There are a lot of different keys to becoming successful as a Real Estate Entrepreneur. Not the least of which is learning the financing game. Now, when I say financing, most of you will default to the bread and butter debt financing prevalent in the Real Estate Market. Let's call it Institutional Financing for lack of a better term. The average cat will never know anything more than Institutional Financing.
However, the real economic swingers have many more tools in their financing arsenal. Some call this Creative Financing. Some call it Creative Real Estate. Learning how to utilize these non-institutional methods of financing makes the world your oyster. It opens doors. It breaks down barriers. It releases the ties that bind you.
Dear Friend and Subscriber,
Who'd have ever guessed I'd be writing a newsletter on Non-Institutional Financing techniques when the cost of Institutional Financing is at a 30 year low? The Fed has reduced their interest rate an unprecedented 11 times this year alone. Money is as cheap as it's ever been in my adult lifetime! But… these are strange times. The newspapers are full of doom and gloom. People are being laid off in droves. Big Businesses are failing. The Stock Market has gone from boom to bust. Many institutional pension plans have lost an extraordinary amount of value. And to top it all off, we now have the effects of terrorism to deal with.
The Land Of Opportunity
Right now, as you read this, there is a unique set of economic variables in place. Low interest rates that appear to be going even lower. A sluggish economy. Fear and uncertainty. The lack of “security”. Low or non-existent inflation. In some parts of the country maybe even deflation. Zero percent financing on a lot of new car purchases, while the used car market is being hammered. Easy to buy. Hard to sell. Most people need to sell their used car before they can buy a new one. Results = sluggishness.
People are buying. But, most retailers will tell you the average purchase is smaller. Lots of buyers. Smaller tickets. I don't know for sure… but I would bet credit card debt is on it's way up this Christmas season. This may be the final crank of the card for a lot of people.
Home sales are slow to say the least. Higher priced homes are at a stand still. Lower priced homes aren't moving because of lack of acceptable financing for these buyers. It's becoming harder and harder to get lower end buyers qualified for decent financing. Yet… homes in the median price range seem to be moving better than ever.
Do you know what the median price is in your market? You should!
What else is hot? Well the refinancing market may be the hottest game in town. So if you already own a home (and still have an income) you can really take advantage of some outstanding interest rates. Will rates go lower? I think so… but they ain't bad right now!
Here's the way I look at his market… it's one big correction designed to flush out the amateurs. You may be wondering what I mean by that. You see… there is a tendency for all of us to be linear thinkers. Straight liners. When things are going up… we tend to think they will always go up.
When money is plentiful… we tend to think it will always be plentiful. When things are bad… we tend to think they will always be bad. Yet, we all know that's just not true. Things go in waves. Cycles. They move up. They move down. Markets are hot. Markets cool off. Money is plentiful. Money is scarce. Things rarely stay the same. Yet we all are subject to falling into the trap of thinking they will.
One trick ponies are short lived. It's time to learn some new tricks to take advantage of the tremendous opportunities this market offers. Time to broaden your horizons.
In The Beginning There Was No Financing!
Home financing is a fairly recent phenomena. When it comes to affordable home financing, the U.S. has led the way. Most of the strides in this area have come in the last 50-60 years when it was deemed desirable for more and more people to own their own homes. After all, it is part of The American Dream. Enter FHA, VA, Fannie Mae and a host of other quasi governmental agencies designed to promote home ownership through affordable loan programs.
Today there are a vast array of loan products available to qualified purchasers. These can get confusing if you are not careful. There are Jumbo Loans, Conventional Loans, Adjustable Rate Mortgages, Reverse Annuity Mortgages, Non-conventional Loans, Bond Money Loans and on and on. Most of these fall within what I refer to as Institutional Loans. They represent the only type of financing most people will ever know. They are, in fact, the one and only trick linear thinkers will ever know. The long and short of it is this. These are loans you (or somebody) has to qualify to obtain. There is paperwork. There are tax returns. There are verifications of everything. There is also a total break down in privacy. You become a public record. You bare yourself to total strangers (don't get excited there Wally). You might as well put your life history on the Internet.
The other problem… and the bigger problem… is the fact that these loans were designed by and large for “Owner Occupants”. The lowly Investor is virtually priced out of the market with unreasonable qualifying requirements (such as high down payment/low loan to value ratio loans). Investors are square pegs in a round peg/round hole game.
