How To Fund Your Apartment Purchases Using None Of Your Own Money
Buying The Property.
Now that you know how to analyze apartment deals it won’t be long before you have a property that fits your goals and has all the potential value plays ready for you to capitalize on.
Now it’s time to buy the property. How do you go about it?
Terry Vaughan’s 60-Second Real Estate Course Most of us know about creative financing but let’s reduce financing to it’s essence. Once gain we will draw from the wisdom of Terry Vaughan, this time using his famous 60-Second Real Estate Course.
In any real estate transaction, whether it’s a single family home or a 200 unit apartment building, all that ever happens is the buyer and seller find a way to give the seller his/her equitable interest, so they can both win and go away happy.
(Note: Equitable interest = Fair market value minus total loans/debt on the property.)
There are only four ways to do this. I know, you hear all the gurus railing on about all kinds of creative techniques, but strip away the fancy packaging, and there are still only four.
2) Lump Sum
3) Different Form
4) Combination – Pieces, Lump Sum and Differennt Form
Pieces are installment payments, monthly or otherwise, with interest or no interest, principal only or P&I, or with interest paid in a lump sum after 10 years. Whatever is agreed upon by both parties.
Banks have conditioned us to believe the 30 year fully amortized note is the only way an installment payment can be structured. This is far from the truth, and once you can pry a sellers’ thinking away from this sterotype structuring a deal that is a win for both of you becomes much easier.
This is what everyone is used to; all the underlying loans are paid off and the seller receives their equity in a lump some of cash. You hear it referred to as Cash-to-new-loan by realtors and loan agents.
When the buyer has the ability to pay cash for the property, the universe of deals available to him/her opens up dramatically.
This is where the equity is paid to the seller with almost anything that the seller perceives is as valuable as the equity in the property. So instead of taking the equity as cash, the seller may agree to take some Microsoft stock, or a condo in Miami, or a mobile home in Georgia, a car. Anything can used as payment for the sellers equity as long as the seller is happy to take it.
The fourth and final way a seller can receive their equity is through a combination of the other three – pieces, lump sum, and different form.
eg. The owner of a 50 unit building wants to retire and go on a road trip with his wife. Instead of waiting he agrees to you assuming the $1.2M loan, taking back a $600,000 note at 6% interest, $100,000 cash, and motor home valued at $100,000, for a total price of $2M.
As you might be already thinking, the possibilities for different combinations are only limited by your imagination … and your negotiating skills.
Different Ways To Buy
When you are starting out it’s very likely you either have all your money tied up in other investments, like stocks or bonds, or you just don’t have any money, saved or otherwise, so buying an apartment building using your own money isn’t an option.
This is how it is with most people sarting out, so you have to look for ways to purchase the property with no money out of your pocket.
The list of different ways to buy with none of your own money would easily top 100, but let’s not stray too far off the beaten track and look at a few of the most common.
This is a simple arrangement. Once you find a profitable deal you team up with a money partner to raise the cash needed to close. The partners job is to provide money for the earnest money, the down payment, closing costs, and repairs if needed. Your job is to manage the property, execute your value plays to capture the upside value of the property and the sell the property at the market peak to realize you and your partner’s profit.
This is a great way to get started, no cash or credit need by you, just your knowledge and your time and effort. The downside is you give away half the deal to your partner.
Also known as Owner Financing, this is when the seller agrees to finance all or part of the purchase price. Because there is no bank involved, no credit or large cash down payments are required. You and the seller are free to set up whatever financing makes the deal work for both of you.
If the seller is flexible there are many ways you can go:
– Seller refinances to pull cash out of the property, carries back a 2nd for the balance of the purchase price. You take over the new loan Subject-To.
– Seller’s property is free and clear. Seller carries back a 70% LTV 1st at 7%, 30 years, carries back a 2nd for the balance, principal only payments.
– You take over the existing loan Subject-To, Seller carries a 2nd, no payments for two years, then interest only for 5 years, ballon payment at the end of 7 years.
– And so on. As long as you and seller are in agreeemt about owner financing you simply structure the terms that allow both of you to get what you need out of the deal.
Raise Money From A Private Lender
When you get a profitable deal under contract and you need cash for earnest money, down payment, closing costs, rehab, you go out and find a private lender who will loan you the money so you can cover all of these and close. You pay the private lender an attractive rate of return they are unlikely to get anywhere else with the same security.
A lot of investors have problems understanding private lending. “I mean, who on earth would hand over their precious savings to someone so they can go and buy a piece of real estate?”
