I’ve found that splitting the equity and giving financially distressed owners reduced rent until they can get back on their feet to be readily acceptable. The key is to never give a seller an Option to repurchase the property under any circumstances. This has been construed to be usurious practice in most States. An owner who is having trouble making payments on a $55,000 loan balance on a $150,000 house might be delighted to sign over half the house to you in return for your making all the payments while he continues to occupy it. Now, the plot thickens: Let’s say that you would be making all the payments; It would be only fair that he pay you fair market rents for the half of the house that you bought.
Here’s how the math on one case worked out: Half of a house worth $165,000 with a mortgage balance of $65,000 and PITI payments of $578 per month was sold by the distressed owner. The terms included a Promissory Note that called for a series of payments equal to the loan payments. Payments were to be paid directly to the institutional mortgage lender through a local bank until the loan was completely paid off. Title was held as Joint Tenants. The occupant leased the buyers interest for the earlier of 10 years or date the house was sold at a flat rate of $200 per month plus all repairs needed to maintain the house in current condition. During the lease period, so long as the occupant didn’t default on the lease, the buyer agreed not to sell his half of the house to another investor.
The bad news was that the buyer had to pay out $6900 per year on an existing mortgage while receiving only $2400 per year. The good news was that the negative cash flow was deductible against rents from other properties. There was no need for maintenance or management effort, or liability on the loan. The buyer was able to buy $82,250 in the form of half a nice house with nothing down simply by taking over the payments on the $65,000 loan.
Being willing to endure negative cash flow for long periods can buy a lot of equity. For example, if a $150,000 house that ordinarily might rent for $1100 per month were leased for $2000 per month, full credit might be negotiated toward the purchase price on an Option. In the interim, you’d hopefully be sub-leasing the house at market rents. Assuming 95% occupancy over the period, if this were done, in a little over 6 years, (75 months) the $150,000 house would be free and clear at a total cost of around $71,625 out of pocket plus repairs. Note that there would have been no down payment per se.
If the same house had been bought with a 6% fixed rate, level payment loan, monthly payments of $899.33 would have been required for thirty years. A total of $323,757.28 would have been paid in. So put this into perspective, consider that by paying an extra $1100.67 per month over the ordinary loan payments for 75 months ($82,550.25 total) $241,207 in payments could be saved.
Looked at yet another way, you’d have been able to pay off all debt and enjoy cash flow rents 285 months earlier than with conventional financing. In short, if average net monthly rents over the entire period remained at $1100, the extra $82,550 paid in over 75 months would have yielded $313,500 more in cash flow.
Once you enter into such a lease/Option transaction, the job is half done. Now, you‘ve got to find someone willing to put up the needed cash for half of the profit. In today‘s overheated housing market, a lot of people would like to put spare cash into nice houses, but just don‘t know how. I know a guy who has built a portfolio of 80 houses doing just that. He finds the house, negotiates the terms, then brings in an investor who can afford to pick up the negative cash flow until the property begins to produce a profit.
Once you demonstrate that you can find good deals and manage property, there are lots of people out there with big incomes who’d like to invest in houses. Beware! It’s essential that you pick and choose investors carefully. Like the fairy princess said, “You’ve got to kiss a lot of frogs in order to find a prince.”
