One continually hears about creative financing, but it rarely materializes. I was once in Novia Scotia discussing the purchase of a summer home. The real estate agent proudly proclaimed that creative financing terms were available on one of them. The terms were: half this year and half next year.
When I say creative financing, that’s not what I’m talking about. I’m talking about ways to buy or sell a house without using institutional financing except for loans that are already on the house. The way that I go about creating a financial structure is to look at the tools that are available to me. Here’s a short list:
First there are myriad ways to take title to property. Let’s start with Tenancies. These include joint venturing with the owner or another investor, holding title as Joint Tenants with rights of survivorship, or as Tenants in Common, or taking title in a legal entity such as a corporation, trust, LLC, partnership, or joint venture.
An example might be when I hold title with an investor, each sharing half ownership, profit, and losses equally.
Next, there are various estates in title. Estates are periods of ownership held by various parties. They can be divided and subdivided almost at will through the use of deeds rather than contracts. These include Life Estates, Estates for Term, Leasehold Estates, Remainder Estates, etc. Here again, I might pay the owner to divide ownership with me. The seller might retain an estate for life, or for a set number of years, and with the remainder of all right, title, and interest reverting to me at the end of that period.
Then there are rights that are marketable. These include water rights, mineral rights, developmental rights, air rights, riparian rights, etc. When Donald Trump build Trump Tower, he paid $20 million for the air rights over an adjacent lot. While not being an interest in real estate, an Option is a right to such an interest. Let’s not forget easements.
All of the above are on the table when it comes to crafting a deal. As you might suspect from the foregoing, there’s a lot more to creative financing than just haggling over price and payment terms.
I’ll give you some short-burst examples. See if you can find out where the profit to both sides comes from.
One guy bought snips and shards of rusty, dusty, industrial land at tax-sale, then sold them to the surrounding neighbors at the same price he paid for them. How can this be profitable? First of all, he got all of his money back that he had spent to buy the lots. He also retained all of the sub-surface, air, developmental, and mineral rights. Every time someone wanted to use the land, they had to dicker with him; this included an airport authority that wanted to fly through his air space, utility companies that needed to lease easements for their pipes and lines, and even the local subway authority that leased its tunnels. All of these produce income to him without any investment.
When elderly people in a waterfront community were threatened with rising property taxes and insurance, they sold Remainder Estates at a deep discount to the property value that would revert to their holder. In return, he agreed to pay their taxes and insurance for the remainder of their lives. He was thus able to control tremendously valuable property for a mere fraction of its value simply by making annual payments. How could he afford to do this? He sold half interest in his deeded Remainder Estate to investors who wanted quiet, effortless, risk-free investments for their Roth IRAs.
One enterprising person focused on owners of up-scale houses that had bought fast appreciating homes with high monthly carrying costs expecting to sell them at the end of two years. Now, after living in the house for two years, sales are cooling, even with a high appreciating equity, they can’t afford the payments; but don’t want to move out.
In return for them selling him a half interest in their home as Tenant in Common on an installment, he agreed to pay an amount on his contract equal to half of their $3000 per month payments. They paid $500 per month in net rent after all expenses to him for his half. In effect, this reduced their total payments by about a thousand dollars a month.
With nothing down, he is buying half interest in $300,000 equity in a $600,000 house for about $1000 per month on a zero interest loan. If the house enjoyed 5% per year in appreciation, his half would be going up $15,000 per year while his loan was amortizing at $12,000 per year. His investment would be building $27,000 on a $12,000 investment each year without any effort on his part at all.
Look at the tax angle: His tax basis is $300,000. Allocating $240,000 to the improvements, his depreciation deduction is $8727 and his negative cash flow is $12,000, so in the 15% tax bracket, when the smoke clears his after-tax cost is $8890 after deducting his negative cash flow and depreciation. As a result of their residential exemption, the sellers pay no tax at all on the $1500 per month he pays them.
