Creative Financing

22 Replies

Question for the BP forum? What do you do when you are tapped out of liquid cast to jump on a deal? This is for general knowledge and also evaluating my situation question. Say you have a seller that wants out completely ie No seller finance. You want to jump on the deal, get the seller their funds and have capital for rehab. This is for buy and hold. Obvious choices aside, Hard/Private money, Seller Carry, wholesale, contract carry, Investor cash...

What are some of the most creative deals you guys have pulled off?

JV Partner with a doctor

Ex 

$100K ARV needs $20K

Offer .65 x 100K - $20K = $45K

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Start LLC with Doctor - Go to Sercretary State's Website

Operator Agreement 2 Party LLC download

see attorney

---

Say to Doc

"Doc, I have a business propostion for you.

"I find a steal of a re investment, needs work, say after repaired value = $100K, needs $20K, I get it for $45K.

"You and partner up, You buy it and put up the $20K, you have $45 + $20K = $65 K into it.

"You and I sign a LLC partnership agreement. After we sell it, you get all your money back, All $65K, and pay the costs to sell.

"Say it goes like this:

"Costs to Acquire - $45K 

"Costs to Fix - $20K

"Costs to Sell for $100K - agents commission, closing coasts, holding costs = $10K

-------------------

"$75,000

"Net $25,000

"You get your $65,000 costs back plus 50% of gross profit $25,000 or plus $12,500.

"Annual % profit -    $12,500 div $65,000 = 19.2% annually

"For 3 months = 19.2 x 4 = 76.8 % annual

"We can do 4 of those a year.

"What do you think Doc?

And by the way, Doc, you can use your IRA money, and if you set up a Roth IRA, you never pay tax on the profit, EVER."

@Dmitriy Fomichenko  

if you could say a few words about SDIRAs and JV Partnering.

@Brian Gibbons 

The proposal to JV with another investor is fine. If an IRA is involved, the key concern is avoiding any dealings with disqualified parties. So long as said doctor is not a lineal relative, that would be a non-issue.

The only thing you overlook is that if the IRA has an equity stake in a flipping transaction, that is considered a trade or business activity and comes with exposure to UBTI taxation. Sometimes that is OK and the return is still superior to other options. More often than not, it is better for an IRA to be a lender and receive a fixed interest return - which is passive and not subject to UBTI.

As an investor seeking to work with private capital, it is important that you have a good resource for self directed IRA plans to refer investor partners to. Don't try to become a tax expert yourself. Focus on the opportunity at hand and letting the partner know they could use IRA funds if they choose, then let the professionals provide tax guidance.

Originally posted by @Brian Eastman :

@Brian Gibbons 

The proposal to JV with another investor is fine. If an IRA is involved, the key concern is avoiding any dealings with disqualified parties. So long as said doctor is not a lineal relative, that would be a non-issue.

The only thing you overlook is that if the IRA has an equity stake in a flipping transaction, that is considered a trade or business activity and comes with exposure to UBTI taxation. Sometimes that is OK and the return is still superior to other options. More often than not, it is better for an IRA to be a lender and receive a fixed interest return - which is passive and not subject to UBTI.

As an investor seeking to work with private capital, it is important that you have a good resource for self directed IRA plans to refer investor partners to. Don't try to become a tax expert yourself. Focus on the opportunity at hand and letting the partner know they could use IRA funds if they choose, then let the professionals provide tax guidance.

 Yes Brian all that is true, 

I have all my JV Cash and Credit Partners read this book.

http://www.amazon.com/IRA-Wealth-Revolutionary-Str...

Patrick Rice from Pensco Trust.  Best book on the subject.  

I use www.TrustETC.com

Read this to be a private lender or help others be a private lender

https://www.trustetc.com/resources/education/artic...

