ACTUAL CASE STUDY: One of my real estate investor mentoring students will make over $400,000 on a single probate real estate deal this year.
She mailed out a few probate letters and found the owner of a free and clear house he inherited. He complained about having to maintain the property and he really wanted to sell it now but the market was slow. The house was worth about $250,000 and needed only minor clean up. It has a good floor plan and sits on a small lake in a desirable residential community. Since the house was free and clear, she offered to buy the house for $200,000 with terms to pay him $1000 a month until paid. Because the house needed a little work and she needed time to find a buyer, payments would begin 90 days after closing. You read that right, she asked for the payments to begin 3 months after closing and he agreed. Do you see what happens when you ask? You can negotiate anything!
Her plan is to rent this property at $1300 a month for the next 10 years and then sell it with 40 year owner financing for about $350,000. In that time, rents and values will rise and by that time she will only owe the original seller $80,000 and have a house worth $350,000. She’ll have created $270,000 in equity. And when she sells it for $350,000 with the owner financing it, she’ll collect over $2,500 a month but only pay out $1,000 a month. That’s right; she will clear about $18,000 a year for about 7 years. Once the underlying mortgage is paid off, she will still collect $2,500 a month in revenue with no outgoing payment. That’s $30,000 income a year for the remaining 29 years.
But let’s say her buyer sells the property in 80 months, which is the same time the underlying mortgage is paid off. It would look something like this:
Rent spread first 10 years $ 15,250*
Interest spread next 80 months $120,000
Remaining equity due $322,563* *
* After taxes & insurance, assumes a 3% annual rent increase
* * Based on a 7.75% interest rate paid by the buyer
A couple of other softer benefits include the fact that her profit will be taxed at the long term capital gains rate. Her other income will be offset by the expenses and depreciation during the period she holds the property as a rental, and she now has an excellent income stream to supplement her retirement. That’s what I call maximizing her intellectual capital!
If you’re interested in reading some additional articles related to Probate Real Estate, check out:
What the heck is Probate Real Estate? by Ron Mead
Probate Real Estate, Hidden Gems? by Herb Daly, Jr.
In this post, we begin a multi-part series on Creative Real Estate Investment Strategies that leverage non-traditional methods of financing. The traditional way has been around for years; it doesn’t require much creativity but a disciplined program can create value over time. So let’s dive into some creative real estate investing strategies. Today, I will cover 3:
1. Buy and Hold
2. Buy and Lease (Lease Option or Lease Purchase Homes)
3. Wrap-around Financing
Buy and Hold
Technique #1 is the way our parents bought real estate. You work hard all your life; you have a job, make money and by the time you’re in your mid-40s you have a house and are getting comfortable financially. You decide, “Our house has gone up in value, it’s been such a great investment, let’s buy another one.” So you buy a rental property. Congratulations, you are now a landlord, in the words of Jerry Seinfeld, “not that there’s anything wrong with that!” Unless of course you have no experience with tenant screening, property management or landlord tenant law, but that’s an article for another post.
You look around and get the best deal you can and pay a fair market price. But by the time you find a tenant, pay the property taxes, insurance, maintenance, management, and all the other expenses that go along with it, you’ll be lucky if you are able to break even on the cash flow.
There are several ways to look at the total return on your investment. We can make a better deal because we buy a foreclosure property at a discount. Or we can buy HUD or VA foreclosures. Or buy a bank REO property (REO stands for Real Estate Owned by a bank). Or we can buy from a motivated seller who needs to sell due to job transfer, financial hardship, a divorce, is behind on payments and about to go into foreclosure. With the right expertise we can turn that property around and create positive cash flow on it from day one.
So we buy a property and have a little positive cash flow on it. Our tenants are making the payments for us, including the taxes and insurance. We may have a little maintenance and upkeep on the property but we also get depreciation on the property. That means you get to take 1/27.5 of the property’s value and deduct that from your taxes every year to significantly reduce your taxes.
You also benefit when the property appreciates. We recently bought a property for $140,000. The seller paid $28,000 for it about 25 years ago. Properties go up in value at an average of about 6% a year nationwide (they have ever since the end of the second World War). So properties do go up in value. Markets are cyclical so there are periodic recessions but real estate always rises over time!
