Financing and partnerships
The Real Problem With Subject-To Deals (It Isn't Due-on-Sale)
Why subject-to portfolios end up with no equity and no cash flow, the one deal where I actually used it, and what to do instead to scale.
I've bought hundreds and hundreds of rentals, and most of them used some amount of creative finance or a creative structure. So why not subject-to?
Related reading: The 4 Creative Finance Strategies That Close 99% of Deals
This isn't the usual "well, the bank might call the note due" argument. That's a real and glaring problem with a lot of subject-to transactions, but there's a bigger issue with subject-to that doesn't get talked about enough, and it's the one that actually ruins portfolios.
For context: I started in Washington State, where I bought hundreds of rentals and a seller-financed resort. Then I moved to Texas and bought hundreds and hundreds more: most recently another 144 units in Abilene, an $8.5 million transaction. I've done this a few times. And in the Multifamily Strategy mentorship, one of the single most common ways people show up is: "Hey, I bought a lot of properties subject-to, and I'm joining your group to learn how to get out of trouble on this."
What Subject-To Actually Is
If you're unfamiliar, subject-to has become very popular online. This is not an attack on any one individual who happened to brand heavily off of it: this is about the strategy itself.
It's a clause in a land contract or contract for deed. You purchase, the contract says you're buying the property, and the seller is effectively seller financing you, but instead of transferring title the traditional way, you have a contract to purchase title. Depending on the state, you might both show up on title for the property.
The end goal is that the mortgage stays in the original owner's name. They continue paying their mortgage, and you pay them. There are many different ways to structure how those payments flow, and some are better than others.
The obvious risk is the due-on-sale clause. The bank can end your financial freedom at any time by calling the note due. There may be workarounds, but at the end of the day we don't want to build financial freedom on an unsturdy foundation. If there's no due-on-sale clause at all, go for it: subject-to is an awesome strategy in that case.
But that's not the real problem.
The Real Problem: No Equity, No Cash Flow
People come into the group and say, "I bought six, seven, eight, nine single-family houses or duplexes subject to the existing debt."
Here's what's underneath that. When you do this, you're almost always buying from a distressed seller. And distressed sellers typically aren't the best managers of money and properties. So you're usually buying an asset that has some kind of operational problem, or you're purchasing at a price where there's no equity in the deal.
That's what we keep seeing. Someone says, "I bought subject-to, it's creative finance, I have 10 houses." Then the actual position: ten houses in, they're 100% levered or near it. They borrowed money for the down payments. And even the ones who got in at zero dollars out of pocket are slowly bleeding cash flow.
Related reading: Creative Finance Explained: Deal, Debt, and Equity in Order
What I see consistently in subject-to constructed portfolios is low equity and low cash flow. Who cares if you own a ton of real estate if none of it actually makes any money?
You still have to follow the fundamentals of any other transaction. You have to win on price. You have to win on terms. What I typically see in these deals is that there's no equity to be had, which means you're absolutely exposed to market conditions.
Why the Mentorship Became a Subject-To Recovery Group
Over the past several years the Multifamily Strategy mentorship has become something like a subject-to recovery group.
The story is always some version of the same thing: I thought I could buy all these houses online. Turns out I could buy them, and I'm either losing money, or I haven't made any money, or I'm working really hard. I've done tons of transactions and I've made about $10,000 in the last five years.
I don't know about you, but taking financial risk over multiple years to make a few thousand bucks is not a strategy that's going to work.
So if you're looking at this as a single-strategy idea (subject-to is the secret key that unlocks my portfolio) it's not going to happen.
Where I Actually Used It
I'm not saying the tool is useless. Here's the one place it made perfect sense for me.
I bought the Robin Hood Village Resort: a $4.5 million seller-financed deal across seven parcels. One of those parcels used to be a single-family home that the sellers had added into the resort, and it still carried $70,000 of debt. Even though we'd already given them a million down, they said, "Man, I would love to not pay this thing off."
So here's the clause we wrote. Probably this note never gets called, but if the bank calls it at any point, the seller has to pay it off, and then they seller finance us the delta. The risk sits on them.
I had high confidence they could actually pay it, because I had just given them a million dollars. That structure let us move through a $4.5 million transaction with subject-to covering a very, very small piece of the money. I have the money to back it, they have the money to back it, and the bank isn't going to be a problem. We bypassed the due-on-sale issue and closed.
