Successful Real Estate Investors understand the need to have capital available in order to pursue investments that will allow for their continued business growth. However, this capital does not have to come from their own personal or business funds. The savvy Investor will use every method possible in order to get the most creative financing terms that will benefit them. Some of following methods will actually allow you purchase a property with little or no money down.
Due to the nature of putting creative deals together that may not conform to traditional lending procedures, it is strongly recommended to have your Attorney review any agreements or contracts in advance of you signing them. This will ensure your best interests are being protected.
Don’t Be Afraid To Ask!
The following information will provide an overview on ways to generate creative financing to provide funding for your real estate investments. One thing to keep in mind with regards to getting a seller to agree to creative terms is that if you do not ask for it you will never really know what could have happened. If you provide compelling reasons why your request for creative financing is a Win/Win situation, you just may convince them to look outside their normal comfort zone and do the deal.
Cash is King
When it comes to having a strong negotiating position with a seller, nothing compares to telling them that you are willing to pay them cash immediately. Cash is a powerful tool and it is one way to set you apart from the many investors that may be after the same deal. There are a number of ways to ensure that you will always have the capital available to negotiate your cash deals with motivated sellers. The following sections will provide a number of possibilities.
Borrowing from Friends, Family, and Professionals
Although at first you may have concerns about approaching people you know or who are family members to discuss borrowing money from them, keep in mind you are approaching them with a business opportunity, not a handout from them. Your success in achieving the desired results with these people will depend completely on how you present your opportunity. If you sit down with them not properly prepared without having any of the obvious issues or questions worked out, you will probably walk away without the cash. However, if you put together a project plan that will include an overview and most importantly a viable exit strategy (so they know how they will get paid back) there is a good chance you will be successful.
Once you have exhibited your ability to complete these real estate transactions with the anticipated results, you will have people coming to you as an investment option.
Bring in a Money Partner as a Joint Venture “Equity Sharing” arrangement
Another approach to locate capital is to add a money partner and do a Joint Venture with them. This technique is different than a traditional Hard Money loan because they may take on a more active role in the project and perhaps instead of a straight loan percentage they may take a piece of the profits. In addition, they are typically added as owners any mortgage notes and Deeds. Usually in this arrangement, there is a split of the investment profit and loss as well as tax benefits. Although the split is typically 50/50, it does not have to be and could be determined based on the amount of capital or other skills the partners are bringing into the deal.
Keep in mind that a Joint Venture relationship is usually put together with a specific project in mind. Once the project has been completed, the Joint Venture relationship may end. The specific terms of the joint venture are outlined in a Joint Venture Agreement, which will legally bind the partners to the project.
The Joint Venture approach is a great way to “Test the Waters” with the Partners in order to assess the viability of continuing this relationship on another project or to elevate the relationship to another business level like forming a entity (LLC, S-Corporation, etc,) with them. If you are going to find out that you have selected the wrong partners, it will be much cleaner to find this out when your relationship is only based on the one project.
Partner with the Owners
As another approach to shared equity, you may come across a situation where a seller is looking to sell a property that is in need of rehabilitation and also may be behind on their personal expenses. You could come in and bring the property up to market value by completing any rehabilitation it may require. In return, you would get a percentage or flat return on your investment once the property has been sold. Make sure you have a beneficial interest in the property either by being added to the deed or by issuing a note back to the seller.
This technique can be very advantageous for owners who are unable to pay the monthly expenses.
Buying Low and Refinancing High
Buying low and refinancing high is great way for you to “create” and utilize equity.
This technique works very well on properties that can be acquired far below market value or due to the current poor condition of the property. There is an ability to add value in the form of improvements. By purchasing the property and refinance with a cash out, you can recoup the capital you gave the seller and repeat the process on the next property. This is a great way to leverage the same funds over and over again. In some cases, you may be able to allow the seller to hold the mortgage until you can refinance. One word of caution using this method, make sure you fully understand your ability to get a loan based on the property and your credit qualification. Keep in mind that banks have LTV (Loan to Value) limits on how much they will loan based on the appraised value of the property.
This is a True Story!
On one of our rental properties we purchased we had some very motivated sellers that had a property that would not qualify for traditional financing due to its condition. We were able to negotiate a deal where they would hold a mortgage while we rehabilitated the property. At the end of the mortgage period, we were able to refinance and pay off the owner financing creating a win/win situation.
Another twist to owner financing is a Sale Lease back. With this technique, the seller will provide financing for the sale and you will lease back the property to the seller. You can give either full or partial credit towards the fair market rental value. This arrangement could be a great win/win strategy. The seller’s benefits are highlighted as follows:
* Eliminate the need to maintain the property, this could be very helpful if they are elderly or have an illness.
* The seller will receive an income stream to help pay for their expenses.
* Allows the seller to stay in the home, which can have powerful emotional benefits.
* The seller may benefit from a lump sum of cash from the down payment.
