How Do You Pursue Creative Finance?

Question

For those of you who don't mind sharing, I am curious how you go about finding and applying creative finance deals. For example, when you are marketing, do you do so with a particular strategy in mind or do you just have an arsenal of strategies in your tool box?

If you have multiple, how do you go about presenting each option to the seller? Do you present them with a list of options which you'd like to see happen or do you go down the list and as they shoot one down you present another?

I have no doubt that conversations leading up to the point dictate how you go about solving their problem, but it would be interesting to hear how those ideas are presented in a practical sense.

Stewart Beal · Answer

I am purchasing a 30 unit property in Toledo, Ohio right now on a $0 down land contract.  The owner is struggling with the property and has it on the market but it won't sell in its current condition.  5 year term, 5% interest rate, 20 year amortization.  Instead giving the seller my cash I am going to use that to bring the property back. The key to creative financing and seller financing is finding people that are struggling to sell their properties for whatever reason.  In December 2013 I bought a 45 unit apartment building in Toledo, OH for $0 down land contract. Purchase price was $325,000, 5 year term, 5% interest, 10% amortization.  On the day of closing only 6 people lived in this 45 unit building.  I renovated the property for $75,000 cash and a ton of sweat equity.  Now 41 of the 45 units are rented.

Bill Gulley · Answer

I like Adam's thoughts, I wasn't reading more into it than posted either.

Stewart, even in OH, you have deed in lieu of foreclosure issues, however, in commercial transactions you won't have as many issues as you do in residential. You won't have homestead exemption issues, insurance issues as much, you won't have the maintenance and contracting issues as much either and you can capitalize and expense improvements. I mention this just so folks get the fact that commercial is different than residential.

You'll get an exposure to some creative approaches in the new book on BP that Brandon has authored. It's a beginning and gives examples.

Seems most investors here think that creative financing is somehow a separate aspect from conventional methods, it is not! There is nothing in creative financing solutions that is not anchored in conventional financing aspects if it is legal. Consider that financing ahs been around for thousands of years and there is nothing that can come out of the human mind that is legal that has not been basically done before.

That means that creative financing is the application of "in the box" requirements and fundamentals applied to "out of the box" solutions. You don't have creative financing really, you have creative solutions.

Marketing some plan isn't creative financing, it's seeking acceptance of some plan and identifying those in circumstances where that plan might work. IMO, not a good approach, it makes you a one trick pony as Brian G. puts it.

Where you begin is understanding the "in the box" requirements, then while remaining compliant with those "in the box laws and rules" you adopt modifications or changes (keeping with legal requirements) to come to solutions that meet the needs of the parties concerned.

To be really good at creative financing, you must be really good at conventional financing matters. You don't simply come up with some wild azz plan that might be agreed to, going that direction you'll be guaranteed to miss compliance requirements, guarantee you that you'll mess it up.

How do you present creative solutions?

I have been very successful at creative solutions because of the "in the box" knowledge. I develop a report with the other party, at times you deal from a level of expertise, convincing the other that you know what you're doing is half the battle. I'd put deals together as a consultant, stepping outside my role as a buyer or seller in some ways to that of being more of a teacher, that gives confidence to the other party.

Actually, I'm a pretty creative guy, I don't get to go there on BP as putting out fires consumes most of my time, trying to correct a lot of incorrect thinking.

Basically, designing a deal has four basic factors, the present value of value to be financed. an interest rate, the cost paid over time to "use" the value to be paid over time, the number of periods or term of the transaction and the future value or the costs to be paid over that term. The cost of the use of that value carried is represented by the payment that pays the interest and reduces to amount owing. The term is the time permitted to complete the transaction, we look at that as an amortization.

I didn't say the present value was a loan amount, I spoke of it as a value because really, there are other things that are a benefit other than money. There are intrinsic values, such as blue sky in a business, perceived equities that can be transferred, reducing expenses or liabilities can be a value received, you might want the goose that lays the golden egg!

