While the most common way to finance a property is through a mortgage loan, you can also creatively invest without ever working with a bank. There’s nothing wrong with working with a bank, but it is good to have different techniques in case a mortgage is not the best option.
Here are a few reasons working with a bank alone can sometimes hurt your business:
- The best property deals happen in market down cycles, and that is when the bank lends the least amount of money.
- You take on most of the risk, and the bank takes the least risk possible.
- You cannot control what funding the bank will offer from week to week. Their policies could change and negatively affect you at any time.
- Bank loans often are very slow, and could cause you to lose out on a great property while you’re waiting to hear back from them.
So, what is creative financing then? Below is a quick summary of five of the most common types of creative financing. While each of these are useful, it’s important to remember that you should not try to learn all of them at once. Instead, pick one or two that work for you and research them until you know all the details. Then, start incorporating it into your business when appropriate.
1st: Seller financing.
Seller financing just takes the bank out of the picture without adding in any other players. In this equation, the seller agrees to let the buyer pay for the property in monthly installments. While it isn’t common, that doesn’t mean it won’t work best in certain situations.
2nd: Private Loan from a Self Directed IRA
This tool requires lending, like a traditional mortgage, but it is based off an IRA instead of a bank. Note that you cannot borrow money from your own IRA, but you would find an interested party who is willing to use their funds to invest in the property. A potential investor may be willing to help a fellow investor work towards the same goals, since they are not able to use their IRA funds to invest in their own property.
3rd: Private Loans (not IRA)
This is in essence the same as the last tool, except the money is outside of an IRA. You can often meet people at real estate events who are willing to invest their finances privately in property. These people may even turn out to be mentors and friends who can help you in your career, and because you are controlling their investment, they have a more invested interest in you.
4th: Master Lease with Option to Buy
If a landowner is renting a property and finds themselves not motivated to do work on the property or find new renters, a savvy entrepreneur can come in with this option. She can offer to pay the landowner what she is getting now, put in some maintenance on the property, and fill in the empty spots. The landowner is responsible for taxes, insurance, and major costs, but the entrepreneur covers all the costs associated with rent (vacancy, turnover, etc.). This means the landowner still receives the amount he had, while the entrepreneur is able to make money additional to that, because of her ability to fill the property and gain money from those additional renters.
The option to buy would allow the entrepreneur to buy the property after a set amount of time. Whatever she had invested in the beginning will act as a credit towards the purchasing price. There are a few options for an exit strategy:
- The entrepreneur can save for a down payment and look for financial partners.
- She can do a 1031 exchange, where she essentially just turns a different rental property in for this one, and defers taxes on the difference.
- Finally, she could just sell this option to another investor and walk away with that profit.
This option means less risk for the entrepreneur. She only risks her time and whatever investment she put into the property at the beginning.
5th: Master Lease + Option (with a Credit Partner)
If you want to purchase a property, and just don’t have the money, a credit partner can come in and purchase the property with a mortgage. Then, you master lease the property and take care of it. The credit partner does no work and pockets the rent minus the mortgage fee, while you get the rest of the profits.
There are a variety of exit strategies that could be used here, including the ones listed above, but another option is purchasing at 50% interest in the property at 50% of the original price. That way, each partner could choose to purchase the property from the other, or just eventually sell it and split the profit.
Each of these tools are good in certain situations. Getting to know one or two extremely well will work better in the long run, rather than trying to use them all right away. Hopefully, with more options than just traditional financing, you will be able to invest in a greater variety of properties.