That was technique #1. It is a buy-and-hold rental technique. I encourage you to look at the TOTAL BENEFIT you are getting, not just the cash flow!
Buy and Lease (Lease Options)
Now for a little variation. Let’s say instead of buy and hold, we buy and lease. What if we buy this property and instead of renting it out to somebody, we lease it?
Buy and lease is different than buy and rent. The difference is if a person signs a lease on the property they may be interested in buying that property. You may also be able to SELL them an “option to buy.” This is technique #2.
When you buy this property, you can go to a bank, finance it and buy it in the normal way. However, when you lease this property to somebody who wants to buy it (sometimes called rent-to-own but technically it’s a lease with an option to buy), you are selling them an option to buy this property from you at some future date, typically in one to three years and at a higher price (10 to 15%) than what it is worth right now as they are paying you for that privilege.
They should pay you 3 to 5% of the value of the property as a non-refundable option fee. In addition, they could pay you more then the normal rent because they want to own this property! They also have an owner’s mentality. So when you buy the property and lease it with an option to buy, it gives you a significant benefit over a buy-and-rent strategy.
So technique #2 is better than #1 in some cases. You get cash up front (non-refundable option fee) and more money each month. However, you might not always be able to lease a property so you may have to settle for renting it.
Our third technique is another variation; it’s the buy-and-wrap process; a wrap-around loan. If you want to sell a property and be done with it, you can carry a contract on the property through a wrap-around loan process. That means you keep your name on the title and the underlying mortgage but you sell the property to somebody else on a land contract, an “agreement for deed” or a contract for sale. They will get their name on the title when they make the final payment to you; it’s called a “wrap” or wrap-around financing.
The advantage in this technique is best explained through an example. You have a property you bought for $100,000. You put 10% down and you financed $90,000 at 6 1/2% for 30 years. You sell the property for $115,000 to somebody who is going to only put 3 to 5% down (which is why he is willing to pay you more money for it) and you are going to carry the contract (loan) for him at 8½% interest.
Why would he do that? Because he is not going to qualify for any of the loans available today. He can refinance any time in the next 40 years and pay you off but remember, if he pays you off, you put $15,000 in your pocket (as you paid $100,000; he pays $115,000).
But if you hold the loan, he is paying 8½% interest on $110,000 and you are paying 6½ % on $90,000. So you are putting $277 in your pocket every month; that’s $3,323 per year every year for 30 years or a total of $99,698. But you had a 30 year loan while has a 40 year loan. You could receive another 10 years of incoming payments, without any out-going payments, which totals another $101,496 making your total profit just over $200,000! As the numbers get higher, so do your profits. Amazing! That was technique #3.
So the first three techniques were:
1. Buy and Hold
2. Buy and Lease (Lease Option)
3. Wrap-around Financing
“But how can I do real estate if I don’t have money?” There are lots of ways you can buy real estate with no money out of your pocket! Remember this is only part 1 of a multi-part series. I promise I am going to share with you plenty of no-money-down techniques as well as techniques which require money that doesn’t have to be yours or a bank’s.
It’s not important that you use your own money. It’s not even important that you own the property. What is important is to CONTROL the property.
Whether you are looking at Asset Protection or Wealth Creation, ownership of an asset is usually less important than CONTROL. A wise and wealthy man once said. “Own nothing but control everything!” If you take away nothing else from this article remember the value of Control. Control is a fundamental key in creative real estate investment.
I think the banks have something to learn from the independent real estate investor. Our flexibility is one of the keys to our success.
Based on that statement, I’d like to say that I’m a full time real estate investor. I’m not a speculator, I don’t chase appreciation (though I’ll gladly take it when it comes), and I rarely flip properties. My goal is to buy and hold and on occasion, to help people qualify over time to buy my properties with either lease options, or rent to own programs. Whether the government believes it or not, we’re in a recession. The stock markets are down, the housing market is down, and unemployment is up. It’s starting to sound like the USA is about to nationalize the auto industry, airlines and who knows what’s next. Times are tough, and to add insult to injury, the banks are not lending.
