Creative real estate investing
|This article does not cite any references or sources. (August 2008)|
||The topic of this article may not meet Wikipedia's general notability guideline. (December 2012)|
Creative real estate investing is any non-traditional method of buying and selling real estate. Typically, a buyer will secure financing from a lending institution and pay for the full amount of the purchase price with a combination of the borrowed funds and their own funds (or his "down payment").
One way to buy a home is to pay cash. However, most families are not in a position to do this, and thus must arrange to finance its home purchase. Most families can afford only a modest down payment and are forced to secure the remainder of the purchase price by mortgage from some lending institution. The larger the down payment, the smaller the total interest payment over the term of the mortgage. Buyers, however, should not use all of their savings for the down payment, thus depriving themselves of any reserve to fall back on if extraordinary expenses arise or income falls in the future.
The way investors do it is Alternative Strategies: The mortgage market meltdown, the housing “crisis”, and the volatility in the stock market have all culminated to make real estate investing one of the smartest, safest, and most lucrative investment strategies available. This opportunity, however, does not come without its challenges. Restrictions on lending guidelines have made real estate investment a challenging endeavor to those who are unable to think beyond the standard methods of acquiring and profiting from real estate investments.
Applied wisely, Most real estate investors sought ways to educate themselves to have the knowledge and information for them to acquire as many great investment properties as they can get their hands on without ever having to use their own cash or credit. Whether you have a long term or short term investment strategy, private lending is the single best way to fund the growth of your real estate portfolio. Private lending works the same way as borrowing money from a bank, but the bank is a private individual or institution with little or no stringent lending criteria who simply receives a Note and Deed of Trust or Mortgage (depending on the state you are investing in) in exchange for funding your deal.
"Real Estate Financing Strategies" - Private Money, Best known as OPM(Others People's Money) 1. Cash 2. IRA 3. 401k 4. Non-‐Retirement Investments Accounts 5. Home Equity 6. Credit Cards 7. Personal Credit Lines. Alternative Strategies: 8. Hard Money 9. Business Partnerships 10. Contract Assignments 11. Assumptions 12. Lease Options 13. Subject-‐To (Existing Financing) 14. Owner Financing 15. Buy/Sell in an LLC 16. Cross Collateral-Real Estate or Stock,etc. 17. Fun With Notes –ReFi into a Purchase 18. Credit Partners 19. Rezoning‐ Parcel Splits or Combining 20. Limited Partnership & Private Placements 21. Commercial Bank LOC. I advise you must always consult a licensed professional about different topics related to real estate or preferably with a real estate investor and attorneys.
"Bird dogs" get paid a referral fee for finding good deals for other investors. This is often where people begin their investing career as there is only time at stake. They are typically paid when the deal closes. Some birddogs will structure companies and partnership arrangements as they're frequently not real estate agents and may not be able to collect a "referral fee" for their services. These partnership are often structured utilizing a Joint Venture (JV) Agreement.
Seller finance or "subject to"
Seller financing can refer to one of two things:
- The seller can act as a bank and rather than receiving all or a portion of their equity at close, they can "lend" it to the buyer and receive a regular payment as agreed. They may receive no payments, interest only payments, principal only payments, or a combination. It could be an interest only loan, or an amortized loan. Additionally it could carry either a fixed rate interest payment or a variable rate. These will vary depending on the agreed upon terms of the contract between the buyer and the seller.
- The seller can allow the buyer to "take over" the loan that he or she has in place. This can be done in two ways. The first way is called an "assumption", wherein the lender formally allows the buyer to assume the loan. This entails approval of the buyer's credit, and often a modification of existing loan terms. The other method is called a "subject to" where the lender is not contacted, and the buyer purchases the property "subject to" the existing financing. This can be financially risky in many ways, since many loans have acceleration clauses which permit the lender to call the loan due if the property is transferred. However, more often than not the lender will not exercise the "due on sale clause" if the payments are being made on the underlying mortgage(s). In the rare event that a lender does call the loan due then an investor could quickly sell the property or pay off the loan using any one of the various financing options available, some of which are described below.
