Financing Your Property “No Money Down” – Part 2

- Continued from Part 1 -

Borrowing from Strangers

You should not solicit strangers to do these deals without legal advice. There are state and federal laws that regulate solicitation of money from investors. If you solicit funds from the general public you may be making what is referred to as a “public offering” and then you are subject to securities laws called “blue sky laws”. To legally solicit and accept funds you might have to register with the state or federal government and make certain written disclosures prior to accepting money. This is an area full of pitfalls and if you are soliciting funds from the public consult with an attorney who knows the laws before you solicit the funds.

Extended Due Diligence Periods

If you are buying a property to “flip” you may want to write your agreement of sale so that you settle long in the future and which give you the right to show the property to prospective tenants and buyers during the pendency of the agreement of sale. For example, you might write your agreement of sale to allow you to settle in ninety days but allowing you to bring prospective tenants or buyers through the property during that time period. The idea is for you to obtain a tenant or buyer so that you can either have the property rented the minute you own it or can resell it at the same time you are buying it. This is called a “double closing” and means that you are doing two closings simultaneously – buying it and immediately reselling it. The double closing allows you to use the money from the purchaser to pay for the property! This really makes it “no money down”! It is a little tricky to pull this off, and you should be ready to pay for the property if you have to, but it is a really neat technique. I discuss it more fully in part 3 next week.

Low Deposit Money and Liquidated Damages

To limit your risk of losing money write your agreement of sale so that the seller is limited to retaining your deposit in the event you are unable to close on the property. This is called ”liquidated damages” and limits the losses you can have. You should also keep the deposit low. Try to put down just $500 or $1,000 dollars with the agreement of sale. If you are able to put down a low deposit and include a liquidated damages clause you will limit your risk of loss to $500 or $1,000.

Option to Purchase

A very interesting no money down technique is an option to purchase. An option to purchase is an agreement between a buyer and a seller where the seller agrees that the buyer, at his option or choice, may purchase the seller’s property at any time over a set time period for a set price. The buyer generally pays a small fee either monthly or up front in exchange for the seller entering into this agreement. The seller keeps the fee whether the buyer exercises his option and purchases the property or not. Typically, if the buyer does purchase the property, the option fee is applied to the purchase price. Generally, the option fee is small in relation to the retail value of the property. A reasonable goal is to pay an option fee of no more than two percent of the retail value of the property.

The option fee can be paid as a monthly fee or, alternatively, as a one-time up front fee. There are many advantages to options from the buyer’s perspective. First, you have a very low outlay compared to the value of the house. You also have time to fix your credit, make repairs to the house, or locate a buyer if you are trying to flip the deal to someone else. You are also not obligated to purchase the house. Those houses do not go up in value, you do not find a buyer or for any other reason you decide not to purchase the house, you are not obligated to buy the property and you only lose your option money. The seller typically still pays the taxes, insurance and repairs and any mortgage that is on the property. If your option is assignable, you can assign your option to your buyer for a fee and you never have to close on the house, meaning you do not need to find a mortgage, pay transfer taxes, title insurance or any other fees. Options are very flexible. You can write them so you can perform repairs and improvements to the property, show the property, or you can write them so that you do nothing at all. This is a terrific strategy for a housing market where prices are increasing quickly.

Options are often for durations of up to two years. If you use an option to lock in a price for two years in a market where houses are going up 10 percent per year, at the end of two years, your house will be worth 20 percent more than it was originally worth. You can then assign the option with a 20 percent profit margin!

The option strategy is also a good strategy when you need time to do some repairs to the house prior to purchasing it, time to fix your credit, or time to find a buyer. You do not have to pay all the money to purchase the property at the time you enter into the option. Instead you pay a small option fee. You save all of the closing costs you normally incur if you purchase the property.

You can also combine an option with a lease by signing two separate documents with the seller. This allows you to lock in a price today and close later on when you have found a buyer, straightened out your credit, or completed the repairs of the house. If you are trying to negotiate this deal with a seller, point out that the seller keeps the fee whether you complete the purchase or not. When you are drafting the option, you should make sure that it is assignable, gives you the right to show the property, and do repairs if necessary. In addition, you should pull a title report and do your home and termite inspections at the beginning of the transaction to make sure that you are dealing with the owner, that all owners are signing the option agreement, that there are not so many liens, judgments, mortgages against the property that even if you pay your option price, you would not be able to get clear title, and finally that the house is in good condition. It is important that you check all of these things in advance because generally the option fee is paid up front to the seller unlike a regular agreement of sale where the up front deposit by the buyer is put into escrow and released only at settlement when the seller has to provide clear title to the property.

