Investing in real estate has changed in many markets in our country. If you are like me, you live in a real estate market that has gone soft. There are still some areas in the country where homes are appreciating nicely, but not like it was just a few years ago. There were a lot of self-proclaimed real estate gurus that popped up during the boom times telling you how to make HUGE PROFITS in real estate. Back then, during the up cycle, investing in real estate was so easy. You could throw money at almost any piece of real estate and be practically guaranteed to make a profit! It seemed like anyone who had flipped a couple of houses and made a profit was an "expert" investor.
Times are different now. Investing in real estate takes a little more effort. Investors that haven’t weathered down cycles before are struggling because all they know are massively appreciating markets. All too many of those self-proclaimed gurus lost their shirts when the markets changed. Those ads that say, "I made $256 Million in real estate in 4 weeks with no money down" are a whole lot less believable. Okay, $256 Million is an exaggeration, but you know what I mean. So, the question is, "How do we still go about investing in real estate and make profits?" Can it be done in these soft and declining markets? The answer to that question is quite simple. I can say without question, without hesitation, the answer is: YES! ABSOLUTELY! I have been investing in real estate for more than 20 years. I have seen up cycles and I have seen down cycles. I have made money and been successful in both. I can tell you several things about down markets that may surprise you. First, experienced real estate investors will tell you that more money is made in down markets than in up markets. It's true, MORE MONEY is made in DOWN markets than in up markets! Second, experienced investors PREFER to do the bulk of their investing in DOWN markets. There are a number of reasons for this but the big ones are that there are more motivated sellers in down markets and the competition (other investors) pursuing these motivated sellers is LOWER. It's a double bonus. Down markets produce more deals and less competition to get those deals. One of the investing techniques I specialize in is Lease Options. Lease options are one of the absolute best techniques for investing in real estate in down markets. I’ll say it again, because if you are looking for ways to get involved with real estate investing you need to know this, Lease Options are one of the absolute best techniques for investing in real estate in down markets. Let's take a look at why. I've already said that down markets produce high numbers of motivated sellers. Right now in Michigan, it's very common to see a house listed on the market in two ways, both for sale and for rent. They are listed this way because the sellers KNOW how bad it is and they want someone, anyone, to cover their mortgage payment. These double listings SCREAM "Motivated Seller!" Now, not every single one of these is going to be an excellent lease option deal. But you know what? That's okay; there are plenty to choose from! The critical part in selecting your lease option candidates, in an up market or a down market, is creating WIN-WIN-WIN situations. The seller must be satisfied with the deal, you must be satisfied, and the end buyer must be satisfied. When investing in real estate, this is what makes us successful. How To Create A Win-Win-Win Scenario To create a WIN for someone we must meet their core need. A motivated seller’s goal is to sell their house. Eventually they need their mortgage paid off and the deed transferred out of their name. If they are willing to rent the house as well as sell it, they are telling you that having their mortgage paid each month is more important right now than actually getting the house sold. If we can find a tenant buyer for them we are satisfying their core need of paying the mortgage each month and eventually selling the home. This is a WIN for the seller. Our end buyer is looking for a home to own. Their current situation prevents them from getting a mortgage immediately but they plan on being able to get a mortgage soon. They want a home now. They don't want to wait to get their house. By allowing them to lease and then purchase the house we are meeting their core need. This gives our buyer a WIN. Before we talk about what makes a WIN for us as an investor let's talk a little more about mortgages for our end buyer. There has been a lot of news lately about sub-prime lending woes and how lenders with riskier loans are facing high rates of foreclosure and may be going bankrupt. As a result it is getting much harder for people with poor credit to obtain a mortgage. It is also getting harder for ANYONE to obtain a mortgage with 100% financing (i.e. no money out of the buyer’s pocket). This may sound crazy, but this is actually a good thing for us when investing in real estate. When investing in real estate by doing lease options it is harder for us to find quality tenant buyers when almost anyone who can fog a mirror can get a mortgage. Not only that, but because it was so easy to get 100% financing most buyers save nothing and are unable or unwilling to pay much for an option fee. With the lending companies tightening their belts I expect we will see a growing population of QUALITY tenant buyers who are able to pay HIGHER option fees. The flip side of this is that because lenders are tightening their belts your tenant buyers will need to work harder to restore their credit. It may take as much as 2 to 3 years for some tenant buyers to be able to qualify for mortgages instead of just 1 year as we had seen before. The bottom line is when investing in real estate by using Lease Options the difficulties of the mortgage lenders are just another reason why this down market is a GREAT time for us investors. Part 2 of this article will cover more details about Soft Markets. Soft markets were defined in Part 1. In Part 2, we will talk about how to make a profit in soft markets.
