Traditional vs. Creative Financing
What Does it Really Mean?

(excerpt from The Lazy Investor’s Guide to REAL ESTATE)

Through years and years of transactions, the traditional method of buying and selling Real Estate investments has evolved into a market of its own and has grown into a Real Estate ‘machine’ that circulates mass amounts of money through Real Estate Agents, real estate appraisals, Title & Escrow Companies, Banks, and Mortgage Companies. These once-simple real estate investments have grown from a modest fee for a professional to keep the Buyer’s or Seller’s best interest in mind during negotiations, to now, traditionally, 6% (or more) of the total sales price being paid to Real Estate Agents (via Brokers who often take the majority of the money), another 3 – 5% being paid to Title, Mortgage and Escrow Companies for various fees, and then even more is taken for a real estate appraisal - and then a huge amount, by the Bank, through the form of interest payments – usually over 15 – 30 years and totaling 2 – 3 times the original purchase price of the initial Real Estate investment! Down Payments go to pay a variety of fees. Now, don’t get me wrong, it certainly is possible to make money through these methods, but the ‘traditional system’ is designed to simply ‘break even’ for the home owner in purchasing a home in this manner. It is really not designed for the investor, who, of course, wants every real estate investment to make money. Traditional funding only lets the Home Owner break even. Example – Home Owner Financing: List price on property (with Real Estate Agent) $200,000 Bank loan available (owner-occupied, 100% @ 7%) $200,000   Monthly payments (over 30 years) ~ $1350 Taxes, Insurance, etc. (per month) ~ $250 (This example is for an ‘average’ home in an ‘average’ neighborhood, for the ‘average American’ using an ‘average’ interest rate of 7% – of course, these figures do not apply everywhere, but the formula is very similar.) Therefore, the payment for this property is approximately $1600 per month for 30 years, to be paid by the home owner living in the property. Now, the ‘system’ allows for this home owner to have a change in their lives and decide to purchase another (usually larger) home. They have the right and often do ‘rent out’ the first house and move into the new one with their family. As they will be responsible for all repairs as well as their desire to make a small cash flow from this endeavor (by default, becoming an ‘investor’ because their previous home now becomes a real estate investment), they increase the monthly payment to the ‘renter’ by an additional $200 per month, for a total price to the renter of $1800 per month. Reasonable enough – until/unless there are repairs to be made – or, the renter leaves and the new ‘landlord’ has to make payments on this vacant house. Then, the $200 per month doesn’t look so good…. But, the “rent” has been established for that house – and the ‘comparable rent for the area’ can easily be calculated using this method; STANDARD RENT CALCULATION (Simple Method) Total payment for the property (includes Principle, Interest, Taxes and Insurance – known as PITI at 100% loan at 7% interest) + cash flow for the ‘investor’ (usually $200 per month) = ‘Rent’ Note: With several homes in the area of similar size and style, plus the fact that most homeowners in the area have similar loan structuring, we can estimate that whatever the average loan percentage is will create a ‘standard rental rate’ – in this case, $1800. A simple way to remember it is; PITI + $200 = STANDARD RENT If an ‘investor’ (one that seriously wants to make money from buying/selling Real Estate investments) wishes to purchase the same house in the same area and for the same amount of money, the ‘traditional system’ doesn’t allow the investor to really make any money from the transaction. Example – Investor Financing: List price on property (with Real Estate Agent) $200,000 Bank loan available (investor loan, 80% @ 8.4%) $160,000   Monthly payments (over 30 years) ~ $1250 Taxes, Insurance, etc. (per month) ~ $250 (This example is for an ‘average’ home in an ‘average’ neighborhood, for the ‘average American’ with an ‘average’ investor interest rate of 8.4% – of course, these figures do not apply everywhere, but the formula is very similar.) Therefore, the monthly payment for this property is approximately $1500 for the investor, which, at first glance, seems very good, as the investor will have a ‘cash flow’ of $300 per month – more than the home owner turned investor. However, the difference is that the 'Investor’ (the one serious about making a profit from this real estate investment) has brought in cash (out of pocket) of $40,000 – UP FRONT, not to mention the additional interest rate the investor has to pay (in this example, I have included 1.4%, while a bank may charge several percent for investor loans – check with your lending institution on their policies prior to finalizing your loans)! Now, I don’t know about you, but I don’t know too many people with that kind of money for 1 property – not to mention the fact that this person expects to make several real estate investments, repeating ‘what works’ several times. Not only do they have to come up with $40,000 up front, but how long will it take (at $300 per month) to make enough to purchase a second investment property at this rate? 10 YEARS!! (presuming there are never any repairs, the investor never takes out a penny of the cash flow for their own use, etc)! Investors and Homeowners get different bank rates. Not what I call a ‘wealth path’, not what I teach – and certainly not any way to run a business. ‘No Money Down’ and other 'Creative' Real Estate Investment Methods For many years, investors have