How to Deploy it
Where to get funds for a down payment on a rental property
Where do you get money for down payments?
I am a big fan of using cash to buy real estate. It gives you more advantages than any other means of acquiring property. I know all of the theorist who insist that you never touch principle. If you put things into context, what they are referring to is using principle for non-investment purposes. Deploying investment capital to build wealth and income is a good thing, not a bad thing. Deploying investment capital to purchase items for personal use is foolish. For the purpose of our discussion I want to review the different ways to keep and use money that is kept in the various forms of investments.
Savings – This is probably the least effective way to preserve capital. It is however one of the safest. Funds in a savings account are relatively liquid which means you can access them without penalty. Most banks will allow you to withdraw funds 1 to 3 times per month. Savings accounts are a great way to keep an emergency fund on hand. If you have funds in excess of emergency fund requirements then you can safely use this excess to buy investment real estate.
CD’s – CD’s may pay a little more interest than savings accounts, but not much. They usually have early withdrawal penalties, sometimes you simply forfeit any interest you may have earned. CD’s may have a place in some people’s lives but not in mine. Back in the day when I was a young banker we had CD’s that paid 15% and the terms were as long as 10 years. You can bet your bottom dollar that I would gladly own some of these CD’s now. Unfortunately, owning a CD now will likely cost you money instead of making it. If you have money held in CD’s you may want to consider using it to purchase income producing real estate.
Mutual Funds – There are literally thousands of mutual funds, hundreds of mutual fund companies, and dozens of categories of fund types. I like no-load growth stock mutual funds to hold money long term, over and above my real estate holdings. I like Money Market funds for short term holdings and especially for storing money I will use to buy more real estate. Bond funds are made up of Short term, Medium term, and Long term bond holdings. You have to know what you’re doing relative to the interest rate environment to invest wisely in bonds funds. Short term bond funds are the least risky, but they still do have risks. I generally would not use even short term bond funds to hold money that I will eventually use for purchasing real estate.
Stocks – Investing directly in stocks can truly be risky business. Even seasoned professionals get smoked gambling in the stock market. This is not the place to keep money that you intend to use later to buy real estate. If you are enamored by the idea of striking it rich in the stock market then God bless you, get a lot of education, and tread gingerly into those shark infested waters. If you really want to be in stocks why not consider a mutual fund that invests in stocks. Always look at the management of the fund and the manager’s track record not just the track record of the fund itself. Also, look at their performance in up and down markets. Good luck!
Bonds – The basic rule with bonds is that you buy when rates are high and sell when rates are low. This is because people will pay a premium for high yielding bonds when rates are low. Plus while you own the bond you can make a decent return. If you buy high grade bonds then your risk is reduced along with your rate of return. The bottom line here is how do you know when you are in a high rate environment and a low rate environment? Exactly, even the pros have a hard time with market timing. I do not suggest using bond funds for holding money you intend to use for purchasing real estate.
Whole Life Insurance Policy – Check with your Life Insurance Company. You normally can borrow against the cash value of your Whole Life Insurance Policy. Fees are usually minimal and terms are easy. And you pay yourself back!
Home Equity in your person home or another property you own, possible an investment property – Look for banks that are advertising home equity loans to get the best rates and terms. If a bank is advertising checking accounts then look elsewhere. Banks will tell you in their advertising whether or not they need to make loans or take deposits. They need to be both to be a bank but at any given time they will need one more than the other and their ads will reveal this.
Self Directed IRA – You can build up a portfolio of Real Estate from within your Self Directed IRA. This subject requires an entire class to teach. It is complex and considered advanced. There are fees and restrictions involved that you need to be aware of. If you are interested in this please contact me and I will make sure you get the right education and information from the right people.
401-K – if you have a 401K, you should check with your employer because you may be able to borrow against your 401k an amount up to 50% of its contents. It gets even better when you aren’t borrowing from anyone else. You are borrowing from YOU Inc.! And guess what? The interest you pay on what you borrow is paid to YOU too! And guess what else? It isn’t taxed either. You know, maybe our government isn’t so bad after all. The reality though is that our government does suck, maybe not as bad as other governments but it still sucks. In fact I bet there is one good guy in our government who was an entrepreneur at one time and saw this amazing opportunity to do something really good for a lot of people. The cost of borrowing from a 401K is usually a small administration fee. No application fees, no appraisal fees, and no junk fees of any kind.
If you are just starting out and don’t have a lot of cash lying around like us seasoned veterans, take heart. You would be amazed how easy it is to form a partnership with an individual who does have money lying around. Sometimes a veteran real estate investor will partner with one or more newbies to teach them the ropes, and more importantly have one or more “bird dogs” out there to do the hunting. When they find a suitable prey the investor puts up the money then he and his protégé split the profits. I have seen this work with doctors also. In fact, it could work with anyone who has more time and less money.
Another way to begin acquiring real estate when you are starting out and don’t have a lot of cash is to borrow from a private investor. They usually charge more in interest and fees than a bank but they are also more open-minded and creative. They usually understand the real estate investing game and aren’t interested in forming partnerships or teaching newbies. They will often finance up to 100%. They may also loan you money that you secure with other property you have. They are really not that hard to find either. Some mortgage bankers and brokers keep private investors in their back pockets to keep a deal moving forward rather than watch it die an agonizing death where nobody gets paid. Private investors can be tough, I have used them, but I don’t recommend it although I know some of you will just have to try because you want that sweet deal. I get it, I really do. I ended up being Okay. But it did cost me a lot of money in interest payments.
Still another way to acquire properties when you don’t have cash is to use hard money lenders. They call them hard money lenders for a reason. It is a hard way to do business. They charge exorbitant interest rates and exorbitant fees to get the money. They usually have a very quick term, sometimes referred to as a balloon payment. In other words, you have three to six months to use their money paying interest only, then at the end of the three – or six-month term you have to pay back all of the principle you borrowed. If you can’t pay it back they will take your property, and they will, trust me. Sometimes people use this method to buy a rental property that needs work. They will borrow enough money from the hard money lender to buy the property and rehab it so they can rent it out, then go to a commercial bank to get a traditional mortgage on the property and pay back the hard money lender, and have excess cash from the traditional loan to line their pockets.
For years when money was easy I would pay cash for a property and for the remodeling then borrow from a bank in the form of a traditional first mortgage with easy terms and a low interest rate. This way I would continue to build my rental property empire while at the same time increase the amount of capital I had to work with. Keep in mind that it all has to be paid back and if you are a borrower you have to keep your ratios in check or you will get off and stop growing or borrow from private investors, or worse yet, hard money lenders.
Remember, all you borrower’s out there, to keep your ratios in check. Never owe cumulatively more than 2/3 of what you own and never have debt payments more than 1/3 of your gross rents. If you manage to keep to these ratios the banks will always love you and unless you are a complete moron you should always be making money.
If you borrow, borrow from yourself. Eliminate another party to the transaction and you retain a stronger ownership position and contain the risk to yourself.
In the end Cash is King. If you use any other method to acquire real estate then you are putting yourself at risk, sometimes grave risk. Life happens and when it does remember the old saying: “The man with the Gold makes the rules”. If you don’t owe the banks and other people you get to make the rules. If you owe the banks and other people they make the rules and they aren’t as nice to you as you are. Don’t be a sucker and fall for all that debt crap. Be a man and pay cash.
For more information please visit www.MyInvestmentServices.com, call 800-931-2605 or email Gary@WinRealtyAdvisors.com
Written by Gary Wilson, May 9, 2014
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