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Dear Investors and Entrepreneurs, Creative financing has and will continue to be used by most real estate millionaires. Why? Real estate is the only asset that has the power of leverage to permit both the rich and poor to accumulate wealth. Most people aspire to be a millionaire but few understand how using other people’s money is the primary mechanism of creating wealth in real estate. The use of other people’s money permits any American to create million dollar returns. With appreciable gains from natural forecast trends, leveraging other’s money makes you money while sleeping. This is truly magic!
Seasoned investors ultimately use several methods of financing a portfolio. Depending on the forecast season and the amount of property owned it usually becomes necessary to use a variety of financing methods. The primary goal is to build growth based assets until all your financial dreams come true. The larger the dream the more necessary creative financing becomes. The best lending sources change with the forecast cycle. For example, traditional money markets tighten during deceleration seasons which can make lending more difficult even for high worth individuals. Meanwhile during acceleration seasons banks are looking to place loans as fast as possible and therefore make the qualification process easier. A fundamental part of real estate is the act of building wealth over time. There is no reason that anyone cannot build a millionaire dollar portfolio within five years using various traditional or creative lending sources. For those who are seeking a one year get rich scheme, real estate will not be your avenue. Sure sometimes it happens, but I like to promote a three to five year plan for achieving your first million. This is accessible to just about anyone with willingness, self discipline, self determination and a few extra hours a week. For many the path to million dollar wealth will require the use of creative financing. Creative financing does not stop anyone from achieving their desired results and when integrated to your plan will open you to more transactions to accumulate wealth quicker. Some of you have the luxury of good credit and income to create a larger real estate portfolio using both creative and traditional sources. Even the most credit worthy will want to diversity financing methods to speed wealth accumulation and improve returns. The power of leveraging is why real estate is the best method of creating wealth. In other liquid cash investments, like stocks, you have to start with money to make money. Liquid cash investments rarely have methods for leverage to accumulate wealth. When buying real estate almost all investors use lending sources to leverage the asset and generate even more money. The leveraged portion consists of the borrowed portion of the investment. A real estate investor enjoys forecast equity resulting in appreciation from both borrowed and non-borrowed money. Instead of earning an eight percent return on cash in a typical money investment (i.e. stocks, bonds, time deposits), a real estate investor will earn the appreciable return rate on the entire property. From 1995 to 2005 many parts of the United States gave an investor a 100% appreciable return rate on the property. This means if you bought a property for $100,000 after ten years the property value would have doubled to $200,000. In this example let’s say the investor put a cash down payment of $10,000 in 1995. He would have made from appreciation ten times his $10,000 initial cash investment or $100,000 in addition equity (purchased for $100,000 in 1995, worth $200,000 in 2005, total added equity $100,000.) Thanks to leveraged investing this investor made ten times his original $10,000 cash investment ($10,000 multiplied by 10 = $100,000 of equity). This represents not a 100% return on your cash but a 1000% return. Leveraging creates wealth in multiples. Any smart investor knows the borrowing money in real estate is a good thing. To begin it is important that you understand which financing options are available to you. Since the strictest method for loan qualification comes from traditional institutional lending sources, the guidelines are listed in the next section for you to gain an understanding of the process. Even if you are not intending to use a traditional lending source (i.e. bank) you need to understand the qualification steps since other non-traditional sources (no money down deals) may use one or more of these in their qualification process.
Several sources exist for you to finance a property portfolio. The more sources you tap into the faster to your wealth building goals. The sources described are typically called no-money-down methods for obtaining finance. We all know that real estate wealth is built through leveraging. I prefer not using no-money-down and call it using “other people’s money.” Even when you obtain a bank loan you are using other people’s money. The “other people” are usually happy since all methods described in this section are a win-win for all parties. Another added value to creative financing methods on real estate is the investor’s ability to take their savings and spread it among multiple investments. For instance, if you have $20,000 in savings that you want to apply towards real estate you could choose to buy a single $200,000 home with a 10% down payment or $20,000. This would leave you with one property in your investment portfolio. A forecast can be used to calculate your total return over time. In this $200,000 single home purchase this property may have a forecast appreciation rate of 20% over the next five years. That would mean $40,000 in total equity or wealth gain. Sure this means you were able to get a 200% return on your original $20,000 down payment, but it hardly makes you a millionaire. By now you know that one property at a $200,000 purchase price is unlikely to produce a million dollar return over the next five years. The financial power of real estate is in leveraging to capture gains from appreciation over time. Now let’s take your savings of $20,000 and spread it over ten properties with approximately the same purchase price and make up any down payment difference from creative financing. You would have received $40,000 in equity on each of the ten properties or $400,000 of wealth accumulation. Buying ten properties with creative financing makes you a lot closer to your first million in real estate. Creative financing is also the reason for faster wealth accumulation. The following section details several of the commonly used methods of creative financing. The methods are not mutually exclusive. Some work better during a slow forecast and others will not even be possible. Since many different methods exist there is almost always a method to secure financing on a well thought out acquisition. In fact almost all transactions involve multiple methods. The goal is to be comfortable with the methods so that you can easily mix and match with the opportunity. For clarification purposes the methods have been categorized by funding source as follows; Seller Financing (How to) Realtor Contribution (How to) Renter Contribution (How to) Investor Sourcing
