When I first went into the real estate business, my office building sat next to a little wooden shack. The proprietor, Frank, drove an old Toyota and seemed to have no means of income. One day he explained to me that he’d made over $100,000 per year for 30 years simply buying houses on low interest terms from owners and selling them on installment contracts at higher interest rates rather than renting them. Borrowers, who were owner/occupants took care of all expenses, taxes and insurance, and paid him interest for the privilege of doing so. When loans were defaulted, he foreclosed and resold the property at a price that reflected any appreciation in value. Thus, he captured income, appreciation, investment yield, leverage, and loan amortization. By giving up all depreciation, he also avoided all repair expenses. As a new Broker, I didn’t pay much attention, but when the real estate market slowed down and Frank’s income continued to come in while I worked harder just to stay even, I vowed to learn more about financing.
In the housing market buyers need credit to buy, and sellers need it to sell. When mortgage loans become hard to get, many more houses come into the market owned by highly motivated sellers. This can be a cornucopia for entrepreneurs who can find ways to buy and to sell. There’s usually very little competition and very strong demand for credit. So long as buyers can afford the down payment and monthly loan payments, they are usually willing to pay higher prices and higher interest rates. Let’s look as some of the ways this situation can be exploited.
1. Do what Frank did: He bought houses using minimum cash. When he offered them for sale, he kept the down payment and price low, but marked up the interest rate. When inventory is sold on interest-only installment terms, the profit is immediately taxable, but Frank didn’t make much profit by raising the price; he made it on the interest. By stringing out interest payments for years, he avoided tax on his profit until the loan was paid off. This gave him plenty of cash to pay taxes with.
2. Use idle self-directed retirement plan money to finance speculators, rehabbers, and people confronting balloon payments they can’t refinance. Structure “interest-only” terms, and wait until the loan is paid off realize any taxable gain. Rather than charging interest, secure your loan with a Purchase Option which will convey a percentage of the profits. By sharing the risk, you should get at least half of the net profit. On more speculative deals, structure a preferred position. Charge a specified yield plus half of the remaining profit. Never take so much money off the table that the borrower has no profit incentive to repay you, but bear in mind, there’s lots of potential profit when the market slows down.
3. Create a market for seller financing by buying the debt sellers carry at discount for cash. You can dictate the terms, collateral, credit score of buyers, etc. to the buyer prior to the sale to create the yield you want.
4. Option a seller’s house at a low price with very little cash, then mark up the price and finance a retail buyer by buying the Notes he uses to pay the seller at deep discount. This benefits the seller by creating a market for a slow-moving house; and the buyer by enabling him to buy the house; and yourself because of all the profit centers you’ve created.
5. When you’ve demonstrated that you can produce high-yielding transactions, you can divide profits with investors by using, or re-lending, their funds to finance houses; or to help others sell and buy houses. The profit potential far exceeds normal brokerage fees.