I wanted to do, for what I wanted to do here. So the question is how important is business structure in doing what I want to do, accomplishing what I want to accomplish and or systems and team structure, to this business?

Pace:
How great of a question is this? So phenomenal. Here’s what I find out is that the corporate structure let’s just be clear for everybody paying attention. Corporate structure would be like my company setup, my LLC, or maybe a general partnership if that’s the direction I want to go. Establishing an actual business costs a couple 100 dollars. And I give you suggestion on that live. I use a company called Prime Corporate Services as who I use and I love Prime. They’re great. But what I love about having an LLC set up is that you don’t think about it. A lot of times I run into investors that are still starting, starting, starting, and that when they get their first contract, maybe it’s a wholesale contract or they land their first flip or what have you. They’re really scared that they then don’t have an LLC.
And they say, “Should I buy this property in my personal name?” Now, an LLC does multiple things for you. It subconsciously tells you, you are truly in business because you now have a corporate entity. It’s a subconscious thing that allows you to move forward in your business. And so a lot of people that are just consuming content and not taking action. One of those very small actions you can take is go get an LLC set up. Okay? Very inexpensive. Now you can say, “I’m in business. I’ve got a business. I need to start filling that business’ bank account with real money and real deals.” The next thing an LLC does is it protects you. So let’s say you go do a fix and flip, let’s say, you go do a buy and hold, let’s say you go do a wholesale deal. When you do those deals, you want to do them inside of your LLC, because in the event, which it will happen.
If you haven’t been in a lawsuit, my feeling is you haven’t been in business long enough. You will run into weird things. You’ll run into a tenant problem. We ran into an issue five or six years ago where we did a fix and flip. And a year later, the person who bought the property from us on the retail market sued us because of a faulty roof. And what was funny is we didn’t even do the roof. We never touched the roof. It was an older roof and we didn’t provide them a warranty, it wasn’t our responsibility. They had an inspection, but it doesn’t mean people won’t sue you. People can sue you for anything at any time. So if you get a lawsuit, the last thing you want to do is have a lawsuit in your personal name. You want to have that in an LLC because it provides protection against you and all your personal assets.
They can’t come after you personally, if you did the activities in an LLC. So for me, it’s more peace of mind knowing that when I’m running down this path and I’m building a team and systems and processes, I know that I’m doing it inside of an LLC. That personally I have no liability whatsoever so that if something goes wrong, I’m fine, my family’s fine, my personal assets are fine. So for me, it is a couple 100 dollars, which people go to the movies and have a sushi dinner, spend 200, $300, go spend the money on the LLC, get the LLC set up properly. Now in that 26 hour live, I educated you guys on what I suggest for the LLC structure just to make it simple and expensive, et cetera. Now, after you start that LLC, your next question, Eric is how important are business systems and processes?
Well, let me tell you how important they are. It’s noon, my time. Most people that are running real estate businesses and have 30 active fix and flips going on and have a tremendous amount of buy and hold properties. And a lot of Airbnbs all over the place. We have an active wholesale operation, A&E and us have a five year contract for a television show. We own virtual assistant businesses, we have all these things. Without systems and processes, I would not physically be able to be here. I would be running and gunning like a chicken with its head cut off because I didn’t have processes and systems. Somebody to answer the phone, somebody to put out a fire, somebody to move a lead along. Even when a lead comes to me, sometimes people will go, “Pace, I need help with this lead.”
I’ll answer a question real quick. And I throw it right back into the system, right back into the conveyor belt and have the acquisition people handle it. I never get myself caught inside my business because I am actually my own worst enemy. I had to learn how to create systems and processes so that business would run without me. It is very, very important. So Eric, in the very beginning of your business, I would suggest the first and most important thing I would do is you should get a virtual assistant. Have you considered getting a virtual assistant?

Eric Clinton:
Absolutely.

