101 Recipes for Riches in Real Estate

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2.

Dirt for Down

Scenario: The market is a bit slow and Max owns a piece of raw land valued at $100,000. A fellow Exchangor, Lee, owns an apartment building that he is tired of managing. He has some other business challenges and urgently needs some cash to meet his obligations. His apartments have been on the market for $500,000, but have not sold. Lee owes $250,000 on his apartment building. He suspects he could quick-sell the property for about $400,000, but does not want to sacrifice his equity just to generate the needed cash. During a recent slowdown, he went late on a couple of mortgage payments and cannot qualify to pull cash out of his property through a refinance. Max has an idea.

Solution: Max makes Lee an offer to purchase his apartments for $500,000, using his land as a down payment and by taking out a purchase money mortgage for the $400,000 balance of the purchase price. In return, Max asks Lee to pay all of the closing costs on the loan, which come to approximately $20,000. Lee accepts the offer and Max closes the purchase.

Benefits to Lee:

Lee receives $130,000 cash out of the transaction ($500,000 less $100,000 land for down, less $250,000 payoff of his mortgage, less $20,000 closing costs). This affords him the liquidity that is critical to restoring his credit and keeping his financial life on track.

He is relieved of the management responsibilities, which gives him more time to pursue new ventures.

He retains his equity, in the form of Max’s land, which he would have sacrificed with a quick, discounted cash sale.

Benefits to Max:

Max is able to convert the equity in his land to a cash-flowing asset, without having to first find a cash buyer for the land.

Properly structured, Max’s acquisition may qualify as a tax-deferred exchange under IRS Code Section 1031.

He finances the new property without personally paying any closing costs.

He now has a tax shelter in the form of depreciation on the new property that he did not have on the land.

He improves his asset class and now has a property that will likely be more valuable in a future exchange.

Formulas Used: Chapter 2, Dirt for Down, A variation on Chapter 23, Liquefy Your Lot Equity (Using land as a down payment), A variation of Chapter 25, Stair Steps to Cash, (Structuring a transaction to get cash out of your land with other than a sale), A variation on Chapter 55, Overpay and Still Make a Profit, Chapter 83, Build a Formula Freight Train, and Chapter 94, Hopping up the Hierarchy.

Footnote: See the next page for a chart that illustrates the rankings of given property types in an exchange. You can see that by trading raw, unencumbered land for a 5+ Unit apartment, Max’s equity has jumped three levels up the chart. This upgrade should make subsequent exchanges easier for Max to accomplish. Always seek to move upward, even if you must first take a strategic step backwards to improve your position.

Hierarchy of Exchange

The higher up the pyramid of exchange, the more desirable a property type is in an exchange. Individual circumstances, skills and desired benefits may cause this hierarchy to shift some. For example, if the party exchanging is a large Real Estate Investment Trust, specializing in apartments, then large apartments would be more desirable than certain other property types that might be higher up this pyramid. This chart is a general illustration of values in exchange for a private investor with a small to medium size portfolio. Find your maximum benefit level. Hint: Cash is definitely not always best.

3.

Convert Vacancy to Currency

Scenario: A semi-retired couple owns a boutique bed and breakfast in a seasonal resort town. The vacancies in the off-season create a big dip in their income. They realize that the room nights are a perishable commodity and lose all value if they go unused. They wonder how they might entice people to stay at their B&B during off-peak times.

Solution: Jim, a friend of the B&B owners, who is an Exchangor, comes up with a creative idea. He suggests that they print coupons that are redeemable for free weeknight stays and steeply discounted off-season weekend stays. The owners print the coupons and use them as currency that they trade for goods and services with merchants in surrounding communities. In other words, they turn room nights that will likely go unused into a form of barter currency. They get something of value for the coupons and those who accept their coupons in trade can use them in ways that benefit themselves and their businesses, too.

Benefits to Owners:

The benefits to the B&B owners are obvious. They create tangible value from their inventory of otherwise unoccupied room nights that lose all value if they remain vacant.

Benefits to Jim:

The owners give Jim a few coupons to pass on to family and friends in appreciation of his creative idea.

The owners tell their friends how brilliant and talented he is.

His reputation as a professional in his field is underscored.

Benefits to Other Merchants:

Other merchants can trade their goods and services for a pleasant stay in a beautiful place, at a cost presumed to be significantly lower than if they rented the rooms with after tax dollars.

