Turning Creative Deals into Cash
By Vena Jones-Cox

It’s not your fault that you think creative deals are over your head, too advanced for you, or otherwise overly-complicated.

It’s a product of the era during which you were introduced to the real estate business; for the past 15 years or so, there’s been a heavy emphasis at REIA groups and seminars on one- or two-step cash exit strategies (like wholesaling and retailing) and on “sandwich”-type finance deals (buy on lease/option, sell on lease/option). There’s been very little talk about, education about, or even mention of more sophisticated strategies like buying with owner-held mortgages, selling with wrap-around notes, and otherwise doing more out-of-the-box stuff.

As a result, the people who know how to do this out-of-the-box stuff, and who do it on a regular basis, don’t show up at our local association meetings, giving us all the impression that it’s cool and esoteric to know these strategies, but that they’re not happening in the real world.

Well, let me tell you, kids…back in my day (she says in a shaky voice while leaning on her walker and drawing her shawl more tightly around her shoulders), EVERYONE, from raw beginners on up, understood and used “creative finance” strategies, and nobody held this belief that it was only for later, only for seasoned veterans, or only to be pulled out in rare cases.

We all did creative deals, because bank money was expensive and hard to get, but there were a lot of great deals on the market that we wanted to buy. Sound familiar?

I’m not going to spend pages trying to convince you that you need to get over your phobia of creative finance and just do it; instead, I’m going to expose you to a way that you can turn a creative deal into what you apparently seem to want more than cash flow or high return, and that’s cash. Maybe when you’ve seen it, you’ll decide that there might be some value in learning how to do this—and it ain’t that hard, trust me.

Here’s the deal:

6 room 3 bedroom brick house in a borderzone
ARV approximately $65,000
Repair costs approximately $20,000 labor and materials, when done by professional contractors
Rent when repaired: $850/mo
Purchase price: $11,000
Wholesale sale price: $17,000

This was one of those deals where the purchase price was contingent upon a very quick closing: the seller had already purchased another house; he had to close the new house in a week or lose it; he had had a contract to sell this house which fell through at the last minute; he agreed to sell to us for $13,000 less than the prior buyer had agreed to pay, but only if we could close in time for him to buy his new house.

So we lined up a private loan at 8% to buy the house, since a week is usually not long enough to find a buyer AND get to closing. We then began marketing the property to investor/buyers at $17,000.

But before we could find one, a couple approached us about buying the home to live in. They didn’t have $17,000, but they did have $2,500, and wanted to know if we would finance it for them. After assuring ourselves that they had the skills and additional cash to complete the repairs AND that they could easily afford the monthly payment, we agreed to sell it on financing under the following terms:

Purchase price $35,000
Down payment $2,500
Interest rate 8%
Principal and interest payment $394.31
Total payment (with taxes and insurance)$486.31
Amortization period: 10 years
Now, in case you’re asking yourself, “How is this deal fair to these buyers, when you were trying to sell it for $17,000 to an investor?”, I’d suggest that you re-read the IC e-lesson from 2 weeks ago entitled “Real Estate is Worthless”.

But the bottom line is this: it’s a good deal for them because:

Their use for the house—to be a family home—is different than an investor’s, which is to have a large amount of equity and cash flow.
They will not spend $20,000 on the renovation, because they’ll buy materials but do their own labor in most cases. Their total repair costs will be around $11,000, which means that they will have “paid” $35,000+$11,000, or $46,000, for a property that’s worth $65,000 today.
With $2500 down and substandard credit, their other options would be to:
Wait for someone else to buy and fix the house, then rent it for $850/mo and never own it
Lease/option the same house, fixed up, for $850 per month and pay $65,000 for it when and if they are able to get financing
In short, getting $19,000 in equity, paying a little more than half of market rent each month, and OWNING THE HOUSE FREE AND CLEAR IN 10 YEARS is an excellent deal for them, and one that they’d not be likely to find elsewhere.