Pace:
Okay. So get a virtual assistant to take one task off your plate per month. And for a lot of people, if you’re out there looking for deals that could be, take the cold calling off your plate. So I would suggest choose one activity per month that you don’t want to do and hand it over to that virtual assistant, train them until they can’t do anymore and then get another virtual assistant.
And by the time you have two virtual assistants, I would then have a conversation internally and say, “Do I need an actual assistant or an actual employee on boots on the ground?” But most investors looking for wholesale deals, fix and flips, creative finance opportunities. They’re cold calling, they’re texting, they’re on social media, looking and going through Facebook groups and looking for deals. Those are tasks that a virtual assistant can do, and those can be automated. So when you wake up in the morning, your calendar is booked with appointments to talk to sellers. That is the first thing I would do is how do I offload those tasks? So all day long, I’m just talking to sellers and making money phone calls. What most people do is they make the cold calls themselves, which can be done by a nine or $10 an hour person, even part-time.
And then you hear them saying, “I’ve been trying to get into real estate for six months.” And I go, “Okay, great. What are you doing every day? What’s your day look like?” “Well, I start out by cold calling five or six hours a day.” And I go, “You, what? You cold call yourself five or six hours? You should not be doing that. You offload that to a lower paying position and they should be amplifying you on money, making conversations only.” And so those systems and processes will keep your sanity. You’ll make way more money and you’ll be motivated and you’ll have tons of passion. You won’t feel like you’ll ever burn out if you’re offloading those things right out of the gate.

Eric Clinton:
Awesome.

Pace:
What do you feel like you need to outsource right out of the gate?

Eric Clinton:
Just that, the cold calling.

Pace:
There you go. I see a lot of people teaching how to cold call, how to cold call, how to cold call. I personally think cold calling is a waste of time for somebody like me. I would never do it. What I would do is if I’m lacking budget, I would probably drive for or deals. And I would call and text sellers directly, but cold calling, just hitting the phone and calling some big, massive list. That’s something that a virtual assistant can do. And if you don’t have the budget for it, start with driving for deals, then upgrade and hire a cold caller that just sits there full time and call sellers. In fact, my goal for you, Eric would be, how quickly can I get somebody else setting two appointments a day for me every day. Now you’ll see this with me and my partners.
We do this obviously in our business, our virtual assistants can generate two good leads per day each. So two leads per day. Man, those are good quality conversations with sellers. Some of them might say, “Ah, I want too much money.” Well, at that point, you know this, Eric, you can pivot that conversation to creative finance, which is great. But let’s keep it basic. You’ve got to have an LLC just for the subconscious and you’ve got to have the virtual assistant just so you don’t burn yourself out. The last thing you want to do is be three months, four months into this and go, “Man, I…” (silence)

Eric Clinton:
I don’t go on vacation. So no, I’m over motivated by that, I’d been there.

Pace:
Do you know what I’m saying a barbecue or I went to a football game or whatever.

Eric Clinton:
I know what you’re saying, no.

Pace:
But that’s the thing, Eric, do you deserve a vacation?

Eric Clinton:
Absolutely. Absolutely.

Pace:
And the thing keeping you from being on vacation is one of two things. It’s either a lack of deals or it’s a lack of systems.

Eric Clinton:
Both.

Pace:
Right. And guess what? A virtual assistant can solve both of those. So I would maybe, and this is what I tell people a lot of times too, this is so important that I would go squat up. I would go find somebody else and say, “Hey, let’s share a virtual assistant. So we don’t have the added expense that’s too great.” I mean a virtual assistance, like one fifth, the cost of an American employee. So it’s a great way to go for that cold calling or texting task. And then you don’t ever have to do it. And all you do is you look at your calendar every morning and you say, “Who am I talking to? Not who am I cold calling.”

Eric Clinton:
Awesome. That’s what’s going to happen.

Pace:
Yeah, that’s what’s going to happen.

Eric Clinton:
I appreciate your time brother. That was great.

