Today I had a chat with a fellow real estate investor and it was always quite nice to meet someone who shares similar views on many aspects of life. As an avid creative real estate guy, out of the conversation today I think I’ve come up with a pretty good creative real estate financing scenario as to what I would like to do in 2013 real estate wise. This is a gold nugget so pay close attention.
So the scenario goes like this:
Let’s say there’s Bob and I. Bob has a full time job with great credit. Bob is a great candidate for a mortgage. I, on the other hand, do not ever want to work full time, so I am out of the race. If you read my stuff you’d know that I tend to pay interest rates between 6 and 7% in my seller financing deals. The interest rates aren’t crazy, but they are not as good as I’d like. While on some deals I put a very low down, for the most part I tend to have to put a decent down to get the house.
Bob doesn’t like to spend too much time on real estate, however. After all, landlording after a few more properties is not all that much fun, especially if you have a full time job. I, on the other hand, just have a ton of time…for better or worse. I manage properties alright.
Bob likes the cash flow aspect of real estate. I, on the other hand, strongly believe real estate is due for a big bounce back (even bigger than what the news might lead you to believe).
So, do you smell a possible win-win scenario?
I do. And here’s what I believe is a play. In summary, I am looking to structure a deal in which Bob would be able to earn monthly cash flow with minimal exposure to the risks of real estate while I would be able to get financing while putting very little money down.
Here’s an example. It is a long read, but I bet you won’t regret it.
First, I would have to flip a property to earn my down. I would purchase a property, say $60k cash, put down $10k to repair, so my total cost is $70k.
After repair, the property would be worth $90k market value, or ARV (after repair value – if you desire to learn the lingo).
But as you may or may not know, usually a flipper would have to pony up up to 10% in selling costs (commissions, closing costs, and escrow). So in this instance if I were just flipping a house, my return would be $90k – $9k (10%) = 81k, $thus earning $11k on a $70k investment before taxes, 15.7% return. Not too shabby depending on how long this process would take.
Also, keep in mind that once you fixed up the property you would have to market the property and get it closed. That itself can take up to 45-75 days depending how long it is on the market and what kind of buyers they are (FHA buyers take at least 45 days to close). Obviously, the longer it takes, the less attractive that 15.7% will become after you convert it into annual return.
So instead, I would sell this property to Bob for $90k with no agents involved and go straight through escrow. I hate to get too specific, so let’s not calculate escrow and closing costs (may cost $2-3k in real life, but let’s not get too specific here). Meanwhile, Bob will put 25% down on the property via a conventional loan. That means he would be buying the property with a $22.5k down payment and say he’d probably get a 4.5% 30-year fixed mortgage. The appraisal should go through because it would be sold for market value.
At this point, after closing, I would get say, pretty close to $90k.
But as soon as he purchases the property, he would resell me the property with seller financing at $105k. He would require me to put $22.5k down for the down payment and will carry the loan of $82.5k at 6.5% 30 year fixed.
So what does this all mean?
It means Bob initially has a 30 year loan of $67.5k at 4.5%, which means his monthly principal and interest are at $342. To make this quicker, let’s just say insurance and property taxes are $125 a month, so his total payment is $467.
However, remember he now sold me back the house with a new loan wrapped around it. My payments to him is a 30 year loan of $82.5k at 6.5%. My monthly principal and interest will be at $522, with insurance and taxes I will be paying him $647 a month.
As a result, Bob will be making an interest (6.5% versus 4.5%) and loan ($82.5k versus $62.5k) spread. Remember, even though initially he put $22.5k down on the conventional loan, I put $22.5k down as a down payment when I bought the house back from him. Essentially, he put ZERO money down and is making $180 per month….for 30 years! Just a gross calculation that is $64.8k earned in total.
Meanwhile, remember that I flipped the house to Bob and made a spread of $20k (okay, there are escrow costs, but come on we don’t have all day to calculate this stuff). So because I “made” $20k, when I put down a $22.5k for the purchase I only put out $2.5k in extra capital from the very beginning ($70k – $2.5k = $67.5k to put into other deals).
