2. THE BUYER
The second area of flexibility in solving the problem of down payments has to do with the real estate investor's own resources. "But," you say, "If we are trying to spare the downtrodden, cash-poor real estate investor from coming up with down payments in the first place. Why bother to look to his personal resources?" The reason is that real estate investors often overlook valuable resources right under their own noses. They frequently have personal real estate property, talents, expertise, or equity resources that could be used to acquire desirable income - producing real estate property without the need for cash. And sometimes they even have cash or inheritances that could be applied - there's no shame to that, if you have the money at hand! This section reviews ten techniques in the area of real estate investor flexibility.
Practitioners of the Nothing Down System sometimes get the notion that putting their own money into a deal is somehow tantamount to failure. Nonsense! If you have it, use it, but use it with skill and creativity. The conventional real estate investor with $25,000 to spare will go out into the marketplace and plunk the full amount down on a single real estate property. He might find a nice rental home worth $60,000 with a $35,000 mortgage. His first instinct is to take his $25.000 and cash out the seller. There will be no contract payments or balloon mortgages to worry about. Very likely there will be a modest positive cash flow after expenses and debt service are taken care of. He is happy watching his rental unit appreciate in value.
By way of contrast, the creative real estate investor takes his $25,000 and distributes it over. Let's say five rental homes worth a total of $300,000. By using a combination of creative acquisition techniques and strategies for avoiding negative cash flows. This real estate investor puts down only $5,000 on each of the homes. He must be careful to structure his deals advantageously, but the outcome is that he controls the growth of five times the real estate for the same amount of investment. His yield will therefore be much greater.
In either case, the best approach might be to use the cash resources as collateral to borrow down payment funds. That way the cash assets can remain in the hands of the real estate investor and earn a substantial amount of interest. The same might be true of coming inheritances that would be acceptable as collateral on loans.
Technique No. 10 Supply the Seller What He Needs
The question of "seller needs" is a complex one. Often real estate investors resort to sophisticated psychological observation and strategic interrogation in order to penetrate the seller's wall of secrecy. That is fine as far as it goes. But the best approach is nearly always the direct one in the form of one simple question: "What do you need the money for?" There are more subtle variations, such as, "What do you plan to do with the proceeds of the transaction?" But it all boils down to the same thing - letting the seller know that you can solve his problem best if you know what he plans to do with the cash coming to him as a result of the sale.
Often the seller has consumer needs that the real estate investor could satisfy by carrying the necessary amounts on charge accounts or credit cards. In this way, the immediate upfront cash needs are spread out over time. Frequently the seller will be anticipating financial obligations that will require a set amount of cash each month beginning at some time in the future. If the real estate investor is on his toes, he can help the seller translate the down payment into installment payments that can be taken over by the real estate investor in lieu of a heavy cash down payment.
One real estate investor we know of in Stanford, California, gained insight into the seller's need for future day-care funds and persuaded her to reduce the down payment by $13,500 in exchange for his providing monthly payments toward her day care for the next thirty years at very low interest. He was able to supply the seller what was needed and spare himself a heavy down payment obligation.
Technique No. 11 Assume Seller's Obligations
Often a seller is planning to apply down payment funds to debts he may have or payments that may be overdue. If the real estate investor can arrange to assume these debts and then pay for them over time, he can avoid having to come up with the down payment funds all at once.
One Cleveland real estate investor of a small rental home was able to take care of the seller's arrears mortgage payments and utility bills and then cover some consumer debt obligations through installment payments. The result was the relaxation of the upfront cash requirements for the transaction.
Technique No. 12 Using Talents, Not Money
A real estate investor will often have professional expertise that can be "traded" in lieu of down payment funds. Contractors, painters, landscapers, health-care professionals, lawyers, realtors, insurance agents, car dealers, merchants - all of these can provide valuable services or discounts that could be used in place of down payments. The potential list is not restricted to professional consideration either, sometimes a supply of plain elbow grease can help swing a deal in the absence of funds.
One beginning investor we know of was able to assume a seller's obligations and work off part of the debt by providing maintenance and management services for the creditor. As a result he picked up his first investment real estate property - a mobile home - for nothing down.
Technique No. 13 Borrow Against Life Insurance Policy
In an age of oppressively high interest rates, it is inconceivable why people will leave assets lying around unused in the cash-value accounts of their life insurance policies. But many do it, not realizing that for a pittance (perhaps as low as five or six percent interest) they can pull those funds out of their policies and apply them to other investment.
