Deal Case Study: How To Pull Off A Seller Wrap

Dan Austin: [0:00] Hey there. Welcome back to another episode of the collecting keys real estate investing podcast. This is the show where we talk about making massive income, not just passive income. Because if you've been in the real estate game for even ten seconds, you'll know that creating enough passive income to replace your active income through your w two job or whatever else you do, is extremely hard. So we focus on how to create massive income first. Today, I will be your host, Dan Austin. And today's episode is a Friday focus episode, which means I am going to do a deep dive into a specific topic. But I'm going to make it a hybrid episode, where the specific topic is paired with a deal case study. It's a deal that Mike and I are selling. In fact, by the time this episode airs, we will have sold the property, we'll sign it away, and I'm going to dive into the topic of seller wraps or wraparound mortgages, because that's the way we chose to exit this property. And don't worry, if you don't know what a seller wrap is, you think it's over complicated, or something crazy that won't ever affect you, maybe, maybe not, but I will explain what that is. But let me set this up, let me talk about the deal. So a couple years ago, Mike and I bought a house, we went direct to seller with a marketing campaign, like we always talk about with a direct mail marketing campaign. A lady wanted to sell the house, downsize, get out of town, it was actually a turnkey house. So the house is probably worth, you know, $2.90, $2.95 when we when we bought it, we paid her right around 200, I think, maybe $20.05 for it at the most.

Dan Austin: [1:31] And again, this was just a couple years ago, I think this was like 2021. Anyways, we bought it because it was turnkey and we did end up replacing some of the carpet and do painting some walls, and then we furnished it. It's in a fantastic location for a short term rental. It's really near a trendy area in town, close to downtown. All that cool stuff as far as a good, at the time, especially Airbnb. Well, once we furnished it, we got it all done, and we started renting on Airbnb, and then we quickly realized we'd rather rent it to an arbitrager, who is going to pay us $2,100 a month, and cover all the expenses as well. Our loan on this is 1,500, including you know, this is our pity PITI, property, principal, interest, taxes and insurance. The loan we have on it is a thirty year fixed DSCR, Debt Service Coverage Ratio loan, which is a common loan for investors to get, because they underwrite the asset and not the individual, so a lot of folks out there that don't have w twos and really solid income, because you're an entrepreneur or real estate investor, these loans are really good for you, they typically come with a higher interest rate, and some other stipulations like a prepayment penalty, which we have on this one, we had a five year prepayment penalty and it's an interest one point per year, so five years if you sell it right away, you have 5%, you know, 4%, 3%, 2%, one down to zero after you've owned it for five five years. Anyways, so 200 purchase, $20.05 k, whatever it was, it was within that range.

Dan Austin: [2:50] Great property, we were cash flowing $600 a month, because like I said, all of our expenses were covered by the Arbitrage, and that was probably about $300 more a month than we could have done as a long term rental at that time, and we would have had all the expenses, right? So we would have been negative cash flow, had we done short term or this arbitrage, so that's why we did it. And this whole time, we've had an arbitrage, we're making $600 a month, cashing that check, boom boom boom boom, it was awesome, and then the arbitrager turned out, was not good at arbitraging Airbnb's, it took him two years to find that out, and he had to turn it back over to us, which it was fine, we were ready for it, and we made the decision to sell it, we looked at renting it out, we looked at doing our own short term rental management on it again, we looked at doing another arbitrage, or we looked at all the angles, and we decided to sell it. The reason why we decided to sell it, is because we had some deferred maintenance, we had a new roof that needed to go on, we were looking at painting the exterior, we needed to really put a sprinkler system in, because the yard was just a pain in the ass to maintain in the summertime, and there were some other it was a flipped house when the old lady that we bought it from bought it, and the flipper wasn't very good.