I just want to clarify that Pat Rice is not associated with PENSCO Trust Company. His book is a good resource for beginner IRA investors, but he is in no way affiliated with or a spokesman for PENSCO. Various staff members including PENSCO's founder, Tom Anderson, provided Mr. Rice with technical guidance when writing the book.

@Justin Green Seems like a self-directed IRA is a solid way to go. There's a BP Podcast, episode 084 with @Chad Carson  where he explains how he does it. Let us know if and when you've figured it out. 

@Brian Gibbons  Thanks for a wonderful breakdown. The numbers along with your verbiage is really helpful. 

@Brian Eastman  Wonderful point about let tax professionals do their thing. I think the number one thing is to protect the integrity of the relationship you're trying to foster.  

Thanks, guys, for a great mini lesson for this newbie : ) 

Thanks guys. Taking on a partner to flip is an option although I don't like that much personally. Also I am a buy and hold young guy so the sale will be many years down the road. I do have a good amount of funds in my 401K but also being a W2 employee at the moment does not allow self directed IRA.

Also self directed IRA would be great for retirement not the next few years. All cash flow and profit would be right back in the self directed IRA, that's OK if I build another portfolio inside the IRA but I wont see that for 25 years without penalty.

I agree that it would be more prudent for IRA holder to simply act as lender in a transaction that may involve UBIT otherwise.

If the doctor is self-employed even better route would be self-directed Solo 401k, which would allow him to fund this deal inside of his retirement account but also gives him the option of pulling up to $50K via participant loan and keep all the profits to himself. This is a great option to invest in a transaction that would otherwise be prohibited (if it involves 'disqualified person').

Dmitriy Fomichenko, Broker
(949) 228-9393

Great discussion all of you.

A few questions and maybe a comment too.

 @Brian Gibbons 1) Thanks for the book recommendation - I ordered it this morning both for myself to read and a couple of people I have been talking too about being Private Lenders/Investors.

 2) In your scenario above (great breakdown of things) do you see that as the 'active partner' doing the labor themselves, or hiring out things and just coordinating? I am asking because I am mostly interested in buy-n-hold rentals, but one investor is interested in doing almost exactly what you outlined above - him and I need to talk details yet.

@Dmitriy Fomichenko   I need to read up  more on the Solo40s still. I think you might have commented on this in another tread, but I can't find it. I am self employed right now. I have a SIMPLE from a previous employer, and I have been doing ROTHs currently for myself. 

1) If I remember correctly, there is NOT a version of solo401 that I can roll my existing ROTHs into, correct? 

2) If I understand correctly, I cannot contribute more than I make as 'earned income' into the Solo401 - Is that also correct?My thought is when I have a slow year in business, say I make 10K that year, that I might sell an asset I have been thinking about and have 'extra dollars' above my earned income that year to contribute. 

3) If my assumption above is correct that I cant roll my current ROTHs over, would there be any logic to withdrawing some of my contributions to those ROTHs and putting them into the Solo401? I am particularly interested in this as I am working on locating Private Lenders to do Non-recourse Loans to my SDIRA for buy-n-holds so would be 'leveraged' there.

Thanks, Dan Dietz

608-524-4899
Originally posted by @Justin Green :

Thanks guys. Taking on a partner to flip is an option although I don't like that much personally. Also I am a buy and hold young guy so the sale will be many years down the road. I do have a good amount of funds in my 401K but also being a W2 employee at the moment does not allow self directed IRA.

 You should look into ways to make your 401k money available in the short term without penalty. This would be a short term solution to a long term plan if you are going to buy & hold. If your cash shortage is temporary, that is okay. You may have to remove money from your 401k and roll it into a situation where you have a local money manager i.e. Edward Jones etc.

I often tap into my IRA's in the short term when there is a deal too good to pass up and I believe that I will have cash to replace the borrowed amount. It has to be worth the risk though, if you don't have the cash, you could be in trouble.

