Let’s face it; we have all seen the reality TV shows and have probably gotten countless emails about how real estate “flipping” is a great way to earn a living. Let me tell you from experience, it is never as easy as it looks or as easy as they are going to tell you.
One of the largest hurdles most new real estate investors face is where exactly can they get the money to do all this. Notice that most of the so called “gurus” out there will tell you just about everything you need to know about flipping properties except where to get the money. This is because it is a very closely guarded secret that they want you to pay a lot of money to find out; preferably to them.
So as a former mortgage banker let me tell you one of the best ways to get all the money you need to become a real estate investor.
Quite simply, it is your family and friends! I know sounds way to simple to believe but let me map this out for you so you can see how this is done with minimal risk to your “investors.”
First of all you will need to set up a real estate investment trust which is known as a REIT. Take the time to set this up correctly. Now, your “beneficiaries” are going to be your investors. They get the “benefit of the trust.” You are going to be the “trustee” and manage the trust. Believe it or not you really do not need a lot of money to make this happen.
If you only get 20 people and each can contribute only $2,500 that is $50,000 and that will be about all you need. But if you can get up to $100K you are doing fantastic!Now, you have a trust that is worth $50K. Honestly, it could be less and if it is you just have to start with a smaller home. Don’t go for the big win on your first time out of the gate. You are going to learn a lot of hard lessons along the way and you don’t want to lose. So start small, make small mistakes.
With a $50K trust you can very easily leverage the assets of the trust along with the value of the home to secure a loan. You can do this one of two ways. First, if you have enough cash is to find a hard money lender and get him to give you a three month contract. That gives you 90 days to fix up the home, stage it and sell it. Time, in any real estate adventure, is your enemy. The second option, which takes a lot longer is to go the traditional route.
If you are a renter, now might be a good time to mention the FHA 203K program. This is a government sponsored program that will guarantee your loan and provide you with a cash account in order to pay for the improvements and renovations of the home. The caveat is that it has to be your primary place of residence. However, last time I checked it made no specification as to how long you actually had to live in the house. Double check with applicable laws but it is a great option for your first home.
So here is how a typical real estate transaction can occur.
You first get the trust set up, then you find a home that based on your knowledge and opinion of the market would make a great property to buy, renovate and then flip. Let’s call the sale price $189,000. It happens to be a foreclosure property that the bank had been sitting on for a while and the property is now distressed. In other words, the bank is desperate to sell because the property is deteriorated. Now most hard money lenders will work with you and to a 60% to 70% LTV. Well, what is 30% of $189,000? It would be a little over $56,000. So what do you do?
Well, here is what I do. I go to a bank. I ask for a $100,000 loan. I pledge the assets of the trust against the loan along with a promissory note against the home I want to purchase. Notice, this is not a mortgage. It is a short term “bridge loan.” It may take some work but eventually you can find a bank willing to do this. Now, go back to the hard money lender, he will give you the 70% of the sales price, take $60,000 from your $100,000 loan to buy the house and to cover closing. That leaves you $40,000 to renovate and cover expenses if you have to float the note for a month or two.
Renovate, update and then sell the house. Say you can sell it at market value of about $249,000. Ok, so now you have $249,000. You need to pay back the hard money lender his $132,300 then you need to pay the bank back their $100,000 for a grand total of $232,300. $249,000 less the $232,300 in outstanding loans leaves a total gross profit of $16,700 plus whatever was left of the $40K you had to renovate. Make sure to pay your taxes and expenses.
The remaining profit MUST go into the trust. At which point you as the trustee start paying back your investors. Let’s say you promised a 10% rate of return. That means you need to pay $250 to each investor. That means $5,000. Call it another $6,700 for taxes and expenses. Oh yes, before I forget, the most important part; don’t forget to pay yourself for all the work you did as the trustee with the remaining $5,000.
So now you know a great way to get the money you need to start real estate investing and all in all it is not a bad return on their investment or your hard work.
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