In my blog post, “Why Debt Infinitely Trumps Savings,” I talked about the importance of understanding good debt and how to put it to work for you. I call this using OPM or Other People’s Money. When I discuss the idea of OPM, most people are on board with it-excited even about the possibilities. But then they become intimidated by the idea of how exactly to find and use OPM.
This is normal for people. When we learn new ideas, our mind does its best to create reasons why the idea is wrong or it won’t work. Our mind tells us things like, “No one would ever give you money,” “You can’t find good enough investments to attract OPM,” or, “Using OPM is taking on too much risk. Better off just putting money into your retirement account.”
Here are a few posts to help you on that front:
How to Get Paid $180 to Buy a New Investment Property
The Four Profit Centers That Make Real Estate The Most Powerful Investment
Once you have the right property, getting OPM becomes quite easy if you know where to look. And when you begin to build your real estate portfolio, it gets even easier.
This one should be obvious. If you own a house, you know what it’s like to go to a bank to apply for a mortgage. Most people don’t think of it this way, but a mortgage is a form of OPM. Generally, with a single-family home, a bank will cover up to 80% of a home’s value. You, as the purchaser, will pony up the other 20%.
This isn’t always the case, however. For first-time homebuyers, an FHA loan can cover up to 97% of the purchase price with the buyer only having to contribute the other 3%. Of course, there are stipulations on this, such as you have to live in the home for a certain number of years before you can rent it out.
When it comes to real estate investing, when a property gets to a certain size, it no longer is viewed as a residential property but instead as a commercial property. This means that any bank looking to make a loan will base the loan criteria on the operating income of the property, not on the “market value” like they do for a home.
Often times, if you can make the business case for a loan to cover not only a portion of the purchase price but also for the execution of the business plan to grow the property’s value, you can fund a lot of your capital costs with the bank’s money.
Banks are notoriously conservative, so if you’re looking to have little-to-no money in a deal, a bank might not be your best option. But it can be a good place to start.
While banks are generally public institutions that have high regulatory requirements, you can work with private lenders and equity firms that are willing to invest in real estate. These could be angel funds, investment groups, and more. You’d be surprised how many institutions are out there with the sole purpose of finding good investments to pour money into. You can find these lenders by either asking other investors you know or by doing some searches on the internet, where you can find things like private lender associations. These loans can be a bit more expensive with higher interest rates, so weigh your options.
A seller carries back is where the seller of a property acts as the lender. There are a number of reasons why a seller might do this. Perhaps they are tired of the work required to operate a piece of property, or maybe they are looking for a steady return by collecting set interest on their money rather than rely on rental income ups and downs.
Because it is a private transaction, there are many options for seller carrybacks, and it just depends on your negotiating skills. The seller could finance all or part of the property. The rate could be at market or it could be higher than market depending on risk. The seller could participate in part of the profit in exchange for a lower rate and you doing the work and management to execute the business plan. The options are nearly limitless.
If you have a good investment property, it will be easy to line up private investors who will want to provide the equity money for the property. Often times this is how you can raise the money for the percentage of the purchase price that a bank will require you to pay. So, for instance, if you are buying a four-plex and the bank requires you to put down 25%, you would use private lenders to raise most or all of the equity money needed for that 25%.
This means you need to put together a solid investment prospectus that shows the potential of return for the investors. Ideally, you would have done that for the bank as well, so it should be ready to shop.
This is how Rich Dad Advisor Ken McElroy does his deals, and he has grown his portfolio from one apartment building to thousands of units in multiple states.
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Government Tax Credits
If you are interested in doing investing in properties that the government subsidies, like affordable housing, you can utilize a slew of tax credits to help fund your real estate investment. Here are two explained by thefinancebase.com:
The Internal Revenue Service (IRS) offers investors a credit to rehabilitate some residential or non-residential properties. The credit applies to a portion of the costs to renovate, restore or completely reconstruct. For buildings placed in use before 1936, you can receive a tax credit worth 10 percent of your expenses. If you purchase and rehabilitate a certified historic structure, you may be due a 20 percent tax credit based on your costs. If the buildings are in a disaster area, such as those impacted by certain hurricanes, your tax credits increase to 13 and 26 percent, respectively. As of the time of publication, in order to qualify for the tax credit, you must spend $5,000 in a 24-month period.
The U.S. Department of Housing and Urban Development (HUD) oversees the Low-Income Housing Tax Credit (LIHTC) Program. The goal is to encourage private sector residential developers to build affordable housing. Tax credits are given to builders, who then sell them to investors to raise money for low-income housing. The investors, in turn, can benefit from tax credits for 10 years for each dollar invested, as long as the building qualifies for the program. It must be a residential real estate, meet low-income tenant eligibility and be rent controlled.
These types of investments require a high-level of financial intelligence, so you don’t want to just jump in. But if you do the work to become a pro, you can make a very good living.
Additionally, you can find tax credits for building or retrofitting properties with environmentally friendly enhancements. It varies from marketing to market, so do your homework and see what you can get.
This is where things get very fun and why I believe real estate is one of the best ways to accelerate the velocity of your money. Once you have a good real estate investment property and a plan for growing its value, you can utilize that property itself as a means to generate cash out of thin air for other real estate deals.
I hit on this in my last post when I talked about how to improve a property for greater cash flow and value:
As an example, let’s talk about Rich Dad investor Ken McElroy. Ken, as you may know, is a real estate mogul specializing in apartments-a real estate class called multi-family housing.
What Ken and his partners do is find apartment buildings that underperform. Because the value of a commercial real estate asset like an apartment is based on the Net Operating Income (income after expenses), any opportunity to increase NOI is an opportunity to see a healthy return.
For Ken and his team, a variety of factors could help with this. For instance, the current landlord could be renting units well-below market rates. Turning those units and raising the rent could dramatically increase NOI. Or perhaps retrofitting units with washers and dryers, as well as a cosmetic facelift could increase rents by anywhere from $25 to $50 a month. Multiply that by hundreds of units and you’ll see a lot of lift in income.
Since the bank values a property on the Net Operating Income, not on “market value”, a lift in income is a sizable lift in value. You can use this higher value to do a refinance, pull money out of a property tax-free, and then redeploy it into another real estate investment. Continuing the cycle over and over again over many years exponentially grows your portfolio-and your wealth. And it’s all done with OPM.
This is another original article by Ernst Georges, co-owner of Yanex Real Estate Investing, LLC at http://www.yanexhome.com/. Are you looking for an experienced Brooklyn, Queens, Long Island New York Investors? With a service based, business experience, Ernst Georges and Partners work hard to serve home buyers and sellers for the Kings, Queens, Nassau and Suffolk Counties and surrounding areas.
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