Now, let’s look at the last part of our WIN-WIN-WIN equation -- the WIN for us, the investor. For us to WIN we need to make a profit. The profit comes both from the equity spread between your option price to the seller and the buyer’s option price to you as well as any monthly cash flow in the rental payments. With lease options it pays to be creative. You’ll find a lot more deals and be a lot more successful investing in real estate if you practice creativity in your structuring. The most common motivated seller we encounter is the one who has little to no equity in his home. Too many sellers get calls from real estate investors that only care about “What’s it worth?” and “What do you owe?” If the numbers are too close together, they say, “Sorry I can’t help you.” Click. What if you pursue it a little further with a creative mind? A good question to always ask is “What are your monthly payments?” If the payments are lower than rental rates you may be able to make some monthly cash flow. Another good question to ask is, “How soon do you need to sell the house?” You may want to ask this question a couple of times while you are talking to them. You could be surprised to find that the number grows longer each time you ask. There aren’t too many markets I can think of that stay down forever. Eventually the house should start appreciating again. If your option period to the seller is long enough you can capture appreciation to make your profit. What about this – “Are you willing to bring money to closing to sell your house?” And if their monthly payment is higher than what you can rent the house for, “Are you willing to pay the difference between the rental amount and your monthly payment?” These two questions may seem brazen, but ask yourself, what have you got to lose? If the seller is fully leveraged on the house or their payment is higher than the rental rate you have nothing to lose, because if they aren’t willing to make concessions then you can’t help them! Certainly some of us feel awkward in asking these questions, but trust me, if you ask this question 30 times, no matter how embarrassed you might feel at the beginning, you will start to feel much more comfortable by the end. These are just a few creative questions you might come up with to try to find terms that will allow you, as the investor, to make a profit, a WIN for you.When you add all of three of these together, meeting the seller’s need, meeting the buyer’s need and you making a profit, you have created a WIN-WIN-WIN. This is what you MUST do to be successful when investing in real estate with lease options. Do you see how much BETTER it can be to find deals in down markets? Motivated Sellers are EVERYWHERE and there are FEWER investors competing with you. Combining these two factors allows you to choose your deals with greater care. Always “Cherry Pick” your deals in a soft market. This is why experienced investors, who have been in both up markets and down markets, prefer the down markets. Soft markets can provide some of the best deals when investing in real estate. There are two issues that involve realtors and investors:
1) Should I become a Realtor? 2) How can I work with Realtors? Working with Realtors: Many investors think that real estate agents don't have the best deals, or they have all been picked over by the time they actually hit the market. I believe that some of the sweetest deals are sitting on the market. We automatically think that Realtors or their clients will snatch up the best deals before they hit the market. It is true that some of the best deals do get snatched up before they hit the market, but ……there are many other deals left behind that no one sees. The reason that no one sees them is because they are looking for 'traditional' or what I call 'retail' homes, not 'lease option' homes. These are two very different markets. The retail market is what 90+% of the people and investors understand. The Lease Option market takes up a portion of the remaining 10% of the market. I look to work with Realtors that understand the concept of lease options and can help their sellers understand lease options. This understanding can take time. Your job is to assist Realtors to understand lease options. I do this by using several techniques. First, I have a letter that I send to a listing agent explaining the concept, second, I have a presentation that I do for my local real estate offices, and third I network and continually tell Realtors what I do. I hear investors tell me all the time that Realtors just don't understand or want to understand what they do. I can only say that patience and persistence pays off. Realtors aren't trained in unique selling techniques, they are trained in the 'Retail Market' which is 90+% of what is out there. As investors, it is our job to continue to help those around us understand what we do so they know when to call us. The type of home I am looking for through a Realtor is one that the seller: 1) Doesn't need their equity out 2) Doesn't have any equity in their home When a Realtor hears a seller say, "If my home doesn't sell soon I