Could “Repair for Equity” be Part of the Solution to the “Affordable Housing Crisis”?

Lawmakers all over the U.S. are tearing their hair out over the lack of affordable housing, and trying desperately (generally through lots of restrictions of property rights and lots of taxes that lead to a lot fewer new units than the private market could have built) to make housing more affordable for both renters and buyers.

They overlook or dismiss the things that people are doing with other people that create affordable housing by creating housing OPTIONS, especially in rental and bread and butter areas, that banks and governments can’t match.

One small solution for one set of renter/buyers is Repair for Equity deals. When done right, they have the strong potential to make homeowners out of people who can’t qualify for a bank loan, and at a lower monthly cost than renting. And the fact that YOU can make a lot of money PROVIDING them is an added bonus; all that income makes you want to do MORE, which makes this option more available to more American.

Let me explain.

I didn’t actually start out out wholesaling properties. My first 30 or so deals were actually what some people call ‘Repair for Equity’, some call ‘Option to Buy After Repairs are Made’, some call ‘Sweat Equity Deals’, and some just call ‘Slow Flipping’.

Basically, these deals work like this:

1. You buy a property needing repair, but which is livable, at a discount of 25-30% below market
2. You offer that property at a higher, but still under-market, price, on payments to people who want to live in it and have the skills to fix it up
3. That buyer puts down a small up-front payment, repaired the property, and either finances it conventionally or continues to pay you until the final payment is made and he owns the property

There are dozens of mix-and-match variations of this deal, but the general benefit to you is that you get a high return with no repairs or management, while the buyer gets to use his skills and the your financing to acquire a property he wouldn’t otherwise be able to, at a price that allowed him to have immediate and future equity in the property.

I did perhaps 150 of these deals for myself and others between 1989 and 1998. Then I stopped, for the simple reason that as the availability of easy institutional financing increased, it got harder and harder to find viable buyers who couldn’t just go buy any house they wanted.

But the world has turned, and many potential buyers with a lot of skills and a little money and not a lot of credit are out there once again, looking for these deals. If you can provide the supply, the demand is back, big time—and, when they work, these deals can be a lot more profitable than either wholesaling or retailing the same property, with less hassle than renting, too.

Let me give you the most recent example of the ways in which these deals can create income and cash for you with minimal hassle:

Last month, I sold a 4 bedroom brick home on a nice street in a rental area.

The buyers were a young couple, and the husband had grown up on the street. The wife’s father was a contractor who had originally approached us about buying the house as an investment, but bowed out when his daughter and son-in-law decided they wanted to live there.

I bought the property for $11,000, using a private mortgage at 8% interest. The after-repaired value is around $65,000. My estimate of repair costs—which included hiring contractors to do all the work—was around $25,000.

I did no work to the property, but sold it within a month to the young couple for $35,000 on a contract for deed under the following terms:

$2,500 down

8% interest

10 year term

Principal and interest payment $394/mo.

The couple is expected to (and qualified to) to all of the work on the property.

So why in the world is this a good deal for them? I mean, they paid $35,000 for a house that needs $25,000 in work and will be worth $65,000 when they’re done!

Here’s why:

1. They won’t spend $25,000 to do the work. They’ll buy the materials (mostly through the contractor father, who gets discounts on most building materials) and do the work themselves. That’s why it’s called “Repair for Equity”—because they’ll actually invest somewhere in the $10,000-$12,000 range in the property, for a total of $47,000, max. And yes, it will be worth $65,000, and that’s $18,000 in equity for their work
2. In the meantime, they’ll live in their own home for a total PITI payment of around $450 per month. The identical houses next door and across the street are rented for $825—thus, they’ll actually save almost $400/mo. vs. renting the same property
3. AND, in 10 years, they’ll own that house free and clear. The low sale price allows a shorter amortization than the usual 30 year with payments that are still reasonable. Every month, they’re buying quite a bit of mortgage pay down, which wouldn’t happen if they rented and wouldn’t happen if they borrowed 30 year money from the bank.
4. Plus, owner financing is the only way in the current market that they could buy a house at all. The wife had just gotten a new job after a lengthy layoff; the husband’s credit was bad thanks to the loss of her income and a divorce a few years back.

Perhaps it’s obvious why I’D want to do this deal, but let me enumerate the reasons anyway:

1. I put no money down, and got $2,500 down
2. I paid $11,000 for the property and sold it for $35,000
3. My monthly payments to my lender are $80.71 a month; I’m getting $394
4. I didn’t have to repair anything
5. If I choose, I can now sell the property subject to the contract for deed to another investor for around $24,000, paying off my underlying loan, and creating a return of 16% for the investor/buyer

Sounds great, right? And it is, under the right circumstances. There are tons of people who want a deal like this, and tons of deals that you can make work like this. However, like any real estate transaction, it can go wrong if it’s done with the wrong people or not set up correctly to begin with. The primary risks are:

1. The buyer doesn’t make payments, and you’re forced to take the property back. Depending on how you conveyed control of the property in the first place (Lease/option, contract for deed, and seller-held mortgage are all options), you might have to do that through foreclosure. In states where judicial foreclosures are the rule, this can take months and cost several thousand dollars.
2. The buyer doesn’t pay the real estate taxes due on the property, and it’s sold at tax sale or a tax lien is issued against the property. You’ll end up paying the taxes in order to retain your 1^st position lien on the property
3. The buyer doesn’t purchase insurance, or the insurance lapses, and a fire or other damage to the property occurs

For these reasons, it’s crucial that you do the following:

• Screen the buyer as you would any other borrower or tenant. Make sure that he has the income to support the entire principal, interest, tax, and insurance payment AND that he has the excess income AND skills to do whatever work is necessary. Check his criminal and civil record, employment, and so on.
• Make his taxes and insurance part of his monthly payment. The simplest way to do this, AND make sure that the tax and insurance bills are being paid, is to get a loan servicer involved. For under $20 a month—usually paid by the buyer—a loan servicer will take in the payments, pay the underlying mortgage payment, if any, and escrow the taxes and insurance for payment when the bills are due. The balance is, of course, sent to you, and the servicer notifies you if payments are late or not made.
• Make the term of the deal as short as practical. Back in the day, I and others set up these deals as 30 year amortizing land contracts or mortgages, often with balloons in 2-5 years.

But thanks to Messrs. Dodd and Frank, who knew a lot more about owner financing than, you know, the people who do it every day, these balloons are now illegal. One option, of course, it to offer a lease/option rather than an actual financing instrument, but they have their own set of problems.

So the balancing act for you is that you want to give the buyer more than enough time to create his equity, but not be in a 30-year relationship with him. So I typically do the shortest amortization I can that still results in a PITI payment that is less than rent. In most cases, this is under 15 years; in some, under 10. Your buyers LOVE this, by the way—the idea that they could own a property in 10 or 15 years for less than the rent payment, I mean.

• Make sure that the paperwork is detailed, correct, and correctly recorded. You may use a contract for deed strategy, or you may choose a wrap-around mortgage or deed of trust to memorialize these deals. Whichever you choose, you and your buyer both need to understand your rights and responsibilities under the terms of the contract, and any contract you use will need to be recorded in the public record. Each of these contracts is heavily governed by and state law, so don’t just grab one out of some course and use it. Have a local attorney draft and/or review the contracts before you use them.
• Address default at the beginning of the deal. Sometimes, buyers default on these deals due to reasons that neither of you can control or predict. Divorce, illness, job transfer, and other unforeseen problems can force the buyer into a position where he can’t pay. His options at that point are to 1) resell the deal himself to pay you off 2) give you a deed in lieu of foreclosure or 3) be foreclosed on. I strongly suggest that you outline these options (with a heavy emphasis on why #3 is an option he wants to avoid at any cost) and get his agreement that #2 is the most right, fair, and pleasant of his choices. This won’t guarantee his cooperation in case of default, but will make his cooperation more likely.
• Do a real closing. You’re selling a property; there are tax prorations, transfer taxes, and county forms to be dealt with. There should be a closing statement prepared. The purchaser should be encouraged to get title insurance, and you as the lender should get a lender’s policy. These things—especially the latter—require a qualified attorney or title agent.
• No one gets in no money down. A buyer without a down payment is a buyer who’s not qualified. A buyer who hasn’t made a significant down payment—5% or more—is a buyer who’s much more likely to walk away from the deal.
• Selling these deals to people without the skills to renovate them is an invitation to disaster. You’ll often hear this: “If I get the property back with half the repairs made, I’m ahead of the game, because I’ve got a more valuable property to resell.” That’s all well and good, except in the case where the buyer’s repairs are of such poor quality that they have to be redone, or where the buyer does things to the property that make it less valuable.
• Be aware of the other requirements of the Dodd–Frank Act and Safe Act as it relates to these deals. Since contracts for deed ARE considered “financing” under these new federal regulations, you must follow the guidelines set out by them. In short, they include the requirement that you verify the buyer’s ability to pay, that you not include “growing equity” provisions (that is, the loan balance doesn’t increase over time), and that, if you do more than a handful a year, they be processed through a “licensed mortgage originator”. You need to familiarize yourself with these rules; they’re ridiculous, but followable.

In years past, before I more closely controlled these deal, I had a number of problems along these lines: one buyer removed the supports for the porch, intending to rebuild it, then left in unsupported until the porch collapsed, pulling off part of the siding in the process. Another “Handy Harry” framed a 5×5 bathroom in a 12×9 living room, creating an l-shaped 4×7 living space. Another cut a “pass through” between the kitchen and living room, in a load bearing wall, without supporting the resulting opening.

Each of these “buyers” had something in common: they were not experienced renovators. Today, my buyers must have the background to do the necessary upgrades, or must have an experienced rehabber who will sign an affidavit that he or she will be doing the work on the property.

Like any deal, repair for equity arrangements must be carefully controlled to be advantageous to both you and your buyer. But the demand is high enough, and the deals available enough, that they are, once again, worth adding to your exit strategy arsenal.

AND, you’ll be doing your little part to make housing more affordable for Americans.