I like to speed.
Traveling down the freeway, something just seems wrong about going the speed limit. I have to push the limits just a little. This is what intrigues me about the Autobahn in Germany. This federal highway has no federally mandated blanket speed limit, which makes it a dream for people like me.
However, just because the highway has no speed limits, that doesn’t mean a driver can afford to be stupid.
In fact, Autobahn drivers are mandated to control their speed during adverse weather conditions and in urban areas of the road. Additionally, an “advisory speed limit” of 81 mph applies to the entire freeway system to protect drivers.
What does this have to do with creative real estate investing? Creativity in real estate is a kind of open road that often appears to be “rule free.” However, the same conditions that make it so exhilarating can also lead to the greatest crashes. Therefore, investing in creative real estate has its own “advisory speed limits” in the form of four important guidelines.
These are four of the primary rules and advisory limits of creative real estate investing. These have been passed down from one established investor to another with the goal of keeping aspiring investors from crashing and burning.
The 4 Commandments of Using Creative Investing Responsibly
1. When investing creatively, you need to find even better deals than those who invest normally.
Let me explain what I mean. Let’s say a certain home is worth $100,000. A traditional investor might pay $100,000 for that home, put a 30% down payment ($30,000) on the property, and make a nice return on investment from the cash flow (the extra money left after all the expenses are paid).
However, if I were to purchase that same house for $60,000 because I took the extra steps necessary to get a great deal, which of us is in the better position? The traditional investor, who has $30,000 of their cash tied up in their property and no real equity, or me, who has nothing invested but owes less?
Because of the deal I obtained, I have far greater potential for profit and for a better return on investment than the normal investor, but less of my cash is at risk because I have no cash invested at all. However, what if I decided to be just a “normal” investor and pay full price for that $100,000 property, with no money down? Most likely, my mortgage payment would be so high that good cash flow would be out of reach, and I would not have the equity necessary to be able to sell the property. In this case, the “good” investor would be in a better position because they owed only $70,000.
Hopefully, you are following my argument here—creative investing means you must invest in incredible deals, or it’s simply not worth doing. There are exceptions to this rule, of course. Sometimes the method of financing can sweeten a deal enough to entice you to jump in. We’ll talk more about those strategies later in this book.
2. When investing creatively, you must be extremely conservative.
I’m not talking politics here; I’m talking about planning for the future. This means assuming the worst when buying property. Take as a given that taxes will go up, your unit will sit vacant for a certain percentage of each year (higher than the average for your area), repairs will be numerous and expensive, and you will need to evict deadbeat tenants. Plan for these costs and only buy property that proves to still be a good deal even after a conservative estimate.
Although the analysis side of the real estate transaction is beyond the scope of this book on creative real estate investing, I encourage you to spend some time on this subject by studying how to analyze an investment property on BiggerPockets.
3. Creative finance requires sacrifice.
Remember my definition of creative finance: the ability to trade cash for creativity. Notice there is a trade-off involved—one you need to accept. Most of the methods I’ve used to acquire real estate, I discovered the methods at 4:00 a.m. after an eight-hour brain-storming session with my wife, my pen, and my paper, desperately trying to figure out the missing puzzle piece that would enable me to close a deal.
This is often the trade. It requires jumping through a lot of mental hoops, numerous conversations with others, and the ability to ask for help. Creative real estate investing is a puzzle that takes real mental (and sometimes physical) effort to put together.
If you want easy, then stick with a job, a sizable down payment, and average returns. There is nothing wrong with that, and I’d have chosen the same if I’d had enough money and income when I started. But I didn’t, so I chose creativity. I chose to sacrifice. Will you?
4. Creative finance does not mean investing without a cushion.
A wise man and mentor once told me, “You can go broke buying good deals.” Even though you need to get killer good deals if you are going to invest with no or little money down, you still need to understand that bad stuff happens. Murphy will show up on your doorstep and start knocking. He might even move his whole family in. (If you don’t understand the reference, Google “Murphy’s Law.”)
Therefore, maintaining a financial cushion to deal with problems is imperative. You don’t need $50,000 in the bank to buy a small rental house, but you do need to be able to weather the storms that will come, relative to the size of the property you are buying and that property’s risk for loss. For example, if you needed to evict a tenant, could you handle several months of lost rent, more than $2,000 in eviction costs, and several thousands of dollars to repair the property? What if you had to do this twice in the same year? These are important questions you must be able to answer, or at least discuss. Many of the strategies in this book will deal with solutions for issues like this, so don’t give up on this book quite yet if you are down to your last dollar. These questions do have answers, so hang in there and keep your brain turning.
I can’t tell you exactly how much money you’ll need to save, because that depends largely on a number of factors, including the following:
- The strength of your target real estate market
- Your ability to manage effectively
- You ability and desire to repair things yourself, if needed
- How difficult and lengthy evictions are in your state
- How good your credit is
- How much cash flow you can get
- The average purchase price of your target properties
- The niche you enter
- The strategy you use
- And a whole lot more
The point is, be conservative, buy great deals, and have a financial back-up plan. If this means spending six months working a second job to save up $5,000 to put into a savings account, then start that second job tomorrow. Maybe it means asking your boss for a raise or lowering your living expenses (remember… sacrifice!).
Whatever you need to do, get started as soon as possible. Stop wasting time on excuses and start planning for how you are going to get there.
Furthermore, even though having a large financial cushion to weather storms can help you significantly offset risk, you cannot simply throw money at real estate investments and hope they turn out well. Education is key. Will you read the books, study the material, ask the right questions, and insist on becoming the best? I hope so.
[This article is an excerpt from Brandon Turner’s The Book on Investing in Real Estate with No (or Low) Money Down.]
Are you looking to use creative finance in your investments? How do you plan on using it safely?
Let me know with a comment!
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.