Epic Real Estate Investing - Behind The Scenes Of Subject-To Deals: Legal Tips + Traps | Chris Johnsen | 1378

Episode Date: November 8, 2024

In this episode of the Epic Real Estate Investing Show, host Matt Theriault is joined by business lawyer and seasoned entrepreneur Chris Johnsen for an in-depth conversation about the critical legal considerations every real estate investor should understand. Drawing from his extensive legal background, Chris dives into the world of creative real estate financing, with a particular focus on 'subject-to' deals, assignments, and novations. He unpacks the importance of thorough due diligence, staying compliant with state-specific regulations, and ensuring full transparency in every transaction to safeguard against potential liabilities.  Chris also sheds light on the strategic use of special purpose entities (SPEs) for property investments, offering valuable advice on how to structure deals for maximum protection and tax efficiency. In addition, he shares tips on selecting investor-friendly title companies that can help streamline the closing process. The conversation doesn’t stop there—Chris and Matt also explore the legal implications of Dodd-Frank for investor-to-resident financing, the intricacies of wholesaling, and the power of using trusts and options in real estate transactions. Whether you’re new to creative financing or an experienced investor, this episode is packed with essential legal insights to help you navigate the complexities of real estate deals with confidence. Learn more about your ad choices. Visit megaphone.fm/adchoices

This is Terio Media. Hey, strap in. It's time for the epic real estate investing show. We'll be your guides as we navigate the housing market, the landscape of creative financing strategies, and everything you need to swap that office chair for a beach chair. If you're looking for some one-on-one help, meet us at rei-i-a-s.com. Let's go, let's go, let's go, let's go, let's go, let's go.

Let's go. All right, please help me welcome to the show. attorney at large, Mr. Chris Johnson. Chris, welcome to the Epic Real Estate Investing Show. Hey, thanks for having me, Matt. Good to have you. We talked a little bit yesterday and I'm excited about what we talked about today. I just say we're going to help keep investors out of jail. How about that? Okay, let's do it. First, that gives a little background on yourself on what type of law do you practice? I'm a business lawyer and entrepreneur. I consider myself a business person first. I was in real estate before anything else. I worked in retail strip centers, buying and selling

them typically over a five-year hold pattern. We'd buy them in great locations, but typically run down strip centers, look for opportunity value ads. I'm a major in finance and real estate, went to the law like you alluded to, and did that whole track at Big Law until I was partner, and I was partner for a couple years, decided to start my own practice. So I now have two law firms. One is Johnson Law, which is a full service business firm representing businesses and the owners on pretty much anything they need, including real estate, but we also do a lot of corporate M&A, securities work, litigation, things like that. I have Texas estate and probate lawyers is another firm that focuses exclusively on a streamlined intake process for the estate planning

and probate that 99% of Texans need where that firm just represents Texas with the other ones nationwide. I have a title company where I work with a lot of real estate investors closing their deals. Awesome. Cool. So probably narrowing mostly on a title conversation and the type of stuff you see and where the legalities are and everything.

But I could imagine we could venture into some of those other channels as well to kind of see where it takes us. Sound good. Okay. Let's do it. All right. So creative financing. I've been creatively acquiring property from the very, very beginning.

And when I got started in real estate, I just come out of the music business. and wife left and filed bankruptcy and just I was a disaster when it came to becomes to lendability. So I had no other option then to learn how to do real estate and acquire creatively. So that's the only thing I've ever known. And now that I am lendable and I do have money, I'm still like, well, why would I want to do that? I know how to do it this other way. But the creative aspects of everything is, it's really gotten popular, right, with subject to and seller financing.

It has. And so I kind of wanted to pick your brain a little bit. I hate that expression, but I just said it. Kind of tap into what you see from a title perspective of where investors could get themselves in trouble with the creative strategies. Yeah, so first of all, we're an investor-friendly title company. We do work with a number of investors, and then I represent them on the legal side, including lenders, too. A lot of people go from the creative financing like you start to doing their own deals and they have a portfolio, and then they realize, geez, managing this is a lot of work.