In fact, most Entrepreneurs are outside of the system looking in. We just don't fit the forms. But it gets worse. If you play exclusively in this institutional game, you become subject to the credit markets. What does that mean exactly? Well, it means when money is loose everything is rosy. When the supply of money dries up, you are virtually out of business.
Dependency on Institutional Financing puts you 180 degrees out of sync. You should be selling the caboose when money is loose and buying right when money is tight.
Getting Into Sync
There are many other ways of financing your purchases advantageously without the pitfalls of Institutional Financing. In fact, most other techniques for financing are far superior. Keeping the Institutions out of your transactions can produce many benefits. Probably the biggest benefit of all is that it puts you in sync with the buying and selling cycles.
Now… some of you may never sell your properties. But it would behoove you to at least be able to identify Seller markets… for one day your crop will be harvested. Maybe not in your generation, but the next or the next. We all need an exit strategy. Knowing when to sell is critical if you want to maximize your efforts. The difference between selling at the right time… and selling at the wrong time can be very significant. Very significant!
In my opinion, now is a great time to buy. Especially in certain price ranges. Why? Simply because the sheer number of Buyers has diminished. We could argue about why the number of Buyers has diminished, but that's really not as important. As I have been preaching for the last few months, this market is an aberration. Forces outside of the norm have effected this market. You have the Greenspan over-reaction factor working. He crippled the economy without any real justification… and is now working in reverse trying to bring it back.
The effects of his unprecedented 11 interest rate reductions in 2001 won't be felt for many months. It may, in fact, take longer than I expected for his reductions to fuel the economy once again. The reason I say this is a lot of people have lost their jobs. Companies have laid people off in droves. Many have found more efficient ways of doing business and will never rehire these workers. New businesses will have to be formed in order to absorb the excess work force. The sheer number of consumers is still massive, but the problem this time is jobs.
People will crank their cards over the Holiday Season… but beyond that… they just don't have the spendable income. It could take years to reverse this situation.
How does this effect Real Estate and your financial future?
Think of it this way… people without jobs can't qualify for loans. It doesn't matter how low and affordable interests rates are… if you don't have an income, you can't buy (conventionally, that is). Greenspan has also created a real problem for the CD (Certificate of Deposit) crowd as well. Yields are so low you almost have to pay the bank to keep your money.
Seller Financing Your Best Partner!
Day in and day out, the best and most consistent source of deals in Real Estate are found by dealing with Owners directly. Real people, not Institutions. This is a better source than foreclosures, tax liens, bank owned, FHA or VA repos. You name it. Working directly with Owners is the top shelf.
There are many reasons why this is the case. Not the least of which is the ability to structure transactions outside of the norm. Transactions without Institutional Lenders as middle men. Creative transactions. This is nothing more than sitting down with the Sellers and structuring your transactions in such a way as to meet their real needs. It's dividing up benefits. It's a practical way to do business.
Let me give you an example:
I think is indicative of today's market. A young Attorney asked me if I could help him buy a house for he and his family. They already had found a house. In fact, it was a close family friends home. The lady was elderly and wanted to see them have this home. He could qualify for financing at today's low rates but was short on the down payment. There wasn't a Realtor involved and the price seemed to be a bit high for the area although not drastically out of line. Let's just say the price was high retail.
The Buyer didn't want to ask his parents for any help with the down payment. This was a big issue. The Seller was planning on buying a smaller place or moving into a retirement community. Information on the Seller was sketchy as the Buyer wanted the home and hadn't really ascertained the Seller's needs. We started with institutional options because this was where his head was. There were several different options available to him. I slowly worked him into considering other possibilities. Bear in mind, this is a civilian we are talking about here. All this is new to him. His default setting is institutional.
I asked him what she was going to do with the cash if he bought her house. Stack it up on the kitchen table and build a shrine to it? (Fortunato) He said she would use it to buy her new home. Either that or put it in the bank.
That's when it hit me he may be doing her a great disservice by giving her cash. With the low yields available, cash is a poor investment right now. Think about it! It would be much smarter to give her a mortgage at the prevailing mortgage rates for the purchase price less his down payment. He could structure the deal so as to pay her a large down payment over time. He had just received a healthy raise and would be able to afford to give her several lumps sums over a period of time. The mortgage payments could be used to offset the payments on her new home. Since she is an owner occupant, she would qualify for the lowest rates available. His mortgage to her could mirror this rate.
