The 3 Levels of Real Estate Investors

Once upon a time not too long ago, a peanut farmer had just left the White House, a former actor replaced him in our nation’s highest office, and the Prime Rate (the interest rate banks charge their most credit worthy customers–usually their most prominent and stable business customers), was at 20%.

The national average contract mortgage rate derived from the Federal Housing Finance Board’s Monthly Interest Rate Survey (MIRS), an average rate based on conventional fixed and adjustable rate loans on previously occupied nonfarm, single-family homes was at 15.5%. Most lenders who made real estate mortgage loans during this time were called Savings and Loans.

The failure of the Savings and Loans

These S & Ls, as they were called, were having trouble attracting depositors because of ceilings imposed by the federal government on what they could pay as incentive to savers. They also had too many low, fixed-interest, long-term loans on their books.

The federal government loosened many of the S & Ls’ imposed restrictions. But because of continued mismanagement, many of these S & Ls were forced to merge, consolidate, or outright fail. Our banking industry and the real estate markets around the country experienced tough times.

The Financial Institutions Reform Recovery and Enforcement Act (FIRREA) of 1989 established a new government organization called the RTC (Resolution Trust Corporation), an organization designed to bail out the S & Ls.

Creative investors look for solutions

During those turbulent times, it was impossible for real estate investors to get traditional financing for non-owner-occupied properties unless they put down 20% or more in cash. In short, access to mortgage money and the overall availability of credit was very tight. Investors found it very difficult and sought alternative ways to put together transactions.

One way was owner-assisted financing. Motivated sellers who had to dispose of their real estate holdings could, in essence, act as the bank and elect to finance the buyers themselves. In many marketplaces around the country, this was one of the few ways property sales were actively transacted.

While this trip down memory lane may be a reminder to some, many new investors cannot comprehend that the free-flowing mortgage marketplace as they know it today was far different back then. Since history is said to repeat itself, most long-term real estate investors understand that property values run in cycles.

While I cannot predict what might happen or when it might take place, I can tell you from our history that generally when interest rates rise:

  • Availability to capital tightens

  • Loan programs and underwriting requirements become more stringent, and

  • Access to mortgage money overall is more restrictive

Those who understand of how to buy, finance, and sell real estate without traditional financing will have a tremendous edge over those who do not. Here are just a few reasons why:

Reason #1

When you borrow money from traditional mortgage lenders, you have to take their standardized loan programs which leave little room for “tweaking” the terms of how you will repay back their debt. I label traditional mortgage financing products as being “off-the-rack” financing.

However when a willing buyer and seller get together to create a “custom-tailored” plan between themselves, the components involved in financing the transaction can be negotiated, such as: price, interest, and how payments are paid (daily, monthly, annually, simple or compounded, etc), the timing of the repayment, etc.

Reason #2

Often, motivated sellers who NEED to sell will sell you their property and finance the balance of their equity with a zero interest, sometimes zero payment program. First determine if a seller really needs their equity out of their property in cash right now. Most can wait and are willing to wait.

Some only need some cash now and can wait to receive the rest later. If the seller is willing to wait for the balance of their equity, you could offer to pay more to them for their property if you can pay them when the property sells. Just try getting that type of financing from a traditional mortgage lender.

Reason #3

Recourse Vs Non-Recourse Debt: Why should you put all of your hard-earned assets at risk if one of your investments does not pan out? With private financing negotiated, it’s very feasible to limit your risk.

Reason #4

Properly structured real estate secured paper has tremendous marketability in good and bad times. The conversion of the paper into cash allows you to obtain the best of both worlds: flexible repayment terms while still generating cash to the seller.

Reason #5

Through an understanding of various real estate financing devices like Wraparound Mortgages, AITDs, Contract for Deed, etc., you can become the banker yourself and start offering your own financing programs to unbankable buyers. You can now create positive “spreads” in equities, cash flow, and interest rates in your favor.

By CREOnline Contributor

A content contributor to the original