Pace:
I hope that was helpful. I wish I could jump in a time machine and tell myself that seven, eight years ago.

Eric Clinton:
And that’s why I asked the question.

Pace:
I was hustling and I was reveling in the hustle mode and the mentality. And then I realized, man, I just spent three years chasing my tail when I could have just hired somebody to do a lot of these tasks. And now I can do all sorts of things. And people ask me all the time, “How do you have your hands in so many things and how are you doing so much?” I go, “Because other people are doing the majority of the work.” I’m the one that gets to do the high level tasks, the tasks that make me the most money. That’s where I focus all my time and energy.”

Eric Clinton:
That’s great. Thanks for being awesome, Pace. I always appreciate you.

Pace:
Eric, you’re the man brother, thank you for the question. It was awesome.

Eric Clinton:
You got it.

Pace:
Well, let’s get into this Ralph. Welcome to the BiggerPockets show. Thank you so much for coming on here. You have a great question. I’m excited to answer. What is your questions for the audience?

Ralph:
So my question is when locking a sub two deal I was wondering how you feel about adjustable-rate mortgages. So I found that out recently about a guy I was… The deal actually didn’t end up going through anyways, but it would still be good to know what the approach should be.

Pace:
Phenomenal question. So let me reiterate the question for the people in the back that don’t understand exactly what the question was. Your question is Pace, how do you feel about buying a home subject to which means keeping the mortgage in the seller’s name and taking the deed right? Subject to. How do you feel about buying a house subject to that has an adjustable rate mortgage? And my answer is I don’t mind it, but I have an equation where I only take on one out of 20 acquisitions that I do in my portfolio are allowed to have an adjustable rate mortgage. Okay? So let me tell you what happened in 2008, 2009, a lot of the investors that were buying subject to, that’s right guys, subject to’s been around a very long time. In fact, we know subject to’s been going out back at least 100 years.
People have been taking deeds on properties that have mortgages and debts on them for a very, very, a long time. It is perfectly legal just to be very clear with you guys in future episodes of being in BiggerPockets I really hope to bring on a couple of my attorneys and we can chop up some of the legalities and the fun parts of the inner workings of subject to. But let’s throw that to the side. It’s not illegal. It is perfectly illegal. It’s fun. In fact, a lot of my investors are lenders in my business, which is great. But in 2008 and 2009, the majority of my colleagues were buying subject to deals on adjustable-rate mortgages. Now at the time those properties were cash flowing and that perfectly fine. If the market crashes, what do I care about the value of the house going down as long as my cashflow continues to go? Because we all know the market’s going to rebound at some point might be five years, might be 20 years, whatever.
Why was it so bad in 2008 and 2009? When the interest rates rose on those adjustable-rate mortgages? What happened is those properties no longer cash flowed. And now my colleagues who are now hemorrhaging money on every property and those properties were underwater. So it was a double whammy. They had no equity. In fact, they had negative equity and they had an adjustable-rate mortgage that now just turned the opposite direction. And now they’re losing $200 a month, not making 400 or $500 a month. It was that dramatic. I had friends that were worth 20, 30, 40 million that ended up losing just about everything. And the main reason why is because they were acquiring subject to deals on adjustable-rate mortgages. And they weren’t thinking what would happen if the market completely turned and at the interest rates rose. So for us, we own multiple houses with adjustable-rate mortgages. I’m not opposed to it. I just limit my exposure to it by limiting one out of 20 acquisitions into my portfolio are allowed to have adjustable-rate mortgage.

Ralph:
So you will do it, but you don’t want to have any properties it’s kind of here and there.

