Buying Investment Real Estate with little or no Cash

What can you do if, after taking stock of the more "traditional" means of generating funds to purchase investment real estate, you find that none of them is right for you? There are, indeed, ways to buy property with very little or no money down. It's quite likely that you've seen a late-night infomercial or two touting the ease of these concepts. Well, the truth is that they can be done. The further truth, however, is that they are not easy. No-money-down deals typically involve a considerable amount of risk and, as such, deserve a great deal of evaluation and care. They're also incumbent upon finding an owner who's willing – or can be persuaded – to sell on such terms. In short, they're easier said than done. If they weren't, everyone would be doing them. But they can be put together, and here are just a few methods:

Option contract - An option contract is simply a contract between a prospective buyer and seller that provides the buyer with an option to purchase the seller's property within a given period of time. As consideration for the option, the buyer pays an agreed-upon sum of money that's non-refundable should he or she choose not to exercise the option to purchase the property. If the buyer decides not to purchase the property, the 'option money' is forfeited, going to the seller. If the buyer chooses to exercise the option, the money becomes part of the down payment.

An option is a unilateral contract, which means that all rights to buy or not buy the property belong to the option purchaser. Once the contract is executed, the seller has absolutely no more control over the sale. For this reason the seller will often request a fairly substantial option deposit. The contract, in effect, forces the seller to take his or her property off the market for a period of time, at the end of which it still may not be sold – depending upon whether the buyer decides to exercise the option to purchase the property or not.

An option contract can be an invaluable tool for a prospective buyer. For example, you might find a property that you're very interested in, but at the present time your available cash may be limited. However, you know that in just a few months you'll have enough cash available to purchase the property. Or perhaps you might be waiting for another property that you own to sell or close. Your money might also be temporarily deposited in time certificates or other vehicles, and withdrawing the funds prior to maturity would result in substantial interest penalties. Whatever the case, you don't want to lose your opportunity to buy the investment property in the meantime, so you use an option contract to gain control of, or tie up, the property.

Lease with option to buy - A property owner who's highly motivated to sell may consider leasing his or her investment property to a prospective buyer and giving the buyer an option to buy the property at an agreed-upon date in the future. This type of transaction can be used very effectively when a seller needs to get out of the ownership or management of his or her property, perhaps due to illness or relocation from the area. The purchaser agrees to lease the property for a specified period of time, while preparing financially to purchase it. Depending upon the contract terms agreed to by both parties, part of the lease payments might be applied toward the down payment.

Contract for deed - The contract for deed is very similar to the lease option, with the exception that there's no option involved. It basically works in this manner: instead of optioning it, the buyer agrees to purchase the property, but typically doesn't have the necessary cash to do so. Likewise, the owner agrees to sell his or her property to the buyer. The buyer may give the seller a small cash down payment, but title to the property remains in the seller's name. The balance of the required down payment will come from the lease payments that the buyer makes to the seller. An agreed-upon portion of the lease payments will apply toward the down payment (perhaps as much as fifty percent). When the full required down payment amount has been accumulated from the lease payments, title to the property is transferred to the buyer.

This type of purchase can actually be looked upon as a savings plan in which the buyer is adding to his or her real estate investment. During the savings period, the buyer is also realizing the appreciation and principal-reduction benefits produced by the property.

Distressed properties - A distressed property is one in which the present owner – for whatever reason – has gotten into trouble and needs or simply wants very badly to sell. But just because the owner is anxious and wants out of the property doesn't mean that you should automatically jump into it without careful analysis to determine if the property has investment potential. If it does, you can try to convince the owner to sell you the property with no money down and carry back a mortgage for the difference between the existing financing and your agreed-upon price.

But keep in mind that the seller needs to sell. A property in substandard condition should always be purchased at a price well below current market value. Your property analysis should allow for things such as excessive vacancies, higher than normal operating expenses and, of course, 100 percent financing. To put it bluntly, make sure that you don't get yourself into the same position as the current owner. You should expect to incur temporarily higher expenses in order to turn the property back into a profit-generating investment. Many investors have made huge sums of money by specializing in buying distressed properties at below-market prices, fixing them up and selling them at a large profit.

Ask the broker for a little help - It's not totally uncommon for a broker – in lieu of cash – to take all or part of his or her commission in the form of a second or third mortgage on the property being sold. A sale that's in danger of not materializing because the buyer lacks sufficient cash may be just the incentive that a broker needs to agree to this provision. After all, having a commission spread out over the term of a mortgage is typically better than earning no commission at all. Furthermore, a broker who's had a particularly good year may actually prefer to spread his or her income out over a period of time for income tax purposes. You could also ask the broker to reduce his or her fees; real estate professional fees are often negotiated on large property sales.

Paying a premium for the property - Another method of inducing a seller to agree to a no-down-payment sale is to offer more for the property than he or she can expect to get from a buyer with a cash down payment. By doing this, you're playing on the age-old emotion commonly referred to as greed. But again, you must carefully analyze the investment beforehand in order to determine what price you can afford to pay, and if the investment will ultimately be worth it.

Profit sharing - A prospective buyer can offer the seller a share of the profits generated by the property as added incentive to sell the investment with no down payment requirement. In doing so, not only will the seller receive a portion of the income produced by the building, but he or she will still be carrying back a second mortgage as well. The method of determining the profit distribution and the length of time that it's to be paid are negotiable.

Mortgage hypothecation - If you own a home or other real estate in which you have substantial equity, it's possible to offer the seller of an investment property a second mortgage on the real estate you own. This is known as mortgage hypothecation, and it works in this manner: let's assume that your home has a market value of $150,000. Your present mortgage balance is $80,000, giving you an equity amount of $70,000. You find an investment property that requires $40,000 in cash as a down payment (which you, of course, don't have). You therefore offer the seller – in lieu of cash – a second mortgage on your home in the amount of $40,000 (or even $45,000 to sweeten the deal).

However, this is another situation in which you should weigh the transaction and its potential consequences very carefully. Many people do not want to risk the equity that they've built up in their homes. On the other hand, there are others who've come to regard the equity in their home as one of the best sources of investment capital that they have, and in some cases, the only one. Rather than pay the closing costs and higher interest rates of refinancing, they use this method as a quick and inexpensive means of generating the funding that they need.

 

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