Sun Tzu wrote that the wise general only committed to a battle he had already won before the fighting started. “To win without fighting is the acme of skill,” wrote the great Chinese military theorist.
Well, not everything in an ancient tome of warfare is directly applicable to business today, but this one comes close, for flippers: Lucky and wise is the investor who commits funds only to a property he has already sold.
And sure enough, there is a way to do that in real estate investing: The double-closing. The double-close is sort of the hat-trick of real estate investing: The flipper begins the process of acquiring a property, and as the process is underway, simultaneously finds a buyer. He then enters into a contract to deliver the property before he has even closed on acquiring the house.
Profits can be quick in these transactions – nearly instantaneous, in fact. Theoretically, you can sell the property within hours or even minutes of acquisition. You may even walk into one room, close on a purchase, then immediately walk into the next room with your buyer and close on the sale. There are transaction costs, of course – but there are no interest payments to make, no PMI payments if you’re not putting up at least 20 percent down, and no expensive repair or upgrade costs, because there’s no time to make them. You are simply turning the property around quickly to a buyer whom you’ve already identified.
The Simultaneous Closing
In a simultaneous closing, the closings can be literally just minutes apart. Or you may schedule them a day or two apart. What defines a double closing is that you have already secured a buyer’s commitment and lined up the paperwork before you have closed on the first deal. In a simultaneous closing, though, you may be relying on the proceeds from your buyer’s financing to close on the property yourself. In this case, everyone needs to be working on the deal together.
Are double closings legal? Of course. Though you have to be careful with simultaneous closings where you as a flipper are using your buyer’s money to close on the deal yourself. Some jurisdictions prohibit this practice. More on this concept below.
Don’t Call Yourself a “Broker”
In a double closing, you are acquiring a property at wholesale prices and turning it around – hopefully – at a retail price, or close to it. This is similar to the role a broker would play, but be careful about calling yourself a broker. Doing so may expose you to some regulatory hazards, as your jurisdiction may require a specific license to operate as a broker. It’s better just to refer to yourself as an “investor” or “fix-and-flipper.”
At any rate, the double-closing is the ultimate in property flipping, and the purest form of the art: You are simply exploiting the inefficiency of real estate markets by doing a better job of finding a buyer than the original seller.
That said, the double-closing is very difficult to do in practice. For one thing, contracting to deliver a house you don’t yet own is a tricky thing. You may have trouble delivering if your financing hits a snag – and it could hit a snag just hours before you are scheduled to sell the property. To minimize the chances of a financing issue derailing the whole deal, have enough in reserve to buy the property in cash. That way, it’s just you and the seller. Sure, you don’t want to have to commit your own funds, since you give up the theoretical advantage of leverage. But on a double-closing deal, you aren’t out your money for very long – and if you’re buying a home for $100,000 and selling it the next day for $115,000, minus 6 percent in commissions, plus closing costs and fees, you’re still doing pretty well.
When you are lining up a potential buyer for a double-close, it pays to know how he’s going to be financing it. Is he planning to use an FHA loan? He’s not a candidate for this kind of deal. That’s because FHA guidelines have so-called “seasoning” requirements. They won’t back a loan if the seller hasn’t owned the house at least 90 days (though the FHA has been known to issue temporary across-the-board waivers of this requirement). And if you have to wait 90 days to sell, you might have a chance to add value through improvements and get a better price for the property – even accounting for improvement and renovation costs and costs of carry.
Furthermore, even aside from the FHA seasoning requirements, some lenders are leery of financing a deal where the owner hasn’t held the property at least six months. They will typically conduct a chain of title review to ensure compliance. There are just too many opportunities for title issues to arise. And from their point of view, they know the seller hasn’t even held the home through all four seasons. Even assuming good faith on the part of the seller, it’s too easy for a seasonal problem, such as an HVAC or heating issue, to emerge that the seller isn’t even aware of. And if a seller isn’t aware of a problem, he can hardly be expected to disclose the fault.
So some lenders won’t finance purchases on flips – let alone double-closings. It pays to know who they are in your community. Not every lender is a good match for every transaction. If you aren’t careful about selecting financing partners, or helping your buyers navigate the special lending considerations on these kinds of deals, You may wind up holding a home longer than you want to.
It’s important to do your homework. In addition to the FHA seasoning requirements above, different states also have different laws that apply specifically to seasoning and double closings. Generally, state laws differ on the issue of whether it’s legal for the flipper to use his buyers’ funds to close on his purchase – a true “simultaneous closing.” Your area title companies will generally have a good grasp on your states’ rules, so have a good heart-to-heart with the title company before you embark on any double-closing deals. Like lenders, some title companies are more open to the process than others.
Financing the Deal
You will be hard-pressed to find any kind of conventional mortgage financing for a deal like this. Most plain-vanilla mortgage lenders just don’t have an appetite for this kind of deal. If you’re not bringing your own money to the table, you may consider forming a relationship with a bridge-loan financing company that provides short-term construction financing, from anywhere from a few days to a few months (a so-called ‘hard money’ lender). There are even “transactional finance” companies that specialize in providing an overnight loan or a loan for a few days to help you execute the deal. Expect to pay about 2 percent of the transaction or so each time you do this. That’s a pretty steep interest rate for an overnight loan. It’s much better to be the lender on those transactions than the borrower!
A Word of Warning
Don’t worry about trying to build a business around the double-closing technique. It’s very rare when all the stars align to make this kind of transaction feasible. You need to have exactly the right kind of buyer lined up at exactly the right time, with either cash or exactly the right kind of financing to make it work. It’s possible that you will eventually be an initial seller or ultimate buyer of a double-closed property, and you should know enough about the process to make an assessment about the middleman’s capacity to actually execute the deal. Is he relying on the ultimate buyer to come up with the funds to buy your property? Or will he be able to sell you the property free and clear of title defects? Title insurance and escrow on these deals are musts.
Technique: Contracts can be “assigned” from one party to another. If you have entered into an agreement to buy a property, and run into a financing snag, it is theoretically possible for you to assign your contract to buy the property to the person buying it from you. You step aside, and you can give the buyer a bit of a sweetener in the form of a discount. This technique runs the risk of a counterparty saying “no,” of course, but it can also save the cost of two separate closings.
Jason Van Steenwyk is a veteran financial industry journalist who has been fighting to make the world safe for the retail investor since 1999. He lives at Ground Zero of the real estate bubble in Fort Lauderdale, Florida.