That's an appropriate use. Now, had we bought that whole resort subject to a multi-million-dollar existing loan and that note came due, everyone's hosed. The whole transaction implodes. It's a complete mess.
We don't want notes called. We don't want to buy zero-equity deals with tons of hair on them. And I don't want to be paying a seller and trusting that they're going to pay everything correctly. There are too many variables. Eliminate the excess variables.
What to Do Instead
If you want to scale, it's much easier to do in multifamily. You're going to raise capital either way, and it's easier to raise for a multifamily deal than a single-family deal: larger investor pool, more benefits, easier management. So if your goal is to scale and build cash flow, you'll get out of single-family, duplex, and triplex pretty quickly, if you even start there at all, and get into the mid-size multifamily game. Five to 50 units is the sweet spot we've seen work for a lot of people and where I built a lot of my portfolio.
Here's the other structural issue with making subject-to your strategy: if you limit yourself to only subject-to deals, you're not going to find many, and most of the ones you do find will have problems. You've narrowed your entire funnel to the worst-conditioned inventory.
The better sequence is to manufacture the deal:
- Find a seller who's interested and create a real opportunity.
- Line up the appropriate debt product: seller financing, bank financing, private capital, a DSCR loan, and the list goes on.
- If you need more money, bring on additional people to finalize the deal and close.
Find the deal first, line the right debt product to it, and then find the equity once you already have the opportunity created.
Key Takeaways
- Due-on-sale is a real risk, but the bigger problem is that subject-to portfolios tend to have low equity and low cash flow.
- Subject-to almost always means a distressed seller, which means an operational problem or no equity in the price.
- Owning a lot of real estate that doesn't make money isn't a portfolio. You still have to win on price and win on terms.
- Used correctly it's fine: on Robin Hood we covered $70,000 on one parcel, with a clause putting the call risk back on the seller.
- Never take on a multi-million-dollar loan subject-to. If that gets called, the whole deal implodes.
- Restricting yourself to subject-to deals shrinks your funnel to the worst inventory available.
So can you use subject-to? Absolutely: sparingly, appropriately, rarely. It's one of the least used tools in the creative toolbox for a reason. It has a lot of inherent pitfalls. Used correctly in the right situation, like Robin Hood, it can be the perfect tool and isn't that hard to execute. Just put it in the tool belt, bring it out very rarely, and don't believe the story that subject-to properties are something you should actively be hunting for or using as a primary acquisition strategy. If you can avoid it altogether, you'll avoid a lot of headache and find more opportunities.
Watch the full episode above for the complete breakdown, including how the Robin Hood clause was written. If you want to go further, there's a free multifamily course on the site, a free Skool community with a deal calculator included, and details on the mentorship if you want direct help: whether you're starting fresh or digging out.
Read the episode transcript
0:00 Welcome back to Multif Family Strategy. 0:01 [music] I'm Christian, your channel 0:02 host. I've bought hundreds and hundreds 0:03 of rentals. Most of them have used some 0:06 amount of creative finance or a creative 0:07 [music] structure. So, why not subject 0:10 two? This is not the typical like, well, 0:11 the bank might [music] call the note 0:13 due. Yeah, it's a glaring problem with a 0:16 lot of subject two transactions, but 0:17 there's a bigger issue with subject 2 0:20 that we're going to get into on today's 0:21 video that's not talked about enough. 0:23 So, welcome to the channel. If you don't 0:25 know me, my name is Christian. I started 0:26 in Washington State. I bought hundreds 0:27 of rentals up there and a seller finance 0:30 resort. Moved to Texas, bought hundreds 0:32 and hund hundreds of rentals down here. 0:34 In fact, recently just closed on another 0:37 144 units in Abalene, Texas. $8.5 0:40 million transaction. I've done this a 0:42 couple times in the multif family 0:44 strategy mentorship. One of the most 0:47 common starting points people get into 0:48 the group on is, "Hey, I bought a lot of 0:50 properties subject to and I'm joining 0:52 your group to learn how to get out of 0:55 trouble on this. I have some experience 0:57 with scaling your business to try to 0:59 undo mistakes in the past in your 1:01 business. So, I I get this a lot. So, 1:03 here's the thing with subject two. If 1:05 you're unfamiliar with what subject two 1:06 is, it's become very popular online. And 1:08 no, this is not attack on one individual 1:10 who happened to brand very heavily off 1:12 of this. This is just the strategy 1:14 itself. It is a clause in a land 1:17 contract or contract for deed. 1:18 Essentially, you purchase a contract 1:20 says, "Hey, I'm buying this property." 