seen beyond the ‘traditional methods’ of investing as described above as a lot less than desirable! They began looking at the prices of houses and finding methods of bringing the price more in line with making more money in a faster way. They developed ways to get loans on properties that allowed them to pull money out when they purchased the property (‘cash back at closing’) and lower their payments to build up their cash flow. They even developed methods of determining a Seller’s motivation for selling and bought the property at a discount price. These creative investors also saw that some Sellers were not able (for whatever reason) to sell the property at a discount price, however, they still needed to get rid of the property, as they didn’t know how to manage it as a landlord, or make money from it – not that it couldn’t be done, they simply lacked the knowledge of how to do it. These investors understood how to make money from such houses, and did. They bought the property on discount terms, and made money from the spread by selling it at retail price and/or terms (certainly one of my favorite methods of real estate investing). Buy property on Discount Price or Discount Terms. Several years ago (actually, it really took off in the 1980’s), Real Estate Investors began seeing the potential for making money in bringing this treasured knowledge to the public in the form of home-study courses, seminars and ‘Boot Camps’. They found that it wouldn’t create ‘competition’ for themselves, as many people, even though they purchase courses, attend seminars and ‘Boot Camps’, will not actually take the information and utilize it to make the hundreds and even thousands of dollars possible for anyone serious about Real Estate Investing. These investors found that this side of the business was lucrative – often making more income than the actual real estate investments themselves. It is important to understand that these instructors (now dubbed ‘gurus’) learned early that they can only teach others what to do, not be responsible for the other person’s success. Providing the information to those that choose not to use it is very similar to the old adage “You can lead a horse to water, but you can’t make it drink.” Yes, these ‘gurus’ got wealthy from selling this information, but the theories, principles and techniques taught thousands of others how to realize their dreams utilizing their tried and true methods. From home-study courses and seminars, to boot camps and one-on-one training, these methods have been proven to be not only interesting to millions of people, but capable of bringing massive wealth to those that take action on what is taught. This knowledge of ‘no money down’ techniques being known by thousands of Sellers has made changes in the industry. By bringing the Seller into the knowledgeable realm of Real Estate investing, Sellers know many of the methods that the gurus teach. This is both a blessing and a curse. To the talented investor, these knowledgeable people are more likely to work to create a WIN-WIN situation. Investors that avoid the ‘tricks’ and stick to the basic techniques and terms that have been proven to work over and over again, have proven these powerful strategies work even with these informed Sellers. Oh, yes, many of these real estate investment techniques work – today, as they have for many years. So much so that it is almost possible to say they have become ‘principles’; things that work, over and over, the same way – no matter what happens – like gravity. However, sadly, they are not really principles, as several of the methods and techniques that worked in the 1980s and even through the 1990s are today not as powerful, nor do they work as often as they did before. Some of this decline is due to a more educated society (due to the flood of information available via books, tapes, home-study courses and the Internet), while some of it is due to simple changes in policies and laws. It seems like a wave started – late in 2003, the FHA announced that “flips” (transactions where investors buy houses cheaply and sell them at or near market rates) are “illegal”. (Note that “illegal” in this context is not a legal term, but one that has been adopted from “you are not allowed to do that.”) The FHA’s announcement started a wave of concern (if not panic) throughout the Real Estate investing community. Title and Mortgage companies began to tighten up their reigns. Many of these companies, in lieu of direct information, began simply not completing any transactions that did not look ‘traditional’. This made it hard for investors to complete transactions that involved simple buy-then-resell agreements (not really a real estate investment, but a rather nice way to make some fast CA$H!). In rapid appreciation areas (California and Nevada, for example), the ability to ‘flip’ a property all but stopped (became “illegal”). All the traditionally creative real estate investing methods were virtually put on hold. Ingenuity to the rescue, other methods of completing the transactions always seem to pop up. After all, “Necessity is the Mother of Invention”, and “Where there is a Will, there is a Way” are absolute principles. Investors had to make a way to get things done, and even more creative real estate investing methods were developed - to keep real estate investors, and the love of real estate investment, alive forever. =-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=- Steve Majors - The Lazy Investor Profit from Real Estate Investing articles, information and news from one of the most creative investors on the planet! http://TheLazyInvestor.com =-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=- Keywords: real estate investing, real estate investment, real estate