Nothing Down Real Estate Techniques



The Robert G. Allen’s Nothing Down System

By Robert G. Allen and Richard Allen

“Don’t wait to buy real estate. Buy real estate and wait."

The world of real estate has been governed for years by one dominant train of thought,

i.e., in order to buy and hold property successfully, the average person must have

excellent credit, a strong financial statement, good income, lots of money for a substantial

down payment, and strong collaborative support from the hard-money lenders.

Those who agreed that income property was the finest investment found they could not

hope to participate in owning a larger piece of America under the dominant rules that had

obtained hitherto. New patterns were needed if the cash-poor but creative individual was

to break into the world of property ownership.

This report outlines my 50 favorites nothing down techniques, organized into 10 separate

areas:

1. The Seller

2. The Buyer

3. The Realtor

4. The Renters

5. The Property

6. Hard-Money Lenders

7. Underlying Mortgages

8. Investors

9. Partners

10. Options

1. THE SELLER

Among the nine major sources of down payment funds for property acquisition,

the seller is no doubt the most important. If the buyer has done his selection job well he

will be dealing with a person who is anxious to sell and therefore flexible with financing

arrangements. The seller will need to take on a role that might be new for him – that of

lender. But if the buyer is sensitive to the needs of the seller, he will foster trust and see

to it that both parties win. (Lending can, after all be a lucrative business with its own

slate of benefits even for property sellers.)

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This section reviews eight nothing down techniques involving seller financing.

Technique No. 1 The Ultimate Paper Cut

An investor in Milwaukee was able to acquire a $48,000 triplex from a banker who not

only arranged for a new low-interest first mortgage, but also carried back virtually all the

remaining equity in the form of second at below-market rates. Another investor in West

Palm Beach, Florida, picked up a single family home for $66,500 by putting on a new

first and having the anxious seller carry back all the rest of his equity ($36,500) for five

years, no payments, no interest. Both of these investors were using the technique known

as – “The Ultimate Paper Out". Here is how it works.

When we are talking about buying or selling a piece real estate, we are really talking

about the problem of defining and dealing with the seller’s equity. Equity as a concept is

straightforward enough. Everyone knows that it represents that portion of the value of a

property that is not encumbered, that belongs lock, stock, and barrel to the owner. But

equity is a fluid concept. It can be specified only in relation to that mysterious shifting

quantity called the “fair market value".

The owner has dreams about equity of such and such – usually an optimistically high

number. But the truth of the matter is that market forces determine his equity by

determining how much his property is really worth at any moment in time. The members

of the market club - you and I – gang up on the poor old seller and say collectively, “You

have a nice little place, but we’ve taken a vote around town, and the best we could come

up with is a price of such and such." At that moment in time, the seller’s equity is

defined, and the problem becomes how to transfer to him value equal to the equity

involved.

The majority of sellers, of course, will want to hold out for a selling price at the high end

of the scale. They want their equity to be overweight. No one can blame them for that

but among the army of sellers in the marketplace at any given time, there are always a

few – perhaps five percent or less – who say to themselves, “We like our equity and want

to preserve it and derive benefit from it, but we are very anxious to sell. So anxious in

fact, that we might give up some of the equity in order to get rid of the property quickly."

Alternately, these don’t-want sellers might be thinking – I don’t really feel like

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discounting my equity for a quick sale, but I would be willing to wait until later for a part

or all of my equity to be converted to cash."

And that is the issue when it comes to “papering out" a deal. After the seller and the

buyer have determined what equity is involved, the next step is to decide how soon the

equity is to be converted. It all boils down to a matter of patience. The seller with

infinite patience (and infinite desperation) will say, “Here’s my equity, take it all and just

get me out of this place." In a case like that the selling price is equal to the liens. But

such cases are rare.