Dan Austin: [3:48] He left some, you know, kind of areas that kinda made us question the quality. So we're just worried, know, we had probably about $30,000 we needed to spend on the house in the next two years, and there's just really, we didn't see a way, a path in the next two years to get that money out, or increase our ROI by doing it. It was like, put the money into it because you have to, it's not gonna give you more rent. So we decided to sell it, I was preparing the listing, I was going to list it for us, and we were going to list it as a turnkey, ready to go Airbnb for someone that wanted to get in the Airbnb game, and at that point in time, we had found a buyer. So that's the deal, I'll stop there, and I will set up what is a seller wrap, and then I'll get back into the actual case studies. So a seller wrap is a loan where you go subject to the existing mortgage, and then you wrap around your equity. So like I said, we paid 200 k for this, we're selling it for $325,000 fully furnished, all in. So we have about 80,000 and some change, probably like $86,000 in equity on this property. And so that equity gets wrapped around, if you can think of the circle in the middle, like graphically think of the circle as the loan, that our actual underlying loan, and then the $80,000 of equity is a larger circle around that, and the equity buffers in between, and the outside of this circle is called the wraparound mortgage. People have used these forever, it's a good way to sell a property that has an existing loan, and let that person kinda just take over those payments, and there's various reasons why you would do that, including lower interest rates on the older loan, the buyer can't be underwritten, or the buyer's going to have some advantage by taking over your loan and equity, so you can get a higher price as a seller.

Dan Austin: [5:25] I would say that's the reason why we went this way. We're getting a higher price from the seller, and we're not having to pay a lot of the different costs, because they don't have all the loan costs either, so and we're we're not having to pay costs, because we're ending up actually not having to pay the prepayment penalty, because that loan is sitting is sitting there in place still. So once we chose to do the seller wrap, we ended up finding a guy right before we listed to this thing, because we were gonna go traditionally and sell it that way, which was gonna be somewhat tricky, and we may not have been able to do a seller wrap if we couldn't buy and underwrite a good buyer. So this buyer was in a Facebook group posted, I am looking to do subject to deals in the city where I'm at, where this house is at in Spokane, Washington. So this is one of the first and most important pieces to what you need to hear if you're gonna write anything down in this podcast, or try to take a mental note while you're driving down the road, you gotta underwrite a good buyer. We had a deal, a different house, just before this, a few months before this, we tried to sell on a seller wrap. I thought I'd explained to the buyer what a seller wrap was, I thought that I had given him all the documents he would need to understand this, he even got to review the closing documents, showing all the different layers to this deal with the due on sale, the risk of due on sale disclosure, the two different notes that he was signing, essentially taking over the subject, you know, subject to to the mortgage that's there, plus adding in the note that we were wrapping around with our equity. He got to review it all, saw it all, it was kind of a pain in the ass, he was hard to communicate with for the whole, like, sixty day closing, And anyways, he got to the closing table, signed half the documents, and and walked away, said, no, this is weird. I don't wanna do it. I failed to underwrite this guy properly.

Dan Austin: [7:00] So I chose to fix that mistake. I vetted this guy to make sure he understood what sub two was, what he how much he understood about a seller wrap, knew a lot about sub two, didn't know a lot about seller wrap, so I educated him there, told him all the risks, I was upfront with him. Told him all the risks of it, how we're going to do the transaction, I told him step by step how we're gonna do the transaction. He was on board with that, I got to know him a little bit more, I asked him what's he planning to do with this property. He wants to move to Spokane, his son is an adult, is moving to Spokane first, and needs a place to live. So he's going to rent this out to his son, before him and his wife can move over here. He wants a rental property, he wants to do subject to, that's his thing. I don't know exactly why, but he really wants to do sub to, and this works out for that. He is not planning to live in, he's planning to keep it as a rental once his son moves out. So he's incentivized for a couple different reasons, and I talked to him, I got to know him, I built some trust with him, I really like the guy, and I believed in him, based on some of the questions I was asking, and I was very inquisitive on that to make sure that he was going to be a buyer that I would trust to sell any property to, let alone a seller wrap, or you know, wraparound mortgage situation like we're doing here.

