Rather than re-hash the same “getting started in real estate without cash” article, I thought I would take my post in a different direction.
Let me explain. . .
A few weeks ago, Todd, a former co-worker, and I went out to dinner. During our meal, the topic of real estate investing came up. Todd shared that he had wanted to invest in real estate, but just never had enough capital to get started. I asked him why he let money stand in the way of his goals. Of course, he had no idea what I was alluding to, so I spent the next thirty minutes sharing the various ways he could get involved with real estate investing without using his own cash.
The outcome of our conversation was an equity partnership which allowed Todd to consequently get started in real estate without using his own cash.
Highlights from our conversation
The first point I shared with Todd is that a deal is comprised of many variables: time, capital, relationships, knowledge, etc. I told him the key to becoming integrated into any deal is figuring out the value he brings into the equation. I asked him what value he thought he could offer to another investor.
The question worked somewhat against me because he grew discouraged considering what value he could bring. He shared that he didn’t know much about finding deals or raising capital and didn’t have a lot of time to allocate to overseeing contractors. I was quick to point out that there was one potential asset he overlooked: credit worthiness.
I shared how, with the right partner, his credit worthiness might be enough to get him into his first deal. This immediately perked his interest and we spent the rest of our time outlining the details of how we could make an equity partnership work.
Here is how we worked out our first deal:
Acquisition: Since I can no longer qualify for conventional financing, I have been purchasing homes in cash, fixing them up and refinancing them via a home equity line of credit. In my agreement with Todd, I would continue to front all the capital for the acquisition and the rehab costs.
Financing: After the property is rehabbed, he would be put on the title as well as take out a line of credit on the property. Todd agreed to be the sole individual responsible on the debt service.
Loan-to-value: The local bank we are working with will allow him to pull 70% of the market value. The goal for each purchase is to buy below market value, rehab the property, and have it appraise for significantly more than I purchased it for. The property we are currently working on has a purchase price of $80K and needs about $7K in repairs. The after-repair value is approximately $115-120K (depending on the appraiser). If all goes according to plan, the equity line will be about $80K. My cash in the deal should be about $7k.
Equity: In exchange for borrowing his credit, I have agreed to provide Todd with a 20% equity stake in the property as well as a percentage of the net cash flow.
Timeline: We have agreed to structure the deal for a period of 8 years with the option to extend an additional 5 years (side note: the HELOC is for a period of 15 years). At the end of our agreement, we will liquidate the property and Todd will collect 20% of the net appreciation.
Fail-safe: In the event that he needs to get out of our agreement, I have 15 months to obtain favorable financing or to liquidate the property. We also have several other details drawn up in our partnership agreement in the case of divorce, death, etc. (email me if you want more info).
Before we put anything in writing, I had both Todd and his wife over for dinner to discuss the details of our agreement and the responsibilities of each party. After our conversation, they both agreed that they were very excited to move forward with this opportunity. If all goes according to plan, they stand to generate about $100 a month in passive income and have a 20% equity stake in their first rental.
I know that $1,200/year may not seem like a significant sum of money, but considering his options, this is a great opportunity for him to grow his passive income, learn the ropes of the rental business and capture potential upside on the sale of the property – all with no money in the deal. Also, with talks about doing a second deal already in the works, Todd can begin building his own real estate portfolio.
If you are just getting started or are looking at new ways to continue to expand your rental business, this type of partnership might be a valid option to consider.
Readers, what types of strategic partnerships have you used to continue to grow your business in this market?
Photo: Casey SerinReal Estate Investing Without Cash: Leasing Your Credit by Arthur Garcia