Discover how to buy commercial real estate without using bank loans. You'll learn about creative financing techniques such as master leases, seller financing and installment sales. This is a must watch video for anyone interested in commercial real estate investing.
7 Reasons to Use Creative Financing in Your Commercial Real Estate Deals
1. The first reason is leverage, lower down payment, not having to deal with banks.
2. You have the cash resources but not the credit.
3. If you are whole selling this deal, creative financing gives you the immediate impression that the deal is unique, special, and desirable. I guess for you whole sellers out there, this is really important for you guys.
4. It’s a way to finance a property that's in disrepair or distress whereby bank financing just couldn't happen.
5. If you have seller who wants to avoid or delay capital gains taxes on a sale
6. Seller is ill, old and tired, or burnt out, very, very common reason to use creative financing in commercial deals.
7. It's just a fun and cool thing to do.
What's the Secret to Structuring Seller Financed Deals of Any Size?
This goes for apartments, self-storage, mobile home parks, office, retail, all the above. What's the secret to structuring seller financed or creative financing? Ready for the secret? The secret is asking.
You have to ask. There's power in asking
My 1 Rule in Asking
Don't ask about seller financing or anything creative during your first phone call. That might tell them that you have no money and scare them away. Wait until the second or third phone call to do that.
The 3 Simple Creative Financing Methods For Today
This is must-know for you. You just have to know how to do these. If a seller has, for example, no debt on his property, he can act as a bank for your financing needs, for your purchase.
Simply put he hosts the mortgage for you.
Here's an example.
If the purchase price is 500,000 and you put down 50,000, and then you will make a monthly payment on the remaining 450,000 balance. Follow me so far? That balance is called owner carry. As for the loan terms and things like that, that's up to the unit seller. That is called an owner carry first mortgage.
Why would the seller do this for you?
Reason number 1.
- The seller may not want to pay taxes on the sale. The seller can avoid capital gains taxes at the sell and spread out his tax consequences over a period of time if he wants to. That's the beauty of a seller carry first.
- The seller will get a down payment, will get monthly payments for as long as agreed.
- Eventually, he'll get paid his entire payment depending on when the owner carry amount comes due.
- For tax consequences, the seller will only claim as income the money you pay him, down payment plus the payments for the taxable year.
Reason Number 2
- Let's say their property is well below market vacancy. There's lot of occupancy and it’s in poor condition. This means that the bank will not lend on the property unless you can show profit and have this physical condition remedied. You’ve got to fix it up.
- This is what we call a non-performing or distressed commercial property, with high vacancy and an ugly property. Banks don't like those types of properties. This is ideal for creative commercial financing.
- Now, tell me this. How many of those properties have you seen out there? I'm sure you've seen a few, and you had no idea what to do with them. This is how you buy them.
Reason Number 3
- Let's say the property is in good condition, but the seller kept poor or non-existent financial documentation, such as bookkeeping. Banks will refuse to lend fully on that type of property.
- If you don't have good books and records, how can a bank verify what the historical income has been? They can't. If you do get a loan, the loan terms won't be that great.
- What you can do is you can purchase this property with creative commercial financing with the seller being the bank for you. You can nurse their property back up, and then later on when the seller financing expires, and the building is working great, you can finance into A class or A level loans, a good loan term.
Reason Number 4
- The seller may need a quick sell because of personal circumstances, such as illness, relocation, divorce, or a need for quick cash
- I'm positive that some of you have seen situations where sellers are sick, they have to relocate overseas, there's a divorce going on and he need quick cash. Seller carry first mortgages are ideal here, so you must know how to do those.
By the way, the 4 reasons I gave you, these are what I call seller motivations that you really need to watch out for. You want to know why? It's because seller financed deals are put together around seller motivations. If you ever wanted to know how to put together a creative deal or a seller financed deal, get the seller motivations, number 1.
They've been around for quite a while, since the origination of mortgages.
Let's say the buyer does not have quite enough saved up for down payment. Let's say that you only have 15% of the purchase price and the lender wants 25%, so you're a few dollars short. What the seller can do is help you buy the property by honing a second mortgage for the remaining down payment proceeds. Again, you have 15%, the bank wants 25%. The seller can hold the remaining 10% as a second mortgage, thereby satisfying the lender's 25% requirement.
Let's say that you do not have quite enough saved up for down payment and the bank wants 25%, you only have 15%. The seller can help you by holding a second mortgage for the remaining 10%, and thereby satisfying the lender's 25% equity requirement.