1:21 the seller is effectively seller 1:24 financing, but instead of transferring 1:26 title the traditional way, you have a 1:28 contract to purchase title. Depending on 1:30 what state you're in, you might actually 1:32 both show up on title for the property. 1:34 The end goal is that the mortgage stays 1:37 in the original owner's name and they 1:40 continue paying their mortgage and you 1:42 pay them. Now, there's many different 1:43 ways to structure how those payments go 1:45 through and there's better strategies 1:46 than others, but here's the core 1:48 problem. Yeah, there's usually a do on 1:51 sale clause and so the bank could just 1:54 end your financial freedom at any time 1:56 by calling the no dou. While there may 1:59 be some workarounds for this at the end 2:00 of the day, we don't want to build 2:01 financial freedom on an unurdy 2:04 foundation. So subject two usually 2:06 doesn't work. Now if you have no do on 2:07 sale clause, go for it. Subject two, 2:10 awesome strategy. I'll even share in 2:13 this video where I have used subject two 2:15 and where it does make sense even in 2:16 commercial real estate. Here's the real 2:18 problem, though. A lot of people get 2:20 into the group and they're like, "Hey, I 2:21 bought six, seven, eight, nine single 2:23 family houses or duplexes subject to the 2:26 existing debt. When you do this, it's 2:28 almost always you're buying from a 2:30 distressed seller. Distressed sellers 2:33 typically aren't the best managers of 2:35 money and properties. And so, you're 2:37 usually buying an asset that has some 2:39 sort of operational problem or you're 2:42 purchasing at a price where there's no 2:44 equity in the deal. And that's what we 2:45 keep seeing. I'll get people in the 2:47 group are like, "Hey, I bought subject 2:48 two. It's creative finance. I have 10 2:50 houses. Here's the problem. 10 houses 2:53 in. I'm 100% levered or near 100% 2:57 levered. I borrowed money as a down 2:59 payments to buy this thing." Or even if 3:01 they bought it zero dollars out of 3:03 pocket, they're slowly bleeding cash 3:06 flow. What I see consistently in sub two 3:09 constructed portfolios, low equity, low 3:12 cash flow. Who cares if you own a ton of 3:15 real estate if none of it actually makes 3:17 any money? And this is a core problem 3:19 with a lot of subject two deals. You 3:21 have to follow the fundamentals of any 3:24 other transaction. You have to win on 3:26 price. You have to win on terms. And 3:27 what I typically see in these sub two 3:29 deals is there's no equity to be had. 3:32 You're absolutely exposed to market 3:36 conditions. Now, if you came in and you 3:38 went on price, yes, you still have the 3:40 problem of do on sale clause. There's a 3:42 lot of issues with it, but I just have 3:44 noticed this over the past several 3:45 years. Multif family strategy, the 3:47 mentorship program, has become kind of 3:49 like a subject to recovery group. You're 3:51 like, I I thought I could buy all these 3:53 houses online. Turns out I could buy 3:54 them and I'm either losing money or I 3:56 haven't made any money or I'm working 3:58 really hard. I've done tons of 3:59 transactions and I've made like $10,000 4:01 in the last 5 years. I don't know about 4:04 you, but taking financial risk over 4:06 multiple years to make a few thousand 4:07 bucks, not a strategy that's going to 4:10 work. So, if you're looking at this as a 4:12 single strategy idea, hey, I'm going to 4:14 use subject two as the secret key to 4:17 unlock my portfolio, it's not going to 4:19 happen. Here's where you do use it. One, 4:21 if you want to scale portfolio, it's 4:23 much easier to do in multif family. If 4:25 you're going to raise capital either 4:26 way, it's easier to raise for a multif 4:28 family deal than a single family deal. 4:30 Larger investor pool, more benefits, 4:32 easier management. So, generally 4:35 speaking, if your goal is to scale and 4:36 build cash flow, you're going to get out 4:38 of the single family, duplex, triplex 4:40 pretty quickly, if not just starting 4:42 beyond those and get into the midsize 4:45 multif family game, 5 to 50 units. 