Investor | Serial Entrepreneur |Founder Lex Real Estate Group, Lex Holdings, CEO of the Distressed Real Estate Institute.
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One of the most difficult concepts for new real estate investors to understand is the concept of buying real estate with no money down.
What Is ‘No Money Down?’
The term “no money down” is misleading. The definition does not mean no money down. It simply means none of your money down. You could be borrowing the money from your favorite uncle or getting a loan from a private lender.
In a traditional real estate transaction, you typically purchase a property with a down payment, usually 20%, and getting a mortgage for the balance. However, not all sellers of properties allow mortgages. For example, bank owned properties all require an all-cash offer — no mortgages allowed.
The key to understanding “no money down” real estate is to understand that bank-owned properties often sell at a deep discount to market value because they require a cash investor and do not allow mortgages.
Private Lenders
If you do not have the cash to pay for a bank-owned property, you can borrow the money from a private lender. Private lenders differ from conventional lenders in that they are more concerned with the value of the property than the credit of the borrower.
Assume that you found a $200,000 bank-owned property that you could purchase for $120,000 cash. This would represent a purchase price of 60 cents on the dollar. This property needs at least $30,000 in repairs for it to be able to appraise at its full market value of $200,000.
An investor would be interested in purchasing the property, renovating it and then selling the property for a profit. That is one strategy. But there is one more strategy that can be even more lucrative.
Assume you found a private lender that was willing to lend you $110,000 of the $120,000 purchase price. Their collateral is the property, and since the property is worth $200,000 after it has been repaired, it is not a very risky proposition for them to loan you $110,000 and earn a high rate of interest on their money.
Assume that you had the $30,000 for repairs — or you could borrow it from a relative or partner in the deal.
Step One: Purchase The Property
Your first step would be to purchase the property. You do this by putting down the $10,000 and borrowing the $110,000 from the private lender. You would also have closing costs, points and fees, which would probably add up to around $5,000. Your out-of-pocket cost at this point would be $15,000.
Step Two: Repair The Property
After you have purchased the property, your next step would be to repair the property. You would need to hire a general contractor and pay them the $30,000 for them to renovate and remodel the property. The ideal properties would require only flooring, kitchens, bathrooms and paint to be completely renovated.
Step Three: Rent The Property
After the property has been renovated, your goal would be to place a tenant in the property. Assume you can get $2,000 per month in rental income.
Step Four: Refinance Your Loan
After you have your tenant in place, the next step is to refinance your loan. Your mortgage broker will order an appraisal, and if your numbers that you originally calculated are correct, the property should appraise for at least $200,000. Considering that everything is brand new inside the house, your appraisal may come in higher than anticipated.
The bank is willing to lend you 80% of the $200,000 appraisal value. This amounts to $160,000. The fee that the bank will charge you to refinance this loan is $5,000. After loan fees you will be left with $155,000. The bank will pay off the existing $110,000 loan to the private lender and will give you the balance of $45,000 in what is known as a cash-out refinance.
Your Out-Of-Pocket Expenses
$10,000: Down payment
$5,000: Points and fees
$30,000: Repairs
Total cash out of pocket: $45,000
After you refinanced the loan, the cash that you received at closing from the refinance is exactly $45,000.
The net result is that you now own a $200,000 rental property with a $160,000 mortgage and have equity in the property of $40,000. You have increased your net worth by $40,000. The $45,000 cash that you invested to buy and repair the property is now back in your bank account. You have essentially purchased a property with almost no money down. You would still have incurred some expenses along the way for interest expense, property insurance and taxes. But these would be offset by the tenant giving you first, last and security deposit.
Repeating The Process
You can follow this same process to buy your second, third and fourth rental properties. Current regulations allow you to have up to ten rental properties in your own name. This is one of the easiest ways to create wealth. The only requirements are for you to have a job and for you to have decent credit. With interest rates at record lows, this is a great time to be employing this investing strategy.
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