This is not a deal where you negotiate price. This is where you negotiate terms. So how big of a down payment should he give her. I say the bigger the better. Why? Because he could basically have her set this portion of her equity on the sidelines and deal with it over time.
It's kind of like a mortgage except for the interest rate. Did you realize nobody associates interest rates with down payments. A little side note here. I have a friend down in Florida who purchases properties for “All Cash”. He buys nice big houses. Now this guy isn't a pauper, but I wondered where he kept coming up with the cash to fund his purchases.
Here's how he did it. He would offer $100,000.00 “All Cash” for a property payable $10,000.00 per year in cash over a 10 year period. He said nobody associates interest with cash… so he liked the “All Cash” offer just fine. He'd give them the $10,000.00 up front and said it was kind of like buying payments for 10 years, one year at a time and ending up with a free and clear house to boot.
Anyway… there are zero interest loans made everyday. It's all the way in which you couch them. My friend should want to give the Seller a big down payment over time. If he will do a little probing, he could time these payments to coincide with her needs.
The Big Lesson here is this. There is no need to bring in a middle man to solve this problem. The middle man being the institutions. Between the two of them they have all the tools to make this deal work at a much lower cost to both of them.
Who ever thought Owner Financing would be in vogue when interest rates are at a 30-40 year low? But it's always in vogue for those who know how to structure transactions… for those who think in terms of benefits.
The other technique at work here is setting a portion of the Seller's Equity on the sidelines for a period of time without interest. There are many ways of doing this. You should be constantly striving to use this technique in your Buying program. After all, the Seller really is your best partner. Which brings up an important topic…
When Is A Partnership… Not A Partnership?
Partnerships are a legal entity much like Corporations, Limited Liability Companies, Trusts and so forth. They have their own pro's and con's. Their own nuances. Legal Partnerships have their place but they can also be devastating since one partner can be deemed fully liable for the other partners actions. Because of this factor, you want to be careful not to utilize partnerships except in certain very limited situations. You should also be aware of what is called an “Implied Partnership”. This is where you hold yourself out to others (the public) as being partners, or make some representation of a partnership, when no actual legal partnership entity exists. By doing this, you may actually be taking on liability for your implied partner's acts.
Needless to say, you want to protect yourself from these implied partnerships. Now… we just talked about the Seller being your best financial partner. There is no legal Partnership formed. There is no Implied Partnership. There really isn't a Partnership at all. The benefits are divided up in such a manner as to avoid any resemblance to a Partnership whatsoever. It's important to make this distinction because you will be using other people as Lenders. You don't want a Partnership arrangement with these individuals, either actual or implied. You want to divide up the interests in the Real Estate in such a way as to distribute benefits without creating a Partnership.
As an example, you wouldn't want to hold title with a Private Lender. Either you (or an entity which you control) or the person who provides the financing would hold title. But not both of you together. So you will want to use all the tools available to you to carve out the various interests. Tools such as Deeds, Mortgages (Deeds of Trust), Options, Leases, etc.
These tools allow you to do business with others while avoiding Partnership status. This is very important! While you might mentally consider these people your partners, you don't want to create the legal liability of a Partnership. Both you as the Real Estate Entrepreneur and the Private Lender bring something of value to the table.
Each of you walks away with something of equal or great value than you brought in the form of an interest in the real estate itself. Not a Partnership interest, but a secured interest in the Real Estate.
Interest, Equity, Cash Flow, Depreciation, Appreciation… Or Any Combination
In our earlier example of the Seller carrying back the financing, the Seller, in return for Selling their home, agreed to carry back the financing. They agreed to accept payments for their equity. Interest on this amount is negotiable, isn't it? It could range anywhere from 0% to however high you wanted to go. The point is… they agreed to settle for a return on their investment as an integral part of the sale.