Money wise, we have the PV as the beginning loan amount, the number of payments over an amortized period, the payment required to pay interest and, if required, reduce amounts owing and the interest rate for the use of funds and, we have a future value, the total benefits received by the lender. Any three of these factors may be used to compute a 4th factor as the unknown.

This won't be a marathon post, but any of those factors may be adjusted or modified to come to a solution. Payments do not need to remain constant, if compliant, additional lump sum payments might be used, payments can be indexed to income generated by a project or be agreed to be received from other assets. Payments might be tied to a lease up period of a project for example.

Interest can be adjusted but this aspect is more restricted by legal aspects, usury laws, APR requirements, tax implications and predatory lending issues. Interest is the reflection of the risk assumed by a lender as to gaining a reasonable profit from advancing funds or allowing credit. This factor is not easily justified as to risks or legal aspects and is not that easily modified over a term. Adjustable interest rates are tied to economic changes that keep the assumption of risk constant in current economic conditions. Not the best choice to play with, but, if risks change the interest may reflect those changes. All I need to do to point out an example is your credit card, a late payment carries a higher risk and interest charge.

The amortized period or term is a variable that is` easily changed. Most know how a balloon payment works. Most probably aren't aware of escalating payment schedules. Instead of trying to change the payment or an interest rate, the term can be made longer or shorter of the contract period to increase or decrease the payment applied to the amount owing. In Stewart's deal, if I were the seller. I could agree to a 25 year amortization for the first 5 years, then after an expected lease up level was reached I could reduce the amortization to 15 years that would make a greater contribution to my amount financed. I can tie these modifications of the amortized period or term to increased income, to certain events. to points in time or a combination of these factors. I can also change an amortization period keeping payments the same, allowing unpaid principal to accrue to another balance that may carry a different rate, a different payment, like an annual payment.

I can also simply adjust the payment required. Loans that have negative amortization simply have insufficient payments being required to reduce the outstand principal or interest or both. Not really someplace to go and they have huge compliance issues. I mentioned limp sum payments, these may be added in addition to regular scheduled payments. Payments can be deferred or set off to a later date. I could agree to a different application of payments being made. A front end load or back end load might be part of the principal amount.  Quick example;

I sell a farm for 300K, the price includes 25K in equipment. I don't mind carrying the land long term as nothing will really happen to that, but my equipment will be used, it wears out, it depreciates, so I'd be nuts to amortize the value of my equipment for the longer term I finance the farm. So, I apply more of the payments to the value of the equipment than to the RE until that amount is reduced, then I allocate more to the RE portion.

I could make a blanket loan or buy several properties, (which side you stand on) as a back end allocated payment, paying off a particular property first, then another.

There are many aspects of financing that can be creatively constructed that go  unmentioned on BP, we always get stuck in thinking in more simple terms of some lease-option or installment contract as being creative, actually, that stuff is really elementary in the creative financing arena. To go even deeper, think in terms of mixing these aspects together.

You will generally mix two or more of these concepts to arrive at a solution, like the amortization and the modify the application of payments.

I can make a loan dance to any song you need to sing! And, the creativeness applied is almost without limits. That is creative financing, that and using other assets to reduce risk, make additional income to apply to amounts owing, trading assets, collateralization of other assets and timing of the credit extended.

All of these aspects must still take into consideration a borrower's ability to pay, the more creative you get, the greater the burden becomes on the lender to ensure the loan is possible and not predatory.

That's why I say you must know how to operate inside the box before you get out of the box, creatively financing some transaction isn't just dreaming up some wild agreement, it must be anchored in financing theories.

No, this was not a marathon post....  :)

Stewart Beal · Answer

Jeremy,

The 45 unit apartment building called The Avenue is in a somewhat distressed part of Toledo, OH at the corner of Collingwood and Bancroft.  It is on the edge of the beautiful Old West End neighborhood but I have had trouble getting any benefit from that.  The one bedrooms rent for $415/mo and the 2bdrms rent for $500/mo.  The rent roll exceeds $15,000 on a monthly basis, the principle + interest is $3,447.13/mo.  The challenge with managing a building in a distressed area is that you do not get the best of the best tenants being attracted to your property so there are higher than average turn over and eviction costs.  One nice thing about a 10 year amortization and being able to afford that aggressive pay down is that at the end of the 5 year land contract I will only owe $182,000 on a building I figure will be worth $900,000 (45 units x $20,000 per unit).  I haven't owned the building for a year yet but I anticipate in year 2 the cash flow will exceed $10,000 on a monthly basis.