might have to RENT it!", then the Realtor should think of you. (assuming you have continued to remind them of what you do) All you need is 2-4 good listing Realtors. They work directly with the sellers and know which sellers are in trouble, which ones can rent, and which homes are vacant. Once a Realtor knows what you do and has a seller that can accept your terms - viola! You are the proud new owner of a lease option. One of the most important things for anyone is that they get paid for what they do. Realtors are just like everyone else in this regard. When I am taking on an option, I am asking the seller to wait 2-3 years to get cashed out. I don't want to make the Realtor wait that long. If I do, they won't even tell the seller about what I can offer. Why should they? It might not do them any good. They are doing all the work now to get the deal done and want to get paid for it. So I give them the listing agent portion of the commission up front. This is my option fee and is applied to the purchase price when I get my mortgage or when I sell the home. The agent is therefore paid on what they do just as if they sold it conventionally to another buyer. When you sell the home you will be asking for 3-5% down from your tenant/buyer, therefore, you are still minimal or zero down/out-of-pocket. If you aren't a licensed agent/broker and entitled to ½ of the commission, then let the Realtor "Double-Dip". They can get the listing agent portion down upfront from you and the selling agent portion when the home closes in 2-3 years. They will wait for the second half if the first half is paid up front. The second half would just be a bonus that most agents wouldn't expect anyway. Becoming a Realtor: Investors tend to be adamant one way or the other about being a licensed Realtor. I am on the side of being licensed. Being licensed has been one of the best tools that I have as an investor. Being licensed allows you access to your database of 'comps' or comparables. This is the data you need to buy and sell real estate. If you have a great Realtor and you don't want to be licensed, fine, but I still think it is better to be licensed than not. Some investors say it gives you more liability to be licensed. I have two answers to that: 1) What are you doing to create liability? 2) Don't you think a judge is going to know you are an 'expert' anyway when they find that you do real estate investments? Some investors say that sellers won't sell to you if you are licensed. I find the opposite is true. Most sellers are happy that I am licensed and 'know what I am doing'. My recommendation is to GET LICENSED!!! When I started out in real estate I had no experience, no money, and no credit. I was not yet an attorney - in fact law school had not even occurred to me. I was working in corporate America and I had a dream of real estate millions - but my fear was holding me back.
Real Estate Partnerships Work I had friends who felt the same way - so we decided to partner up. Since then, my friends and I have made millions of dollars together. We helped each other get over fear, we raised money from friends and family, split up the work and shared our expertise to deal real estate deals together. I doubt I would have ever gotten started without my various partners. I bet a partnership would help you also. Help you do bigger deals, get over your fears, bring resources you do not have, and split up the work. Partnerships can be great, but they do not last forever (eventually someone decides they no longer want to work together or a partner dies). When partnerships end, they can end badly in disputes and even litigation! That is why smart investors use written partnership agreements to bring the issues out in the open and reach an agreement on key points before the partners have money, work and emotion tied up in a deal. One of the main hold backs for investors is understanding what they need to discuss with their prospective partner and having a form to work with. There are issues you must discuss with your prospective partner before doing business as a partnership. Here are ten items you must discuss before entering into an agreement with a prospective partner: Top Ten Discussion Items For Real Estate Partners 1. How much money will each partner put up. 2. Who will be responsible and pay into the business if extra money is needed due to cost-overruns, slow selling, or for any other reason? 3. Whether either party can sell to a new partner without the existing partners' permission. If the non-selling partner does not want to give permission how can the partner who wants to sell get out? 4. The exact nature of the business proposed to be done by the partnership. For example: Will you be renting properties, flipping them, doing both? 5. What authority each of you will have to sign contracts, hire people, take loans and otherwise bind the partnership to obligations to outside parties. Do you have to agree on every item? Is there a certain amount you can spend before needing permission? 6. How long you plan to work in partnership before splitting up the properties and/or profits? 