The problem with buying houses to hold long term is that it consumes a lot of cash and credit and requires years to build wealth. One enterprising fellow found a way to get around this problem by recycling his cash in and out of houses on a monthly basis while he left his un-sold equity behind to continue to grow and compound at unbelievable rates of yield. Here’s what he did:
First, he set up a Private Line of Credit with the owner of a Self-Directed IRA whereby, in lieu of paying interest, he shared profits with the IRA in return for a $200,000 line of credit. By attending foreclosure sales, he was able to buy houses at about 70% loan to value including all repairs and legal shenanigans. Then he sold the houses to other investors for exactly the same amount of cash that he had invested in them, but retained the right to buy half of the house for half of the price paid by the buyers at any time in the future that he wanted to.
During the interim, he agreed to lease the property on a Performance Lease under the terms of which he was paid 90% of the gross rents collected but was not responsible for any other expenses of the property. Let’s look at an example:
One such house that cost $200,000 at foreclosure sale had an appraised market value of about $275,000. It was placed into a Land Trust and he named himself as Trustee. After placing a Mortgage on the house reflecting the initial fair market value together with a $1,000,000 liability policy and spending $5000 to clean up the property and ready it for rent, he sold the beneficial interest in the Trust to an out-of-area investor for $205,000 and put the money back into the bank to buy another house. His remaining half of the equity, $35,000, was divided with the investor who had put up the initial $200,000. The $200,000 in cash was recycled back into the market into another house and the cycle was repeated. Let’s see who got what:
The final buyer of the house got a whole-sale price and an instant equity of $35,000 on day #1. Plus, he got a hands off rental with a manager who had a financial interest in keeping the property maintained. Since the house was in Trust, no financial mishap in the personal life of the manager or investor would attach as a lien on the property, and nothing done by the tenant would create a liability for him as the Beneficiary of a Trust. The free and clear house generated both positive cash flow and tax shelter after all management and repair expense.
The entrepreneur created both an instant equity of $17,500 with absolutely no investment other than his time and talent, and he also set up a lease income stream based upon 90% of the rents he collected. With the initial rent pegged at $1800 per month, he took home $180 in cash flow with a zero investment. None of the investors he knew who owned similar rentals even broke even after loan payments were made.
Since all this income was from rents, there was no earned income nor any payroll taxes to pay. If the house were to appreciate at an average rate of 7.2% per year, his equity would grow by 25% of 7.2% X $275,000, or $4950 each year, and more each year after than. In the meantime he would be earning $2160 in rents from his sandwich lease arrangement.
The part that might perk up the casual observer was that he was able to repeat this little act 4 or 5 times a year, so both his net worth and his income were leap-frogging as he continued to add the equity and income from one house to that of all the other houses he had bought this way.
What about the investor who put up the original $200,000 purse? It was an IRA. There was no great sacrifice since none of the invested was available to the owner of the IRA because he hadn’t reached retirement age. Each time the entrepreneur recycled the cash, using our pro-forma example, the IRA grew by $17,500. With a single infusion of $200,000 he was averaging about $70,000 per year, or 35% tax-free.
In yet another variation of a theme, the entrepreneur could have taken a small percentage of the future growth and insisted upon additional cash from the investor who bought the house.
For instance, he might have settled for 40% of the future growth in exchange for receiving $10,000 at point of sale, leaving the additional 10% for either the investor who had funded him, or for the buyer of the house who paid back all of the money. This way, he’d have had part of a cake and part of the equity up front rather than later on.
Can you imagine any investor or entrepreneur who wouldn’t want to take any part of this transaction? Still, who else to you know who knows how to do it? The sky is clear and the track is fast for those who want to buy upscale houses using this technique.
