Dodd Frank went into effect January 10, 2014. How will this affect real estate investors? You're about to discover the most important details of this new legislation as it pertains to real estate investing. Certainly this should not be construed as legal advice, that's what attorneys can help you with, but hopefully it will help raise your awareness so that you can dig deeper if need be.
Dodd Frank Effects on Real Estate Investing
What I want to describe for your are what effects the new legislation, which is termed Dodd Frank, it's actually the Dodd Frank Wall Street Reform and Consumer Protection Act, how that's going to effect real estate investors, those who are invested in real estate.
Now, it was actually put into legislation in 2010, but it went into effect on January 10, 2014. I got a lot of questions about it.
- How is it going to affect things?
- What's it going to do?
People usually fall into two categories as it relates to new changes in legislation, how it affects real estate investing. You have those that think, "The sky is falling." Then you have others that just don't care, and they just move on as if it didn't happen.
I'm kind of in the middle. I like to know exactly what's going on with legislation and then I'd like to think creatively about where I fit into the legislation, where the exemptions are, those sorts of things.
I'm going to start with the exemptions. Why? There's a big gaping exemption as it relates to real estate investing. An exemption is where you don't have to follow and meet the guidelines of this. This is any situation where it's non-consumer.
What is non-consumer?
That's going to be anything where you're reselling a property to an investor. I'm going to say investor transactions. What I mean by that though is those that you are selling to an investor and in situations where you're buying from a homeowner but you're an investor. The intent of this law, this is my interpretation of it ... By the way, I'm not giving legal advice on this video. Please reach out to an attorney if you want to know if exactly what you're doing fall within these guidelines or not.
The Intent of the law
- The intent was to protect the consumer. We had an absolute financial melt down in 2006 through 2009, 2010. That's where this legislation was birth from. It's geared toward consumers.
- Specifically in the many parts of the way it was written, it's focusing on the way the loan terms are and who can get a loan. If you're not creating loans for the properties you're selling, which I'm going to get to in a moment, I don't ever do that, then in most cases this won't even affect you.
- If you're flipping a property to an investor, you won't even fit into the guidelines of this because it's non-consumer.
- If you're buying a property from a seller and you're doing owner financing, well, you're buying as an investor so, once again, you're in that exemption. Does that makes sense?
If you watch any of my videos and you know anything about what we do, that's a pretty encompassing part of what we do. That pretty much covers almost every transaction. There are a couple of transactions where consumers are involved where you might be originating a loan or a quasi-loan. Let's talk about that.
Rent to Own
This is a big one, lease options. I call it a rent to own, but some people use that phrase. I call it a rent to own. When I'm selling properties, I usually sell them to the ultimate retail buyer who's getting a loan and they're going to cash me out. However, sometimes I will take over a property subject to the existing financing or maybe do an owner financed transaction where the seller becomes the bank. In either of those cases, I may actually move somebody into the property on a rent to own basis where what they're going to do is they're going to put down a down payment that's more than a rental deposit, so it's probably in the range of like four to 5,000 sometimes more for properties nicer. Then they're also going to pay rent.
Set Up Two Different Agreements
One agreement is the lease. One, I have the lease. Then, two, I have this option agreement. Now, for the longest time this idea of a lease option ... First of all, in certain parts of the country, you do have to know the rules on that like Texas, there are certain rules that you can't have longer than six months. Otherwise, what happens is it could be considered like an installment sale for IRS purposes. In most parts of the country, you can do a two, as much as three year. I've always done two year lease options or rent to owns.
My lease is for two years and they have an option to purchase for two years. Now, this could potentially be construed as originating the loan to a consumer which would fit into this Dodd Frank. Now, what Dodd Frank talks about is this idea that you have to have some qualifications before you can quote, originate a loan.
Criteria for Rent to Own Tenant
Now, what's interesting about this is any time I do a rent to own with somebody, I put them through the ringer. I pull credit. I do job verification like serious job verification. I'll find a way to contact the company, not through the number they gave me, but through a different number. Sometimes they give you their cousin's number. "Yeah, he's worked there for 12 years." I call the real company. I go to the backdoor way.
Verify where they lived, not just where they're coming from because if they're moving out and their landlord hates them, the landlord may say, "Yeah, this person is a great tenant," when in fact they're not. Instead, I'll go to the one before they were at. I'll contact that landlord and they'll tell me the truth. I do a lot to verify their income situation, their debts to see if they can even pay. If they can't make the payments, I don't want them moving in. Does that make sense?
That's a really big part of Dodd Frank. They have these nine criteria that you want to cover, most importantly it will be debt to income ratio, to verify that these people can actually afford it, that you actually have criteria to be able to verify that they can move in.