7. Can each of you do deals outside the partnership or will you do all deals together? 8. Will the partnership be one deal or multiple deals? 9. What if the partners cannot agree? How is a deadlock resolved? 10. What happens if a partner dies? Does his share go to his heirs or will the business pay his estate cash to buy out the shares? (Note: This is usually done with life or key man insurance) Putting a Real estate Investment Partnership Together Usually you will need a written partnership agreement and you will also need an operating entity such as an LLC to limit your personal liability. Real Estate Investment Partners can create an LLC online quickly, but it's advised to use the help of an attorney in putting together a detailed operating agreement the first few times. It's a small price for real estate investors to pay for a piece of mind and protection of each member's interest. Lastly, in my experience, it is important to distinguish real estate investment partnerships from pooled money from several investors when going into a real estate deal. Go forth and Prosper. Bob Diamond Here's my 7 Step Process to Setting Up a Legal Structure for Your Real Estate Investing Business...(It’s secretly simple!)
When I first began learning about real estate investing, I thought for certain I was “putting the cart before the horse” by setting up a corporate structure for my company when I had no revenue or company assets to protect at the time. I quickly learned (from Jeff Watson; an expert short-sale lawyer and resource of mine), that you really can’t do this step too early in your real estate business or in any business venture of your own for that matter. If you are working hard to get it – work hard to protect it! The main reason for initially setting up a business structure is to set clear parameters that you and your business are operating as two separate entities in the eyes of the IRS. There are many entity structures to choose from (since I am not an attorney nor an accountant, I can’t professionally advise); but I can tell you that I personally set up an LLC. The 2 Greatest Pieces Of Information I Discovered When I Wanted To Set Up My LLC Was That: 1) You do not need an attorney to do this 2) It does not cost a ton of money or time These steps today are customized for people wanting to incorporate in the State of Michigan; however, other states have similar processes and you can use these steps as a guideline. I recommend you start with your state’s Secretary of State website since you can usually find quick links to “starting a business”. Even quicker, simply Google “incorporating in (name of your state)” to start. Here Are The 7 Simple Steps To Get A Legal Structure Set Up For Your Real Estate Investing Business In The State Of Michigan: 1.) Verify Business Name is Available: Go to the State of Michigan’s Department of Energy, Labor & Economic Growth (DELEG) website and search the Corporation Division Name Division to be sure your desired business name is not currently being used: http://www2.dleg.state.mi.us/CORPORATIONS/htmldb/f?p=210:1:3618253801012695048 2.) Download Forms: Go to this link on the State of MI DELEG website and download the following forms: http://www.dleg.state.mi.us/dms/results.asp?docowner=BCSC&doccat=LLC 3.) Pay Registration Fee: Use form 901 - a one page fax-sheet used to get your credit card on file with the state so you can pay for the $50 LLC registration fee via credit card (I opted to do this because I didn’t want to mail payment via a check, which obviously takes longer). This fee can vary widely by state of course. 4.) Verification: You will know that your credit card is correctly on file with the State because they will fax you back a form with your “new assigned Mich-ELF Filer Number”. 5.) Complete Articles of Organization: Complete form 700 – the Articles of Organization. This is where you write in the desired name of your LLC, the address, and name yourself as the registered agent. 6.) Fax Articles of Organization: Fax the completed form 700 to the State of MI (the # to fax to is on the document); and use form 900 as a cover sheet. You must use form 900 as a cover sheet because that is where you will include that new Mich-ELF Filer Number the State assigned you and this will bill the credit card associated with that ELF number for the processing of your LLC. 7.) Confirm Status: In my experience, within 24 hours, you can confirm the status of your LLC by going to: http://www.dleg.state.mi.us/bcs_corp/sr_corp.asp. Type in your entity name to see the filing status, or you can always call the State office to be sure your request has been processed. Once completed, CONGRATS! You have taken the first steps to setting up a legal structure for your business! The pros and cons of forming limited liability entities such as Limited Partnerships, Family Limited Partnerships and Limited Liability Companies is a much discussed topic these days. It is this latter device, the much misunderstood "LLC," which is the newest, though less notorious, least used, and arguably the most straightforward and valuable of them all.
