Anyone ever tried this??

Question

I have been buying really, really cheap homes. I'm doing pretty well with them. However, right now I'm financing them on commercial bank loans (through my LLC) and ARM's. I don't want to do many more ARM's and the 20-25% down is rough. I know a number of people with money and are looking to park their money in some kind of safe investment. I was thinking of seeing if they wanted to give me the cash to buy these homes in full ($30-50K) and they would basically be the bank... I'd love to get in 0% down with a fixed rate 20 year or so. So basically they would get a "mortgage payment" check each month for 20 years. Has anyone ever structured something like this? If so, what were the terms? Working well? Thanks guys.

Aaron Mazzrillo · Answer

I did a bunch of equity partner deals. Here is a quick explanation:

I'd purchase a $100K house for $50K. It needed about $8-9K in rehab to get it rent ready.

My equity partner would put up $65K and get a 1st position trust deed for the money. In exchange, I'd give him 50% interest in the property and half the cash flow. (In the beginning I gave away too much cash flow.)

I'd use the $65K to buy the property, cover closing costs, rehab it, and whatever was left over was my 'acquisition fee.'

The property was held by trust with my corp being the trustee, and my partner holding 50% beneficial interest and me the other 50%.

I handled all the management, maintenance, and payment of all taxes and insurance.

If the property was vacant, no checks went out.

I withhold from rent 10% for management (paid to me) 10% for taxes, 5% for insurance, and 5% for maintenance. Since we just rehabbed it, not much else goes wrong so the 5% covers all the little things. I then passed all the remaining cash flow along to the equity partner. However, on later deals, I split the cash flow 50/50.

The exit strategy was to sell when the property appreciated to double what the ARV was at time of purchase - so $200K. The equity investor gets paid their $65K TD first, then we split the remaining net 50/50.

Benefits for you: You get paid to buy rental houses. You get paid to manage those rental houses, and you get to keep 50% of the upside. You have no money into the deal.

Benefits for EP: They get a turn key rental without the headaches of management. They get cash flow on lazy money. They get tax benefits. They get equity in a discounted house.

Down for you: The way I originally structured it, with me giving away too much cash flow, if there was a repair (and they are split 50/50) the cost had the potential to wipe out my 10% income for the whole year.

Down for EP: They are writing a large check today with no way of getting their money back for a potentially long period of time. However, something can be written into the agreement that if either partner wants out early, a discounted pay off should be pre-negotiated into the contract. If the manager doesn't do a good job, it could be disastrous. Make sure the person handling the investment is knows what he/she is doing and there is a clause in the contract to fire him or her if not.

J. Martin · Answer

Good deals @Aaron Mazzrillo ! If the days of buying property 50% below "market" are still around, keep at it!

@Zac P. If I understand correctly, you want to borrower money from these outside parties w/o giving up equity, which is a little different than Aaron's strategy. Is that right?

One thing you may find challenging is to locate the investors willing to extend 20-yr fixed rate money to you. (I assume you want a fixed interest rate, which is why you're seeking 20 year maturity.) The reason the residential underwriting guidelines for long-term loans are the way they are, is because that's what's needed for the bank to securitize it and sell it because not many folks want to hold onto 20+ year fixed rate assets. (Or maybe try offering an equity buy-in or kicker to sweeten the 20-yr lock-up.) But if you have the demand for it, congrats to you!

One option you may consider is to buy a property for cash, then get a home equity loan or line of credit. I believe I've seen 10-15 or 20 yr fixed rate terms for HE loan. And 10yr interest/only variable w/ option to term-out for 10 years at then-current fixed rate for HELOC. Rates can be competitive, especially if low LTV on  a home owned outright.

Getting very-long-term fixed rate money is a HUGE advantage IMO, especially if you think rates will move higher and/or are wary of long-term inflation potential. For anyone focused on interest rate risk, look at the "economic" value of a long-term fixed-rate liability on your balance sheet when you're funding investments in ten years with the remainder of your 20-yr maturity liabilities. That's why I bought a 4plex with FHA 3.5% down. 96.5% LTV for 30-yr fixed @ 3.25%! Some PMI for a few more years, but well worth it.. It's about as close as you can get to 0% down on income properties w/ long-term, except for VA on SFH if you're a vet. Let me know if you find a good institutional source for long-term money! Good luck!

Christina R. · Answer

@Aaron Mazzrillo

So did you actually manage it yourself or had a prop mgr/co do it, and your 10% was the cost of you overseeing the property manager?  Also, you said you gave away too much of your cash flow early on.  Looking back, what % would you have determined should be your EP's cut of the cash flow?  Is this due to being new to the biz or new to the equity partner aspect of it (what was your rationale on giving away 50% of the cash flow monthly?)

Aaron Mazzrillo · Answer

Still have quite a few of these going. I was managing them, but once they are rented up, they are like any house, pretty much on autopilot. I have an out of office assistant who handles rent collections and all maintenance issues so I don't ever do anything. The 10% was my cut. It wasn't enough. I should have just charged 50% of the net rent after expenses. The way we originally structured it, the EP was getting an 8% return on his cash invested. Pretty good return for not doing any work. Also, I did most of these at a time when not many people were making money in real estate; 2009. At least, not here in California. I didn't think I would be able to sell it if I took 1/2 the cash flow. However, there is a nice chunk of equity because I never put anyone in over 70% of ARV so even with 1/2 the cash flow, there still is a good reason to invest - they are capturing solid equity at close of escrow and it is something a civilian just has no wherewhithall to do.

Anyone ever tried this??

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