Let me give you an example how that works. Let's say you're going to purchase 10-unit apartment building and the purchase price is 500,000. The down payment requirement is 25% or 125,000, but you only have $75,000. You only have 15%, but you need 25%.
In order to satisfy the down payment requirement spot of the bank, the seller agrees to hold a second mortgage against their property for the remaining $50,000 or %10. Now, everyone is happy because seller gets to sell their property, You get to purchase the property, and lastly, the lenders active requirement is satisfied.
That's how you do an owner carry second mortgage it is a very, very popular way to leverage yourself into a commercial property, very popular way. All right.
3. Master Lease
Agreement where you need no banks, no credit, no experience for this strategy. It's one of my favorites.
To get started here, I'm going to share with you an example of a deal that we did. It was an office building from one of our students. Her name is Karen, and she found her deal on LoopNet.com, a vacant class A, 8,600 square foot former Remax real estate office. The Remax office went out of business. The owner was 3 months behind in their mortgage. She's sunk her life savings into the building and the business. She wants to basically avoid bankruptcy and foreclosure. She is facing financial ruin, so she's very motivated.
Karen came to me, "Peter, this is what I found." After hearing her, I go. "This is ideal for master lease, Karen. Here is what I want you to do."
To make a long story short, Karen's idea was to turn the office space into office suites, after studying the area's needs. Basically what she did was she called a professional leasing company, and she asked them point blank, what does the area need? They said the area needs office suites very badly. We decided to convert this Remax offers into office suites. In this building, all the copy machines were there. All the furniture was there. The break room was all outfitted with nice tables. Everything was there. This was just ideal for this situation.
Here's the deal. The purchase price is $1.3 million. We use a master lease agreement. We put down $75,000, and we took over the mortgage payments, the tax payments and the insurance payments for the owner. This $75,000 down payment was used to catch up with the late payments, pay off the liens and pay broker commissions. To make a long story short, once this property was 80% leased up, their property will be worth $2.3 million at a 7 cap. Remember, we bought it for 1.3, empty, and 80% occupied is worth 2.3 million dollars at a 7 cap, in which the area can easily afford a 7 cap. It's probably below 7 cap today.
Now, maybe they're asking, "How did Karen come up with the 75,000?" She borrowed it from a mother and a sister. Here are the terms that she paid her mother and sister. She gets her mother and sister 8%, annually, plus she gave them 25% of their profits when she sells. 8% interest paid annually, plus a 25% kicker on the backend. That's what you can do with the master lease.
Now, here's a good question that many of you maybe are wondering. Why was a master lease ideal for this situation? When Karen brought this deal to me, why did I say this is ideal for a master lease?
The reason why is the seller was distressed. She had missed mortgage payments, she had a failed business. The building was empty, and she had her life savings at stake, again, seller motivations. The seller may have been a good real estate agent, but she was not a good investors. How many times have you seen that these days?
Now, another reason why this was ideal for a master lease is most banks will not lend conventionally on an empty commercial property.
If we wanted to take advantage of this situation, buy this property, we had to deal with a master lease. The fourth reason why it's ideal for a master lease is Karen didn't have a down payment or the credit or the net worth to buy a property herself. She just didn't have it. Many of you are like that. That's where the master lease comes into play.
Secret Sauce to Master Leases?
I'm going to give it to you in imaginary quotations. Here it is in quotation mark. "Mr. Seller, I will give you your price if you give me my terms
" Let me repeat that. "Mr. or Mrs. Seller, I will give you your price if you give me my terms."
That is key language. If the owner of that Remax office wanted her price, she needs to give us our terms, and then we have a deal.
How Do You Come Up With the Terms?
Well, it depends on the deal.
- Right now I'll give you a few examples of what some of the terms look like, just so you can maybe fit them to the deal, maybe one of the current deals you're looking at, or perhaps one that you passed up in the past.
Term Number 1. No money down.
Term Number 2. No money down at closing, but down payment split into payments as certain thresholds like occupancy is achieved.
Term Number 3. No money down and a joint venture with the seller. See how creative we can be with this stuff.
Term Number 4. Let's say you do 5% or 10% down and you just take over his or her mortgage payments. How about 5% or 10% down and take over mortgage payments, but not payments are made for the first 12 months. How about this? 20% to 25% down, take over mortgage payments, but seller pays a monthly premium.
Again, I can go on, and on, and on, and on, and on with these terms, but they depend on the deal.
How Do You Come Up With These Terms?
You come up with the terms by discovering what the seller motivations are, and then you structure the deal around those motivations.