A growing awareness of creative real estate financing techniques is producing a boon in small-scale investor purchases of rental homes and condominiums -- despite the slump in the over-all housing market nationwide.
Brokers in cities across the country report that sales of residential properties to two-income families and single professionals who plan to rent them out are on the upswing, moving counter to the rest of the industry.
The tightness in the conventional mortgage money market has accelerated activity by small investors, brokers suggest, because it has opened opportunities for the growing numbers of buyers who don't depend on S&Ls or banks to finance their purchases.
Tight money, in the words of surburban Chicago investment counselor William Warr, has also "softened up sellers of homes who really need to sell -- making them willing to cut prices and particate in financing to a degree they'd never consider in a stronger economy."
The combination of a buyer's market and greater sophistication in financing knowledge "is dynamite" for investors and their brokers right now, Warr said.
From downtown Chicago condominium apartments to tract subdivisions outside Washington, Houston, Phoenix, Tampa, Kansas City and West Coast cities, creative financing techniques are behind a high percentage of purchases of residential real estate by small scale investors.
Many of the techniques being used were little known 10 years ago, but have mushroomed in popularity since 1975, thanks to a spate of books, seminar programs, and efforts by local brokers to educate prospective clients.
The essential ingredient of most of the techniques is avoidance of the conventional money market, where funds are either unavailable for small investors today, or prohibitively expensive.
Rather than buying a suburban home or in-town condo via the traditional route -- going to a bank or S&L for aconventional mortgage -- investors increasingly insist on assumptions of existing mortgages plus participation in some form of secondary financing by the seller or the seller's broker.
Savy, small-scale investors in rentalhouses also getting involved in custom-tailored land contracts, tax-deferred exchanges, options contracts, wrap-around mortgages or deeds of trust, and other financial exotica.
Here's a quick overview of the main techniques and how they work for investors.
Assumptions plus secondary notes. Assumptions of existing mortgages are nothing new, but the 1980 rental-home investor demands more than that from sellers. FHA, VA and some conventional S&L and bank mortgages are assumable by buyers, often with attractive interest rates. But they tend to require large equity investments by the purchaser to step into the shoes of the seller.
In the case of a $70,000 VA financed house with a $35,000 mortgage balance at 9 percent, for example, the equity investment required for an assumption would be $35,000.
Rental home investors in soft marketscut that amount to $10,000 or less by insisting that the seller "take back" a note secured by the house for $25,000 or more, repayable at a negotiated interest rate over a three-to five-year period. Investors seeking "no-money-down" terms convince the seller's broker, or the seller, to take back another note for the balance of the equity requirement, again repayable at negotiated terms.
Sellers are willing to go along with such deals because they're getting the best price possible for their property in a dead market, and the secondary notes often bear 13 to15 percent interest rates. The notes are also convertible to instant cash, if the seller desires, through sale to local investors who buy them at discounts.
Land contracts. When rental-home investors want to assume a conventional mortgage that prohibits assumption without a step-up in interest rate, they negotiate land contracts, also known as "contracts for deed." Title doesn't pass immediately to the buyer, but the contract can permit little or nothing down, plus below-market interest rates and lengthy principal paybacks.
The main risk to investors is the possibility of a legal challenge by the lender against the seller, charging that he or she has transferred the property without the lender's consent.
Tax-deferred exchanges. Investors with one or more houses are swapping them profitably, tax-free, with no cash outlay, by using Section 1031 of the Internal Revenue Code. The law allows deferral of capital gains taxation on exchanges of real estate investment equity, until the property owner eventually sells the real estate for cash. Options contracts. A technique that is most popular in Sun Belt markets, options contracts allow investors to nail down purchases in future years with small payments today. Rather than buying a house outright, the investor makes a $1,000 or $2,000 payment to the current owner-occupant for the right to buy it within the next several years at agreed-upon, favorable price and terms.
The investor gains effective control of the house -- though not actual ownership -- for very little, and can exercise (or get out of) the legally binding option, according to the dictates of the market.