I'm no expert on this, that's why I pay accountants & financial advisors, but I know I can borrow up to 50% of my total IRA value once per year as long as the money is back in there by December 31 maybe even April 15, not sure. Just a thought here, I'm sure it will take some time to get in place and probably won't work for a deal you have right now, but once its in place, its ready for the next one.

@Daniel Dietz  

You are not allowed to rollover Roth IRA into Solo 401k.

The contributions to Solo 401k are based only on the 'earned self-employment income'. Sale of an asset or property is not self-employment income, and distributions from Roth IRA are also not your earned self-employment income.

Dmitriy Fomichenko, Broker
(949) 228-9393
Originally posted by @Eric Christians :

I often tap into my IRA's in the short term when there is a deal too good to pass up and I believe that I will have cash to replace the borrowed amount. It has to be worth the risk though, if you don't have the cash, you could be in trouble.

I'm no expert on this, that's why I pay accountants & financial advisors, but I know I can borrow up to 50% of my total IRA value once per year as long as the money is back in there by December 31 maybe even April 15, not sure. Just a thought here, I'm sure it will take some time to get in place and probably won't work for a deal you have right now, but once its in place, its ready for the next one.

With IRA you are not allowed to 'borrow' any money from your account. The loan feature is available only with 401k. If 401k plan allows participant loan, then the account holder can borrow up to $50K or 50% of the account balance. The loan must be paid back using amortized schedule over 5 years.

I hear sometimes people referring to 60-days rollover rule by pulling funds from their IRA and using them for their own purposes. IRS allows you to take a distribution from an IRA and as long as those funds are deposited into another qualified account within 60 days it will not be taxable event. In my opinion this is dangerous practice to use those funds to invest in real estate deal. First of all this is not the purpose of the 60-day rollover, and second, if for some reasons you are not able to dispose of that deal and can't get the funds within that 60-days window you will be taxed and penalized on the entire amount.

Dmitriy Fomichenko, Broker
(949) 228-9393

IRS allows you to take a distribution from an IRA and as long as those funds are deposited into another qualified account within 60 days it will not be taxable event. In my opinion this is dangerous practice to use those funds to invest in real estate deal. First of all this is not the purpose of the 60-day rollover, and second, if for some reasons you are not able to dispose of that deal and can't get the funds within that 60-days window you will be taxed and penalized on the entire amount.

 Thanks for clarifying Demitry, I'm not sure how I got the end of year and 60 days mixed up. Either way, I do this quite often, I think you are allowed to do it once a year and I've done it every year I can remember, but like you said, it is a dangerous practice. I have only done it when a deal presents itself that would be worth paying the tax & penalties on if I had to,  and I also have some flips ready to hit the market but no contract yet and I have high confidence that they will sell fast. I don't necessarily have to turn the house that I'm borrowing the funds for in 60 days. 

I have taken great risks but the rewards have been worth it. I'm sure there are plenty of others who have taken the same risks and would say otherwise, but its all a game, win some, lose some, and as Demitry said, it is dangerous.

@Dmitriy Fomichenko so if I am understanding you correctly, even thought there is a "ROTH Solo401k" option when setting up a new account, my existing ROTH IRA cannot be rolled into that type of plan?

IF that is correct, do you or any others here see a problem with this potential course of action; 

Say I have 50K of original contributions in my ROTH that I can withdraw without penalty (leaving the earning in there) at a rate of 10K per year. From what I understand this would be tax free since it was taxed before going into the ROTH. If I have 40K of self employed income this year, put not enough 'cash flow' from that income to contribute to the Solo401k, I could use the 10K withdrawal from the ROTH that I took to fund the Solo401K. It 'seems' like it would work, but maybe I am missing something?

Dan Dietz

608-524-4899
Originally posted by @Justin Green :

Question for the BP forum? What do you do when you are tapped out of liquid cast to jump on a deal? This is for general knowledge and also evaluating my situation question. Say you have a seller that wants out completely ie No seller finance. You want to jump on the deal, get the seller their funds and have capital for rehab. This is for buy and hold. Obvious choices aside, Hard/Private money, Seller Carry, wholesale, contract carry, Investor cash...

