If You Finance Your Properties Conventionally, Your Ability to Grow Your Real Estate Portfolio Will be Limited by Your Available Cash. If You Learn Creative Finance Techniques, You'll be Able to Buy as Many Properties as You Like.
For some new investors, the goal is simply to build long-term wealth and cash flow. This goal can easily be reached by acquiring just a few profitable rentals a year over the course of 10-20 years.
But for a surprising number of people just starting out in real estate, the goal is to be financially independent-that is, to be able to quit their jobs-in a time frame of 3 years or less. And reaching this dream requires acquiring properties at a relatively quick pace in order to be able to replace their current salaries with real estate profits.
The problem that these folks typically run into is lack of cash. As we discussed earlier, conventional lenders require a substantial down payment from non-occupant owners-20% to 30% of the purchase price-and charge fees, closing costs, and points that generally total thousands of additional dollars. A new investor starting with $500,000 cash (and this would be an unusually high figure for most people) would be able to purchase less than ten $250,000 properties before running out of money. And, in reality, 10 mortgaged properties will not produce enough cash flow to replace a $60,000 a year salary.
If you want to be on the "fast track" in your real estate career, and quit your job in relatively short order, you have 2 choices. The first is to build your cash assets through a strategy like wholesaling or retailing, and continue to buy your cashflow-producing rentals and lease/options conventionally. The other choice is to learn how to buy properties creatively, using little or none of your own money, and leverage the cash you do have into more assets than are possible conventionally.
Creative finance, or "no money down real estate", as it is often called, has gotten an unfairly bad rap due to its ubiquitous presence as a late-night TV sales pitch. Many people assume that because "no money down" is the theme of so many infomercials, it must be little than a come-on to sell home study courses. But the truth is, no money down deals are done every day by sophisticated real estate investors, and are relatively easy to accomplish when you know how they work and-more importantly-how they can benefit you and your sellers.
The first key to negotiating no money down deals is starting with the right seller. A property owner who has all the time in the world to sell his home or rental property and who has a property in great condition in a desirable area doesn't want or need to consider creative finance-he will simply wait until a retail buyer comes along who will pay full price and bring their own financing to the table. But the seller who needs to sell quickly due to financial problems, an impending divorce, a job transfer, or any one of dozens of other common motivating factors, is often very open to alternative solutions that involve waiting for months or years for the final payoff on their property. Perhaps a few real-life examples can help to show the types of solutions you can work out with sellers in these positions.
Example #1—health problems, geographical distance, and property condition combine to make a mortgage assumption the best answer for a seller.
In July of 2003, I got a call from a seller who lived more than two hour's drive from her rental property in Cincinnati. This tiny 1-bedroom house had been her home for more than 15 years; when she moved to Lexington, Kentucky to pursue her dream of opening a bed-and-breakfast, she rented the property to tenants who ultimately trashed the property and moved out. To compound the problem, her husband had been diagnosed with lung cancer, and she was spending 3 days a week taking him to treatments and staying with him while he underwent chemotherapy. She had neither the energy nor the money to do the $20,000 or so in repairs the home needed, and she needed nothing more than to sell the property as soon as possible.
Before she purchased the home, she lived in it for several years as a rental property. When she approached the owner about buying it, he suggested that, instead of receiving the purchase price in cash, he'd rather continue to get monthly income in the form of mortgage payments from her. In this way, he could be assured of continued cash flow from the property, even though he would no longer own it. Because the previous owner did not charge the points, closing costs, appraisal fees, or other costs associated with a conventional loan, my seller was happy to seal the deal.
When she called me, she still owed approximately $23,000 to the previous owner, who was by now fairly elderly. Upon inspection, I decided that I could pay no more than $20,000 for the property due to the cost of the necessary repairs. However, I agreed to pay $25,000 if she-and the previous owner would allow me to assume the underlying $23,000 with no assignment fee, and agreed to hold the interest rate at 6%.
By making this deal, I was able to acquire a property ultimately worth over $60,000 for just $2,000 down, with payments of less than $400 a month with just 5 years remaining on the loan. But more importantly, I was able to close on the property in less than a week-meeting my seller's need for quick action-and give her a few thousand dollars that I would normally have spent on financing costs. She was able to get on with the important task of getting her husband healthy without worrying about a trashed, vacant rental-or the debt against it-anymore.