Pace:
The thing is the adjustable-rate mortgages are kind of a thing of the past, if you run into them, they’re very, very rare. Back in 2006, 2005, 2007, they were everywhere. Everybody was doing adjustable-rate mortgages. That’s kind of an old model. Do they still exist? Yes they do. But they’re very rare. Most of the properties that you’re going to run into now with subject to opportunities are going to be fixed rate mortgages. So last month we bought a property with an adjustable-rate mortgage. Now let’s look at this, okay? If I have one property in adjustable-rate mortgage, and I’m making $300 a month in cashflow, what I do is I say, let’s say worst case scenario, the interest rates go up at 4%. Am I still cash flowing? And if I’m not cash flowing, do I have the ability to cover that cost?
My feeling is if it’s your first subject to deal, that you’re ever buying, do not buy it with an adjustable-rate mortgages. I would assign it to another investor like me, who can handle if the market fluctuates. If you send me a deal and it’s adjustable-rate mortgage, I’ve got so many other properties that are cash flowing, that one property, not cash flowing in my portfolio is not going to make a dent in my portfolio.

Ralph:
That answers the next question I was going to ask that was perfect.

Pace:
Yeah. Assign the deal to a seasoned investor like me, you can lock those deals up, just plan on assigning them. If you’re newer to creative finance and make 10, 15, $20,000 assignment fee on those things and let somebody else take on the adjustable-rate mortgage, that’s more experienced, has more resources.

Ralph:
Thank you Pace, that fixes everything there.

Pace:
That’s the goal. That’s my job, brother. Thank you so much for the question.

Ralph:
Absolutely. Do we have time for maybe a follow up question?

Pace:
Come on bro. You know me, I love to talk. Lets go.

Ralph:
Awesome. So I am talking to another seller later today who is stuck on a number that… I mean, I still have to bring her down to reality, but we’re starting to think together that we’re good, the people I’m squatting up with. We’re thinking about pitching a novation. I don’t know. I know some very basics of it, but if you were me and you were going to try to just pitch it at its most basic, how would you pitch that? Do you have anything you could give me?

Pace:
I do just locked up a seller on a novation agreement on a 26 hour live I did on YouTube, but I will reiterate and do it in a very simple format for everybody here on BiggerPockets. What is a novation agreement first and foremost? A novation agreement is an instrument that allows me to fix and flip a property without ever having to own it. And so what I tell a sellers, I say, “Well, what if we just partner on the fix and flip? What if I just lock in a number for you, you let me go fix and flip the property. And when I sell it to my buyer, I then pay you off.” Now in the real estate community, this is also known as a net listing, but I imagine Ralph, you’re not a realtor, right?

Ralph:
Mm-Hmm, no.

Pace:
Okay. So a realtor can go to a seller and say, “I want to put you in an agreement called a net listing, which means I’m going to list the property with a promise of giving you a net number.” So what that means is, what does the seller want Ralph?

Ralph:
Unless, you want a number?

Pace:
Yeah.

Ralph:
165.

Pace:
Okay. So the seller wants 165. So I would tell the seller this, I would just say, “Look, if I can come up to your number of 165, what it’s going to do is it’s going to put me in a realm where I probably can’t make the money I need to make. It’s going to put me in a really tight area that if one thing goes wrong, I could potentially lose money. And I don’t want to do that. However, if you let me renovate and clean up the property and put it on the market, invest my money into the property. And I guarantee you in our agreement that you will get 165, when I sell it to my end buyer, would you be opening to a partnership or something along those lines?” That’s the question. And they go, “Okay, so you’re not buying it?” “No, I’m not buying it. I’m not buying the property. I’m guaranteeing you 165 number after I clean up, put the property on the market and I sell it to my end buyer.”
Okay. In the real estate world. Again, if I’m a real estate agent, I would do it a little bit different. I would say, “I’m going to list your property for whatever I think I can list it for a billion dollars, $20 billion. It doesn’t matter to you Mr. Seller, because I’m going to guarantee you $165,000. If I can guarantee you $165,000, do I have your permission to clean up the property and list the property as long as I can get you your 165?” That’s called a net listing when you’re a real estate agent. Does that make sense?

Ralph:
Yes.

