What is CREATIVE real estate today?

[Don Konipol]

No doubt about it; the laws, rules, and regulations have drastically changed over the last 40 years making many of the “creative” deals we did in the 1970s and 80s are illegal today, or at least highly likely to be subject to a lawsuit.  But, there are still many strategies and techniques that can be used outside the “norm” associated with real estate financing. 

Many of these are best used in transactions involving commercial, rather than residential property; or at least when both parties are “sophisticated” investors.  It’s important for BOTH parties to derive benefit from the transaction, and not one party’s  “gain” at the expense of the other.  

One of the most powerful tools of “creative” real estate is “substitution” of collateral.  I will provide an actual example of how it works.

I was always investing in both notes, and real property. While I also lend hard money, I’d much rather buy an existing note at a large discount to principal balance (LOL), the problem being the prices have been bid up so much that they’re hard (but not impossible) to find.

I had previously purchased a note secured by a small retail center and anchored by a convenience store.  The remaining principal balance of the note was $476,000, the note carried a 6% interest rate, and much to my surprise my initial lowball offer of $245,000 was accepted! 

At the same time I owned a property I had purchased two years earlier utilizing seller carryback financing that was a 20 year note and had a remaining balance of $503,000. Because I had put almost no money down, and the LTV was probably 95%, the note holder had virtually no market to sell the note. He came to me asking what type of discount he could offer me to pay off the note immediately, as he needed cash. My thinking was about a 45% discount, his thinking was about a 5% discount, so there was no deal to be made there.

I asked the note holder/former seller how much $ he actually needed. After initially naming an inflated number, he finally admitted that somewhere in the $50k range would suffice. So, I made him this offer, which he readily accepted; I would pay him $50k cash and give him the note I recently purchased with a principal balance of $476,000, in exchange for cancelling the note I owed on the subject property. The advantage to him was (1) $50k in cash meeting his immediate liquidity needs (2) ownership of a $476K note rather than a $430k note that would have resulted with a $50k pay down and 5% discount and (3) a note at 65% LTV vs a note at 95% LTV.

The kicker was I had an offer to sell the subject property for about $650,000 to a developer putting together a development deal.  So, by doing the substitution of collateral, I was able to pay off the $503k debt with $50k in cash and a note I had purchased for $245k.   My profit selling and paying off the $503k note would have been about $150k.  My profit under the substitution of collateral was about $350k !