Sure, I may have overpaid $15k on the house, but that $15k is minuscule compared to how much little money I had to put down for a house I plan to own for a long time. Essentially I have to pay $180 a month for the reason that I don’t want to work a full time job.
Yet currently in Vegas, this house could very well rent for $1,000. Let’s be a bit conservative and say I have 10% vacancy and 10% maintenance costs (I don’t account for management because I manage myself). So I am really collecting $800 a month from a tenant. Since I am making a payment of $647 a month, I will be making $153 a month. Not too shabby on a $2,500 investment.
Just a recap:
Bob – $0 down, earning $180 a month
Me – $2,500 down, earning $153 a month
Pros for Bob are that:
1) He does not have to manage the property at all.
2) If I ever default, he gets back a property that will net him even more money ($800 – $467) – $333 a month. And he gets back a house he doesn’t have to put anything down! If anything, everyday he’s rooting for me to default.
3) He could do multiple deals, especially if he is credit worthy enough to borrow more than 10, 20 plus properties (imagine putting $0 down and earning $1,800 a month).
Cons for Bob:
1) He doesn’t get to participate in the appreciation aspect of real estate. This issue could be solved by having him participate in some sort of equity appreciation in the future and setting a floor on the selling price.
2) I refinance the loan and all of a sudden he just gets back a bunch of cash for no reason . This issue could be solved by setting a high prepayment penalty.
Pros for me:
1) I get to own real estate by putting down very little capital (think of a stock option).
2) Most likely I will be cash flow positive monthly. This helps a lot when you start accumulating a lot of properties. It won’t be long till I make back my initial investment.
3) When real estate ever appreciates, I stand to make an insane return based on what I put down. For example, if that house goes up to $200k sometime in the future, I will make nearly $100k since I’ve paid down some of the loan and I am getting positive cash flow every month.
Cons for me:
1) I am getting more leveraged. Have to be careful when it comes to leveraging. Vacancies and maintenance hurt.
2) I have to manage the property.
3) I probably won’t be able to refinance these properties into a lower rate.
4) I may have to give up a bit of equity appreciation (really, stop being cheap).
So this is a scenario in which both sides can win. Our interests are aligned. Our wants are being met. And most importantly, both of us put very little money down to take this advantage (please, you tell me what return is like for a $0 investment).
With that being said, this match can work very well. Even though again, if you have a job, good credit, and get a cheap loan, you own real estate yourself you are going to earn like mad. Lazy people like me have to work a little harder (haha?) to do real estate deals.
One more nugget. I could lower my initial capital investment by getting a hard money loan. Let’s just say I can get a loan at 60% ARV, which meant 60% of $90k would be $54k at 12% interest and 1 point (1 point means 1% of the value of the loan, which at $54k is $540). So instead, I would really have to put down $6k of my own money. As for the rehab costs of $10k, let’s be realistic and say $5k material I used my CC and paid $5k cash for labor. So I end up spending $11,540 as my initial investment.
And say I’m really good at rehab and I can get it all done in one month while it takes one month for Bob to get the conventional loan. So two months of 12% at 54k is $1080. Two months of $5k of CC at 15.24% is $127.
So in total that would be $12,747. So I spent $1,747 but lowered my capital from $70k to $12,747, a 82% reduction!
Yes, you can buy real estate without that much money. You just need to find more ways to borrow money. And honestly I think I just taught you more than half of what you need to know in finance (well there’s a lot more to learn in real estate)…for free! Can you believe some real estate gurus charge several thousands of dollars if not more to teach you stuff that’s not even close to this kind of stuff? Again, I would recommend learning creative real estate stuff from smart guys like Shawn Watkins and Pete Fortunato. They continue to blow my mind on with what they can do in real estate and they don’t charge you an arm and a leg for it. I have them to thank for opening up my mind.
So in conclusion, if you want to make some extra income, sell your credit to a friend who does real estate. If you need to make it in real estate, ask your friend to be your credit partner. Both stand to win.
As for me, I have to find my next flip first. Let’s go 2013. Time to work harder so I can be even lazier. Hope this creative real estate financing scenario has been an eye-opener.