The next best situation is the case in which the seller says, “Here’s my equity, pay me for

it when you can. Let’s work out the schedule." That is the technique referred to as - The

Ultimate Paper Out." All of the seller’s equity is converted to paper before it is

converted to cash. When the buyer takes over the property, he gives the seller paper for

his equity and obligates himself to redeem the paper according to mutually agreeable

terms.

Not all sellers will agree to an “Ultimate Paper Out" but creative buyers should always

ask. You never know exactly what the seller is thinking or how anxious he really is to

sell. Perhaps only one seller in twenty will be wiling to enter into a nothing down deal

and of these, perhaps only one in ten will agree to an “Ultimate Paper Out" that means

that Technique No. 1 will show up in only one out of every 200 creative deals. But it

does happen from time to time – much to the surprise and delight of the creative buyer.

Technique No. 2 The Blanket Mortgage

The key to using the seller as lender in a real estate transaction is trust. The seller has to

trust us to pay him his equity according to the terms of the agreement we work out with

him. The conventional way to “buy" trust is to give the seller a large cash down payment

that way he knows that we will not likely walk away from the property. We are going to

stay around and take care of our obligations. Otherwise the seller will be able to take

back the property, and we will lose not only that big cash down payment but also any

appreciated value above the seller’s equity.

But how do we develop trust when there is little or no cash put down on the property?

How does the buyer make the seller feel secure in such cases? Often the buyer can

develop personal trust with the seller simply on the basis of personal qualities and

win/win attitudes.

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In such cases, the equity of the subject property itself is sufficient to close the deal.

In some instances, however, a little extra is needed to remove lingering suspicions on the

part of the seller. That is where the blanket mortgage comes into play. In any mortgage

or trust deed arrangement, there are two basic documents that are prepared. One is a note

given by the buyer to the seller setting forth the terms for converting the equity to cash,

the other is a security agreement in which the buyer says to the seller, in effect, “If I don’t

perform according to the terms of the note, then you can take back the property." In a

cashless or near cashless transaction, the security of the subject property may not be

enough to satisfy the seller. Therefore, the buyer may choose to secure the note with

additional collateral – not only the subject property but also additional property (equity)

he may have in his portfolio.

The note itself stays the same, but the security agreement is changed to increase the

collateral and build trust with the seller. Naturally, the buyer will want to arrange to have

the seller release the additional collateral as soon as the subject property appreciates to a

predetermined value or as soon as the buyer has proven himself to be dependable and

prompt in making his payments. The blanket mortgage technique is not among the most

frequently used in creative finance. The buyer hopes to build trust without having to tie

up his other equities. Still when a seller needs that extra bit of persuasion, the blanket

mortgage technique can come in handy.

For example, one creative investor we know of recently acquired a nice four-bedroom,

three-bath home for $75,000. The investor put a new first on the property) which was

nearly free and clear) and had the sellers move their remaining equity ($35,000) to

another property owned by the investor. To build trust with the sellers, the buyer granted

them a blanket mortgage that also included his equity in another rental property he

owned. Although the buyer did not put any of his own money into the deal (the bank

provided all that was needed), he was able to persuade the sellers to agree on the basis of

his neck being on the line with the blanket mortgage.

Technique No. 3 Life Insurance Policy

There is another strategy the buyer can use to persuade the seller to play lender in a

transaction. As in the case of the blanket mortgage, the key is building trust. What if you

say to the still somewhat incredulous seller, “Since you are permitting me to pay off your

equity

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in cash over a period of time, how would it be if I took out an insurance policy in the

amount of the note and made you the beneficiary? That way you will feel secure that the

note will be paid off no matter what."

This technique is not usually necessary. Still it is an inexpensive way to build trust if the

seller cannot quite see it your way and needs just a bit more persuasion.

