Many of you out there rent your space from a landlord. I spoke with a colleague of mine recently that is in the middle of physically moving his business. My colleague, let’s call him Skippy, is also wanting to build more equity in his business. Skippy’s new landlords took a liking to him as he is a rather likable guy. They offered to sell the entire building to him with about 16% down and they would finance the rest. Due to circumstances that I will not digress into, Skippy is unable to secure conventional financing for the 16%. He brought the situation to me and I saw a perfect opportunity to help him, his credit, increase his business’s net worth, and do it all using someone else’s money. Whether you are in a similar situation or you simply want to own real estate while someone else pays for it, read on as this could be helpful to you. For the sake of this post I will use fictional numbers that are in scale with the actual occurrence.

First let me give you some numbers and then we’ll dive into the process. The entire building has 7 units and each unit rents for $375. This is a total rental income of $2625 per month. The property taxes are $100 per month, the insurance is $100 per month, and the building maintenance account allotment is $75 per month. Total monthly expenses are $275. Each unit is full and the occupancy rate has been 100% for the past 3 years. In order to rent you must be placed on a waiting list. Average repairs on the building annually over the past 3 years have never exceeded $700. The building is for sale to Skippy for $240,000 with $40,000 down. Those are the basic numbers. Let’s get into the process of how he can acquire this building without any of his own money.

The landlord requires $40,000 down and will finance the balance, $200,000, over 20 years at 6% interest. You may have to tweak the process for your situation but the overall gist is the same. And if you have problems or questions, contact me. Remember, Skippy could not get conventional financing and he does not borrow from friends and family. An unfortunate event has depleted his cash reserves. So we are basically starting from scratch. Here is Skippy’s process.

Approach the landlord and ask for a no money down financing from them. The proposed terms are 6.5% interest on a 20 year amortization with a 7 year balloon. Why would they consider this offer? Because if Skippy defaults at any point, the landlord takes their building back and keeps every penny collected thus far. They can put it on the market again and repeat the process. Believe it or not, there are people that hope the individuals they finace default so they can resell the same property over and over normally charging a few thousand dollars to process the paperwork. And if Skippy makes good on his financing deal, the landlords will earn 6.5% on the note carried and the balance in one lump sum after 7 years. So they will get their asking price plus interest and without fear of losing their building in case of default. Believe it or not, there are many people out there that will negotiate a deal like this. You may have to educate the uninitiated as to the benefits, but you will never find the deals if you don’t ask.

How does this help Skippy? Why would he take on almost a quarter of a million dollar debt when he has little to no cash reserves and he is unable to obtain a conventional loan? I’m glad you asked. Let’s look at the numbers. The story is always in the numbers. A $240,000 loan at 6.5% interest with a 20 year amortization is $1789.38 per month. We’ll round that to $1800 for easy math. Skippy will receive $2625 each month in rental income. Yes I know he will receive rental income from himself, bear with me. The monthly expenses are an $1800 loan payment, $100 property tax payment, $100 insurance payment, and $75 placed into his maintenance account for routine maintenance. This totals $2075 per month in expenses giving Skippy a net profit of $550 per month. Skippy will place the profit in an interest bearing account each month. I know there are better investment vehicles for the profits, but that is another story in another post. Keeping this pace for the next 6 and 1/2 years, Skippy will accumulate $42,900 not including interest. It is time to visit a bank.

Skippy will proceed to the bank where he faithfully deposited his money every month for the past 78 months. At this point he owes the landlord $191,909.80. Skippy will talk with the commercial real estate officer of the bank that he has cultivated a personal relationship with over the years. You see, Skippy went to this individual in the beginning and explained his plans. He was honest and forthright about all pertinent details. Banks may be leery if you had credit problems in the past, but look at Citi Bank, B of A, Bear Sterns, etc. Everyone, including banks, can run into financial difficulty every now and then. Things happen sometimes that are beyond your control. The bank wants to lend you money. It is their job to lend you money. Cash in their vaults that is not committed to a loan is a liability to them. They are paying interest on money that is making them nothing. Are you starting to get the picture? Skippy went and sat down with the bank’s commercial loan officer in the beginning to build a raport and prepare the loan officer for what was coming down the road. When Skippy goes in after 78 months of doing exactly what he said he was going to do and amassing $42,900 in cash during the process, the bank officer will listen to his word because he has proved that his word is good and his work ethics are sound. If your bank won’t work with you or they talk down to you, find another bank. Now Skippy applies for a conventional loan of $240,000. The bank will oan an 80% loan to value. The building was worth more than $240,000 when Skippy bought it 78 months ago and the area is known for land appreciation, even in the mortgage crisis. For the sake of this example, we will say it is simply valued at $240,000. So the bank will loan 80% of its value or $192,000.

Skippy pays of the loan balance of $191,909.80 to the original landlord. His terms with the bank were 7% fixed interest on a 20 year amortization which brings his monthly loan expense down to $1488.57. This saves Skippy a little more that $300 per month in expense over his previous loan arrangement with the original landlord. Now Skippy is able to put $860 in his account, in profit, every month. Now after 78 months, Skippy has a good relationship with an institution that wouldn’t initially loan him money, he has over $40,000 in cash reserves in the bank, he has a positive cash flow from his real estate of $860 per month and he did it all without using a dime of his own money. Skippy is happy. I’m happy I could help him. That initial landlord is happy they made more from their building than they asked for and the bank is happy that they are able to do their job and loan money. It is a regular Happy Happy Joy Joy Day.

Last note that I didn’t include, Skippy did every transaction through a Limited Liability Company. He did so to protect his personal assets, take advantage of various tax benefits, and increase the net worth of his business. Entity selection and their benefits were beyond the scope of this post but will be the topic of a future one. Now get off your hind quarters, get out there and start asking for the deal rather than waiting for it to be offered to you. As always, contact me if you have questions.

This entry was posted on Friday, August 8th, 2008 at 3:34 am and is filed under Money, Real Estate. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.