Limited Liability Company (LLC): A membership business entity that provides the protection of a corporation, but which is more like a partnership arrangement in many ways. LLC "members (versus 'share-holders' or 'partners')" participate in the day-to-day management of the company without incurring personal liability. All taxing agencies (state and federal) tend to "look through" the LLC to its member/s as the responsible parties in terms of accounting for, and payment of, income tax. Profits and losses relative to passive activities within the company flow to the members who remain free of individual self-employment tax. Since there is no plethora of case law concerning the LLC at this time, it is, of course, advisable to seek out good professional legal and accounting advice before considering its use. Although it is only within the past few years that the Limited Liability Company has been accepted and recognized throughout the U.S., all fifty states have now adopted and recognize the LLC as an acceptable, viable and valuable business entity (since 1997). It should be noted, however, that some states (e.g., New York which imposes a $2,000 surcharge for the establishment of an LLC), by imposing large - if not onerous - tax penalties on LLC’s, can make its use somewhat impractical relative to the cost savings of, say, a Subchapter S Corporation (also an income tax ‘pass-through’ entity, see IRC §1361). While on the surface the S-Corporation and the LLC may seem similar, there are some significant distinctions: 1) The S-Corporation is limited to 75 shareholders, whereas the LLC has no limit to the number of members it can have; 2) All the shareholders of an S-Corporation must be persons, who are U.S. citizens or permanent resident aliens, whereas LLC members can be business entities (corporations, partnerships, trusts, etc.) or individuals…even non-resident aliens; 3) S-Corporations are permitted to issue only one class of stock, while an LLC can issue several different classes of stock in the form of membership certificates (capital, common, preferred, etc.) and priorities of ownership, and 4) Even though treated preferentially by the IRS, the S Corporation is treated for income tax purposes on a state level the same as would be any other Corporation. Perhaps the simplest way to look at the Limited Liability Company structure might be to view it as basically a fusion or hybrid of the corporate structure and the partnership arrangement: but with all of the essential features, benefits and advantages of both…though minus the disadvantages of each. For example: in terms of taxation, the corporate structure allows for double taxation of its owners (i.e., income tax is imposed on the Corporation as well as personally on any owner salaries or withdrawals): and in terms of asset protection, the General Partnership structure allows for a creditors charging orders against individual partners. The LLC, on the other hand, effectively avoids both of these negatives. As well, like the corporation, the LLC also provides "lawsuit protection" for its members (analogous to stockholders in a corporation) who are not personally responsible for the liabilities or the indebtedness of the company. An LLC that holds real estate, for example, effectively protects its member-owners from personal lawsuits and creditor claims or judgments against the LLC. In addition, unless they were to have personally guaranteed the indebtedness, a foreclosure upon a Limited Liability Company does not create personal liability for its members. Even today, in some quarters one might still find some negativity or misunderstanding by legal and accounting professionals regarding the viability and dependability of the LLC due to its newness. With its earliest advent in the U.S., many, if not most, financial planners remained long unconvinced (and some still do) as to how an LLC might fare under scrutiny by the IRS, or how it might hold up in court. Prior to 1997 the common use of the LLC as an asset shielding vehicle or business entity was uncommon, to say the least. Recent IRS rulings are now clear in their treatment of the LLC as a "partnership" for income tax purposes…so long as there are at least two members. A single-member LLC will however, be "disregarded (looked-through)" for income tax purposes: with the full tax liability falling to the member as if no business entity existed. This characterization of the single member LLC does not, however, mean that it would not be held completely valid relative to asset protection under state legislation (i.e., treated essentially as a sole proprietorship). The overall effect of the single member LLC is that asset protection (against liability claims) need not incur additional federal income tax reporting requirements, system documentation and record keeping or major set up expense. As is commonly known, a regular corporation (e.g., a "C" corporation) is taxed first at the corporate level, then the