Creative Real Estate Investing
Encyclopedia
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
. Buyer
s, 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.
, 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.
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.
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.
rs 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 property is gained at a significant discount the buyer quickly sells at markup of the buying price. Typical amounts range from $5,000-$15,000
In a nut shell real estate wholesale companies put properties (normally distressed properties) under contract and assigns or resells the property to another investor. The end investor uses ether 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: finding deals and their network of investors to sell to.
s 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.
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):
. 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.
. Properties with homes are usually purchased by investors (often referred to as sharks) prior to foreclosure.
transactions by arranging buyers and sellers of notes to meet or by buying them and immediately selling them for a profit.
, 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.
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 clause
s 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. 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).
Real estate
In general use, esp. North American, 'real estate' is taken to mean "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; an item of real property; buildings or...
. 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
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
and his own funds (or his "down payment").
One way to buy a home is to pay cash
Cash
In common language cash refers to money in the physical form of currency, such as banknotes and coins.In bookkeeping and finance, cash refers to current assets comprising currency or currency equivalents that can be accessed immediately or near-immediately...
. 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
Down payment
Down payment is a payment used in the context of the purchase of expensive items such as a car and a house, whereby the payment is the initial upfront portion of the total amount due and it is usually given in cash at the time of finalizing the transaction.A loan is then required to make the full...
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
Mortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
. Buyer
Buyer
When someone gets characterised by their role as buyer of certain assets, the term "buyer" gets new meaning:A "buyer" or merchandiser is a person who purchases finished goods, typically for resale, for a firm, government, or organization...
s, 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
"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:- The seller can act as a bankBankA bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
and rather than receiving all or a portion of their equityOwnership equityIn accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists...
at close, they can "lend" it to the buyer and receive a regular payment as agreed. They may receive no payments, interestInterestInterest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
only payments, principalDebtA debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
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 creditCredit ratingA credit rating evaluates the credit worthiness of an issuer of specific types of debt, specifically, debt issued by a business enterprise such as a corporation or a government. It is an evaluation made by a credit rating agency of the debt issuers likelihood of default. Credit ratings are...
, 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
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.Lease option
This is made up of two parts: A leaseLease
A lease is a contractual arrangement calling for the lessee to pay the lessor for use of an asset. A rental agreement is a lease in which the asset is tangible property...
, or rental agreement, and an option. They may be written together as one contract
Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
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
Insurance
In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...
, maintenance
Maintenance, Repair and Operations
Maintenance, repair, and operations or maintenance, repair, and overhaul involves fixing any sort of mechanical or electrical device should it become out of order or broken...
, 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 mortgageMortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
payments for a number of months they are in default. The first step of the foreclosure
Foreclosure
Foreclosure is the legal process by which a mortgage lender , or other lien holder, obtains a termination of a mortgage borrower 's equitable right of redemption, either by court order or by operation of law...
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.
Wholesaling
WholesaleWholesale
Wholesaling, jobbing, or distributing is defined as the sale of goods or merchandise to retailers, to industrial, commercial, institutional, or other professional business users, or to other wholesalers and related subordinated services...
rs 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 property is gained at a significant discount the buyer quickly sells at markup of the buying price. Typical amounts range from $5,000-$15,000
In a nut shell real estate wholesale companies put properties (normally distressed properties) under contract and assigns or resells the property to another investor. The end investor uses ether 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: finding deals and their 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 scoreCredit score
A credit score is a numerical expression based on a statistical analysis of a person's credit files, to represent the creditworthiness of that person...
s and income
Income
Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...
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
Collateral (finance)
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...
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
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 lienLien
In law, a lien is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation...
or deed
Deed
A deed is any legal instrument in writing which passes, or affirms or confirms something which passes, an interest, right, or property and that is signed, attested, delivered, and in some jurisdictions sealed...
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 auctionAuction
An auction is a process of buying and selling goods or services by offering them up for bid, taking bids, and then selling the item to the highest bidder...
. 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
House
A house is a building or structure that has the ability to be occupied for dwelling by human beings or other creatures. The term house includes many kinds of different dwellings ranging from rudimentary huts of nomadic tribes to free standing individual structures...
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 onlineONLINE
ONLINE is a magazine for information systems first published in 1977. The publisher Online, Inc. was founded the year before. In May 2002, Information Today, Inc. acquired the assets of Online Inc....
. Properties with homes are usually purchased by investors (often referred to as sharks) prior to foreclosure.
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 brokerBroker
A broker is a party that arranges transactions between a buyer and a seller, and gets a commission when the deal is executed. A broker who also acts as a seller or as a buyer becomes a principal party to the deal...
transactions by arranging buyers and sellers of notes to meet or by buying them and immediately selling them for a profit.
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 moldMold
Molds are fungi that grow in the form of multicellular filaments called hyphae. Molds are not considered to be microbes but microscopic fungi that grow as single cells called yeasts...
, asbestos
Asbestos
Asbestos is a set of six naturally occurring silicate minerals used commercially for their desirable physical properties. They all have in common their eponymous, asbestiform habit: long, thin fibrous crystals...
, 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
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 foreclosureForeclosure
Foreclosure is the legal process by which a mortgage lender , or other lien holder, obtains a termination of a mortgage borrower 's equitable right of redemption, either by court order or by operation of law...
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 clause
Due-on-sale clause
A due-on-sale clause is a clause in a loan or promissory note that stipulates that the full balance may be called due upon sale or transfer of ownership of the property used to secure the note...
s to force the refinancing
Refinancing
Refinancing may refer to the replacement of an existing debt obligation with a debt obligation under different terms. The terms and conditions of refinancing may vary widely by country, province, or state, based on several economic factors such as, inherent risk, projected risk, political...
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.
See also
- Real estate investingReal estate investingReal estate investing involves the purchase, ownership, management, rental and/or sale of real estate for profit. Improvement of realty property as part of a real estate investment strategy is generally considered to be a sub-specialty of real estate investing called real estate development...
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).