Doing a “Subject To”
The concept of a “Subject To” deal is that you will take title on a property subject to the existing mortgage remaining in place. This technique is different than assuming the loan because with an assumption, the loan is “transferred” to the new buyer. With a Subject To, you will pay the mortgage on behalf of the current owner. A Subject To deal is usually applicable when the property is not a candidate for a Short Sale. On a Subject To property there usually is significant equity in the property as apposed to a Short Sale that may not have any or negative equity.
Home Equity Line Of Credit (HELOC)
A HELOC is a great resource to have when you need capital to fund your next acquisition. How this type of loan product works is fairly straightforward. If you currently own property that has equitity (the difference between the market value and the total amount of all mortgages), you can use that equity to secure a line of credit. A line of credit is a perpetual loan meaning as you use the line and pay it back, you can borrow it again. A HELOC usually comes with check writing capabilities so you can fund deals as soon as you locate them. Lenders will have underwriting guidelines that will limit the amount of equity they will allow you to pull from the secured property.
You should exercise when considering using this type of loan product. Remember, if your project fails and you can no longer make loan payments, the bank will foreclose on the property that held the security and it may be your home.
Using Credit Cards
There may be instances where you may need quick cash for a short period of time. Don’t discount using your credit cards and requesting a cash advance. Although this option may cost you in terms of the high interest rate payments, it can be a viable approach to get you out of a jam with your cash flow or to raise capital for the acquisition of properties. If you have very good credit, I’m sure you are continuously bombarded with credit applications. Perhaps you should apply for a few of them and use the cash advance as another capital generation tool. Remember, most credit cards are free so if you do not use it, it will not cost you anything.
Assuming the Existing Mortgage
Assuming a mortgage is a great way to avoid dealing with all of the cost, time and underwriting criteria you may encounter when originating a new loan with your bank.
Basically, when you assume an existing mortgage, you are replacing the current borrower and stepping in and assuming all of the terms of the existing mortgage. Although at first this may seem like a great option, make sure you fully understand all of the terms and conditions of the loan. Many of these loans were originated when the interest rates were not as favorable as they are by today’s standards.
The following list will summarize the key points you need to review before agreeing to assume the loan:
* Interest rate and any adjustments that may occur
* Any balloon payments
* Prepayment penalties
* Assumption fee
* Term left on mortgage
* Assumption qualifications
Owner Holding a Mortgage
One of the most effective ways of doing creative financing is when the current owner is willing to hold a mortgage for you. This method is clearly a win/win situation. The following highlights will summarize the benefits of this approach:
* The seller could benefit from reducing their Capital Gains tax resulting from a traditional transaction. In addition, they will receive monthly payments that will generate an income stream at a good rate of return.
* With potentially reduced closing costs, the seller may attract more buyers
* Rates and terms are negotiable
* Since institutional banks are not involved, the transaction can close faster which could benefit the seller.
* Property condition is not a problem because you will not have a bank underwriting the loan with specific guidelines regarding the condition of the property.
* The seller may get a higher sales price because some buyers will be willing to pay a premium for this benefit, especially if they are not currently a good candidate for traditional financing
* If the subject property is commercial and not performing well due to poor management or vacancy issues, a lender may not write the loan. Lenders are very sensitive to the Debt Service Coverage Ratio (DSCR). See “Performing Financial Analysis on Investment Properties” handout for more information on this topic.
Once you have convinced the owner to hold a mortgage for you, your next objective is to work out the best terms of the loan. During the terms negotiating, there are a number of techniques you may want to consider to optimize the situation for you. The following will highlight some of the things you may want to negotiate with the seller:
* Defer the start of the payment cycle until you can generate income from the property.
* Have the interest rate on a sliding scale so that the early years have a lower rate than the later years. This could be beneficial in an appreciating rental market.
* Request interest only payments with a balloon payment due at some future point in time.
* Giving the seller a higher sales price in return for no or low interest rate.
Substitution of Collateral
A substitution of collateral basically means that you will use another property to secure a mortgage other than the property you are purchasing. For example, you can attach the mortgage to your primary home leaving the investment property you just purchased free of any liens. This technique will allow you to sell the investment property without having to satisfy the mortgage and leveraging the additional capital you will receive from the sale.
Perhaps the most powerful technique in creating deals is using the concepts of Options. Basically, an option is a formal contract between a buyer and seller that states that the seller will agree to the sale of the property at some point in the future for a pre-determined price and the buyer has the option of moving forward with the sale. For the privilege of having the option to purchase, the buyer will usually be required to pay an option fee upfront and if they do not “exercise the option”, the fee will be surrendered to the seller. Typically, these option fees are held in escrow and will be managed in accordance with the options contract. Keep in mind that with these types of transactions, the seller is required to sell but the buyer has an option to purchase.
What the options technique allows you to accomplish is to have control over properties with very little money in the deal. Your only risk will be the loss of your option fee. During the option period, you will not be required to manage or provide capital for the underlying property including insurance or taxes.
A property owner usually retains the right to sell to someone else other than the purchaser of the option. However, the option will still survive the sale and just like a lease, the new owner must accept the terms and conditions of the option agreement.