The other merchants can use the coupons as perks to promote their own businesses, or to house family visitors and guests when they come to town.

4.

Buy Time With Paper

Scenario: Ken is in trouble on an apartment building he owns. He moved an hour away from the property to accept a new, demanding job and the property management has gotten away from him. Vacancies are high and the few tenants who are still there are mostly trouble. The property is in severe need of rehab. Ken doesn’t have the time or the will to tackle the problem. He is willing to discount the price of the property to sell it and to carry back financing to make the purchase more attractive for a new buyer.

Ron, who is an experienced rehabber, would like to buy the property, but knows it will take at least 2 years to rehab the property and turn the tenancy around. He has the cash to make the needed improvements and has property management experience. To him, the existing tenants are an interesting challenge that will only require time and a steady hand to overcome.

Solution: Ron negotiates with Ken to carry back a wrap around loan on the property, leaving his existing debt in place. Ken agrees to waive payments and all interest charges for the first three years on the portion of the loan that represents his equity, giving Ron enough time to evict the bad guys, remodel and re-lease the apartments to quality tenants.

Benefits to Ken:

Ken is free of any further responsibility to manage the property.

He gets a higher price for the property than he would likely have realized if he had demanded all cash.

He is assured that the underlying mortgage payment will be paid without having to reach into his own pocket, as he has been doing for months.

Ken stabilizes his remaining equity in the form of a note receivable.

In 3 years, his cash flow resumes.

Ken’s wife is happier because she no longer needs to worry about her husband being gone several nights each month trying to collect rent from dangerous criminals.

Ken’s time is freed up to pursue other opportunities closer to home.

Benefits to Ron:

Ron is able to acquire a property with only closing costs as a down payment.

He buys the property for substantially less than the market price when stabilized.

He secures private financing on the property that insulates him against negative cash flow during the turn around period.

He sets himself up to create significant equity in the property as he solves the problems.

He is well thought of by Ken and his wife for saving them from a dire situation.

The police and other city officials in the town where the property is located appreciate Ron’s professionalism in cleaning up a problem.

They refer other property owners to him who are also in trouble.

Footnote: Ken may want to discuss the tax consequences of this transaction with his tax advisor. He may be subject to imputed interest on the note he carries back. Ron may want to include language about such taxes in the purchase documents to make it clear who is responsible for what.

Definition: A Wrap Around mortgage (a Wrap), and/or All-Inclusive Trust Deed (AITD) are debt instruments that secure a loan between parties. The amount of the loan should always be equal to or greater than the sum of all junior liens on the property. For example, Johnny bought a house from Barry. The house has a first mortgage balance of $45,000, and a second mortgage balance of $15,000. Johnny has equity in the home of $20,000. He agrees to sell the home to Dan for zero down. Johnny will execute a wrap around mortgage in the amount of $80,000 for Dan. The $80,000 Wrap encompasses, includes, or wraps around" the two senior liens. Dan will make his payment to Johnny on the $80,000 note and Johnny is still liable for the payments on the underlying loans.

Caution: If at all possible, whether you are paying payments on a wrap around or receiving payments on a wrap around, it is a good idea to have an escrow company manage the accounting and disbursement of the wrap around payments to the senior liens. There have been many equity scams, where someone sells on a wrap around, the buyer faithfully makes the payments, but the seller fails to make the underlying payment(s). Some months later, a foreclosure notice is tacked on the door and much if not all of the equity in the property has been erased by accruing balances on the senior liens. Do not put yourself in that position.

Formulas Used: Chapter 52, Customize the Paper, Chapter 83, Build a Formula Freight Train, Chapter 90, Forced Appreciation, Chapter 98, Nothing Down, and Chapter 99, Seller Carry Back.

5.

Make the Mortgage Mobile

Scenario: Reta owns an office building that is valued at $2,000,000. It has a first mortgage loan on it for $1,000,000 and a second mortgage- a prior seller carry back loan- of $200,000. Reta plans to go on an extended humanitarian mission to a foreign country and wants to eliminate her management responsibilities while she is gone.