What can we do in a market where banks want 25% down and a large number of otherwise credit-worthy would-be buyers can’t scrape together that kind of cash? Buyers can’t find financing and so they can’t buy. Sellers can’t find buyers with financing, so they can’t sell. It’s a real problem, or is it? For a well trained or seasoned investor, it just might be an awesome opportunity!
As an experienced real estate investor, I coach several student investors each year on creative investing strategies and alternative financing options, among other things. The number one question I hear right now is “how can I buy and sell houses when money is so hard to get? The banks just aren’t lending.”
One answer: “You become the bank.”
What is banking really, anyway? Put simply, they take money in the form of deposits from one person and then lend it to another for a profit. The problem comes when the collateral or the borrower are unfit…that’s what got us where we are today. The key to this real estate market is to learn how to be a transaction engineer. A person who considers the exit strategy just as much as they think about how and what to buy. One of my favorite techniques in this kind of market is to focus on helping sellers: sellers who own their houses free and clear. According to the US Census Bureau, over 33% of owner occupied homes are owned free and clear, meaning, no mortgage. Statistically speaking, one in three home owners with whom you speak owns their home free and clear. This is a perfect opportunity for a real estate investor to facilitate a seller financing transaction. You can pay the seller for their equity over time and they get an income stream while you get a property with financing already in place.
When a bank is not involved in the transaction, everything becomes negotiable ;you don’t have to charge lender fees or points. You can roll closing costs into the loan or not. Also, there is not a set down payment requirement, and a seller can also be more flexible with the terms, interest and payment schedule. While facilitating seller financing deals won’t help the banks, it certainly can help to get the housing market moving again. Many times you can then re-sell the property while keeping the existing financing in place which benefits the original seller because they keep their income stream. Your buyer benefits because they can buy with financing in place and you, you get the profit along with a possible interest rate spread. Wow, a triple play where everybody wins!
Just remember to think outside the box. When traditional methods of financing dry up, be creative, and keep the engine moving.
Real estate entrepreneurs get paid for solving problems, don’t we? And, the more problems we solve for sellers and buyers alike, the more profits we create. In this highly illiquid market, Americans are experiencing serious obstacles to buying (no loans are available) and selling (no loans for buyers). This is where savvy real estate entrepreneurs have an opportunity to build incredible fortunes by using their intellectual capital.
The beauty of this market is that there are no limits because so many people need our help. By learning to buy and sell using creative financing techniques, you will serve a great many people and leave your competition in the dust. In this post we’ll discuss my favorite financing technique! The best part is that anyone can learn to do this.
Seller Financing 101
This model works in all markets, anywhere in the country, but it works best in markets that lack liquidity (that is, available bank financing). It works with residential as well as commercial real estate. The technique is simple to use and only requires common sense and a little understanding of numbers. I know, “you don’t like math.” As my friend Gary Johnston likes to say, “it’s not math…its money.” And he’s right. You can easily build an entire business around this model because each step in the buying and selling process can be made easy and systematic. I’ve been using it as part of my business for years.
Here’s the Model:
Think of all the ways we could buy property as a ‘transaction engineer.’ To begin, we have four primary types of property you might target; such as pretty houses, ugly houses, multi-family or commercial. Next we have a variety of NO BANK acquisition strategies to buy or control the property; such as options, leases, subject to, owner financing, or paying all cash. Finally, we have our exit strategies which help us get to the cash or cash flow. We can employ numerous ways to rent, sell or hold a property; such as quick turning (a/k/a flipping), renting, lease optioning, retailing or selling with owner financing.
A good system addresses the whole transaction, from acquisition to disposition, and that’s what differentiates the newbie from the seasoned pro. You need to consider what you buy, how you will finance it, and how you will sell or rent it. This approach gives you a solid business model. We all know there are multiple strategies to do great deals. My coaching clients and I have made millions of dollars using all of them but there is one technique that is my #1 favorite.