For example, a Eugene, Oregon, investor recently put together a deal on a duplex by taking the real estate property "subject to" the existing first, having the seller carry back a sizeable second for five years, and generating the $8,000 down payment by borrowing it from the cash value of his insurance policy at 5% interest Another investor in San Jose, California, set up a transaction involving a $57,500 single family house by assuming the existing first of $25,400, planning to put on a hard-money second in the amount of $20,000, and having the sellers carry back the rest in the form of a third. However, when he went to put on the second, the lenders required him to come up with 10% down in the form of cash. He solved this problem by going to the cash value of his life insurance policy and borrowing $5,800 at 5% interest The amount needed from the hard-money second was now only $14,200, and everyone was happy. The beauty of insurance loans of this type is that the principal need not ever be paid back (except out of the death or annuity benefits of the policy).
Technique No. 14 Anything Goes
Down payments need not be in the form of cash. We have already seen how professional services can be used in lieu of cash. The same is true of personal real estate property that the real estate investor might offer the seller to satisfy down payment needs. Cars, boats, furniture, art, clothing, musical instruments - anything acceptable to the seller might be used. We have even heard of pets such as rare monkeys or valuable cats being used as down payments. One real estate investor in San Diego acquired a luxurious new home by using gems - diamonds, rubies, and emeralds - as the down payment. For another investor we know of, five truckloads of topsoil did the trick. Anything goes if it satisfies the seller's needs.
Technique No. 15 Creation of Paper
An investor in Sacramento, California, picked up a clean SFH for $56,000 as follows: assume existing $28,000 first mortgage, assume existing $7,700 second due in 7 months, have realtor carry back a third for $2,500, have seller carry back a note on another real estate property owned by the investor in the amount of $11,600, put down $6,000 cash (borrowed from credit union). By having the balance of the seller's equity carried back in the form of a note secured on the other real estate property, the real estate investor was able to put his equity in the other real estate property to use and leave himself in the position to be able to refinance the newly acquired real estate property with a new hard-money second in order to retire the existing balloon second and pay off both the realtor and the credit union. In fact, he had a kitty of $6,800 left over to handle the negative cash flows for several years. The central strategy in this deal was creating paper against the other rental real estate property already owned by the real estate investor.
Frequently a cashless real estate investor can solve down payment hurdles by applying the value of his other equities to the deal at hand. If the seller is amenable, it is a simple matter to prepare a note secured by the real estate investor's equity in other properties and hand it to the seller as all or part of the down payment on the subject real estate property. In effect, the real estate investor says, "I don't have the cash to give you as a down payment, but I can give you this note in exchange for your equity. The note will generate payments to you on mutually acceptable terms. I will maintain the collateral real estate property in excellent condition as security for the note". Then the real estate investor has a trust deed prepared in favor of the seller to back up the trust deed note.
What the real estate investor has done is magic - he has created paper out of thin air. But his paper has value. It is solid consideration for the seller's equity and is used in good faith in lieu of all or part of the cash down payment required. If the seller is dependent on such an exchange to consummate the deal but hungry for the cash just the same, he can always sell the note at a discount for cash. (Technique No. 40, explained later on).
Not only is the Creation of Paper technique valuable in real estate property acquisition, it permits the complete leveraging of a real estate investor's other holdings. Usually commercial lenders will lend only up to 80% of the value of a collateral real estate property. If an owner wants to borrow against his assets at levels higher than 80%, he can readily create paper against the top 20% value and use it for exchange purposes. Rarely will a seller ask for credit checks or complicated paperwork to back up such a technique.
Technique No. 16 The Two-Way Exchange
In the Creation of Paper Technique, the real estate investor retains ownership of the real estate property used to secure the note given to the seller as down payment on the subject real estate property. In an exchange, the seller actually receives the real estate investor's real estate property in exchange for his own. Title transfers.
Buying real estate property by means of an exchange, if correctly done, provides great benefits in the form of tax deferrals. Section 1031 of the Internal Revenue Service Code permits trading of properties without triggering taxation on the gains. This is one of the single most important strategies in building up a real estate portfolio.
One Milwaukee investor we know of recently traded his $170,000 7-plex for a more desirable $280,000 12-plex by means of a two-way exchange. In another illustration, the owners of a free and clear $150,000 home in Palo Alto, California, traded their real estate property for three other homes in the area and enhanced their tax and cash flow situation. There are countless variations of this type of exchange going on all the time.
Technique No. 17 The Three-Way Exchange
The principles are the same as in the two-way exchange except that the seller, while anxious to get rid of his own real estate property, is not willing to accept the real estate investor's real estate property in exchange. However, if someone with a real estate property acceptable to the seller is willing to take over the real estate investor's real estate property, then everything will fall into place. The end result is the same as a simple exchange except that an extra link is added to the chain. Theoretically any number of links might be added. As a result, the business can get complicate - but the outcomes can be spectacular.
Technique No. 18 Lemonading
In exchanging parlance, lemonading refers to the technique of adding cash to a real estate property that, for one reason or another, has not sold as readily as the seller had hoped (a "lemon"). The new package of real estate property-plus-cash is then offered in exchange for any acceptable package on the market With the cash sweetener added, the lemon is supposed to become more palatable to the marketplace -"lemonade."
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