Use OPC — Other People’s Credit

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Topics: Buying & Selling, Financing

Jose’ had worked at Tampa’s airport for nearly 20 years when he called me.  He was from Costa Rico and wanted to borrow money to send to his family there.  Because he was a foreigner who had a free pass out of the country, most private lenders were reluctant to lend him any money that might not be paid back if he went home and didn’t return.  They were less interested in foreclosing his house than they were in being repaid on time.  I was a little different because I was trying to buy houses, not lend money.

Jose’ owned a small house worth about $125,000.  It was in a good area near the local military base that would make a good rental, so there was very little risk in buying his house, but I didn’t have enough cash to pay for it, and I didn’t want to borrow the money to pay Joss’ for his $5000 equity.  Besides, he didn’t want to move, he just wanted to raise some money.  Here’s what we worked out.

Jose’ borrowed $4000 on a 7% 2nd mortgage loan that would be fully amortized in 8 years.  Payments were $54.53 per month.  He deeded me the house and leased it back for 8 years under a net lease arrangement which required him to make all the PITI payments on the first mortgage on time as well as pay for any needed repairs.
I agreed to make the payments on the 2nd mortgage.  Voila!  Jose’ got the money he wanted and I bought his house with nothing down.  Admittedly, I would pay $654.42 in negative cash flow per year for 8 years, but I would get all the tax write-offs, all the amortization, and all the appreciation from that point on.

Under the terms of the lease, if Jose’ failed to make his payments on the first mortgage for 90 days, his lease was cancelled.  At that point my negative cash flow would be well covered by rents.  As it turned out, one day after a couple of years, Jose’ went back to Costa Rico and didn’t return.  I canceled the lease and re-rented the house.  By using Jose’s credit, I was able to finance my payments to him at a very low cost in what turned out to be a very passive investment.

When working with investors, there is a kind of no man’s land that is rarely talked about, and even more rarely used; but it can be very profitable for both entrepreneurs and investors alike.  I call it “renting a signature”, but it boils down to getting an investor to obtain an institutional short term loan for you without your having to qualify for it.  This can make the difference between getting approved and getting turned down, and it is especially valuable to the entrepreneur who is long on opportunity, but short on cash and credit.  Here’s an example of how it worked for me:

Back when I was a Broker, Mr. McGoon listed a 4-plex with me that I was able to sell fairly quickly at the full listed price.  This brought us into contact  and gave us a chance to get to know a little more about each other.  He saw in me a hard working person with a good credit rating who could find opportunities.  I saw in him a potential investor who had become successful buying and selling real estate, but who now preferred to pay others to do what he could have done himself.

When I explained to him how much more business I could do buying houses that wouldn’t finance, then fixing them up so they would finance, he offered to co-sign my loans at his bank so long as loans were used to buy and fix up houses, and were repaid every time a house was sold.  For this, he charged me 15% of the amount borrowed.  To put that into perspective, suppose a house could be bought for about 60% of what it could be sold for after some fix up; McGoon would call the bank and have them prepare the loan papers, then we’d go down and he’d co-sign the Note.  He’d have the money wired into the title company that was going to close my purchase of the target house.

At settlement, I’d sign a corporate non-recourse Note back to McGoon that was secured by a first mortgage on the house.  The note called for no payments until the loan was paid off, but it included a 15% origination fee to McGoon.  When the house sold, I repaid the loan as agreed plus an additional 15% to McGoon.

Using the above percentages, without investing any of his own money at all, McGoon would get a 15% profit on my deals.  I’d get 85% less my actual expenses.  We’d make several of these deals each year, and we both made a lot more money than if we’d used any other investment vehicle.

A few years later, I undertook the role of McGoon by financing others who could use my money to earn a profit, but I did things a little differently:  When I was approached, instead of borrowing money from the bank and re-lending it, My pension plan bought the property outright and had it placed into a Trust and the Beneficial Interest was pledged to me..  The entrepreneur who needed the money was named as Trustee.  He signed a Lease and an Option.  The lease called for him to bring the property up to rentable condition at no cost to the pension plan prior to occupying it.

In return, the entrepreneur also got a short term Option to buy the property at a price 15%higher than my cost.  All he had to invest was the money to fix up the property.  If he failed to exercise the Option within the time limits agreed to, he forfeited all of his work and invested money to me.  Of course, if he there were extenuating circumstances and he was willing to pay a little more to me, I could always extend the Option period.  But either way, he had neither payments nor debt to burden him, and I couldn’t lose either.

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