To me, it doesn't get any better than this! But, let's say you hammered the price down with the Power of Cash. You agreed to pay them “All Cash” in one lump sum payment at closing in exchange for a discount in the price. You can do that with cash, you know! Small problem. You don't have the cash! You start looking for an Private Lender who is willing to supply the cash in exchange for a return on his money. Maybe you are lucky enough to find a Certificate of Deposit investor who is earning 2% on his money, and they would be tickled with a 6% return. Or maybe you can attract all the money you want by paying 7%, 8%, 9% or more.
The numbers will vary with 1) what you believe is possible in combination with 2) what the market demands. There is private money available to you at some rate of interest. I have heard of many investors who have borrowed money at 15-18% interest with 5-10 points up front. To me this puts you in the position of working for the Lender. But, everybody has to start somewhere. You have to like this if you are the Lender, but if you are the Borrower you need to find cheaper money at the first available opportunity.
Higher interest rates and loan costs have the effect of transferring a portion (if not all) of your equity to the Lender.
A high risk way of allowing the Lender to participate and profit from your efforts. There are better ways.
Equity Financing
So far we have been talking about Debt Financing. There is a way of financing you're acquisitions without debt. It's called Equity Financing… and it's the way many large companies in this country use to raise money. Here's how it works. You sell a portion of your Equity for enough money to satisfy the purchase price or satisfy your debt.
In our “All Cash” example above, if we could purchase this property for 50 cents on the dollar, we could in theory sell half of the property to our Private Lender in return for the cash necessary to close. Now… instead of owning 100 percent of the house… we would in effect own 50%. What's the difference? Quite simply… no debt.
Using Equity Financing allows you to acquire more properties safely. Half of something is a lot better than all of nothing. This is a great way to get out of the banks altogether. If you already own property, you may want to look at your loan balances and see if you would be interested in bringing in a Private Lender to pay these mortgages off in return for a percentage ownership in the properties. The results should be an immediate increase in cash flow and a big bump in safety.
A Variation On The Same Theme
Okay. Let's say you found a great deal where the owner would carry back the financing as terms of the sale. Maybe even at 0% interest. Only problem… they want $10,000.00 cash down payment… and they want it now. You're only $10K short. Can you now see how you could bring in a Private Lender to put up the $10K in exchange for half of the equity in the property. Or, they could put up $5K and lend you the other $5K (at no interest of course) payable on the sale of the property. Of course you could divide up the cash flow, depreciation, appreciation and so forth to make this deal work by using the proper tools.
Borrowing Credit
Believe it or not, there are round pegs in this world. They're not bad people. Usually they are hard workers who have protected their credit and accumulated some assets. They want to play, they just don't know how and don't have the time to learn.
Getting back to our “All Cash” example, these people might be willing to qualify for financing at today's low interests rates in exchange for some of the benefits of ownership. In effect, you could borrow their credit and access today's low rates without having to personally go to the bank. If you will open your mind up to the possibilities, you will be amazed at all the different ways these type of transactions can be structured.
Keys To Working With Private Lenders Including Sellers
1. Never allow a Private Lender to loose a penny with you. Don't put them in questionable deals. Do whatever you have to do to make sure they get paid first. Take a night job pumping gas before you ever let them suffer even the smallest loss with you. Do this and you'll never have a problem finding money when you need it.
2. Avoid Partnerships. Divide up the interests in Real Estate using Deeds, Options, Promissory Notes, Mortgages and Leases. There are simple ways to carve out the benefits Real Estate provides without forming legal Partnerships. Secure your Private Lenders. Do the paperwork right.
3. Always keep in mind your best financial partner may be the Seller. After all, they do in fact already have the property financed… even if it's free and clear. Plus, you are dealing with real people who have real needs. There are things you can do for them and they can do for you that no institution or governmental agency will ever be able to do.
4. If you can negotiate a favorable interest rate with a Seller, you should also negotiate “Substitution of Collateral”. This allows you to sell the property for cash, take the cash and pay off an institutional loan or higher interest rate loan and replace it with the favorable Seller Financed Loan. A great way for Sellers to help you get out of the banks altogether. This also allows you to buy and sell property at the same price and benefit from the financing.
5. One of the primary reasons people don't invest in Real Estate is because of Management. It's the glue that holds most deals together and insures their profitability. Many investors will give up 50% of their equity/profits in exchange for professional management. Become a good property manager can solve your financing problems!
Best of Real Estate Success!
Scott Britton
www.RealEstateSuccess.com