I'm just going to start lending my money out, which tends to be less labor intensive and provide some really good returns. So I've helped with a lot of that stuff. So problems that people can face. So I guess when you say creative financing, you're talking about subject two. And a subject two has different meanings. And I really have to drill down on it. So let's talk about assignment. So assignment is when you transfer your contract to somebody.

else. And a novation is when you move the original contracting party completely from the contract and replace it with the new party. So when you say subject to, most of the time they do not mean a novation because an ovation would include involving the lender and getting the lenders buy and approval and they'll typically want to do, go through a full underwriting process to get this new party added. They'll want their fees, all that kind of stuff. And they'll probably want the higher interest rate, which is most of the time you're doing a subject to deal because you want that sweet 3% interest rate, two and a half, whatever people had a couple years ago. And you want it now because interest rates are like 7%, and you want the property at a lower interest rate.

Right. So first of all, there's this thing called a due on sale clause and nearly any mortgage. really any assignment transfer of a mortgage is going to call that provision into issues. So I would find out, first of all, I would just know what you're dealing with. Look at the due on sale clause and see, can this be assignable? VA loans, by the way, can be assignable. So if you find a VA loan, those are really nice. Those are really valuable for the seller because they can legitimately transfer that loan over to the new buyer. and they can be removed from liability and obligation completely.

So when you're dealing with a subject to as the buyer, because I assume we're talking about buyers here, because we're talking about real estate investors, they're going to find a property. Typically a property in distress, even though it's a 3% interest rate, the person's having a hard time paying. They're having a hard time catching up.

And the investor is going to want to, typically their value proposition is I'm going to make it so you don't have this as a tarnish on your credit history. You're not going to go into default. You're not going to lose the property through a foreclosure. I can offer that to you. And I can also offer you some money, maybe not a whole lot, but some money. So the seller has some money to walk away. If there is a realtor involved, then they'll typically have to structure the deal so they can pay the realtor some of them.

out of money too. So you're going to want to think about that, negotiate it, whether it's 3% or 2% or whatever can be negotiated on that deal. And then let's say the deal goes through. So the risk for the buyer, the one taking subject to is that this lender finds out. I haven't heard that this is very common that the lender finds out. I've talked to so many people and clients and I've said out of hundreds of deals, maybe one, the lender does. But the lender could find out and meaning that they could call the whole thing due. And the lender and the buyers in a position where they have to either pay the full amount of the mortgage, which they may or may not be able to do. They're able to do it great. And now they have the property, if they want it, free and clear,

if they have the cash, if they don't have the cash to do it, then they're going to be in a position, well, I can lose the property. So if they're taking it subject to and they're entering into a lease with someone else, that can put them in default of the lease. So now they're dealing with a lawsuit on the lease because now the property is being foreclosed on and taken. You also have issues with elder fraud, I guess I don't want to use that word, but elder abuse, elder fraud statutes out there. So when you're dealing with an elderly person, you need to be careful about that we need to be careful about any misrepresentations and how the contract's structured. You don't want in any instance for it to be represented that the person is going to be off the

hook when you're taking subject to because that original seller is going to remain on the hook. So I think this can be done certainly and certainly legally there's nothing wrong with it. There just needs to be a well-drafted contract. And typically these subject to investors will have a custom-made contract. They won't use, like in Texas, the TREC form or in other states to other promulgated form. So I would say if anyone is looking to do these deals, it's a nice investment. You're going to go, and I would say more than just joining a group and getting their contract because maybe their contract works in Florida, but it doesn't work in California. So I would really go to a state-specific real estate attorney, prepare the contract. So it has

I would want disclosures in there. I would want it really up front to the seller that this is how the deal is structured. These are the consequences of the deal. So if something goes wrong later on, it can't bite you in the butt. And I suspect with the increasing popularity, the regulators, our friends in government, are going to look for ways to go after people if for some reason a deal goes wrong and things aren't properly disclosed. Got it.