An option is defined as the right to buy a property for a specified price (strike price) during a specified period of time. An owner of a property may sell an option for someone to buy it on or before a future date at a predetermined price. The buyer of the option hopes the value of the property will either go up or is already low. The seller receives a premium called "option consideration". The buyer may then either exercise the option by buying the property or sell the option to someone else to exercise (or sell). This is often done to obtain control over a property without much cash. Option premiums are typically non-refundable. The option represents an equitable interest in the property and may be recorded at the county recorders office.
This is made up of two parts: A lease, or rental agreement, and an option. They may be written together as one contract or as two. The Lease is simply a rental agreement between the owner and the potential lessee (tenant). Often these leases will be "triple net lease" leases (NNN) in which the lessee is responsible for paying for the taxes, insurance, maintenance, and upkeep of the property. The lease payment is typically 5-15% higher than rent might be for the same property. This type of lease can be structured so that the lessee can take the tax benefits as if he were the home owner.
Sandwich lease option
A sandwich lease is not an option at all.
A sandwich lease is a lease created by a tenant wishing to exit his/her unit as a tenant while not having a "exit option" written into their lease by the landlord.
To provide a mitigation option [way to reduce one's risk or cost], one may find a replacement tenant for a unit. This tenant becomes the tenant of the exiting tenant and NOT a tenant of the current, legal landlord. The new lessor, [the legal tenant] creates whatever policies and rent and deposits he wishes with the new tenant. The new landlord should inform the tenant that their tenancy lasts only until the landlord's lease expires.
If the new tenant seeks maintenance or has any problems whatever with the unit, the "new tenant" must contact her landlord who will then contact the legal landlord for maintenance or repairs.
The new tenant makes all her payments to her temporary landlord who then makes her rent payment and everyone is kept legal and paid up.
When the "proper tenant's" lease is about to expire, the proper tenant submits her 30 day notice of intent to not renew the lease to the landlord—unless the lease is a fixed duration lease—which makes the notice unnecessary.
The 'proper tenant returns for the exit walk-through, and introduces the temporary tenant [sandwich leasee] to the legal landlord and helps the sandwich leasee [whose lease now expires] to become the new, sole tenant, of the unit.
The sandwich lease is ONLY used when the landlord's lease does not provide a pre-expiration date exit from the lease option.
Short sale or preforeclosure
When a property owner fails to make their mortgage payments for a number of months they are in default. The first step of the foreclosure process (which typically takes a number of months) that the lender will take is to file the notice of default. This is a public document that is recorded. The property owner will contract to sell the home conditioned upon the lender accepting a lesser amount than what is owed on the mortgage. Note that there are no similarities between a real estate short sale and selling a stock short.
In many jurisdictions, including the United States, the seller is responsible for taxes on the amount of the mortgage left unpaid after the sale as ordinary income.
The Mortgage Forgiveness Debt Relief Act of 2007, enacted Dec 20, 2007, generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief. The original effective date was through 2009 but in October 2008, legislation extended the relief through 2012. Use IRS form 982 to handle the debt relief provision.
Wholesalers typically make smaller profits but buy and sell properties in large quantities. They may buy 50 homes at a time from a bank and then sell them for a small markup to move them quickly and do it again.
A more common wholesale approach among creative real estate investors is to secure properties with no money down and do a "quick flip". Typically, the property or owner must be distressed in some way for the deal to make sense.
Wholesalers work on some sort of distress either by the owner or the property. Distress can come in many ways such as divorce, job relocation, unemployment, severe damage to the property, etc. Once a property is gained at a significant discount the buyer quickly sells at markup of the buying price. Typical markup amounts range from $5,000-$15,000.
In a nut shell, real estate wholesale companies put properties (normally distressed properties) under contract and assign or resell the property to another investor. The end investor uses either cash, lines of credit, or hard money loans to purchase the discount property. This allows quick closings on properties that sometimes need extensive repairs.
A wholesaler lives off of the idea that price overcomes all objections. If you can sell a property for a low enough price it doesn't matter what’s wrong with it, somebody will buy it. A wholesaler focuses on developing two things: a system for finding deals, and a network of investors to sell to.
Hard money lenders
These are often used to finance projects that are unconventional, great deals, or where money is needed quickly. Typically hard money lenders will lend 50-70% of the value of the property regardless of the sales price (unlike banks). They will typically close loans in 2–7 days. Credit scores and income are often overlooked by hard money lenders, however they may ask to see a business plan or exit strategy for the project. They may get paid via points (e.g. 1 point equals one percent of the total amount borrowed), interest rate (10-20% per year is common), and an equitable interest. These will vary based on the size of the project and the agreed upon contract. Hard money lenders are collateral based and typically require first position on the property.