Pace:
It’s very simple, a novation agreement. I hate the way that it’s worded because a novation is a word that most people have never heard before. And so it like kind of scrambles the brain and it tells you that this should be way more complex than it really is. It is the most simple, creative finance strategy ever. It is simply renovating a property that you don’t own promising the seller, a very specific number before you start renovating and you get the seller their number when you finalize the renovation and you sell it to a home buyer on the back end.

Ralph:
Got you. Yeah, that’s great.

Pace:
And for the people that are paying attention, they might say, “Well, why would I use a novation agreement?” Well, think about this. Let’s say that Ralph’s number to the seller is 150. And the seller says, “I’m not going to sell unless I get 165.” A lot of the times a fix and flipper can’t pay 165 is because they have acquisition costs.
We pay hard money lender fees. We pay hard money payments. We pay closing costs, title and escrow fees. We pay insurance and all these things along the way that a lot of times cost us $15,000. So in essence, if I’m buying a property from a homeowner for 150, with all of those added expenses and things that add up, I’m really it for 165. It’s just that the seller doesn’t get the 165, they get 150 and all these other people get paid $15,000. So in a novation agreement, it allows me to pay 165 because I don’t have to pay hard money lender fees. I don’t have to pay close of escrow fees. I don’t have to pay title and escrow fees and guess where that money goes? It doesn’t go to all these other business professionals. It goes to the seller, which is where it should go.
So when you pitch it like that to a seller and you let the seller know, look in a novation agreement, which I don’t ever call it a novation agreement with the seller, I call it a partnership agreement. So they understand it’s a partnership. I’m giving you a guaranteed number. You’re letting me to the property without owning it. And then there’s obviously a lot of mechanics behind the scenes of like how to protect yourself, how to make sure that you don’t lose money. There’s all those things, which is another conversation for another day. But if you just tell the seller, “I can give you 165, as long as I can give you 165. And you don’t force me to give you 165 and then other people and other 15 grand. Why don’t I give you 165 and we meet in the middle? You let me renovate the property without purchasing it. And I will guarantee that I can come up to that 165 in our agreement.”

Ralph:
Genius, I like that.

Pace:
It’s very simple. It’s logical. That’s the beautiful thing about creative finance. It is the only logical way for both parties to truly win.

Ralph:
Yeah. And this is the only way that she’ll do it because I mean, I’ve talked her down from 180 down to that and she’s not budging from there. It’s been weeks.

Pace:
Yeah. Go through exactly what I just told you. Say, “If I bought it from you at 165, I’m really buying it for 180 and here’s why.”

Ralph:
Mm-hmm (affirmative). Yeah.

Pace:
“And I would love to give you 165, as long as I can give you 165 and nobody else any money. And that would require for us to have an agreement together.” That’s sort of a partnership.

Ralph:
That’s perfect. I’m calling her tonight, so.

Pace:
Do it, lock it up, man. Go get the deal done.

Ralph:
Awesome.

Pace:
Good work brother. Thank you for the question. It’s really good.

Ralph:
Absolutely. Thank you as well. And thank you for your time. I really appreciate you.

Pace:
Anytime, brother, anytime. Thank you.

Ralph:
Awesome. All right, bye.

Pace:
Thank you, BiggerPockets for having me on today’s show. I am so grateful. I have learned so much over the years on this exact podcast. It is almost surreal that I’m here in person. And guys, if you’ve gotten value today, please make sure you download this podcast anywhere you get your podcast. Make sure you like, you subscribe, you comment down below. This is all about action taking, building community, down in the comments and encouraging each other to take the next step in your real estate journey. We’ll see you on the next episode of the BiggerPockets Podcast. This is Pace Morby signing off for the BiggerPockets Podcast. Please follow me, I am a future TV reality star. I have a bikini calendar coming out next year. So look forward to that. Join me on my Instagram @pacemorby and look out for that calendar coming soon.