Andy Luick · Answer

Every situation is different so it pays to have a bunch of strategies in your mind going in.  Our whole process is a bit different but you will find that those most open to creative financing on the buy side are the most desperate.  Either they are about to lose the house to foreclosure, going through a divorce, a death or the place needs too much work to list at retail.  Having a great contractor on the team or being one will help immensely.  You can partner with someone needing to repair the home where you front repairs and you split the profit on the sale.  We've done those deals before and often got them through realtors who came across properties that couldn't list retail....we usually gave them back the listing once it was repaired and ready to go.

With what we do today, we partner with cash investors with $40k to $70k in available funds.  We then identify properties that will be suitable for our program and our cash partner in the deal takes title to it.  We then work up a repair bid with video documentation to support what we're doing.  We sign a joint venture agreement but the JV partner retains ownership of the property.  Sometimes we will put our cash in for the repairs or sometimes we will raise the funds from a crowdfunding source like groundfloor.us where we currently are raising $25k for a project.

Once we repair and rent the property up with our shared housing model, it is then sold off to passive investors with a 8% to 12% return guaranty for 18 months.  The front-end partner gets 10% to 20% on their money and we split the profits.  If someone referred that cash partner to us, we split our initial profit with them 50/50 for the referral and they stay in for a 10% residual going forward.  It's not the easiest model to work but it is creative and works for us as we have all of the parts.  In one of our current projects, the front-end partner will take a minimum of $7k on a $37k participation but is looking to take closer to a 90% return for a 12 month hold.

Brandon G. · Answer

Thanks everyone for the great replies. I have a lot of reading to do...it's a lot to soak in all at once!

Jeremy Davis · Answer

awesome numbers! sounds like an amazing deal! I am currently looking at a deal similar 110k purchase price needs rehab has 22 units i would rent fro 400-450 so 9300/month on averaged but kind of in the same situation not the nicest area of town but not the worst.

Engelo Rumora · Answer

Numbers look great Stewart.

Well done.

Jeremy Davis · Answer

@Stewart  Beal I would love to hear your numbers on the 45 unit building thats now renting out 41 of 45 the obvious is

325k purchase price

75k rehab

so i am curious what is your monthly gross income off of the units and whats your monthly payments  you don't have to tell but i am curious is all :D

Adam Johnson · Answer

Probably the single most important tool you have is your ears.  Get the seller talking, sit back, listen, and ask questions that keeps them talking.  I don't like to throw out a stream of ideas to get shot down.  I like to listen to all of the factors that will come into play for the seller, then go through my "toolbox" and pick out what I consider the best tool for the particular "job".  After proposing my deal, I again listen for objections from the other side of the table.  If I have done my job well, they will be minor and easier to resolve.  This does take practice and not every deal will be a closer.  The more you practice, the better you will get.  I have walked away half way through a deal because I simply don't see a win-win offer to put together.  With that said, I was never afraid to propose a creative deal even if the seller said they would only accept a cash deal.  If for nothing else, it gave me a chance to practice.

I have read a lot of books about creative financing.  Some of the ideas are pretty off the wall, but doing that helped to get my mind on the right track and every once in a while I will refer back to the books for ideas.  Every deal/seller will be different.  The better you listen, the better your chances for success.

Mike Nuss · Answer

@Brandon G. you can never have too many tools, so always sharpen the ones you have while learning others.

That being said, the first step in getting creative financing comes from your marketing. We do a lot of seller carry deals. I would say our marketing sets us up for it by the demographics of the majority of our callers. However, the conversation is much more important. No trust = no creative deals. You have to have a comfortable seller in order to get creative in your deal structure. A seller will not go down that path with someone they do not trust.

How Do You Pursue Creative Finance?

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