True hard money lenders do not charge any front fees whatsoever; nothing for appraisals, app fees, credit fees or anything else. One common secret of many hard money lenders is that they want the property for themselves, and thus do not care if the borrower is unable to continue with their payments. After one or two missed payments, the hard money lender will file foreclosure proceedings and usually add the reclaimed property to their portfolio. They also do not care about exit strategies.
This may not clearly fall in the category of "real estate investing", however it is worth mentioning. Each state creates the system and rules for the lien or deed process so careful research is necessary. In general, property owners are notified regarding the amount of taxes owed and are given a period of time to pay. If the amount remains delinquent, the state will take one of the following paths (though some have created a hybrid):
Tax lien state
The county in which the property is located sells the lien certificate at a sale or auction. Some states sell the lien for the delinquent amount while others allow bidding to begin at that price. The purchaser of the tax lien collects interest (predetermined by the state) from the home owner on the amount that was paid for the tax lien. If the tax lien (with interest) goes unpaid during the redemption period, the investor may foreclose on the home. Unlike most foreclosures, when a tax lien is foreclosed on, all other liens and mortgages are abolished and the property would be owned "free and clear". Typically the lender will pay off the tax lien to avoid losing their house and/or property.
Tax deed state
The county government sells the deed to the property at a public sale or auction. The benefit for investors is the ability to purchase property at discounted rates, often for the amount owed in taxes. When an account becomes delinquent, the property is listed at the tax assessor's office, some are even online. Properties with homes are usually purchased by investors (often referred to as sharks) prior to foreclosure.
This also is less of a "creative real estate investing" technique as typically described. Mortgages are often sold by lenders to other lending institutions. Investors can broker transactions by arranging buyers and sellers of notes to meet or by buying them and immediately selling them for a profit.
Flipping is buying an under priced property and then quickly reselling it at market value. Homes are typically sold below value by uninformed sellers or those in distress (like job loss or foreclosure). Often a property is sold under market value because it is a "fixer upper". Sometimes they require very little such as paint and carpet and other times they have mold, asbestos, or foundation issues. These inherently hold more risk and more work, and therefore often have substantial profits.
While there have been many seminars on the virtues of flipping, in reality, few people earn a profit from flipping and for all practical matters, once the market burst, flipping became a 'dinosaur', unused process.
Land Trusts have traditionally been used as a non-profit entity to own property. In recent years, many companies have developed methodologies that allow for Land Trusts to be used to acquire properties in foreclosure allowing homeowners to save their homes and making it possible for investors to see incredible returns. In a Real Estate Investment model Land Trusts bring ease to the transaction. While some people believe that using a Land Trust also brings a benefit of not causing Due-on-sale clauses to force the refinancing of the subject property, this is only true when the borrower is and remains a beneficiary of the trust and which does not relate to a transfer of rights of occupancy in the property. While the use of Land Trusts by real estate investors does make it more difficult for a lender to discover a transfer has occurred, the loan can still be accelerated if it is discovered since a transfer has occurred.
By federal law a transfer to a trustee in an inter vivos trust (to which classification a residential property land trust belongs) cannot be considered a due-on-sale (due-on-transfer) violation unless all of one's beneficiary interest would have been transferred to another. Title 12 of the US Code Para. 1701-j-3 - i.e., the Garn–St. Germain Depository Institutions Act of 1982, specifically makes this point.
What this means is that a partial beneficiary interest, of one to ninety-nine percent, can be given (assigned) to a co-beneficiary without triggering a lender's alienation recourse (i.e., the due-on-sale penalty requiring immediate satisfaction in-full of the mortgage loan.
In so much as the land trust is beneficiary-directed rather than being directed and managed by its trustee, a remainder agent (i.e., a party appointed to assume responsibility for the trust and its corpus in the event of the death or incapacity of the original director-manager beneficiary) can be a remainder beneficiary (co-beneficiary), rather than needing to be remainder trustee, as would be the case with the standard, and far more common, trustee-directed inter vivos trust (i.e., the fully funded inter vivos family trust).