Yeah, disclosed, disclose, for sure. You said something that I'll come back to sub two, but you said something that I've never been able to really ask or pinpoint, because it's never like someone ever been a concern for me. But you said, I get asked this a lot about our specific contract that we give to our clients. You know, you said that this contract might work in Florida, but not in California. I mean, a contract is an agreement between a buyer and a seller. What's something that would make it not work on one state versus another?

So what type of clause in there would be not allowable? I don't know every state, to be honest. I'm licensed in Florida and Texas and New Mexico. And then there's attorneys at the firm that are licensed in other states. I do know anytime you're dealing in a blue state, if you're on the West Coast or if you're in the northeast, I would proceed with caution with any form contract given to me and I would go to a real estate attorney first. what there could be, there could be state statutes or like if you're in New York City or something, there could even be some city regulations, something like that, making these types of arrangements

unenforceable. I don't really want to speak out of turn, but that's just my gut is that I would check those things and especially with the evolving landscape. Other than that, just as long as the material terms are there, and as long as it's clearly understood, and as long as the mechanics of the transaction are explained, parties should be pretty okay to rely on that contract. Because the biggest thing, again, is we don't want someone turning around and saying, well, I had no idea what was being done. I was taking advantage of. I'm elderly. I have dementia, and you know that. And then, you know, you could not only just be dealing with that person who, you know, maybe

you're probably not because they don't have the money to begin with to fight it, to hire an attorney. But you could be dealing with their family members. They could lose the house. And then the family members step in at that point. And they do have the resources. And they're like, this property was essentially taken away from mom. We want to make sure that, you know, bring a claim for fraud or something like that. Let me talk about litigation real quick.

because it's not about right or wrong. It's about whether you have a good faith, or it's not about right or wrong or winning and losing. Because you can win something, you can be right. But if you have to spend $50,000 to prove that you're right and you ultimately win, that's still a loss. Because you're still paying $50,000 in attorney's fees. So what you want to do is prevent a good faith basis for going to be. into the court system. So the threshold is lower than winning. It's just enough to plead that there's something there. So having the contract as good as possible and avoiding any fraudulent misrepresentations

outside of the contract, especially in writing, is very important because if, you know, you deal what you're dealing with some plaintiff's attorney on the other side, they're going to review the contract. That's the first thing they're going to look at. They're going to review text messages. They're going to review emails. They're going to ask the client, was anything represented to you different from this contract about how this deal works, then you've got your good faith basis. And that's just enough to get them into the court system. And once they're in the court system, now you're having to deal with this thing. Got it. Let me talk about entities and stuff, too, because I think that could be important here. So I think any real estate investor should be

using at least a special purpose entity, or sometimes it's called a special purpose vehicle to hold the investment. Companies do this all the time. I mean, a company is a special purpose entity. It's an entity established for the operation of the company. A real estate investor for every single property they have should be held in a separate entity. Now, that doesn't protect you from fraud, but it does do a lot to protect from personal liability outside of any fraud. claims. In Texas, we have something called a series LLC. And what that enables is the filing and creation of one like mother company. I like to think of it. And then by contract, the statute says you can create separate entities. So if I was doing a bunch of real estate deals, buy and hold,

flip, subject two, even wholesaling, I would just have a series LLC set up. And I would use a separate agreement to spin up that separate entity, have it available. We can have it available in a matter of minutes, as long as it takes to prepare the contract. I would have that entity is the one that closes at the title company, receives title to the property, the deeds in the name of the separate series entity, and then that keeps everything separate. You do have to keep things separate. So you would have to create a separate EIN number for the separate.

series. You'd have to have a separate bank account for the separate series, separate books, things like that. You don't want to commingle among the series. Otherwise tax returns? Tax returns, you can roll all the separate series up to the mother series. And the mother series can file its own tax return. It's called a consolidated tax return, just like a holding company that has interest in different entities can file a consolidated tax return. But you want to keep those separate books so then everything can be rolled up and filed under one tax return. every year. Got it.

Good to know. But that's not every state because I don't know some states don't allow the series. They don't. Delaware does. We do them all the time. Texas does. Florida does. But you're right.

Not every state does. Yeah. California wants to get that $8.50 a bar every year. 8. Every year for L.C. Yeah. Oh, my Lord. Yeah.