4:48 Really, the sweet spot that we have seen 4:50 for a lot of people and where I built a 4:52 lot of my portfolio. So, as you are 4:55 building this strategy, if you limit 4:57 yourself to only subject two deals, 4:59 you're not going to find a lot and most 5:01 of the ones you're going to find are 5:02 going to have some problems. If you just 5:04 look at, hey, let's manufacture a deal, 5:06 let's find a seller who's interested, 5:07 and then let's line an appropriate debt 5:09 product. Could be seller financing, 5:10 could be bank financing, could be 5:12 private capital, it could be a DSCR 5:13 loan, and the list goes on and on and 5:14 on. And then if we need more money, 5:17 bring on additional people to finalize 5:19 the deal and close the transaction. It's 5:21 a great way to do it. Where subject two 5:23 does come into play, I bought a resort, 5:26 $4.5 million seller finance resort. The 5:29 seller had on one of the seven 5:32 parcels,000 of debt. It used to be a 5:34 single family home. They added it into 5:36 the resort going through part of the 5:39 process. They had $70,000 of debt on one 5:41 of the parcels. It actually used to be a 5:43 single family house. They added it to 5:44 the Robin Hood Village Resort. And so, 5:46 as part of this transaction, even though 5:48 we already given them a million down, 5:49 they're like, "Man, I would love to not 5:50 pay this thing off." 5:53 Here's what clause we put in here that 5:54 made it work. We said, "Hey, probably 5:56 not going to get called. If the note 5:58 gets called by the bank at any point, 6:00 you have to pay it off and then you 6:02 seller finance us the delta." So, the 6:05 risk is on them. Now, I have high 6:07 confidence they can actually pay it 6:08 because I just gave them a million 6:09 dollars. It allowed us to move through a 6:11 $4.5 million transaction as a very, very 6:14 small piece of the money. I have the 6:16 money to back it. They have the money to 6:18 back it. The bank is not going to be a 6:20 problem. We bypass the do on sale 6:22 problem and we go ahead and close the 6:25 transaction. That's an appropriate use. 6:27 Now, had we bought the resort subject to 6:30 the existing debt on a multi-million 6:32 dollar loan and that comes due, 6:34 everyone's hosed, we lose the pro, the 6:36 whole transaction implodes. It's a 6:38 complete mess. We do not want to get 6:41 notes called. We also don't want to buy 6:42 these zero equity deals with tons of 6:45 hair on them. And I don't want to be 6:46 paying a seller trusting that they're 6:48 going to pay everything correctly. 6:49 there's too many variables. Eliminate 6:51 the excess variables. Don't do it. But 6:54 this is just so consistently people come 6:56 to our group specifically because 6:58 they're like, "Hey, the subject to thing 6:59 didn't work for me. I did buy a lot of 7:02 rentals. I did do this a bunch of times. 7:04 The problem is it's not making any money 7:06 or even worse, it's losing money and now 7:08 I need help to buy multif family deals 7:10 to scale through the negative I've 7:12 created for myself." They just do not 7:15 tend to work the way that you think. So, 7:17 can you use subject 2? Absolutely. 7:19 Sparingly, appropriately, rarely. It is 7:22 one of the least used tools in the 7:24 creative toolbox for a reason. It has a 7:27 lot of in it has a lot of inherent 7:30 pitfalls that you want to avoid. When 7:32 used correctly in the right situation, 7:34 like in the event of the Robin Hood 7:36 Resort, it could be the perfect tool and 7:39 not that hard to execute. Just put it in 7:41 your tool belt. Bring it out very 7:43 sparingly and do not believe the story 7:46 that subject to properties are something 7:48 that you should actively be hunting for 7:51 or using as a primary acquisition 7:53 strategy. I hope this helped. If you can 7:54 avoid subject two altogether, you're 7:56 going to avoid a lot of headache. You're 7:58 going to find more opportunities. Just 8:00 learn other ways to close a deal. There 8:02 are tons of different ways to do it, but 8:03 at the end of the day, it's always the 8:05 same advice. Follow the strategy of find 8:07 a deal first, a real deal that makes 8:09 money. line the right debt [music] 8:11 product to it, whatever that product is. 8:13 And if you need additional capital, then 8:15 you can find the equity when you already 8:17 have the opportunity created. Hope this 8:19 helps. I'll see you guys on the next
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