I've decided to get a head start on my New Year's resolution to buy at least one rental property this year for my personal investment portfolio. I think I may even be able to do it with no or very little money out of my pocket.
Over the weekend, I heard an investor / businessman on a real estate investing radio program talk about filled lease option properties that his companies sells. Now, I've been aware of these for a while because I've been on his mailing list for quite some time, however, this was the first time I actually got to hear him speak about it in detail and take questions from listeners. In a nutshell, you can buy a property from his company for under fair market value. The property has a tenant in place who has an option to buy the property at your appraised price after 1 or 2 years. The best part is that, at the close of escrow, you get a year or more of pre-paid rent. This means you won't get cashflow since the tenant isn't paying rent, but instead you get all that rent money up front. And thanks to inflation, money now is always better than money in the future!
My plan is to buy one of these properties with hard money, then refinance to a conventional loan. If the purchase price is low enough, I may even be able to completely pay off the hard money loan, thus getting into the property for no out of pocket costs (except for the 1 or 2 months interest I may have to pay on the hard money loan). My investors in my flipping LLC have agreed to be my hard money lender and earn some interest while they wait for their other funds to because available.
Before I embarked down this path, I had a couple of nagging questions. How should I structure the purchase from a paperwork perspective? Should the hard money lender buy the property outright and have a private note between itself and my company for the loan (the easier route) or should an actual mortgage be created and recorded with my company as the property owner and the hard money lender as the mortgage holder? It's helpful to remember that the goal of this process is to refinance later with a conventional lender, so I need to look at the paperwork from that perspective. Is it easier for a bank to approve a new, cash out mortgage on a free and clear property, which would be needed in the first case, or a refinance of an existing loan?
This is the first time I've done a deal involving bank loans from the hard money lender's perspective, so this is fairly new to me. Back in 2002, I purchased my very first rental property using hard money and then refinanced through a bank to pay it off, so I went back and checked the paperwork for that deal. In that case, the hard money lender actually took title to the property and gave me a private contract stating he would sell the property to me for a certain price. So when I "refinanced," what actually occurred was a sale from the hard money lender to me.
I also called and spoke to my friend Les, a real estate investor and former mortgage broker and that call settled the issue. He said it is much easier to do a refi of an existing mortgage than to get a brand new mortgage on a free and clear property - the bank's lending standards are much lower. Additionally, he pointed out that, on jumbo loans (loans for more than $417,000), the most cash back you can get is $200,000. The properties I am looking at are less than that, but it is a good piece of information to know.
Now, it's just time to find a property!