Keep in mind that there is no requirement that you buy. If you are unable to find a buyer, the price of housing drops, or anything else happens that makes you uninterested in the deal, you are not obligated to purchase and the only thing you have at risk is your option fee which should be a relatively small amount of money in relation to the value of the property. In a rapidly increasing market because you are using small amounts of money to control large amounts of property, you can potentially make a lot of money with a small investment.

Let’s say for example you were taking out two-year options where housing prices are increasing at ten percent per year, and let’s say that you are paying two percent of the market value of the property with the option. If you purchased three options on three separate $100,000.00 properties, you would spend $6,000.00. If you assigned all of the options at the end of the 24-month option period, the houses would have increased in value twenty percent. This means you would have three houses that have increased in value by $20,000.00 each giving you $60,000.00 in gross income. If we deduct the $6,000.00 you invested in option fees, you have a net profit of $54,000.00 from a $6,000.00 investment! That represents a 115% annual return on your investment!

Lease –Option

This technique involves combining a regular lease with an option to purchase (as described above). The difference between a lease option and an option is that the lease allows you the right to use or occupy the property during the term of the lease. You may also gain the right to sublet the property by re-renting to another. This is a way to make a profit on a property you do not own and have little investment in.

For example if a seller agreed to lease you a property for $600 per month for two years, and then purchase it for any time during that two year period for $50,000 you could lease the property for $500 per month, re-rent it to someone else for one year at $650 per month, make $1,800 over the course of the lease, and then sell the property after the first year after it has gone up on value.

I usually draft these agreements as two separate documents. The first document is an ordinary lease that allows me to sub-lease and the second is an option agreement. This kind of arrangement has a lot of advantages for a buyer. It allows a buyer to lock-in a purchase price today, use the property, show it, sublet for a profit and gives the buyer time to find a new buyer at a higher price. The buyer has a very low cash outlay because he does not have to pay closing costs such as mortgage application fees, title insurance fees, transfer taxes and other expenses normally associated with purchasing a property. The buyer still has many of the advantages of ownership but without the expense. If you are in a housing market where prices are going up, you get to lock in your price today and sell it for a higher price tomorrow. You can also make a profit by just sub-letting properties that you may never close on. If you are trying to convince a seller to enter into this kind of arrangement, you should tell the seller that he is getting a tenant who has a stake in the property. Often the buyer takes care of minor repairs and usually needs little management because they are planning on purchasing the property and thus will take care of it. Prior to entering into this kind of agreement you should obtain a title report to be sure all of the owners on the current deed are signing the agreement. You should also perform a home inspection and termite inspection up front. This way you know you have a good house without surprises before you have invested a lot of money or time into a project. You should carefully check the title search to be sure that the liens, mortgages, judgments and other encumbrances on title are not more than your purchase price.

In summary, this is a great technique to lock in a price while you fix your credit, obtain mortgage or investor, or locate a buyer. You should be sure to write the lease to allow you to sublet and rent to someone else. This allows you to make a profit from the beginning of the transaction. Another great feature of this technique is that you do not have to put out a down payment, pass the rigorous screening of mortgage companies. The only money you need to come up with is two or three months rent to cover the first months rent and security deposit. This will almost always be a “no money down” deal because two or three months rent is almost always less than 5% of the value of the property. In addition you save up-front money because you do not have to pay for closing costs to purchase (title insurance, mortgage fees, etc.) If you re-rent the property to another you may be reimbursed for all the money you put out when they put down their security deposit, first and last months rent! Finally, you are not obligated to buy when you use this technique. You can always walk away at the end of the deal.

Lease- Purchase

This technique involves combining a regular lease with an agreement of sale. The difference between a lease-purchase and a lease-option is that the lease-purchase commits you to purchasing the property unlike a lease-option where you can decide later whether you want to complete the purchase or not. You have many of the same features and benefits in a lease-purchase as you do with a lease option. Both allow you the right to use or occupy the property during the term of the lease. You may also gain the right to sublet the property by re- renting to another.

I also usually draft these agreements as two separate documents. The first document is an ordinary lease that allows me to sub-lease and the second is an agreement of sale. The lease-purchase arrangement has a lot of advantages for a buyer. It allows a buyer to lock-in a purchase price today, use the property, show it, sublet for a profit and gives the buyer time to find a new buyer at a higher price. The buyer has a very low cash outlay because he does not have to pay closing costs such as mortgage application fees, title insurance fees, transfer taxes and other expenses normally associated with purchasing a property. The buyer still has many of the advantages of ownership but without the expense.