Example #2-when the seller wants income more than cash. In 1998, I bought a 3 bedroom ranch house in a nice suburb of Cincinnati. Noticing that the seller had no underlying mortgage, I asked him what he planned to do with the sales proceeds. He answered that, since he was a retiree, he planned to put the money in a bond fund that would yield about 3% interest. I asked whether he expected to need the money soon; he replied that he planned to leave it in the fund for at least 10 years. I pointed out to him that I would be willing to pay 6% interest on an owner-held first mortgage if he would be willing to forego a downpayment. He immediately agreed, since he had no need for cash anyway. I got a no-fee, no-points, no-closing cost loan; he got twice the return he would have by taking the purchase price and investing it elsewhere.
These are just two of the hundreds of real-life examples I could site where owner financing actually worked better for the owner than cash-and this is, of course, why sellers agree to creative financing. It benefits them, period. But it's YOUR job to learn how the various creative finance techniques are good for particular sellers-and you job to educate your sellers about these facts. When you do, you'll find that owner financing is widely available to you. When you don't, you'll find it's almost impossible to secure.
A small sampling of the ways in which sellers can benefit from creative financing techniques includes:
a. continued income, at a higher rate of return than he can get from other secured investments
b. a higher overall sales price, as you can pay HIM what you would normally pay a conventional lender in fees.
c. A very quick sale, since you don't have to wait the 45-60 days it takes for a conventional lender to complete an appraisal, inspections, due diligence, and so on.
d. debt relief, when the seller's main problem is that he can no longer make the payment on his property.
e. tax benefits, as carrying financing normally means that a seller of a highly-appreciated investment property can pay the capital gains tax under the installment method, rather than all at once.
Just as there are a number of ways to make money from a property, there are a number of ways to use other people's money to finance the purchase. A quick overview might include:
Assuming existing loans. This is usually done when the seller owes as much-or nearly as much-as the property is worth. In other words, they won't receive any cash from a conventional sale anyway, so letting you take over the debt does not affect their bottom line. The advantage to you, of course, is that you get to take over the homeowner's low, fixed interest rate-and therefore low payment-which creates cash flow that you simply wouldn't have if you secured your own higher-rate, higher-payment financing. Furthermore, taking over the existing loan means no loan costs-which conserves your cash for the next deal.
Owner-held mortgages. When a seller owns his property free and clear of any debts, he can choose to allow you to pay the purchase price over time, rather then all at once. His security is in the form of a mortgage, which allows him to foreclose if you don't make the payments. When an owner has equity but does not own the property free and clear, he can allow you to get financing to pay off his existing loan (or assume it, of course), then carry the difference as an owner-held second mortgage.
Land installment contracts (aka contracts for deed, agreements for deed, bonds for deed, etc). When a seller is willing to accept payments, but doesn't want to give up the deed to the property, a land contract is often the best solution. In a land contract, the owner agrees to transfer the deed to the buyer only when the final payment of principle is made; in the meantime, the buyer-although not the legal title holder-has all the rights of an owner. The buyer gets to depreciate the property for tax purposes, and can rent, renovate, sell, or otherwise dispose of the property. As the buyer, your interest in the property is reflected in a recorded document at the courthouse.
Lease/options. Just as you can sell a property you own via a lease with option to buy, you can buy someone else's property on lease/option. As the "buyer", you are actually in a tenant/landlord relationship with the owner-only you have the right to sublease the property to your own tenant or tenant/buyer. Since your purchased price is fixed during the term of the option with the seller, you get the advantage of appreciation-that is, if the property increases in value while you have control over it, you can sell it for more than you owe. You have a second source of income in the form of cash flow, since you always negotiate a lower rent payment with the seller than you can get from a tenant. On the other hand, if the property decreases in value or turns out to be more trouble than it's worth, you can simply choose not to exercise your option to buy-and the only "loss" you will incur will be the amount of the option fee you paid up front.
Private lenders and partnerships. Let's face it, not every seller can or will finance his property for you. That's when you turn to other individuals who have money they'd like to invest for a fixed return (private lenders) or who would like to take the higher risk (and reap the higher profits) of partial ownership of a property as a partner. There are literally hundreds of thousands of these folks in the country today. They range from "stock market refugees" who have cash assets that they've divested sitting around in low-yielding accounts to more seasoned real estate investors who'd like to provide all the money and have you do all the work. And as with other forms of creative finance, you can negotiate the terms to your heart's content - I currently have a loan from a private lender wherein the payments are optional, for instance. If I'm in a cash crunch one month, she's just as happy to have me skip a payment, which gets added to the loan and becomes subject to the interest rate of 8%, which increases her overall yield. Don't try this with your local bank-they get nervous and want to foreclose-but if it works for you and your private lender or partner, go for it.
Source: www.regoddess.com
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