Structuring deals
Learning how to creatively structure deals is something that has been essential for my and Ashley’s success in real estate investing.
The main reason for that fact is that we didn’t have access to funds when we started.
So, we had to figure out how to buy houses with very little cash and without going to a bank.
And that skill has allowed us to make some profitable deals even more profitable. But it has also taught us how to make any deal possible. My main mentors in real estate investing were a couple from Adairsville named Bill and Kim Cook.
They used to host a REIA at their ranch back in the day. And one of things I loved about that meeting was that Bill would break out a white board, give some information about a deal and then ask the people at the meeting to structure the deal. I learned so much from this exercise and it really opened my mind up to what is possible.
So, with that in mind, I thought I would try that same exercise with you on a deal I’m currently working on. Now, it’s going to be a little different than those longago REIAs because I can’t hear your input. But, if you would like to me write with it, I’d love to hear it.
My contact info is on the website at the end of this column. So, here’s the deal: It’s a four-bedroom, 2 1/2 bathroom, 2,000-squarefoot double wide on a permanent foundation.
And it’s sitting on a little over 1 1/2 acres. It would resale for $185,000 and would easily rent for $1,200 a month. The house is a beautiful home and needs absolutely no rehab.
The seller’s needs out. They recently purchased this house, but they had a life changing event take place and are now needing to get out from under the $750 mortgage payment.
The balance on that mortgage is $120,000, and the owner wants $160,000. They’re not opposed to doing something creative. They just want to quickly recoup the 20% down payment they made when they bought it — that amount is around $40,000.
So… how would you structure this deal? The first question I’d ask myself is, “Does it make sense to keep this house, or should I flip it?”
In this situation, we have $25,000 in equity. But that number is misleading. When you take out the 6% in realtor commissions to sell it, you lop off over $11,000 of the profit. And if you have to pay any seller closing contribution, then your profit will get cut to well under $10,000. So, selling it straight out as a flip is a little thin.
So, what about renting it out? Market rents are conservatively $1,200 right now. So, what if you offered to buy it subject-to (meaning you leave the seller’s mortgage in place after you buy the house and then make payments on that mortgage until it is paid off) and, give the seller the $40,000 difference in sales price and mortgage balance. Would that work?
Once again, this option is a little thin. You see, a common mistake is to take the rent rate and subtract the mortgage payment from it to get your monthly cashflow. For example: $1,200 rent minus $750 mortgage payment equals $450 monthly cashflow.
This method doesn’t take into account any of the other expenses associated with having a rental property aside from PITI payments: mortgage principle, interest, taxes and insurance. There are other real costs, like repairs, that will drive your cashflow down to more like $250 a month. That’s not a bad cashflow, but at that rate, it will take you over 13 years to get your $40,000 back.
Another idea would be to do a sandwich lease option. In this scenario, you rent the house from the owner with the right to sublease for $750 a month and have an option to buy the house in the next 5 years for the $160,000. You then do a lease option with the end user, renting it out for $1,200 a month and with a sales price of $185,000.
In this scenario, your cashflow really is the $450 because, since you’re not the owner of the house, the repairs are not yours to make. And the profit on the sale really is $25,000 because there’s no realtor commission associated with it. Do you see how that little strategy just made this deal much more profitable?
Don’t forget to write in and tell me your ideas. And if you are looking to learn more about creative deal structure, Bill is teaching a 3-day course on the subject in February. Go check out BillandKimCook.com for more details.