See, Texas. It's $300 once. That's it. You don't have to pay a fee every year. Oh, my gosh. That's even better. No wonder everyone's moving from California and doing business in Texas. That's a big incentive right there alone.

So, all right, so we did the state to state thing. Now, back to subject two. As far as I understand, I've always understood this, but I don't know if it's valid or not. Still, it's been a while since I even looked into it. But there is an exemption for the due on sale clause under the Garnes-St. Germain Act. Are you familiar with that? Yes, I am familiar with that. All right.

So is that a true exemption? It is. But it's limited to certain things. so you need to make sure you fall under that exemption. I've seen it thrown out a lot, especially in real estate investment communities. It's like, oh, there's an exemption. This is illegal. They can't prevent me from doing this.

The bank has to agree. It's not in every instance. You would have to go on a case-by-case basis, look at the statue, which is, I don't forget, St. Jormaids might be a case, actually, but it spells it all out and make sure you fall under that. Got it. And so if you're listening and you don't know what that is, is that's when you're transferring your property first before you acquire it to a trust with the owner, the existing owner, the seller, being the beneficiary, then you actually transact and sell the trust

or assign the beneficiary interest over to you being the buyer, right? Yep. That's a way to do it. Right. And then that trust. And the reason that doesn't really, it also kind of conceals that there was a transfer at all because it's a state planning practice, right? So it doesn't really show up the red flags to the bank when they see a property transferred into a trust.

Is that accurate? Yeah, I would say so. Okay. Cool. And then I have a question. I've done it. I'm going to say a million times, not a million times, but probably at least two dozen times. We do it differently now, but I don't remember, if you're going to do that, assign the beneficiary interest over to somebody or sell the beneficiary interest to somebody, does that have to go through title?

No, that would not have to do some. Okay. But there's like a bill of sale. that's included, I think, right, if you're selling that beneficiary. They're a word, really, yes. Okay. Cool. All right.

So none of that has changed. Yeah, the way that my transaction coordinator does it now, she sets me up with a new LLC and positions me as the property manager who's responsible for paying her bills. And she fully discloses to the bank what's happening. And we haven't had a due on sale clause call ever. That's good. Good. Yeah.

A lot less moving parts, too, which is like, that's why we do it that way now. Cool. Okay. So here's one. Say I get a property under contract with sub two agreement. Everything's disclosed and everything and everybody knows what's going on. But then I assign that to another investor. Okay.

So now we're subject to wholesale. Correct. Correct. I've never done it. I've heard people teach it on the world famous YouTube's. But I see a whole lot of liability for the person that put the deal together and is assigning it to someone else. Yeah. I would put in the contract that this contracts maybe.

assigns and you have a right to assign it, that's for sure. And then you might have problems on a state-by-state basis with the wholesale statutes, which I think are just being violated left and right. You told me about Illinois, which Illinois, they want you to have your license. They want you to be a realtor because they consider that's an end run around the real estate licensure statute. But in Texas, there just has to be full disclosure that this is happening, that there's multiple parties involved. You have to tell the seller, essentially, in that assignment document. You can't keep it from the seller. You can't do a double blind close or any of that kind of stuff.

And so the states and Texas just amended their wholesale statute this last year. So this area is changing rapidly and all over the country too. So this is one that you absolutely have to know the state you're in and know what's allowed, what's not allowed, and structure your deal accordingly. So where I saw the potential for that structure, for that liability is if I were to put that together and assign it to somebody else, and then a year or two down the road, there's some sort of dispute between the buyer and the seller. That could easily, I could be pulled back into that by putting that whole thing together. I do agree with that. I would do an assignment and novation. First of all, I would get the seller's original, because remember, the novation removes you from obligations under the contract. So now you're in the middle of a wholesale deal. If you just assign it, you actually, your duties remain under that contract. The rights to the contract are being signed away, but you remain the duties. Just like a sub-lease. Think about a sub-lease. Or if I have someone, if I sub-lease to someone else, and they default on paying the rent, I'm still liable for the rent. So what I would do is I would structure that assignment.

