By Jack Miller
The root of all evil when it comes to making money in real estate is conventional financing. Even with record low interest rates, people still find that they can’t afford to buy in the expensive house markets such as might prevail in parts of California, Florida, Texas, Virginia, and near water front everywhere. The culprit is two-fold.
First, they use conventional financing to get loans with market terms that can’t be tailored to their specific needs and capabilities.
Second, they can’t afford to pay enough down payment to buy the house, so they embark on a multitude of financing schemes, all of which serve to increase their carrying costs and risk of loss.
Any house at any price will produce net cash flow if it’s free and clear, so the problem lies in the mortgaging. I recently discussed the cash flow squeeze with a speculator who had bought a brand new $1.6 million house and now couldn’t sell it. You can add or subtract a zero here and there, but the problem is the same; the rental income won’t cover the operating expenses and debt payments.
The solution would be not to buy the house at all, but to lease it at market rents, and sub-lease it to an occupant. At the same time, if an Option were bought with terms that were the same as the price one might have been willing to finance, then all the same benefits of leveraged appreciation would still be acquired, but without the negative cash flow or impairment to the borrowers FICO score.
Who would make such a deal? Almost any builder who is sitting on dozens of expensive unsold homes, and who is trying to get his banker to give him more time. With a lease in hand that reflects that some income is being generated, he has a lot more chance of getting a stay of his financial execution; and at the same time, has someone working as hard as he is to get the house sold to an owner occupant.
Why would someone rent a house that is going to be sold at any time? Because the entrepreneur would offer his tenant a $25,000 rental refund for cooperating with his sale of the house. From the tenants point of view, this could amount to free rent once the house was sold.
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