Subject To Exposed: NEVER use this Real Estate Strategy!

Subject-to deals, you need to never do these. Stay away from subject-to. Super controversial coming from the Creative Finance guys. However, uh, you're going to want to listen close to this episode because this is a creative strategy that you want to stay away from. Welcome back to the channel. I'm Christian, joined today by Caleb Hommel, a friend of the channel. Fantastic. One of our original mentees. He owns 53 multifamily units, all creatively financed.

No subject to zero subject to.

Yeah. And we're going to go into why that is. This is a real estate technique that's been made popular for a while and we've never used it. You don't need to use it. You can buy stuff low to no money down without it. But there's a couple of reasons that you shouldn't. So on today's episode, this is what to expect. We're going to talk about subject to what it is, what it isn't, why it does not belong in our portfolio and why it shouldn't belong in yours either. So we're going to rip right into this. I'm going to start with a quick intro on what subject-to is. So you have two forms of primary creative finance to close a contract. You can do a seller-financed note, or you can do something called contract for deed, also known as a land contract. That's going to be more similar to a payment of the car as opposed to like a traditional real estate thing. If you have a car payment, the bank is is going to take the title to your car and they hold onto it while you have equitable title. You get to use the vehicle, you get to do everything, all the benefits of ownership. You get to own it, sell it, use it just like you own it, except they show up on title. When you're doing a land contract or a contract for deed, also known as a sales contract, there's a ton of names for it, but when you're doing this type of contract, you both show up on title. So one person's going to have equitable title, you, the owner, and one person will still hold legal title. Now it's going to be easier for them to foreclose if you miss a payment. You have to follow the contract to the letter, which is an advantage to the seller. What's nice for you is that instead of creating a lien, you just both show up on title and it's backed by the contract. Gives you flexibility in that there's a clause, and this clause is called subject to. It's subject to the existing debt. What you can do, and it is legal to do, is you can on a contract for deed, on a subject to existing debt, you can keep the other person's debt in place. So for example, I sell Caleb a piece of real estate. I still have debt on it, so I can't seller finance it. I keep the debt in my name. Caleb makes the payments usually through a third-party company, automatically pays down my mortgage, but the debt stays in my name and the asset is in Caleb's name. Problem, almost all debts have a due-on-sale clause. Almost all of them.

Yep.

Seller finance, it's optional. I actually have one that doesn't have a due-on-sale clause. I can, I can actually keep the debt and eliminate the access, which is kind of silly. We won't do that, but you can.

That is it.

Generally speaking, yeah, yeah. All the banks though, banks are always gonna have a due-on-sale clause that is still triggered if they find out that you sold it. They can call your note due. This was not an issue at all when rates went from 5% to 3%. Why would a bank make any effort when their whole job is to place money? Why would they try to call your 5% note to replace the money at 3%? They wouldn't.

It doesn't make sense. It just doesn't make any sense. And then since then, the economic environment has done a million 180s, for lack of a better term.

Well, we've done— we've gone from a 3% environment to a 7 or 8% environment in a very short period of time. So if you are the lender, imagine that you're the bank here. You have all these notes out at 3%, and then there's a whole bunch of people advertising online, hey, you can buy property subject to the existing debt. If I'm looking at how to place my money as a bank at a great— today's environment, that is the first thing I'm going to do. I'm like, oh my gosh, you know what we can do? We can just look at title for who actually sold their things and didn't tell us, and we can call all these notes due.

To do.

Not only does it logically make sense, it is happening. I am hearing people, yes, over the country. And I don't want to say that there's no way out of it or no way to renegotiate.

No, there, there is escapes. There are escapes. But it's like, why would you put yourself in that position?

And so what I'm seeing a lot of people do is their notes getting called, they're deeding the property back to the original owner, and they're trying to do some other thing that I would avoid, like a lease option.

Oh gosh, lease options are disgusting. They're—

a lease option is a way to buy you time, and there are actually some correct uses for them. We're not going to get into this for this video, but I want you to hear the first part. Whenever you're hearing all the cures, the cures for getting your note called start with deed the property back. Our model is how do you own it, how do you never lose it. You're losing the part where you own it, and you're having to restructure in a way where the title matches the person on the note. That is way in the danger zone. And your goal is to own and hold real estate.

Yeah.

So that's the biggest problem I see with the subject-to strategy. Do we use contract for deed? All the time. Caleb, you've done 4 deals. They're all seller financed, right? You don't— have you done a land contract yet?

Nope. I just go straight seller finance.

Okay. I prefer seller finance because you have the most protections around it and it's the most traditional. Seller financing is basically the exact same thing as a bank note, except you negotiate the terms and the seller holds the note. It's bad, you know, it's a note and deed of trust, just like a bank, just like a bank loan, all the way across the board. It's just, you know, you don't have the same, uh, the same restrictions and a million more pieces of paperwork with bank loans. Yep, yep, yep. It's a, it's a slower process. It's an actual legal foreclosure if they need a foreclosure on a for close line if you default. It is a standard, it's the best practice you can possibly do to get into deals low down. That being said, it doesn't work for every scenario. Sometimes the contract for deed makes more sense. The subject-to clause should be off limits to absolutely everyone. Um, you're adding risk. And here's what I found. Cody and I, we have about a 200-unit multifamily portfolio. Yeah, Caleb, you're sitting at 53 units. We've built this without using that clause. If you can do that, Caleb, can you think of any reasons that you would add subject-to to get more deals done if you can buy deals low, no money down without adding that risk? I'm drawing a blank. I have, I have no reason you would do this.