Technique No. 4 Contract or Wraparound Mortgage

An Albuquerque investor recently bought a triplex for $69,300 by putting down $1,000

and having the seller accept a contract for the remaining $68,300, 10.75% interest for 35

years, and payout after 12 years. The contract wrapped around a small underlying first

mortgage. Similarly an investor in Springfield, Massachusetts acquired an $80,000 free

and clear single-family house by putting a small sum down and having the seller carry

back the rest in the form of a contract. These are variations of the technique referred

under various names such as “contract, wrap-around, or owner carry back".

This technique is one of the most frequently used creative finance tools. It is the

foundation of seller financing rather than refinancing the property or formally assuming

the existing mortgage. The buyer uses a contract as the purchase instrument. Technically

he does not get title to the property until he has performed according to the provisions of

the agreement. In effect, he says to the seller, “I’ll pay your equity off in installments

over time. And as soon as I have paid everything off, you will give me the deed for the

property, and it will be mine. In the meantime, I will act as the owner by taking over the

management and getting all the tax benefits and the appreciated equity above what the

property is worth at the time of purchase. Of course, all the expenses in the meantime are

mine as well."

If the property is free and clear at the time of purchase, the seller pockets all the

installment payments on the contract if there are existing encumbrances on the property.

Then the contract is referred to as a wrap-around contract or wrap-around mortgage. It

“wraps around" the existing first and subsequent mortgages or trust deed. When the

seller receives the installment payments, he has to first make payments on the existing

notes before he can pocket the rest. The advantage to him is that the interest rate on the

total wraparound contract will be higher than on the underlying loans. Therefore, he will

be making an interest spread on the underlying part of the note – not a bad deal for a

seller-turned-lender. In addition, he

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will be able to spread his capital gains profit out over time rather than receiving all of it

during one year. The tax advantages are considerable. With the recent liberalization of

installment sale provisions by the IRS, sellers have great leeway in how contracts are set

up for maximum tax benefits. A competent tax accountant can spell out the detail.

The advantage to the buyer is that he does not need to come up with a large cash down

payment. Frequently a moderate amount down will close the deal. In addition, the

interest rates acceptable to sellers are usually far below conventional market rates for new

financing.

In practice, a contract sale is bandied by an escrow company, which holds the preexecuted

deed from the seller in favor of the buyer until the latter satisfies the terms of

the contract. Generally the escrow or title company will also hold a quitclaim deed made

out by the buyer in favor of the seller, which is to be released to the seller in case of

default. It is in the best interests of the buyer if the escrow company is making the

payments on the underlying loans before disbursing the balance to the seller. That way

the buyer can be assured that his money winds up in the right places.

An alternative form of the “contract wrap" technique is the situation where a buyer takes

title subject to the existing financing (agrees to take over the seller’s obligations) or goes

through the formal procedure of assuming the existing financing (qualification, credit

checks, transfer of title). The buyer then signs a contract with the seller for the equity

above the existing loans and makes payments according to a mutually agreeable

schedule. A note secured by the property itself covers the seller’s equity. The usual term

for this arrangement is “owner carry back". The term refers to the fact that the seller

carries back paper to cover the unpaid equity on his property. Terms on the paper are

negotiable and vary from case to case.

Technique No. 5 Raise the Price, Lower the Terms

Seller financing has already become a convention for real estate transactions in the

decade of the 1980’s. Currently nearly two-thirds of all home sales involved contract

sales or assumptions with owner carry-back second mortgages. Tight money conditions

always foster seller financing of this type. Yet even though the concept of “seller as

lender" is no longer foreign to the American way of real property transfer, there are

variations to the game that give creative buyers the advantage over the competition.

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One such variation is the important technique called “Raise the Price, Lower the Terms."

Simply put, this technique calls for the buyer to offer the seller more than he is asking for

the property in exchange for flexibility with the terms. For example, one investor we

know of recently took an interest in Jacksonville, Florida estate house with adjoining

triplex. He offered to raise the sales price by $5,000 if the seller would lower the down

payment requirement and accept payments over 15 years. By using this technique, he out

acted the competition and