Well … let’s list a few:
– thousands and thousands of people who have their savings sitting in a bank being eroded by inflation while collecting between 2% interest.
– veteran landlords who are sick of the game but still want the passive income.
– attorneys who work 80 hour weeks, make a lot of money, want to be in real estate but don’t have the time to be personally involved. The same goes for doctors, dentists and other professionals.
– accredited investors; high net worth individuals who want their money to grow at high rates in a secure environment.
– a fellow investor who may very well be in your local Real Estate Investment Club (REIA).
– this list too goes on and on.
What makes a person a candidate to be a private lender is they have excess funds sitting in an account somewhere that they wish were getting a higher return. You know you have a private lender when, if you contact them and ask if they would like to get 10% return on their money secured by real estate, their eyes light up.
There are many, many other ways to buy property with none of your own money, and they can be used with success to enable you to purchase a profitable apartment building with none of your own money.
The Downside To “Non-Cash” Financing
The downside to most of these techniques though, is they are specific solutions to unusual situations that are not too common.
When all you have are creative, “non-cash” financing methods to acquire property, you limit yourself to just the sellers who can be helped with those techniques and forgo all of the other sellers who are highly motivated (like banks) and quite willing to come down on price, but require you to pay cash.
When you can pay cash, the universe of deals available to you opens up considerably. Adding “all cash” to your arsenal allows you to work short sales and REO’s aggressively. In essence, being a cash buyer gives you the ability to fill you deal pipeline as full as you want it.
When you consider the realm of commercial lending it is sometimes hard to really comprehend the scale involved. Small loans are a few million dollars. The larger commercial loans are nine figures. The institutions making the loans have balance sheets in the tens of billions of dollars.
They operate under different guidelines to residential lenders because there are no unsophistcated borrowers to protect. If you are ambitious enough to be an investor, it’s buyer beware. As a result commercial lending is very entrepreneurial and creative.
But when the economy turns south and the holders of these huge notes have to take the property back all of a sudden those former assets are now non-performing assets and liquidity is very important to the lender.
Availability Of Cash
For a lender in distress, loaded with REO, what matters to them is that the cash is available. An all-cash offer at a low price will be accepted by the lender over a contingent offer every time.
Owner financing is not even considered.
In some cases, the very existence of the lender is at stake so the primary concern they have is that you are going to come through and close with cash. Price less a concern than the certainty that you will close so they can restore some liquidity to their company.
It’s investors with the ability to buy with cash that can take advantage of these opportunities.
Of the ways to buy apartments using none of your own money that we talked about above, only two involved paying all-cash; getting a partner, and borrowing from a private lender.
Taking on a partner can be hugely beneficial for a beginning investor. Firstly, because the partner brings the financial resources to the table the beginning investor doesn’t have yet. Secondly, often a partner can mentor the investor with business advice and real estate specific advice that may otherwise take you years to come across.
However, once the investor has built up his/her own track record and have accumulated financial resources of their own, there really isn’t any good reason to continue doing deals with a partner for only 50% of the profits.
What begins to make more sense is borrowing money from private lenders and taking control of the whole process. Private lenders allow you to cover all of the cash requirements of the deal and you get to keep the lion’s share of the profits for yourself. And when you are talking about large apartment buildings, this is a considerable amount of money.
Private Money Sources
So having decided that being a cash buyer opens you up to the most opportunity and that utilizing private money is the best way to do that, where do you find it?
A private lender is anyone who would be thrilled to get around 10% return on their money secured by real estate.
That covers a lot of people, and it covers even more when you take into account those that don’t know they are interested yet because they don’t know about it.
The frst place to start is your immediate contacts.
I know, you’re afraid of sounding like you are coming on with some MLM deal. That’s a legitimate concern given how off-putting that is. The best approach is to narrow the list of people you contact to those you know have money, then be up-front and direct in your conversation with them.
You could open with, “Hi Jim how’s things. I’m in the process of buying an apartment building and I need to raise the money to cover the down payment and fixup costs. I’m looking for people to be private lenders in the project. Would you be interested or do you know anyone who would be interested in earning above market returns on their money secured by real estate?”
You’ll either get a response of “tell me more”, or the person will wave you off. If you do get the brushoff don’t be discouraged, it’s just one person, and there are many more fish in the sea. But also, you have planted a seed. If you keep contacting people you know you will eventually find someone who wants to invest, and word will eventually find it’s back to the person who gave you the brushoff.