Option terms are completely negotiable and usually no two deals look the same. The length of the option period can be anywhere from a few weeks to a number of years. Usually the shorter option periods are used when a buyer has determined that there is currently substantial equity and/or cash flow and need some time to either raise capital or locate another buyer to flip the deal to. Longer option periods are typically used when the buyer is anticipating future equity and/or cash flow. It is recommended that you consider having a provision in the contract that will allow you to extend the option period if it expires. This is referred to as a rolling option. Having the ability to extend the option period will usually cost additional option fees, but may be worth it if the property has the value you are anticipating.
Assignment of the Option
It is recommended that you add an assignment clause in the option contract that will allow someone else to walk into this contract. Consult your Attorney on the development of this document.
A variation to the option technique is a Lease-Option. This technique combines a typical lease with a purchase option. Unlike a straight option, the lease-option will shift the responsibility of property management to the leaseholder. With this technique, you will benefit from any cash flow and also tax advantages if this is a rental property.
Another technique to finance your acquisitions is to take a second mortgage out on a property you currently own. If you feel you will need these funds for an extended period of time, this could be a better solution than a HELOC loan because many of these loans are interest only and if you hold the property for an extended period of time, you would not be reducing the principle amount.
Using Signature Loans
If you have a good credit score, you may want to consider taking out a signature loan to help fund your acquisition Capital. This type of loan product is not secure by real estate and is based solely on your ability to pay. These types of loans can typically have a higher interest rate than a secured loan due to the higher risk levels the lender is accepting. In addition, there are limits that banks are willing to lend on an un-secured loan. A technique to provide a private lender more security on these types of loans is to take out a life insurance policy for the amount of the note and interest and make the lender the loss payee.
Tap Your Life Insurance Policy
There are some life insurance policies that will accumulate a cash value, this cash may be available to the policy owner in the form of a loan or cash value reduction. See your Insurance Broker for more details on this method.
Self -Directed IRA’S
You may want to consider using a Self-directed IRA to fund your investment capital needs. Self-Directed IRA’s have become extremely popular in recent years due to their flexibility with investment options. However, make sure you fully understand the specific rules and requirements of your plan with regards to the capital moving in and out of you account. There are limited custodians that offer the Self-directed IRA. See the workbook module “Reference Information List” handout for contact information.
Transactional funding can be an outstanding method for you to financing some of your deals without any of your own capital. A transactional lender will provide extremely short term financing in order to complete the sales transaction and the term of the loan is usually one to a few days. This type of financing is only suited for certain types of real estate transactions like Flipping where in the course of a day, you will close on the purchase side and re-sell it to your buyer. The fees associated with Transactional Funding can be high (2-4% of the loan amount) plus a few points or processing fee. However, when these costs are considered and the transaction is still viable, it can be a great way to complete another deal with other people’s money.
Using Your Company Sponsored Retirement Plan
Another technique to raise capital is to take a loan out on your retirement plan. For some, this can be a great way to leverage your money and earn even greater returns than you are currently receiving. The benefits of the approach are summarized below:
* Approval of the loan is usually very easy
* You are paying yourself back with interest instead of another bank or investor with hard money.
* Payments are usually made through payroll deductions making it very convenient.
* Interest rates are lower than hard money (be cautious with this method regarding your monthly payment because with the shorter loan terms typical of this product, you will be paying a higher monthly premium).
Other People’s Money (OPM)
When talking about creative financing techniques, you will hear many references to “OPM”. The concept of using other people’s money is a sure fire way for you to get into a deal with little or none of your own capital. The many different ways to use OPM is limited only by the creatively of the people putting the deal together. By definition, creative financing does not have any hard rules. The level of creativity is usually directly proportionate to the motivation of the parties involved.
As an investor, there are tremendous benefits to you using OPM. These benefits are summarized below:
* When you rely solely on your own capital to fund a project, you are limiting your acquisition plan due to your capital being tied up until your current deal completes the exit strategy. In addition, you will be limited on the scope of the project based on your available funds. However, when you leverage the use of OPM you are effectively creating an endless supply of required capital. This leverage will allow you to attain your financial goals in a more effective time frame.
* If you do not have any capital of your own to invest with, this method may be the only way you may be able to enter the real estate investment business.
* If you have poor credit, conventional financing may not be possible.
* Allow you to shift some of the financial risk to someone who will be benefiting by receiving a good return on his or her investment.
Using Personal Property as Down Payments or Collateral
In some cases, you may be able to offer your personal property as either a down payment or collateral. The seller for example may be willing to take ownership of your car as the down payment. This option offers many interesting possibilities.
Using Hard Money to fund your deal
Using Hard Money to fund your capital needs is a very common financing approach that should be considered. This method of financing is a great win/win strategy. As part of the development of your Success Team, you should have a number of Hard Money Lenders on-line ready to provide you the required capital. One of the benefits of using Hard Money Lenders over other ways of raising capital (like asking your family and friends) is that there is no emotional connection in the deal; either the deal makes sense or not. The criteria that Hard Money Lenders have are usually fixed with little room for negotiation.