Over the next several years of deceleration seller financed transactions will certainly be the best way to obtain financing. Of course it is not the only way. You may want to combine multiple seller financing methods or combine it with another financing strategy. The art of creativity in financing is based on how you mix and match multiple methods of financing to achieve the greatest profits and least amount of cash requirement. It is an art since only you can paint the picture in any transaction. When you come to the negotiating table armed with multiple methods of financing you have plenty of ammunition to win in low or no money down investing. During a market deceleration seller financing is the most common source that investors use. Sellers are often anxious to offer a willing buyer some form of financing to move their property. This is especially true when the property has been marketed for an extended period of time or the seller is facing financial problems (pre-foreclosure). The slowing real estate season brings higher levels of foreclosures and the over supply of “for sale” inventory. For these reasons it is an extremely exciting time to achieve better results. Many courses and seminars focus on the psychologically understanding of the seller to achieve optimal results on the purchase. From my experience usually the simplest and best approach is to get an understanding of what the seller wants out of his transaction. Once you provide a win-win for both parties a deal is executed. Good negotiations involved understanding the seller transaction envelope also referred to as a “negotiation envelope”. The envelope represents a price and terms range acceptable to the seller. Your goal is to find out the sellers hidden worst case price and terms that would still be satisfactory. It is unlikely that the seller has written down or defined all the variations of a negotiation, especially since you will be presenting some new techniques for making a win-win transaction. You as the investor also have a negotiation envelope. The investor envelope is made up of the worst case price and terms that would make an acceptable purchase. Yours will be easily defined at the time of negotiations since you will come prepared. The investor must probe with questions to help the seller discover his envelope. The seller will usually first share his best case price and terms to the investor. After a few direct questions the envelope will start to reveal itself. Once the investor envelope matches the seller envelope and agreement is reached for purchase. An investors’ worst case envelope might look something like this: a. No more than $2,000 of investor cash in deal b. Must have positive cash flow from renting after all expenses c. Property needs to show a minimum total equity return of $80,000 over five years. A sellers’ worst case envelope might look something like this: d. Need at least $5,000 cash to have a down payment for a rental and moving expenses e. Must get at least $10,000 of the equity back over time.
The direct but sensitive approach is often the best for negotiating. An investor that asks honest and direct questions while offering quick and easy solutions will build more trust than trying to manipulate the negotiation. A direct approach is a “just ask” approach. The investor asks what the seller needs out of the sale. Be certain not to confuse “needs” with “wants”. Wants are the high end of the envelope. Needs are the minimum requirement to make a winning agreement. Sellers are usually not familiar with acting as a lender. Therefore you will need to first probe the sellers needs before you suggest seller financing. The best way to find out needs is to ask (i.e. What do you need the cash for? What do you plan to do with the money proceeds?). In our seller envelope example you will quickly determine that he needs $5,000. Now that you determined the cash requirements of the seller you can determine if your arsenal of creative financing methods will work. Purchase price is almost always the first subject that a seller likes to share. Again to determine the price that a seller might be willing to accept it is necessary to probe with “just ask” questions. Instead of asking “how much?” an investor would ask “What do you think the property is worth in today’s market?” or “What is the best price you are willing to do for fast sale today?” It is likely that even then the seller will have a price higher than what you are willing to pay. At that point you would come back and use the direct approach of “This is what we believe the property is worth today and what we are willing to pay.” A negotiation will involve a lot more than just price and cash-out to seller. It will require the investor to have multiple no-money-down tools and methods to pull from. Ultimately once all needs are determined a direct approach for offer can be made. If the investor did a good job of finding out all the sellers needs the offer should be the easiest part of the negotiation. For instance in our example the investor would need to bring $5,000 of his own money to the table or use another creative money source before the property could be purchased. Seller specific creative financing methods and tools are described in the next section. The seller tools may only be part of the investor solution. Investors will commonly combine multiple parties to create the final financing solution. Common seller specific financing tools are as follows: 1. Contract-Wraparound Trust Deed-AITD 2. Trade or Exchange 3. Investor Tools to Ease Seller Concerns (meet seller needs) a. Balloon the Financing Terms b. Blanket Mortgage c. Offer a Higher Price to Seller d. Insurance Policy e. Higher Short Term Interest or Greater Principle Payments Earlier
Most investors never realize that this can be a source of limited but useful funding. During a deceleration cycle many realtors are left with unsold listings of property. A ready and willing buyer is welcome. Agents are paid a commission, usually with the preference of being cash at closing. No law exists forcing the payment to be cash. Many realtors are happy to see a property close by providing commissions in the form of a promissory note with some short terms (one to twenty-four months.) The investor can negotiate with the realtor to delay part or all of the fees. Since these fees are typically paid by the seller to the agent, an investor may assume part or all of the responsibility to repay the realtor upon closing of the sale. The average three to six percent commission might be applied towards an investor down payment or closing costs.
A buyer of residential rental property often has existing tenant(s) with leases in place. These tenants almost always have some form of security deposit. In addition when a purchase transaction is closed near the beginning of a month the responsibility of the full months rent collection is almost always done by the seller. The deposits and rents are directly given to the buyer in the settlement statement. This can mean a lot of additional liquid capital to apply towards the down payment. Meanwhile it is traditional that interest on any note is paid in arrears. This gives the buyer as much as thirty days of mortgage relief. Each investor should work towards an early month close and add back in these fees to the final cash outlay. It is important that an investor also remember that they are still responsible to give back security deposits to tenants upon moving out and the arrears of interest would be deducted from equity upon refinancing or resell.
The final source of investing lies in the hands of the investor. The techniques are used in combination with previous sections to create the most advantageous approach towards purchase. Buyer techniques can be summarized into four different types: Buyer Resources Capital Lending Sources and Methods Options Partners
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