I mean, what would the point be, right? I mean, if I was dying with 53 multifamily units to go buy some single families, sure. But at the same time, it's like it just doesn't make any sense, especially it's What's the point exactly? If you're trying to like do it for the views, sure, go get foreclosed on by a bank.

Yeah, that's about it. Use it for marketing. Yeah, you, you don't want to do that. Which brings us to another point: scalability.

That's the biggest one for me out of everything. It's like that other stuff, cool, there's ways out of it, whatever. If you want to go one at a time, be my guest. You'd have to do 53 deals by the time that I started real estate to catch me. And it's like, that doesn't make a lick of sense.

Yeah. So let's, let's think of it this way. If you're trying to scale small portfolio and you want to do something subject to, it's likely going to be a single-family house up to a fourplex. If you try to do this on a commercial deal, it is not going to fly. That note is getting called. There's no gray area. There's no, oh, the bank might not call this. You try that on a commercial bank loan and you are absolutely not getting away with that.

It's just a different playing field. It's like, for— it's like your grandma on her single-family house, and then with JPMorgan Chase, and then it's like a commercial debt product, Fannie and Freddie, Fannie Freddie, whatever. Completely different ballgame.

Yep. So, so if you're doing multifamily 5-up, which you absolutely should for scalability purposes, subject to is not going to make any sense because it's not going to work. You, you will get called. A non-viable option. So let's run this back really quick. Problem with subject-to, and I have a couple more for you, but I'm just— refresher course. Subject-to, you are coming in assuming someone else's debt and creating a callable note. Huge problem. Huge problem. Two, you can't scale it because it's not for commercial products. Huge problem. 3, it's unnecessary because you can find plenty of deals without adding that many steps. There's one more piece of the subject too that's really important here. So Caleb, you're the seller. I'm going to make the basic pitch to you here. You're selling a building. Caleb, I want to buy your building.

Okay.

But I don't have any money down. I would like to actually keep all the debt in your name and you keep paying the mortgage and then I'll just pay you for it. We'll put it on autopay and then I'll own the building. But I want you to hold the debt and I'll hold the building.

How does that make any sense for me?

It doesn't unless you are a distressed seller in desperate times where you're going, I'm not going to make my mortgage, I'm about to lose my property. Our model does not rely on distressed sellers. I do not want to take a property from someone who is in dire straits. Now, there's no ethical problems with that. If you can come in and fix someone's project problems and that's what you want to do.

Cool.

Yeah, there's nothing wrong with it. But that's not our model. Our model is let's learn from masters of the game, people who paid off our debt. By the way, our next episode, we're going to talk about the debt hammer and why we pay off debt. But masters of the game build their portfolio. They stabilize it, they optimize it, and they pay off all the debt. We work from people. Basically what we're doing is we're picking up deals that take time. In order to get money. So we're trading time and our efforts for money. As you get farther in the game, you have more money than you have time and you make the opposite trade. And that's what seller finance is. You have someone who has their real estate portfolio, they've stabilized, they've optimized, they've built their business, and now they want less problems or less management. They're going to trade you a building in exchange for payments. It's that simple. Very easy to replicate. These people exist in every single market. They are not ever distressed sellers. You do not have a lot of distressed people who are holding no debt. It's very rare.

Yeah, I don't really understand that. Yeah, I'm not really sure I understand where the distress would come from. Yeah, I've got an X amount of real estate paid off, X millions, and I'm just dying to sell my buildings. I'm super distressed.

Old age, maybe. The only times you're distressed and seller financing is when they're horrible managers, but they've still managed to pay off all their debt. Like, they hold it without debt. So it's usually not any major financial stress.

Yeah, there's not that many of them out there. I can think of one who we both understand who is in the South, but that is the only one that I can think of.

Yeah. And well, the first building coding I bought, that was a distressed property where they paid it all the way off and it was still breaking even with no debt. 38 units.

Yeah. Yeah. The 38-plex is a different kind of animal though.

But so, so I mean, it's not that you can't buy distressed properties or there's not these big value-add opportunities, but you're dealing with people who have managed to win the debt game and get debt-free or have low debt on a high equity position. When you're working with those people, it's a different ballgame. You're working with someone more sophisticated. They're going to be able to carry a contract and they're going to be able to help you successfully run the project. But yeah, all of these are reasons why subject-to off the table, throw it out. If you're looking at how am I going to build my portfolio or make this happen, There are other strategies and you can learn them for free, uh, both on this YouTube channel and we have a free course in the link. Uh, go to that. It's like 10 minutes on exactly what Cody, my strategy was to get to 100 units. Watch that video. That's going to break down exactly how we do what we do the way we do it. Um, so check that out, click that link. All I need is your email and we'll send that all over to you. Um, but really excited to have you there. If you haven't yet, like and subscribe to the channel and, um, join us on our next episode where Caleb and I are going to be talking about The Debt Hammer and why you should pay off your debts. See you there.