Creative real estate investing
Creative real estate investing is a term used to describe non-traditional methods 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 his own funds (or his "down payment").
One way to buy a home is to pay cash. But the typical American family is 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.
Bird-Dogging
See also: Bird dog (person)
"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.
Seller finance or "subject to"
Seller financing can refer to one of two things:
1. 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.
2. 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.
Options
Main article: Option (finance)
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.
[edit] Lease option
Main article: Lease-option
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.......[whenever 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 of 2008, legislation extended the relief through 2012. Use IRS form 982 to handle
the debt relief provision.
Wholesaling
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 way such a s divorce, job relocation, unemployment, severe damage to the
property etc... Once a propery is gained at a significant discount the buyer quickly sells
at markup of the buying price. Typical amounts range from $5,000-$15,000
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 whatever; nothing for appraisals, app
fees, credit fees or anything else. ONE of the unique secrets of many hard money lenders is
that they want the property and thus, do not care at all 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.
Tax liens
Main article: Tax liens
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):
[edit] 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.
[edit] Paper/notes/mortgage investing
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
Main article: Flipping
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 trust
Main article: Land trust
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.
Real estate investing
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. Germaine 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).