It’s truly amazing how the phenomenon of social proof can change the attitudes and behavior of people. Someone who formerly viewed investing with you as too risky will suddenly be a fervent advocate once they are faced with missing out on an opportunity his friends are all making money on.
Peer group pressure is very powerful. Just press on, keep calling, making contacts, you will soon find an investor, and word will get around, and you will have more investors.
**Quick Note: Not everyone has the guts to be a real estate investor. When enough people see you are determined to raise the money, and that their skepticism didn’t make a dent in your drive make your deal happen, they often realize you have something they don’t possess, and will come around and support you, to be part of your grand adventure.
Very often getting the first investor is key to getting the second. The principle of Social Proof states that, we view behaviour as correct in a given situation to the degree that we see others performing it. So if you can say that you’ve raised, $25,000 for earnest money, that’s important.
A place where you “can” raise up to $25,000 for any venture is www.prosper.com. Go there now and take a look. You don’t have an excuse for not getting started any more. www.prosper.com
Professionals, Business People
After you have exhausted all of your immediate contacts, if you still don’t have the funds you need the next group to contact are professionals and other business people who are cash rich and time poor.
The benefits to them investing with you are obvious, and the whole problem of what to do with all their money is probably weighing on their mind. They just don’t have the time to do anything about it.
It’s as simple as grabbing your local yellow pages and beginning calling. Start with attorneys, they are the classic 80 hour week types and have usually had some kind of exposure to real estate.
Take the opener you used before, modify it a little to this, “Hello Hudson. Thank you for taking my call. My name is Ben, I’m a real estate entrepreneur, and I’m in the process of raising money to buy an apartment building. I’m looking for people to be private lenders in the project. Would you be interested or do you know anyone who would be interested in earning above market returns on their money secured by real estate?”
If you happen to be on the line with a ham and eggs lawyer you’ll probably get the brushoff, or possibly a dose of their negative view of the world. However a more successful attorney will prick up their ears and ask you for more information.
Good attorneys are highly networked and understand how the world works. When they see an opportunity to create value for clients and people they know, they take personal responsibility for the making the introduction.
(For more on this read Networking with the Affluent by Thomas J. Stanley.)
As with your contacts keep calling until you make it through every attorney listed in the Yellow Pages. If you get sent to voice mail, speak your opener onto the voice mail in an upbeat voice.
After calling all the attorneys listed in the Yellow Pages in your town or city, it is very unlikely you won’t have your deal fully funded. If need be though, move on to doctors, dentists, landlords, business owners in the town you are investing in.
You may be getting worn out just reading about all this phone calling. Just bear in mind, you have a deal under contract that is going to provide you with a five figure monthly cashflow, and over the next ten years add a couple million dollars to your net worth.
The fire of that vision should be driving you. But if it’s not, just think about how $10,000 coming in every month, automatically, can change how you live your life, and that $10,000 monthly is your reward for making all these phone calls.
Bottom line … MAKE THE CALLS!
There are some rules you have to play by when you are raising private money, and we’ll talk about the SEC in a minute, but if you have a bit of a bankroll and you trying to raise a large sum of money, say, over $1M, you can do a general solicitation to a class of investor known as “accredited investors”
These are people with an annual income of more than $200K, a joint income of more than $300,000 or a net worth in excess of $1M.
Just as you set up a two step mailing process to get motivated sellers calling you, you can do the same to get private lenders calling you.
But only with accredited investors. Accredited investors are exempt from the SEC rules barring general soliciation to the public, so you can market to them in whatever way you think will be most effective.
Warning! DO NOT send mailings to people about private lending UNLESS they are Acredited Investors, and ONLY contact them when you have a deal already under contract you are trying to fund.
An example of an effective mailing to accredited investors would be:
– buy list of Acredited Investors.
– send postcard asking them to call a free recorded message to order a free report.
– before sending the report, call the person up to verify they are an accredited investor. Answer any questions they have about the deal.
– send free report.
– follow up after 5 days, ask if they are interested:
- set up a meeting with them.
- take them through a presentation outlining the deal, showing how you create value, showing how they get paid, showing how they are protected.
- answer any further questions they have, get their verbal commitment to to invest a specific amount
– follow up weekly keeping them informed of your progress finding a profitable deal.
– when you find a profitable deal, call each investor again to go through the numbers with them, give them wiring instructions for the title company or escrow company handling the closing so they can send their agreed investment.
As with calling your contacts and professionals, mailing Accredited investors is a numbers game. Direct mail standards apply. Expect 1-2% response.
