With the mortgage meltdown and liquidity crisis, sellers are having trouble selling and buyers are having trouble buying unless they are prepared to pay all cash.
Virtually all loans for buyers with a marginal credit score are gone. Even good credit buyers are being left wanting. This lack of mortgage money has created a growing demand for rentals and the need for creative owner financing. This is the “Perfect Storm” that I wrote about earlier in the year (March 2008). This awesome technique is the solution. BE THE BANK!
When you’ve created 0% owner financing on a house you’ve bought, you’re like a bank borrowing from the Fed! How quickly do you want to pay it off? Never! Then how can you sell? You simply sell to a tenant buyer and insist they close with a wrap-around mortgage or similar owner financing instrument (just like a bank) after they complete their term in a lease option. Or, find a buyer with more money down and close now with ‘wraparound owner financing’ (just like a bank). Or just rent it and let your tenant buy the property for you. Using a “Wrap Around Mortgage,” “Contract for Deed” or “Agreement for Deed” (whichever is the standard in your part of the country), your buyer will make a mortgage payment to you and you make your payment on the underlying owner financing to your seller. The difference is your monthly cash flow. This is how it works:
Option #1: Give your seller some cash now and some cash later
Your seller has a pretty house worth $220,000 in today’s market, it needs no repairs and is owned free and clear but the seller has difficulty finding a buyer and wants to sell now. The market is slow, they need to sell and you estimate that within 60 days you can find a buyer that will pay $220,000 if you finance $200,000 at 6% or $1,000 a month interest-only payments with a $20,000 down payment.
While it would be easy to show the seller that $200,000 is a fair price when taking into account 10% for normal sales costs but the seller demands his full price of $220,000 with $20,000 down. Could you actually pay that much? Yes, you can. The only question is how long could you wait to come up with the money? What if you gave the seller $20,000 now and $200,000 as a lump sum balloon payment due in 7 years? They get their price and some cash now with the balance coming later. What do you get in return? You get $1,000 a month for 84 months or $84,000 with no property management! At the end of 7 years you owe $200,000 to the seller and your buyer still owes you $200,000 (as the $1,000/month was interest-only payments; nothing was paid towards the principal). In spite of the fact that you owe and are owed $200,000, you’ve earned $84,000. So now you see the power that comes when you choose to “Be the Bank”!
Option #2: You give the seller the cash flow and you get cash at both ends
Using the same scenario as above but the seller agrees to nothing down. Now you can pay the seller $1,000 principle-only payments each month instead. In this case you keep the $20,000 from your buyer. In 7 years you owe the seller $136,000 (as you paid $1,000 per month for 84 months towards the principle) but your buyer still owes $200,000. That’s a $64,000 back-end payday! This gives you tremendous leverage, not to mention the impact on your financial situation if you did 10 or 20 of these transactions. The cumulative effect can be staggering.
Option #3: You give the seller monthly payments and arbitrage the money
With everything being the same, you give the seller $20,000 down and 200 payments of $1000, (an interest free loan) no balloon. You finance your buyer at 6% amortizing or $1,199.10 per month for 360 months. Effectively you have just created a cash machine which will generate $200 per month cash flow for 200 months or $40,000. Plus the buyer will make an additional 160 payments of $1,199.10 each which means another $192,000. The total profit on this deal is $232,000 (assuming the loan goes the full 30 years). The beauty of this strategy is that even if your buyer sells in the future, your underlying loan is paying down at a much faster rate, thereby providing you an increasing equity position.
If you would like to learn more about these and other great Transaction Engineering strategies and techniques while starting, building or growing your real estate business, you can shorten your learning curve and increase your effectiveness with PACT, Personal Action Coaching Tracks
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This post was written by Augie on November 27, 2008