So it's an assignment and nobation and the seller signs off on it and completely removes me from the deal. It agrees. You are selling this contract to someone else and I'm going to remove you from any obligations under our original deal. Got it. That would involve disclosure too. We just keep getting into this disclosure thing. And I know that's an uncomfortable, sticky topic for the subduism. So I think the conversation there is how do you sell it?

How do you communicate with your clients so you can just be up front about the whole thing and not feel guilty, dirty like you're doing anything wrong? It's just like, hey, I was going to buy this property, but I have a friend. You know, I have a bunch of friends and they wanted the deal instead. No, I agree. And I'm not trying to conceal anything. I know though from now, let's see, it's my 15th year anniversary of doing this podcast

and receiving the amount of correspondence and communication I've had from listeners. I know people, they hear something really slick here on the show and they kind of have their own way of doing it when they get out there. And I just want them to be careful when they get out there and try to do it their own way. Yeah.

For sure. Okay, so there was that and that. And then was there one more thing with this up to? Oh, the assignment. So, yes, you're right. The laws are getting a little more strict. Illinois was kind of the first one to the game and putting those restrictions on from what I understand in North Carolina. So apparently you still can wholesale in a sign or whatever.

But they kind of figured out how to circumvent all the workarounds by not being able to enter the B to C contract before the A to B contract. Yeah. Right. So that makes a little difficult. Now you have to come with another strategy and play the backdating game or something. Right, right. Right. Like effective date and lawyers do that all the time.

You can put an effective date on anything, which essentially backdates it or moves the date forward. So you can just mess with the effective date. Got it. So I think Ohio's one and more and more states would come on. You know, like you even said that Dallas or Texas is starting to look at that as types of things and maybe tightening those restrictions. So if it's not an assignment and say it's not a double close, what other mechanisms could use? You could use an option, right? put a property under option.

Yeah, so the option, I think, would be tied in a lease. It would be somewhat a lease situation. Let's see, I've done this where the seller on a commercial building did not want to remain liable on the bank note without having some semblance of control over the process. And so we structured it as a lease. Now, my client, the buyer, wanted to ensure that the bank actually receipt the payments, right? Because if you're paying the lease payments to the landlord, essentially, the one that you're buying the business from eventually, they might just run off with the money.

So we were like, no, we're not going to do it that way. We'll pay the bank directly under the lease a certain amount called 70% of the money owed under the lease. The other 30% will go to the seller of the property. We'll stay in the property for a period of time. And then we'll have an option to purchase the property at a later date. hopefully when interest rates are lower. Right. So that's a little bit more of a twist on designing the sub two, right?

Okay, what if we were just going to straight assign the property outright? Just let's talk straight wholesaling. Straight wholesaling. Okay. The state doesn't want you or the closing agencies don't want you to use the assignment. They're not going to let you do the double escrow. Could you use an option to do that? Put a property under an option and then you sell the option.

My guess is the wholesale stat you have to look at the statute and look at what a transfer of real property or however is defined and then ask the question, does an option constitute that? Does it right to purchase the property at a future date? Does it trigger the wholesale statute? And if it doesn't, then I would say you could do that. Got it. Okay. So next thing would be my wife and I, we really made, had some of our most lucrative years

during 2009, 10, and 11-ish. Because we were. I love it. When I hear people say they made the most money. after future sessions, the best. Yeah, we're wholesaling short sales, right? We're flipping short sales. So we put in the contract, negotiate the price down with the bank, and then we'd sell it.

And that was a good, good run until they started putting the deed restrictions, the no flipping deed restrictions in there. I just heard, this was from about two years ago, and I just heard someone says, oh, we kept on doing it. We would just buy the property in an LLC and then just sell the LLC. Oh, sell the interest in the LLC. I was like, gosh, can you do that? We would have to look at those deed restrictions. So if it's a special purpose entity, so the only function of this entity is to hold 100% of the real estate and you sell 100% of the entity holding the real estate, does that constitute the sale of real estate? So you have to read the fine print.