A 1,000 postcard mailing may generate 15 responses. However those 15 are highly qualified calls, and followup is key. As you followup with each lead, the longer they stay with you, wanting you to continue following up with them, the higher the likelihood they will become a private lender and invest with you.
Even if they don’t, at the end of your process they will have received a lot of information from you and if you have treated them well you will have built trust, good rapport and established yourself as an expert in the field of providing safe, high returns. Odds are in your favor they will refer you, or invest later when the time is right for them, are very good The bottom line with Accredited Investors though is, the more you mail to the more quickly you will get to those who want to invest.
The SEC – What NOT To Do!
This is the part about private money that usually scares people into not wanting to use it, and that is … tangling with the SEC.
The Securities Excahange Commission was set up in 1993 after the ’29 stock market crash, with it’s mandate to “protect the public” from undue risk inherent in investing in capital markets.
So the primary SEC rule that deals with our efforts to find private money deal with what the SEC calls “general solicitation”.
This means that if you are offering a security then you can’t go out and solicit the general public in a public forum (like newspapers, TV, radio) to buy your investment opportunity, unless you have a securities license.
The Four Part Formula
So how do you go out and find private lenders, who may not be accredited investors, without engaging in “general solicitation”?
There is a four part formula, that if you follow, will keep you in bounds with the SEC, and any state securities division (but also, it is a must for you to consult your attorney for additional state rules that apply).
Predisposed To Real Estate
The first part of the four part formula is to only approach people who have already demonstrated they have an interest in real estate investing. You don’t have to educate them about the merits of investing in real estate, they are already sold on it. All you have to do is convince them about you and your deal.
Examples of this would be, real estate networking events, your local real estate investors association, landlord associations, anywhere people familiar with real estate gather.
The second part of the formula is Control. This means they can get their money out of the deal if you don’t perform.
It also means they never have to just “trust you”. They don’t write you a check, they wire the money to an escrow officer who is conducting an insured closing. The funds are secured by a lien on the title to the property. Money for rehab is only released after the work has been completed.
These procedures give the investor control over the funds they have invested in the property.
No Risk – Low Risk
The third part of the formula is low/no risk. This means the investor feels that their investment is secure. They can see and fully understand that even if everything goes all wrong, they still get their money back.
One of the real strengths of investing in real estate is that you have a hard asset serving as collateral. The title is insured, the property and structures are insured, and even the life of the property owner can be insured.
The fourth part of the formula is high return. Generally, when people see an investment with a high return the thing they immediately associate with that is high risk.
For any investor the thing that is on their mind most when releasing their money is preservation of capital. So if you offer a return that is so high it is out¨of line with the security your investment offers you will probably eliminate a lot of your target group, as well as attracting the interest of securities regulators.
Offer security at a safe loan-to-value to ensure capital preservation for the investor, and make the interest rate a fair amount that allows you to both win. The private lender gets an above market rate of return and you, the investor, get the cash for your deal at a reasonable cost.
When you put you your investors’ interests first by using the four part formula, everybody gets what they want … a win/win transaction.
The SEC is mainly concerned with general solicitation to the public. If you do not approach people cold that you don’t know, but approach people on a referral basis and use the four part formula you will be working well within SEC guidlines and can raise all of the money you will ever need.
If you have a larger deal and you need to raise larger amounts of money, like, over $1M, you don’t want to even think about the SEC, and you have a bit of a bankroll, retaining a securities attorney to do the job for you is an effective option.
Securities Attorneys have their securities license, are well networked with money sources and usually have their own list of clients they tap whenever raising money.
For the most part you’ll pay a retainer ranging from $2K to $25K and a success fee in the vicinity of 6%. The success fee is simply a commission paid upon the successful raising of your capital.
Each attorney operates a little differently so it’s worth contacting a few and talking with them. Don’t waste their time, make offers first, have Letters Of Intent out in the hands of sellers, then approach a securities attorney with the deal.
You may or may not retain him/her, but you will learn an awful lot about raising money and funding big deals.
I highly recommend you do this. Take a look at these sites to get started.
Doing The Deal
There’s a whole lot you will learn about raising private money that can’t be taught here. You have to go an find out for yourself. Sorry, that’s how it is. You will learn the real nuggets, the little hinges that swing the big doors open when you are out taking action getting your ducks in a row.
Use all the information you have learned here. Once you have found a profitable deal that supports the achievement of your goals, calculate the amount of private money you will need and use the strategy discussed here for raising private money that is most appropriate.