Understanding Subject-to Clauses

Subject-to Clauses
February 27, 2021

Subject-to clauses are used to note different conditions in a real estate contract. It can pertain to many different things. For example, the sale of a commercial real estate building can be deemed ‘subject to the sale of another property. If the other property doesn’t sell within a set timeframe, the contract becomes invalid.

A subject-to clause may also indicate that the purchase of a property is contingent on the buyer being able to sell another property to finance the purchase. Should the buyer fail to sell the property before the deadline, the contract is invalidated, and the sale does not go through. In this case, the subject-to clause prevents the seller from accepting other offers during a pre-agreed period while the buyer tries to sell the other property.

But in the realm of commercial real estate investing, the words ‘subject-to’ are often used to creatively sell or buy properties ‘subject to their existing financing.’

A subject-to financing clause is a legally binding condition in the contract allowing the buyer to purchase a commercial property ‘subject to its current/existing financing.’ This essentially means that the buyer is taking over the payments of the existing loan. It is a way of purchasing a property while leaving the loan originally taken out by the seller in place. The buyer doesn’t have to take out new financing; they buy the commercial property subject to its existing debt.

The exact conditions of a subject-to investing scenario can vary widely, but most of them require the buyer to pay a down payment in cash to the seller, and the buyer taking over the payments for the current loan.

Suppose you are a commercial real estate investor. In that case, there are genuine benefits and opportunities in using subject-to clauses when buying or selling real estate assets—but this is only factual inappropriate scenarios. Continue reading to get a better grasp of how subject-to clauses work, as well as the pros and cons of selling or buying a subject-to commercial property.

Advantages of ‘Subject-To’ Property Investing.

1. Save time and money.

Don’t want to waste time trying to get loan approval for a flip for a wholesale deal? Don’t want to tie up your credit for a property that will quickly be in someone else’s hands? Buying commercial property subject-to can be a sensible way to structure such deals. In this case, you can buy the asset subject to its existing financing, pay the monthly dues according to the loan terms, and pay the balance in full when the property sells.

2. Get a deal done even with a low credit score.

Subject-to clauses can also help commercial real estate buyers without stellar credit and investors whose credit is tied to several other properties. The associated credit score, interest rate, and loan are all on the property’s original owner—not you as the new buyer. There’s some room for significant leverage here because the only thing you have to pay out of pocket is the down payment.

3. Enjoy ownership without assuming the risks of the mortgage.

In subject-to commercial real estate investing, you as the investor don’t assume the mortgage—you’re merely taking on the payments on behalf of the original owner/seller. As a buyer, there is no personal liability in this scenario. Should a foreclosure occur, the event won’t affect your credit score because you are not legally obligated to pay that loan in the first place. It’s the seller’s credit score that will be marred.

Disadvantages of ‘Subject-To’ property investing.

A subject-to clause can open excellent opportunities for both buyers and sellers of commercial real estate. However, it can also pose some very serious and genuine risks.

1. As an investor, you trust and entirely rely on the seller to make the payments as agreed to the lender. Should the seller decide to take your money and run instead of paying the loan, the property foreclosed even though you paid its debt obligations. You will end up losing your investment.

2. If you are the seller, you have to trust the buyer to keep paying the loan as agreed. If they stop paying, you’re still legally obligated to continue paying down the loan until you’re able to pursue legal action to regain rights to the property.

3. If the original loan contains a due-on-sale clause, the bank or lender can call the full amount if they find out or suspect that a subject-to agreement was made behind their backs. The good news is there are ways to put legal workarounds for this scenario; still, it’s crucial to exercise extreme caution when pursuing this deal. You also need to have a viable alternative plan so that you don’t risk losing the asset.

Some tips on choosing subject-to real estate investments

One of the keys to successfully using a subject-to clause in a commercial real estate investment scenario is finding a seller who is motivated to do the deal. You want someone ready to deed their property to you.

Motivated sellers who agree to subject-to clauses usually need to get out of situations that put them in a financial bind. Some of them may be in over their heads and need debt relief instantly. For example, some sellers may be facing significant life changes (personal and/or professional) that leave them financially strapped. A subject-to-the-deal can free them from the situation while giving you a substantial investment opportunity. It’s a win-win arrangement.

It’s also a good idea to choose a commercial property with a low fixed-rate loan. You may want to stay away from adjustable-rate loans because they can quickly increase your payments and decrease your cash flow.

In most cases, it doesn’t matter if how much equity the seller has on the commercial property. The deal should work either way successfully.

Should you do it?

Overall, purchasing a subject-to commercial property can be a quick, advantageous, and relatively low-risk investment strategy. It requires modest capital to begin buying and lets you enjoy instant ownership without being legally saddled with a loan in your name.

Also, you don’t have to qualify for financing. You’ll also save time and money on closing costs. This investing strategy essentially lets you leverage someone else’s credit.

That said, it does come with risks. It’s a good idea to talk to a commercial real estate lawyer before pursuing a subject-to-deal to ensure that your interests are protected.

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