If you are in a housing market where prices are going up, you get to lock in your price today and sell it for a higher price tomorrow. You can also make a profit during the period of time before you close on the property

by sub-letting the properties at a higher price than your monthly lease payment. If you are trying to convince a seller to enter into this kind of arrangement, you should tell the seller that he is getting a tenant who has a stake in the property. Often the buyer takes care of minor repairs and usually needs little management because they are committed to purchasing the property and thus will take care of it. Prior to entering into this kind of agreement you should obtain a title report to be sure all of the owners on the current deed are signing the agreements. You should also perform a home inspection and termite inspection up front. This way you know you have a good house without surprises before you have invested a lot of money or time into a project. If problems come up later you may have a difficult time getting your money back, especially if you have invested in repairs. You should carefully check the title search to be sure that the liens, mortgages, judgments and other encumbrances on title are not more than your purchase price.

In summary, this is a great technique to lock in a house and a price while you fix your credit, obtain mortgage or investor, or locate a buyer. You should be sure to write the lease to allow you to sublet and rent to someone else. This allows you to make a profit from the beginning of the transaction. Another great feature of this technique is that you do not have to put out a down payment, pass the rigorous screening of mortgage companies until later on when you have had time to repair your credit or save more down payment money.

This will almost always be a “no money down” deal because two or three months rent is almost always less than 5% of the value of the property. In addition you save up-front money because you do not have to pay for closing costs to purchase (title insurance, mortgage fees, etc.). The only money you need to come up with is two or three months rent to cover the first months rent and security deposit. If you re-rent the property to another you may be reimbursed for all the money you put out when they put down their security deposit, first and last months rent! Remember, thought, you are obligated to buy when you use this technique. Unlike the lease-option you cannot just walk away at the end of the deal. In most circumstances I prefer a lease-option to a lease purchase for that reason. The lease-option has all the same advantages but without the disadvantage of the commitment.

Installment Sale Contract

This technique is sometimes called a land-sale contract. With this technique, the buyer and seller enter into an agreement whereby the buyer signs a document which allows him to occupy the property before closing, pay a monthly fee, and have part of the fee being credited to the purchase price when closing finally takes place. Often when closing takes place the deed is transferred to the buyer but the seller continues to collect a monthly payment arising from a mortgage he obtains on the property. This arrangement has a lot of the features of a lease-purchase (as discussed above) but sometimes the buyer and seller both have some tax advantages with this arrangement. You will need to discuss what those might be with your accountant.

The lease-purchase and installment sale contract both commit you to purchasing the property unlike a lease-option where you can decide later whether you want to complete the purchase or not. In some states, the installment sale contract often forces the seller to use a judicial foreclosure process to terminate the agreement, especially if a lot of payments have been made. This can be an advantage to the buyer if he thinks he may miss payments from time to time. You have many of the same features and benefits in a as you do with a lease option and lease-purchase. All forms of agreement allow you the right to use or occupy the property during the term of the lease. You may also gain the right to sublet the property by re-renting to another.

This agreement is drafted as one document and is usually the way VA foreclosures are sold. The installment sale arrangement has a lot of advantages for a buyer. It allows a buyer to lock-in a purchase price today, use the property, show it, sublet for a profit and gives the buyer time to find a new buyer at a higher price. The buyer has a very low cash outlay because he does not have to pay closing costs such as mortgage application fees, title insurance fees, transfer taxes and other expenses normally associated with purchasing a property. In addition, you are getting owner financing on the entire project. The buyer still has many of the advantages of ownership but without the up-front expenses. If you are in a housing market where prices are going up, you get to lock in your price today and sell it for a higher price tomorrow. You can also make a profit by sub-letting the properties at a higher price than your monthly lease payment. If you are trying to convince a seller to enter into this kind of arrangement, you should tell the seller that he is getting a tenant who has a stake in the property. Often the buyer takes care of all repairs and usually needs little management because they are purchasing the property and thus will take care of it. Prior to entering into this kind of agreement you should obtain a title report to be sure all of the owners on the current deed are signing the agreements. You should also perform a home inspection and termite inspection up front. This way you know you have a good house without surprises before you have invested a lot of money or time into a project. If problems come up later you may have a difficult time getting your money back, especially if you have invested in repairs. You should carefully check the title search to be sure that the liens, mortgages, judgments and other encumbrances on title are not more than your purchase price.

In summary, this is a great technique to obtain a house when your credit needs some work or if you want owner financing. Another great feature of this technique is that you do not have to put out a down payment, pass the rigorous screening of mortgage companies until later on when you have had time to repair your credit or save more down payment money. You are also getting owner financing for the whole transaction. This will almost always be a “no money down” deal because you often make only a small down payment and you often do not have to pay for closing costs to purchase (title insurance, mortgage fees, etc.) until you close on the property. Remember that you are obligated to buy when you use this technique. Unlike the lease-option you cannot just walk away at the end of the deal.

- Part 3 will follow next week -