What are some of the most creative deals you guys have pulled off?

You could check the cushions in the couch and on the floor of the car, check between the seat and the console. ( LOL )

Creative financing is tossed around a lot with mentions of retirement accounts or seller financing or cross-collateralization as being "creative". I think a better term for these options would be more to "alternative financing" as creative is something that is unique, not often used, something developed to the circumstances that best use the assets you control or influence.

Not saying that the proper use of retirement accounts isn't good cash management, a good way to fund operations, but as often as these funds are employed, I don't see them being creative financing. BTW, good information above about utilizing these accounts!

'Creative financing" begins by identifying liquid, non-liquid and economic assets.

Cash accounts, cash, savings, retirement funds, securities, accounts receivables, annuities and insurance are all sources of funds.  These are "current assets" in accounting terms that can be drawn upon quickly that are liquid assets.

Non-liquid are "long term assets" which can not be converted within one year without a significant loss in value (liquidation sale). I had one investor that was in the heavy equipment business, I'd take equipment as collateral to take care of down payments, rehab or operational expenses, he was using non-liquid assets to obtain financing.

Economic assets will be getting more creative, these boil down to the basic principles of economics, land, labor, capital and entrepreneurship. Now, take out land and capital as those aspects are pretty well understood by RE investors. Labor, your labor can establish sweat equity, you may quickly force appreciation to increase value. Labor is also going to be an expense in rehabs, paying for labor of others, how labor is paid effects your cash flow and the funds needed, reduce or delay these expenses and you can reduce the financing required. Entrepreneurship is your management and business expertise.

Your management or how you devise your transaction may reduce or even eliminate cash required in conventional transactions. If circumstances exist you can partner with the owner and many are receptive if you sweeten the deal for them at the end.  

Reducing the cash required is a creative financing aspect when the price can not be reduced, it's the goal really of getting creative. Wipe away the entry costs and you have substituted you management skills for what otherwise would have been financed.

The efficient use of the assets available to you will present the options available to you, creative financing is not dreaming up unconventional loan terms or bumping into financing compliance matters.

Before you can apply creative financing through a loan, you must clearly understand what is legal, illegal, acceptable, enforceable, securitized and can be managed under various events that may pop up over the term of that loan. If you don't know the financing rules, laws and compliance matters you'll be playing with nuclear waste!

Various sources of funding used in combinations provide creative solutions, seller financing, crowd funding, angel funding, investor pools, joint venture capital, conventional financing and other sources can be combined to provide unlimited possibilities.

Deals done? I've employed all these facets:

Factoring receivables, (borrowing against income) lease income may be pledged to a lender. Certificates of deposits or securities may be pledged. Not only can a pledge of collateral be made to a lender but also to a seller, an investor to partner, to a GC to carry labor costs or reduce expenses by delaying an expense. 

Pledging assets held or controlled has been used, through contributing management and services in partnerships the use of assets of the partner are pledged.

Partnering, formally or informally with a GC having them finance materials and labor to the end eliminates the need to finance the rehab, simply contract on a turn-key basis.

Don't forget government as a financing source, economic development loans, tax abatements and bond financing can be used in connection with private funding. Tax credits are rather a creative financing concept, but it's a long used program that really places it in that alternative financing category.     

I have had many sellers partner for a better deal at the end. On a larger scale, by playing on the sentimental and empathetic nature of an owner, where the land had been owned since the Civil War (zero basis) and desired the use of land to benefit lower income clients, the owner was elderly and knew the use of the farm that was inside the city limits would change, it became a manner of ensuring how the property changed, BTW, this owner kicked in cash for the development as well. It became more about estate planning, using a Charitable Remainder Trust taxes were reduced and a special note addressed the needs of heirs. I've posted this deal before so details would be redundant.