Alan owns a parcel of commercial land in an area that is growing rapidly. His property is worth about $1,200,000 and is free and clear. It is expected that the property will have significant appreciation in value over the next few years because of its location and due to job and population growth in the surrounding area. Alan would like to convert his equity in the land to something that generates income. He makes an offer on Reta’s office building to convey his land as a down payment and to assume the existing loan. However, Alan wants Reta to pay off the second mortgage.

Solution: Reta likes Alan’s land and would like to accept his offer, especially since he is offering her $200,000 more than the current value for her office building. However, she doesn’t want to tap her cash reserves to pay off the second mortgage, since she will not have an income for the next couple of years. Reta contacts Kerry, the person who originally sold the office building to her and is now holding the second mortgage note on the property. She asks him if he would consider moving his $200,000 loan to Alan’s commercial land, as part of her closing with Alan. Kerry agrees to move the note.

Benefits to Reta:

She converts her equity to an asset that requires no management or operational risk while she is out of the country.

She avoids using any of her cash to acquire the property.

She secures financing (through Kerry) to balance the equities (by moving the loan), without having to make an application for a new loan and without any closing costs for a refinance.

She keeps her equity in play in a property that may deliver a handsome return to her while she is away.

Benefits to Alan:

Alan is able to use equity in land that is not income producing, to acquire the office building that generates a positive cash flow.

He upgrades his equity on the exchange pyramid by five notches (See Chapter 2 , Dirt for Down).

By spending $ 1,000,000 more than his land is worth and by purchasing an improved property, he now has the ability to depreciate part of the purchase price, thereby generating tax benefits through his ownership of the office building.

Alan assumes the first mortgage on the office building with minimum cost, which saves him the hassle of doing a full refinance on the property.

Alan is able to accomplish all of this without first having to find a cash buyer for his land.

By working directly with Reta, he avoids having to pay any real estate commissions on the sale of his land.

Benefits to Kerry:

Kerry moves his note from a subordinate position on the office building to a first mortgage position on the land. If Reta ever has trouble making her payments, Kerry could foreclose without worrying about paying off the underlying loan.

Kerry will have a 17% loan-to-value ratio on the land, whereas he had a combined-loan-to-value ratio of 60% on the office building. Most lenders would consider Kerry’s new position to be more secure.

In his new position, Kerry might expect that he could be paid off in a few years when the commercial land sells, as opposed being tied to the office building through a long-term amortization.

While responding to Reta’s request to move the loan, Kerry could also negotiate for modifications to his note, such as adding a balloon payment, a due on sale clause or bumping the interest rate.

Same Deal, Scenario B: Under a different scenario, let’s say Kerry refuses to move his note because he is more comfortable keeping the office building that he once owned as collateral for his loan. He figures the devil he knows is better than the one he doesn’t. Rather than let the transaction fail, Reta agrees to execute a note and mortgage against the land, payable to Alan, that is a mirror image of the note Kerry owns, which is secured by the office building. The payment from Reta to Alan on the new note offsets Alan’s second mortgage payment on the office building. It also satisfies Alan’s concern about assuming the second mortgage debt on the office building because if Reta doesn’t pay her payment, he could foreclose on the land and end up with both properties. He decides he likes those odds. For more information on the use of an offsetting note, see Chapter 10, Mortgage in the Mirror.

Tax implications: Reta may have a taxable event when she is relieved of the first mortgage debt. Kerry needs to be careful about modifying what was originally a note created in an installment sale under IRS Code Section 453i. A modification may constitute constructive receipt of the principal portion of the note and trigger capital gains taxes that were deferred by Kerry in the installment sale with Reta. All parties should, as always, consult tax professionals for guidance through the tax consequences of this or any transaction.

Formulas Used: Chapter 2, Dirt for Down, Chapter 10, Mortgage in the Mirror, Chapter 83, Build a Formula Freight Train, Chapter 91, Walk the Debt, Chapter 94, Hopping up the Hierarchy, and Chapter 95, Overtrade.

6.

Feed My Gator

Scenario: George has a small rental house worth about $150,000. The house is free and clear and George wants to use his equity as a down payment on a larger multi-unit income property owned by Bryan, who is an absentee landlord, meaning that he lives out of town. Bryan’s property is worth $400,000 and has a mortgage of $250,000. The larger property has a negative cash flow of about $200.00 per month, as currently operated. Exchangors refer to negative-cash properties as Gators, because like hungry alligators devour prey, such properties eat cash. George believes that over time, he can improve the operations to turn the cash flow positive. George has a positive cash flow on his house that he is reluctant to give up in the trade. Bryan wants out of the debt on the larger property and out of management by remote.