stockholders (owners) are taxed again on the owner withdrawals. The LLC, on the other hand, by providing "pass-through" tax treatment, as would, say, a general partnership, averts such "double taxation." In other words, the LLC as an operating entity is not taxed on its own profits; but instead on the income taken from it by its members (i.e., income accounting responsibility and income taxation is "passed-through" to the individual member/s). Regarding creditor claims, do note that even though a judgment creditor’s claim may be imposed upon an LLC, such claim may not be imposed individual upon its member/s (i.e., even with regard to single member LLC…see U.S. Uniform Partnership Act §28 relative to restrictions concerning charging orders per se). What this then means is that the personal assets of an LLC’s member/s would not be reachable by a judgment creditor without a valid claim against, and the dissolution of, the entity: which dissolution would, of course, not be allowed unless somehow all the members were to have conspired and acted in concert to create the cause for the claim. Before the advent of the Limited Liability Company, the "Family" Limited Partnership was considered a superlative instrument for estate planning and protection. However, the chief reason for forming an "FLP" versus a General Partnership was to avoid creditor claims against assets held in the partnership, by avoiding charging orders against the limited partners. That is to say that under a Family Limited Partnership, a judgment creditor could not attach a limited partner's interest, and the general partner’s exposure would thereby be limited only to its percentage of the total value of the assets so held. The problem with the FLP for holding real estate, however, was (is) that the general partner still has personal liability to the extent of his percentage of ownership. An answer, of course would be to name a corporation as the "general partner." Interestingly enough, though, the LLC actually affords its members the same creditor protection as would such a limited partnership, but wholly without personal liability of any of its members: and without the added legal work, time and expense of creating, administering and maintaining the corporation and all of its reporting requirements. Note that even though the IRS does not consider the single member LLC to exist…the structure none-the-less continues to afford maximum protection against creditor claims and lawsuits: even though the owner member continues to report its income and expenses as an individual (e.g., a Form 1040, with a Schedule C for the business and Schedule "E" for rental income). While on the surface the LLC seems to be a fairly uncomplicated and innocuous device for doing business and for holding assets, it still has many other relatively unexplored facets. One of which is that of holding real estate assets and protecting them from judgment creditors, bankruptcy actions and actions in marital dispute. For example, all of one’s real estate holdings can be placed into an individual LLC; or each separate property or parcel can be held by a separate LLC, with a different investor or beneficiary "partner" in each one. In using the LLC for holding real estate in this manner, separate tax returns for each entity need not be filed…and of even greater interest, a tenant’s injury on the premises will not create a personal liability for the member/members. Only the LLC can be sued. Therefore, by holding properties in this manner, other properties remain apart from involvement in the claims of creditors arising out of a lawsuit against a particular LLC. The LLC also provides a truly serviceable vehicle for shielding or passing wealth to family members without having to re-title the real estate. Once real estate is transferred into an LLC, the members' interest is converted to, and its ownership characterized thereafter as, Personalty (i.e., personal property) Vs. Realty (real estate), which "shares of ownership" can then be transferred, all or in part, as tax-free gifts (in blocks up to $10,000 per-year to each recipient). Again, note that the procedure for transferring LLC shares is far less complicated (quite simple in-fact) as compared, say, to altering, preparing and filing new transfer documentation (e.g., Grant Deed, Warranty Deed, Bargain and Sale Deed, etc.) and the requisite Preliminary Change of Ownership documentation. Moreover, when the gift is to a child, the LLC allows the parent to easily retain full control of the asset throughout its lifetime by continuing to act as "Managing Member" for the LLC. In short…the benefits afforded by the Limited Liability Company are long overdue, but apparently here to stay, with confidence within the financial community growing stronger everyday. And a major welcome benefit of the LLC is that one can be set up for as little as $199.00 (go to www.mycorporation.com). |
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