Let me tell you about one of the most successful real estate wheeler/dealers I ever met. He bought over 550 houses in a single year by finding people who were relocating. He sought out those who had homes with loans equal to approximately 60% of value. He also tried to locate owners of free and clear building lots of equivalent equity value. He would offer the home owner one of the lots free and clear in return for the owner’s equity. And he’d offer the lot owner a 2nd mortgage at low interest rates and low payments in return for the lot.
At settlement, the following things transpired. First, the home owner would deed the house to the wheeler dealer who we’ll call Bob. As the new owner, Bob would sign a Note and Mortgage and give it to the lot owner. The former lot owner would deed the lot to the home owner. The key to these transactions lay in the payments on the note that Bob signed. These were equal to the net rental income of the property he acquired.
This way, he avoided negative cash flow problems with properties with ‘break even’ cash flows.
Eventually, over a couple of years, Bob accumulated literally hundreds of houses with virtually no equity. They produced little free cash flow while throwing off more tax shelter than he had any use for. Bob wasn’t a happy camper. Despite a staggering amount of assets, he was working harder and enjoying it less without any liquid cash. He wanted to convert his equities to cash and/or cash flow. Bob sought out property owners with free and clear rentals which were out of depreciation. He’d offer to exchange 30 of his highly leveraged houses for one of theirs.
Here’s how that might have worked. Let’s assume all houses were worth about $100,000. He’d give up $3,000,000 in assets with little or no equity in return for one asset free and clear worth $100,000. From time to time Bob had to sell the house he received to pay the taxes on the gain he realized as a result of his being freed from the debt he gave up. Nonetheless, in a little over a year, he was able to accumulate over a million dollars in free and clear rented houses that produced about $75,000 per year net cash flow. The parties with whom he exchanged his properties were thus able to re-leverage and step up the depreciable basis in their portfolios without qualifying for any new loans, and without paying any taxes on their profits.
People who want to avoid taxes by exchanging their properties often place the sale proceeds into a special escrow with a “Qualified Intermediary”, then use it to buy replacement properties. Qualified Intermediaries are a wonderful source of funds that entrepreneurs overlook. Moreover, many Brokers lose sales because they too overlook this valuable source of funds. Almost every time a Broker is trying to find financing, he will rely upon the buyer being able to obtain a conventional mortgage loan.
From Jack Miller’s CREATING WEALTH WITH HOUSES eManual