Solution: Bryan suggests George re-price the house in the exchange, adding $10,000 to the value. Among Exchangors this is called an "Overtrade (See Chapter 95)." Bryan then agrees to sign a note for the $10,000 payable over 5 yeas at 10% interest with a monthly payment of $212.47. The income on the note offsets the negative cash flow on the property George is receiving in the exchange. It is agreed that the note will be secured by the house Bryan is taking in trade. This gives George the assurance he seeks that the negative cash flow won’t fall to him unless it includes a much bigger benefit and is at Bryan’s expense. If Bryan defaults on the note, George can foreclose to get his house back. That arrangement calms his concerns completely.

Benefits to George:

George gets the larger apartment building he wants.

He has a five-year head start on improving the cash flow problem to erase the initial negative.

He acquires a larger property that with solid management should give him greater profit potential.

He increases his depreciation on the higher priced building, thereby enhancing his tax benefits.

He has $212.00 per month in income that will be a bonus if he achieves a break even anytime prior to 60 months.

Benefits to Bryan:

Bryan reduces his risk by getting rid of the debt on the larger building.

He frees himself from long distant management responsibilities.

Because of the positive cash flow on the home he receives, George eliminates the negative cash flow on the multi-unit building by taking the smaller, cash flowing property in exchange, even after considering the payment on the note to George.

Footnote: Creating paper, or notes, in a real estate transaction is often an easy and effective way to transfer risk, balance equities, solve challenges and resolve other gaps in the exchange. This is primarily because paper is so fluid and malleable, which means that it can be molded into a desired shape, for a specific purpose.

Caution: By trading down, (trading a property of greater value for a property of lesser value), Bryan may trigger taxes in the exchange. As always, check with competent tax and legal counsel to know what the consequences of any exchange will be.

Formulas Used: Chapter 83, Build a Formula Freight Train, Chapter 99, Seller Carry Back, Chapter 52, Customize the Paper, Chapter 24, Bonding Performance with a Mortgage or Deed of Trust, and Chapter 95, Overtrade.

7.

Developer Sale/ Lease Back

Scenario: Gale is a commercial developer/builder who has an industrial project that offers office warehouse condominiums. He locked in his costs on a dozen units and built them all at once, resulting in more inventory than he can immediately lease. He lists the properties for sale or lease with a broker, Gary, who is trained in Equity Marketing.

Solution. Gary brings Gale a group of offers from clients who have money that they want to place in commercial real estate, but insist that the properties they purchase are leased. The buyers each agree to purchase a unit, providing Gale will lease back the properties, assuring them of income on their investments. Gale agrees to do so, with the provision that his guarantee will end, as soon as he is successful in subletting the properties to qualified tenants. Gale and the buyers enter into a written agreement as to the minimum qualifications new tenants will have. With the risk of the initial lease up remaining with Gale, the buyers close on the purchases.

Benefits to Buyers:

Each buyer has a way to buy a brand new unit and to have immediate income on the unit.

They don’t have to worry about the risk of lease up, as Gale insulates them from that.

They are able to place their money immediately, instead of having to wait for the units to be occupied.

They lock in today’s price on the units.

They need shop no further for their next property.

Benefits to Gale:

Gale sells all of his remaining inventory and pockets his profit on the construction.

He pays his construction loan in full and stops the interest clock.

Gale can now redirect the money he was using to pay the construction loan interest to paying lease payments to his buyers while he leases the properties to other tenants.

He is able to free up his capital and credit to go on to the next phase of the current project or another project.

He can demonstrate brisk activity and full-priced comparables for appraisal purposes, which substantiate the value of future phases.

He can invest his profits to offset the lease payments, which cushions his carrying costs during the lease up period.

Footnote: As a variable for this formula, the lease payment can be reduced periodically (i.e. monthly, quarterly or annually) gradually shifting the risk of lease up from Gale to the buyers.

Formulas Used: Chapter 3, Convert Vacancy to Currency (Gale freed up equity by leasing back vacant space), Chapter 35, Creation of Wealth (Creating lease income before you have tenants), Chapter 60, Lemonade (Adding sugar in the form of lease payments to sweeten the bitter vacancy), Chapter 52, Customize the Paper. Chapter 83, Build a Formula Freight Train, and Chapter 96, Fix the Vacancy.

