The Ultimate List of Ways to Finance Buy & Hold Property
Last week, I made the case that buy and hold real estate is the best investment around.
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Unfortunately, like all good things, there’s always a catch. Buying real estate and holding it requires money, and if you don’t start with much, that can be a great challenge. Luckily, there are many methods to overcome such a problem. However, first it’s important to understand the most important principle of buy and hold.
The Prerequisite for Buy and Hold
In the famous Stanford marshmallow experiment, children were given the choice between eating one marshmallow or waiting about 15 minutes with said marshmallow staring them right in the face, in which case they would get two. Most kids yielded to temptation and ate the marshmallow well before the 15 minutes were up.
The researchers then kept track of the children and found that those who had waited for the second marshmallow had substantially better life outcomes.
The ability to delay gratification is paramount to success. Buy and hold is the second marshmallow. Buy and hold is the ultimate get rich slow scheme. Most buy and hold investors live substantially below their means for many years before building enough equity and/or enough cash flow to fully enjoy the fruits of their labor.
Once that principle is established, you can incorporate any of the following methods into growing your real estate empire.
Methods for Financing Buy and Hold Properties
Save and Hold
It’s absolutely possible for people with decent jobs to simply live below their means and invest in real estate on the side. The advantage to this is that it’s much easier to get bank loans when you can show W2 income, and a job also provides a consistent source of income, even if a particular investment falters.
However, it’s also much more challenging to find good deals when you are tied down with a job, and, of course, you are stuck with the job. This is a fairly passive approach to real estate investment, but it can still be very effective.
FHA loans are a great place to begin for the “Save and Hold” investor. FHA will finance 96.5% of the price of deal at very low interest rates for a homeowner’s property.
The great part is that you can finance up to a fourplex. So why not buy a fourplex, live in one unit and rent out the other three?
Flip and Hold
This is probably the safest, most effective way to get into buy and hold. For investors who are flipping, why not hold every 2nd or 3rd deal instead of flipping it?
For example, use the profit from the first flip to live off of and the profit from the second flip for the down payment on a property to hold. Then rinse and repeat.
When a seller is motivated, there is often an opportunity to get into a property for little to no money down. For example, if the seller has some equity, then they can loan you the money to buy their house from them. Or they can loan a second to you behind a bank loan or another private loan to cover the down payment.
Another option is to buy the property subject to the existing financing. This transfers the deed to you, but leaves the seller on the original mortgage. Be forewarned: this does trigger the "due on sale" clause of a normal bank loan, so the bank could potentially foreclose. And furthermore, it will take a lot of motivation â and plenty of rapport â to convince a seller to do these types of deals, but they're done all the time.
(For more on the subject of creative financing, check out Brandon Turner’s new book The Book on Investing in Real Estate with No or Low Money Down)
It may feel awkward to ask family or friends for money (as an investment or otherwise), but you shouldn’t pass up a major opportunity just because it’s awkward. After all, I went into business with my father and my brother. Family and friends can be a great source of capital as either partners or lenders.
And yes, you will want to be extra careful with their money. But then again, you should be extra careful with any investor’s money.
Bank loans won’t cover the full cost of an acquisition, and hard money loans are too expensive for the buy and hold strategy, but luckily, there is a third way. The method we’ve used the most is to fully finance properties (purchase and rehab) with a trust deed from a private lender — usually someone we know or have networked with — at 9 percent interest only.
Properties won’t cash flow in all markets at 9%, but in working class areas, especially in Southern and Midwestern markets, as well as smaller towns, they often do. It will take a lot of rapport building to convince someone to lend 100% to you. Therefore, it’s certainly helpful to have some deals under your belt to show them, but it is not mandatory.
And remember, you never know who has money. Tell people what you do and what you offer often, and if they show interest, invite them to lunch or a casual meeting. Make a business plan and a packet of case studies (if you have them) to show any potential lender. We’ve found that once people trust us, they are quite willing to swap the 0.2 percent return they are getting in a CD for the 9 percent we offer.
And if you are buying at the same discounts you do when flipping, you should be able to refinance the whole loan (or at least most of it) with a traditional bank in a year or so after the property has "seasoned" (the bank will refinance it based on appraised value instead of what you have into it). By buying it at a discount, you also protect the lender because you still have a substantial equity cushion even though they have fully financed the property.
Instead of finding several private lenders, you can find one person with a lot of money and partner with them. They bring the money, you do the work — and you split the equity in some way that you both find agreeable. This is one of the most effective ways to buy and hold, although again, it will probably take a track record in real estate to convince such a person to partner with you.
Partners can also be done on a one by one basis, but I would hesitate to recommend this approach. Every new partnership needs to be accounted for separately, which can make for an accounting nightmare. More importantly, each partner has a controlling stake in their property, which can lead to all sorts of arguments and disagreements. And this problem will just multiply if you have many such partnerships.
Still, the approach can make sense early on with a few properties if you cannot convince such people to lend instead of partner.
Don’t let the excuse of not having enough money right now stop you. It may take time, but there are plenty of ways to get started in buy and hold. Whatever method you choose, buy and hold can grow your wealth exponentially, so get started as soon as possible.
What’s your favorite way to finance buy and holds? What would you add to my list?
Leave me a comment below!