Dan Austin: [8:05] So underwrite your buyer, and be very open on all the disclosures you're do. If you're gonna try to find a retail buyer this way, make sure that the agent and you have a good conversation, and that you connect one to one with that buyer, and talk them about everything, because you and the buyer are going to be partners after this, not the agent. So do that. Okay. Once we got that piece settled in, we'd already negotiated on the price, and and basically the monthly payment, because what I wanted to do is match our monthly payment to what we were getting in rent, which is about $2,100, so we can continue to get $600 in cash flow. So he already knew that was kind of the thing. $2,100, 32,000, 10% down, so 32,500 down, monthly payment was set, and he would have to pay the underlying mortgage, included in that was property insurance and taxes. So his payment was gonna be 1,500 plus our 6, which was 2,100, he knew that. Now it was, how do we set up that $600 cash flow? We opted to do an 8 percent mortgage, amortized over thirty years, and the whole thing, including the underlying loan was due in five. All that worked out, the reason why we did that, 8% is a good number, current rates are at seven and a quarter, we could have probably gone a little higher, but we just thought it was a fair number to work with, and we're not trying to rip anybody off, or make it we don't wanna set him up for failure, so he's gonna get some equity pay down on both the underlying mortgage, and on our equity, but not a lot, because it's amortized over thirty years. And again, the reason why I picked those numbers is, I was just trying to pull the levers to get $600 in cash flow a month. Yes, some of that, a very small portion of each month is principal, but most of it's interest, so it's almost like we are cash flowing as a rental property, and this is just our cash flow for rent checks. The most, next most important thing to do, you've got the deal laid out, now go and find a lawyer that knows how to do these and has done these. Call everybody in town, find the right one you feel comfortable with, you know, there's several in town that have told me they do seller wraps, and when it was time to call them, they're like, oh, we don't do seller apps anymore, like literally week, from one week to the next week, they decided they weren't gonna do them.

Dan Austin: [10:04] It's because they weren't very good at it, and there are risks associated with it, so you have for the lawyers, right, because they're essentially kind of going, they're reading a document that says, hey if this thing changes hands, we're going to call the loan due. That's the due on sale clause in the underlying mortgage right. So they're knowingly setting this up with that in process. The lawyer we work with, he sets that up with the seller, he puts all the disclosures in place of what it means to go subject to to this existing mortgage, what are the risks? And that's why I like working with our lawyer that does these things. Find one that is honest, that understands these, and has done dozens, if not, you know, a 100 plus of these transactions, they will be the ones you wanna work with. As we're setting these documents up, you will want to make sure you are disclosing the due on sale, that they are doing subject to, and that this this is a second note. So the note, you have the underlying mortgage that you're doing subject to, and then a second separate note, that's our 8% at thirty years, that is also going to go against the property, but it's, when you think about it, the way I was taught, is that it wraps around it, and you'd have the total purchase price minus the down payment as the loan, that is not how we do it, I have not found a lawyer that can do it that way. So think about it in two separate loans, when you actually think look at the paperwork, so don't get confused by that when your lawyer says that, if they say that. The next piece that is so critical, is the insurance piece, and that this is the other piece that will stop you from being able to do transactions.

Dan Austin: [11:27] People out there, the gurus, will say, oh, just get the buyer, and I've had lawyers tell me this too, just get the buyer to put insurance, and you keep your insurance in place as a seller. Now think about that, how weird that is, is if you're negotiating off market with a seller, and you're just going to become the buyer, or you're going to wholesale this to somebody, which I don't recommend, but you are, that's so weird, right? Oh, just keep paying your insurance. The problem with that is, is that, okay, the you have your name on an insurance policy with the lender, that's all good and copacetic with the lender, they're not gonna see anything change, and so they're not going to call the loan due on sale, because they happen to see somebody else's name on the insurance policy. They just see your policy, and you keep paying it, you keep updating it. Problem is, and I talked to my insurance about, my insurance agents about this, they will not do a payout on a claim if you are not the owner on title. Plain and simple. And I would be willing to guess that most insurance agents are gonna say the exact same thing. So that means that you cannot have a policy that would protect you, and that's why people are saying, well, the buyer can just get their own policy. Okay, that works out kind of, but you're double paying insurance, and guess what, his insurance is likely, is not likely to pay out when they see somebody else's insurance.

Dan Austin: [12:46] Hey, you have insurance, I see you own the property, but what's this other insurance claim? This isn't our, what are you doing here? But more importantly, because I don't know that for fact, more importantly, they need to put the lender on their policy to protect them, They should as the buyer have some protections in that, and guess what? When you do that, it just gets really tricky, and now you're walking a fine line. And the whole goal here with the insurance policies is to not trigger a due on sale clause, and that's why everybody gets super tricky with having two policies, or do this, or do that. There's a lot of reasons why it doesn't work. So what we're opting to do, is our insurance agent is essentially taking our policy, and re underwriting everything the same, with the new buyer, making sure that the new buyer and his wife are good to go as clients of theirs, so then they'll get an insurance policy, and then we will be listed as additionally insured, that protects us, if the house burns down and he skips town and can't be found. Because at the end of the day, we still gotta make that mortgage payment, we're still personally guaranteeing that mortgage, the underlying note, And if the house burns down, there's nothing there to collect rents on, we're just coming out of pocket every month. So we need to be able to just call the lender and say, hey, it burned down, insurance company, pay us the value, and pay the lender off. Because ultimately, regardless of whatever happens, we want the letter to be paid off, so we're not caught in the middle of being personally guaranteeing a loan on a house that doesn't exist.