8.

Differentiate Your Digs

Scenario: Janice is an up and coming real estate investor with background in daycare. Ever since she was a teenager, she has worked in childcare services. She locates an apartment building owned by Aaron, located spot on a city bus stop. The apartments have a very high vacancy factor, which occupancy problem has persisted for several years. Janice is nervous about buying the property, even though the price is quite low, unless she has some idea of how she will remedy the vacancy issue.

Debbie, a veteran Exchangor has been one of Janice’s best friends since their school days. She gets together for lunch with Janice to brainstorm an offer on the property. As they toss around ideas about what could make the property work, they come upon a novel way to combine all of Janice’s talents into one project.

Solution: Janice succeeds in getting a permit from the city to turn one of the main floor apartment units into a daycare. With confidence that she can attract new tenants, she buys the building. She ends up renting the units, primarily to single mothers with small children. The mothers greatly appreciate being able to keep their children on the property where they live, while they are at work, both for the convenience the arrangement offers and for the sake of safety. Janice not only fills her building rapidly, but does so at higher rental rates.

Benefits to Janice:

She is able to make an offer for the property at the distressed price, knowing that she has a plan to make the property perform much better.

She leverages her experience in daycare to create additional income in the form of a small business.

She is highly regarded by the parents of the daycare kids for the valuable service she provides.

A few months after purchase, her apartment is worth twice what she paid for it because all of the units fill up at slightly higher than market rates.

Janice experiences very low turnover because the package of shelter and daycare that she offers is not easily duplicated.

Benefits to the Tenants:

Single parents are able to simplify their schedules and save time by having the day care on the property where they live.

The children are more content because they never really leave home when mom or dad goes to work.

Being located next to public transportation and without the need to transport children to daycare, many mothers are able to save significantly on automobile expenses. This helps with strained family budgets.

Bonus Thoughts: Other applications of this same formula might be singles-only rentals, seniors-only rentals, LGBTQ communities, student housing with cutting edge electronic connections for technology, properties allowing pets, equestrian properties, properties catering to those with disabilities and a hypoallergenic environment for those with severe allergies. Applications for this formula are only limited by your imagination and ability to identify a market that has a need.

Footnote: It is wise to check with governmental bodies concerning zoning, use and licensing requirements before planning to establish a business in a residential property. Also do your homework before advertising for tenants of a specific type or category, to make sure that you are not violating any anti-discrimination or Federal Fair Housing guidelines.

Formulas Used: Chapter 90, Forced Appreciation.

9.

No Credit No Problem or Master Lease with Option

Scenario: Investor, Brandon struggled through a recession when the local economy tanked. His credit was badly damaged in the downturn. However, he fought through the tough times and managed to hold onto a few properties and to eventually pay off those to whom he owed money. He is in the process of rebuilding his credit rating and has several people who will vouch for his reliability, in spite of his past struggles. Still, he can’t yet qualify for institutional financing.

Rufus is an older gentleman who has made conspicuous amounts of money rehabbing apartments. He now wants to retire and to convert his equity into a carefree monthly income. He has a solid 24-unit apartment building that has a $ 1,000 per month positive cash flow, if managed carefully. It has been three years since he last raised rents.

Solution: Brandon approaches Rufus and explains to him that he doesn’t have the credit to buy the building just yet, but that he would like to eventually do so when he is able to restore his credit standing. He offers to immediately take over management of the property, according to the terms of a master lease agreement with an option to purchase. The lease calls for a guaranteed net payment of $800 per month to Rufus, after all expenses are met and gives Brandon the right to exercise the option with the payment of a nominal fee in addition to the option price that represents today’s value of the property. The option price will decrease by an amount equal to the amortization on the loan(s) Rufus has on the property, until the option exercise date.

Brandon furthermore offers to deed a piece of property to Rufus that is currently worth $50,000, as option consideration and to secure his performance under the master lease. If Brandon honors the terms of the lease, Rufus will credit the $50,000 to the purchase price at the time the option is exercised. If Brandon defaults under the lease, Rufus evicts him, takes back control of the apartment building and keeps the property Brandon deeded to him. He gives references to Rufus and several people vouch that Brandon is dependable. The transaction goes to escrow and