In business sales, the sale of a grocery store, inventory was financed with an assignment of sales receipts, as the inventory was sold the seller received the cost plus part of the profit. I've set up equipment lease financing, car dealers, even a pawn shop and jewelry dealer's operations.         

Creative financing is problem solving, the more you know in areas of finance, such as financial planning, estate planning, securities, banking, insurance and cash management the more tools you will have in any situation.

Learning to be creative begins with understanding what assets you have to leverage a deal. You must be aware of legal aspects and the rules to ensure strategy is safe, doable and will end up they way you planned it. Before you can think out of the box, you need to understand what is in the box! That's enough! :)

Originally posted by @Daniel Dietz :

@Dmitriy Fomichenko so if I am understanding you correctly, even thought there is a "ROTH Solo401k" option when setting up a new account, my existing ROTH IRA cannot be rolled into that type of plan?

IF that is correct, do you or any others here see a problem with this potential course of action:

Say I have 50K of original contributions in my ROTH that I can withdraw without penalty (leaving the earning in there) at a rate of 10K per year. From what I understand this would be tax free since it was taxed before going into the ROTH. If I have 40K of self employed income this year, put not enough 'cash flow' from that income to contribute to the Solo401k, I could use the 10K withdrawal from the ROTH that I took to fund the Solo401K. It 'seems' like it would work, but maybe I am missing something?

With Solo 401k you can make post-tax (Roth) contributions (if your plan allows) as well as conversion of your pre-tax contributions or rollover into Roth 401k (again, if your plan allows), but you are not allowed to rollover Roth IRA into Roth 401k.

Unfortunately I'm not qualified to answer this question since I'm not a tax attorney or CPA. I suggest that you speak with qualified professional about your specific situation. 

Dmitriy Fomichenko, Broker
(949) 228-9393

@Chad Carson   That is a great idea. I take it you are testing the waters on a property with this method. Getting tenants in and rented. Meanwhile holding exclusive option to purchase with fixed costs to your credit partner. I will explore this more on some easier properties. It gives you control without using your funds. I follow the logic.

My option strike price increased yearly at a 3% rate to give my credit partner a capital gain. 

Are you setting option price from the beginning and increasing it every year? depending on amounts I would imagine your option being 2-5% then 3% on top of option price.

example $10,000 option raises by 3% every year if not exercised? 10,300 after year 1?

@Bill G.  Thank you for that thoughtful response. This is opening my eyes over the last few years to this new world, so far open my eyelids are pasted to the back of my head.

Solving a problem is the key to creativity. I come from a world of fixing things with whatever you have on hand.

I am taking a long look at all my assets that can delay the need for immediate funds.

No funds, Seller wants out completely? Either get a private loan from someone else, or find a partner to tackle the deal!

Hold on folks, increasing your option price is no longer an option contract, you have a disguised sale contract that has no buyer default provision. This is exactly the type of issue Brian posted about in another thread, if you don't have a true option, then you don't have an option with an option price paid, it changes the stripes of the money you received.

If you want to increase the sale price, do options annually!

You could have a 5 year option, you can then agree to enter into a new agreement and terminate the old one and allow the consideration to be credited to a new contract.

An option must have a fixed and measurable price, stated consideration to be paid. That is the basis of valuing an option as it is valued as to the price agreed compared to the expected price in the future and, if leased, the value of the difference between the amounts paid and expected rents to be paid in the future. Putting the agreed price or option fee in an agreement as a moving target destroys the purpose of an option and it's valuation.

Options must have the names of the parties, the subject asset described, an option price stated as consideration for granting the option, a fixed purchase price allowing an asset to be purchased over the term of the agreement, the term must be stated with a termination date and it may not require any performance required, of any kind, by the optionee (buyer) or be conditioned on some future event or factor. If any of these aspects are not met, then you don't have an option, you have a purchase arrangement. :) 

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