In the foreclosure business, profit is measured between the amount owed on a property and the net sale proceeds after all expenses. Often, this is confused with “equity”. Equity is a lot like sex appeal. The owner may be the only one around who believes he has any! People seem to get a real kick out of constructing personal Net Worth Statements that are based upon some fanciful idea of both high retail market value for their house, and their best guestimate of what will be left after they sell their property. They term this their “equity”. Unfortunately, there are huge gaps between this equity and what they'll get after sale in the foreclosure marketplace.
There are several definitions of EQUITY. “That part of real estate that makes you feel good until the day you have to sell” is one of them. Another defines equity as the difference between Fair Market Value and the loan balance. Yet another subtracts CALLABLE loans from LIQUIDATION SALE VALUE (and that includes any loans with due-on-sale restrictions). I like to think of equity as that part of the property that produces NET INCOME AFTER TAXES. I used to buy property solely for APPRECIATION, but I've found after almost 40 years of active investing that appreciation can be an ephemeral benefit.
I've seer my equity wiped out by Zoning, Land use Restrictions, Highway By-Passes, Credit Crunches, Bankruptces of Lenders, Title problems, Income Tax Law changes, Property Tax reassessments, Sewer and Water moratoriums, Economic and Social changes in my neighborhoods, War and Peace. That's why I like my definition best. If the property can't produce net income, I can't buy much with what's eft; thus, my living standards depend on my purchasing power. For this reason, while “yield” is always welcomed, I'm most interested in how much net income after all expenses a transactor can reasonably be expected to generate.
A few years ago, a speculator approached me in need of cash. (What else is new?) He was in default on a $15,000 second mortgage and the 3rd would balloon the following month.
He was out of time, even though he was sure he could sell the property within 90 days for cash. Even at 100% of value, the second lien holder wouldn't sell me the 2nd Note so I could stall the sale, so instead I bought the property at sale for $15,000; subject to the 1st mortgage lien.
The foreclosure of the 2nd position lien wiped out both the 3rd lien, and the foreclosed owner's equity. The 3rd lien holder hadn't realized how vulnerable Notes can be in a down market. Like the foreclosed owner, he too couldn't raise the funds to protect his position. Following the sale, my equity consisted of the $17,000 third lien + $10,000 in equity above that + my $15,000. 1 then co-ventured the property with the original distressed party. It produces $600/month in rents.
In a similiar situation, I was able to buy the 2nd lien at 10% of the remaining balance, but the 3rd lien holder was too strong. He bid in the property up to the amount of the first and second liens and bought it. I'd paid $550 for my lien. The bidder bid his lien up to 100% of the balance to protect his lien. While he had the title, I had my profit. I paid $550 and received $5500 in a matter of days.
In both of the above illustrations, the profit related to the control over the middle position – the 2nd mortgage and note – between the 1st and 3rd mortgages. In the one instance I ended up with the house. In the other, I wound up with the profit. I was able to buy the 2nd at discount from a weak lender who couldn't afford to bid at the foreclosure.
Both owners and lenders found themselves at a disadvantage because they'd relied upon credit to protect themselves. Without avail-able refinancing, I, as a cash buyer, won the day.
