Real estate investor Justin Pierce writes an occasional column about his experiences buying and selling houses in the Washington area.
No money down is one of the most talked about topics in real estate investing.
A lot of folks who are trying to sell real estate education courses often throw the term out to get people’s attention. Buying real estate with nothing out of pocket is very possible. Money is still required but other people’s money is used rather than your own.
But just because you can do it doesn’t mean that you should. A no money down deal in and of itself does not necessarily make a deal good.
There are many creative ways to finance real estate. There are some ways that will get you in trouble but most are completely legal and sometimes very ingenious.
One of the favored methods among real estate investors is to use seller financing. This strategy is most often used when accumulating rental properties or longer-term holds. Usually the seller owns the home “free and clear” (no mortgage) but it is not necessary.
Instead of selling the home outright, the seller becomes the mortgage holder. Title to the home is passed to the buyer but a mortgage or deed of trust is registered on the property with a promissory note where the buyer agrees to whatever terms were negotiated. This is a private transaction so pretty much any interest rate and/or points could be charged as long as both parties agree. Sellers may require a down payment but if they don’t, then you have yourself a no-money-down deal.
Why would a home seller want to do this? Well, there are a lot of reasons.
First, sellers can sell quickly this way and unload a property that they just may not want to manage anymore. It also defers the tax bill. They only pay taxes on the amount that they collect in that year rather than a big lump sum as they would if the home was sold outright. Also, if they sell the home outright what are they going to do with the cash? They might be able to get a much better return on the money by taking interest payments from their home buyer than they would by putting the money in a bank account. Often there is a payoff requirement within three to five years but the seller may opt to collect payments over a full 30 years, essentially turning the deal into a little annuity of sorts.
Another very common way to achieve a no money down deal is to use private money. This can either be a wealthy friend or family member or it can be a professional private lender or hard money lender. These people are not hard to find if you know where to look.
A private or a hard money lender will usually lend 60 to 70 percent of a home’s end value. So the real estate investor’s task becomes to find homes that they can purchase at 50 cents on the dollar. It’s not easy but it is possible. I make my living doing it.
Let’s say you find a home that will be worth $200,000 after all the fix up and you negotiate a purchase price of $100,000. You could then take that deal to a private lender, which might issue you a loan of around $140,000. That may be enough to pay for the purchase, the closing costs and the fix up. No money is required from the investor. These days many private lenders want down payments from unproven real estate investors but if you have a good enough deal you’ll be able to find someone to finance it.
I do this on occasion. I just recently did a single-family rehab where it just sort of worked out that I didn’t need to bring any of my own money. The deal was good enough and the fix-up budget came in a little under my estimate and I was able to make a decent little profit without dipping into my account. I have to say, these deals are nice if they work out.
The problem with no money down deals is that interest payments can really kill your cash flow and eat up profits. I’ve also seen investors over pay for a property because they’re only concerned with keeping their money out of the deal and didn’t keep their eye on the bigger picture. If you’re using a 100 percent seller financing then no one is going to make you get an appraisal. Then the interest payments strangle cash flow and the investor starts to bleed to death slowly. If the home was purchased at a premium then the investor will not be able to sell the home and he might find himself stuck in an overall bad situation.
I once heard a very prominent real estate guru say, “You can name the price if I can name the terms,” meaning that price doesn’t matter if you can get the interest rate, payoff term and down payment you want. That statement is true to a degree but it certainly has its limitations. The rules of business and economics are like those of physics, and breaking them can end in catastrophe.
Keeping your money out of a deal is great. If you don’t have much money then this allows you to get a foot in the door of a great industry and if you do have money it allows you to hold it in a rainy day reserve or take on additional projects.
However, investors always need to think cash flow first, then ensure overall profitability of the deal and have at least two exit strategies. If these three very important things cannot be reasonably assured then you need to walk away regardless of the size of the down payment.
Justin Pierce is a real estate investor in Northern Virginia. Follow him on Twitter at @justinpierce1.