The Art of Creating Equity

The Art of Creating Equity
By
Herbert J. Strather

The airwaves are full of promoters, authors and so-called real estate experts telling you how to purchase property with no money down. I have read very little ‘properly structured’ transactions allowing for 'no money down'. No money down deals are great and feasible but they must be structured properly. Making a secret deal with the seller for money under the table or falsifying a purchase agreement to a lender is fraught with problems that could even land you in jail. On the other hand, most lenders will not knowingly allow you to purchase property with no money down (on arm length purchases) or take money from the closing table even if you are buying the property at a deep discount. Most lenders residential mortgage policies are to loan 75% to 95% of the purchase price or appraisal price, whichever is less. So how then does a purchaser structure a compliance transaction that results in them taking money away from the closing table?

The first step is to find a deal with plenty of equity in it. That should be the easy part nowadays as deals are everywhere. Just make sure you check out the comparables to confirm the value and have good comps for the appraiser. In the case of income property, carefully underwrite the deal by arriving at a projected Net Operating Income (NOI). Some municipalities adjust or 'uncap' property taxes after a sale. If you do not determine what your future property assessment will be upfront, you could have a very bad day after you have acquired the property and your assessment triples. If any of you are unable to properly underwrite deals to arrive at a reliable projected NOI, then stay tuned to my future articles or you can acquire a proforma disk with instructions by ordering directly from our website at: www.stratheracademy.com.

Once you have arrived at an estimated value and a NOI, it is time to negotiate with the seller. Always approach your seller with an open mind. I often say that if the seller is blue then you be blue. Find common ground with the seller. Never sit down and commence negotiations without breaking the ice. Once the seller is relaxed and ready to listen, carefully explain your offer to the seller. You should have thought through your approach in advance of the meeting. Let’s use an example of a two flat that would be worth say, $100,000 if it is fixed up. Let’s say the property is in slight disrepair and could use about $15,000 worth of upgrading. You might offer the seller in today's market around $40,000. This amount represents a conservative price in the current real estate market for a 2-flat that requires repairs. If the seller accepts this amount as his net sales price, you must then ask the seller the magic question. “Mr. Seller, if we agree on the price and terms you want ,do you mind how I structure the deal so long as it has no adverse ramifications to you?” I have never had a seller turn me down however, if the answer is negative then get up and leave, find another deal. If the seller goes along with the proposition, then my friend you are almost home.

The idea here is that you want to buy the property with a fix up budget attached. The fix up responsibility along with the check to pay for the work should be transferred from the seller via the title company, to your friendly contractor at closing. The last thing you want is to buy a dog and then try to find the money to fix it up. You should fix up the property immediately after closing for all stakeholders which includes you, the community, the lender and the future tenants.
Someone once asked me, What price does your purchase agreement reflect on the 'creative deals' that you do? My answer was simply, the maximum price possible! The difference between what the seller wants and the mortgage amount less fix-up and mortgage costs belongs to the purchaser. You want the maximum price possible in order to receive the maximum possible mortgage in order for you to have adequate funds to complete repairs. It may also ensure the possibility of money left over to put in your pocket. In addition, you want the highest price possible because you want to protect the comparables in the community. One of the worst things you can do is to lower the values in a community by recording a low purchase price. Remember, the stated purchase price in the purchase agreement does not necessarily reflect what you are actually paying after you deduct credits for repairs, closing costs and fees if you are a real estate agent.

So the only real question we have pending is how do you get money back at closing?

i. Enter into a fully priced purchase agreement with contingencies. An example would be worded as, “This sale is contingent on seller being responsible for all reasonable improvements that the city inspectors, the buyer or their home inspector requests, to be determined within 45 days after this agreements date of origination. If seller and buyer cannot come to terms, this transaction shall be cancelled and the deposit returned to the buyer”. Note: there is no mention of the seller’s net amount. Try to put this language in the body of the purchase agreement and not on a rider. If this is in a rider, it will draw the attention of the lender.

ii. Have your mortgage approved (within the 45 days) then finalize the purchase agreement. At this point, you will know the net mortgage proceeds so you and the seller can come to terms.

iii. At the closing, the repair funds are paid to your friendly contractor, to complete repairs for you. The check should also include the buyers’ name to ensure the repairs are completed satisfactory before the contractor negotiates the check.

When all the smoke clears, your numbers should look like this:

Sales Price: $100,000
Down Payment: -$20,000 (possibly via a trade or note if you have no cash)
Mortgage : $80,000
Proceeds to seller: -$40,000
Gross to buyer: $40,000 (less closing costs, plus note)
Less closing costs -$5,000
Less repairs -$15,000 - $35,000
Net to buyer 0 - $20,000

Under this scenario your friendly contractor (and you) should walk away from the closing table with a check for about $35,000 (plus your promissory note of $20,000). This amount represents the net proceeds after subtracting closing costs and adjustments. Perhaps you can help the contractor fix up the property for reduced costs.

One last important thing, try not to acquire a property that needs a lot of obvious fix up. The lender might escrow the funds with the title company to be disbursed after the repairs are completed and the buyer will not walk away with money unless the buyer does the fix-up based on a competitive bid. To learn more about creative purchase agreements and strategies please considered purchasing ‘Getting Rich Is Easy’ by going to www.stratheracademy.com



About Herb Strather.

Herbert (Herb) J. Strather, author of Getting Rich Is Easy and How to Survive and Thrive in a Recession is a successful businessman and real estate entrepreneur who has purchased, brokered and developed more than 3 million square feet of real estate totaling more than $2 billion in real estate deals. Some of his noteworthy developments that have significantly impacted Detroit includes Woodbridge Estates, a 46 acre, $100 million mixed use residential community and the elegantly appointed, Hotel St. Regis. He is one of the originators of the casino industry in Detroit and is the former Chairman of Atwater Entertainment which developed and sold Motor City Casino.

A philanthropist and member of several boards and organizations, Herb Strather is on the international board of Optimist International, an association of more than 3,000 Optimist Clubs worldwide dedicated to “Bringing out the Best in Kids”. Strather has personally established more than 130 Optimist Clubs worldwide. Strather has lectured at the Summer Leadership Institute at Harvard Divinity School where he teaches Faith and Finance and is also a regular lecturer at the University of Michigan's Stephen Ross School of Business and Wayne County Community College in Detroit. Strather is currently focusing his attention on helping people to 'survive and thrive' during the current real estate and financial crisis through his books, DVD’s, seminars, lecturers and Strather Academy (www.stratheracademy.com)