Yeah, read the fine print and do an analysis. I mean, that is what lawyers are taught to do. Awesome. Well, it's good that I have one I can talk to today. Yeah, absolutely. So let's shift to creative financing with regard to seller financing to the resident owner. Because I know investor to investor does not embark or does not initiate the year. Just a normal seller financing? Yeah. Okay. So I know investment investor, you're exempt from Dodd-Frank. But an investor to resident owner, I think Dodd-Frank comes in and puts some serious restrictions on you on now. From what I understand, I guess you can't do two or more a year without getting a registered mortgage lender involved to do the underwriting.

You can't do adjustable interest. You can't do balloon payments. That's to be traditional 30 year. Is there anything new to that? Is that still in existence? Do you know? Yeah, it's still in existence. And that hasn't been changed much.

That was a huge piece of legislation that went into effect after the Great Recession. Yeah. It impacted the banks, impacted other people, including. this little subset, but it hasn't changed much since I'm got it. Great. So those are my specific question. So as a title, someone that owns a title company, what are some of the big mistakes you see just overall investors make when they come to transact real estate?

So first of all, real estate investors oftentimes want to find an investor-friendly title company. I see that all the time. So I would just remember when you find an investor-friendly title company, that's great because they know how to do these deals and they're comfortable. with it. They don't see anything wrong with it. They're not going to ask a bunch of questions, blah, blah, blah. However, you know, just remember they're your partner in future transactions, and you can burn the bridge of a partner. So what I've seen, every time you order a title

commitment from the plant, there's a fee. The title company has to pay the fee. The title company doesn't get compensated until a deal actually closes. So I see investors entering in into deals or maybe the deal is not going to close. I think it involves a sense of understanding which deals are like hot and going to close and not and getting better at it and better at your trick and trade because what you don't want is you have a good title company that's ready to work for you. And then the last three, four deals opened, title was ordered. Everything was getting moving along and then the deal busts for whatever reason.

At some point, that title company is not going to be super excited to work with you. I've had that discussion with some clients. I've called them up and been like, look, make sure the deal's going to close before you send me a contract. Because we've already had like three or four of them bust. That makes a lot of sense. Do you operate? Can you do real estate in all 50 states with your title company? Yeah, my title company, I underwrite through Fidelity and they're all over the place.

It can be a little tricky in some states that are attorney controlled like New York. Georgia is a little tricky. There's a few of them out there that are more traditional. but we can still get it done through our affiliates, through our partners. Super. Well, there's a window of opportunity right there. If you're looking for an investor-friendly title company, what is the best way for someone to reach out to you?

Go to the Johnson Law website, which is joh-h-n-s-s-en-law.com, and there's a scheduling widget, and you can schedule a 15-minute consultation to talk through any of these issues. Chat with me about anything what's going on your business for free. That's available to anyone. That's it. Johnson Law? Yep. J-O-H-N-S-E-N. Law.com.

Very good. Yeah, find a good partner. Real estate agents, you know, that's part of the reason that they are valuable. And I do think that they're valuable because they have vendors, partners, I like to call them, that they trust, that they know can get the deal done. You know, the investors don't make money unless the deal gets done, too. So they want to make sure that they're working with people that are going to get the deal done. Great. It's a very common thing. How do I find an investor-friendly fill-in-the-blank? So if you're looking for an investor-friendly title company, JohnsonLaw.com, that's Johnson with an E.

All right. Chris, I really appreciate you hanging out with us today and answering some questions. Let's stay in touch and let's do it again. Okay, Matt. Thanks a lot. You back, Chris. Take care. And that wraps up the epic show. If you found this episode valuable, who else do you know that might too? There's a really good chance you know someone else who would. and when their name comes to mind, please share it with them and ask them to click the subscribe button when they get here and I'll take great care of them.

God loves you and so do I. Health, peace, blessings, and success to you. I'm Matt Terrio. Living the dream. Yeah, yeah, we got the cash flow. You didn't know home world, we got the cash low. This podcast is a part of the C-suite Radio Network. For more top business podcasts, visit c-sweetradio.com.