In this post, we begin a multi-part series on Creative Real Estate Investment Strategies that leverage non-traditional methods of financing. The traditional way has been around for years; it doesn’t require much creativity but a disciplined program can create value over time. So let’s dive into some creative real estate investing strategies. Today, I will cover 3:
1. Buy and Hold
2. Buy and Lease (Lease Option or Lease Purchase Homes)
3. Wrap-around Financing
Buy and Hold
Technique #1 is the way our parents bought real estate. You work hard all your life; you have a job, make money and by the time you’re in your mid-40s you have a house and are getting comfortable financially. You decide, “Our house has gone up in value, it’s been such a great investment, let’s buy another one.” So you buy a rental property. Congratulations, you are now a landlord, in the words of Jerry Seinfeld, “not that there’s anything wrong with that!” Unless of course you have no experience with tenant screening, property management or landlord tenant law, but that’s an article for another post.
You look around and get the best deal you can and pay a fair market price. But by the time you find a tenant, pay the property taxes, insurance, maintenance, management, and all the other expenses that go along with it, you’ll be lucky if you are able to break even on the cash flow.
There are several ways to look at the total return on your investment. We can make a better deal because we buy a foreclosure property at a discount. Or we can buy HUD or VA foreclosures. Or buy a bank REO property (REO stands for Real Estate Owned by a bank). Or we can buy from a motivated seller who needs to sell due to job transfer, financial hardship, a divorce, is behind on payments and about to go into foreclosure. With the right expertise we can turn that property around and create positive cash flow on it from day one.
So we buy a property and have a little positive cash flow on it. Our tenants are making the payments for us, including the taxes and insurance. We may have a little maintenance and upkeep on the property but we also get depreciation on the property. That means you get to take 1/27.5 of the property’s value and deduct that from your taxes every year to significantly reduce your taxes.
You also benefit when the property appreciates. We recently bought a property for $140,000. The seller paid $28,000 for it about 25 years ago. Properties go up in value at an average of about 6% a year nationwide (they have ever since the end of the second World War). So properties do go up in value. Markets are cyclical so there are periodic recessions but real estate always rises over time!
That was technique #1. It is a buy-and-hold rental technique. I encourage you to look at the TOTAL BENEFIT you are getting, not just the cash flow!
Buy and Lease (Lease Options)
Now for a little variation. Let’s say instead of buy and hold, we buy and lease. What if we buy this property and instead of renting it out to somebody, we lease it?
Buy and lease is different than buy and rent. The difference is if a person signs a lease on the property they may be interested in buying that property. You may also be able to SELL them an “option to buy.” This is technique #2.
When you buy this property, you can go to a bank, finance it and buy it in the normal way. However, when you lease this property to somebody who wants to buy it (sometimes called rent-to-own but technically it’s a lease with an option to buy), you are selling them an option to buy this property from you at some future date, typically in one to three years and at a higher price (10 to 15%) than what it is worth right now as they are paying you for that privilege.
They should pay you 3 to 5% of the value of the property as a non-refundable option fee. In addition, they could pay you more then the normal rent because they want to own this property! They also have an owner’s mentality. So when you buy the property and lease it with an option to buy, it gives you a significant benefit over a buy-and-rent strategy.
So technique #2 is better than #1 in some cases. You get cash up front (non-refundable option fee) and more money each month. However, you might not always be able to lease a property so you may have to settle for renting it.
Our third technique is another variation; it’s the buy-and-wrap process; a wrap-around loan. If you want to sell a property and be done with it, you can carry a contract on the property through a wrap-around loan process. That means you keep your name on the title and the underlying mortgage but you sell the property to somebody else on a land contract, an “agreement for deed” or a contract for sale. They will get their name on the title when they make the final payment to you; it’s called a “wrap” or wrap-around financing.
The advantage in this technique is best explained through an example. You have a property you bought for $100,000. You put 10% down and you financed $90,000 at 6 1/2% for 30 years. You sell the property for $115,000 to somebody who is going to only put 3 to 5% down (which is why he is willing to pay you more money for it) and you are going to carry the contract (loan) for him at 8½% interest.
Why would he do that? Because he is not going to qualify for any of the loans available today. He can refinance any time in the next 40 years and pay you off but remember, if he pays you off, you put $15,000 in your pocket (as you paid $100,000; he pays $115,000).
But if you hold the loan, he is paying 8½% interest on $110,000 and you are paying 6½ % on $90,000. So you are putting $277 in your pocket every month; that’s $3,323 per year every year for 30 years or a total of $99,698. But you had a 30 year loan while has a 40 year loan. You could receive another 10 years of incoming payments, without any out-going payments, which totals another $101,496 making your total profit just over $200,000! As the numbers get higher, so do your profits. Amazing! That was technique #3.
So the first three techniques were:
1. Buy and Hold
2. Buy and Lease (Lease Option)
3. Wrap-around Financing
“But how can I do real estate if I don’t have money?” There are lots of ways you can buy real estate with no money out of your pocket! Remember this is only part 1 of a multi-part series. I promise I am going to share with you plenty of no-money-down techniques as well as techniques which require money that doesn’t have to be yours or a bank’s.
It’s not important that you use your own money. It’s not even important that you own the property. What is important is to CONTROL the property.
Whether you are looking at Asset Protection or Wealth Creation, ownership of an asset is usually less important than CONTROL. A wise and wealthy man once said. “Own nothing but control everything!” If you take away nothing else from this article remember the value of Control. Control is a fundamental key in creative real estate investment.