This is somewhat quasi whether or not it even fits into here. It could or it could not. Since that's the way I operate anyways and that is I do a very, very heavy scrutiny of the application they provide. I actually call their references or I have my assistant do it. We verify what's going on with that person. We turn down a lot of applications. To get into one of my rent to owns, it's kind of you're a needle in a haystack. You got to have some money for a down payment.
It's okay if you have poor credit so long as that was from something in the past because I don't want to see anything recent where they're not paying their bills. I'm talking if it was three years ago. They had a divorce. They had something going on back then. Then, now, they've had these two years of great track record. I'm okay with that.
What's interesting is the way that I either I teach my mentors, my mentees, I do it personally, is that I actually scrutinize the heck out of these people before I move them in, which is exactly what Dodd Frank wants in the legislation. They want you to verify, not just let anybody in and create a new loan.
Now, what I don't do is I don't offer owner financing to the new buyer. I hear of others and other investors that do that. More power to them. Those people would definitely fit within Dodd Frank and they only have to do this criteria which is not a big deal.
I don't ever offer that and here's why. If you offer owner financing to a new buyer and they move in ... Let's say they give you a down payment, and all that great stuff, and all their stuff checks up. They're fine. They have good credit and they can make the payments. Then they stop paying you. It's not if but when. Most landlords will tell you that, at some point, the tenants stop paying you.
Now, what I love about a rent to own is I get an option payment, 3, 4, $5,000 which can help offset the empty payments. If you have an owner financed deal where you are letting the new person move in, they become the owner and they don't pay you, you have to foreclose to get them out of there. Do you know how long it takes to foreclose? A long time. No matter what state you're in, it takes a long time. That's expensive. Plus, if you do the foreclosure wrong, of course, the attorneys are going to charge you a lot of money. You see what happens to these banks that have to foreclose. It's a nightmare. Now, remember, the banks aren't lending their own money and they have basically unlimited funds, basically. Being able to pay for foreclosure isn't the end of the world to them, but it could be to you.
Do Your Homework
I don't ever offer owner financing. From that perspective, I don't have to deal with that part of the Dodd Frank. Certainly, when I offer a rent to own to a consumer, although it should be considered a lease and then there's just a separate option, that's the way it usually works, just to be on the safe side, do what is economically practically anyways and scrutinize the heck out of them. Pull their credit. Do a debt to income ratio check. Do all the things that you need to do to verify that they can actually make the payments. Does that make sense?
Now, obviously, there are some other far-reaching and maybe people watching this video could share in the comments below some other intelligence about what could possibly happen as a result of this legislation such as making the foreclosure process longer, making it more difficult for people to get mortgages because now there's legislation that require certain scrutiny and all sorts of other potential guesses at what could happen. That's what they are. They are guesses.
One thing you've probably learned from me if you watched my other videos is I'm a big, big fan of the book The Signal and the Noise by Nate Silver where he argues, and I think he does a great job of doing it, that us human beings are awful at forecasting. We're terrible at guesstimating what's going to happen tomorrow, especially on large things like the economy. For example, a lot of people were saying that in 2012 we were going to have a double dip in real estate whereby the market would drop even more because of all the the shadow inventory. Do you remember that? Well, if you're brand new to real estate, you may not recognize that part. This was a big deal.
You get towards the end of 2011, the sky was falling again. There's massive amount of shadow inventory these banks had. We're all going to be thrown on the market and then the market was going to collapse some more. You know what happened? For the first time in history, Wall Street got involved and began buying tens of thousands of single family homes and then renting them out. Then another landmark item, they securitize these investments, and they sold them on the bond market. They actually have a bond. They have a rating like the AA rating or something, the last I checked.
What many of the pundits didn't predict was that as these market prices got so low, all of a sudden, a bunch of hedge funds would buy up tens of thousands of single family homes and, thereby, got rid of a large portion of the shadow inventory. That's why we never had the double dip. That's why the real estate market has rebounded. Now, we're hoping it'll continue to rebound. Whether it does or it doesn't, we're going to be making plenty of money because we know how to make money up and down markets.
I point that story out to say this. I don't know want all of the long-term effects could be and these major changes that could occur. I do know, as it relates to on the granular level doing deals, be aware that if you're doing anything with a consumer, and you're originating a loan or, in this case, doing a rent to own, you want to make sure to evaluate that person, put him through quote, underwriting process. I've done that my entire investing career though. My mentor showed me that. Never put somebody in a property that you don't fully know what their story is because it can be a nightmare to get them out of there. It's a lot easier to get a tenant in the property as to get them out.
I hope this has helped to give you a little bit of understanding of the Dodd Frank Act and how that can play a role to you as a real estate investor. As you can tell, it's not that big of a deal but there are some details you may want to focus on and some things that you may want to get a little more detailed about. You can search it online or talk to an attorney. They can give you a little bit more insight.