My Personal Favorite
If you remember the classic movie Caddy Shack, the wild and crazy Chevy Chase gave the young caddy, Donnie, a putting lesson and used a line echoed by golfers ever since. He said, “See the ball, be the ball.” Well, I am a benefits-driven investor and whether it’s wholesaling, retailing, lease options, rehabbing, short sales, or whatever, I look for the technique which provides the most benefits for each transaction. But, my favorite technique provides the maximum benefit while eliminating virtually all the transaction related hurdles real estate entrepreneurs’ face. It is a truly powerful technique. I call this awesome technique, “Be the Bank.” Like Chevy Chase’s, “See the ball, be the ball,” I prefer, “See the Bank, Be the Bank.” As an entrepreneur, I don’t want anyone or anything to restrict my ability to do business, just look what’s happening in the US economy…the banks can’t perform so the country can’t perform. That’s absurd!
This is how “Be the Bank” works
Begin by focusing on free and clear properties.
Seasoned real estate entrepreneurs know that when there’s more equity in a deal, we have more ways to create offers and more exits. (No equity means you have fewer options because you will have to create equity by discounting the debt or wait for the property to appreciate.)
The benefits of focusing on properties that are free and clear include:
• The ability to buy using installments, paying the seller with a fixed monthly payment provided by the income from the property. This is because frequently sellers with free and clear properties do not need any of their equity in cash now. If they did, they could easily have pulled it out sooner.
• The flexibility to borrow against the equity (without using a bank) by using hard money, private investors or better yet – the seller. This can provide funds for buying, holding and getting a house occupied with little or no out of pocket expenses.
• The possibility of negotiating very favorable financing terms. The seller’s goal is to sell the property so they may be willing to offer low or no interest, deferred payments, additional repair funds etc.
• Many free and clear properties are non-owner occupied and the seller could face a big tax bill if they collected all their cash at once. By having them finance the sale, you can help them defer or reduce their tax bill.
• You might find landlords with multiple properties who want to eliminate all their management hassles and sell their portfolio. They may even be willing to start by leasing the properties to you with options to buy (so you can generate cash flow) and then buy them on a tax efficient schedule.
• You can even re-sell the property and offer seller financing to your buyer by leveraging the existing financing you just created with the seller.
Now we create offers based on monthly payment and end up with low or 0% seller financing.
Long term seller financing reduces my resistance to price because it really doesn’t matter what price a seller wants with a free and clear property. I can always pay it. Terms are the key. I frequently ask my seminar attendees if anyone is willing to sell me their house for a million dollars. Lots of hands go up and then I tell them they’ll receive $1.00 a month for one million months. So when it comes to price, the only question is how long I have to pay. The longer they can wait, the more I can pay. The benefits of creating a seller held note at low or 0% interest include:
• Low or 0% interest allows us to offer a higher purchase price and get more of our offers accepted by having the seller defer payment on part or all of their equity.
• You could offer a balloon payment due in several years and enjoy the cash flow from the property until the balloon comes due. Personally, I think this choice is a little short sighted. History has taught me that balloon payments always come due at the most inconvenient time. However, you can protect yourself with a simple clause in the note which allows for an extension until borrowing rates improve.
• Another option is to give all the positive cash flow (cash above taxes, insurance and maintenance) to the seller and quickly pay down the principle and build a large equity position. Again, not your best choice.
• You can structure the payments low enough that the property will cash flow from day one. Rents will rise over time and so will your net cash flow. Over 10 to 20 years the value of the property will rise and so will rents. Now you’re creating wealth with a low fixed payment. A very good choice!
• You can increase your yield by offering multiple payments in exchange for a discount; i.e., “Mr. Seller, if you ever need a lump of cash, I’ll give 3 payments in advance for a 10% discount or 6 payments for a 15% discount.” That’s like getting one or two months free. The seller gets a nice lump of cash and you get a great yield. An even better choice!
• If the seller wants to be paid off early, you can discount their entire note at an even larger yield. That’s the deal after the deal…extra profit!
• Lastly, when negotiating seller held financing, we can negotiate the ability to substitute collateral (move the mortgage to another property) or subordinate the mortgage so that you can borrow on the property and the seller note remains in second position. That’s financial flexibility!