Dan Austin: [14:12] So we're listed as additionally insured, and then the lender is also listed on the policy as the lender, and they are covered based on all of the requirements that the lender requires for an insurance policy, which is like, that the insurance policy is either a repair value, or a market value, you know, like they're going to have all their restrictions on what they require in a policy. And the idea being is that, and it's still walking a fine line, is that when we change title, when we sell the properties, that they'll see, oh, we have this buyer's name on here, but we still have, okay, we still have Mike and Dan on here, that's it's less likely that you're gonna do on sale clause. That's the best way I know how to do it, it's the most ethical way, and it puts everybody in the best position. Are we still risking do on sale clause? Absolutely. That's the name of the game here, And as long as everybody going back to teaching, and coaching, and underwriting that niche that buyer, that that's why it's so important that everybody gets it, so if that does happen, and talk to them about that. If that does happen, what will you do? Right? It's like a worst case scenario, but you need to talk about it. I know this is getting a little long, so I'm gonna rush through this last piece.

Dan Austin: [15:20] Getting a note servicer. You need to call around, and find a note servicing company that does hybrid wraparounds, or wraparound mortgage note servicing. Do it this way, you will be happy you did it, and if they say they do them, make sure that they have experience, and vet their experience. Most of the people in town where we're at, stop doing them, or don't do them anymore, and so I found one, you know, in a town that's a few hours away, and they're they have several different branches around the our the Northwest area, so they're like, we'll be happy to service it, and guess what, you need to fall into our categories, you're not doing any slick rick, shady shit, what you do has to fit into our boxes, and I love that, because it means they know what they're doing. The way that they will service this, is the buyer will pay, know, like I've been talking about, $2,100 or so, the buyer will pay that every month, 600 will get disbursed to us, and then the rest will get dispersed to our lender, and they will take the which they already have impound accounts set up, they will take the insurance and the taxes, put it in the impound account, and then they will pay the insurance company and the taxes through that impound account.

Dan Austin: [16:23] So everybody's made whole, and as long as nothing crazy happens, we don't have to foreclose on the guy, because he didn't pay it, make a payment, the lender doesn't call us due on sale, in five years, he is required to pay us off completely and having that loan paid off. So it should go off without a hitch, every month we'll get a statement, every month he'll get a statement, and we'll all be hopefully on the same page, and it won't be any issues. So the last thing I will say, when you're working with a partner on these, and you're selling your own property, if you're working with a seller, and you're buying it on a hybrid seller wrap, they become your partners until that's paid off. So make sure you're willing to get in bed with them, and that you're willing to do business with them for at least, whatever the balloon is, five years, three years, whatever you set that balloon at. That's one of the most important things in these, and then finding the right experts to walk you through this. If you're hearing about it in some Facebook group, or some guru talking about it, fact check it, because I guarantee you it's likely to not be true. I just walked you through as great of a way as I could, going through this exact process that Mike and I are going through right now on a deal we are selling using a wrap. I can't get any more detailed on that, this is what I know, and this is exactly what we ran into. We've ran into problems doing these before, because we had people that buyers didn't know what they're doing, we had lawyers that didn't know what they're doing, we had sellers that didn't know what they're we didn't know what we're doing. So this is my best attempt to help that.

Dan Austin: [17:46] If you still have questions, hit me up on Instagram at investorman dan, I would love to talk through this. If you have any advice or input and experience with these, hit me up, let me know, I'll bring you on the show and let's talk about these things, so we can set the record straight for everybody that's our listeners, because all we wanna do is convey the truth and the facts on how to do these types of deals, because they are a great tool to use. So I'll leave it at that. Have a great weekend, I hope you found this helpful. See you next week.