Ever wonder why some investors manage to close deals on great investment property even when the market isn’t the best? Are you curious why some investors close one deal after another, while others can’t seem to get out of the gate?
“You need money to get money” is a cliche that is passed around from one investor to another, but it’s not true.
Understanding what makes an investment property a great deal is an essential part of being a commercial real estate investor. But knowing how to creatively finance a deal even when your money is stretched, is what separates the pros from the weekend investor.
If you’re serious about raising your passive income to the next level, then take note of the creative financing methods below.
1. Seller Financing
If you’re having trouble getting a bank to finance a deal, then seller financing might be a good first choice. If the seller owns the property free and clear and is willing to carry the majority of the financing, they can take a note as most of the purchase price. The note is secured by a mortgage or deed of trust against the property. You receive title to it and the seller retains a lien against the investment property.
Some owners offer terms that are actually higher than the banks. These owners will offer what seem like great terms. However, they set up a financing structure that is ultimately doomed to failure.
For example, the cash flow of the property may actually create a high debt service ratio, making it a money pit that you will end up forced to default. Factors like a higher vacancy rate, renovation costs, real estate taxes, and operating costs.
Other owners will put in a balloon payment that ends after just a few years. While their goal is to get their money as soon as possible, it can also shorten the amount of time you have to turn around the investment property and create enough profit to pay off the loan.
Even if the property is now profitable, you may be forced to scramble for a loan to cover the balloon payment, refinance the loan through the owner, or sell it too soon.
2. Joint Venture Partnerships
Joint venture partnerships occur when two or more individuals pool their money to achieve the best possible outcome. JV partnerships differ from hard money lenders. While the latter retains no ownership or rights to the investment property, JV partners share expenses, revenue, and maintain a pre-determined percentage of ownership of the property.
This allows investors to benefit in 3 ways.
- It allows an investor to participate in a deal they would otherwise be unable to take advantage of due to lack of funds.
- It allows investors to consider new projects that would have beyond them due to the experience of the investor or the scope of the project.
- The entire group not only shares the risks of the project, but they also can benefit from the advice and expertise of each partner.
The drawback of JV partnerships is the difficulty in finding a group of people who will agree on the same goals and get along with each other. Since time is often of the essence, it sometimes happens that the chosen partners aren’t well suited to each other. And this results in delayed decisions, conflict, and improper handling of the investment property.
It’s sometimes difficult for investors to learn how to work constructively with other investors. It’s often difficult for an investor who’s been working on his own, to strike a balance between a heavy-handed leader and a micro-manager. Each member of the joint venture must learn how to accommodate the others.
Lastly, if one member of the group has a lot of debt, then his personal debt affects the entire group. All members become ultimately liable for his actions.
3. Master Lease Agreement
A master lease agreement is an excellent method of financing a deal when:
- you have poor or non-existent credit,
- a low down payment or
- simply want to avoid bank loans.
In a master lease agreement, an investor buys an investment property from the owner with little or no money down. At closing, the buyer receives what is termed an “equitable title.”
An “equitable title” makes you responsible for all the investment property expenses. It also allows you to the receive the cash flow, tax benefits and any profit accrued upon selling the property.
The price of the investment property remains the same. That means that any amount of money made over and above the original price of the property automatically belongs to the master lease owner. Thus if you are able to re-purpose the building and increase profits, or you simply increase the rents, you will be entitled to keep the profit.
At the end of the lease, you will have the option of purchasing the property at the original price agreed upon upon signing of the lease.
For the seller, master lease agreements make for a quick and easy sale. The seller is free from dealing with daily operation. The seller also gets a quick cash flow without any having any responsibility for financial issues. The buyer gets cash flow, with little risk, and has the opportunity to test out the investment property before buying. With the option to buy after a set period, both parties have the opportunity to benefit.
The risk of the property not making enough money to cover the lease payment is a real one. It can easily result in a rapidly drained bank account. Most master leases are fixed, which means you’ll have to pay no matter what.
A second disadvantage is that cash flow will remain unpredictable due to capital repairs or unexpected expenses. These can significantly undercut profits. Investors will need to do their due diligence and to set aside an amount specified for that purpose.
Learning how to finance your deal is an excellent way of rapidly building a successful commercial investment portfolio. If you’re interested in finding the next great commercial real estate deal, please contact us.