But that’s just part 1 of the deal, and would not satisfy most of you despite the $2,500 up front (vs. the $0 we paid up front, since the private lender covered the entire purchase price) a monthly cashflow on the property of around $150 per month (with no management or maintenance, since the occupants are buyers, not renters), and a literally infinite return on investment. Nope, you want cash, just like we set out to get by wholesaling the property.

Well, here’s how to get it.

Did you know that there are tons of people out in the world who have money in retirement plans or investment accounts that are earning practically nothing on it? And that don’t know how to (or don’t want to) deal with tenants, renovation, and management?

Of course you did—that’s where private lenders come from.

Well, what could be a better investment for one of these “passive investors” than to own the financing on this property, especially after a few months with the buyers have already done massive improvements to it (and proven that they can make the payments)?

Now, be clear, no one is going to buy this note from you at the 8% interest rate that the buyers are paying, or at the 8% rate YOU pay private lenders.

Here’s why: the risk of foreclosure is higher on this deal because 1) the person responsible for making the payments is a homeowner, not you and 2) the term of the loan is 10 years, which is a longer time for things to “go wrong” than the typical 1-2 year investor loan.

So the buyer is going to want more like 16% interest to compensate him for the risk of having to spend the money and time foreclosing against your buyers, who become his buyers as soon as he’s bought the note. How do you get a 16% rate out of an 8% loan? By selling your investor the loan at less than the “face value” of $32,500.

In case you’re interested in working through this exercise for yourself, here’s how it works: you get out your handy-dandy financial calculator and enter the following:

FV=0
Number of periods= however many months are left on the loan at the time at which you sell it
Interest rate=.16/12
Payment=$394.31 (just the principal and interest—the tax and insurance portion is flow through, and isn’t profit to the investor)
Then hit “compute” and “present value”

If you do this exercise assuming that your buyer has made 4 payments—which is what had happened when I sold this loan—the “present value” that represents a 16% annual return over 116 payments of $394.91 is $23,539.33—and that’s what you’ll sell the loan for.

At that point, of course, you’ll pay off the $11,000 private loan, leaving you with a profit of just over $12,500 PLUS the buyer’s original downpayment of $2,500—more than TWICE what you’d have made by wholesaling the deal in the first place.

And in cash.

So there you go.

And what happens after you’ve sold the note? You notify your buyer to make future payments to your investor, not to you. Nothing changes for the buyer other than the mailing address: he still owes the same amount, he still owns the house, his payments don’t change, and in fact, he doesn’t even know the amount for which you sold the loan.

And what happens to the investor if the buyer doesn’t pay? One of 3 things:

He gets a deed in lieu of foreclosure from the buyer, gets the property (now worth more thanks to the buyer’s improvements), and can either sell it for a profit, rent it for a profit, or find another buyer and do it all over again.
He can’t get a deed in lieu of foreclosure, and has to foreclose. In Ohio and other judicial foreclosure states, this could take up to 6 months (meaning that the seller could lose as many as 8 months’ worth of payments, given that the buyer gets a 30 day notice to begin with and that he may have to be evicted) and cost $3000. At the foreclosure sale one of 2 things could happen:
An outside buyer bids an amount higher than the outstanding loan balance—which remember, is significantly higher than what the investor actually paid for the loan—and the investor walks away with his cash back plus a tidy profit. Or:
No one else bids, and the investor walks away with the house for $23,539 less any principal paydown he got from the buyer plus $3,000 in foreclosure costs, and does one of the same things he’d do in example #1
Or, as happened in this case, the investor goes on collecting his 16% return. How? Well, when we sold this note, we “guaranteed” it in the sense that we told the investor that if the buyer got more than 30 days behind in payments, we’d take the loan back and REPLACE it with another note on another property with the same return and terms. We will then do the foreclosure, and then do one of the things suggested in #1.
So, with a little knowledge and a few keystrokes on a financial calculator, you can do creative deals, turn them into cash, provide a great deal to a buyer and to an investor, and make even more money for yourself.

Are you ready to study that creative finance thing yet?


Reprinted with permission of Vena Jones-Cox. To get more free articles and tips, subscribe at www.TheRealEstateGoddess.com