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Unraveling The Mysteries of ‘Subject To’

A Primer For Creative Acquisition Strategies

Written by Robert Feol for the Baltimore Real Estate Investor’s Association

If you are like me, or should I say ‘were’ like me, the acquisition strategy of taking a property ‘Subject To’ is a bit of an enigma.  ‘I took that property ‘Subject To’’ the annoying guy at your local REIA says, somewhat boastfully, knowing that he SOUNDS like he knows so much more than you ever will.  You quietly walk away wondering if you will ever be successful in real estate investing.  After all, you probably are unsure of exactly what taking a property ‘Subject To’ is, let alone how it is accomplished.  In and of itself the phrase doesn’t even make sense – “I took a property ‘Subject To’”, grammatically, isn’t even proper English.  It’s an incomplete phrase.  Your 7th Grade English teacher would fail you if you tried to diagram the sentence.  Older generation, you know what I mean.  So let’s figure out what taking a property ‘Subject To’ really is, and isn’t.

First all, the easiest way to get an inkling of what a ‘Subject To’ acquisition strategy entails is to actually complete the sentence – ‘Subject To’ being a curt way of saying ‘Subject To existing financing’.  Translated, you take over a property and assume control of the parcel of real estate without having to bring new financing to ‘cash out’ the seller.   In its simplest form, you(discretely) take over the loan.  Obviously, your discretion is not from the seller, who should be, ideally, completely aware of what you are doing.  Discretion plays a role when you are transferring ownership of the property, because most lending institutions have a Due on Sale or Acceleration Clause, saying if an owner transfers their beneficial interest without having the lien the bank holds released, then the bank has the right to call the loan ‘due’ and force the seller to pay up, in full, or face immediate foreclosure.  So your mission, if you are trying to take over a property Subject To, is to actually get control of the property while doing the transaction in such a discrete way that the bank is unaware of what is taking place.

Remember the old FHA assumable loans from the 70’s and early 80’s?  You could take over those loans without a bank really giving you a hassle.  Think of taking a property Subject To as assuming the seller’s loan, because that is essentially what you are doing.  The only difference is the bank doesn’t give its blessing on such a transaction.  Yet, if you do the transaction correctly the bank will continue to receive its payments on time and you can continue the work of being a successful real estate investor in earnest.  Subject To transactions, when done properly, satisfy all parties involved – the bank continues to get paid, the seller salvages their credit, and the investor gets the benefit of controlling a piece of real estate with no money down.

Let’s recap three points so far:

1) ‘Subject To’ means ‘Subject To the existing financing in place against the property’

2) Due on Sale Clause means ‘if the seller gives the home to someone without paying off the bank, the bank can foreclose’.  This is known as triggering the Due on Sale Clause.

3) Triggering the Due on Sale Clause is BAD.

Ok then, so now you understand what taking a property Subject To means!  But, do you REALLY understand why a person would implement it, let alone HOW a person would implement it?   Most people, when they first hear about how Subject To transactions work, immediately ask the question – ‘why would the seller GIVE someone their house?’  They think of everything in terms of what they know – for example, if you are reading this the thought of you ‘giving’ your home to someone else is bizarre.  So why do Subject To transactions happen and why are they generally win – win situations?

ENTER DISTRESSED SELLER

Consider my friend Trent.  Trent bought some properties in Memphis, but he wasn’t really prepared for owning investment property, and the individual he bought them from didn’t set him up for success.  Not his fault, really, but what we are interested is in Trent’s emotional state as he started to fall behind on payments.  Trent had great credit and always paid his bills on time.  His dad was a successful banker in Mississippi.  The embarrassment that Trent was facing by losing the homes was HUGE for him.  He would have done anything to get away from the homes, including GIVE them away.  He didn’t want any money.  He wanted to save his credit and reputation, and move to France.  His phone wouldn’t stop ringing with creditors. He just wanted to get out.

Now, Trent was a prime example of someone who had properties that could be taken Subject To.  The common investor, however, is usually looking for a ‘deal’, and on the surface most Subject To transactions don’t appear to be ‘deals’.  Let’s say Trent had a home that was worth 65k but he owed 60k.  That isn’t really a deal by any measure.

Ordinary investors wouldn’t touch it.  It makes zero sense to bring new financing against a property that is leveraged at almost 100% of appraised value.  For the average investor, there are better deals to be found.  They would simply pass on the deal and say ‘Good Luck’.

But, for the non – ordinary investor(YOU), your creative approach could have solved Trent’s problem, because Trent is willing to cede control of the home to you, and have you take responsibility for the payments.  If you are willing to take over the responsibilities of home ownership(and YES, that includes maintenance and repairs), then you can have a piece of real estate, at times for zero down.  Let’s see how Trent’s house could have worked for us in a Subject To scenario. Assume the payments are current for this solution.

Home is worth: 65k

Amount owed on home: 60k

Mortgage Payment(PITI): $550/month

Rent: $700

Gross Cash Flow: $150

So, if someone took over the payments on the house by getting the deed in their name(taking a home Subject To) they would make $150/month gross positive cash flow.  Not bad for buying a home for zero down.  But, if you factor in vacancy and maintenance, then really the cash flow is nominal, if not a bit negative!  So, how do you get around that?

Many savvy transactions engineers(read: real estate investors) would ask the seller to subsidize the monthly mortgage payment, until a suitable exit strategy can be found.  So, in the example above someone could ask Trent to pay $250/month to help offset the maintenance and vacancy factors.   Then the positive cash flow would be almost $400/month! Even with this subsidy, however, if you are a serious real estate investor and you take a home Subject To, your responsibilities include:

1) Paying the monthly mortgage payment ON TIME, regardless if the home is rented or vacant.

2) Managing the property yourself or with a management company.

3) Handling all maintenance in a timely fashion, paying for repairs out of YOUR pocket.

4) Maintaining up to date insurance on the property and keeping accurate records.

Generally, when you take a home Subject To the current owners are done with the home.  They move out(if they live there), and have very little involvement(if any) with the home after you have taken control of the property.  While the methodology of how, specifically, you accomplish the transaction is beyond the scope of this article, two important points to remember are as follows:

1)     People generally avoid triggering the due on sale by moving the property into a ‘Family Trust’, i.e. ‘Trent Family Trust’, with the real estate investor being the beneficiary of the trust.

2)     It is CRITICAL that you get power of attorney over all documentation pertaining to the owner and the specific property, so when the owner moves away you do not have to track them down for signatures when you get the home sold, and there is no possible way they can contest the sale of the home(or your potential profit!)

Like so many niches in real estate investing, very few people really understand the intricacies of Subject To transactions.  If you are looking for a profitable opportunity to do some deals with no money down, Subject To investing may be for you.  However, remember – distressed sellers often have back payments that need to be made up and repairs needed to get a home into rentable/saleable condition.  So, not every Subject To opportunity is a truly zero down opportunity!  Prudence and sage analysis are the greatest factors in determining if a distressed seller’s property is fool’s gold or truly the end of the rainbow.

Join me next time as we look at some examples and strategies of how to take homes Subject To.

Robert Feol is an author, speaker, teacher, investor, and radio personality whose primary focus is helping others get safely into real estate investments. Want to learn more? Listen to his radio show every Saturday at 11 AM CST on News Radio 600 WREC, Memphis. Or, catch the archived show here: http://www.wrecradio.com/pages/expert.html.

You can also catch him at his latest project website, memphistenantplacement.com