Flag Lot Creates Instant Equity

We found this house while doing a simple MLS search for homes on big lots. This house has 2,100 square feet and sits on a lot with over 16,000 square feet. As it turns out, the neighborhood sits in a zone that allows 6,000 square foot lots (R1-6); it also allows a flag lot if the body of the lot is at least 8,000 square feet (not including the access/stem). A flag lot gets its name from the shape of the lot, the body looks like the flag and the access/stem looks like the flag pole.
The subdivision was a simple process. We hired a surveyor to create the plat map, completed the city application and paid the city fees. Our survey showed that the existing lot lines overlapped in places and had gaps in other places. We didn't worry about correcting the overlap (the fence was encroaching onto our property) because that gave us some needed square footage to meet the city criteria for the flag lot. We needed a little more room on the other side of the property. After a short discussion with the neighbor we discovered that they believed the property line to be in our favor. So we prepared a lot line adjustment document and had the neighbors sign (and notarized) that we could record giving us permanent possession of the area in question. Now we had more than enough frontage and area to meet all the city requirements. Because the lot fit the city criteria for the subdivision we didn't meet any resistance and proceeded through all city meetings. Once the new lots were approved we were able to record them.
Financing this project was the trickiest part of the whole deal. The simplest way would have been to pay cash for the original parcel, record the lot split and then sell or refinance the property seperately. We tried to do a conventional purchase and ran into many challenges...
Equity Partner...new lending guidelines limit a traditional borrower to 4 financed properties! It doesn't matter how the properties are financed (which includes property that is seller financed). In order to be able to continuing doing these residential deals we found several clients who wanted to participate in investing. A partner has to have several things to qualify as an equity partner: 1) documentable income, 2) low debt (income to debt ratios), 3) good credit (over 700 is preferable), 4) cash reserves (liquid assets in savings, available home equity, retirement account monies, etc).
Simultaneous closing...buying a property and then selling the same property using the proceeds of the second sale to fund the first. Our lender thought of this brillant plan to sell the lot and use the proceeds to cover the down payment on the house (since we had 2 seperate properties after the lot split). In this way we could own the house with no money out of our pockets. However, the title insurance companies have decided that this kind of transaction is not insurable. The reason is that we cannot sell something that we don't own and we cannot use the proceeds of the sale of the property to finance our purchase (we have to show that our money stands seperate from the money of the second transaction). So we used different (short-term) funds for the property purchase and the sale of the lot proceeds to pay off the short-term funds.
Seasoned Funds...funds that can be documented and shown to exist for a period of time (usually about 2 months or more). The down payment for the original purchase needed to be seasoned, or at least documented to show that they were not a loan or borrowed funds that would need to be reported on the loan application. The overcome the seasoning issue we were going to use the proceeds of the lot sale as our down payment. Obviously that was not an option due to the simultaneous closing issue. What we finally realized is that we could borrow the funds for the down payment as long as there was no monthly payment (interest could accrue but would be paid at the end of the term of the note) and the money was secured by a trust deed and note to a completely different piece of real estate. With no monthly payment there is no debt service and those income to debt ratios are not affected. And with the note secured to a different piece of property it is no different that a home equity line of credit and is considered seasoned funds.
Tax IDs...tax identification numbers are used to identify each parcel of land (much like a social security number for a person) and is used for a government municipality for taxing purposes. Originally our lender wanted to use the lot proceeds to help finance the property purchase and so he had us record the lot subdivision. Since the bank loan was only going to encumber the lot with the house we had to use its specific tax id and not the old tax id representing the entire original parcel. It took 4 weeks for the county to show the newly assigned tax id numbers for each lot and we couldn't proceed with the loan until the new numbers could be shown. In addition, traditional residential lending cannot encumber parcels with multiple tax ids. Because we were purchasing 2 parcels instead of one (due to our lot split) we had to create a second REPC (Real Estate Purchase Contract) for the flag lot.
Extended Closing...the deadline for settlement of the purchase contract is extended beyond a traditional timeframe and may be tied to a specific event in the deal process. Our original REPC was a full price offer with an extended closing (the closing date was set to 14 days after we had city approval of our flag lot subdivision). We managed to expedite the city process by meeting all the submittal deadlines (and our surveyor was very helpful in getting the necessary changes made). Just before our first closing deadline our first investor backed out of the deal. We had to find a new investor for the project; with a new investor came new funding processes and we needed more time. We increased our earnest money and released it to the seller to "buy" more time and extended our closing 30 days. The next deadline came but we had to wait for the tax id numbers to be assigned because of our lot split so we increased our earnest money and released it to the seller and gave ourselves a new extended closing deadline (a few days from receipt of new tax id numbers). The extended closing ultimately save this project and all our work into the deal.
Instant Equity through the Foundation to Success! When we found this house it was already a decent deal at $165,000. After the lot split we had a house worth $158,000 and a lot worth $60,000 for a total of $218,000. That represents $53,000 of instant equity! The deal would have had an even greater equity position had we completed the transaction in 2 months instead of 12 months (this property went under contract the first time in September of 2007 and finally closed in August of 2008) due to our current market factors.
While this process was lengthy and filled with problems, loopholes, and conditions, it has proven to be a valuable learning experience. I would hope that future investors won't make the same mistakes that I made on this project!